U.S. to sue S&P over Ratings – that was this years’ February 5th headline in the Wall Street Journal. If the federal government is suing a ratings agency for providing overly rosy evaluations on bundled mortgage-backed securities, what does that imply for their ability to rate insurance companies?
Should we as consumers place our trust in or be guided by a third-party evaluator of annuity providers? For most of us, the answer is YES.
Ratings of insurance companies should be one of the key components of your decision when selecting an annuity provider. When you purchase a lifetime annuity, you must believe that the company will survive longer than their obligation to you.
Third party ratings provide guidance to consumers who would not otherwise have any basis on which to compare companies. Should these ratings be the sole basis for making an annuity decision? NO. History has taught us that these ratings are just one piece of the total puzzle.
Dick and Eric share their thoughts on the validity of third-party ratings of annuity providers in this weeks video.
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
Still have concerns about annuities, check out this article on “How Safe are Annuities“.
How Safe Are Annuities?
Safety of money is generally relative to comparing levels of risk between Government backed, insurance backed or individual securities investment risk.
In regard to non-variable fixed annuities, State Regulation forces insurance companies to follow what is known as Statutory Accounting unlike generally acceptable accounting methods (GAAP) utilized by publicly owned corporations. Statutory accounting is a show me the money type of accounting whereby expenses are written off immediately and not capitalized to inflate profits for corporate convenience or even fraud. Most insurance carriers are also publicly traded companies that additionally must also meet GAAP standards.
Insurance institutions are required to demonstrate to state regulatory authorities that dollar for dollar a client’s money (premium) is safely on deposit in secure financial vehicles such as investment grade bonds or government bonds. In addition they are required to have reserves known as additional surplus reserves. The minimum amount of required reserves is decided based on the safety of the investments as determined by state regulators. So based on these stringent requirements insurance carriers are scrutinized and forced by law to meet and maintain a legal reserve for the safety of their clients.
Each insurance carrier is also compelled to participate in a mandated state insurance **guarantee association (SIGA) whereby insured clients have minimum **guarantees on their annuities and life insurance typically and minimally $100,000 on annuities and $300,000 on life insurance some states have higher limits. These **guarantees are not to be confused with FDIC insurance or used in marketing insurance products. The state’s first concern is the safety of the client so in the majority of situations when an insurer begins to have any serious financial concerns the state places them in receivership and transfer s ownership to a better run profitable carrier with all assets moved over from the faltering company. Thus the insured client remains whole and the **guarantee association is absolved of any liability. [Read More…]
Annuity Guys® Video Transcript:
Dick: You’ve probably seen a lot of the news just recently about the rating agencies.
Eric: The US governments, the state governments are suing Standard & Poor’s.
Dick: The S&P 500, that’s right the rating agency.
Eric: Standard & Poor’s is on its way to writing a nice little check.
Dick: Do you think this could have something to do with them lowering the government’s credit rating?
Eric: Are you saying there’s a…
Dick: Do you think it could be a conflict of interest?
Eric: Well, speaking of conflicts of interest. This is probably the perfect introduction into our topic today, when we talk about, when we’re looking at annuities and insurance companies, the rating agencies how do they go about determining these rating agencies, and how they’re going to be selected and how their criteria is?
Dick: Well, it’s very interesting and as you read these articles about the rating agencies out there Eric, so many of them actually are paid by the folks they’re rating.
Eric: That’s exactly, so I’m an insurance company. I want to be rated. I write you a check to come in and…
Dick: To come in and rate me, right.
Eric: … look at my books. So is there a conflict of interest there, perhaps?
Dick: I think we’d have to say, yes.
Eric: Now if you’re going to give me a bad rating, wouldn’t I be better off just not having you come in and look at the books?
Dick: Well, that being the case, you would have competitors out there that would have positive ratings, and you would have poor ratings or no ratings. So you’re forced to comply. Now is that to say that, because there is this conflict of interest that exists, that you can’t rely on any ratings agencies?
Eric: No, I say this as I say it the everyman type of philosophy in the sense of, if I wanted to go in and evaluate each insurance company on my own merits where I want to walk in and say “All right, show me your books. Show me your balance sheet. I’m going to determine if this is a safe to place to put money.”
Dick: You’d have to take a battery of CPA’s and attorneys.
Eric: I don’t have the manpower. Exactly, so what we’re doing is we’re having to rely on these third party agencies, which they’ve been doing this for hundreds of years in some cases, to take a look and say all right, what is the financial status? What’s a third party review of where they’re at financially?
Dick: And if we go from the investment world, and we look at some things that have been going on, packaging the mortgages and this type of thing, the ratings agencies did miss it.
Eric: Well, and that was always the question. How could they miss it? There are some suggestions that perhaps, they didn’t even follow their own standards, when doing those evaluations. Then of course, then we hear about things in the recent past, not so recent past like Enron where they were too late to the bell, and then it even goes back to the 1970’s where New York City had its issues, and of course, the ratings agencies didn’t quite get on top of that in time.
Dick: Now I look at insurance companies a little differently and I think there’s good reason for that, and that is that state by state they have what we would call a statutory type accounting requirement where, maybe a good description would be show me the cash. In other words, they can’t use what’s the generally, acceptable accounting practices, the Gott method, which is used by corporations and that allows corporations to put these things off into the future, to hide present income or to hide present expenses to kind of cook the books. Used properly it’s fair, but if you want to cook the books you can do it sometimes.
Eric: There’s a little bit more manipulative action.
Dick: The Enron example would be good. But when it comes to insurance companies, they have to have everything transparent, out in the open in the statutory type accounting. So the third party rating agencies have quite an advantage there.
Eric: And we have a favorite, in the sense of, when we typically have a conversation with a client we tend a lot to use AM Best, because of their history with evaluating insurance companies, and that’s what you want, a consistency across time in what they invest since 1906.
Dick: They’ve been doing it for over 100 years and the thing that I like about it is that they have just a history, that when you go back and you look at companies, things don’t change fast. So a rating where a company has an A or A-plus rating, if they were to move down to maybe all the way down to a B-rating, that good take place over years and years and years. It isn’t typically anything that happens overnight.
Eric: Let’s talk about ratings and I hate to the example of one company, but it’s AIG.
Dick: Everyone knows AIG.
Eric: Everybody knows AIG. Here it is. Here’s a company that had an A-rating, on the insurance side. Now there’s always some question as to “All right, were they really in trouble,” in the sense of they’re going through a government bailout, all these things are happening.
Dick: And they were rated by AM Best, and yet even CNN reported that folks may need to be aware because of AIG going through all of this trouble, and it really had more to do with their investment side, and amazingly their insurance side was A-rated, remained A-rated, is still A-rated and very safe, and secure.
Eric: And that’s where you have to look at a company, when it’s a large company like that, that has multiple divisions. The insurance side may be a separate entity than what’s maybe getting the black marks out there.
Dick: Exactly and what would’ve actually taken place with AIG or other insurance companies is, if they really had gotten into trouble, all of the assets are there that gives them an A-rating. They would’ve been put in receivership. So a more profitable company that has economies of scale is making a profit off of their assets would have all of AIG assets moved over to them, and they would continue to operate profitably with those assets.
Eric: So I guess let’s look at this in totality now. So if I’m somebody coming in looking at annuities can I rely on these third party ratings, effectively, to help me judge what something is going to be a good choice for me.
Dick: I think the answer to that is, yes.