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Using Insurer Financial Ratings to Choose Your Insurance Carrier

The right to choose is one of our most closely guarded freedoms. But along with that right comes the responsibility of being accountable for the consequences of your choice. If the choice turns out to be a poor one, the consequences can have devastating effects, especially if the decision-making is in a business context.

When you select an insurance carrier you need to weigh each option against the same set of objective criteria. The goal is to use a set of pre-established conditions that will ensure the selected carrier will have the financial strength to stick with you over the long-term. This concept is the foundation for what insurance evaluation services perform. 

Analyzing a carrier's financial standing is a fairly complex task requiring a lot of intricate calculations. Each of the recognized insurance ratings firms have a somewhat subjective way of arriving at the ratings they give companies. However, there are some common criteria they all use in their evaluations. The first criterion is the company's liquidity. Going-hand-in-hand with liquidity is leverage. Leverage is the amount of money a company borrows to increase its assets either through purchase or investment. The more leveraged a company is, the more debt and conversely, the less equity they have, which affects their liquidity.

Of course, companies are rated on their investment portfolio because it also affects their liquidity. Their portfolio needs to be diversified with quality securities in order to receive a high mark in this area.  The next evaluation point is risk-based capitalization. This is the theoretical amount of capital needed to cover the risks associated with their operation. If this money is put in reserve, it lessens a company's available liquid assets. It also affects profitability, which is another area for evaluation.

Other more general aspects that are assessed include the overall conditions of the market, how diversified the carrier's product line is, how competitive they are when measured against other carriers with a similar product lines, the experience level of their management team, how much of their product line is made up of policies that are extremely risky to underwrite and how large a reserve they have to cover risk. An insurance carrier that receives high marks in all of these areas of assessment is one that you can depend on to be around when you need them.

You have access to this information by reading reports generated by the insurance evaluation services. There are a number of them available, but the three most commonly used are:

  • A.M. Best Company - they are the original insurance raters, established in 1906. They use letter ratings to evaluate not only the company's current financial condition, but also its future outlook. They also have a NR designation, or "not rated." The NR designation includes the general reason why a rating was not assigned. Best lists its ratings scale and insurer profiles on its web site www.ambest.com.
  • Standard & Poor's - they assign an insurer a financial strength rating based on an assessment of whether or not the carrier has the financial capability to meet its obligations as outlined in the terms of its insurance policies and contracts. A Standard & Poor's evaluation uses both hard numbers and subjective factors such as general attitudes toward the company. Their ratings categories and reports can be found at www.standardandpoors.com.
  • Moody's Investor Services - they also use an evaluative approach that includes both objective and subjective factors to determine if a carrier can meet its obligations to its policyholders. You can find their reports at www.moodys.com.

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