COLUMN ONE : Are the Watchdogs Watching? : Investors increasingly rely on ratings agencies to say what’s safe and what’s not. But apparent failures in the insurance crisis have again left the firms looking less than alert.
For Mutual Benefit Life Insurance Co., the handwriting had been on the wall for months as the company searched for investors to bail it out of woes brought on by a plunging real estate portfolio.
But it was not until July 3--less than two weeks before Mutual Benefit’s directors threw in the towel and invited New Jersey regulators to seize the company--that vaunted insurance industry watchdog A. M. Best Co. pulled its coveted A plus (superior) rating of the company.
Best’s sluggishness has prompted many to question whether the watchdog--whose ratings help to direct billions and billions of dollars worth of investment decisions by consumers, financial institutions, insurance agents and companies--was slumbering, casting doubt on its ratings for hundreds of other insurers.
“Either they were asleep at the switch, or didn’t want to trigger a run, or are too close to the industry,” said Robert Lamb, professor of finance at New York University’s Stern School of Business and a longtime critic of the rating services. “Probably all three.”
Not so, responded Best senior vice president Paul Wish, who insisted that even the most diligent analyst could not have predicted the policyholder run and bad-mouthing by competitors that contributed to Mutual Benefit’s seizure, the largest collapse of a life insurance company in U.S. history.
Best’s inaction has sparked new criticism of ratings agencies at a time when financial instability is on the rise as bank and thrift failures, corporate and municipal bankruptcies and insurance company collapses become everyday news. In addition, new and exotic financing devices are proliferating--precisely when consumers and investors most need credible and reliable ratings services.
“The whole financial structure is so friable at the moment that the ratings agencies have an added responsibility to properly evaluate the companies they rate,” said Morris Mendelson, professor of finance at the University of Pennsylvania’s Wharton School. “If the rating agencies won’t warn the public when a company is in trouble, what is the good of a rating agency?”
Since Best’s formation in 1906, investors have looked toward rating services--including Moody’s Investors Service Inc., Standard & Poor’s Corp. and a handful of others--to let them know if there were signs of trouble ahead. While Moody’s and S&P; are best known for rating corporate and municipal bonds, Best specializes in insurance.
Using raw data from insurers’ financial statements, Best measures profitability, debt levels and access to quick cash before assigning ratings. The quantitative review is complemented by a qualitative review which considers the competence, integrity and experience of company management, Best says.
The Mutual Benefit situation is not the first time the major rating services have faced critical scrutiny.
The agencies were also slow to spot difficulties at Executive Life Insurance Co. and First Capital Life Co., Los Angeles-based companies whose huge portfolios of junk bonds were clear warning signs to many in the industry. Executive Life was winning “A” ratings from Best months before it was seized by California regulators in April.
Taken to Task
A decade ago, Moody’s and S&P; also were taken to task for ignoring difficulties at the Washington Public Power Supply System before the nuclear power producer defaulted on $2.25 billion in bonds. And in 1975, they were criticized by the Securities and Exchange Commission for failing to make “diligent inquiry” into the extent of New York City’s fiscal crisis.
Though most observers believe that Moody’s and S&P; have improved in recent years, “the ratings agencies continue to be a lagging--not a leading--indicator of what is happening in the marketplace,” Lamb said.
But it is the ratings agencies’ performance in the current insurance crisis that is drawing the most fire these days, especially because insurance agents and pension fund trustees have pointed to high ratings as justification for steering investor funds to companies that turned out to have been deeply troubled. And it is Best, an Oldwick, N.J., publishing company that specializes in insurance, that is taking the brunt of the criticism.
“A. M. Best is the one that has lagged behind and is the most vulnerable to criticism,” said Stephen Brobeck, executive director of the Consumer Federation of America in Washington, D. C. “It may reflect the fact that they are closer to the industry, and may try to err on the side of the industry when there is a question.”
“Consistently, the ratings agencies continued to give top rating to (Executive Life and First Capital Life) at a time when anybody with a room temperature IQ in the insurance industry knew they were in trouble,” charged Sen. Richard H. Bryan (D-Nev.), in an interview. “If these ratings are illustrative, then ratings are meaningless to the consumer. They provide no assurance or benefit at all.”
Bryan, whose consumer subcommittee of the Senate Commerce, Science and Transportation Committee held hearings on insurance company failures, said the ratings agencies declined two invitations to testify before his subcommittee in May. “They gave us the cold shoulder,” he said.
“Time and time again, consumers have relied upon these A plus and Triple A ratings in buying insurance policies and annuities,” added Michael Sherman, an attorney with Barrack, Rodos and Bacine in San Diego, who is suing Best, Moody’s and S&P; on behalf of policyholders of Executive Life.
“I haven’t found the smoking gun yet, but what you have is a seemingly incestuous relationship where high ratings figure prominently in the sales and marketing literature of these insurance companies.”
Indeed, policyholders who invested in Executive Life based on its high ratings feel betrayed.
“I’ve been buying insurance policies since 1946, and I would never touch anything less than A plus,” said Dr. Julius Steve Brodie, 70, a retired physician in Los Angeles.
He was attracted to Executive Life because it paid high yields and had the top rating by Best in the late 1980s. Now that the cash value of his $90,000 policy has been frozen as a result of the company’s failure, Brodie now looks at raters and ratings with a jaundiced eye.
“It tells me that they are not competent, that they don’t investigate thoroughly,” he said.
