Insurers Concerned About NAIC Pursuit of Its Own Rating Agency

Sean P. Carr
A. M. Best
April 20, 2009

Some insurers increasingly are concerned about a National Association of Insurance Commissioners' initiative to establish its own rating entity, fearing they could be saddled with high start-up costs and be subject to decisions made by combined regulator-raters with their own conflicts of interest.

The NAIC concluded its national meeting in March with charges to review the issue of rating agencies on parallel tracks. An SVO Initiatives Working Group is investigating whether and how to expand the existing New York City-based Securities Valuation Office into a full-fledged nonprofit rating agency. The Rating Agency Working Group is examining the reliance on ratings provided by Nationally Recognized Statistical Rating Organizations by the NAIC, the insurance industry and the insurance marketplace, including "the problems inherent in reliance on ratings" and "the reasons for recent rating shortcomings," according to NAIC documents.

Industry representatives said an examination of the impact of rating agencies, and what can be done better, may have merit.

"It's always worthwhile to explore what the ratings agencies are doing and how they impact the marketplace," said Phil Carson, assistant general counsel for the American Insurance Association. "Have regulators been unduly relying on raters to do their jobs for them?"

But they have questions about whether an NAIC-run rating agency is feasible and what commissioners hope to achieve. They worry a new levy on insurance companies to finance a rating entity would send the wrong signal to the industry, particularly in the current economic climate.

"How do you fund the process of getting ratings? Somebody has to pay those analysts," said Jim Olsen, director of insurance accounting and investment for the Property Casualty Insurers Association of America. "There may be talented people out there looking for jobs right now, but what's it going to cost to bring them in?"

Neither committee has released updates on their work. The NAIC declined to comment on their progress or when any reports or recommendations may be released. In March, the SVO group, chaired by NAIC President and New Hampshire Insurance Commissioner Roger Sevigny, filed a report saying it expects to issue formal recommendations before the next NAIC national meeting in June (BestWire, March 17, 2009).

"We have questions. Everybody's had questions. They're being vague about it," Carson said.

As currently constituted, the NAIC SVO provides credit quality assessment and valuation of securities owned by state-regulated insurance companies; it provides information to regulators about industry transactions. If the NAIC pursues a rating agency plan, it would apply to the U.S. Securities and Exchange Commission for NRSRO recognition.

If the NAIC would be approved as an NRSRO, the potential conflicts of interest outweigh likely benefits, Olsen said. State regulators could use their authority to drive companies to do business with the NAIC agency and limit their other options, he said.

Said Carson, "Would they issue a rating on securities they'd then be regulating?"

Olsen said it is likely the NAIC will determine forming its own rating agency is "an impossible job" — logistically, legally, politically and financially. "From a practical standpoint, there's a lot of obstacles to making things work."

As long as an NAIC entity is up-front about what criteria it uses in its rating designations, there would not be conflicts of interest, said Birny Birnbaum, executive director of the Center for Economic Justice and an NAIC-designated consumer representative.

Last fall, a former managing director for Moody's Investors Service testified at a Congressional hearing that Congress should take up legislation to scrap or radically reform the NRSRO designation, in light of the failure of some credit rating agencies to effectively warn of systemic problems posed by the massive growth in subprime lending (BestWire, Oct. 22, 2008).

In testimony before the U.S. Securities and Exchange Commission on April 15, former Morgan Stanley global research director Mayree C. Clark said federal economic rescue programs could be used to launch a new model for rating the creditworthiness and financial strength of securities and issuing firms (BestWire, April 15, 2009).

A potential upside to the NAIC SVO discussion, Olsen said, is that by merely proposing its own rating agency, the NAIC has sent a jolt to the industry that "could lead to creative thinking," he said.

A.M. Best Co. is an NRSRO, as are Moody's, Standard & Poor's and Fitch.
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