Insurance Company Ratings: What They Are & How They Work

May 1, 2024
8 min read

Key Takeaways

Insurance company ratings are tools that offer insights into the potential financial stability and reliability of insurers. These ratings play a pivotal role in guiding consumers, businesses, and investors in making informed decisions about selecting insurance providers.

The insurance company ratings process involves an evaluation based on several financial metrics such as (but not limited to) capital reserves, asset quality, profitability, operational performance, and liquidity. This approach helps in predicting the insurer’s ability to meet its obligations and handle claims effectively.

The significance of these ratings extends beyond just assessing financial health; they also influence the insurance terms and premiums that companies can offer, directly affecting their market competitiveness. For businesses, particularly those requiring substantial coverage like blanket insurance, these ratings determine which insurers may be capable of being long-term partners.

In the U.S., four major agencies—AM Best, Standard & Poor’s, Moody’s and Demotech—specialize in providing these ratings. Each agency uses distinct criteria and scales, but their common goal is to measure an insurer’s financial strength and claims-paying ability. Understanding the nuances of these ratings and the reputation of these agencies helps stakeholders choose insurance partnerships.

What Are Insurance Company Ratings?

Insurance company ratings are essential tools that serve as indicators of an insurer’s reliability and financial health. These ratings are vital for consumers choosing a policy, investors seeking stable returns, and regulators overseeing industry practices. They provide a quantifiable measure of an insurer’s prospective ability to meet its policy obligations, thereby helping inform of policyholders and prospective policyholders.

When considering an insurance provider, ratings can be one of the most critical factors in the decision-making process. They offer an independent assessment of the risk associated with an insurer’s ability to meet obligations. Additionally, these ratings may influence the terms and premiums an insurer can offer, impacting their competitiveness in the market.

Insurance company ratings are prepared through a meticulous process and are based on a wide range of financial indicators, including profitability, liquidity, capital adequacy and historical performance. Rating agencies also consider the quality of the company’s business, its market position, and its ability to adapt to changing market conditions.

For businesses, understanding these ratings helps in making informed choices about which insurers are more likely to be reliable long-term partners. For insurers, maintaining a high rating is crucial for attracting and retaining customers and for favorable borrowing terms in the financial markets.

Overall, insurance company ratings aren’t just about financial metrics; they encapsulate the economic resilience, operational effectiveness, and strategic foresight of an insurer, making them a key component in the financial landscape of the insurance industry.

Insurance Company Ratings: How They Work

Insurance companies are rated according to an evaluation of the company’s financial stability. This includes consideration of everything the insurance company is responsible for, such as overhead, salaries and the liabilities of its customers. The key financial metrics and factors that are taken into account are:

Capital Reserves

This is one of the most important metrics, since an insurance company must be solvent in order to pay out claims. The company needs to have a significant capital buffer so that it can absorb losses and still continue operations.

Quality of Assets

Insurance company ratings include the quality and diversification of a company’s assets. The ratings agencies review the insurance company’s investment portfolio to evaluate it.

Profitability

The insurance company is rated on its history of profitability, which is a positive indicator of its strength. The company’s ability to generate profits from core business activities is key to growth and sustainability over the long term.

Operational Performance

Ratings agencies take a look at how well the insurance company performs its duties. This includes all areas of the operations, such as employee retention rate, customer satisfaction, underwriting discipline, administrative practices, claims management and more.

Liquidity

Insurance company ratings also reflect liquidity. This is how easily the company would be able to meet short-term financial obligations without having its financial stability placed in jeopardy.

Who Rates Insurance Companies?

Insurance companies are rated by third-parties that should have the capacity to be objective because they are not stakeholders in the insurance companies they rate. In the U.S. four companies are primarily responsible for insurance company ratings, which serves to set benchmarks for insurer reliability. Using rigorous, proprietary techniques and processes, these agencies assess the financial strength and claims-paying ability of insurance companies; a service that is crucial for policyholders, investors and regulators. The four rating agencies are:

AM Best

AM Best has a long history; founded in 1899 in New Jersey. It began during a time when insurance company failures were common, and its services are still invaluable today, even though insurance company failures are much more rare. AM Best has a stellar reputation for its comprehensive insurance company ratings, which are often used as a standard measure of financial strength. The ratings provided by AM Best range from A++ (Superior), indicating top-tier financial stability, down to D (Poor), signaling financial vulnerability. Notably, AM Best exclusively focuses on the insurance sector, making its evaluations highly specific and relevant to insurance companies.

Standard & Poor’s

Standard & Poor’s was founded in 1860 by Henry Varnum Poor. Unlike AM Best, Standard & Poor’s evaluates companies other than insurance companies, but it still excels in the insurance sector. S&P’s ratings assess a company’s capacity and reliability in meeting its financial commitments punctually and fully. This includes the company’s likelihood of timely and complete claims payment to policyholders. The rating scale at S&P stretches from AAA (Extremely Strong), representing the highest level of financial assurance, down to D, indicating poor financial health.

Moody’s

Founded in 1909 by John Moody of New York City, Moody’s began by publishing statistical manuals for evaluating railroad bonds. It’s now one of the largest credit rating agencies in the world, and one of its specialties is insurance company ratings. They do this with the intent of determining, like other rating companies, how likely an insurance company is to be able to pay out a claim on time. Their highest score is Aaa (Highest Quality) while C (lowest-rated, typically in default) is the lowest.

Demotech

Demotech is the youngest of the insurance company rating agencies, having been founded in 1985 in Columbus, Ohio. It specializes in rating small to mid-size insurance companies, and its research and reports are well-respected. Its rating scale is a little different, in that the highest score offered is A” and the lowest an L, with A’, A, S, M in the middle. A” is double prime, A’ is prime, A is excellent, S is substantial, M is moderate and L is licensed.

In What Other Ways Can I Evaluate the Quality of an Insurance Company?

While the independent agencies listed above do a comprehensive job of evaluation an insurance company’s financial stability, your organization may wish to take a closer look at factors such as customer complaints. There are two other organizations that provide insurance company ratings concerning customer relationships and incidences of customer complaints. They are J.D. Power and National Association for Insurance Commissioners (NAIC) / state insurance regulators.

J.D. Power publishes a yearly report that contains information about customer satisfaction and claims handling satisfaction. Major insurance companies are included in this annual list.

NAIC has what they call a complaint index. This number is based on the number of reported complaints against the insurance company. This is broken down into product categories, so you can filter the results so you’re only looking at what is relevant to your organization. The benchmark index is 1.0. A higher number indicates that the company has received a larger number of complaints relative to the number of customers served.

Why You Should Care About Insurance Company Ratings

Choosing a financially stable insurance company with a reputation for providing excellent customer service is important; particularly for business organizations. Your own financial stability depends upon you making a good choice when it comes to an insurance company. Your organization trusts and relies on the insurance company to provide the services and claims payouts that you need to continue operations.

Bottom Line

Insurance company ratings are crucial for assessing an insurer’s financial stability and reliability, directly impacting business decisions. These ratings, provided by authoritative agencies like AM Best, Standard & Poor’s, Moody’s, and Demotech guide stakeholders in choosing insurers that are most likely to remain solvent and fulfill claims. By understanding these ratings, organizations can mitigate the risk of financial losses and ensure seamless coverage continuity. As shown, selecting a highly-rated insurance provider is not just a precaution; it’s a strategic decision that safeguards financial interests and fosters long-term security.