The Reason for Ratings

Kate McGinn XL Specialty Insurance Co. Exton, Pa. www.xlinsurance.com

HOTELS AND RESTAURANTS STRIVE FOR the coveted “five-star” rating, and film studios seek four-star reviews from movie critics. Even peppers have their own scale to rate their hotness. So, it is no wonder that there is a rating system for insurance companies. The ratings should be important considerations when selecting an insurance carrier.

Like peppers' Scoville Scale of hotness, insurance company ratings aim to keep buyers from getting “burned,” and offers some assurance that a particular company is financially fit. Several independent rating agencies evaluate the financial stability of insurance companies, including A.M. Best Co. Founded in 1899, the company was established to help protect consumers from insurer insolvency by providing third-party evaluations of insurance firms. A.M. Best's rating system helps customers by providing a market profile and an evaluation of the financial condition and operating performance of the firm.

Today, more than 400 A.M. Best personnel provide this financial and operating information. A.M. Best also publishes a Financial Performance Rating (FPR) of each company it evaluates.

Standard & Poor's (S&P), New York, initially began publishing financial assessments of the nation's railroads, but now also provides insurance company ratings. Its credit ratings can apply to an insurance carrier's general creditworthiness or to specific financial obligations. Long-term ratings range from “AAA,” which reflects the strongest credit quality, to “D,” the lowest.

Similar to S&P, John Moody began analyzing railroad securities in 1909 and later extended to include the insurance industry. Today, New York-based Moody's Investor Services provides ratings for nearly 300 property and casualty insurers, as well as life insurers, financial guarantors and major reinsurance companies.

The importance of insurance ratings continues to attract additional ratings providers, including New York-based Fitch Investor Services and Weiss Research, Jupiter, Fla. With so many providers available, one may wonder why ratings deserve so much attention.

The answer is that ratings agencies complement other regulatory activities affecting insurance companies and can provide businesses with the impartial information necessary for an educated buying decision. Because ratings services offer independent, well-analyzed opinions on insurance carriers' financial strength, they can provide insight into changing industry dynamics, competitive concerns and a company's creditworthiness.

The ratings are especially important when a firm is purchasing a policy that is “non-admitted.” A non-admitted policy often is not covered by a state's insurance guarantee fund. As a result, if the insurance company is unable to pay a firm's claim, the state fund will not protect the policyholder. When an insurance carrier has a strong financial rating, however, a non-admitted policy becomes less of an issue.

To evaluate an insurance company's worthiness, companies such as A.M. Best, Moody's Investor Service and Standard & Poor's Insurance Rating Service evaluate the following: Financial strength; a company's solvency, which means how the company's assets plus its surplus compare to its liabilities and projected reserve requirements; the soundness of a company's method of determining reserves; and liquidity, including assets and the ability to pay obligations.

Businesses with marginal financial strength — including insurance companies — can be affected greatly by external regional, political, market and economic instabilities. Add to this concern some attention-getting insurance company insolvencies, and it is easy to see why insurance industry ratings are an important consideration when buying a policy.

Buying from a financially strong company is wise. But while ratings are important, other factors should be considered when choosing an insurance carrier. Specific policy details, such as premium cost and deductibles, and a company's waste industry knowledge and underwriting expertise cannot be excluded from the decision-making process.