Chapter 7
Most consumers do not understand the
importance of choosing an insurance company.
Agents should understand this and direct consumers to appropriate
companies. It would be hard to
understand why an agent would use any company that could not demonstrate
financial strength. It would be even
harder to explain replacing a policy underwritten by a financially strong
company with a policy issued by a financially weak company.
There are multiple rating firms which rate
insurance companies based on various financial data. Many professionals
recommend looking at the rating of more than one financial service.
The prospective nature of a credit rating
for insurance companies is determined through a forward-looking assessment of
the companys unique fundamental characteristics, as well as various macro and
industry factors. Each rating company
may use different measurements, so it is always best to review more than one
rating of each insurance company.
While different companies may have different
views of a company, Fitch has held a negative rating outlook on the North
American life insurance industry for several years. Since January 1st, 2001, downgrades have outpaced
upgrades by a ratio of more than 10 to 1.
The two core drivers of the Negative Outlook are intense competitive
pressure from both inside and outside the industry, and a shift in business mix
away from traditional life insurance and other protection products to lower
margin products such as variable annuities and mutual funds. The manifestation of these two challenges
has resulted in increased earnings volatility, stressed risk-adjusted profit
margins, and therefore declining sustainable earnings and capital growth rates.[1]
Other factors will also affect how insurance
companies do financially which then affects their credit ratings with the
rating companies. The difficult credit
environment and poor equity market performance has certainly had an adverse
affect on the life insurance industry as a whole. Credit defaults are currently at a 12-year high.[2] The timing of the current down cycle has
affected many industries, but perhaps none as seriously as the insurance
industry. It has caused the industry to
experience higher than expected realized losses and write-downs. In addition, below-investment-grade exposure
has increased as many corporate issuers have been downgraded from
investment-grade rating levels. Even
within the investment-grade portfolios, there has been downward migration in
credit quality issuers. Furthermore,
the current low interest rate environment has caused profit spreads to narrow
for fixed product writers (such as annuities).
In the past, equity market performance has
not had a major impact on life insurers from an investment perspective due to
relatively low direct exposure to equity investments. As the life industry shifted its business mix to equity-linked
products, this has changed. These
products include variable annuities, variable life insurance, equity-indexed
annuities and mutual funds. The impact
of declining equity markets on companies writing these products include lower
sales, reduced fee income tied to lower assets under management, increased
reserves for minimum death benefit/income guarantees, and acceleration of
deferred acquisition cost (DAC) amortization.
The various rating companies look through
economic and business cycles. However,
some rating companies (such as Fitch Ratings) believe the current situation may
be different from past experiences. The change in product mix has made the
industry more exposed to investment-market declines than in previous
turndowns. In addition, the already
challenging competitive environment will make it difficult for the industry to
regenerate the capital lost due to strained investment markets. Therefore, many companies that have
consistently been termed as very stable may be seeing some rate changes. Those with large in-force blocks of
traditional individual life insurance business will be the most likely to
receive high ratings.
Due diligence is a term familiar to most insurance agents.
Diligence involves doing what was required in a reasonably prompt manner. It
also means knowing enough about the companies represented to feel comfortable
about their financial strength.
As we know, agents have an ethical
obligation to describe accurately to the client the financial strength (or
weakness) of the insurance company being proposed. This is true of any insurance
policy being proposed or replaced. In fact, it has been held that an agent has
a legal obligation to accurately describe such financial data. A lawsuit could
be brought against an agent who causes a client to suffer financially as a
result of the agent's failure to fulfill these "due diligence"
responsibilities.
We believe that an agent wishes to give his
or her client the best products available. Certainly a career agent would want
to do so simply to remain in business. Often, it is the agent's lack of
understanding of or attention to some of the technical terminology used in
documents pertaining to the financial strength of insurance companies that
causes the agent problems down the road. In other words, many agents either do
not understand or fail to read much of the material that is available regarding
the companies they deal with. Terms such as admitted assets, consolidated
assets, projected mortality plus many other terms do not completely register
consumer understanding. The agent may have a vague idea of what the terms mean,
but not an actual understanding. Certainly, much of the printed material
available is not stated in a way that makes the information easily readable.
Many of the terms used are associated with
the company's balance sheet, its statement of assets, liabilities, and the
owner's equity.
ADMITTED ASSETS are
those assets the company is allowed by state regulatory authorities to include
in its statutory annual balance sheet. Some of a life insurance company's
assets may be excluded in the interest of balance sheet conservatism, although
most assets are admitted. If an asset is a non-admitted
asset it is generally regarded by regulators as a bit less sound
than admitted assets. Non-admitted
assets are typically thought to provide less security for the company's
policyholders. Non-admitted assets include such things as the agents' balances
owed to the company, office furniture and mortgage loan interest income that is
overdue by more than a specified length of time.
