Insurer Strength Ratings - Relevant Benchmark or Marketing Scam?

The rating of life insurance companies recently became compulsory in New Zealand - but are these ratings a valid measurement for advisers and clients, or are they just some artificial index aimed at assisting the sale process?

Having introduced independent advisers to AIA's AAA Standard & Poor's rating in the mid-1990's, perhaps a balanced view from a reasonably well-informed source (the Laird) would be helpful.

It's essential to be aware at the outset that these ratings cost money - and plenty of it!

A full rating exercise from an approved agency can run well beyond $20,000 p.a, a financial incentive which many claim renders the rating exercise unreliable. In other words, the rating agency has a financial interest in ensuring that the client has an acceptable rating - at least good enough to attract sufficient new business to pay the agency's fees!

For large, complex, and global clients - as AIG used to be - the rating agencies financial interest is extensive, given the sheer number of subsidiaries that needed a rating to support their presence in numerous locations around the globe. AIA - New Zealand was in this category, and obtaining the AAA rating was a feather in our cap here, as no other Asian territory within the AIA Asia/Pacific Region had felt the need in those far-off days to carry a financial strength rating.

Conversely, lower rated organisations, or those which only operate locally, mean less fee income for the rating agency, are less complex, and are of less significance.

Check the records to see when Standard & Poor's began issuing warnings about AIG.  Oh sure, the AAA status had long gone by the time the Fed had to mount its bail-out strategy, but take it from me, S & P were not the whistle-blowers of the near-terminal financial turbulence within AIG.

So it's as well to bear in mind that there is a financial relationship between the rating agencies and their clients.

Also, the financial strength of a life company offers little guidance to their willingness to pay claims.

In this context, Partners Life claim -  "if it's grey, we'll pay" has yet to be well and truly tested. On the other hand, Sovereign has had some well-publicised claims disputes recently  - think Bronwyn Pullar. In the midst of all the noise re the ACC's disastrous privacy breaches, it's easily forgotten that the lady's public status was due to support from political figures representing her in the course of a claim against Sovereign.

I doubt if Ms Pullar would be even slightly impressed with Charles Anderson's suggestion that a AA+ AM Best rating "should drive at least some part of the decision-making process with people".

Also, it's important to be aware that the contract of reinsurance is between the life insurance company and the reinsurance organisation. In the event, that an insurance company runs into financial difficulties, there is no obligation on the reinsurer to continue claims payments, or to entertain further claims.

At best, ratings are an indication that, according to an objective and impartial  analyst that the company under consideration is likely to be able to meet its obligations - or not, as the case may be.

At worst, ratings are a financially induced initiative with a relatively poor track record of  forecasting financial collapse before it actually happens.

The Reserve Bank may well think that financial strength rating from an accredited agency is important, but most informed financial advisers, observers, and commentators would regard such a rating as being a relatively minor factor in the product selection and recommendation process.

I'd recommend that these ratings are taken with a very healthy pinch of salt - and perhaps a wee single malt, just in case.

Slàinte mhòr agad

The Laird of Albany