A prudent annual review of life insurance policies includes not only an in-depth analysis of an individual contract’s projected performance but also of the insurer of the contract. Tiers of regulatory protection, including strong reserve and surplus requirements, help ensure the claims-paying abilities of insurance companies; however, an insurance company’s reduced financial strength can still be an indicator of problems in the future. Financial rating downgrades can be harbingers of increased insurance costs and diminished customer service. While an insurance policy’s performance always requires monitoring, this becomes even more important when a company has been downgraded to a “Vulnerable” financial rating. Understanding what makes an insurance company “Vulnerable,” as well as considerations for ongoing policy management, is a key to successful oversight of a life insurance portfolio.
Five major rating agencies—A.M. Best, Standard and Poor’s, Moody’s, Fitch, and Weiss Ratings rate the financial strength of insurance companies. For consumers, these ratings can be difficult to interpret, as each agency has its own rating scale, standards, and rating code. An “A” from A.M. Best, for example, indicates excellent financial strength, with a strong ability to meet their ongoing obligations to policyholders, while an “A” from Moody’s indicates a company currently offers good financial security, but may have elements present which suggest a susceptibility to impairment in the future. The latter rating presents no need for panic or major concern, but it is prudent to recognize the nuance between the two ratings. Most important, however, is recognizing at what point a rating agency delineates a “Secure” insurance company from a “Vulnerable” insurance company. A “Vulnerable” rating would indicate the rating agency views the insurance company as having significant risk of being unable to meet financial obligations in an unfavorable economic environment.
The degree to which a life insurance policy might be impacted by an insurance company’s financial struggles can vary widely, depending on factors such as policy type and, of course, the extent of the company’s misfortunes. Policies with guaranteed pricing and costs—level premium term plans or no lapse guarantee products, for example—are still likely to meet their objectives without incident. Products relying on non-guaranteed crediting and costs, however, could potentially see deteriorating performance, as an insurance carrier may reduce crediting and increase costs closer to the contractual guarantees of a policy. (This phenomenon isn’t exclusive to “Vulnerable” insurance companies, but monitoring for this is especially important when a company is struggling.) In some cases, RIC has experienced a correlation between “Vulnerable” companies and inferior customer service, either reflected in poor response time or in a company’s inability or unwillingness to provide illustrations assuming current crediting and cost assumptions. When an insurance company provides projections only at guaranteed assumptions, estate planning may become exponentially more uncertain and complex.
Policy replacement is an option for policies with “Vulnerable” insurance carrier ratings, however, RIC typically recommends looking for additional justification for replacing policies beyond a “Vulnerable” rating. If the insured is still insurable and the policy can be replaced at about the same cost with a much stronger insurance carrier, it is worthwhile to explore that option. Paying significantly more for the same coverage with a stronger insurance carrier, though, probably isn’t warranted unless other conditions exist. If the current plan of insurance is no longer suitable, replacement might make sense in that scenario. If there is a loan attached to a policy, replacement can sometimes produce cost savings. These are examples of how replacement should be approached when a policy has a “Vulnerable” insurer, as historically RIC has seen insurance companies persist for long periods with financial challenges.
As mentioned previously, there is significant regulatory protection related to insurance companies. If surpluses and reserves are not maintained, further regulatory monitoring and/or control will be triggered. If a carrier winds up under regulatory control, the state of domicile will use available resources to place existing blocks of business with other insurance carriers if other rehabilitation is not successful. Additionally, insurance carriers facing financial challenges often invite acquisition by another carrier before any regulatory control is initiated. In a worst-case scenario, there is the safety net of state guaranty associations, which allow state insurance departments to assess other insurance companies to assure (typically) $300,000 of death benefit and $100,000 of cash value. These scenarios of regulatory or guaranty association involvement are exceedingly rare. Generally speaking, reduced policy performance and diminished customer service are issues that will be much more likely in need of consideration.
Ultimately, an important first step when an insurance company’s financial strength is flagged as “Vulnerable” (an RIC classification) on a policy review is to learn the source of the “Vulnerable” rating. Do all five rating agencies consider the company “Vulnerable,” or only one? To what degree is the grade below the “Secure” level? If the policy is otherwise performing well, there may be no cause for further action aside from monitoring the company’s financial strength more closely. If the policy is no longer suitable or impaired in some manner—underfunded, lacking competitiveness, indebtedness—then a “Vulnerable” rating may be an impetus to explore policy replacement. Life insurance policies can have numerous moving parts and factors that affect their performance. The financial health of the insurer of the policy is one more element that needs to be monitored and evaluated on an ongoing basis.
RIC is a nation-leading independent risk manager partnering with over 200 corporate trustees. We provide independent policy reviews, ILIT administration software, and remediation services for Trust Owned Life Insurance. As we do not market or sell insurance of any kind, our entire focus is on reducing fiduciary risk and helping trustees meet regulatory oversight requirements.
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