CONSOLIDATED ASSETS
are the total of the assets of the parent insurance company and all the
subsidiary companies, if more than 50 percent of the voting stock is owned.
Even though the assets are owned by two or more separate companies, for the
purpose of the balance sheet the assets are combined and treated as if they
were owned entirely by the parent company. This is due to the voting control
the parent company has. Even the assets of subsidiaries not engaged in the life
insurance business are included in the consolidated assets of the parent
company.
INVESTMENT GRADE ISSUES
are something often seen in percentage forms. These are bonds whose insurers
have been evaluated by a recognized rating agency that has placed them in one
of the agency's few highest quality rating classifications. Generally speaking,
the higher this percentage is, the greater the safety of the bonds in the
portfolio. Therefore, the greater the insurance company's financial soundness.
Even so, the rating assigned to any particular bond issue can be lowered
without warning as a result of many circumstances or events.
It is common for insurance companies to
advertise that their assets exceed large quantities of money; for instance
$2-billion may be stated. While it is important to have sufficient quantities
of assets, the amount of those assets will mean nothing if the company's liabilities
equal or top the amount of assets. The sizes of a company's assets are less
important than the percentage of liabilities to assets. There is a basic
balance sheet equation:
Assets = liabilities +
owners' equity.
All three components must be considered
before the strength of a company may be correctly judged.
OWNERS' EQUITY is the
amount of the insurance company's assets that are financed with funds that were
supplied by owners rather than by creditors.
CONTINGENCY RESERVES
are accounts (from owners' equity) that are voluntarily set aside by the
insurance companies for the possibility of unforeseen future adverse
circumstances. Usually the board of directors will not pay dividends from these
reserves.
UNASSIGNED OR PERMANENT SURPLUS is the amount of the mutual insurer's owners' equity that has not
been set aside for any specific reserve or purpose.
COMMON STOCK that is
referred to in financial statements are the total number of shares of common
stock outstanding. They are usually valued at an arbitrary (and usually low)
dollar amount. This may be called par
or stated value per share.
ADDITIONAL PAID-IN CAPITAL and CONTRIBUTED SURPLUS
is the same thing. It is the excess of the selling price of the stock at the
time it was issued over its par value. Neither the amount of the capital stock
account nor the additional paid-in capital account has any relationship to the
present value of the stock life insurer's common shares.
A balance sheet also contains a section on
the company's liabilities. The largest amount listed will be for amounts owed
to policy-owners and the beneficiaries of the life insurance policies. There
may be (though not always) the normal borrowed funds and accrued expenses
payable.
MANDATORY SECURITIES VALUATION RESERVE is also generally listed in the liability section.
This is a reserve (as the name implies) of some of the assets (not necessarily
cash), which is set aside to prevent changes in the amount of the company's
unassigned or permanent surplus, which may result from fluctuations in the
market value of other assets such as bonds, preferred stock and common stock.
Even though the Mandatory Securities
Valuation Reserve is listed in the liability column of the balance sheet, it is
not a true liability. It is more like a reserve for amounts owed to others.
State regulatory authorities decide the size the reserve must be which is
determined by a number of factors.
CAPITAL RATIO is the portion of the company's total assets that
are financed by owner's funds. This is often the measure used to determine the
insurance company's financial strength. It may also be called Capital-To-Assets Ratio or Surplus-To-Assets Ratio.
The higher this percentage is, if all other things are basically equal,
the greater the company's financial strength is thought to be.
Notice that the previous statement said "if
all other things are basically equal." Since the Capital Ratio is so often used to compare the
financial strength of companies, it is important to realize that different
ingredients may be used in determining the ratio.
Sometimes an insurance company will make
reference to its income statement as a basis of financial strength. Income is
only part of the picture, of course. A company's direct premium income does not
show any premium income or outlays resulting from reinsurance transactions, for
example.
NET PREMIUM INCOME is
typically defined as its direct premium income plus premiums it earns from
reinsurance it assumes, minus premiums it gives up due to reinsurance
that it transfers to another company.
The equation is basic:
Even though this formula may be used by an
insurance company to suggest its financial strength, it really is only about
half of the needed information to make a sound judgment call. In fact it is
more likely to tell an agent the size of the company, rather than its financial
strength.
SURPLUS REINSURANCE is
the transfer of a portion of the amount of coverage under a life insurance
policy to a reinsurer. The ceding or surrendering company then is allowed, if
regulatory requirements are met, to also transfer to the reinsurer a
corresponding portion of the aggregate reserve liability under the policy. The
ceding company (transferring company) receives a credit against its liability
for the portion transferred. Some feel the use of surplus reinsurance may be a
sign of an insurance company's financial weakness.
