Vol 9 No 8		October 2007

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Nuances of Financial Strength Ratings You Need to Know

"The financial strength rating services provide a valuable service by assessing known financial parameters. The rating services are naturally not able to cope as well with undeveloped issues that lie ahead of them. For this reason I see ratings for some companies that give a false sense of security to advisors. Rating services have very clear rearview mirrors, but images out the front windows appear less clear."

Those of us involved in assisting clients with buying and managing their life insurance pay attention to the primary financial strength rating services as part of the due diligence process. It is my observation that those with the least boots-on-the-ground experiences take the greatest satisfaction upon learning that a particular life insurance company under consideration has excellent ratings. For some life insurance companies the ratings are absolutely a reflection of strength, but for others it isn't.

Let's look at two situations. Acme Life has two top ratings, a second and a third from the four major rating companies. Baker Life has the highest rating from three and a second ranking from the fourth rater. Following the recipe book an advisor would feel comfortable with either company insuring their client for, say, an estate tax liquidity policy not expected to pay off for many years.

What the less experienced advisor may not know is that Acme Life has basically thrown out the underwriting rule book and has been passing out standard offers like jelly beans compared with other companies underwriting the same risks. Lax underwriting means that the company gets more business but will likely have lower profits due to higher mortality than they may be reserving for. Acme Life has also been among the most competitive in pricing their exaggerated guaranteed policies (universal life with no lapse riders). This practice also garners them additional business, but some actuaries believe that such low pricing is made possible by not reserving the risks they are taking on properly. Baker Life continues very prudent underwriting practices and has not followed some other companies down the exaggerated guaranteed pricing hole. The problem is that lax underwriting and exaggerated low guaranteed pricing may not appear distinctly on financial strength rating companies' radar screens until a life insurance company, either internally or from outside audit, realizes it has to do some major reserve strengthening that could exceed free surplus and this equals insolvency.

I believe the rating services understand the low reserving inherent with some of the lowest priced no lapse rider policies and they are aware of the demand from a segment of the actuarial profession for higher reserving. But I don't think the rating companies have a good sense for which companies are so aggressively selling them and piling up large inventories of policies sold, so their ratings haven't been affected.

I have had cases where Acme Life has been the only standard offer and their guaranteed pricing at standard is much lower than the alternatives. We explain all of this to the client and advisors and usually take this best pricing, but with full understanding that we are accepting the risk that a company like Acme Life could fail. The older the client the less concerned we are.

A company that is seized for solvency problems will enter a rehabilitation process supervised by its state of domicile. Once the actuarial and financial issues are ironed out and the various blocks of business are addressed, the affected company will either reenter under the same banner (Mutual Benefit example), continue as a new entity (Executive Life example), or various blocks of business will be acquired by other companies (Confederation Life example). My theory is that the no lapse policyholders will be given the choice of letting the coverage lapse, reduce the death benefits quite significantly with the same premium, or increase the premium substantially to continue the same death benefits. Policy guarantees will only be as good as the company offering them remaining solvent.

The financial strength rating services provide a valuable service by assessing known financial parameters. The rating services are naturally not able to cope as well with undeveloped issues that lie ahead of them. For this reason I see ratings for some companies that give a false sense of security to advisors. Rating services have very clear rearview mirrors, but images out the front windows appear less clear.