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 would probably not be 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.
The most overlooked factor in selecting an insurer from which to purchase annuities (or any other types of insurance) is the financial stability of the company. If a customer purchases from a financially strong company, then there is an increased likelihood that benefits will be paid when they are due. In the 1970’s, Baldwin United Life Insurance Co. was taken over by the insurance departments due to their financial instability. Their portfolio (consisting primarily of annuities) was eventually moved to several other insurers. Those companies assuming the annuities were able to keep the annuities in force but they could only do so if the insurers did not have to pay the interest accumulated for a period of time. The result was that many individuals – including many senior citizens who depended upon their annuity payments in order to survive, suffered, but at least they eventually received interest income again.
Life insurance and annuity companies otherwise always fulfilled their obligations until 1991 when a large California company was taken over by regulators. Since that time there have been several large and old insurers that met the same fate. While this was well publicized, many, if not most, purchasers still simply ask the agent if the company was financially strong. Sometimes a “handout” from the company is provided which usually states that the company has “sufficient funds” to meet its obligations.
There is no guarantee system for insurance policyholders similar to the FDIC that guarantees bank customers that their funds are protected by the federal government. In the insurance industry, insurers are assessed through state guaranty associations and in most states, the company can take subsequent credit against their state taxes for the assessments – therefore most of the cost associated with failed companies is out of the pockets of the taxpayers.
Regardless, when a company is taken over by a regulator the primary purpose of the regulator is to rehabilitate or sell the company and often, as with the Baldwin United case, regulators may find it necessary to recommend that the court approve altering the policies in force, such as placing liens on cash values, reducing minimum interest rates guaranteed in the policy, and in one case, noncancellable policies were made guaranteed renewable.
For the typical insurance purchaser, understanding financial standing of insurers is confusing, to say the least, and the professional agent is heavily relied upon to provide this service. Therefore, the agent must be familiar with the rating services.
There are five principal rating services: A.M. Best Co.; Fitch Ratings; Moody’s Investors Service; Standard and Poor’s (S&P); and Weiss Ratings. These companies provide rating services which is “an expression of the rating firm’s opinion about the financial strength of a company.”83 Therefore, a high rating does not mean that a company will survive, but the higher the rating, the more likely it is that the company will survive. Conversely, a low rating does not mean that the company will fail, but there is a good likelihood that it will fail. An astute professional will not only look at the ratings, but will also read the rating firm’s reports regarding the company. And, of course, one should never rely too heavily upon what a company has to say about itself – or pay much attention as to what a competitor says about another company.
To confuse the matter even more, it is important to know where a rating fits among the rating firm’s categories. For instance, one would probably think that an A+ rating would be the top rating, and for Weiss Ratings, this is so. But for Best’s, it is the second best (after A++), Fitch’s fifth class (after AAA, AA+, AA, AA-) and S&P’s it is also the fifth. In the same vein, A1 might seem to be the best, but for Moody’s Ratings, it also is 5th. To muddy the waters further, Best has 15 ratings, Fitch has 22, Moody’s has 21, S&P has 19 and Weiss has 16.
As of Aug 1, 2003, Best had assigned ratings to 1,209 life-health insurance companies, Fitch had rated 279, Moody’s 179, S&P 462 and Weiss 1,025. Therefore, for purposes of this text, it could be suggested that if no other reason than more companies are rated, Best and Weiss should be consulted and if the agency or agent does not have access to their ratings, the public libraries can help. Best will provide ratings without charge on their website. (Incidentally, they will provide two types of ratings – one for those companies that have consulted with Best plus an analysis of several years of financial data provided by the company, and an evaluation of the company’s balance sheet and operating performances. The other, “pd” rating is provided from information from public data but with no consultation, etc. with Best.
The Insurance Forum, a private publication that rates companies in depth and uses all of the rating services for their recommendations, suggests that a company that has a high rating from at least 3 of the 5 firms be considered as “extremely conservative, and as of 9/03, 55 companies would be in this category. “Very conservative” consisted of 142 companies (including the 55 companies) by expanding the ratings requirements, and “conservative” for 196 companies (including the ones in the previous categories).
Also, The Insurance Forum publishes a list of life-health insurance companies that are on the watch list, which is a list of companies that has a low rating from at least one of the rating services, plus other information that would indicate that there could be financial problems in the future.
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 or someone who is a part-timer or moonlighter.
An annuity owner should not only be aware of the financial strength of the replacing insurer, but also of the replaced insurer. One company could be much more financially stronger than the other, and if the client is considering exchanging an annuity from a highly rated insurer, to an insurer that is rated lower – or perhaps one on the “watch list” – then, “there you go.”
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, then 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 the 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 such as Standard & Poor's or Moody's Investors Service 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 included Metropolitan Life). 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 and were depending upon the promised return for their living expenses.
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 a 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 types 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 success 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.
