A typical consumer has no idea as to how to determine if a particular insurance company will be around to make its financial commitments when it is needed. They may rely upon the Department of Insurance, but many people do not even know how to contact them. When a person is purchasing an annuity, usually there is a considerable amount of cash involved that will be sent to the insurer with the “promise” that certain amounts will be paid, and/or investments will be made on behalf of the annuity owner. When an investor uses Certificates of Deposit for investments, there is the government guarantee of liquidity within certain limits, but with an insurance company a prospective client (or “investor”) would be negligent if they did not inquire as to the financial standing of the insurance company that has received their hard-earned funds. They are not comfortable knowing that their funds are going to be co-mingled with assets of other annuity holders. Variable Annuity funds are not co-mingled with the insurer’s funds, so owners of Variable Annuities do not have this concern.
A professional will carry information with them from at least one of the rating services giving the rating of the annuity carriers that he/she represents. This information is available from most public libraries, and a professional adviser will maintain the necessary information so if they do not have them at point of sale, then can supply the client with this very necessary information immediately thereafter. The client (investor) can also make inquiries of the financial planner, broker, or agent to find out whether he or she is dealing with a full-time, professional adviser.
The general areas that can be furnished to the investor by rating services are:
Perhaps the best known of the rating services is A.M. Best. Most agents have a copy of Best Agents Guide to Life Insurance Companies. A.M. Best Company reviews the financial status of thousands of insurers and rates them on their financial strength and operating performance based on the norms of the life and health insurance industry. The Best Company has been in business since 1899 and started rating insurers in 1906. In 1934, Best stopped its alphabetical ratings (A+, A, etc.) and began a rating system based on general descriptions measuring the performance of each company in the areas of: competency of underwriting, control of expenses, adequacy of reserves, soundness of investments, and capital sufficiency.
The ratings for A.M. Best are:
A++ Superior
A+ Superior
A Excellent
A Excellent
B++ Very good
B+ Very good
B Fair
B Fair
C++ Marginal
C+ Marginal
c Weak
D Poor
E Regulatory supervision
F Liquidation
s Rating suspended
In general, a prudent investor should only consider the top four categories, particularly with fixed-rate contracts. There are no advantages in dealing with a company that has a B++ or lower rating. Variable Annuities, on the other hand, do not co-mingle their accounts and some financial advisors believe that lack of solvency or bankruptcy does not affect the value or integrity of Variable Annuity investments. However, to be realistic, if an insurance company goes bankrupt, it is possible that the return on variable contracts might be frozen by a purchaser of the contracts or by the Department of Insurance. In any event, the “prudent” investor would want to avoid any such eventualities, even though remote.
A client might want to survey the net yield on invested assets of the insurer. There should be justified suspicion of a company offering a rate equal to or higher than what they are earning on the money.
In considering any of the rating services, they are usually published on a quarterly (at best) basis. Things can change rapidly before the next book is published.
Standard & Poor’s (S&P) has been well known in the financial rating system of insurance companies for over 25years but it’s ratings were not made public before 1983. The company's reputation in the financial guarantee area, however, has enabled S&P to assume a number two position in the “rating’ field.
S&P evaluates the ability of an insurer to meet its obligations based upon and agreement with the insurer to provide S&P with information necessary to achieve a final rating. All claims- paying ability ratings are voluntary with the company’s cooperation. A rating from S&P costs anywhere from $15,000 to $30,000 per year, depending on the company's size.
The information received from the company initially covers about six years of operations and then subdivided into other areas for evaluation. S&P maintains that an essential part of the rating methodology is the identification of the company's product lines and distribution systems and determining its strengths and weaknesses and comparing them to the insurance industry as a whole.
Some of the areas that S&P investigates are:
And many other similar questions are also asked and studied.
After all of the information is studied and discussed S&P deletes the confidential material and publishes the information in: (1) S&P's Insurance Book, a loose-leaf collection of full, in-depth reports on each rated insurer, complete with charts and graphs, updated throughout the year as necessary, (2) S&P Insurance Digest, a quarterly publication containing the company's letter rating and a rationale for the rating, and (3) S&P's Insurer Ratings List, a monthly listing of insurers and their letter ratings.
