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Financial Express - Rating Agencies Forced To Play Dual Role - Swiss Re.
Source: Financial Times
Date: August 24, 2003
Author: N/A
Reinsurance giant Swiss Re has expressed concern over the pressure of increasingly stringent rating standards that are forcing insurers to hold excess capital. In its latest Sigma study, "Insurance company ratings", it has also pointed out that rating agencies are having to play an uneasy role of for-profit business and quasi-regulator "that may raise conflicts of interest." The study has examined how rating firms evaluate insurers and the accuracy and implications of these ratings. Insurance company ratings are assessments of the financial soundness and creditworthiness of insurers and provide valuable information to the marketplace. It found that, to be rated interactively, insurers pay annual fees ranging from $5,000 to over $1 million. While the financial strength rating (FSR) is an opinion on an insurer's ability to pay senior policyholder claims and obligations punctually, debt rating pertains to a specific security that a firm has issued.
Of the more than 100 rating firms in the world, it stated, just four - A.M. Best, Fitch Ratings, Moody's Investors Service, and Standard & Poor's (S&P) - account for an estimated 98 per cent of industry revenues. Each of these firms has built a reputation by providing ratings for nearly a century. A.M. Best is focused exclusively on the insurance sector. The other three are larger and rate a wide range of debt issuers. The study estimates that in the business of rating insurers, A.M. Best generates the most revenue, followed by S&P, Moody's and Fitch. It conceded that ratings are useful risk barometers. Bond yields are highly correlated with ratings because ratings are accurate predictors of default. In addition, industry watchers have high regard for, and make extensive use of, the written industry analyses that rating firms produce. Still, market participants feel that the rating process is reasonably focused, fair and balanced. Nonetheless, Rating firms appear to have followed increasingly stringent standards in the 1990s, pressuring insurers to hold excess capital to maintain their existing ratings. Some rating firm capital adequacy models punish non-life insurers for raising rates and fail to adequately credit insurers for geographic and line of business diversification.
Partially in response to the slow pace at which ratings react to current developments, a new generation of purely quantitative models has emerged. They provide accurate and more timely assessments of default risk. These services, such as Moody's KMV and RiskMetrics, are popular with institutions that must continuously monitor their counterparty exposures. Over time, regulators have increasingly incorporated ratings in their rules. Ratings also play an important role in private contracts through "rating triggers," which are provisions in financial or business contracts that allow one party to take protective action if the credit rating of its counterparty falls below a predetermined threshold. Rating firms have been under heightened scrutiny since the Enron scandal. The US Securities and Exchange Commission is now exploring aspects of rating agencies like the quality of information flows; reducing regulatory barriers to entry; potential conflicts of interest; alleged anti-competitive practices; and the potential need for ongoing oversight of rating firms. It is expected take steps to promote increased competition in the rating industry.
The Financial Times Limited. Asia Africa Intelligence Wire. All material subject to copyright. Financial Express © 2003 All rights reserved.
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