Financial Strength Ratings and You

Financial Strength Ratings and You

Buying life insurance can be complicated –but don’t let all the finer details take your eyes off of one of the most important attributes about insurers:  their financial strength rating.

A financial strength rating is an opinion of an insurer’s ability to meet their claims paying obligations.   Financial Strength Ratings, or FSRs for short, are similar to a companies’ credit rating, however they focus on policies in force and less on general cash flow.   Although this sounds rather obvious to most insurance consumers, locating, understanding, and analyzing FSRs is anything but simple.

Financial Strength Ratings, the basics:

There are three credit rating bureaus: S&P, Moodys, and Fitch Ratings, combined with Insurance rating specialist AM Best that each issue FSRs on most of the larger insurance companies.  Each bureau has their own rating system.   These ratings are merely intelligent opinions about these companies’ financial situations, but in no way guarantee solvency.

The Focus on AM Best:

Of all four or the rating agencies, AM Best is probably the most consumer friendly, therefore for the purposes of this article we shall focus on how best to use their rating system.   There really is nothing inheritably better about their product than any of the other raters.  However they are probably the easiest for consumers to gain access to and to understand.

Locating Financial Strength Ratings:

First off go to the website:   ambest.com and create an account.  They will require you to set up a login and a password.   Next search for the company that you are interested in.  For some companies this will be very easy, for others that either have a marketing name that differs from their legal name or for companies that are part of a large conglomerate, this could prove difficult.

For those insurers that have what I call ‘marketing names’, you will need to find the true legal name of the proposed life insurer.  You may need to look closely at the quote you were given or to reach out and ask your insurance agent.

Second, for insurers that are part of large complex corporate entities, you may, unfortunately have to do some digging.   Often insurance entities will have the exact same financial strength rating as their parents or siblings, but sometimes this is not the case.   AM Best does a pretty good job of allowing you to search under the so called “Ultimate Parent” and through the “Operating Insurance Entities.”

Collect all of this data about the actual insurer and any ultimate parent and other operating insurance entities involved and focus mostly on the actual insurer’s financial strength rating.

Of special note here is that AM Best also rates insurers on their Long Term Credit Rating.  These are important, but for our purposes, we will not consider them.   We will consider the actual FSR and to a lesser extent the size category rating.

Understanding Financial Strength Ratings:

Only in the world of financial strength ratings is an A+ not the very best grade that you can receive.   The highest rating from AM Best is reserved for an A++.  However the distinction and difference between A++ and A+ is so minor to make me wonder if it matters at all.  They are both considered Superior.  The odds of either of them going under, very slim.

Analyzing Financial Strength Ratings: 

Performing self-analysis on financial strength ratings for insurers that you are considering is not simple.  Most consumers merely review the ratings and take them at face value.  This is probably the smart thing to do for most insurance policies that you are likely to purchase.  The exception to this are for clients that are considering an insurer for any type of annuity and for any type of cash value life insurance policy, such as whole and universal.  If you plan on relying on an insurer for 40, 50, or 60 years a deep financial analysis is important. 

Clients that are purchasing popular and simple term life policies probably should concern themselves with staying in the A range.  Meaning A- or higher, even for One million dollar term policies.   In most cases you should not need to purchase a product from anything lower than that.

The case with permanent insurance and annuities is vastly different though.   Obviously you should not purchase a universal policy from a carrier that is rated B++.  Is an A a high enough grade or does it make sense to solely focus on A+ and A++ carriers?

There is no clear answer to this – likely some of the insurance salesmen that you meet will have obvious opinions about this matter.  I would caution you against instantly agreeing with them.

The statistical odds of an A, A+, or A++ carrier falling into insolvency, are not that high.  They are not nonexistence though.   The discussion of the exact statistics though is not as useful as one might think, given the special rules that exist to prevent insurers from closing up shop and failing to pay legitimate claims.  Insurance companies, governed by various state laws, do not just go bankrupt.  The simple version is that the State Regulator, basically takes a form of control and the state Insurance Guarantee fund may pitch in to assist.  There are numerous limitations to this.  There is a lot to prevent life insurance firms from going under in today’s modern society.

So is an A+ firm always a better choice than an A insurer?  The answer is yes if they are two identical companies, but no two firms are.  

The Size Factor:

One of the other ratings that you will see near the FSR is the size categorization.  This rating is displayed in Roman numeral format.   Although important the main goal for consumers may be to be to be potentially stay away from the smallest of the insurers.

Other Non-Rating Considerations:

One of most important things that consumers can ask themselves of their potential future insurer is what other businesses are they involved in?  For example Pruco Insurance, through its ultimate parent Prudential performs all sorts of other non-insurance functions.  These include mutual funds, financial advisement, etc.  These would seem to be an important factor going into making your decision.

AIG, which is one of the largest insurers on the planet, had at the time of the great recent financial crisis a large book of business in what we now all know as Credit Default Swaps.   These swaps are the type of product that probably should have been factored into their Financial Strength Ratings at the time, but I doubt that it was.

The Real Value of Financial Strength Ratings:

The real value of financial strength ratings is to give consumers a glimpse into an insurers claims paying ability. Using these ratings consumers should be able to stay away from poorly rated companies that may not last the length of the insurance or annuity policy.

Scott W Johnson is the owner of Whole Vs Term Life Insurance – A California based Term Life Insurance shop.  Scott is a consumer advocate and spends his time with his family.