Biting the Hand That Feeds

An interesting public dialogue between the German Insurance Association (GDV) and Fitch Ratings Service in April raises some interesting, broader issues associated with the growing influence and power of independent financial ratings agencies.

Ratings agencies derive their power in part through access to insurers’ financial information. Sometimes this information is publicly obtained; other times, insurers co-operate with agencies and supplement public data with their own private, confidential data.

The point is this: the opportunity to analyze and publicly judge such data gives independent ratings agencies a certain power over an insurer’s public image. This state of affairs has people in the North American insurance industry talking anecdotally about whether there is any suitable opportunity for appraised insurers to critique the methods of their financial appraisers.

It says something that this conversation could only come to the public’s attention through formal letters of complaint of the type written by GDV. Because of the power imbalance between ratings agencies and insurers, insurers generally don’t feel free to talk publicly or candidly about their concerns. And who can blame them? We’ve all intuited the truth of the expression: ”Don’t bite the hand that feeds you.’ [And don’t forget the corollary statement: ‘Don’t bite the hand that trains you with a newspaper.’]

Credit the Fitch/GDV exchange (and Fitch) for putting these issues into the public domain. The exchange suggests the possibility for a structured dialogue to occur in the future about the methodologies ratings agencies use to rate insurance companies.

On Apr. 3, 2006, Fitch Ratings Service posted online a letter it received from the GDV concerning “Fitch’s business conduct in the German insurance market.” Specifically, the GDV says in its letter, “in our view, Fitch’s business conduct in the German insurance market still fails to comply with the provisions of the IOSCO (International Organization of Securities Commission) code in many instances.”

After conducting a review of its processes, Fitch responded to the GDV posting in great detail. It agreed to address matters related specifically to the German market context. However, in general, Fitch “noted that there are no requirements, implicit or otherwise, in the IOSCO code or its predecessor documents relating to the format or frequency with which rating agencies should disclose agency-initiated and non-participative ratings, contrary to the statement in GDV’s complaint.”

The ‘IOSCO code’ is the Code of Conduct Fundamentals for Credit Rating Agencies. An updated version of the code was released in December 2004. IOSCO designed the code to be incorporated into credit ratings agency’s codes of conduct worldwide.

Fitch published the GDV’s letter in accordance with the IOSCO Code. Provision 4.2 of the Code calls on credit rating agencies to communicate “with market participants and the public about any questions, concerns or complaints that the CRA (credit rating agency)may receive.”

The most germane parts of the GDV’s letter to Fitch relate mainly to Section 3 of the Code, which deals with the transparency of the ratings.

The issue of transparency perhaps finds the most resonance with some internal mumblings within North America’s P&C industry.

With regard to Provision 3 of the Code the GDV’s observations are two-fold:

1) Fitch, the GDV argues, only posts whether a German insurer participated in the rating process for seven days after the rating is first released to the public; after that, any notation about the company’s co-operation in the rating is available only to those who contact the rating agency for more information about the rating. “We…call on Fitch to clearly mark all unsolicited or non-participating ratings of German insurers in any publication or at any time when these ratings are referred to by Fitch in public,” the GDV urges in its letter.

2) Provision 3.7 of the Code says that “where feasible and appropriate, prior to issuing and revising a rating, the CRA should inform the issuer of the critical information and principal considerations upon which a rating will be based and afford the issuer an opportunity to clarify any likely factual misperceptions or other matters that the CRA would wish to be made aware of in order to produce an accurate rating.” Fitch follows the letter, but not the spirit of the code, GDV says, because it provides German companies with an “insufficient” time to respond.

For its part, Fitch says, where transparency and disclosure are concerned, “Fitch’s current disclosure policy remains appropriate. A comparison with other major rating agencies indicates that Fitch’s current policy conforms with market practice in this area.”

But what if ratings agencies’ market practices need to be changed? What if they need to change the way they publicize their ratings?

If such an issue is only to be expressed by insurers anecdotally, it will be impossible to gauge the true scope and extent of the concerns within the North American P&C context. For this reason, there needs to be some kind of formal channel for the discussion to be expressed in a way that insurers aren’t going to offend the ratings companies that have so much control over the public perception of a company’s financial strength.