AM Best has published a new commentary focusing on its approach to evaluating country risk amidst growing concerns about China's economic deceleration and the sovereign risk posed by its government.
Titled “Frequently Asked Questions: AM Best’s Country Risk Evaluation of China,” the commentary aims to address questions about how AM Best handles sovereign credit risk and its integration into the ratings process. It also seeks to delineate the distinction between sovereign credit risk and country risk.
Under AM Best’s country risk assessment framework, China is currently positioned as a CRT-3 country. This classification, the mid-point of a five-tier system, indicates a low level of economic risk and moderate political and financial system risks for China.
“Barring any significant developments, AM Best does not foresee any changes to China’s tier status in the medium term,” AM Best senior economist Graziano Brady said.
The commentary clarifies that while AM Best does not assign sovereign credit ratings, it does not limit an insurer's credit rating based on the sovereign credit rating of the insurer’s domicile or major exposure countries. According to AM Best, it is possible for an insurer to exhibit greater financial stability than its home country's government, and to manage country risk effectively. This can be achieved through various strategies such as maintaining additional capital buffers, adhering to stringent underwriting disciplines, or diversifying their portfolio.
Differing from sovereign credit risk, which evaluates a country's overall ability and intent to meet its financial commitments, AM Best’s country risk assessment in its rating process includes specific country factors that could negatively impact an insurer's capacity to fulfil its financial obligations.
This encompasses assessments of the wider operational environment, as well as economic, political, and financial system risks. An insurer’s proficiency in addressing, managing, and mitigating country risk exposures is assessed individually and factored into the analysis of their balance sheet strength, operational performance, and business profile.
Despite China’s stable position in the CRT-3 category, the country faces several economic challenges. Notable among these are the extensive off-balance sheet debts of local government financing vehicles and the sluggish property sector, which is impeding overall economic growth. Nonetheless, AM Best anticipates that China will utilise its fiscal and monetary policies effectively to achieve its growth objectives in the short to medium term, while undergoing structural transformations.
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