In 1994, the government enacted the Insurance Companies (Ratings and Inspections) Act
The act provided for ‘The rating of the claims paying ability of insurers in relation to the business of insurance except life insurance …’ It obliged nearly all general insurers to obtain a claims paying ability rating from one of two approved rating agencies: Standard & Poor’s and AM Best. General insurers had to disclose the rating to prospective policyholders before those policyholders entered into contracts of insurance with them.
The rationale behind the new law was laudable at the time; the government viewed it as the answer to recent insurance company insolvencies. Essentially that rationale could be summed up as buyer beware. Consumers could use the ratings as a way of assessing the risk of an insurer’s insolvency. There was no minimum rating required to conduct business in New Zealand. Rather, consumers could use it as a tool to compare insurers – it was up to the consumer to decide whether to pay more (in theory) for a higher rated insurer or less for a lower rated insurer. This made assumptions about how the market would react to the ratings.
The original act was repealed when the Insurance (Prudential Supervision) act came into force in 2010 (Supervision Act). Most of the provisions of the original Act in relation to ratings were transferred into the Supervision Act at sections 60 – 71. The rating was renamed as the "financial strength rating", and an offence was created for not complying with disclosure, punishable by a fine of up to $500,000.
This regulatory regime has been in place for over 20 years now – is it a useful consumer tool?
Insurers encountered two practical problems with the regime under the original act. The first was that the rating disclosure prescribed included the date of the rating. As the rating had to be reviewed every 12 months, the date changed every 12 months even if the rating itself didn’t. This caused unnecessary costs. The second was a view held by some insurers that the two approved rating agencies were possibly acting as a duopoly.
The Supervision Act addressed both of these problems by dropping the need to provide the date of the rating in the disclosure (it just has to be no more than 12 months old) and adding a third rating agency to the approved list of rating agencies.
However, some core issues with the regime remain:
1. The three rating scales for the three rating agencies are all different. This makes comparing insurers with different rating agencies a challenge. For example, how does one agency’s rating of B+ compare to another’s of BBB?
2. In my experience, awareness of the ratings and the purpose of them is not widespread among consumers even after 20 years. Are consumers in fact gaining any benefit from the regime?
3. The cost to insurers of obtaining the ratings is significant. I understand the cost is measured in tens of thousands of dollars. Is it worth it?
The final core issue is whether the ratings are sufficiently accurate to provide meaningful information to consumers. History would suggest otherwise. Before AIG’s near collapse at the beginning of the GFC, it enjoyed an AAA rating (highest) from Standard & Poor’s. More recently, we have seen AM Best downgrade CBL Insurance Limited, a New Zealand licensed insurer, from A- (Excellent) to B++ (Good) on 6 February 2018. Then 18 days later, it had to downgrade it again to E (Regulatory Action) when the Reserve Bank of New Zealand successfully sought an interim liquidation order against the company in the High Court.
In order to appreciate the scale of that last change, the rating in one day moved through the following bands of AM Best’s scale: Fair, Marginal, Weak, and Poor, before reaching the lowest scale of Regulatory Action. I suggest this raises concerns about the accuracy of a B+ rating only 18 days earlier, and perhaps about the A- rating before that.
These are examples, both nationally and internationally, of the ratings enjoyed by two insurers immediately before they suffered calamitous financial events being a very poor guide to their financial strength at the time. Given this and the other concerns referred to above, I suggest the question should be asked: is this regulatory requirement delivering to consumers or not? I suggest not. The only winners so far have been the rating agencies.
Crossley Gates is a partner at Keegan Alexander.