If a company objects to the ratings, they always have the right to deny publication of the rating and choose to remain unrated.
With this rating system, AAA companies may not be the best for investment contracts as often they have more capital than needed because they pay a conservative rate of return to the policyholders. Companies rated AA or A may be willing to take more risks (though not drastic ones) and they usually pay a better rate of return.
Moody's Investors Service has been evaluating life insurance companies since the 1970s. Moody’s introduced financial strength ratings so as to provide guaranteed investment contract (GIC) investors with objective and independent credit opinions. Moody’s changed some formulae in the early 1990’s to better reflect all of the changes occurring in the insurance industry.
Insurance companies will pay about $30,000 for the service, but Moody's considers its real clients as financial intermediaries such as brokers, pension plan sponsors, structured settlement advisers, and agents, with attention particularly to insurers in the group pension and individual annuity business. Their coverage has significantly expanded from initial focus on companies selling GICs to annuity providers, universal life writers, and providers of other life products. Consequently, Moody's rates a number of small companies as well as the giants.
Carriers that contract with Moody's can refuse to have a rating published, but only if they do not become active in the market that Moody's currently covers (group pension and individual annuities). If the carrier enters the market later on, or Moody's expands to cover the carrier's market, Moody's can release the rating.
Moody's ratings are opinions of the relative financial strength or weakness of insurance companies and are intended to summarize its opinion concerning the likelihood that an insurance company will be able to meet its future obligations to policyholders. Moody’s considers financial strength actually as meaning "claims paying ability."
The Duff & Phelps (D&P) insurance company rating process, is a relatively newcomer, first used in 1986. The companies using this service pays $20,000 for the rating, which, similarly to other rating companies, is derived from information provided by the insurer, then on-site meetings, and the rating is provided after considerable consultation with experts in financial matters. The insurer may either publish the rating, or decide not to.
Weiss has publicly stated that a rating system should "flag potential problems in such a way that the average consumer will be adequately informed in a timely fashion." The company employs about 50 people, including analysts, programmers and technicians, clerks, and customer service counselors, nearly all located in Florida.
Weiss is a little different from other rating services, as it is highly “computerized”, and uses a model they developed that uses some 200 ratios derived from 750 pieces of data to determine an insurer's rating. The data for these calculations come from the statutory reports insurance companies submit to the state insurance commissioners, plus supplemental data from the companies. Weiss is also rather unique inasmuch as it does not interview managers of the insurance companies. Weiss is very statistical driven and believes that good results come from good management, and if the experience of the company is otherwise, no amount of discussions with managers will change the outcome.
The companies are requested to review the results of the analysis and the ratings, and to examine such data and verify it. Historically, some companies do not respond to these requests, or they object to it (sometimes quite vociferously). New information is added to the analytical process and is reported in quarterly updates.
Moody’s and S&P are the primary rating systems that rate the claims paying abilities.
Moody's rating system consists of Aaa (highest quality) down to C (lowest quality) Claims paying ratings are: Aaa, Aal, Aa2, Aa3, Al, A2, Baal, Baa2, Baa3, Bal, Ba2, Ba3, BI, B2, B3, Caa, Ca, and C. The numerical qualifiers (1,2,3) indicate whether a company is in the higher(1), middle(2), or lower(3) end of the category.
Standard & Poor's ratings are similar, with categories ranging from AAA to BBB and speculative grade ratings from BB down to D. The D rating is used only for an insurance company placed under a court liquidation order.
Annual statements are filed by each insurance company with every state in which the insurer does business. In Schedule F of this statement, the amount of claims paid out and claims resisted is listed. The lower the net dollars paid out, the more financially sound the insurer.
A professional should also have the ability to review the annual statement (the “blue book” as they are known to Insurance Departments) and determine other information that can be of value in discussing the financial stability of the insurer to a prospective investor. One does not have to be an accountant to garner interesting information from the statement. For instance, if the insurance company is owned by another company, if the Board of Directors contains a well known public or wealthy figure, the number of states the company operates in, the Capital and Surplus of the company, etc., are easily found and recognized.
