Why Shouldn’t The NAIC Form Its Own Rating Agency?
Am I the only one who thinks it might actually be a good idea for state regulators to consider forming their own insurance company rating organization to compete with A.M. Best, Fitch, Moody’s and Standard and Poor’s?
The idea raised by the National Association of Insurance Commissioners is in its embryonic stage, and it’s not at all clear it will ever get off the drawing board. The question for today, however, is whether this is a project worth pursuing, and if so, whether the NAIC could actually pull it off.
The NAIC says the idea was first floated before last month’s subprime mortgage tsunami swept through Wall Street, threatening to take down AIG and others with reckless purchases of collateralized debt obligations and unregulated trades involving credit default swaps.
Still, the fallout from our financial meltdown might certainly help make NAIC’s case for a new ratings organization, especially after seeing private agencies skewered in Congress last month, with some testifying that conflicts of interest and fear of losing accounts took precedence over sound judgment.
Will these concerns prompt stiffer regulation—similar to the way Uncle Sam cracked down on investment analysts whose independence and judgment in assessing stocks were called into question? It’s not clear anything will change anytime soon, giving the NAIC its opening.
However, there are many concerns the group must address before proceeding. For one, building a new rating agency from scratch would be an enormous undertaking. NAIC runs a very real risk of biting off more than it can chew.
Where would they get the money? During the NAIC budget process, the group said while there is no specific funding yet, other regulatory modernization initiative budget lines would be tapped. Okay, but beyond the initial seed money, how would the NAIC finance its agency? Will they have to make NAIC ratings mandatory, and charge insurers for the privilege?
This raises another problem. However the NAIC implements its idea, it’s doubtful the new rating agency would compete with existing firms on a level playing field. Even without a mandate, all carriers would likely feel pressured to get an NAIC rating.
Would the establishment of an NAIC ratings arm drive some, if not all of the current private agencies out of the business? Might an NAIC-sanctioned organization eventually become the only agency in the market? That would not be a welcome development for either insurers or their policyholders.
The concern is magnified when you ask where the NAIC would get the talent to run its new organization. Wouldn’t they have to raid existing firms, thus diluting the talent pool available for everyone to get the job done? Or would they train novices in the field, creating another set of problems?
In addition, while the new agency would supposedly be independent from the NAIC, it is hard to imagine individual regulators not being tempted to try to influence the ratings of carriers domiciled in their states.
When you factor in the revolving door at work, with regulators regularly joining insurance departments from the industry, only to eventually head right back for lucrative gigs after putting a few years into public service, that precious aura of independence would be even harder to maintain over the long haul.
Despite these concerns, at this point I would not dismiss the notion out of hand. Since state regulators already do a good job assuring solvency, why not let them hand down financial strength and claims-paying ability ratings?
What do you folks think?
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I agree that this is an idea that should be discussed.
However, I do believe that there is another option to get the NAIC into the ratings game–they could simply purchase one of the existing rating agencies. This would eliminate the issue of diluting the pool of talent and would get them into the game in a short period of time.
My larger question is what will they bring to the table? If the organization is a regulatory adjunct to the NAIC, they could obviously request more detailed and confidential information than any of the current rating organizations. This may or may not help them to determine the risk factors.
The real question is does anyone have a model that is accurately predicting the probability of loss far enough in advance that it allows a regulator to take action.
It would be interesting to see a study of the various rating agencies, and whose model does the best job of predicting 12 – 18 months out, the companies that need help.
It may sound like I’m a bit skeptical of the process, but I’m not. With the recent utilization of more advanced modeling techniques, the access to more confidential information and the technical ability to provide more “real time” data, it should be possible to develop a better model.
I would say that it will not be easy, and we should never expect that under the current competitive rating model we operate under, that all problems can be avoided.
The insurance industry needs more transparency and objective oversight, not less. The NAIC as a rating agency would not add to that imperative.
Truth be told, while the general public may have to depend on rating agencies, I doubt there is one competent corporate risk manager or investment professional that would stake any important decision solely on any rating agency, preferring instead to perform their own due diligence.
Having said that, introducing more transparency and oversight of existing rating agencies might indeed be a more worthwhile initiative than looking to the NAIC for help.
Creating a “rating agency” is an absolute conflict of interest and nothing but another means for the NAIC to increase its budget base.
As has been mentioned, their lack of transparency and frantic efforts to protect their proprietary interests (i.e. proposals to create an optional federal charter, federal Office of Insurance Information and other regulatory efforts). The potential reward in having another rating agency is severely undermined.
I think a revisiting of the funding mechanism of the current rating agencies is a more effective solution, as opposed to the NAIC taking this competitive (self-serving) step in an area that they’ve left alone all these years.
The NAIC already has a rating agency. It’s called the Securities Valuation Office. Their objective is to provide risk designations from 1 to 4 that maps to the S&P and Moody’s ratings.
The staffing is comprised of fixed income analysts from the sell- and buy-side, and former rating agency people. You can find information on the SVO on the NAIC Web site.
The critical questions are the size of the staff to keep the workload at a manageable level, the reliance on major agency ratings in lieu of original in-house analysis, and the depth of analysis on new instruments beyond plain vanilla bonds.
As a regulator, the fees are customarily paid by the regulated industry, so in this case, the insurers would be charged to bolster the NAIC budget.
As Wall Street shrinks, there is plenty of talented staff and there is a large number of buy-side analysts in the insurers and pension funds.
This is a lovely idea that won’t work.
The reason is that the NAIC could never assign a rating below “Excellent” to a carrier. Assigning a worse rating to a carrier would cause a run on the bank.
Any entity that depends on the confidence of the buyer, whether an insurer or a banker or a stockbroker, cannot continue to function if its reputation is tainted.
If the NAIC intends to cull the herd, this proposal will surely accomplish that result.