Life Insurance Company Ratings–Do They Matter?

The last few years have certainly seen an unprecedented amount of chaos in the global financial markets. And life insurance companies have not been immune to the aftershocks. We all know that in large part, the turmoil was caused by the collapse of the derivatives market.

All of the financial unrest has lead to a much greater awareness and concern regarding life insurance company ratings, overall financial stability and how the carriers are being overseen by third party rating agencies.

One of the first things you should consider, is that the life insurance industry does not have any oversight from the federal government (unless of course you're talking about variable products i.e. variable universal life, variable annuities etc.).  Each state has its own department of insurance which oversees various aspects of the insurance companies admitted to do business in the state.

As such, each insurance department possesses the authority to shut down a company from doing business in their state if the company’s financial condition endangers its ability to meet future obligations.

Which is just a fancy way of saying that if a company doesn’t look like it’ll be able to pay claims, we’re not gonna let that life insurance company keep taking premiums for new policies from the people who live in our state.

Third Party Rating Agencies

I guess we should preface this portion of our article by letting you know that in the last few years, a vast majority of life insurers have been downgraded by rating agencies.  This is most certainly due at least partially to the fact that the “independent” (detect sarcasm) rating agencies were caught  asleep at the wheel and with their hands in the cookie jar at the same time.

That being said, the reaction from the rating agencies has been to now overreact and downgrade all life insurance companies.  The downgrades are due in large part to the mark-to- market accounting rules that have adversely impacted most large financial institutions.

This has lead to most big banks and insurance companies being forced to record huge losses on their balance sheets over the last few years.

Sorry to lead you down that meandering rabbit trail but I felt like framing some of that in context would better help you in understanding the whole system of life insurance company ratings.

AA is the new AAA

Of course we don't put much faith in the outside rating agencies as such, seeing as how many of the CDO's, SIV's, CDS's and CMO's etc. were rated “AAA” right up to the day they fell apart.

Kind of like saying, “It was working just fine, right up to the point that it didn't”.

I'm not exactly sure what we expected as there's obviously not much integrity in a system that requires you to pay a company to issue a rating for your product…right? (sidenote: if you’d like to read the best account of how the financial crisis of 2008 went down, read The Big Short by Michael Lewis)

However, all that being said, within the life insurance industry we are fortunate enough to have ratings from the A.M. Best company.

To our knowledge, they've never been involved in any sort of “pay us for a good rating” scandal. A.M. Best is generally regarded as the gold-standard in the insurance industry when measuring a company's financial strength and claims paying ability.  They have been successful at maintaining their independence when so many other rating agencies have failed.

If you want to better understand how A.M. Best looks at things for the companies that they cover, check out this blurb from their website:

Best's Credit Ratings are independent opinions regarding the creditworthiness of an issuer or debt obligation. Best's Credit Ratings are based on a comprehensive quantitative and qualitative evaluation of a company's balance sheet strength, operating performance and business profile, or, where appropriate, the specific nature and details of a debt security. The complete Best's Credit Rating Methodology is available.

Does my company pass or fail?

A.M. Best uses an alphabetical range, with an A++ (Excellent) being the top rating, moving down to an E (the doors may be chained shut at any moment) at the bottom of the scale to indicate a company’s financial strength.  When Best computes this value they complete an exhaustive analysis of a company’s balance sheet, book of business, and operational performance metrics.

They also look at additional information including what the life insurance companies report as policyowner surplus, reserves, investment performance and funds for contingency expense.

Obviously, we want you to know that we are merely giving you the 30,000 foot view of their rating system.

Keep in mind, their process is proprietary and we don’t know every detail.  But they disclose an amazing amount of information about the individual life insurance companies and about the process they use to derive their ratings.

And for that, we tip our hat.

What does this mean for you?

Well, it means that you have to keep your eyes wide open.

The ratings are definitely a moving target in our current financial and political climate.  You have to ask yourself, “how confident am I that the company issuing my life insurance policy will be around when I need to borrow money from my policy or when I’m dead and my family’s trying to collect on the claim?”

That’s ultimately where the rubber meets the road.

We will say this–at the very least, A.M. Best is fiercely independent and works hard to give an objective analysis of all insurance companies not just life insurance companies.  For that fact, we and many others in the industry rely on their ratings.  By looking at the ratings they provide combined with those from other independent, non-governmental agencies we are able to get a more detailed picture of a company’s overall health.

If we only had a magic eight ball!

Admittedly, were not soothsayers and it’s hard to predict how anything will look five, ten or fifty years from now but using the A.M. Best rating system is our most reliable indicator for now.

It would be worth your time to dig in to their system a bit.  And of course you should be working with us—as we do keep our eye on the ratings and relative financial strength of all our partner companies.