I had a rather lengthy discussion today about the merits of financial ratings as they relate to insurance, annuity, and financial services companies. The contention was that you should never deal with a company that doesn’t have the highest financial rating. Granted, the financial advisor I was talking to works for one of the highest rated insurance companies in the country (New York Life) – so I suspect that he is at least a little biased and maybe rightly so.
On the other hand, the financial ratings of a company are only part of the story. Case in point, AIG had one of the highest ratings available just days prior to their meltdown. AIG hadn’t lied to, deceived, or even misinformed the ratings agencies, but they had asked the ratings agencies (who agreed) to provide a financial assessment based on factors they didn’t fully understand – namely mortgage backed securities and derivatives.
As a result the ratings services have initiated a huge and industry wide backlash on the financial industry. Many financial companies have been downgraded two or more times in the last 12 months on little more than conjecture and speculation. Others probably need to be downgraded further. The point is that the rating services have missed the boat, not just today but in the past as well. Enron, WorldCom, and AIG are just a few recent examples.
So the question becomes, what can you do? Should you disregard the financial ratings completely? Obvious, the answer is “no”, but you shouldn’t rely exclusively on them. A few other factors you should look at or ask for when dealing with any financial advisor or insurance agent are:
- The Bond Quality of the Company – Look for how many bonds are at or near default vs. the number of high quality bonds in the company’s portfolio.
- The Profitability of the Company – Expressed as a ratio between Total General Expenses vs. Total Income.
- Total Admitted Assets – What the company owns.
- Total Admitted Liabilities – What the company owes, this should be less than their Total Admitted Assets.
- RBC Ratio (Risk Based Capital) – This is the most important number when dealing with insurance and annuity companies, it identifies the ratio between a company’s obligations to policy holders vs. their cash reserves. A general rule of thumb is that a “healthy” insurance company will have an RBC of at least 300%.
There is one other rating exclusive to insurance and annuity companies called a Comdex rating. This is a number expressed as a percentile. It indicates how an individual company compares to other insurance and annuity companies. A Comdex of 90 would indicate that a company is more financially sound than 90% of their industry peers. Obviously, the higher this number, the better.
These numbers, the Comdex, and the ratings from the rating services, will give you a clearer picture of the companies you are being asked to trust with your money. Remember, a true “Financial Professional” will be able to discuss these numbers, show you the ratings of any company they are recommending, and will only use products from companies of the highest caliber.
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