Life insurance financial ratings: a system in need of an update?

By John Hilton

After a pair of life insurers sued AM Best last year in response to a planned downgrade of their financial ratings, concerns quickly followed.

The implications were readily apparent: is the door open for life insurance companies to sue their way to better ratings? Will financial ratings retain any meaning in the future?

Four months after AM Best and Atlantic Coast Life Insurance Co. and Sentinel Security Life Insurance Co. settled their lawsuit, those questions remain unanswered. Settlement terms are unknown.

"The ability of those ratings' agencies to deliver candid information is highly dependent on their ability to offer independent, unfettered disclosures," said Tom Gober, a certified fraud examiner with expertise in life insurance. "I was shocked when I learned that the A-Cap carriers, facing a likely significant ratings downgrade, filed a lawsuit against AM Best.

"I hope that rating agencies do not feel threatened into delaying a crucial downgrade for fear of litigation. Surely, this ridiculous precedent will not stand."

The insurers are part of the A-Cap insurance group.

AM Best declined to comment on the Sentinel Security/Atlantic Coast settlement terms or any impact on the future ratings of those insurers. But Sridhar Manyem, senior director, Industry Research and Analytics for AM Best, responded to several general questions about the ratings system.

An AM Best credit rating is based on "an in-depth evaluation of balance sheet strength, operating performance, business profile and enterprise risk management, and includes interactive communications with the management team requesting the rating opinion to complete the analysis," he explained.

The gold standard

Founded in New York City in 1899 by Alfred M. Best, AM Best quickly found an important niche in the insurance world. The 1906 San Francisco earthquake devastated much of the city, resulting in insurance claims bankrupting 12 American companies and two more in Europe.

The emergence of modern American society required insurers to demonstrate strong financial footing. They turned to AM Best to validate their books. Ratings continue to dominate perceptions of insurers' financial strength today.

"Stellar financial ratings indicate that a company is in an excellent position to meet all of its financial obligations," New York Life writes on its website. "Dicey ratings may indicate that a company could have problems down the road. Since life insurance is a long-term product, it's essential that the company backing them have excellent insurance ratings."

Unsurprisingly, New York Life is A++ rated by AM Best.

The only rating agency to focus solely on the insurance industry, AM Best's rating system focuses on an insurer's claims-paying ability and the credit quality of its obligations.

"Our rating analysis relies primarily on information provided by the rated entity, including annual and quarterly (if available) statements, presented in accordance with the customs or regulatory requirements of the country of domicile," Manyem said. "AM Best does not audit the company’s financial statements or records, or otherwise independently verify the accuracy and reliability of the information provided."

AM Best also meets with insurance companies to discuss further financial issues.

"Key executives are present to discuss their areas of responsibility, including strategy, distribution, underwriting, reserving, investments, claims, ERM and overall financial results and projections," Manyem said. "The ongoing dialogue with company management is the foundation of our rating process."

Getting more difficult

InsuranceNewsNet also reached out to Fitch Ratings and Moody's Ratings for comment. Fitch Senior Director Jamie Tucker responded with insights into how his company handles ratings.

Fitch criteria is a mix of quantitative and qualitative factors, he explained. Key rating drivers for life insurers are company profile, capitalization and leverage, debt service capabilities and financial flexibility, financial performance and earnings, investment and asset risk, and asset/liability and liquidity management.

Tucker acknowledged that rating life insurance companies is becoming more of a challenge all the time.

"We have seen increasing complexity within the sector, particularly on the investment side as insurers have increased the allocation to less-liquid, more complex and esoteric investments," he said. "This has been driven by various factors, including the relationships with alternative investment managers."

New reinsurance alliances, many with companies based in Bermuda or the Cayman Islands, represent another difficulty in accurate ratings.

In February 2024, AM Best downgraded the long-term issuer credit rating to from bbb+ to bbb for both Atlantic Coast and Sentinel Security. The downgrade was based on "risk management of reinsurance counterparties and its reliance on those counterparties,” AM Best said in a news release.

By late April, AM Best was concerned enough to settle on another downgrade to Atlantic Coast and Sentinel Security, which would have taken their financial strength rating down three notches, from B++ to B-. A month later, the insurers sued AM Best in the District of New Jersey federal court.

Much of the ensuing court proceedings were shielded as proprietary. But AM Best's attorneys claimed in court documents that the insurers failed to provide the information on its assets that would help determine whether its rating action is justified.

Ratings as a start

Richard M. Weber is a 58-year veteran of the life insurance industry, having been a successful agent, a home office executive, a software designer, and the author of four books. He sees a "conundrum" with the current rating system.

The industry is getting more complex all the time, he noted, and it's the agents who are the consumer's link to life insurance.

"Agents must understand more than they tend to about carrier finances, especially today with the degree of offshoring and reinsurance, but at the end of the day, the typical agent is never going to know everything they need to know," Weber said.

Many agents just end up looking at Comdex scores, which combine all of an insurance company’s ratings into a single numerical score. While in theory, making it easier to compare insurance companies' financial strength, it also obscures any outlier negative ratings, Weber noted.

"Agents need to better understand what the ratings mean and what they don't mean," he added.

Traditional financial ratings still have a place in the life insurance world, Gober said, but more is needed.

"No rating agency is perfect. Any industry professional should look deeper than merely an A rating," Gober said. "Let an A rating be the start of additional diligence. Remember that consumers have a rightful, legal claim against only the stand-alone carrier itself. While the carrier might have a thousand affiliates, only the carrier is there for them."

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.