How Do I Rate … ?

Where once catastrophes such as hurricanes, earthquakes and floods were the dread of property and casualty insurers worldwide, the post-9/11 risk environment has introduced a new threat, one which strikes to the heart of the insurance industry: corporate catastrophes.

While the corporate disasters of Enron and Worldcom, and for that matter the ripple effect that went out from these most well-known of failures leaving casualties in the accounting and auditing sector, were unrelated to the 9//11 terrorist attacks, the culmination of all these events shook the once secure foundations of the North American investment community – the economic consequences of which are still very much current. Last year’s casualty list of well-known corporate names that fell to bankruptcy under suspicious accounting circumstances heightened awareness of regulators and politicians to the danger of public corporate scandals.

The subsequent government “witch hunts” that followed in the U.S. brought on new caution in the corridors of the corporate world – perhaps even paranoia. With the risks associated with corporate governance under the media spotlight, a new “beast” was born in financial rating agencies. Although rating agencies have been a part of the global corporate environment almost since companies and governments began issuing paper securities, their role has been “backseat”, serving primarily as observers in doing their analysis.

What does this have to do with p&c insurers? In addition to the increased risk of directors’ and offices’ (D&O) and errors and omissions (E&O) exposures to their corporate books of business, the 9/11 terrorist attacks drew regulatory scrutiny to the financial affairs of insurers. The otherwise fairly benign financial rating agencies began adopting pro-active positions in their ratings, and, as some insurers have voiced, “adopting bullying tactics” in directing companies toward actions to preserve or improve their ratings (see Insight of this issue for further details). Needless to say, insurers have their own “biased slant” in that they would prefer not to have their dirty laundry hung out in the open and risk exposures they face such as to asbestos (among a long list of emerging liability risks) being given a high-public profile. Over the past year, several of the rating agencies have issued industry analysis reports concerning asbestos exposures and presumed under-reserving by companies – a fairly unusual occurrence for an industry that likes to keep a low-profile.

However, significant doubt has been cast on the role the rating agencies play within the p&c insurance industry – from insurers to regulators. Notably, the U.S.’s National Association of Insurance Commissioners (NAIC) is currently investigating the relationship between rating agencies and insurers (with the possibility of regulating rating agencies). This action was motivated after a leading insurance company split its “good business” from the bad, and placed the latter into a separate run-off operation supposedly based on the advice of a rating agency. Regulators are also concerned over the fact that rating agencies are remunerated by the insurers they rate, and that companies primarily use these services for marketing purposes.

On the other hand, some insurers feel that the rating agencies in the post-9/11 era have become overly aggressive in their rating actions. As many in the industry point out, there have been more rating “downgrades” than “upgrades” over the past year. The rating agencies are also tending to speculate on industry-wide trends and the potential impact on specific insurers. “They [rating agencies] aren’t afraid to downgrade a whole industry,” observes Ramani Ayer, the CEO of The Hartford Financial Services Group Inc. The real concern, however, is whether the ratings issued are based on sound factual information. Ayer adds, “they [rating agencies are being more pro-active, the question is, are they skilled to do so?”

With 9/11 having brought on a “flight of business” to top-rated insurers and reinsurers, the rating agencies are holding the best cards, company CEO’s grumble. Companies can ill afford to not retain the services of a rating agency, and with the high-profile of these ratings, some insurers feel that the role of the rating agency has gone beyond being that of an “observer” to having a direct impact on day-today operations and perhaps even more importantly, strategic direction.

That said, The Liberty Mutual Group’s CEO Edmund Kelly notes that the global insurance industry’s balance-sheet is “not strong”. When you look at the fallout following Enron, combined with the new risks facing insurers from terrorism and liability exposures, the cost of which is still not yet fully known, it is understandable to why the rating agencies have adopted such a conservative approach, he adds. Furthermore, Ayer notes that increased transparency of the workings of the p&c insurance industry may not be a bad turn over the long-run. However, the thought that no doubt remains in every insurer CEO’s mind when debating the value of rating agencies is, “how do you separate ‘transparency’ from the ‘interference’ factor?”