John Patrick Hunt

Abstract

Solvency regulation lies at the core of insurance regulation, and—for now—credit ratings lie at the core of solvency regulation. U.S. insurance regulators have long relied heavily on credit ratings to determine which investments insurers may make and to assess the riskiness of those investments. This dependence enabled insurers to invest in novel financial products so long as those products received high ratings. When downgrades and losses later occurred, insurers experienced consequences ranging from severe stress—such as the life insurance industry’s need to raise billions in additional capital—to catastrophic collapse, as seen with AIG and the bond insurance industry. These failures challenged the conventional wisdom that insurers do not pose systemic risk. Although eliminating credit ratings or analogous private credit assessments from insurance regulation entirely is politically and substantively difficult, this Article proposes an alternative: a “seasoning requirement” for credit ratings on novel products, under which such ratings would not receive regulatory effect for a set period, perhaps one full economic cycle. Because many novel financial products failed quickly during the recent downturn, a seasoning requirement would have avoided the most serious drawbacks of rating-dependent regulation while posing far fewer political, theoretical, and practical obstacles than proposals to eliminate reliance on ratings altogether.

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