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The consumer's perspective on the insurance crisis.

Fears of another savings and loan crisis and a shortage of objective advice have left consumers confused, nervous and distrustful of the insurance industry. In 1991, state regulators seized six major insurance companies: Executive Life, Executive Life of New York, Fidelity Bankers Life, First Capital Life, Monarch Life and Mutual Benefit Life. Other household names such as Aetna, Kemper, John Hancock and Travelers had their ratings downgraded. (See the sidebar on pages 66-67 for an explanation of insurance ratings.)

The insurance industry shake-up has clients asking questions:

* What happened? Isn't insurance supposed to be among the safest investments?

* My company is in trouble. Will I be paid? If so, how much and when?

* Which insurance company is next? Answering these and other questions helps clients cope with the current crisis. Providing an objective second opinion also may prevent future problems. This article should help practitioners answer client questions and describe the expanded role CPAs can take in insurance due diligence.


The image of the insurance industry as rock solid never has been based on fact; insurance is a business like any other. An insurance policy's viability depends on the management and financial stability of the company issuing it. No agency like the Federal Deposit Insurance Corp. exists for the insurance industry. Consumers' only protection is state insurance funds, which have many limitations. Until 1991, many populous states--California and New Jersey among them--did not even have life, health or disability insurance funds. Since the onset of the current insurance crisis, changes have been rapid. All states now have insurance guarantee funds, and the District of Columbia is adopting legislation,

Life insurance and annuity payments are supported primarily by the underlying investments issuing companies make. For most companies, corporate bonds represent the largest holding. For example, the 1991 edition of Best's Insurance Reports LifeHealth shows corporate bonds constitute 36.8% of assets for U.S. life insurance companies. While highly rated corporate bonds are a fairly secure investment, they are not as secure as Treasury bills (100% guaranteed by the federal government) or certificates of deposit (guaranteed up to $100,000 by the FDIC).

In the late 1970s and early 1980s, competition, inflation and new insurance products (such as universal life) were incentives for companies to outperform competitors with higher returns and lower premiums that could be achieved only with more speculative investments. A February 1990 report by a U.S. House of Representatives oversight panel said troubled insurance company balance sheets were camouflaged with "false reports" and "complex reinsurance" agreements. (A policy is reinsured when an insurance company transfers all or part of its exposure under the policy to another company.)


When an insurance company becomes insolvent, there generally are five sources of funds to pay policyholders:

* Other insurance companies. Baldwin United often is cited as an example of how the insurance industry can "take care of its own." Baldwin United was a large insurance company that failed in the early 1980s; its brokers and salespeople contributed $167 million and the insurance industry $62 million to pay policyholders. Despite this there still are questions whether all Baldwin United policyholders were fully compensated, even after state insurance funds stepped in.

* Liquidation of assets or sale of a company, or both. In November 1991 an investor group headed by Altus Finance, a subsidiary of Credit Lyonnais, was selected on the recommendation of California Insurance Commissioner John Garamendi to acquire Executive Life. Altus Finance will pay $3.25 billion for most of Executive Life's junk bond portfolio. A second group of investors, headed by Mutuelle Assurance Artisanale de France, will then buy what remains of Executive Life. They plan to inject additional capital and rename the company Aurora National Life Assurance Company.

This combination of sale and liquidation still will not fully compensate Executive Life policyholders, although state insurance funds are expected to pay up to $100,000 per policyholder in a reimbursement plan negotiated by Garamendi. New Jersey and South Carolina are the only states not expected to participate in the plan since they are not members of the National Organization of Life and Health Guaranty Associations.

* Lawsuits. While policyholders also can file lawsuits, this assumes there is someone with assets who can be sued.

* State insurance funds. Policyholders' final recourse is state insurance funds, but such funds do not always provide prompt or full payment. Most are not prefunded, and companies are not assessed until other sources (buyers, liquidation of assets) have been exhausted. In addition, most states have annual limits on the amounts assessed.

