New Swiss Re Sigma Study Examines Ratings

August 22, 2003

A newly issued sigma study from Swiss Re “Insurance company ratings”, examines rating assessments, as determined by the four major agencies, A.M. Best, Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s (S&P), and considers their influence on the industry.

The study concluded that of the more than 100 rating firms in the world, the big four “account for an estimated 98% of industry revenues.” These come from the payments insurers make, between $5000 and $1 million annually, according to Swiss Re, to be rated interactively. It notes that ” Each of these firms has built a reputation by providing ratings for nearly a century. A.M. Best is focused exclusively on the insurance sector. The other three are larger and rate a wide range of debt issuers.” The study estimates that Best “generates the most revenue, followed by S&P, Moody’s, and Fitch.”

It points out the different types of ratings, such as the basic financial strength rating (FSR) and the ratings accorded to debt issues. It notes that they are “useful risk barometers,” and that “bond yields are highly correlated with ratings because ratings are accurate predictors of default. In addition, industry watchers have high regard for, and make extensive use of, the written industry analyses that rating firms produce.”

The study found that, while most “market participants feel that the rating process is reasonably focused, fair, and balanced,” there are some concerns, which it noted as follows:
— Rating firms appear to have followed increasingly stringent standards in the 1990s (see figure), pressuring insurers to hold excess capital to maintain their existing ratings.
— By charging for ratings and selling consulting services to clients, rating firms are in the uneasy dual role of for-profit business and quasi-regulator that may raise conflicts of interest.
— Some rating firm capital adequacy models punish non-life insurers for raising rates and fail to adequately credit insurers for geographic and line of business diversification.

The study includes a chart showing that “the proportion of top-rated US insurers has sharply declined since 1990.

It also points out that “Partially in response to the slow pace at which ratings react to current developments, a new generation of purely quantitative models has emerged that provides accurate, more timely assessments of default risk. These services, such as Moody’s KMV and RiskMetrics, are popular with institutions that must continuously monitor their counterparty exposures.”

The sigma report also noted that “regulators have increasingly incorporated ratings in their rules,” and that they “also play an important role in private contracts through ‘rating triggers’, which are provisions in financial or business contracts that allow one party to take protective action if the credit rating of its counterparty falls below a predetermined threshold.”

Enron and other corporate scandals have put rating agencies “under heightened scrutiny,” Swiss Re concluded. “Areas that the US Securities and Exchange Commission is now exploring include: the quality of information flows; reducing regulatory barriers to entry; potential conflicts of interest; alleged anticompetitive practices; and the potential need for ongoing oversight of rating firms. In coming months the SEC is likely to take steps to promote increased competition in the rating industry.”

The report may be dowloaded at the company’s Web site:

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