For a person with accounting background, the Statements can be a little confusing, as insurance accounting is quite different in some areas, than usual business accounting. If there is ever a question, specific questions will be addressed by accountants or actuaries at the insurance company. Actually, if the insurer would hesitate in furnishing any requested financial information; there could easily be a question whether an annuity should be placed with the company. Agents have been sued when an insurer that they represent, goes “down the tubes.” The presumption by the client is that the agent should have been aware of any financial difficulties, etc.
Insurance companies help keep printers and paper companies in business, it seems, and fixed rate annuity companies are no slouches in this respect. Most, if not all, offer information on their investment portfolio in brochures and other marketing material. If further information is needed, a call to the marketing department of the insurer should bring results. Of courses, other sources could be the Wall Street journal, Barron's, and materials published by A.M. Best, Moody's, and Standard & Poor's, as well as other financial newsletters and periodicals. When all else fails, one can always contact state's Department of Insurance.
It is not unreasonable, at all, for a potential client to ask for a summary of the insurance company's investment portfolio to see how its assets are distributed. There is no right or wrong mix of investments, but there are industry norms that have proven sound through good and bad times, and most insurance companies tend to follow them. For whatever it is worth, the American Council of Life Insurance (ACLI), reviews the annual financial statements of nearly every U.S. insurance company and reports the industry portfolio averages. As expected, the investments of insurers must be conservative, as indicated by the latest statistics: 43 percent corporate bonds, 22 percent mortgages, 15 percent government securities, 5 percent policy loans, 5 percent stocks, 3 percent real estate, and 7 percent in other asset categories.
A general consensus of investment advisors say that their clients can feel quite confident if they only do business with the approximately 25 percent of insurers reviewed by A.M. Best that get the company's A++ or A+ rating, particularly those that have had that rating consistently for years. A second rating from a company Standard & Poor's, Moody's Investors Service and Duff & Phelps, can solidify the confidence. Unfortunately, most insurers, while rated by Best, are not rated by the debt rating agencies. The debt rating companies, unlike Best, rate only those insurers that pay to be rated; the largest and those most likely to get a high rating have chosen to do so.
In 1991, Executive Life Insurance Company of California was seized by California regulators due principally to its having nearly 2/3 of its assets in junk bonds while the industry average is about 6%. Policyholders of interest-sensitive life insurance policies, approximately 170,000 life insurance policies outstanding, with a face value of $38 billion, and the owners of their 75,000 fixed-rate annuities with a value of $2.5 billion, as a whole, were not complaining, as the investment in junk bonds allowed a higher return on their portfolio than that experienced by other companies. However, the insurance industry is closely regulated, and rightfully so, and the insurance departments (not only of California) were not comfortable.
Earlier, Baldwin-United, an annuity writer failed in 1983. No investor lost any money because of their collapse, however, annuity owners had their assets frozen during the period of time that the insurance departments were shopping for a savior (which eventually became Metropolitan Life primarily). The contract owners got only 7.5 percent on their money, not the 13.6 percent initially promised. So even though no one “lost” any money, many of the annuity owners were elderly persons who did not need this type of problem late in their life.
Life and Health insurance companies (and other insurers also) belong to Guaranty pools, or at least protected by some sort of guaranty fund, in their state of domicile. Therefore, while an annuity may not be backed by government funds, as a CD purchased from a bank does, there is still considerable financial backing if an insurer becomes insolvent. The guarantee as far as the individual annuity owner is concerned, depends entirely upon how the insurer becomes insolvent, residence of the contract owner, type of annuity, and value of the annuity. Guaranty laws have been established in 46 states for the purpose of protecting policyholders against insolvency. Generally, there is a limit of $ 100,000 on cash values of life insurance policies and up to $300,000 on combined benefits from all life insurance policies. The Guaranty funds are backed by assessments of solvent insurers when an insurer becomes insolvent. Annuity investors are protected, with overall coverage limits normally being higher. Coverage for annuities is typically 80% of the annuity’s contract, or $100,000, whichever is lower. There are multiple coverages if there are multiple policies issued to the same person. All annuities are covered by these guaranty laws with the exception of those contracts owned by corporations or partnerships, what are referred to in the industry as "unallocated annuities." In the case of an insurance company's death benefit, protection against an insurer's insolvency is covered for up to $250,000 per policy or 80 percent of the death benefit, whichever is less.
