In light of the recent, highly publicised downgrades, what legal recourse may there be where the basis of a security rating is challenged, or a cedant suffers loss as a result of a rating that fails to reflect a reinsurer's financial strength?
Some reinsurers believe the recent downgrades are a reaction to concerns that are industry-wide rather than about individual companies. It has also been suggested that they are an attempt to counter accusations that the failures of companies such as Independent Insurance took the rating agencies by surprise. The rating agencies' methodologies and reliability are being questioned but, as a rating is no more than an opinion, it is difficult to dispute its validity or sustain a case that it is negligent or defamatory.
Cedants rely on rating agencies in as much as their purchase of reinsurance will be subject to minimum security requirements and because reinsurance contracts often incorporate cancellation clauses triggered when a reinsurer's security rating is downgraded. The failure to downgrade a reinsurer in financial difficulty will mean a cedant retains a reinsurer as security, which may ultimately be unable to pay all its claims. This prompts the question as to whether a cedant can sue a rating agency for any loss it suffers as a result of such failure. For a cedant to bring such an action, it would first have to establish that it was owed a duty of care.
Duty of care
The duty owed to third parties for negligent mis-statements is very limited. Caparo Industries v Dickman ( 2 AC 249) held that it was limited to statements made where it was known that they would be relied on by a particular person, or class of persons, for a particular purpose. A duty of care could not be established where a statement was put into general circulation even if it was foreseeable that certain persons might rely on it. This is clearly the case with rating agencies whose publications are used throughout the business world. It is therefore unlikely any cedant could sustain an argument that it was owed a duty of care by a rating agency. A further obstacle to such a claim will be disclaimers as to the accuracy of the information and exclusions of liability used by the rating agencies.
There are no known instances in English law of a downgraded reinsurer taking legal action against a rating agency. One likely reason for this is that, in most cases, the reinsurer will have had a contract with the rating agency to produce the rating and it would have been published with the knowledge and consent of the reinsurer.
The position is more interesting when a rating is unsolicited. It is strongly arguable that a duty of care would be imposed in such circumstances because the loss suffered by the downgraded reinsurer would be relatively foreseeable and it would be reasonable to impose a duty as there would be no other recourse to recover the potentially significant losses resulting from the negligent downgrading. However, having got over this hurdle, the reinsurer then has to establish on the balance of probabilities that the rating agency has been negligent in that it has failed to exercise reasonable skill and care in producing the rating. Relevant factors would include: failure to take into account other information in the public domain; inconsistency in the application of the ratings methodologies between different reinsurers; and reliance on inaccurate information in the public domain (such as market gossip) that had not been properly verified by the agency. This raises the question of to what extent the agencies have a duty to verify with a reinsurer the accuracy and completeness of the information on which they have based their rating, although it is arguably the case that this is no more than good journalistic practice, which in most cases will prevent a dispute.
A case in negligence will be made more difficult to pursue because it is likely that to demonstrate negligence the courts would rely on a test akin to that applied in professional negligence cases. That is, if other rating agencies state they would have reached the same conclusion on the basis of the same information, the agency being sued will have a strong defence.
The wrongly downgraded reinsurer may also have a case in defamation if it can establish that it has suffered commercial disadvantage as a result of a downgrading. The rating agency would probably resist such a claim on the basis that the defence of 'fair comment' applies. This defence allows the free expression of opinions on matters of public interest, provided the opinions are based on verifiable facts. However, this again raises the question of whether the rating agency should verify the facts and obtain a comment from a reinsurer before publishing an unsolicited rating. Fair comment would not apply if it could be shown that the information was inaccurate or materially incomplete.
Rating agencies are coming under increasing scrutiny as to the validity of their ratings but cedants and reinsurers face considerable legal obstacles in establishing negligence or defamation cases against the agencies. However, rating agencies are certainly vulnerable to such claims if they do not ensure that the information on which their ratings are based is complete and accurate.
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