It looks like there are some questionable practices going on with the financial strength rating institutions, according to “CalPERS Gives Rating Agencies an FFF” by Kerry Pechter in the Retirement Income Journal. Investors and advisers alike have historically put a lot of faith in the ratings from Fitch, Standard & Poor’s, and Moody’s. The companies rate the financial strength of annuities, bonds, and bond funds through a letter value system. Unfortunately, a lawsuit filed by California’s state employee pension fund (CalPERS) alleges that the companies have been biased in their ratings process by using an “issuer pay” model. This model basically blurs the lines between the rating and the compensation received by the rating institutions. They stand to receive a higher financial payout with better ratings since they are paid by the debt issuers that they rate.
CalPERS lost close to $1 billion by investing in Structured Investment Vehicles (SIVs) that had the highest long-term debt ratings at the time. They believe that these ratings institutions negligently misrepresented the SIVs because of the issuer pay model pressuring them to give high ratings so they would get large returns. All three ratings companies have promised to look into the issues and make changes if necessary, but also believe that the losses can be attributed to a difficult economic environment and “natural actions.” The possibility exists that although the system used by these institutions may have been unethical, it may very well still be legal which would negate any lawsuit. This makes it more important than ever to do your research in order to find the best annuities, bonds, and stocks for your portfolio.