Basically, there are two types of rating services, those that charge the companies a fee to be rated and those that do not. Those that do not, Weiss Reports and Standard & Poor's Insurer Solvency Review, make their money by selling their reports to investors and brokers.
On the other hand, the companies that charge a fee, Standard & Poor's (in certain instances), Duff & Phelps, Moody's, and A.M. Best, hope that insurers that do not have any kind of rating will look worse to agents and annuity purchasers than companies that have a low rating.
Many insurers either do not want to pay a rating fee, or they do not see the necessity of obtaining a rating from more than one service. There is a certain amount of logic in not getting a second rating, if the first rating is quite high. They can use the high rating to their distinct advantage in advertising. Even with a high rating, an investor can be misled, because they still do not know if the company’s financials are (and if so, how) affected by excellent, good, or bad investments. The job of a true professional is to help guide these clients with accurate information so they can make an intelligent decision.
Finally, it must be stated that rating is rather judgmental, and even the largest and oldest of the rating company’s do not always agree. It can be said that the Weiss Reports and Standard & Poor’s Insurer Solvency Review are targeted toward the average investor rather than the sophisticated broker or financial adviser. And while they are quite easily understandable, neither of them are totally complete. Of course, the same thing can be said about A.M. Best. They often do not agree. A random sampling of an insurer shows that while Weiss shows the company as falling into one of their weakest categories. A.M. Best lists it as “insufficient experience.” However, S&P and D&P, both give it an AA rating. These type of discrepancies are not unique.
What to do? An insurer does not have to have the top rating to be safe. Most experienced insurance experts will agree that it is a mistake to rely too heavily on one rating service. Also, keep in mind that there are only a few banks that carry the top rating (AAA) – however, again, the banks are backed by the strength of the U.S. government.
Perhaps the best advice in this matter came from a very successful financial planner who knows, understands, and likes annuities. He looks at every client as if they were his grandmother (or grandfather) and he was responsible for them to invest their money so they would not have to suffer during retirement. Before he represents some insurers that may not be known as well as the giants, he has been known to go to the home office and personally review their investment operations. He does not feel that this is “overkill”, but is just an action a true professional would automatically perform.
We can all wish that all of those who market annuities would have the same commitment to the profession.
STUDY QUESTIONS
1. Which of the following services to a potential investor cannot be furnished by a rating
service?
A. the investment portfolio
B. claims paying ability
C. policy provisions
D. annual statements
2. An A.M. Best rating of B+ means the company is rated as
A. excellent.
B. very good.
C. fair.
D. great.
3. A rating from Standard & Poor’s
A. is only good for property and casualty companies.
B. is not considered as a major rating service.
C. can cost the company between $15,000 to $30,000 per year.
D. is always disregarded in sales pieces.
4. Companies rated _______ are probably not the best for investment contracts as they have more capital than needed for their operations and could conceivably be too conservative with their investments for their clients.
A. A
B. B
C. BBB
D. AAA
5. Which of the following rating companies considers its “real” clients as financial intermediaries?
A. A.M. Best
B. Standard & Poor’s
C. Moody’s Investor Services
D. Weiss Research
6. Weiss Research, Inc., believes that if the company is managed well,
A. there is no reason to interview the managers.
B. then the managers should be interviewed to anticipate any difficulties.
C. they do not need to be rated.
D. they will automatically be rated A+.
7. The rating services that are the primary companies to evaluate the claims paying ability of an insurer, are
A. A.M. Best & Standard & Poor’s.
B. Weiss Research and Moody’s Investor Services.
C. Moody’s Investor Services and Standard & Poor’s.
D. A.M. Best and Moody’s.
8. Insurance companies invest mostly in
A. mortgages.
B. real estate.
C. corporate bonds.
D. common stocks.
9. The assets of insurance companies in most states are protected by
A. the Federal Deposit Insurance Corporation.
B. the Securities and Exchange Commission.
C. a guaranty fund.
D. State Bonds.
10. Which of the following would be least interested in knowing the rating of an insurer.
A. The purchaser of a fixed premium deferred annuity.
B. The purchaser of a TSA.
C. The purchaser of an EIA.
D. The purchaser of a Variable Annuity.
ANSWERS TO STUDY QUESTIONS
1C 2B 3C 4D 5C 6A 7C 8C 9C 10D