How to Make Sense of Insurance Company Ratings

There are four major rating companies. They include Standard and Poors,
at http://www.standardandpoors.com,  Moody's, at http://www.moodys.com,
Fitch, at http://www.fitchratings.com, and A. M. Best, at http://ambest.com.  To
a certain extent, those web sites are helpful in understanding the financial
condition of insurance companies. The challenge is that there are
complexities in understanding these businesses and their financial situation.

Where to look for ratings

Ratings are published in many places. You will find them on the web site
of the rating agency, on the web site of the insurance company itself, from
special web sites that deal with reference data on business in general or on the
insurance industry, and in the press in company- or industry-oriented feature
stories.The crucial thing to understand about insurance-company ratings is that
their complexity means you cannot deal with them summarily on the courthouse 
steps.

Questions to ask

There are questions that are helpful and practical when faced with
insurance company financial questions. The ultimate question is whether there are
sufficient capital resources to cover the risks the company is assuming.
These risks include, but are not limited to, operating risk (like underwriting
and reserve risk), credit risk, and equity market risk.

An important element in understanding insurance company finance is that
separate lines of insurance are considered separately. Property and
casualty insurance lines are considered separately from life and health insurance
lines.Here is an example of some language from a Fitch Ratings report, dated
December 3, 2001, entitled "Life Insurance Industry Loss Estimates from
Sept. 11 Events" on http://www.fitchratings.com:

It is important to state up front that the impact on the life insurance
industry from the events of Sept. 11 was more modest relative to losses
experienced by property/casualty insurers, and the events are not expected to have a material impact on industry solvency characteristics.  In order to place losses in perspective, consider that the life insurance industry has $3.1 trillion
in assets and pays $52 billion in claims in a year.

Further, the recent developments for the life insurance industry have been favorable as seen by increased life

insurance sales, recovering stock prices, and positive reestimations of
losses from the events of Sept. 11. [emphasis in the original]

Note that this study was of the life-insurance industry only and not of
other lines of insurance. It is easy to quote conclusions out of
context--especially when they are shimmering crystals of clarity in the customary dense underbrush of verbiage--and assume that the data applying to one line of insurance applies to the whole industry. We must be on guard to be part of the solution of clarity rather than the dense underbrush.

There is no one generally accepted rating standard in the insurance
industry. Each rating company publishes documentation that defines its ratings and
criteria for particular ratings. While you are looking at that documentation, you
should look for clues that are important to the understanding of the application
of those criteria. Note the nature of ratio analysis used by the ratings and, in
particular, the sources for the numbers that go into those ratios. Take
the analysis one step further and try to grasp the timing of the numbers that
go into ratios because that timing can affect the final ratio that is generated.
Be sensitive to how the rating company pays its bills--if the rating company
is paid by the companies it rates, it may be less likely to generate negative
ratings on them.

Answers to these questions help us get an accurate financial picture of
particular insurance lines and help us make better decisions for our
clients.