When evaluating life insurance companies to purchase life insurance, the standard protocol is to utilize one or more of the rating agencies that rate their financial-strength and soundness. Although their are 5 such agencies utilized in the life insurance industry, their ratings are not always easy to interpret and the lack of standardization of ratings adds to the confusion in deciphering their findings. Combine this with the fact that insurers pay some agencies for ratings, and it leads to potential conflicts of interest and creates a confusing system that consumers are left to sort through.
The 5 major ratings agencies in the life insurance industry are; Standard & Poor’s, A.M. Best, Moody’s, Fitch, and TheStreet.com. In a 2009 article by Consumer Reports it was revealed that Fitch, Moody’s, and Standard & Poor’s “have damaged credibility because they earned billions in fees rating mortgage-backed securities that started as “investment grade” but later were downgraded to “speculative”.” We’ve also discovered that most of the agencies are paid by insurers for their ratings creating a potential conflict of interest. Nonetheless, research has demonstrated that the basic validity of the system and the use of the system by consumers is useful.
The basic idea of the rating system with all ratings agencies is that the insurers with the highest grades are the least likely to become insolvent. As an insurer ranks lower, it’s chances of becoming insolvent are greater. Part of the difficulty in interpreting these ratings lies in the fact that the ratings scales and definitions vary so greatly between ratings agencies making it next to impossible to cross reference amongst them. Furthermore, only one agency, TheStreet.com, is funded exclusively from sources outside of the insurers interest. TheStreet.com ratings research is funded through sales of guidebooks and reports to investment advisers and libraries. On the other side of the coin, according to Consumer Reports, a majority if not all of Best’s, Moody’s, and S&P’s ratings are paid for by insurers, and Fitch’s ratings fall somewhere in the middle with less than 50% of their funding provided by insurers. Does this mean the life insurance ratings system cannot be trusted? Not at all. We again fall back on the fact that research has demonstrated the basic validity of the system. However, amidst all the confusion, we do suggest only utilizing companies with high marks when it comes to buying life insurance.
So how do these companies derive their ratings? Most companies rely on a system of analyzing financial data including but not limited to the insurer’s balance sheet, reserves, capital ratio, and other financials. Most of this data comes from reports filed with the state regulators but includes independent market data. All of the ratings companies with the exception of TheStreet.com also use meetings with the insurer’s management to discover more about the company’s plans that they may use to adjust their ratings. TheStreet.com’s reasoning for bowing out on utilizing such meetings in their analysis? They feel the subjectiveness of the relationship factor with management may skew their analytics.
Regardless of the company you use when evaluating life insurance companies, the higher the ratings the better. My personal favorite ratings company is A.M. Best and during my tenure as a Certified Financial Planner I relied almost exclusively on ratings from A.M. Best and never had an issue. Regarding what ratings to require of an insurer for your own insurance, If It were up to me and I had the choice of spending a few bucks more on a higher rated insurer, I certainly feel it’s money well spent. Enjoy Life!
Here are some valuable links to the ratings companies:
A.M. Best – www.ambest.com
Standard and Poor’s – www.standardandpoors.com
Moody’s – www.moodys.com
Fitch – www.fitchratings.com
TheStreet.com – TheStreet.com