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Casting doubt on ratings.

BY YEAR-END 1991, more than 200 insurers in the U.S. and London markets were in rehabilitation or liquidation, a figure that is expected to increase significantly this year, according to the International Policyholders Association, Inc. In fact, insurance industry experts predict that the continued economic recession combined with more stringent regulation at the state level may contribute to as many as 45 insolvencies in the United States over the next two years.

Due to this dire situation, public scrutiny has recently shifted from simply examining how officers of troubled insurers conduct business and fulfill their fiduciary duties, to determining the fairness and accuracy of insurer rating practices.

Because such rating agencies as A.M. Best Co., Standard & Poor's Corp., Moody's Investors Service Inc. and Duff & Phelps Credit Rating Co. failed to quickly downgrade the ratings of such troubled insurers as Executive Life Insurance Co. and Mutual Benefit Life Insurance Co., regulators at both the state and federal level are now analyzing those companies' rating procedures.

At a recent hearing of the House Subcommittee on Commerce, Consumer Protection and Competitiveness, Chairwoman Cardiss Collins, D-Ill., announced she will ask the General Accounting Office (GAO) to prepare a study detailing the practices of insurer rating agencies.

"With the public concerned about the solvency of insurance companies, consumers must be able to rely upon the accuracy and fairness of ratings in judging the financial strength of a company. Unfortunately, that has not been the case," she said.

According to Larry Cluff, assistant director of financial institutions and markets at the GAO, his department, "without many preconceptions," will "take a look at the comparability of the different rating agencies" and prepare a report in the next few months.

The federal insurance oversight proposal being drafted by Rep. John Dingell, D-Mich., has also been mentioned as a possible platform in which to scrutinize insurer rating agencies. According to a Dingell aide, only insurer solvency standards will be considered in the current draft. However, the draft does not necessarily preclude future consideration of the issue by Congress. "This is a moving process and we deal with issues as they arise," he says.

Scrutinizing the Process

"WE DO NOT MIND holding up our process to the scrutiny of federal regulators," says Larry Brossman, chief operating officer of the insurance rating division of Duff & Phelps. "However, we are a bit leery of federal regulation because of the bureaucracy it creates in its wake."

To reassure that the company has its own exacting standards, Mr. Brossman says that as a rater of securities, Duff & Phelps is subject to due diligence and a review of its methodology by the Securities and Exchange Commission.

"Fifty percent of the people in our company are chartered financial analysts or holders of other professional designations," he says, adding that increased integrity, knowledge and consistency brought uniformly to bear on the rating approach will ultimately benefit policyholders and insurance companies alike.

At the state level, the National Association of Insurance Commissioners (NAIC) recently published a "white paper" that described the methods and procedures of the various rating agencies, but stopped short of advocating any direct regulatory action. While the report acknowledged a "fairly unanimous agreement" that the availability of multiple rating opinions benefits consumers, it did not rule out the prospect of "further analysis" of the agencies in the future.

Referring to the report, John Snyder, a senior vice president at A.M. Best, says standardization of the rating agencies or other types of regulation on the state level could be imminent.

"There is a groundswell of interest in how we rate that has gone well beyond industry professionals and now concerns the common person on the street," he says. Nonetheless, Mr. Snyder believes that such notoriety is a "healthy" thing and contributes to the educational process for consumers.

However, according to William O'Neill, senior vice president of insurance rating services at Standard & Poor's, the NAIC report is quite interesting for what it does not say, at least explicitly.

Although Mr. O'Neill agrees that the report does not actively advocate regulatory action on the state level, "There is a strong implication about restricting the flow of information from rating agencies," he says. "I think the NAIC sees its role as adjudicating the appropriateness of information about insurers, and I think that is inappropriate."

Mr. O'Neill believes that despite the rash of recent insurer insolvencies, the industry is basiclaly sound, and the "white paper" is just an attempt by the NAIC to "muzzle" the rating agencies.

"For years no one had any problem with how we obtained our information," he says, "but for the last year or two, the scrutiny has been all reactive."

Alphabet Soup?

DESPITE MOUNTING criticism about how the rating agencies do business, ratings remain an important part of the insurance industry, says Robert Hunter, president of the National Insurance Consumers Organization, because small policyholders are not actuaries and therefore must rely on the rating agencies to apprise them about the financial health of a company.

However, Mr. Hunter adds a proviso: "I'd like to see the rating services clean up their own shops and establish their own standards," he says. "Best's, for one, tends to be afreaid of being too clear about insurers that are declining in value of safety. They must improve clarity and do all they can to make ratings simple and understandable."

According to Mr. Hunter, instead of the letter grade system with its myriad of variables and contingencies currently used by some prominent rating agencies, a more appropriate system might involve numbers from one to 10 accompanied by a stamp at the top of the page that explains the grade represented by each number.

At the same time, he says, rating agencies must be sure to warn about trends without projecting them. "That way, if a company was in trouble, a timely warning could shake them up enough so they would get themselves out of trouble before state regulators had to get involved." In addition, Mr. Hunter says the rating agencies should provide more information at the point of sale.

"The rating system is cumbersome and should be restructed," concedes Mr. Snyder. However, he cautions that sensitivity must be shown to the ratings structures now in lace. "In some parts of the country, rating procedures have been written into law and would pose a security hazard if they were abruptly changed.
COPYRIGHT 1992 Risk Management Society Publishing, Inc.
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Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:of insurance companies
Publication:Risk Management
Date:Apr 1, 1992
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