The terms from the balance sheet that we
have discussed here generally are overlooked by most agents. Typically, agents
are more concerned with a company's rating from the rating firms, such as A.M.
Best. That information is certainly easier for the agent to obtain and
understand. It is also probably easier to relay to a potential client in a
sales situation. However, it is becoming increasingly evident that such rating
firms are not infallible. There are also differing opinions among rating firms.
Which one is the correct rating? There have been insurance companies who
enjoyed a high rating and yet ended up in financial trouble. A career agent
simply must look beyond the rating of the companies he or she chooses to
recommend.
Some states have noted that agents tend to
ignore such things as balance sheets when their state has a guaranty fund. Not
all states have such funds. Many agents probably are not aware that such state
guaranty associations typically cover only the guaranteed values of the policy,
not the projected, assumed or illustrated values.
There are so many things that play a part in
an insurance company's financial strength. Things such as underwriting
standards, how reserves are set up, risk spreads, management and reinsurance
practices are a few of the things that will affect a company's financial
strength. An agent cannot know all that is involved in a company, but an agent
can look past the surface of the brochures put out. Remember that any given
company is selling itself not only to policyholders, but to the agents as well.
Insurance companies must sell the agents on
their products in order to acquire a sales staff. With that thought in mind, an agent can take a common sense
approach towards due diligence. For a busy agent, it can be difficult to follow
through on all financial details involved in an insurance company's financial
report. While the technical analysis is certainly important, such analysis is
not always possible.
When using a common sense approach to
determine financial solvency there may be a combination of factors to consider.
A company that makes one or more obviously big financial mistakes may end up
with financial problems. An example of this is the companies that invested in
junk bonds. Although the bonds looked good at the time, there was no lack of
warnings from the professionals about the problems that could occur.
Watch out also for losses within a company
that exceed the gains. While this may occasionally happen, it is most
definitely a warning signal. Losses eat up capital and surplus funds. In fact,
if money is going out faster than it is coming in, for whatever reason, a red
flag should go up.
Sometimes a lack of public trust can cause
problems. If the consumers perceive a problem within a company, they will begin
to withdraw funds or quit paying premiums. A company that is trying to hang on
may be pushed over the edge when such actions occur.
Perhaps the best common sense approach is
simply looking at the products being offered. If any given product seems to
give much, much more (commissions plus high interest rates for the
policyholder, for example) than other similar products, then it is possible
that trouble is waiting down the road. Product design may also reflect the
company's outlook and philosophy. If gimmicks rather than sound design seem to
hold the product together, that could well be the philosophy of the company. Is
the product set up to "catch and hold" a policy-owner rather than
benefit them? Could you find yourself in an embarrassing situation down the
road when your client requires service or benefits?
If a company is not a mutual company, then
it is often a good idea to know who owns the company. The company's owners will
reflect their own values and ethics throughout the company itself. While it may
not be possible to know what the values and ethics are of any given person, the
agent can look to their past history. Do they come from the insurance field?
What financial education do they have? Looking at their backgrounds can give
the field agent a general idea of what to expect.
The object of using these common sense
approaches is not necessarily to find the best companies, but rather to weed
out the worst of them. An alert insurance agent must keep their eyes and ears
open. Listen to other agents. Follow the service given to clients from the home
office. Does service start out well, but then steadily decline? These are signs
of problems. While it may be something as simple as a poorly managed department
within the company, it may also be something as major as an entire company ran
poorly.
Probably every agent alive has ran into the
client that is sure that he or she knows more than you do. Generally, what it
really amounts to is an underlying mistrust of insurance companies and their
agents as a whole. Such people will often bring up the stories of the
"pending disasters" in the insurance industry. Is this really a
worry?
Some have compared the insurance industry to
the savings and loan industry and that is absolutely NOT a valid comparison.
The financial strength and condition of the insurance industry (especially the
life insurance portion) is one of the most financially solvent industries in
the United States. One major difference between the insurance companies and the
savings-and-loan institutions, as pointed out by Frederick L. Huber who is the
administrator and assistant to corporate counsel of Brokers Marketing Service
in Los Angeles, is that the insurance industry has never been subsidized by the
taxpayers.
Certainly, there is concern in any industry
if the number of insolvencies dramatically increase. Currently, about 30
insurance companies become insolvent each year. The majority of those companies
are in the property/casualty field. An insolvency usually reflects poor
management and/or the amount of claims incurred. Natural disasters can
contribute to property/casualty failures.
