“This is an example of underwriters not fully understanding the consequences of what they are doing,” comments Bob Partridge, a managing director in S&P insurance ratings.

On 2 January 2003, JP Morgan Chase & Company received about 60 per cent of a total $1 billion claim on Enron-related surety contracts, negating to a large extent the argument made by the defendant insurers that they had unwittingly insured a loan.

The involvement of multiline insurers in this type of financial-guarantee transaction, which should be the sole province of monoline specialist insurers, reflects “an underwriting breakdown” at the companies involved.

It also highlights the industry’s tendency to take on such business (also known as credit enhancement) under the guise of traditional surety coverage (which typically involves much less risk).

But the two are “entirely different businesses with entirely different capital and liquidity requirements,” says Mark Puccia, a managing director in S&P insurance ratings. According to S&P there should be clear-cut distinctions both in the types of risk involved and in the type of rating applicable.

On the one hand, an insurer’s ability to pay claims on traditional business is addressed in S&P financial strength rating (FSR). On the other hand, the willingness, not just the ability, of a monoline specialist insurer or of a reinsurer to pay claims promptly in the very specialised arena of credit enhancement, irrespective of any suspected fraud in the underlying transaction, is the focus of the rating agency’s financial enhancement rating (FER).

The FER requires the applicable companies to meet the specific needs of investors and lenders with a pay-first, ask-questions-later approach.

This distinction is at least as important in the reinsurance market, where the prospects for reimbursement of the 11 insurers involved is uncertain and where monoline specialist MBIA Insurance Corporation, committed to payment on a transaction related to student loans, filed suit in July 2002 against its reinsurer on the business, a subsidiary of Royal & Sun Alliance Insurance Group.