Inquiry into Demotech's Ratings and Its Impact on Fannie Mae and Freddie Mac

Three U.S. senators—Sheldon Whitehouse of Rhode Island, Ron Wyden of Oregon, and Elizabeth Warren of Massachusetts—have initiated an inquiry into the insurance ratings firm Demotech. They express concern that Demotech's "lightly regulated" assessments may expose Fannie Mae and Freddie Mac, as well as American taxpayers, to significant risks of market collapse. This scrutiny arises amid high failure rates among insurers rated by Demotech, particularly in Florida and Louisiana.

Newsweek

Founded in 1985, Demotech was established to rate smaller insurance companies that typically do not meet the stringent standards of larger rating agencies like AM Best and Standard & Poor’s. The firm has become particularly influential in Florida's homeowners insurance market, which has faced challenges such as widespread fraud, excessive litigation, and increasing natural disaster threats. A study by Columbia Business School, Harvard Business School, and the Federal Reserve Board revealed that over 60% of Florida insurers hold a Demotech rating, with 20% of these rated insurers becoming insolvent despite maintaining an "A" rating between 2009 and 2022.

Newsweek

The senators argue that Fannie Mae and Freddie Mac's reliance on Demotech's ratings allows private lenders to transfer riskier mortgages to these government-sponsored enterprises. They warn that this could lead to "systemic shocks" in the housing market, reminiscent of the 2008 financial crisis. The lawmakers highlighted that as climate-related disasters become more frequent, lenders are increasingly offloading mortgages with higher risks onto Fannie Mae and Freddie Mac, which could destabilize the entire U.S. market.

Newsweek

In their correspondence, the senators criticized Fannie Mae and Freddie Mac for not reevaluating Demotech's methodology, stating, “It is troubling that neither enterprise seems to have revisited the allowance of a minimum Demotech financial stability rating of ‘A.’” They have requested information regarding the risk-management controls these enterprises employ when backing mortgages insured by Demotech-rated companies.

Newsweek

Bob Warren, a ratings manager at Demotech, defended the company's ratings, asserting that predictions about insolvency cannot extend beyond 12 months. He emphasized that the nature of insurance ratings is not to provide long-term forecasts but rather to assess current stability.

Newsweek

The senators have set a deadline of January 13, 2026, for Fannie Mae and Freddie Mac to strengthen their oversight of insurer counterparty risk. They are seeking detailed information on how these enterprises manage risks associated with mortgages backed by Demotech-rated insurers, aiming to mitigate potential financial fallout from a volatile private market.

Newsweek

• “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,” — Sheldon Whitehouse, U.S. Senator

Newsweek

• “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.” — Elizabeth Warren, U.S. Senator

Newsweek

• “Everybody wants the magic eight ball or the mystical orb that says, ‘Hey, in 18 months, this company is going to be insolvent,'” — Bob Warren, Ratings Manager at Demotech

Newsweek