Real estate investments have haunted the
insurance industry to a certain degree. However, when you look at the types of
loans made by insurance companies when compared to the savings and loan
industry, the differences cannot be overlooked. Most of the commercial real
estate loans made by the S&Ls were for new construction. The primary loans
made by insurance companies were on completed projects, which were occupied and
do, therefore, have a cash flow. In 1989, the delinquency rate on real estate
loans by life insurance companies was around 2.47 percent. That represented
about .5 percent of their total assets.
There is one area where many businesses,
including the life insurance industry, has attempted to divert attention. In
the past, debt levels were highly stressed. We are now seeing the emphasis
placed more on returns and profitability. An S&L may boast about the amount
of deposits they have. What they fail to mention is that deposits are actually
considered liabilities; not assets. An insurance company may flaunt the amount
of insurance in force. Again, this is a liability; not an asset. Financial
strength is based upon assets and profitability.
Persistency of in-force policies is one of
the best indicators of strong products and good service. Persistency is a
measure of marketing strength and service effort. It is also a measure of how
well the agents have matched products to a client's needs.
It is never an easy task to be both a
successful agent in the field and a company watchdog as well. Over the long run
it will pay off, however. Think of each contract (policy) as a personally
signed document. You place your name on each policy you write. Do you want your
name on anything less than the very best?
Carrier Ratings
A. M. Best Company
Perhaps
the best-known rating company is A. M. Best Company of Oldewick, New Jersey,
which publishes Bests Insurance Reports. This is the oldest insurance industry rating service. Alfred M. Best began the company in
1899. It was known as an independent
watchdog for the insurance industry.
The agent or consumer can obtain statistical data and comments about the
background and operational methods of American and Canadian insurance companies.
A. M. Best
provides information regarding an insurance company's financial condition, a
brief history of the company in question, information on its management,
operating comments and states in which it is allowed to write and sell
business. A.M. Best also grants its own
ratings to companies, designed to reflect strength and weaknesses in four
areas:
1.
underwriting,
2.
expense control,
3.
reserve adequacy, and
4.
investments.
Companies
not receiving one of these classifications are rated as Not Assigned. This could mean there was not enough data
available to assign a classification or it could mean the company was below
minimum standards and could not achieve any rating at all, not even the lowest
category of C.
Anybody
shopping for an insurance company wants to choose one that will be around for
as long as their money is invested in that company's product. Companies have been developed which rate
insurance companies on numerous facets.
What they look for will appear similar to the car ratings in Consumer
Reports magazine since they look at dependability, durability, and safety among
other things.
You may
not find a rating on an insurance company in question for two reasons; they did
not want to pay the $500 fee, or requested the rating not be published. In this instance, the company is listed, but
without the rating that was given.
In most
cases, a policyholder would be wise to place their trust in a company rated A
or A+ by A.M. Best. An agent would want
to look at the rating system in order to provide a sound company for the
policyholder's investment. Most people
probably would not do their own research on a company, even for their financial
stability. As with all insurance
products, whether annuities or life insurance, due diligence is essential when
recommending a product to a client.
Agents should read the annuity or life insurance contracts in their
entirety. The history of a company's
investment portfolio should be considered before recommending a company. A.M. Best provides one source that this can
be done through. Some critics, though,
question the integrity and meaningfulness of the A.M. Best ratings, claiming
that the information upon which the ratings are based in old information and
that insurance companies can pressure them for a better rating. A.M. Best, of course, defends its integrity
and objectivity.
As
annuities become more competitive, insurance companies may be tempted to
overextend themselves. Due Diligence
requires an agent evaluate the carriers that they represent. An agent should know where their carriers
are investing their money. An agent
should know for how long the money is invested. Most importantly, an agent should know the ratio of assets to
liabilities in the companies they represent.
Remember that the size of the assets alone means very little. If liabilities outmatch assets, trouble
could possibly develop.
A.M. Best
is only one source where company information can be found. There are other sources that can be utilized
regarding the ability of an insurance company to make good on their
promises. A.M. Best Company can be
contacted directly at: Ambest
Road
Oldewick,
NJ 08858
(800)
424-BEST (there is a fee for receiving
this service)
The
following is a list of the A.M. Best ratings and what they mean, how they can
be modified and how the "not assigned" ratings can be
interpreted. For an agent, use only the
most current book. Summaries are
available from A.M. Best and even insurance companies themselves.
A+ (Superior)
Assigned
to the companies which A.M. Best thinks has achieved superior overall
performance when compared to the norms of the life/health insurance
industry. Relatively, the A+ rated
insurance companies generally have demonstrated the strongest ability to meet
their respective policyholder and other contractual obligations.
