Risk Management—January 2011

An Alternative Approach to Ratings: A Case Study

David Paul

At a recent luncheon, before a presentation I was to give on tracking the financial health of life insurance carriers, I got talking to the president of a wholesale general agency who told me the following: "My big problem is that I just don't know how to answer my brokers' questions about financial strength. And I've been getting a lot of them over the last several years. For instance, I got a call the other day from a client asking why RBC Insurance had been downgraded. I had no idea why."

I tell this story because it highlights two problems often seen in our interaction with clients. The first is that the individual responsible for answering questions about financial strength and ratings often does not have the expertise and/or time to properly do so. The second is that the entire ratings paradigm often serves to intensify this problem rather than alleviate it.

To better understand what I mean by this second point, let's return to the example of RBC Insurance. The first problem here is that "RBC Insurance," in a very important sense, does not exist. The downgraded entity is actually Liberty Life Insurance Company, a legal insurance entity domiciled in South Carolina. This company was acquired in 2002 by Royal Bank of Canada, a large banking institution based in Toronto. "RBC Insurance" is simply a marketing name that, by incorporating the parent name, gives the appearance of greater financial heft at the life insurer.

What does this have to do with public ratings? Well, rating agencies can play into this confusion by basing their ratings largely on the financial strength of the parent companies. That is, rating agencies concentrate principally on the implied financial support of the parent organization—often in the form of a rating on holding company debt—and then "notch" the rating of the insurance subsidiary several pegs above those debt ratings. Obscured in this process is the actual financial strength of the underlying entity—e.g. Liberty Life Insurance Company—to which a policyholder has legal exposure. This is why all insurance subsidiaries of a holding company often have the same rating—despite potentially vast differences in their standalone financials.

Returning to our story, the reason Fitch downgraded Liberty Life Insurance Company (aka "RBC Insurance") on August 31st is that parent Royal Bank of Canada announced that it was reviewing "strategic options" for its U.S. insurance business. In other words, RBC was looking to off-load this business. This meant that the implicit support of the parent was diminished and Liberty Life's credit ratings were immediately lowered two pegs.

Taking a step back then, business placed in Liberty Life Insurance Company on August 30th was with an A+ carrier and 24 hours later—with no change to the underlying financials of the actual insurer—that business was suddenly with an A- carrier. Strange!

On October 25th A.M. Best downgraded Liberty Life Insurance Company from A to A- on the announcement that the company was being sold to a private equity firm and was no longer afforded the "ratings enhancement" of ownership by RBC. No wonder our agency president was puzzled.

A New Paradigm

Let's imagine a world without rating agencies for a moment. How would one make decisions about the financial strength of his or her insurance partners? Perhaps one would look first and foremost at the actual financials of the carriers issuing the policies. That is precisely what ALIRT Research does.

The ALIRT Analysis provides a relative financial comparison that quantitatively scores one issuing insurer against another on an on-going basis. ALIRT does this by focusing largely on statutory financial filings, which are filed by all individual U.S. insurers on a quarterly basis. Also factored into ALIRT's ultimate score, though with lesser weightings, are public ratings and parent financials. ALIRT's work is always shown on a five-year and current-period trend and benchmarked against an industry composite, comprised of the leading 100 U.S. life insurers.

The quarterly ALIRT Score ranges from 0-100, with the median score for the industry composite at approximately 54 over the past 10 years. This scoring system provides a meaningful way to compare insurers' underlying financial strength trends over time versus an often static rating, which—again—is largely predicated upon the explicit support of a parent company. The ALIRT Score is for the individual legal insurance entity.

Let's return to Liberty Life Insurance Company, the legal entity underwriting the insurance contract. The ALIRT Scores for this carrier, as seen below, have ranged from 36 to 62 over the past nine years and current period. Importantly, this company's financial profile has exhibited a wave-like motion, improving in the period 2001-2005 before deteriorating in 2006 and after. As shown, the company has underperformed the ALIRT Industry Composite since 2002, at times substantially. Compare this to the second graph, which shows a static rating over the period before a surprise one-day drop in credit ratings in mid-2010.

Which analytical methodology offers more information? Which prompts more questions regarding carrier financial strength? Which better serves the producer and client when making decisions about insurance placement?

With ALIRT's financial performance trend information at hand, our wholesaler would have had important information to share with the broker regarding the relative financial performance of this distinct carrier over a ten year window—outside of parent ownership (which has changed now twice) and ratings. The producer, in turn, could have used the ALIRT Scores of Liberty Life (compared to those of other potential insurers) to help him or her better gauge probability of future financial stress when determining, on a risk-reward basis, where to place business.

Was Liberty Life a good place to be placing business in the period 2006-2010? There is no absolute answer, because much depends on the risk tolerance of the client combined with the product type, term, cost, and design. But the ALIRT Analysis allows distributors to have an objective discussion about such matters with the prospective insured, which the ratings, in this case, largely did not.

As an endnote to our story: the private equity firm that acquired Liberty Life, Athene Holdings, has subsequently reinsured the company's existing life business to Protective Life. The company's fixed annuity and health business is also being placed into run-off, though it will remain with the company. Beyond this, future plans for Liberty Life remain uncertain. The insured's insurance policy will continue to be backed, ultimately, by the claims paying ability of this legal entity, Liberty Life Insurance Company.

David Paul is a partner at ALIRT Insurance Research, a firm specializing in the analysis of insurance company financial performance trends. ALIRT's quarterly insight into the underlying financial strength of insurers allows distributors and buyers of insurance products to anticipate financial stress and/or rating downgrades of insurance partners before they occur.

Paul was a founding member of ALIRT Insurance Research, building out the company's life, property/casualty, and health insurance company analytical models/services. Paul codirects the company's research staff, manages internal IT initiatives and product development, and is active in the industry as an author and public speaker. Paul can be reached via email at, or visit