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May 18, 2012

Why Life Insurance Company Ratings Matter

Summary:

Assessing the Financial Strength of any business partner makes good sense. The unique nature of the life insurance promises requires it to be done at the acquisition date and as part of a regular fiduciary review of any policy.

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Who exactly is making a large financial promise to the family?

In 2011, M Financial published a bulletin taking a look at both the how to and the importance of assessing the overall strength of life insurance carriers. As the bulletin points out:

“The life insurance industry is among the most heavily regulated industries doing business today. In an effort to protect policyholders, life insurance companies are subject to conservative rules and requirements that involve, among other factors, how companies manage their finances and support the products they issue to customers … Embedded within life insurance policies are long-term, intangible financial promises not found with most other financial or consumer products.

The challenge then becomes how to interpret the ratings and understand what the differences mean. When weighing the company selection decision, the implementation stage of a life insurance strategy, it is critical to be sure that advisor bias be removed from the equation. Ratings are one way to address this. The critical factors that need to be addressed, as the bulletin highlights, are:

The Insurer’s Business Profile, or Why Is This The Right Company For This Client (Market) And This Strategy?
The business profile factors are intended to capture those characteristics that reflect the life insurer’s presence in the market. These factors are more subjective than are the financial factors. Insurers that have sustainable competitive advantages in terms of market position and brand, distribution, and product focus and diversification, can be expected to be able to maintain and enhance future profitability and financial strength.

  • Factor 1: Market Position and Brand
  • Factor 2: Distribution
  • Factor 3: Product Focus and Diversification

The Insurer’s Financial Profile, or How Well Are They Running Their Business?
An insurer’s financial profile is of obvious relevance in measuring its financial strength. Moody’s uses five factors to capture this profile. Together, these factors generally account for 60 percent of the overall rating, with the business profile representing the other 40 percent.

  • Factor 4: Asset Quality
  • Factor 5: Capital Adequacy
  • Factor 6: Profitability
  • Factor 7: Liquidity and Asset-Liability Management (ALM)
  • Factor 8: Financial Flexibility

Who Is Vulnerable?
Each Rating Agency defines who they view as vulnerable based on their own criteria. Here are how the four major agencies define a “vulnerable company”:

AM Best 15 Rating Class Assignments – Class 7 to 15 (B to F) – Vulnerable
Fitch 21 Rating Class Assignments – Class 11 to 21 (BB+ to C) – Vulnerable
Moody’s 21 Rating Class Assignments – Class 11 to 21 (Ba1 to C) – Vulnerable
S&P 21 Rating Class Assignments – Class 11 to 21 (BB+ to R) – Vulnerable

Putting It All Together — The Comdex Index
There is an index which is a composite of the average percentile of a company’s ratings. If a company has a Comdex rating of 90 it means that a composite of the company’s ratings has it rated higher than 90% of other companies with multiple ratings.

Ratings Do Not Tell The Whole Story
While it is important to deal with financially sound carriers, there are oftentimes other factors. For example, the underwriting offer from a company with an 88 Comdex may be superior to that from a company with a 92 Comdex. Both companies are in the top 12% of Comdex rated companies, so the need for a competitively priced contract may call for an arrangement with the “lower rated” company.

Assessing the Financial Strength of any business partner makes good sense. The unique nature of the life insurance promises requires it to be done at the acquisition date and as part of a regular fiduciary review of any policy.

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About the Author

Tim Belber is the founder of Generational Wealth Planning & Design.Tim focuses his practice on helping self-made families align the power of their financial assets with their long term goals for flourishing as individuals and families across generations. Tim earned a business degree from the Wharton School at the University of Pennsylvania and a law degree at night from Seton Hall University.

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