State funds also are plagued by conflicts of interest. Assessments are collected from insurance companies doing business in the state while the board authorizing the assessments usually is made up of representatives of the largest of those companies. A General Accounting Office study found 12 instances in the 1980s in which policyholders waited more than a year for payment after their insurance companies ran into problems.

Fund coverage varies from state to state. Most have percentage and dollar limits. California, for example, pays the lesser of $100,000 or 80% of the present value of annuity benefits (the Executive Life reimbursement plan was an exception). State insurance funds often reduce interest rates--retroactively. In California, policyholders will be credited only with 3% interest (based on a formula using current interest rates). Maryland covers the entire contract, whereas most states have maximum limits. Many states don't cover guaranteed investment contracts. Additional information on coverage is available by asking specific states for copies' of the legislation creating the fund.

Given state insurance funds' limitations, it's important for policyholders to lobby state insurance commissioners and legislators for prompt and full settlement of claims. The Action Network for Victims of Executive Life, for example, was formed for that purpose. In Congress, Senator Howard Metzenbaum (D-Ohio) and Representative John Dingell (D-Mich.) introduced legislation to regulate the insurance industry at the federal level. It is too early to tell if the legislation will pass.


Most insurance company failures in the last year resulted from high-risk investment strategies. First Capital Life and Executive Life were overinvested in high-yield junk bonds. Mutual Benefit Life was lending and investing in speculative real estate projects. Monarch Capital--parent of Monarch Life--had large real estate losses. All four companies were rated A or A + by the 1988 Best's Insurance Reports even though they were making high-risk investments that eventually led to their demise. Executive Life earned an A + rating from Best while 66% of its bond portfolio was in noninvestment grade junk bonds.

Traditionally, insurance ratings were designed to determine a company's claims-paying ability. A company with high-risk investments could receive an A + rating as long as it was judged able to pay claims. In Executive Life's case, Best said, "The company's investment strategy has been that the additional yields received from the highyield bonds compensate for the risk of default, which is generally perceived to be greater than that of investment grade quality issues." As with any high-risk investment, the hope is the higher yields will offset the higher risk. As long as such instruments held their value in the market, there was no perceived need to lower company ratings.

Determining a company's claims-paying ability is still the ratings services' primary purpose. Even though the ratings now are more sensitive to investment risk it's important to look beyond them to determine client suitability. While such analysis can be complicated, the important question practitioners must ask is, Would the client buy the insurance company's underlying investments for his or her own portfolio? Matching a client's risk tolerance to the insurance company's risk profile has not been done in the past. Many policyholders assumed wrongly--that their money was invested conservatively. When they discovered otherwise, the insurance panic began.

In some respects insurance companies are like mutual funds. Their underlying assets are composed of investments such as stocks and bonds. The same procedures should be followed when investigating an insurance company as when investigating a mutual fund's investment philosophy before investing. The annual Best's Insurance Reports Life-Health provides detailed summaries of insurance companies' investments. The publication is available in most public libraries or by contacting A, M. Best at Ambest Road, Oldwick, New Jersey 08858.


While most major insurance company failures to date have been life insurance companies, troubles also may be on the horizon for property and casualty companies. In this case the concern is not with risky investments but, rather, with inadequate reserves. In April 1992 Standard & Poor's, admitting it was very concerned about the adequacy of loss reserves, said, "Many companies will need to strengthen reserves, but few companies have begun to do so." CPAs and their clients should exercise caution in selecting companies to insure homes and equipment and even to provide malpractice coverage; the company's reserves should be checked to make certain they are not deteriorating to dangerous levels.

CPAs' ROLE IN INSURANCE DUE DILIGENCE The insurance crisis highlights the need for objective advice on all aspects of insurance. Only a few newsletters, books and magazines on insurance can be found, and while there are thousands of tax practitioners, financial planners and money managers, there are only a handful of fee-only insurance advisers. CPAs interested in entering this field are likely to find it an important source of new business.

Insurance due diligence means matching a client with the right policy issued by the right company. Some important questions that need to be asked include

* Does the client really need life insurance? If so, how much?

