Much ink was spilled over the recent "downgrade" of US government debt by S&P. A second-order effect — which has obvious and important business consequences — occurred with much less fanfare.

S&P's downgrade of the US Sovereign was accompanied by a similar downgrade of the five most highly rated US insurance groups: USAA, NY Life, Northwestern Mutual, TIAA-CREF and Knights of Columbus Fraternal Benefit Society. All of these insurers were previously AAA, but along with Uncle Sam, they were downgraded to "negative outlook."

"The ratings of these five US insurance groups are constrained by the sovereign rating on the US because the insurer's businesses are concentrated in the US, and domestic assets account for a large proportion of their portfolios," S&P wrote in a news release (which didn't make the front page of the Wall Street Journal.) "We factor direct and indirect sovereign risks — such as the impact of macroeconomic volatility, currency devaluation, asset impairment, and investment portfolio deterioration — into our financial strength ratings. The rating and outlook on the US constrain the ratings and outlooks on these five insurers. If we were to lower our ratings on the US, then we would also likely lower our ratings on the insurer[s]."

As S&P's singles out these five insurers (which survived the recent financial crisis with hardly a scratch), it demonstrates the capricious nature of S&P ratings (i.e. why is Northwestern Mutual more vulnerable to macroeconomic volatility than GE, Berkshire Hathaway, and Chubb?), and it also underscores some longer-term consequences should the US Sovereign lose its AAA. Put simply, an insurance company's ability to compete and write new policies is directly related to its credit rating. If/when S&P further downgrades the US Sovereign, these insurance companies will be among the most obvious innocent, first victims.

Sam Marx comments:


Would you say that there's politics involved with the people at S&P who do the ratings?

Imagine the effect on the presidential election that could be had if in late October 2012, they actually downgraded U.S. Government debt.

Russ Sears writes:

If the first law is survival, you have to wonder if the threat of the "nuclear" option was a response to the rumors of Congress taking away the rating agency immunity from investor lawsuits.


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