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Fitch Ratings : Generali’s debt on rating watch negative

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Fitch Ratings has placed Assicurazioni Generali SpA’s (Generali) senior and subordinated notes on Rating Watch Negative (RWN). At the same time, the agency has affirmed Generali and its core subsidiaries’ Insurer Financial Strength (IFS) ratings at ‘A-‘ and Long-term Issuer Default Ratings (IDR) at ‘BBB+’. The Outlooks are Negative. A full list of rating actions is at the end of this release.

The rating actions are in response to three distinct and separate events – Fitch’s downgrade of Italy’s sovereign ratings on 13 March, Generali’s publication of 2012 financial statements, and Generali’s recent announcement of plans to modify its holding company structure. The affirmations reflect that the further decline in Italy’s creditworthiness is not sufficient to warrant further negative ratings actions on Generali, especially in light of certain improvements in Generali’s balance sheet as reported in FY12. The RWN on the debt ratings is related to neither the sovereign action nor any issues in the 2012 financials, but is exclusively linked to the proposed holding company restructuring.

KEY RATING DRIVERS The affirmation of the IFS ratings and IDR follows Fitch’s downgrade of Italy to IDR ‘BBB+’ from ‘A-‘ (see “Fitch Downgrades Italy to ‘BBB+’; Outlook Negative”) and the publication of Generali’s consolidated 2012 financials.

The affirmation reflects Generali’s stronger balance sheet in 2012 compared with 2011, with group shareholders’ funds at EUR22.6bn (2011: EUR18.1bn) and Solvency I ratio at 150% (2011: 117%). Combined with de-risking actions undertaken by Generali (in particular the sharp reduction of cross-border exposure to peripheral government debt – including Italian debt), Fitch believes this allows Generali to better withstand potential credit and other losses.

Generali’s IDR is now at the same level as the Republic of Italy’s IDR at ‘BBB+’. However, Generali’s IFS rating at ‘A-‘ is higher, under the assumption that recovery prospects of policyholders given default remain “good” as defined under Fitch’s insurance rating criteria. Generali’s operations are well diversified geographically. Around two-thirds of business is produced in countries with a higher rating than Italy (notably, Germany; ‘AAA/Stable’ and France; ‘AAA’/Negative). Nevertheless, Generali’s ratings remain constrained by the sovereign rating of Italy given the group’s significant holdings of Italian sovereign debt.

The RWN placed on Generali’s senior and subordinated debt reflects Fitch’s expectation that Generali’s proposed group restructuring will moderately weaken the credit quality of Generali’s debt. Generali plans to reorganise its Italian operation through the creation of a downstream operating company, Assicurazioni Generali Italia. Generali is expected to complete a portfolio transfer of the bulk of its existing insurance operations to the new entity. Fitch believes that after the transfer, Generali will take on more of the characteristics of a holding company, even though it will continue to conduct some insurance business (initially, mainly intra-group reinsurance).

Typically, unsecured senior debt issued by an insurance operating company, in which liquid assets are maintained at many multiples of outstanding debt balances, is rated at one notch lower than the IFS rating of the issuer. This has been the notching approach historically employed for Generali, as it was considered by Fitch to be an operating company. In contrast, unsecured senior debt issued by a pure holding company is typically notched down by three notches from the IFS rating, reflecting both higher default risk and lower recovery prospects in a default.

Following the proposed restructuring, Fitch would view Generali as incrementally having fewer characteristics of an operating company and more of a holding company, than in the past. Accordingly, if the reorganisation is completed in line with Fitch’s understanding, the agency’s notching approach will be updated. Fitch would expect to downgrade the debt ratings by one notch, which would establish the unsecured senior debt at two levels below the IFS. This falls between standard notching for a pure operating company and a pure holding company.

Assicurazioni Generali SpA’s IFS rating is not affected by the Italian reorganisation as the company will underwrite the group’s internal reinsurance business and may expand to write direct corporate business in the future. As such, its IFS rating continues to be aligned with the implied IFS rating of the group as a whole.

RATING SENSITIVITES The RWN will be resolved when the new Italian legal structure comes into effect later this year. At that time, Fitch expects to downgrade the debt ratings by one notch.

Separately, all of Generali’s ratings are likely to be downgraded if Italy is further downgraded.

Other key rating triggers for a downgrade of Generali and its core subsidiaries’ ratings include: –Consolidated FLR not falling below 35% over the next 12-18 months. –Consolidated Solvency I ratio falling below 120% with an expectation that it will not recover within a short period of time.

Key rating triggers for an upgrade of Generali and its core subsidiaries’ ratings include: –Strengthening the group’s capital base to the extent that Generali is able to withstand credit and other losses given a scenario of severe distress. This could be achieved with a consolidated Solvency I consistently above 150% or if the eurozone debt crisis stabilises and Italy’s rating is upgraded to the ‘A’ category.