Rating Agencies Slammed At NAIC Hearing

NU Online News Service

NATIONAL HARBOR, MD--A reevaluation of insurance regulators' use of rating agencies is needed because their poor performance helped prompt the financial crisis, a regulator and consumer advocate testified.

Their comments were made at a meeting session of the National Association of Insurance Commissioners whose members employ rating agency evaluations to determine insurer risk-based capital requirements.

Rating agencies were called to the session to explain their activities.

The Rating Agency Working Group held a three-part hearing, chaired by Illinois Insurance Director Michael McRaith and co-chaired by New York Superintendent James Wrynn, to learn how regulators came to rely on rating agencies, what went wrong, and what to do in the future.

New York Deputy Superintendent Michael Moriarty testified that earlier in this decade, because of its limited resources, the NAIC's Securities Valuation Office sought to enhance its effectiveness by leveraging off ratings and valuations already provided by third parties, such as rating agencies.

As part of regulators' reliance on rating agencies, Moriarty said, the SVO exempted insurers from filing all rated securities with the office. If the security was rated by a nationally-recognized rating organization, the company did not have to file it with the SVO, he noted.

The SVO relied on rating agencies, Mr. Moriarty explained, to make effective use of its limited resources. "The rationale at that time was fairly straightforward," he said, noting that rating agencies had a track record of reliability, with only a few blips.

However, he said this reliance should be reviewed in light of the events of the last few years, which have seen the collapse of highly rated residential mortgage backed securities and other derivatives, events that have led to investor lawsuits against the agencies as well as congressional criticism.

In addition California Attorney General Edmund G. Brown Jr. has announced he has subpoenaed Standard & Poor's, Moody's Investors Service and Fitch Ratings to investigate whether the firms violated California law when they "recklessly" gave "stellar ratings to shaky assets."

Birny Birnbaum, executive director of the Center for Economic Justice consumer organization, criticized regulators for "delegating authority to private enterprises." He said consumer groups in general are troubled by the fact that regulators handed off a critical public role to rating agencies.

He said rating agencies got it wrong on mortgage-backed securities, and if they were wrong before, there is no reason to believe they are right now, even though they have since downgraded those securities.

He also criticized insurers for urging regulators to rely on ratings for mortgage-backed securities when those securities were rated "AAA," but urging regulators to ignore the lower ratings now in some cases as they are causing what insurers see as excessive risk-based capital requirements.

Eric Steigerwalt, senior vice president and chief financial officer of Metropolitan Life Insurance Company, defended insurer requests for a review on the downgrades by stating that regulators should require higher limits of capital for bonds with a high probability of loss, but lower limits of capital for bonds that have been downgraded but have a low probability of loss.

SVO Managing Director Chris Evangel testified that the SVO could conceivably rate securities that are currently evaluated by the rating agencies--but the cost would be high.

He said it would require a "sea change" at the SVO as far as cost and resources. Such a change would be beneficial in down markets, he added, but not necessarily in up markets. He also said such a change would require time to execute.