Monday, June 17, 2013

Insurance Company Ratings

Lately, it seems that the headlines are filled with natural disasters – tornadoes in the Midwest, wildfires in the West and hurricanes in the Southeast and Mid-Atlantic are some of the most recent examples. We’ll leave the debate as to whether these events are happening in increasing frequency to others, but one fact that is not debatable is the destruction that these disasters leave behind. The aftermath can be devastating and, as always, our thoughts and prayers go out to those impacted.

From a financial planning perspective, we often hear a common question posed in light of these events: Is the insurance industry financially sound? The simple answer is yes. Overall, the insurance industry is on solid financial ground and has survived wars and conflicts, natural disasters and financial crises (including the Great Depression and the Great Recession). In an article from 2011 discussing the possible impact of a US Treasury ratings downgrade, the Insurance Information Institute stated insurance companies could not only meet their obligations, but had a cushion of $500 billion, sufficient to cover 12 Hurricane Katrinas – the costliest natural disaster in US history1.

While the general financial strength of the insurance industry as a whole is fine, the financial health of any single insurance company could be a cause for concern for policyholders. With complex balance sheets and complicated legal requirements for cash reserves, it is admittedly difficult for any individual to accurately assess the financial soundness of an insurance company. There are several factors a policyholder should consider to evaluate the different companies.

The first factor is the rating of an independent firm. There are numerous companies that rate insurance firms on their financial strength and ability to meet their obligations, but the main four are S&P, Moody’s, Fitch and A.M. Best. We prefer the ratings of A.M. Best as they use both quantitative and qualitative measures in assigning their ratings. Overall they assign ratings from A++ to F, with 15 possible ratings2.   At Kemp and Associates, we typically only deal with insurance companies rated A++ or A+.

The second factor is the legal oversight over the insurance industry. For the most part, authority for the oversight of insurance companies is given to the states. Each state, therefore, has two primary safeguards to protect policyholders: Reserve Funds and the Guaranty Association. Each state dictates the reserve requirements for insurance companies. Reserve requirements are the assets an insurance company is mandated to have on hand to meet potential obligations. Reserves are separate from and in addition to the other assets of the insurance firm. Each state also establishes a Life & Health Insurance Guaranty Association. The Guaranty Association is a state-administered program mandatorily funded by the insurance companies and designed to protect policyholders in the event an insurance company becomes insolvent. There are limits depending on the state and type of insurance policy, but most policyholders would be receiving some coverage in the event their insurance company became insolvent. (It works much like FDIC and PBGC, but on a state level.)

So, if you are concerned about the financial stability of your insurance company, you should first check their ratings. Ideally, you should work with insurance companies with high ratings. Regardless of the rating(s), there are still other measures in place to help protect policyholders. The analogy we sometimes use is that policyholders have 3 parachutes to pull in the event of an emergency: operating cash and other assets of the insurance company; Reserve funds of the insurance company; and the state Life & Health Insurance Guaranty Associations.

If you have any questions or if we can help in any way, please feel free to contact us.

1 "Insurance Industry's Financial Strength Overwhelms Any Threat from S&P's Downgrade” Insurance & Technology;

2 "Best's Financial Strength Rating" AM Best Ratings & Criteria Center; 


All information herein has been prepared solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular trading strategy.

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