Financial Strength & Claims-Paying Ability

as Seen in National Underwriter AdvisorFX

Barry D. Flagg, CFP, CLU, ChFC, Founder & Inventor THEInsuranceAdvisor.COM

The financial strength and claims paying ability of an insurer is one of the first questions asked when trying to ascertain suitability of life insurance products. However, financial strength and claims-paying ability ratings of the insurer are only one of at least 5 major suitability considerations, and are often misunderstood to mean more than just the financial strength and claims-paying ability of the insurer.  For instance, the answer to the question: “Is this a good product?” is all too often: “Yes, the company is highly rated.” 

An insurer that is highly-rated for financial strength and claims-paying ability does not necessarily mean that every product they manufacture is suitable for every age/gender combination, every health-risk class, every policy size, every product type, every funding strategy, etc.  In just the same way that no investment company offers the best investment products for every client situation, no life insurance company offers products that are best in all client situations.  Instead, certain life insurers excel in manufacturing products that are particularly competitive in certain client situations just like certain investment companies are known for certain types of mutual funds.  

This is not to say that the financial strength and claims-paying ability ratings of the insurer are not relevant to suitability.  They are, and for both the obvious reason and a less obvious reason.  Given that insurance is most simply defined as an agreement for the payment of a premium today in exchange for payment of a claim at some future point, the more time between policy inception and the expected claim date, the more relevant the durable financial strength and long-range claims-paying ability to overall product suitability. That’s the more obvious reason. 

In addition, when an insurer's rating is downgraded, the change often means that either the insurer's profitability has declined, the insurer's reserves have deteriorated, or both. The insurer's most immediate response to a downgrade in its ratings, and its most effective means for restoring profitability and recovering reserves, can be to increase policy costs for cost of insurance (COI) charges and expenses. In other words, when ratings go down, policy charges are more likely to be increased, and thus premiums are likely to (need to) go up.

As such, high and stable ratings for financial strength and claims-paying ability are relevant to overall suitability both for the obvious reason of ensuring death benefits will be paid and because low or declining ratings can be an early warning sign for increases in policy charges.  Rating services like A. M. Best, Standard & Poor's, Moody's, Fitch and TheStreet.com continually evaluate insurance carriers for their financial strength (i.e., the profitability of the insurer's business operations) and claims-paying ability (i.e., the sufficiency of insurer's reserves compared with its future claims obligations).

While rating services may focus on different key indicators or qualitative factors, all ratings reflect some combination of these two measures. Certain ratings are “voluntary”, which is to say the insurer must cooperate with and pay a fee to the rating service for their rating of that insurer. Of course, this cooperation can result in a rating that is based on more information and insight into the financial strength and claims-paying ability of the insurer than that available to “involuntary” ratings services. However, this also means that insurers can “shop” for the most liberal “voluntary” ratings and are usually permitted to withdraw their cooperation when they feel certain public disclosures could hurt business. 

Because ratings services depend on insurance company fees for revenues, and because ratings play a critical role in insurance sales and advertising, some insurers, agents, brokers and/or insurance consultants, therefore, view “voluntary” ratings as less credible due to possible conflicts of interest into the rating process.  It can, therefore, be useful to consider all available ratings from all ratings agencies when determining the financial strength and claims-paying ability ranking for overall suitability of a particular product.

In this way, the relevance of a change in rating change by a single ratings service is less a matter of that isolated change in ratings and more a matter of how such ratings change relates to the ratings of all other insurance companies. Thus, while a product underwritten by an insurer considered to have greater financial strength and claims‑paying ability is not, in and of itself, a more suitable product, products issued by insurers with superior anticipated ability to meet future claims obligations and less financial motivation to increase policy charges are considered more suitable than otherwise. 

THEInsuranceAdvisor.COM provides the empirical pricing and performance research essential to any complete investigation of life insurance policy suitability (as defined by FINRA or the Prudent Investor Act) and which can then lead to independent and objective suitability determinations.  While due care is an emerging field, and while there is room for a difference of opinion in some areas, THEInsuranceAdvisor.COM goes well beyond overly-simplified comparisons of comingled and hypothetical policy values to better protect and/or compete against those misleading Policy Comparison, Policy Audit and/or Policy Evaluation systems or services. 

Use the Confidential Policy Evaluator (CPE) Research Reports to determine the appropriateness of pricing, the reasonableness of performance expectations for invested assets underlying policy cash values, and overall suitability for you(r) clients' policies based on the 5 factors of suitability.  Click here and get up to 3 Confidential Policy Evaluator (CPE) research reports under our NO-RISK trial subscription.