* Have all of the client's needs been met? For example, does a disability policy provide coverage until age 657 is the coverage adequate?

* Is the proposed policy cost-effective? Insurance agent commissions represent between 50% to 160% of the first year's premium. To minimize premiums, consumers should consider low-load (low-commission) policies and commission rebating. Currently, however, the selection of low-load products is limited, and only Florida and California allow commission rebating.

* Will the policy be reinsured? If so, by whom?

* Is the issuing company financially stable?

* Do the company's investments match the client's risk tolerance?

Many of these questions go beyond information obtainable by investigating the company. As a result, personal financial planning needs to be an integral part of insurance due diligence. Additional information about computing insurance needs can be found in the three-volume manual available to members of the American Institute of CPAs PFP division. Other financial planning training materials (including those for the CFP, CLU or ChFC designations) also include information on how to assess insurance needs.


Insurance due diligence can satisfy a dual objective by benefiting clients and enabling practitioners to expand their practices. However, practitioners should check to see if their states have licensing requirements for offering fee-only insurance planning.

More insurance companies' high-risk investment practices may yet be disclosed; the insurance crisis is likely to get worse before it gets better. This means clients will turn with even greater regularity to CPAs for guidance in seeking the best insurance coverage at the lowest price from the soundest company.

MARY KATHERINE DEAN, CPA, APFS, owns Dean Consulting & Associates in San Diego and publishes Dean's Insurance Alert, a monthly newsletter on the insurance industry. She is a member of the American Institute of CPAs accredited personal finaneial specialist subcommittee and the California Society of CPAs and serves on the International Board of Standards and Practices for Certified Financial Planners task force on long-term care.


* THE FAILURE OF SIX MAJOR life insurance companies in 1991 left consumers extremely wary. Most of them are concerned about receiving payments on life insurance and annuity policies they purchased from supposedly solid companies.

* WITH INSURANCE and annuity payments supported primarily by companies' underlying investments, the speculative investment strategies of the last two decades precipitated the current crisis.

* WHEN AN INSURANCE company becomes insolvent, funds to pay policyholders may be available from other insurance companies, liquidation of assets, sale of the company, lawsuits and state insurance funds.

* THIRD-PARTY RATINGS are one way to judge an insurance company's financial health. However, many of the companies that failed in 1991 earned high ratings from some of the major ratings services in the years just before their demise.

* CPAs WILL NEED TO TAKE a more active role in advising clients on all aspects of insurance, including the client's need for the proposed coverage, the adequacy of the coverage and the stability of the company issuing it.


Among the means CPAs can use to evaluate insurance companies are the ratings issued by the four best-known rating companies: A.M. Best, Standard & Poor's, Moody's Investor Services and Duff & Phelps. These ratings can help determine a company's financial strength; CPAs also will find the ratings useful in making judgments about an insurance company's ability to pay future claims.


A.M. Best was the first to rate insurance companies and only recently saw its 50-year monopoly end as others entered the field. Best provides information on a company's current financial condition, management and operating commitments and a synopsis of its history; it also lists the states in which the company can write insurance. Best analysts have confidential meetings with senior managements and access to nonpublic information in making their ratings.

Best divides a company's strengths and weaknesses into four categories: underwriting, expense control, reserve adequacy and investments. Best issues more "superior" ratings than its competitors, because it takes a long-term view of the insurers' relationships with policyholders, assuming insurance companies will survive several general economic cycles of 20 years or more. Best publishes ratings only with the insurer's permission and will withhold a low rating at the company's request. Companies with a published rating are charged a $500 fee.

Best recently changed its rating system to enhance the system's usefulness for both insurance professionals and the public. The changes were made in response to increasing industry challenges; as insurance company failures increased, ratings were subject to increased scrutiny from policyholders, the public and the media. Because of the changes, Best issued new ratings on a weekly basis and completed the process in June. In the future, ratings changes will be made only on an "as needed" basis.