A (Excellent)
Assigned
to the companies which A.M. Best thinks has achieved excellent overall
performance when compared to the norms of the life/health insurance
industry. Relatively, A rated insurance
companies generally demonstrate a strong ability to meet their respective
policyholder and other contractual obligations.
B+ (Very Good)
Assigned
to the companies which A.M. Best thinks has achieved a very good overall performance
when compared to the norms of the life/health insurance industry. Relatively, B+ rated insurance companies
generally demonstrate a very good ability to meet their policyholders and other
contractual obligations.
B (Good)
Assigned
to the companies which A.M. Best thinks has achieved good overall performance
when compared to the norms of the life/health insurance industry. Relatively, B rated insurance companies
generally demonstrates a good ability to meet their policyholder and other
contractual obligations.
C+ (fairly Good)
Assigned
to the companies which A.M. Best thinks has achieved fairly good overall
performance when compared to the norms of the life/health insurance
industry. Relatively, C+ rated
insurance companies generally demonstrate a fairly good ability to meet their
policyholder and other contractual obligations.
C (Fair)
Assigned
to the companies, which A.M. Best thinks has achieved fair overall performance
when compared to the norms of the life/health insurance industry. Relatively, C rated insurance companies
demonstrate a fair ability to meet their policyholder and other contractual
obligations.
A. M. Best's Rating Modifiers:
The
following rating modifiers can be attached to an A.M. Best's rating
classification of A+ through C. The
modifiers are used to qualify the status of the assigned rating. The modifier will appear as a lower case
suffix to the rating.
c - Contingent Rating
This means
that it is temporarily assigned to an insurance company when there has been a
decline in performance in its profitability, leverage and/or liquidity results,
but the decline has not been significant enough to warrant an actual reduction
in the company's previously assigned Rating.
A.M. Best's evaluation may be based on the availability of more current
information and/or contingent on the successful execution by management of a
program of corrective action.
e - Parent Rating
This means
that a company which meets A.M. Best's minimum size requirement and is a wholly
owned subsidiary of a rated life/health insurance company, insurer. However, it has not accumulated at least
five consecutive years of operating experience for rating purposes. The parent company's rating is reference for
companies which meet this criteria until such time as the subsidiary is
assigned an A. M. Best's Rating.
p - Pooled Rating
This is
assigned to companies under common management or ownership which pool 100
percent of their net business. All
premiums, expenses and losses are prorated in accordance with specified
percentages that reasonably relate to the distribution of policyholders'
surplus of each member of the group.
All members participating in the pooling arrangement will be assigned
the same rating and financial size category, based on the consolidated
performance of the group.
r - Reinsured Rating
This
indicates that the rating and financial size category assigned to the company
is that of an affiliated carrier which reinsures 100 percent of the company's
business.
Ratings Not Assigned Classification
Companies
not receiving an A.M. Best's Rating (A+ to C) are assigned to a rating of
"not assigned" classification, which is abbreviated NA. This is divided into ten classifications to
identify the reasons why the company was not eligible or assigned an A.M.
Best's Rating. The primary reason is
identified by the appropriate numeric suffix.
NA-1
Inactive
This is
assigned to a company, which has no net insurance business in force or is
virtually dormant and is not 100 percent reinsured by another company. Normally, A.M. Best will continue to report
on an inactive company if it is associated with a group or is an unaffiliated
stock company pending sale to a new owner.
NA-2 Less than Minimum Size
This is
assigned to a company whose annual net premiums written do not meet A.M. Best's
minimum size requirement of $1,000,000.
The exceptions are:
(a)
The company is 100 percent reinsured by a rated company, or
(b)
The company is a member of a group participating in a business pooling
arrangement, or
(c)
The company was formerly assigned a rating and is expected to meet the
minimum size requirement within a reasonable period of time.
NA-3
Insufficient Experience
This is
assigned to a company, which meets A.M. Best's minimum size requirement, but
has not accumulated at least five consecutive years of representative operating
experience. For most companies, the
year that A.M. Best anticipates assigning a rating is referred to in the report
on the company as set forth in A.M. Best's Insurance Reports, Life/Health
Edition. For all life/health companies
in this category which are wholly owned subsidiaries of a rated life/health
insurance company, the rating of the parent company will also be shown for
reference purposes in A.M. Best's Insurance Reports, Life/Health Edition, until
such time as the subsidiary is assigned a rating.
NA-4 Rating
Procedure Inapplicable
This is
assigned to a company when the nature of its business and/or operations are
such that A.M. Best's normal rating procedure for life/health insurance
companies do not properly apply. Those
companies writing lines of business uncommon to the life/health field; or
companies not soliciting business in the United States; or companies which are not actively
soliciting new business and are in a run-off position; or companies whose sole insurance operation
is the acceptance of business written directly by a parent, subsidiary or
affiliated insurance company or those
writing predominantly property/casualty insurance under a dual charter would be
assigned to this classification.
