Three U.S. senators have launched an inquiry into insurance ratings firm Demotech and how its “lightly regulated” assessments may be exposing Fannie Mae and Freddie Mac—as well as all American taxpayers—to the growing risk of a market collapse.
Demotech has come under recent scrutiny due to high failure rates among its rated insurers, especially in Florida and Louisiana. But despite the company’s “troubled rating history,” the two mortgage giants have not moved to reevaluate the company’s methodology, lawmakers said in a letter sent Tuesday to Fannie Mae chief executive officer Priscilla Almodovar and Freddie Mac interim CEO Michael Hutchins.
“It is troubling that neither enterprise seems to have revisited the allowance of a minimum Demotech financial stability rating of ‘A,’” the senators said. “In fact, there is no indication that Fannie Mae or Freddie Mac has ever reevaluated whether Demotech’s methodology meets modern risk standards, let alone raised the minimum threshold or required a dual rating.”
Newsweek contacted Fannie Mae, Freddie Mac, and Demotech by email on Wednesday for comment.
Why It Matters
Demotech, which is based in Columbus, Ohio, was created in 1985 with the goal of rating smaller insurance companies that would not normally meet the required standards to get an “A” from big ratings companies like AM Best and Standard & Poor’s.
For decades now, the firm has played an outsized role in the Sunshine State’s homeowners insurance market, which has faced an exodus of insurers in recent years due to widespread fraud, excessive litigation, and the growing threat posed by natural disasters.
A 2023 study conducted by the Columbia Business School, Harvard Business School and the Federal Reserve Board found that more than 60 percent of Florida insurers had a Demotech rating—a much higher percentage than in the other five states the firm operates in.
But researchers also found that 20 percent of Demotech-rated Florida insurers became insolvent even while holding an “A” rating between 2009 and 2022.
What To Know
How Demotech operates, and how reliable its ratings are, is relevant to Fannie Mae and Freddie Mac, which together back most of the 51 million residential mortgages in the nation.
Fannie Mae first accepted Demotech’s “A” rating for mortgage eligibility in 1989, while Freddie Mac followed suit a year later. But the three U.S. senators who launched the probe—Democrats Sheldon Whitehouse of Rhode Island, Ron Wyden from Oregon and Massachusetts’ Elizabeth Warren—said they are worried that the two mortgage giants’ reliance on Demotech’s ratings could be allowing private lenders to offload riskier mortgages onto them.
This, in turn, could eventually lead to “systemic shocks” and the destabilization of the entire U.S. market, they said.
“A climate-fueled insurance collapse in a state like Florida could ripple through mortgage-backed securities, trigger defaults, and destabilize the market, threatening a repeat collapse of the enterprises such as what we saw in 2008,” Whitehouse, Wyden, and Warren wrote.
The three Democratic lawmakers cite several studies which have found that, in response to more frequent and more severe natural disasters, lenders are “increasingly offloading mortgages with higher climate-related and insurer counterparty risks onto Fannie Mae and Freddie Mac.”
Despite these known risks, the senators said, Fannie Mae and Freddie Mac have continued to purchase mortgages with property insurance coverage from Demotech-rated insurers, “which have been found to have higher rates of insolvency despite high Demotech ratings.”
The Sunshine State, according to the three lawmakers, is where the firm has shown most of its “repeated methodological shortcomings,” rating insurers as financially stable when they were bound for failure.
As the country faces rising homeowner insurance premiums due to the growing threat of climate-related disasters and a surge in non-renewals in the most vulnerable areas of the country, the two mortgage giants’ “approval of a lightly regulated ratings firm with a checkered record poses systemic financial risk to the housing market—and, ultimately, to American taxpayers,” the three Democrats said.
In a separate letter sent to Joseph L. Petrelli, president and chief executive officer at Demotech, on Tuesday, the lawmakers questioned the company over its Financial Stability Ratings of U.S.-based property insurance companies.
What People Are Saying
Senators Sheldon Whitehouse, Ron Wyden and Elizabeth Warren wrote in their letter: “Demotech’s deep involvement in the Florida insurance market—and its repeated methodological shortcomings—raise profound governance and reliability concerns.”
Bob Warren, ratings manager at Demotech, recently defended the company’s ratings, saying, as reported by Digital Insurance: “Everybody wants the magic eight ball or the mystical orb that says, ‘Hey, in 18 months, this company is going to be insolvent,’” but, he added that projections and ratings should be no more than 12 months into the future.
What Happens Next
Whitehouse, Wyden, and Warren are asking Fannie Mae and Freddie Mac to strengthen their oversight of insurer counterparty risk before they find themselves “backstopping a volatile private market with disastrous potential consequences.”
Specifically, they are asking the two government-sponsored enterprises for “information and answers” relating to their risk-management controls for backing mortgages when the underlying asset is insured by a Demotech-rated insurer by January 13, 2026.
