In the past year, it hasn't been unusual to see reports of companies that have had their debt ratings lowered, although their financial ratings have remained stable. These two seemingly contradictory positions confuse most agents, insureds, company employees, and most everyone else in the insurance industry. Chris Burand explains the important difference between an insurance company's financial stability rating and its debt rating.
Most agents consider only the financial stability rating, otherwise known as the claims paying rating. In discussing the financial stability rating, A.M. Best states, “The objective of Best's rating system is to provide an opinion of an insurer's financial strength and ability to meet ongoing obligations to policyholders.” The emphasis of this rating is on the ability to pay policyholder claims, not creditors.
The second type of rating reflects a company's ability to repay debt. An insurance company might be structured in a way that makes it more able to pay claims than to repay creditors. This could be true even if a company goes out of business. It's also possible to structure a company so that creditors are more likely to be paid than policyholders with claims (although insurance departments probably wouldn't approve of such a structure if they caught it in time).
Most agents and insurance customers pay attention only to the claims paying rating. In fact, I believe most agents and customers focus so exclusively on the claims paying rating that they don't know or care that the debt rating exists. With so much focus on the claims paying rating, is the debt rating even important?
The answer depends on one's perspective. If you're only concerned about whether a company has adequate resources to pay its policyholder claims, then don't worry about the debt rating.
Agents, however, might desire to steer clear of insurance companies that might do one or more of the following: Suddenly drop lines; suddenly drop states; cut costs too deeply, resulting in too few underwriters, poor service, or poor automation; or cut agents' commissions or contingencies.
If these issues concern you, pay attention to debt ratings. Debt ratings are more indicative of a company's financial and operational health. Kemper is a great example of this. Kemper's debt was downgraded to “junk” in January 2003, but they still had a “B+” rating from A.M. Best (they had an “A-” rating until December 2002). Which rating was most indicative of Kemper's unstable future? By mid-June, A.M. Best had downgraded Kemper's financial strength rating to “D,” but the debt rating told the story first. Agencies looking at the debt rating had a lead of more than six months.
Many agents usually review only a carrier's financial strength rating. Get a more complete picture of a company's health and its future stability by paying attention to debt ratings as well.