Why is the financial strength of an insurance company important?

There is a multitude of reasons why, but near the top of that list should be the insurer’s ability to pay out the benefits promised. Those benefits could be having access to the cash value that has accumulated in your policy if needed, or even more important is their ability to pay a death benefit claim to your loved ones after your passing. The stronger and more stable the company, the less probability of default and the greater their ability to pay claims. Who determines their strength? What basis do credit rating agencies use to determine their strength?  

Who determines the strength of the life insurance company? 

Financial strength ratings of insurance companies are issued by credit rating agencies. These independent agencies review and report on their financial stability. The largest and most recognized agencies are Standard & Poor’s (S&P), Moody’s Investor Services, A.M. Best and Fitch Ratings. Do not rely solely on the insurance companies and what they say about their ratings, as these ratings agencies do not always agree on ratings so make sure to use at a minimum of two. The S&P stated, “A financial strength rating is a forward-looking opinion from a credit rating agency about the creditworthiness of an insurer with respect to its current and future financial obligations.” 

If the insurance companies are rated by at least two of the above agencies, then there is another level of rankings that happen and that is a Comdex ranking. This is a composite score averaging the ratings of the major insurance ratings organizations. The Comdex assigns a score from 1 to 100, with one hundred being the best or highest score. 

What basis do credit rating agencies use to determine their strength? 

Ratings are simply based on an insurance company’s claims paying capability, liquidity, profitability, liabilities, and investments. Each credit rating agency has their own rating system. 

The highest ratings awarded are Investment-grade. These are from A, AA, AAA (others list these as A, A+, A++.) The second tier is non-investment grade which are financial ratings of B, BBB or B, B+, B++. These non-investment grades are categorized as “junk” status. If the life insurer has a non-investment grade rating, it means they may suffer a default which means it will not be able to satisfy their promises to policyholders. The third tier is like an Alphabet soup which is everything below non-investment grade ratings. 

Financial strength does not guarantee a life insurance company's future, but it should give comfort that the insurer has a strong and stable future. It indicates that the life insurance company has met all existing, and can meet, all future claims. That alone in itself should give you some peace of mind.