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Mariana Gomez-Vock (Photo: House Financial Services Committee)

Life Health > Annuities > Variable Annuities

S&P Rating Method Update Could Ding Annuities: Hearing Witness

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What You Need to Know

  • An S&P witness argued that some commenters on its new insurance rating proposal seem to assume, incorrectly, that ratings are all about the same.
  • Rep. Brad Sherman has proposed creating a board that would pick the rating agencies that produce the first three ratings of a new corporate bond or asset-backed security.
  • Rating agency reps said the Sherman bill would likely reduce efforts by rating agencies to compete based on rating quality.

The American Council of Life Insurers would prefer to see S&P Global Ratings take a different approach if and when it updates its rules for rating insurers’ capital levels.

Mariana Gomez-Vock, a senior vice president at the ACLI, gave that assessment Wednesday at a hearing on the bond rating industrythat was organized by the House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets.

Most of the witnesses focused on how the S&P capital adequacy rules update proposal might or might not affect the level of competition in the rating industry, and on federal rules and policies that help or hurt the level of competition in the rating industry.

Rep. Bill Huizenga, R-Mich., turned the conversation to the possible effects of the proposal on life insurers by referring to reports that the proposal could hurt variable annuities and other long-duration products.

“What’s the management issue there?” Huizenga asked.

Gomez-Vock said that the issue is that life insurers could end up having to meet two major capital adequacy standards: U.S. state insurance regulators’ risk-based capital ratio system and an approach more like Europe’s Solvency II system.

The U.S. RBC ratio approach is based mainly on how much capital an insurer has, how assets are invested, and what benefits the insurer is promised.

Solvency II is based on cash-flow projections for in-force business, with the assumption that all invested assets will earn the same “risk-free” rate of return.

The Solvency II approach “tends to be unfriendly to long-term products,” Gomez-Vock said.

What It Means

Rating agencies try to help life insurers show that they are likely to be able to meet their insurance policy and annuity contract promises by providing facts and analyses supporting that they are run well and invest in sensible investments.

Any major changes in rating agency rules could affect what kinds of products life insurers can write and how much the products will cost, even if nothing has changed but the rating agency rules.

The S&P Proposal

Traditionally, S&P has competed mainly against Moody’s and Fitch Ratings in the bond ratings business, and against Moody’s, Fitch and AM Best in insurance ratings.

The list of nationally recognized statistical ratings organizations, or NRSROs, recognized by the SEC also includes Japan Credit Rating Agency, Kroll Bond Rating Agency, DBRS, Egan-Jones Ratings and HR Ratings de Mexico.

The National Association of Insurance Commissioners has a different kind of entity, a Securities Valuation Office, that helps state insurance regulators assess the day-to-day credit quality of securities owned by state-regulated insurers.

S&P sparked policymaker interest in the rating industry rules by proposing an update that set tough rules for how its own raters would use securities ratings from outside sources.

S&P suggested that if it had not rated a security, it would start by taking a rating from another NRSRO and reducing that one rating by one level, or “notch.”

Competitors and other critics of the proposal argued that the notch-reduction approach would, in effect, hurt S&P’s competitors by pushing bond issuers that wanted the best possible ratings from S&P to use bonds rated by S&P.

S&P has withdrawn the notching proposal for now, and has said it plans to revise the proposal and seek comments on the revision.

Yann Le Pallec’s Defense

Yann Le Pallec, health of global ratings services at S&P, said S&P proposed treating ratings from outside sources differently from homegrown ratings not to try to hurt competition, but because it believes it has more and better information about bonds and other assets that its own analysts have rated.

Le Pallec argued that regulators should be encouraging rating agencies to use varied approaches to ratings and to compete based on quality, rather than assuming that ratings are all the same and pushing rating agencies toward using the same approach.

Rating users “benefit from a diversity of views,” Le Pallec said.

The Credit Rating Agency Assignment Board Bill

Rep. Brad Sherman, D-Calif., the subcommittee chair, presented a discussion draft of the Commercial Credit Rating Reform Act bill.

Today, insurers and credit issuers typically pay rating agencies for ratings.

Some have argued that the rating agencies end up being too close to the entities getting the ratings because the entities themselves pay for the ratings.

Sherman’s draft would try to reduce that potential conflict of interest by having a board use a random process or other process to pick the rating agencies providing the first three ratings for an insurer or a new debt security.

Rating agency reps said the Sherman bill would likely hurt the quality of ratings by reducing rating agencies’ incentive to compete based on quality.

Barriers to Entry

Angela Liang, general counsel for Kroll, said one way that policymakers could improve the rating industry would be to increase the level of rating agency competition.

One way to do that would be to update any federal regulations, rating agency lists or other documents that still list specific rating agencies as being the main rating agencies, Liang said.

She said another way to increase competition would be to change a rule that now requires a new rating agency to be able to produce assessments from investors that have been using its ratings for at least three years.

Because investors have little reason to use ratings from new rating agencies, the requirement effectively keeps new entrants out of the rating market, Liang reported.

Pictured: Mariana Gomez-Vock testifies Wednesday at a House Financial Services subcommittee hearing on the bond rating industry. (Photo: House Financial Services Committee)


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