Life insurance company due care

1
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care
• Process to research insurance companies
• Assessment of the companys rating by the major
  rating services
• Evaluation of general characteristics and
  financial information
• Review of recent trends for
• Profitability
• Leverage
• Liquidity

2
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Company rating services
• A.M. Best Company
• Rating companies for 85 years
• Low fees
• Best Insurance review
• One-year assessment of companys financial
  situation
• Provide opinions
• Concerning companies relative financial strength
• Companys ability to meet its contractual
  obligations

3
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Company rating services (cont'd)
• A.M. Best Company (cont'd)
• Letter ratings
• A to F
• Additional modifiers
• (g) Group rating
• (p) Pooled rating
• (r) Reinsured rating
• (u) Under review
• Not Rated designations
• NR-1 Insufficient data
• NR-2 Insufficient size or operating experience
• NR-3 Rating procedure is inapplicable
• NR-4 Company request
• NR-5- Not formally followed

4
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Company rating services (cont'd)
• A.M. Best Company (cont'd)
• Financial planers should favor companies that
  have received at least an A rating for a number
  of years
• Financial size rankings
• FSC1 through FSC XV
• Based on capital, surplus and conditional reserve
  fund
• Moodys
• Assigns financial strength ratings
• Aaa to C
• Substantial fee
• Limited number of carriers agree to be rated

5
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Company rating services (cont'd)
• Fitch
• Rates the claim paying abilities
• AAA to D
• Substantial fee
• Standard Poors
• Rates the claims paying abilities
• AAA to R
• Substantial fee
• Quality Solvency Rating
• Mechanical rating system
• Based on purely public information
• From financial statements filed with the state
  regulators

6
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Company rating services (cont'd)
• Standard Poors (cont'd)
• Quality Solvency Rating (cont'd)
• BBBq Above average
• BBq Average
• Bq Below average
• Weiss research
• Relative newcomer to rating services
• Proprietary rating system
• Dependant on publicly available information
• Ratings more severe than those of the other
  rating services
• A through F

7
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
• Company size and age
• Large well established companies are likely to
  weather adverse trends more successfully than
  smaller and newer, less well established
  companies
• Company financial information
• Percentage of premium that is individual life
  premium
• Company could place more emphasis on other lines
  of business at the expense of the life insurance
  policyholders
• Average policy size
• Larger polices lapse less frequently than larger
  policies
• Average policy size and company size are not
  related

8
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Quality of investment assets (cont'd)
• Bonds, mortgages, real estate and policy loans
• Carriers with financial difficulties
• Large percentage of junk bonds
• Large percentage of non-performing real estate or
  mortgages
• Assets are listed by category and investment
  grade
• Bond maturities
• Shorter average maturities are considered less
  risky than longer maturities
• Investment yields
• Return on general portfolio principal source for
• Dividends for participating policies
• Interest credited to interest-sensitive policies

9
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Separate accounts
• Variable life, variable annuity or variable
  universal life
• By law, assets kept in separate account
• Percentage of assets held in these accounts
  indicate companies view of the importance of
  these products.
• Planners should assess the quality of these
  assets as they do the other assets
• Liabilities and payments to surplus indicate
  charges applied against the funds
• Compare separate account net investment income
  against those of competitors

10
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Company history management and operations
• When was company founded?
• Stock or mutual company?
• Subsidiary of another company?
• Recent changes in management?
• Above-average growth?
• Stability of growth?
• How are products are distributed and what is the
  size of the field force?
• How does its size compare industry wide?
• Approved for business in the state of New York?
• Companies most important product line
• Proportion of business for each line

11
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Operating ratios
• Lapse ratio
• How many policies are lapsing annually
• Look for lapse ratios less than 11
• Greater lapse ratio usually means higher than
  average expenses for policyholders
• All else being equal, better to buy from
  companies with larger average policies
• Operating comments
• Compare net yield with the industry wide average
• Reasons why it is higher or lower than the
  industry average
• Reserves
• Set asides to pay promised benefits

12
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Operating comments (cont'd)
• Statutory Reserves
• Amount that together with future net premiums and
  interest will be sufficient to pay future claims
• Measures of expenses
• Ratio of total expenses to total insurance in
  force
• Comparing insurers who are almost exclusively
  life insurers
• No weight to annuities , health insurance,
  disability and accidental death benefits
• No allowance for difference between first year
  and renewal expenses
• No allowance for differences of book of business
  by age or plan

13
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Measures of expenses (cont'd)
• Ratio of total expenses to premiums received
• Gives some weight to annuities, health insurance,
  disability policies, etc
• More appropriate for companies with broader lines
  of business
• Ratio of total expenses to total income
• Broadest overall measure
• Includes weighting for supplemental contracts
• Mortality Experience
• Company that has tough standards desirable
• Future favorable mortality experience translates
  to possible higher dividends or interest credited
  to cash values
• Lower lapse ratios

14
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Dividends
• Compare projected performance against that of the
  actual experience
• Business trends
• New business issued
• Management plans for new lines of business
• Changes in amounts of insurance inforce
• Look for declining trends in expenses
• Trends
• Profitability
• Return on equity