Individual states each have a guaranty fund which protect policyholders and beneficiaries within the state in case the insurer becomes insolvent or is taken over by the state Department of Insurance through receivership. The funds are financially supported by insurers who are authorized to conduct business within the state.
California’s fund, the California Life and Health Guarantee Association (CLHGA) is authorized under the California Insurance Code87 and through this Association, coverage is provided to the covered parties for the extent of coverage as provided in the Code.
Coverage is provided to owners and beneficiaries, including assignees and payees of life, health and annuity policies. Coverage is provided to annuity owners who are California residents, but coverage for non-residents will be provided if the insurer is domiciled in California and has never been authorized in the state in which the annuity owner resides, if the owner’s residence state maintains a guarantee fund which is similar to the CLHGA but the owner is not eligible for coverage with that fund.
In addition to owners, protection is provided for beneficiaries, assignees and payees.
Coverage is provided to group annuity contracts, non-group annuity contracts and supplemental contracts (which are designed to liquidate a principal sum over a predetermined period of time). CLHGA specifically covers the following contracts:
Coverage is NOT provided by CLHGA for the following types of contacts:
CLHGA coverage is limited for other annuity contracts:
(a) an interest rate determined by subtracting 6 percentage points from Moody’s Corporate Bond Yield Average for the four year period prior to the date CLHGA became obligated under the contract – but not less than -0- percent; or
(b) an interest rate determined by subtracting 6 percentage points from Moody’s Average for the period starting with the date that the CLHGA becomes obligated under the contract, but not less than 3%.
Other limitations are placed on benefits as to the lesser of 80% of the contractual obligations for each contract, or $100,000 in present value of annuity benefits, with total CLHGA coverage in aggregate for life insurance and annuities, is limited to $250 for any one life.
STUDY QUESTIONS
1. When an individual decides to purchase an annuity, the most overlooked factor usually is
A. the qualifications of the agent.
B. the commissions paid to the agent.
C. the financial stability of the insurance company.
D. the location of the insurance company.
2. When an insurance company is taken over by the regulators such as the Department of Insurance, the primary purpose of the regulators is
A. to sweep the failure of the company under the carpet for political reasons.
B. to blame the federal authorities.
C. to rehabilitate or sell the company.
D. to make sure all agents are paid promptly.
3. There are five rating services, including
A. A.M. Best Co.
B. Dow Jones Investor’s Service.
C. Medical Information Bureau.
D. Forbe’s.
4. The Insurance Forum, a publication that rates companies in depth, has suggested that a company that has a high rating from at least 3 of the 5 rating firms, are
A. on the “watch” list.
B. would be good companies in which to invest.
C. considered as extremely conservative - which is a high recommendation.
D. considered as “average” for financial stability.
5. Financial information on life and health insurers may be obtained
A. only from insurance agencies.
B. only from direct contact with the Department of Insurance.
C. from public libraries, insurance agencies and the Department of Insurance.
D. only from the insurer as most financial information is highly confidential.
6. The Wall Street Journal, Barron’s , Standard & Poor’s and Moody’s Investor Services are particularly good sources of
A. information on the investment portfolios of insurers.
B. information regarding the comparable number of policyholders of an insurer.
C. inside information of insurance companies, such as the backgrounds of the various
officers and their salaries.
D. lists of agents.
7. A general consensus of investment advisors say that their clients can feel quite confident if they only do business with
A. the 25% of insurers that has Best ratings of A++ or A+.
B. companies that are rated A1 with Moody’s Rating Service.
C. insurance companies that have local offices and more than 10 agents in a locale.
D. companies that have a Weiss rating of A.
8. Most insurers, while rated by Best, are not rated by the debt rating agencies such as Standard & Poor’s because they only rate those insurers that pay to be rated, therefore
A. every insurer that can afford to pay the rates, will be rated.
B. only the very poor and struggling companies will want to be rated by these agencies.
C. there largest and most likely to get a high rating have chosen to be so rated.
D. many states do not allow insurers to pay for these services.
9. There are two types of insurance rating services,
A. those that rate life and health companies, and those that rate property & casualty
companies.
B. those that charge the companies a fee to be rated and those that do not charge.
C. those that rate a company only by claims-paying ability and those that rate only by
the quality of their investment portfolio.
D. those that rate mutual companies and those that rate stock companies/
10. If an agent markets annuities and does not have actual, factual and up-to-date information about the stability of the insurer,
A. there is no worry as the guarantee association will bail the company out if it gets into
trouble.
B. an agent is forbidden by law to recommend one insurer over another, regardless.
C. an agent is not considered as a professional investment advisor, so he can recommend
any company – particularly if they pay the highest commissions – without concern.
D. a professional will make an extra effort to become acquainted with the financial standing
of any company that they represent through not only the rating services, but also from a
review of their investment portfolio, etc.
ANSWERS TO STUDY QUESTIONS
1C 2C 3A 4C 5C 6A 7A 8C 9B 10D