Rating Agencies

Question 1

two types of ratings and primary agencies for each

Answer 1

1) credit ratings for corporate, municipal, and government bonds - primary agencies are S&P’s, Moody’s, and Fitch
2) financial strength ratings for insurers - primary agency is A.M. Best’s

Question 2

purposes/uses by insurers of bond credit ratings (2)

Answer 2

• RBC charges depend on bond class

* SAP values lower rated bonds at market value, not amortized value

Question 3

purposes/uses of financial strength ratings (5)

Answer 3

• makes markets more efficient by reducing information costs for policyholders, agents, regulators
• reinsurers may need investment grade ratings to retain customers
• agents use ratings to place policies with higher rated insurers
• Appointed Actuary is required to consider ratings of reinsurers when evaluating uncollectible reinsurance recoverables
• some DOIs require an insurer to have a specific rating to write some lines of business

Question 4

criticisms of rating agencies (3)

Answer 4

• highly-rating mortgage-backed securities defaulted in 2008-2009
• few rating agencies create an oligopoly
• may be greater efficiency in the free market than in rating agencies, which are slow to react

Question 5

public rating

Answer 5

• insurers who do not pay for interactive ratings may receive ratings based on publicly available information

Question 6

steps in interactive rating process (5)

Answer 6

1) background research by analyst and submission of proprietary data by insurer
2) meetings between ratings analysts and senior managers of the insurer
3) preparation of rating proposal by lead analyst
4) decision by rating committee
5) publication of rating

Question 7

why agencies are hesitant to change ratings quickly

Answer 7

• erroneous downgrades anger clients, who pay the agency’s fees
• erroneous upgrades ruin the agency’s reputation with investors and agents

Question 8

lines of business where high ratings are especially important (4)

Answer 8

• reinsurance - treaties may explicitly link ratings and security required
• surety
• structured settlements - casualty claims may be settled through life annuities
• homeowners - highly rated property insurance required by mortgage issuing banks

Question 9

characteristics of rating agency capital requirements (3)

Answer 9

• capital requirements published with each rating, but no legal authority
• stochastic model as opposed to formulaic approach of RBC
• use qualitative information as well as quantitative items

Question 10

benefits to a rating agency of having a more accurate capital model (2)

Answer 10

• attract customers (insurers) that may be misread by a generic model
• maintain good reputation

Question 11

financial strength ratings categories

Answer 11

• secure (B+ and above)
• vulnerable (B and below)
• suspended (may occur after a major event whose effects are uncertain)