Scoping Out Insurers

How to make sure your insurance Provider is healthy enough to survive bad times.

By Mike Cohn

Will you outlive your life insurance company?

Until quite recently, the question was rhetorical. Little in life was as secure, stable, and enduring as the insurance industry.

Today, however, the field shows signs of weakness.Throughout the industry, increased competition and soured assets have narrowed profit margins. Some firms have even been squeezed out of business. Like thrifts and commercial banks, insurance companies are experiencing a shakeout that would have been unthinkable just a few years ago.

In 1981 not a single insurance company went out of business. Between 1983 and 1988, 89 insurers folded; in 1989, 36 more became insolvent. Most of those were relatively small, but the largest firms haven't fared much better. In 1990, First Executive took a $859 million write-down of its junk bond portfolio, and Equitable posted a loss in excess of $90 million for the first nine months of the year. And the situation might get a whole lot worse: A report recently issued by IDS, a subsidiary of American Express, warns that as many as 20 of the nation's 100 largest life insurance companies might not survive a severe economic downturn.

Unfortunately, insurance guarantee laws provide an inadequate safety net to cushion a fall. Although 45 states have enacted such legislation, which protects policyholders if their insurer folds, the protection is limited to a ceiling of $500,000, hardly enough to cover the demands of a family business.

The industry's troubles have a particularly strong impact on family busi- ness owners, who depend on insurance companies to fund stock repurchase agreements, wealth-transfer plans, and estate-tax liquidity needs.

In the past, a business owner could select an insurer, then stick with the choice for the long term. Today, such a hands-off approach could have disastrous consequences. To protect themselves, executives face the extra burden of keeping closer tabs on the field than ever before. Indeed, consumers now need to research their financial institutions---banks, thrifts, insurance carriers--as rigorously as those institutions examine persons applying for loans and insurance.

Monitoring the industry's members- in terms of both short-term performance and long-term survival--begins by checking the credit rating agencies' reports (see "A guide to credit-rating services," below). Outfits such as A.M. Best, Moody's, Standard and Poor's, and Duff and Phelps analyze the finances of hundreds ofinsurers and passjudgment on the firms' financial health. Within the past year, for example, Moody's Investors Service downgraded Equitable Lbfe Assurance because of the finn's underlying weaknesses.

Credit-rating agencies provide a good overview of a corporation's financial condition, but they aren't the only sources worth consulting. For more detailed information,business owner sshould ask their accountants to investigate six key indicies that measure an insurer's ability to meet its projected returns.

First, a general rule of thumb for evaluating an insurer's financial strength involves its level of capital and surplus, the amount of money above the reserves it's law to set aside. Insurers with assets of $1 billion to $1O billion should have capital and surplus equal to 5 percent to 10 percent of total assets, Firms with assets in excess of S10 billion should have capital and surplus of 3 percent to 7 percent of total assets. Moreover, capital and surplus should grow by at least 5 percent annually.

Second, an insurer's mortality experience-the pricing of products based on average life expectancies--should earn a "most favorable" or "very favorable" rating from a credit rating service. A poorer rating suggests that an insurer has made incorrect assumptions about mortality averages, which can narrow its profit margin, forcing the company either to increase its policy charges or reduce its surplus.

Third, examine the quality of an insurer's investment portfolio. Be cautious if a rating agency such as Standard and Poor's or Moody's reports that a company keeps more than 1O percent of its assets in Junk bonds or nonperforming real estate loans. Risky investments may generate high yields, but they also can plummet in a flash.

Fourth, check the yields of a company's investments. Most insurers guarantee yields ofno more than 5.5 percent but often pay twice that amount. Today, those high-end yields are depressed, and policyholders who thought they'd receive a 13 percent return throughout the life of their policy are hopping mad. Make sure your insurer is offering a credible rate. And beware of a company that projects a higher rate than the rate it's earning on its own investments.

Fifth, track your carrier's expense ratio.The expense of administering policies is difficult to evaluate since Insurers sometimes hide these charges in other areas of the business. Credit services should show that during a five- year period, annual expenses should average no more than 5 percent of premium income plus policy reserves.

Sixth, check the number of individuals who let their policies lapse at a specific carrier. When the so-called lapse rate is low (10 percent or less), a company can price its products quite competitively because it has a good chance of recovering its initial investment through continuing premiums paid by policy holders.

These measurements of an insurance company's financial prowess are relatively easy to determine with the help of credit- rating agencies. If the indicators are moving in the wrong direction, it's time to find a new carrier. And with economic conditions changing so rapidly, that possibility is greater than ever.

Finally, don't make the mistake of placing more emphasis on the policy than the Insurance company. Look for the healthiest carrier, and then get the policy that best suits your needs. Don't blindly place all of your insurance eggs in one basket; diversifying your policies among several insurers is the safest hedge against an uncertain economy.

Mike Cohn is president ofthe Cohn Financial Group, a Phoenix-based Frm that im- plements transfer strategies for family businesses nationwide.

A guide to credit rating services

To determine whether your in- surance company is,really fit, review its credit ratings reports. Ask your agent for reports from A.W. Best, Standard and Poor's, Moody's, and Duff and Phelps, which all rate the claims-paying ability of life insurance companles.

A.M. Best Company annually examines and rates about 1,400 life and health insurance companies. The firm's historical data on insurers is useful for comparative analysis. It rates a variety of important factors and gathers finan- cial information based on the companies'annual reports. Individual company reports cost $l5. (Ambest Road,Oldwick,N.J. 08858; 201-439-2200.)

Standard & Poor's Insurance Rating Services rates 135 life insurers based on an in-depth analysis of carriers' projected claims-paying ability. Rather than computing ratios based on annual statements (A.M. Best's method), S&P examines unpublished historical data, corporate projections, and management's battle plans. Individual company reports cost $25. (25 Broadway, New York, N.Y. 10004; 212-208-8000.)

Moody's Investors Service rates the financial condition of 60 life insurance companies. The rat- ings, similar to its bond-rating system, are accompanied by a thorough review of an insurer's financials. Detailed company reports cost $1,050 annually; summaries cost $125 per year. (99 Church Street, New York, N.Y. 10007; 212-553-1658.)

Duff & Phelps rates the claims- paying ability of life insurers. It publishes in-depth reports on 70 insurers. D&P provides cus-tomized individual company reports for varying fees. (55 E. Monroe Street, Chicago, 111. 60603; 312-263-2610.)

National Association of Insurance Commissioners sells the IRIS Ratio Reports, which tracks companies that have fallen outside its own five measures of risk. The fee is $50. (120 W. 12th Street, Suite 1100, Kansas City, M0.64015;816-842-3600.)

The American Bar Association publishes the ABA Primer: Life Insurance Products, Illustrations, and Due Dilligence (researched by M. Financial Group), which costs $34.95 plus $3.95 for shipping. (750 N. Lakeshore Drive, Chicago, III. 60611; 312-988-5571.)