NA-5
Significant Change
This is
assigned to a previously rated company whose representative operating
experience has been, or is expected to be, significantly interrupted or
changed. This may be the result of
change in ownership and/or management whereby the existing book of business is
sold or reinsured; or a significant revision in the portfolio of coverage
offered; or any other relevant event(s) which has or may affect the general trend
of a company's operations. Depending on
the nature of the change, A.M. Best's rating procedure may require the company
is eligible for a rating.
NA-6
Reinsured by Unrated Reinsurer
This is
assigned to a company which has reinsured a substantial portion of its book of
business or maintains considerable amounts of reinsurance recoverable in
relation to the policyholder's surplus with reinsures which have not been
assigned a A.M. Best Rating.
NA-7
Below Minimum Standards
This is
assigned to a company that meets minimum size and experience requirements, but
does not meet the minimum standards for A.M. Best's Rating of "C."
NA-8
Incomplete Financial Information
This is
assigned to a company which fails to submit, prior to the rating deadline,
complete financial information for any year in the current five year period of
review. This requirement also includes
all domestic life/health subsidiaries in which the company's ownership exceeds
50 percent.
NA-9
Company Request
This is
assigned when a company is eligible for a rating but disputes the A.M. Best's
Rating assignment or procedure. If a
company subsequently requests a rating assignment, A.M. Best's policy normally
requires a minimum period of three years to elapse before the company is
eligible for a rating.
NA-10
Under State Supervision
This is
assigned when a company is under conservator ship, rehabilitation, receivership
or any other form of supervision, control or restraint by state regulatory
authorities.
Standard & Poors Corporation Rating
System
Standard
& Poor's rating system is along the same lines as A.M. Best's. Standard & Poor's insurance
claims-paying ability rating is an opinion of an operating insurance company's
financial capacity to meet the obligations of its insurance policies in
accordance with their terms. The
claims-paying ability ratings are based on current information furnished by the
insurance company or obtained by Standard and Poor's from other sources it
considers reliable. They do not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings
listed below may be modified by adding a plus or minus sign to show relative
standings within the major rating categories.
These reports are generally not available to
the public unless the insurance company which purchases the report chooses to
make it available to the policyholders.
Standard & Poor's Corporation is at:
25
Broadway
New
York, NY 10004
(212)
208-8000
AAA
Extremely
strong capacity to meet contractual policy obligations.
AA
A very
strong capacity to meet contractual policy obligations.
A
Strong
capacity to meet contractual policy obligations.
BBB
Adequate
capacity to meet contractual policy obligations.
BB, B, or CCC
Uncertain
or weak capacity to meet contractual policy obligations, with CCC
assigned to those with the weakest or most uncertain capacity.
D
Default. Terms of the obligation
will not be met.
THE FOLLOWING COMMENTS ARE EXCERPTED FROM
STANDARD & POOR'S INSURANCE RATINGS "FOCUS", DECEMBER 1995, VOL.
4, NO. 4
Some
people believe that insurer ratings are precise "scientific" measures
of the financial strength of insurers.
Ratings, they think, are like a blood pressure test or taking one's
temperature. Such tests produce exact
results and therefore by that analogy, ratings ought to communicate equally
exact information. Of course, this is
not always the case, but by looking at the ratings from several companies, a
fair opinion can be reached.
Standard
& Poor's ratings are opinions about the financial health of insurers based
on the analysis conducted by our professional insurance analysts. These analysts, based in New York, Toronto, London,
Tokyo, Melbourne, and Paris have spent many years evaluating the financial
strength of insurance companies in more than 70 countries throughout the
world. Although many of the tools that
financial analysts use to evaluate insurers are very precise just like the
medical tests used by a doctor, the conclusions that analysts reach from
studying these results are a matter of judgment. Ratings are therefore our judgment of the financial stability of
many thousands of insurance companies.
The
insurers we rate in the "secure" range have, in our opinion, the
financial strength to honor their policyholder obligations. In other words, at a BBB ("adequate
financial security) rating, the insurer has met all of our standards of a
secure company.
Although
some respected observers recommend that insurance be purchased from an insurer
that has the top two ratings of two recognized rating agencies, not everyone
agrees with this very conservative advice.
Certainly, this is not Standard & Poor's viewpoint. In fact what we are saying is that insurers
rated BBB or higher are, in our judgment, secure and likely to remain so.
The
growing reliance on these ratings is a healthy, positive development. Making better informed decisions about
financial strength of insurers is good for consumers, good for brokers, and
ultimately good for the industry itself.
