Concerns have emerged following a lawsuit filed last year by a pair of life insurers against AM Best, a major financial rating agency, in response to a planned downgrade of their financial ratings.
The implications of the suit were quickly recognized. Would this open the door for life insurance companies to potentially sue their way to better ratings? Would financial ratings retain any meaning in the future?
Four months after AM Best settled the lawsuit with Atlantic Coast Life Insurance Co. and Sentinel Security Life Insurance Co., the answers to those questions remain unclear, as the terms of the settlement have not been made public.
“The ability of those ratings’ agencies to deliver candid information is highly dependent on their ability to offer independent, unfettered disclosures,” said Tom Gober, a certified fraud examiner with expertise in life insurance. “I was shocked when I learned that the A-Cap carriers, facing a likely significant ratings downgrade, filed a lawsuit against AM Best. I hope that rating agencies do not feel threatened into delaying a crucial downgrade for fear of litigation. Surely, this ridiculous precedent will not stand.”
The insurers involved are part of the A-Cap insurance group.
AM Best declined to comment on the settlement terms or any potential impact on the future ratings of those insurers. However, Sridhar Manyem, senior director of Industry Research and Analytics for AM Best, did respond to general questions about the ratings system.
An AM Best credit rating is based on “an in-depth evaluation of balance sheet strength, operating performance, business profile and enterprise risk management, and includes interactive communications with the management team requesting the rating opinion to complete the analysis,” Manyem explained.
Gold Standard
Founded in New York City in 1899 by Alfred M. Best, AM Best quickly became a key player in the insurance industry. The 1906 San Francisco earthquake devastated much of the city, leading to insurance claims that bankrupted 12 American companies and two more in Europe. As modern American society developed, it became critical for insurers to show strong financial stability. They turned to AM Best to validate their financial standing, and ratings continue to be important in helping consumers understand insurers’ financial health.
“Stellar financial ratings indicate that a company is in an excellent position to meet all of its financial obligations,” New York Life states on its website. “Dicey ratings may indicate that a company could have problems down the road. Since life insurance is a long-term product, it’s essential that the company backing them have excellent insurance ratings.” Unsurprisingly, New York Life is rated A++ by AM Best.
Focusing solely on the insurance industry, AM Best’s rating system assesses an insurer’s claims-paying ability and the credit quality of its obligations. “Our rating analysis relies primarily on information provided by the rated entity, including annual and quarterly (if available) statements, presented in accordance with the customs or regulatory requirements of the country of domicile,” Manyem stated. “AM Best does not audit the company’s financial statements or records, or otherwise independently verify the accuracy and reliability of the information provided.”
AM Best also meets regularly with insurance companies to discuss financial matters. “Key executives are present to discuss their areas of responsibility, including strategy, distribution, underwriting, reserving, investments, claims, ERM and overall financial results and projections,” Manyem noted. “The ongoing dialogue with company management is the foundation of our rating process.”
Rising Challenges
InsuranceNewsNet also reached out to Fitch Ratings and Moody’s Ratings for comment. Fitch Senior Director Jamie Tucker discussed how his company approaches ratings. Fitch’s criteria are a combination of both quantitative and qualitative factors, he explained.
Key rating drivers for life insurers are company profile, capitalization and leverage, debt service capabilities, financial flexibility, financial performance and earnings, investment and asset risk, and asset/liability and liquidity management. Tucker acknowledged that evaluating life insurance companies is becoming more challenging.
“We have seen increasing complexity within the sector, particularly on the investment side as insurers have increased the allocation to less-liquid, more complex and esoteric investments,” he said. “This has been driven by various factors, including the relationships with alternative investment managers.”
New reinsurance agreements, many involving companies based in Bermuda or the Cayman Islands, introduce another hurdle to accurate ratings.
In February 2024, AM Best downgraded the long-term issuer credit rating from bbb+ to bbb for both Atlantic Coast and Sentinel Security. The downgrade was based on “risk management of reinsurance counterparties and its reliance on those counterparties,” AM Best said in a news release.
By late April, AM Best was concerned enough to determine another planned downgrade, which would have dropped Atlantic Coast and Sentinel Security’s financial strength rating down three notches, from B++ to B-. A month later, the insurers sued AM Best in the District of New Jersey federal court.
Much of the court proceedings were sealed as proprietary. However, AM Best’s attorneys claimed in court documents that the insurers failed to provide adequate information about their assets, which would have helped determine whether the rating action was justified.
Ratings as a Starting Point
Richard M. Weber, a 58-year veteran of the life insurance industry, has been a successful agent, home office executive, software designer, and author of four books. He sees a “conundrum” with the current rating system. The industry is becoming more complex, and agents are the customer’s primary link to life insurance. “Agents must understand more than they tend to about carrier finances, especially today with the degree of offshoring and reinsurance, but at the end of the day, the typical agent is never going to know everything they need to know,” Weber said.
Many agents opt to evaluate insurance companies according to their Comdex scores, which combine all of a company’s ratings into a single number. While this, in theory, makes insurance companies easier to compare, it also obscures negative ratings, Weber noted. “Agents need to better understand what the ratings mean and what they don’t mean,” he added.
Traditional financial ratings still have a role to play in the life insurance world, Gober emphasized, but a deeper dive is needed. “No rating agency is perfect. Any industry professional should look deeper than merely an A rating,” Gober stated. “Let an A rating be the start of additional diligence. Remember that consumers have a rightful, legal claim against only the stand-alone carrier itself. While the carrier might have a thousand affiliates, only the carrier is there for them.”