Best kept most of its old ratings and added three new ones: A+ + (the new top rating), B+ + and C + +. Ratings now range from A + + to F. Companies not in this range are placed in a not assigned (NA) classification. NAs are divided further into 11 classifications, NA-I to NA-11, which identify why a company was not eligible for a rating (too small, insufficient operating experience, incomplete information, etc. ).

Two previous NA categories were replaced with new ratings. The D rating (below minimum standards) replaces NA-7. An E (under state supervision) or F (in liquidation) rating replaces NA-10. Best added NA-11 (rating suspended) to cover companies that experienced a sudden significant event affecting their financial position or operating performance.


S&P rates companies from AAA to D, according to claims-paying ability, and makes qualified solvency ratings ranging from BBBq to Bq. The claims-paying ability rating is S&P's opinion of the company's financial capacity to meet policy obligations. An insurance company must submit five years of statutory annual statements and other public data, agree to meet with S&P analysts and provide nonpublic information that remains confidential. Other factors S&P takes into consideration in making its ratings are a company's mortgage and real estate investment performance and the percentage of junk bonds in its portfolio.

Companies pay between $15,000 and $28,000 for an S&P rating. Due to the high cost, only companies expecting a high rating request one. A company not satisfied with its rating can instruct S&P not to publish it. S&P's report is not available to the public unless the insurance company makes it available.

In April 1991, S&P introduced qualified solvency ratings to fill what it perceived as a gap in the availability of insurance company ratings and to provide rat* ings on hundreds of previously unrated insurers, focusing on companies most likely to face future financial difficulties. To make their ratings, S&P obtains information from companies' publicly filed statements; ratings are issued for each company S&P can obtain data for (assuming the company does not already have an S&P claims-paying ability rating).

S&P issues three qualified solvency ratings:

* BBBq (above average security).

* BBq (average security).

* Bq (below average security).


Moody's ratings concentrate on an insurance company's investment portfolio and range from Aaa to C. A recent change in procedures means a company requesting a Moody's rating will no longer be able to suppress a rating it considers unfavorable. A rating from Moody's costs a company between $15,000 and $28,000. As a result, only companies that are financially strong are likely to request a rating because of the high cost.


In making credit ratings that range from AAA to CCC, D&P takes an overall approach. Ratings apply to corporate debt, preferred stock, real estate, asset-backed financings and the insurance company's claims-paying ability. Of the four major insurance raters, D&P was the first to give Executive Life a low rating. Ratings are developed from interviews with company management and quantitative analysis. Like S&P, D&P publishes ratings only with the insurance company's approval. Once published, ratings are reviewed when a significant event occurs.

Otherwise, reviews are done at least quarterly, and a full-scale review is done annually.


The fact that each rating company uses different symbols can cause additional confusion, making it difficult for all but the experts to compare ratings. When helping clients evaluate insurance companies, CPAs should look at the verbal description that accompanies most letter ratings. In general, CPAs should look for investment grade ratings from at least two of the above companies. Secure ratings are designated as superior and excellent across the top four categories of each rarer. In fact, it may be appropriate to see how all four raters evaluate a particular insurance company. The exhibit on page 68 shows the different designations each rater has for superior and excellent.

--Jeffrey H. Rattinct, CPA, CFP, is director, technical standards, for the International Board of Standards and Practices for Certified Financial Planners, Inc., Denver. He was previously a technical manager in the American Institute of CPAs personal financial planning division.

Mr. Rattiner's views, as expressed in this article, do not necessarily reflect the views of the IBCFP or the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.
 Investment grade ratings
Company Ratings
Best A + (superior), contingent A +,
 A (excellent) and contingent A.
Moody's Aaa (best qualify) and three
 variations of Aa: Aal, Aa2 and Aa
 (high quality).
S&P AAA (extremely strong capacity)
 and three variations of AA: AA +,
 AA and AA - (very strong
D&P AAA (highest claim-paying ability)
 and three variations of AA: AA +,
 AA and AA - (very high
 claims-paying ability).
COPYRIGHT 1992 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:includes related article on evaluating economic strength of insurance companies
Author:Rattiner, Jeffrey H.
Publication:Journal of Accountancy
Date:Aug 1, 1992
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