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

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 for 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 industry that 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.

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 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 “nationally recognized statistical ratings organization,” or 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.