A Credit Rating Agency (CRA) is a company that evaluates and assigns credit ratings for companies. This is done so that the public from a prospective employee to a consumer to an investor can see how the company is doing prior to working for them, purchasing from them or investing in them.
Specifically, they are used to determine the credit- worthiness of a company, their financial strength and their ability to make their short and long-term financial obligations. The ratings provide a window into the stability and financial strength of the company.
These ratings are assigned to public companies of all types including banks and insurance companies. The companies that are considered CRAs are deemed “Nationally Recognized Statistical Rating Organizations” (or “NRSROs“) by the U.S. Securities and Exchange Commission (SEC).
Insurance Company Ratings
This is very relevant for insurance companies since they have to be prepared to pay claims. In insurance speak this is called reserves. Reserves refer to how much money the company is holding in case it meets with a catastrophic loss and has to pay out a significant amount of claims. Part of the insurance company credit ratings take that factor into account.
Insurance companies are rated by companies for their financial strength and credit and debt situation. Their opinions are considered independent meaning they are not swayed by the influence of any company and can therefore be relied upon to be unbiased.
Why Ratings are Important
To insurance companies, a financial strength rating can show consumers that the organization is stable and has decent long term prospects. This provides greater peace of mind when purchasing insurance.
It also can enhance an insurer’s status with reinsurer’s. This is important for companies going into new markets.
For investors, it can indicate the company is worth investing in for the long-term or the short-term. It also means that they can invest with a certain amount of confidence.
The ratings are also vital as a marketing tool for insurance agents who sell to businesses and consumers. It creates confidence in their prospective clients. They know when they are purchasing insurance that the company will be there if they have a claim. Because of this, a rating can influence an agent’s choice on which insurance companies to market.
The ratings are based on a thorough qualitative and quantitative evaluation of an insurance company’s balance sheet, operating performance, and business profile. There are a few credit rating companies that do this. Two of the most well known are AM Best and Fitch.
AM Best has been assigning credit ratings since 1906. In fact, they were the first of the modern credit agencies to use symbols for credit rating differentiation.
Among other types, Best’s assigns a financial strength rating to insurance companies. They are ranked by class according to their financial size. The ratings are classified as follows:
In the secure category:
- A++, A+ (Superior)
- A, A- (Excellent)
- B++, B+ (Good)
In the vulnerable category:
- B, B- (Fair)
- C++, C+ (Marginal)
- C, C- (Weak)
- D (Poor)
- E (Under Regulatory Supervision)
- F (In Liquidation)
- S (Suspended)
In 1913, John Fitch founded the Fitch Publishing Company. The firm published financial statistics for the investment community. They also developed the long-term alphabetic rating scale:
In the investment grade category:
- AAA – the best quality companies, reliable and stable
- AA- quality companies, a bit higher risk than AAA
- A – economic situation can affect finance
- BBB – medium class companies, which are satisfactory at the moment
In the non-investment grade category:
- BB – more prone to changes in the economy
- B- financial situation varies noticeably
- CCC – currently vulnerable and dependent on favorable economic conditions to meet its commitments
- CC- highly vulnerable, very speculative bonds
- C- highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations
- D- has defaulted on obligations and Fitch believes that it will generally default on most or all obligations
- NR – not publicly rated
Fitch Rating is a global rating agency. They provide the world’s credit markets with independent quantitative and qualitative opinions, research and data. They have 49 offices worldwide and are headquartered in New York and London.
Other credit agencies that rate insurance companies are Standard & Poor’s and Moody’s.
Overall, the financial strength ratings indicate the ability of the financial condition of the company and its ability to meet its ongoing policy and contract obligations on a short and long-term basis.