by Jeffery Rowe, JD, Advanced Marketing, Director of Compliance for Creative Marketing
When It Comes to Financial Ratings, Make Sure to Look Under the Hood
I’ve always been a car enthusiast. So, when browsing through news articles the other day, one particular headline caught my eye. The Hyundai Elantra was named the 2012 North American Car of the Year at the recent Detroit Auto Show. Out of 50 cars introduced to the U.S. market last year, the Elantra came out on top according to automotive journalists. Wow, I thought. What a change. In an era when Honda and Toyota have been considered the gold standard, Hyundai takes the prize.
The question arose in my mind, what does this mean? Should I limit myself to looking only at the Hyundai Elantra? Does laying claim to the top spot render other cars inferior? Obviously not; it simply means that a group of professionals has voted differently on the perceived quality or value of a given car. The car may not have changed much, if at all. Rather, journalists’ opinion of the car has changed relative to the automotive environment. As always, buyers still need to look under the hood to find out what they are really getting.
Financial ratings are much the same. A group of professionals weigh in on the perceived strength of a company. It’s true that they say a great deal about an insurance carrier’s reputation and strength, but they, too, are simply a starting point. It’s important that annuity buyers “look under the hood” at a carrier’s financial strength for the whole story.
THE CONTEXT
When looking at a carrier’s financial ratings, it’s important to first consider the context of the rating. In an economic era that includes a ratings downgrade of the U.S. government, the failure of hundreds of banks, highly rated mortgage-backed securities becoming worthless, and A rated companies going to Uncle Sam looking for bailouts, what exactly do ratings even mean? With Standard and Poor’s downgrade of U.S. government debt from its highest rating, does that automatically make all ratings a notch higher? Are today’s AM Best B++ rated carriers the equivalent of yesteryear’s A- rated carriers? To answer that, let’s look deeper into what determines the strength of a carrier or the rating a carrier receives.
The strength of a carrier, whether A- rated or B++ rated, can be discovered by “looking under the hood” at primarily three factors: capital ratio or risk based capital ratio, company history and trajectory, and company management and strategy.
THE FACTORS
Capital ratio refers to the surplus capital a company holds above and beyond its liabilities. This figure is usually expressed in a percentage ratio. For example, a capital ratio of 5% would mean that a company has 5% more capital than its outstanding liabilities. It stands to reason that an insurance company with a higher capital ratio is better protected against losses more than an insurance company with a lower ratio.
Risk based capital ratio is equally, if not more, important. Risk-based capital represents an amount of capital that a company should hold to protect customers against adverse developments based on an assessment of their outstanding policies, the risks they pose and how the company manages their pool of assets. Generally, a risk-based capital ratio of 200 means a company is at the breakeven point. A ratio of 300 represents a company in very good standing, and a ratio in excess of 400 means a carrier has excellent financial strength. Check out the risk-based capital ratios of the carriers you sell for verification of their strength. However, capital ratios are not the only numbers to pay attention to when considering a carrier’s strength.
The total surplus (surplus capital) should also be taken into account. For example, a very large carrier may have a capital ratio of 5% and a total surplus of $2.5 billion. On the other hand, a smaller carrier may have a ratio of 7% and a total surplus of $500 million. Therefore, while the larger carrier has a lower ratio, its total surplus is much higher. The law of large numbers works in its favor, and its size can provide a greater margin. Typically, both carriers with A and B ratings have capital ratios in the neighborhood of 5-8%.
Ratings agencies will also look at the company history and its trajectory. Important factors include the age of the carrier, whether it has been recently acquired by new ownership, whether it has a history of continuous and steady growth, and whether there are any recent changes to the company that might affect its performance moving forward.
For example, a carrier might have great financial ratios, but new ownership or the addition of new product lines might cause a re-evaluation of ratings. The financial stability of the carrier may not be in doubt, but the uncertainty brought about by new ownership can cause an otherwise highly rated company to receive a lower rating.
When looking at the ownership and management of a company, ratings agencies will examine whether a carrier is owned by a larger company that would allow access to additional capital. Perhaps, new ownership has impacted access to additional capital. Agencies will also consider the history and stability of the parent company, as well as the management of the company. For example, is a carrier owned and managed by a group with a long-term record of success in their industry and in managing a portfolio of assets? Answering these questions will provide a better idea of what’s “under the hood.”
All of this begs the question, how have fixed annuity carriers, both those with A and B ratings, fared in this age of economic volatility?
THE EVIDENCE
The best evidence suggests that many of today’s B++ rated carriers are as strong as the A- rated carriers of just a few years ago, and fixed annuity carriers are exceptionally strong. Since 2000, only seven fixed annuity carriers have entered receivership (only one carrier was of any size or significance). In all but one case, the carriers emerged from receivership and were able to honor their obligations to clients. Compare that to the banking world. Since 2000, 446 banks have been taken over by the FDIC, and more than 350 of those banks were not able to make their customers whole.1
The point remains: Fixed annuity carriers have a continued track record of providing great safety and honoring their commitments to clients. When recommending products to your clients, do so with confidence and provide them with the whole story. Remember, today’s B++ rated carrier just might be the new A-.
FOR AGENT USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC. 12146 – 2012/1/18
1 “FDIC bested by annuities on unprotected account balances.” Index Compendium, January 2012.