Overview -- Low interest rates and volatile financial markets continue to weigh on La Societe Hospitaliere d'Assurance Mutuelle's (SHAM) already weak risk-based capital adequacy. -- In addition, we see increasing pressure on prospective earnings and financial flexibility stemming from higher competition in the medical liability business, which reduces SHAM's ability to implement rate increases when needed. -- Consequently, we are revising our outlook on SHAM to negative from stable, and affirming our 'BBB' long-term ratings on the company. -- The negative outlook reflects the possibility that we could downgrade SHAM if it is unable to restore its risk-based capital adequacy to a level more commensurate with the current rating. Rating Action On Dec. 12, 2012, Standard & Poor's Ratings Services revised to negative from stable its outlook on French mutual insurer La Societe Hospitaliere d'Assurances Mutuelles (SHAM). At the same time, we affirmed our 'BBB' long-term counterparty credit and insurer financial strength ratings on SHAM. Rationale The outlook revision reflects our view that low interest rates and adverse financial markets will continue to constrain SHAM's risk-based capital adequacy over the medium term absent restorative management actions. The impact of increasing competition in the French medical liability business on the insurer's prospective earnings also weighs negatively on the ratings. SHAM's risk-based capital adequacy is more sensitive than peers' to interest rate movement and financial market volatility, given the long-term nature of its liabilities and its still-high, albeit reducing, exposure to market risk. We believe that SHAM's capital adequacy will likely remain constrained in the medium term owing to low interest rates. That said, we expect capital requirements for asset and liability risks to slightly reduce, as the company de-risks its asset allocation to a degree while premium volumes stagnate. SHAM's operating performance and financial flexibility benefited from its ability to implement rate increases in recent years, in response to the long-term increase in frequency and average cost of bodily injury claims, and thanks to low competition in its area of expertise. We believe that increasing competition in the French medical liability business could weaken SHAM's earnings by weighing on its technical margins, particularly in the more competitive private clinics sector. In addition, SHAM's financial flexibility relies on tariff increases more than its peers', given its already high use of reinsurance and leveraged balance sheet. Therefore, we believe that SHAM's more limited pricing power has a negative impact on its financial flexibility. Our financial strength ratings on SHAM continue to reflect its leading position and strong expertise in its historical niche market of medical liability insurance for French public hospitals. Operating performance also sustains the final ratings, mirroring our view of good earnings over the cycle, sustained by prudent reinsurance and conservative reserving practices. In particular, positive reserve surpluses over the last two years, thanks to the rapid decrease in ultimate losses in early claims development years, sustain the insurer's positive bottom line results. We expect the net combined ratio to progressively increase to the mid-90s over the next two years, but to remain below 110% through the cycle. According to our estimates, we expect SHAM to post positive net incomes in the EUR15 million-EUR20 million range over that period. Outlook The negative outlook reflects our view that low interest rates and volatile financial markets will continue to constrain SHAM's risk based capital adequacy, and that increasing competition in the French medical liability business could weaken SHAM's earnings and financial flexibility. We could lower our ratings on SHAM if: -- Its risk-based capital adequacy doesn't improve to a level more commensurate with a 'BBB' rating, either through stronger internal earnings generation or restorative management measures; or -- Earnings deviate significantly from our base-case expectations and the insurer loosens its conservative policy on reserving practices. Conversely, we could revise the outlook to stable if SHAM's capitalization improves, earnings meet our abovementioned expectations, and the insurer maintains its good competitive position in its niche market. Related Criteria And Research -- Interactive Ratings Methodology, April 22, 2009 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model, June 7, 2010 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From La Societe Hospitaliere d'Assurances Mutuelles Counterparty Credit Rating Local Currency BBB/Negative/-- BBB/Stable/-- Financial Strength Rating Local Currency BBB/Negative/-- BBB/Stable/-- Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.