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Insurance companies in Russia must face the challenge of responding to the uncertainties of the country’s regulatory and legal landscape if they are to achieve improvements to their financial strength, Standard & Poor’s Ratings Services says in a report called Rating Insurance Companies: Key Influential Heads Of Analysis For Russian Insurers.

The report considers the national and local issues that affect companies operating in Russia and how, in turn, these affect the criteria used by Standard & Poor’s to assess the financial strength of insurance companies. Industry risk, investment risk, and management are considered to be the most significant factors. While the sovereign ratings on the Russian Federation (foreign currency BBB-/Stable/A-3, local currency BBB/Stable/A-3) may act as a potential rating constraint, the weakness in these other areas has a more immediate effect on insurer financial strength ratings in the Russian market.

“Strong regulatory, legal, and accounting environments are essential when a company’s rating is being considered,” says Standard & Poor’s credit analyst David Laxton. “In Russia, all these elements are vulnerable and there is not enough evidence of government support to correct the situation.”

Regulatory decisions have proven to be weak, unpredictable, and lacking in a clear rationale. Furthermore, some of the progress in institutional reform made in 2002-2003 has been placed in jeopardy by greater authoritarianism in 2004. Instability in the market is also indicated by the dominance of tax-optimization schemes, which are unorthodox and prone to rapid change if the government decides to take action. Accounting systems are weak and underdeveloped, and although they continue to develop in the direction of International Financial Reporting Standards (IFRS), they still fall well short of full IFRS requirements. Furthermore, the legal environment is threatened by a weak judicial system, reducing certainty in property and ownership rights. The lack of independent courts, highlighted by the Yukos affair in December 2004, has caused particular concern about sovereign intervention as a risk to private companies.

As well as these industry risks, ratings are also affected by investment risk in the form of poor-quality investment portfolios and a lack of diversity.

 Improving bank creditworthiness is held back by bad practices and leaves the sector as one of the riskiest in the world. For Russian insurers, therefore, the shadow of industry- and countrywide factors is likely to remain for some time. However, as a rating is always an opinion given in the context of an uncertain world, the challenge for insurers is to show they are responding to these uncertainties with a clear, focused strategy.