Moodys Rating System
Moody's
concentrates a little more on the quality of the company's investment
portfolio. The Moody's Investor Service
ratings may be divided into three sub-categories.
Moody's
Investors Service entered the bond-rating business in 1904. They have been evaluating life insurance
companies since the 1970s. In 1986
Moody's introduced insurance financial strength ratings to provide guaranteed
investment contract (GIC) investors with objective, independent credit
opinions. In April 1991, the firm
revised several elements of its benchmark capital ratio to reflect the changing
nature of risk in the life insurance industry and to improve the accuracy of
the ratio. Moody's offers financial
strength ratings on nearly 80 life insurance companies, and the list continues
to grow. The rated companies represent
more than 60 percent of the life insurance industry's assets and more than 90
percent of total GIC assets.
Insurance
companies pay approximately $25,000 for the rating services. Moody's sees its real clients as financial
intermediaries such as brokers, pension plan sponsors, structured settlement
advisors and agents. Much of their
attention has been given to companies involved in group pensions and individual
annuity business. In recent times,
coverage has expanded from initial focus on companies selling GICs to annuity
providers, universal life writers, and providers of other life products.
Like
Standard & Poor's rating service, Moody's ratings are not generally
available to the public unless the insurance company chooses to make them
available to the policyholder. For an
annual fee of $125, Moody's quarterly Life Insurance Handbook gives
ratings, explains rationale, and provides executive summaries for all life
insurance companies. The company can be
contacted at:
99
Church Street
New
York, NY 10007
Aaa
Insurance
companies which are rated Aaa are judged to be of the best quality. Their policy obligations carry the smallest
degree of credit risk. While financial
strength of these companies is likely to change, such changes as can be visualized
are most likely to impair their fundamentally strong position.
Aa
Insurance
companies which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa
group they comprise what is generally known as high-grade companies. They are rated lower than the best companies
because long-term risks appear somewhat larger.
A
Insurance
companies which are rated A possess many favorable attributes and should
be considered upper-medium grade.
Factors giving security to punctual payment of policyholder obligations
are considered adequate but elements may be present which suggest a
susceptibility to impairment some time in the future.
Baa
Insurance
companies which are rated Baa are considered as medium-grade, i.e.,
their policyholder obligations are neither highly protected nor poorly
secured. Factors giving security to
punctual payments to the policyholder obligations are considered adequate for
the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. These companies' policy obligations lack
outstanding investment characteristics and in fact have speculative elements as
well.
Ba
Insurance
companies which are rated Ba are judged to have speculative
elements; their future cannot be
considered as well assured. Often the
ability of these companies to discharge policyholder obligations may be very
moderate and thereby not well safeguarded during other good and bad times in
the future. Uncertainty of position
characterizes policyholder obligations of insurance companies in this class.
B
Policyholder obligations of insurance companies which are rated B
generally lack characteristics of the desirable insurance policy. Assurance of punctual payment of
policyholder obligations over any long period of time is small.
Caa
Insurance
companies which are rated Caa are of poor standing. They may be in default on their policyholder
obligations or there may be present elements of danger with respect to punctual
payments of policyholder obligations and claims.
Ca
Insurance
companies which are rated Ca are speculative in a high degree. Such companies are often in default on their
policyholder obligations or have other marketed shortcomings.
C
Insurance
companies which are rated C are the lowest rated class of insurance
companies and can be regarded as having extremely poor prospects of ever
attaining real investment standing.
The Fitch Ratings
Fitch
Ratings was founded as the Fitch Publishing Company on December 4th,
1913 by John Knowles Fitch. Established
in New York City, the company began as a publisher of financial statistics
whose consumers included the New York Stock Exchange. Fitch became the recognized leader in providing critical
financial statistics to the investment community through such publications as
the Fitch Bond Book and the Fitch Stock and Bond Manual.
In 1924
Fitch introduced the familiar AAA to D ratings that we often use today to
rate insurance companies. In 1975 Fitch
was one of three statistical organization companies recognized by the
Securities and Exchanges Commission.
Since
1989, when Fitch was recapitalized by a new management team, Fitch has seen
lots of growth. In 2000 Fitch acquired
Duff & Phelps Credit Rating Company, headquartered in Chicago. Later that same year they bought the rating
business of Thomson BankWatch. These
two purchases added a significant number of international offices and
affiliates.
The Fitch
Rating Company may be reached at:
One State Street Plaza
New York, NY 10004
www.fitchratings.com
Fitch Ratings uses the following guidelines:
AAA
Exceptionally Strong.
AA
Very
Strong.
A
Strong.
BBB
Good.
There are
subcategories to each of these.