Another Executive Life policyholder who relied on the company’s high ratings is Mellvine Fuchs, a Balboa real estate broker. “Like everybody else, I don’t know anything about insurance,” Fuchs said. But, he was persuaded to invest $500,000 in a single-premium whole life policy with Executive Life when his agent said it was “top rated, no problem.”
“I think the ratings agencies are in bed with the insurance companies,” Fuchs said disgustedly.
Wish acknowledged that Best “is not in an adversarial position” with the industry but rejects criticism that the firm is too close to the companies it rates.
“We are not soporific. We view insurance as a long-term contract,” he said. Wish noted that few critics raised a clamor in the early 1980s when many life insurers were technically insolvent because of the depressed value of their long-term bonds.
Some observers fret that competition among the agencies to adjust ratings first--and criticism such as that being leveled against them in the Mutual Benefit case--may force the agencies to forsake their careful analytical methods and rush to judgment.
Quality of Analysis
“In order to be first out of the box, there may be more headline analysis and less careful financial analysis. In the long run, that could hurt issuers,” said J. Chester Johnson, president of Government Finance Associates Inc. in New York, an independent adviser to government borrowers.
Underlying the discussion is the great power that institutions like Best, Moody’s and S&P; wield. Their ratings can literally mean life or death for a company or municipality, who can be shut out of the bond market as a result of a low rating. At the very least, a higher rating can save bond issuers--and, ultimately, taxpayers or consumers--millions of dollars through lower interest rates.
As a result, mayors, governors and corporate chief executives routinely pay courtesy calls on the ratings agencies and lobby for higher ratings. Municipal officials tailor their budgets to please the raters. And corporations even cite the influence of the ratings agencies in making such crucial decisions on whether to merge.
Just this week, for example, officials of Chemical Banking Corp. and Manufacturers Hanover Corp. said one of the main goals of the merger they announced on Monday was to improve their credit ratings in order for the combined bank to raise capital at more advantageous rates.
The ratings agencies have long been saddled with the reputation of having overworked, underpaid staffs of relatively inexperienced analysts. At Best, for example, just 24 analysts must track a universe of 1,379 life insurers.
Big banks and brokerage firms have bolstered their own analytical staffs to avoid being blindsided. As a result, “the big institutions tend to get wind of problems brewing and pull their money out in advance,” Lamb said. “The little guys”--such as the policyholders who swarmed Mutual Benefit’s Newark, N. J., headquarters this week in a vain attempt to cash out policies--”get left in the lurch.”
What, then, are consumers to do? “Consumers should look for a company that is top-rated by everyone,” Brobeck said. “But even that isn’t a guarantee,” he acknowledged.
Defenders of the rating agencies point out that virtually all the big insurance company failures this year could have been avoided if only consumers were confident enough in the companies’ health and staying power to leave their funds alone, and possibly even invest more.
Weathering Storms
And here may lie the root of the rating service dilemma. Ratings services, as well as many industry experts and regulators, have grown used to insurers being able to weather storms. Even when the economy soured and banks and thrifts failed in record numbers, life insurers stood steady.
These companies were considered somewhat unique because of their mainstay business, long-term life insurance contracts that exact severe penalties on anyone attempting to cash out early. As long as insurance company failures were rare, few consumers were willing to pay that cost. And that gave insurers the ability to ride out many market fluctuations.
But that changed with the failure of Executive Life last April because of its investments in junk bonds. Not only did consumers learn quickly that big insurers can and do fail, they found that a life insurance company failure can prove financially devastating to those caught up in it.
That knowledge has ushered in “a new and dangerous era” for the life insurance industry, said Joseph M. Belth, editor of the Insurance Forum newsletter. “The public henceforth will be more sensitive to bad news about the financial condition of life insurance companies. Consequently, severe runs are now more likely to occur,” he said in a recent publication.
So far, the rating services say they have not figured out how to handle this new-found volatility. But some say they are trying.
“One of the issues we are trying to grapple with is how to attempt to measure investor psychology,” said William O’Neill, vice president of S&P;’s Insurance Rating Services.
“It is not something that you can sit down and figure out on a personal computer, but it is very real. Still, it is difficult to account for the financial equivalent of a company getting struck by lightning.”
Some charged with regulating the health of the insurance industry say discussions of the raters’ credibility are fraught with danger. “Let’s assume that A. M. Best becomes discredited as a rating agency,” said one regulatory official. “The result could be a complete destruction of consumer confidence in the industry.”
But Best’s sharpest critic, Martin D. Weiss of Weiss Research Inc. in West Palm Beach, Fla., contends that “sugar-coating” the insurance industry’s problems does consumers a disservice.
In particular, he takes issue with Best’s rating scale, which ranges from A plus to C minus, coupled with an arcane category called “Not Assigned”
Indeed, companies that fail to meet Best’s minimum standards--”our flunk category,” as Wish puts it--are not “D” but “NA-7.” Companies that do not like their ratings can also request that their ratings not be disclosed.
“The biggest problem with Best is its industry orientation,” said Weiss spokesman Michael Silverman. “If a company can veto a rating, how fair is that to the consumer?”
Staff writer Kathy Kristof in Los Angeles contributed to this story.
More to Read
Inside the business of entertainment
The Wide Shot brings you news, analysis and insights on everything from streaming wars to production — and what it all means for the future.
You may occasionally receive promotional content from the Los Angeles Times.