A lot of our clients want to know why they should trust insurance companies any more than they trust the stock market. After all, many of these clients lived through the financial crises of 2008 and lost millions of dollars in investments that were touted as safe. The fact is, no investment is ever safe — but insurance isn’t an investment.
The insurance industry is regulated by the states the companies do business in and are required to adhere to certain standards. To ensure that you’re working with an insurance company that adheres to these high standards, this is what you need to know about how insurance companies are rated and how they protect your premium.
Who Rates Insurance Companies and How They Do It
Insurance companies are rated by four different private agencies. Standard & Poor’s, Moody’s, A.M. Best, and Fitch are primarily responsible for rating insurance companies and each has its own specific categories it assigns based on relatively the same criteria. These categories, in their most general terms, are:
- Excellent: An excellent rating is usually represented by an AAA or an A+ across all rating agencies. Companies with this rating are financially strong and there is little to no doubt they will be able to pay ongoing obligations regardless of the economic climate.
- Good: Across agencies, a good insurance rating will be represented by an AA, A, A-, B++, or B+. The good rating means that this company is strong financially and it’s unlikely it would be unable to pay its debts, even despite major economic changes.
- Fair: A fair rating is represented by a Baa, Ba, BBB, or a BB, depending on the agency. While this company is currently financially strong, any major changes in the economic climate could significantly impact the company’s ability to pay its debts.
- Marginal: A marginal rating is represented by a B, B-, or CCC. This company might currently be meeting its obligations, but it is entirely possible it will not be able to in the future, regardless of the economic climate.
- Weak: Caa, CC, C, and C- are used by the various agencies to represent a weak rating. While this company may be meeting financial obligations now, it does not have the funds to continue meeting those obligations in the future.
- Poor: A poor rating is represented by a Ca, D, F, or S. When a company receives this rating, they cannot meet current obligations and default status is imminent.
When you’re looking for an insurance policy, you want to go with a company that was either rated good or excellent. There is no reason to use any companies beneath those ratings, as there is a wide range of insurance companies that have maintained those high, safe rankings for years. While a fair or below-rated company might promise more coverage or a higher return, keep in mind you get what you pay for and it’s possible that company could default, causing you to lose a significant amount of money.
Anything not rated at all should be avoided. To be covered under state insurance laws, an insurance company must have an industry-accepted rating. If they do not have a rating at all, they don’t offer the protections that your state demands insurance companies offer.
How Insurance Companies Are Required to Protect Customers
Insurance companies are managed at a state level. When an insurance company wants to do business in a given state, that company must pay into a state insurance fund as a means of insuring their insurance. Essentially, this fund is there so in the worst case scenario, like the company goes bankrupt, funds can be paid out to reimburse clients.
But that isn’t the only protection in place. When an insurance company wants to do business, they have to prove they hold a reserve of funds to pay out claims. Insurance companies grow their funds by holding funds in a general account where they invest them conservatively to back up their obligations.
Many states require that the statutory capital reserves be equal to 125% or more of their obligations in order to make certain that the promise of the insurance policy is kept. The returns of the general portfolio help to grow the funds so that the company has working capital, can make a bit of profit on the premium, and is a position to expedite the claim. The reserve amount the company is required to have is a bulk amount that cannot be invested. It must be held in a safe, secure place where it can be used to pay out claims.
How much of a reserve the insurance company is required varies by state and is comprised by many factors. It should be noted, however, that insurance companies are held to a much higher standard than banks which are not required to retain such reserves since they simply lean on the guarantees offered by the Federal Deposit Insurance Corporation.
The concern with that arrangement is that in the event of a severe market or banking crisis like we experienced in 2008, the pressure on the FDIC may be too much and bank funds could be at risk. That is the reason why the former head of the FDIC had expressed concern about the current arrangement and indicated that the need for “stress testing” was critical across the banking spectrum.
Insurance tends to be a safer, more conservative option because the reserves are already in place and because that system helps people avoid market-based risk. However, the safety of your money depends on the overall safety of your insurance company. When it comes to insurance, Howard Kaye advisors only work with the best, most reputable companies. For more information on using insurance as an alternative to investments, contact us today at 800-DIE-RICH.
