We've discussed life insurance company ratings a couple of times from an informational point of view. Today I want to discuss the topic from a practical point a view (i.e. what's the overall benefit to the end user?).
Some companies would have you believe that their top tier rating means only they have the ability to weather economic downturns and that everyone else is headed into receivership. I used to work for a career mutual where the inference was always “buy from us because we're well rated.” And in 2008 when my career company was the only one in the industry to be upgraded twice by two of the major credit rating agencies and increase its dividend interest rate, you'd better believe that we sang this news from the roof tops (in fact, I will have the full page Wall Street Journal ad Guardian took out just to gloat about these accomplishments).
But does it really matter? In 2008 (and let's be honest every year following) we those (now) Guardian agents had no problem brandying about the news of the company's financial success. But it's not like others who didn't fare as well have gone the way of Shenandoah Life (which is actually still alive and well).
You should Buy from us because we're Triple A Rated…and did we Mention we were Triple A Rated?
We take more than our fair share of shots at Northwestern Mutual (one of these highest rated companies in the industry) because their career agents are some of the biggest offenders of selling products based on nonsense platitudes instead of facts and figures (ain't nobody got time for those). And the old Quiet Company is–at times–a case study for the very topic I want to bring up today.
Northwestern agents are pretty infamous for recommending replacements due only to the fact that the policy someone has currently was not issued by Northwestern Mutual. And when these same agents find themselves in a competitive situation, they jibber-jabber on about nonsensical things and finish up with we're triple A rated why would you want anything else?
But our friends from Milwaukee aren't the only people who commit this offense. All of the big four mutuals have had their moments when, for no reason other than pretension, they've attempted to pretend that no one but they could ever be capable of issuing an insurance contract of any value.
Again, going back to 2008, all of the big four were having the time of their lives postulating on potential failures of each other and their competition…the results were unremarkable. And this fact teases a good question: do these companies overstate their financial position based merely on the fact that they are highly rated right now?
There was no Blood in the Streets
We’ve certainly seen some very unfortunate economic events over the course of the last 5 years, but one thing we’ve not seen is a catastrophic failure of any major life insurer (even the really bad ones).
One of the hardest hit by the 2008 fallout was the Hartford. Prior to 2008, the company held superlative ratings and enjoyed a pretty good position in the variable annuity, term life, and universal life insurance space. Post 2008, the company has plummeted in ratings, exited the individual life market completely, and sold several business units all in the name of raising or freeing up capital. Despite this, no policyholder has been left high and dry.
Claims Paying Ability
Ratings are a measure of perceived claims paying ability. In other words, how well does the company manage the risks to which they have obligated themselves? That’s it. It doesn’t meant one company will pay a better dividends/interest rate or offers better priced life insurance (in fact being pricier helps one’s credit rating).
And lets not forget that not too long ago, we learned the accounting game that goes into the ratings process is manipulate-able—if it weren’t, those Collateralized Debt Obligations would have never made it to triple A status.
Now, I’m not saying that any major insurer is inflated in terms of ratings (I don’t believe that at all).
Additional Core Fundamentals
Ratings are not the only consideration one should take into account when evaluating life insurers. We give ratings so much power because we’re lazy and the ratings system is an overly simplistic crutch we can lean on to recapitulate all of that additional data that makes out heads hurt when we look at it. But the devil is often in the details.
Take the dividend payouts of the big four mutuals. In recent (and in some cases not so recent) years dividend rates have been on a steady slide downwards. This reality comes to light out of two issues:
- A larger pool of policy holders
- A practice of paying a large percentage of total income as dividends
The first one is a tad harder to pick apart than the second. But both circumstances force the insurer’s hand when it comes to dividend payouts because there is much less wiggle room to the insurer. So good years will be good years and bad years will be bad years.
There are other insurers who either have a smaller number of policyholders and/or payout a much smaller percentage of total income as dividends and still have extremely competitive products. These insurers can weather operational downturns in a given year without policyholders ever feeling an effect.
The Comdex, The Laziest Number of them all
The Comdex seems like a great idea. It’s a recapitulation of all of the ratings an insurer presently has and it represents a percentile ranking of the insurer relative to everyone else (e.g. a 90 Comdex indicates an insurer is rated better than 90% of the industry roughly speaking).
But here’s the rub, the Comdex is not an official independent rating. It’s a compiled score awarded by Ebix. Now, Ebix itself is certainly an independent research group that compiles loads of data on insurance companies, but the rating it places on insurers (the Comdex) is not necessarily infallible and certainly not incontrovertible. There are other research firms that evaluate life insurers who disagree with Comdex rankings, meaning what we’ve been lead to believe are lower ranked (rated) companies might just be on a more stable financial footing than other more highly rated companies.
How the Ratings Evaluation Process Works
Most ratings agencies are based off financial data reported under statutory accounting principals (Comdex included). Statutory accounting is different from GAAP (Generally Accepted Accounting Principals), the method of accounting with which we have the most common familiarity, primarily by where the major focus lies. Statutory accounting is concerned mostly with how well a company could dissolve and cover its obligations. GAAP is concerned with the operational profitability.
Think of it this way:
Statutory accounting is focused on how happy your creditors would be if you died, went bankrupt, or otherwise ceased to exist.
GAAP is focused on how well you take what resources you have and turn them into more resources (i.e. how well you make money with your available money in a given time period, e.g. one year).
I mentioned above that ratings are focused on how well we believe a company can pay claims, and while there is some corollary to operational profitability the two can often be mutual exclusive.
Also, there’s a very subtle—but extremely important—point here. The focus is on making policyholders whole, not necessarily how likely the insurer is to remain a going concern. While I assure you no rating agency is oblivious to this consideration, it’s not a primary one.
At the End of the Day…
Ultimately I don’t want to suggest that ratings aren’t important, and I don’t want to suggest the Comdex is of no value. Ratings are useful and the Comdex is extremely useful. But they are not so precise as to tell us that a company with slightly lower ratings is weaker than one with slightly higher ratings.
We can make broad generalizations like a Comdex of 95 is way better than a 65. But the difference between 90 and 100 is negligible (I’d even suggest the difference between 80 and 100 is negligible).
And we must keep in mind that these numbers are not the only numbers that exist. And if one wishes to evaluate companies with cash value accumulation and/or retirement income planning in mind, then life insurance company ratings are tertiary at best considerations (you should be much more worried about operational profitability, which is a much stronger corollary to better cash value performance, than systematic dissolution).