15
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Trends (cont'd)
• Change in capital and surplus
• Measure of net worth
• Excess of assets over liabilities
• Greater surplus equals less risk of insolvency
• MSVR
• Mandatory Securities Valuation Reserve
• Reserve for losses on securities held in the
  general portfolio
• Leverage
• Change in net premiums written
• Measures whether a companies obligations are
  growing at a rate that may exceed its ability to
  handle them

16
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Life insurance company due care checklist
  (cont'd)
• Trends (cont'd)
• Insurance exposure to capital and surplus
• Measure of mortality exposure or mortality
  leverage
• How much adverse mortality experience the company
  can handle
• Liquidity
• Meeting current and future obligations
• Affiliated investments to capital and surplus
• Applies when company is part of an affiliated
  group of companies
• Considers the investments of all affiliated
  companies and compares it to the consolidated
  capital and surplus

17
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Mutual Companies Versus Stock Companies
• Mutual company
• Corporation with no shareholders
• Policyholders are members of the corporation
• Membership rights
• Right to the dividends declared by the board
• Right to participate in the corporate governance
• Election of directors
• Right to receive any remaining value if the
  company is liquidated
• Right to expect the corporation will be run for
  the benefit of its members
• Right to bring legal action against the directors
  and officers for violating their fiduciary duties

18
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Mutual Companies Versus Stock Companies
• Stock Company
• Corporation with stockholders who may or may not
  be policyholders
• Corporation run primarily for the benefit of the
  stockholders
• Advantages and disadvantages Mutual (M) versus
  Stock(S) companies
• M - No conflict of interest between shareholder
  and policyholders
• M - Lower profit goals than stock companies
• M - Management can take a longer term view
• S Greater flexibility to raise capital
• M -Financial reporting less flexible because
  transitions listed on parents books
• S My be easier to provide other financial
  services through its subsidiaries
• S - Management performance subject to higher
  level of scrutiny

19
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Reinsurance - why use it?
• To insure against losses they may incur
• Companies have limited amount of capital
• Cap losses by they incur by purchasing
  reinsurance
• The smaller the company, they more reinsurance
  they will buy
• To seek the reinsurers underwriting and
  expertise
• To seek help to enter or exit given lines of
  business or product lines
• Companys wanting to exit a line of business can
  reinsure the entire line
• Companys wanting to offer a new product or line
  can obtain the help of the reinsurer to
  underwrite and develop the product until the
  company develops its own expertise
• To help a company manage its financial position
• May increase the ceding companys statutory
  earnings and surplus during the year paid

20
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Reinsurance (cont'd)
• Proportional reinsurance
• Reinsurer takes share of losses incurred
• Categories of reinsurance arrangements
• YRT
• Ceding company transfers mortality risk but
  retains responsibility for establishing reserves
• Coinsurance V
• Transfers a proportionate share of all policy
  risks and cash flows
• Relieves strain on surplus
• Coinsurance with funds withheld
• Ceding company keeps premiums normally paid to
  reinsurer
• Reinsurer keeps allowanced normally paid
• Limits cash flow between companies

21
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Reinsurance (cont'd)
• Non-proportional reinsurance
• Only pays if loss exceeds a certain amount
• Risk is allocated by amount
• Categories
• Stop Loss
• Covers ceding companies claims above a
  predetermined dollar amount
• Catastrophe
• Covers losses exceeding a specified amount or
  number of insureds due to a single event (e.g.,
  airplane crash, train wreck or natural disaster)
• Excess of Loss
• Reinsurance above a certain dollar amount for a
  particular claim

22
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Federal and State Laws and Regulation
• Purpose of regulation
• Maintain insurers financial solvency and
  soundness
• Maintain fair treatment of current and
  prospective policyholders
• Insurance carriers regulated by the individual
  states
• Division of insurance
• Investigate claims of unfair trade practices
• Reviewing and approving policy forms used by
  insurance companies
• Approving rates charged for various types of
  insurance
• Ensure compliance with state laws that regulate
  insurance rates

23
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Federal and State Laws and Regulation
• Insurance carriers regulated by the individual
  states (cont'd)
• States assume primary responsibility for
  overseeing financial operations and management of
  companies incorporated in their states
• National Association of Insurance
  Commissioners(NAIC)
• Coordinates the regulatory processes of the
  states
• Suggests model laws state legislatures can enact
• Underwriting
• Determines whether or not to issue a policy and
  at what price

24
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Underwriting (cont'd)
• Factors used in determining offer
• Age
• Sex
• Height and weight
• Health history (including family)
• Purpose of insurance
• Marital status and number of children
• Amount of insurance inforce and applied for
• Occupation
• Income
• Credit history
• Tobacco and alcohol use
• Foreign travel
• Hobbies

25
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Underwriting (cont'd)
• Physical exam
• Medical records
• Blood and urine samples
• Medical Information Bureau (MIB)
• Classifying the risk
• Impacts the price of the coverage
• Preferred, standard, table rating (as examples)
• One companies rating is not necessarily what
  another company would rate

26
How To Determine The Right Company
Chapter 3 Tools Techniques of Life Insurance
Planning

• Company service and fairness to policyholders
• Service is difficult to quantify
• Considerations
• Turnaround time for requests for information,
  policy loans, application processing, death
  claims
• Level of service provided by the agent
• Do policyholders share equitably in the companys
  favorable performance
• Do policyholders of one class of policies share
  equitably as compared to other shareholders of
  other types of policies
• Compare projected dividends against those
  actually paid