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Somebody Has to Say It

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Just when you thought the debt ceiling crisis couldn’t get any uglier, Standard & Poor’s has, as you all well know, downgraded the sovereign creditworthiness of the United States on the rationale that its political infighting is seen as an excessive risk, given the country’s debt load. That’s a decent point to make in an editorial, one supposes. It seems like weak sauce for downgrading the single largest economy in the world, however, one that is still several time the size of China’s, and that has not actually missed a payment yet. To downgrade the U.S. over the political fracas that ensued last month over the debt ceiling (something President Reagan raised 16 times during his administration, by the way, without much fuss) is akin to getting your credit card canceled because Amex heard you had an argument with your spouse.

Frankly, the entire thing displays that like the NAIC, rating agencies wield a power outsized to their public accountability. They are beholden to no government agency, for they are not one. They are private companies, not always running the best data, that are entirely profit-motivated, and not always staffed with the smartest people. These are the folks Wall Street is taking its cues from? We may be in more trouble than we think, people.

Following the news that a number of top life insurers were similarly downgraded yesterday, apparently for their investment in treasuries, all I can conclude is that this entire episode raises more questions about the methodologies of rating agencies than anything else. The financial stability of the life insurance industry is always a fair thing to question. But in the case of companies such as the Knights of Columbus, TIAA, USAA and New York Life, which have all been downgraded, I must wonder how something like this could have come to pass. Either the industry is deeply out of whack, or the people rating it are.

I began my career at the A.M. Best Company.And while I cannot divulge the operational details of how Best rated companies, I can tell you that personally, I don’t think its ratings merit the level of confidence that people outside of the company place upon it. This is a speculative statement, to be sure. But if you doubt me, talk to any ex-employee of A.M. Best and ask them about how things run there. It should not be hard; there are a lot of ex-A.M. Besters. (Leader’s Edge magazine ran a pretty damning cover story in October 2006 about Arthur Snyder, Jr., then the president of Best. Sadly, the Leader’s Edge archive only goes back to 2007, but read the article if you can find it.)

My problems with A.M. Best could be said of any rating agency, however. Case in point: one episode I recall clearly was when a California workers comp writer called Golden Eagle was raided by the California DOI in the late 1990s. The move came as a bit of a surprise, as the company had – until the day of the raid, anyway – pretty good ratings. Nothing from the rating agencies suggested that the company was severely under-capitalized, which it was. So when the raid came, it made the ratings world look a bit foolish for having so clearly dropped the ball on what was supposed to be its core competency: determining insurers’ ability to pay for its obligations. I was fairly new to the insurance news world at the time, but I covered the story after hours so we could get it out ASAP. My favorite detail was that out in the Golden Eagle parking lot was a car abandoned by one of the company’s top executives. In the tape deck was a How to Speak Spanish cassette. So much for this company being on the level. Whoever was rating Golden Eagle at the time surely failed the public just as much as it failed itself and its own stakeholders. And the saddest part is that one suspects that the Golden Eagle debacle is not the only one of its kind.

I wish I could go into further detail about my experiences at Best, but as their legal counsel reminded me a few hours after this story went live, I did sign a confidentiality agreement in 1993, when I joined the firm, and talking about how Best rated Golden Eagle counts as confidential information. Fair enough.And so, certain details about Best’s operations have been scrubbed from this article. That’s alright, because it only makes my point all the more.

That Best would send a legal notice over something that happened so long ago, and over something that I think illustrates a fundamental criticism of how it – and all other rating agencies, really – rates insurers tells me that even these many years later, Best and its competitors probably have not improved the way in which they do business. Much like the NAIC, ratings agencies such as Standard & Poor’s and A.M. Best do not answer to the public they ultimately purport to protect. So when they drop the ball – either by incompetence, a conflict of interest or whatever other reason – there is no mechanism for accountability other than the free market to correct things. Normally, the free market is a great regulator. But not so much in the case of ratings agencies, where a black mark on one’s credibility comes as little solace to people whose lives and livelihoods are negatively impacted by ratings agencies’ failure to carry out their self-appointed task.

National Underwriter is already covering how the S&P downgrade is affecting life insurers, and it will be the cover story of our upcoming August 22 issue. Until then, keep your eyes peeled for ongoing developments and updates to this story. One that came across my desk earlier today is a nice scoop from American Banker, whose people photographed a banner plane hired by a St. Louis banker to buzz lower Manhattan – where the Standard & Poor’s office is located. The banner reads: “Thanks for the downgrade. You should all be fired.” Indeed.