Categories
lower than BBB are considered weak by industry standards.
Weiss Research, Inc. Rating System
Weiss is
based on a rating system that should "flag potential problems in such a
way that the average consumer will be adequately informed in a timely
fashion."
Weiss
developed a proprietary computer model that uses some 200 ratios derived from
750 pieces of data to determine an insurer's rating. They do not meet with managers or other executives for the
rating. Data for these calculations
come from the statutory reports insurance companies submit to the insurance
commissioners, plus supplemental data from the companies themselves. Weiss Research receives quarterly reports
from the insurance companies. New
information is added to the analytical process and is reported in quarterly
updates.
The
results of the analysis and the ratings are sent to the companies with a
request that the data be examined and verified. Some insurance companies do not respond to these requests. Others object to the rating received. Still others object so strenuously that they
threaten lawsuits. Weiss Research, Inc.
can be contacted at:
PO
Box 109665
Palm
Beach Garden, FL 33410
(800)
289-9222
Each
rating can be given a (+) or (-) sign.
The plus sign is an indication that with new data, there is a
modest possibility that this company could be upgraded. The A+ rating is an exception since no
higher grade exists. The minus
sign is an indication that, with new data, there is modest possibility that
this company could be downgraded.
A (Excellent)
This
company offers excellent financial security.
It has maintained a conservative stance in its investment strategies,
business operations and underwriting commitments. While the financial position of any company is subject to change,
we believe that this company has the resources necessary to deal with severe
economic conditions.
B (Good)
This
company offers good financial security and has the resources to deal with a
variety of adverse economic conditions.
However, in the event of a severe recession or major crisis, we
feel that this assessment should be reviewed to make sure that the firm is
still maintaining adequate financial strength.
Important
Note:
Carriers with a rating of B+ of higher are included on our Recommended List.
C (Fair)
This
company offers fair financial security and is currently stable. But during an economic downturn or other
financial pressures, we feel it may encounter difficulties in maintaining its
financial stability.
D (Weak)
This
company currently demonstrates what we consider to be significant weaknesses
which could negatively impact policyholders.
In an unfavorable economic environment, these weaknesses could be
magnified.
E (Very Weak)
This
company currently demonstrates what we consider to be significant weaknesses
and has also failed some of the basic tests that we use to identify fiscal
stability. Therefore, even in a
favorable economic environment, it is our opinion that policyholders could
incur significant risks.
F (Failed)
Company is
under the supervision of state insurance commissioners.
Additional Notations:
SA SB SC SD SE (Smaller Companies)
The S
designates companies with less than $25 million in capital and surplus,
excluding companies with more than $500 million in admitted assets regardless
of the capital and surplus levels. It
does not reduce or diminish the letter grades A through E. The S is simply a reminder that
consumers may want to limit the size of their policy with this company so that
the policy's maximum benefits per risk do not exceed one percent of the
company's capital and surplus.
U (Unrated Companies)
This
company is unrated for one or more of the following reasons:
(a)
total assets are less that $1 million,
(b)
premium income for the current year was less than $100,000, or
(c)
the company functions almost exclusively as a holding company rather
than as an underwriter.
Standard Analytical Services
This
rating service gives a descriptive report of a company relative to the
so-called "25-giants" of the insurance industry. The pamphlet handed out looks very similar
to the one provided by A.M. Best. It is
bought mostly by companies that do not receive a favorable rating from A.M.
Best. Professionals question the
credibility and usefulness of this pamphlets.
What Do All These Letters and Numbers
Mean?
Obviously
A+ under Bests system is better than their rating of C. That much is easily understood. The Best rating system follows what people
are already accustomed to: a system of letters and combinations of numbers and
letters. Standard & Poors system
also uses letters. Since their system
is less detailed some prefer it.
Whichever system is preferred, all rating companies should be used,
comparing the different companies views.
Rating insurance
companies is not an exact science.
While those who do so are very experienced in the industry, there are
still variables that make part of the process a prediction. In fact, the statement made by Standard
& Poor is important to note: Although many of the tools that financial
analysts use to evaluate insurers are very precise just like the medical tests
used by a doctor, the conclusions that analysts reach from studying these
results are a matter of judgment.
Many
agents prefer to represent only companies with the highest ratings from two or
more companies. While companies with
lower ratings often have superb records in claim payments and other
obligations, it is understandable why agents might prefer to stay only with the
top companies. Agents must look at the
data and reach their own conclusions just as analysts do when they look at the
information.
Claims
paying abilities and other obligations will certainly be linked to the
companys financial strength. A company
that is struggling may look for ways to maximize their funds. This might be done by delaying the payment
of claims, commissions, or other obligations.