The rating process, as conducted by Standard and Poor�s, Moody�s, and Duff and Phelps, usually involves the following distinct steps:

There are slight variations in this general process among the three multi-industry rating services, and there can be other variations depending on the rated company�s circumstances. For example, one rating agency invites company officials, at the beginning of the third step above, to meet with members of the committee that will make the rating decision.

Companies seeking ratings for the first time usually have the option of withdrawing the rating request if they do not agree with the agency�s rating decision. For a company with an existing claims-paying ability rating, this is almost never an option because the public perception of a decision not to be rated would probably be worse than the rating itself.

The A.M. Best process includes the same elements as those of the other rating services, but the order of the steps differs because A.M. Best releases its annual ratings in the spring of the year. In addition, A.M. Best does not require visits with company officials each year.

The criteria used by the four principal rating services in reaching their rating decisions, not surprisingly, have a large degree of commonality. They involve elements that are quantitative and elements that are largely qualitative. The quantitative elements frequently involve comparisons to industry norms developed independently by each of the services. Since a claims-paying ability rating is an evaluation of the company�s ability to meet obligations maturing in the future, even the quantitative elements (which are necessarily based on the company�s past performance) must be tempered by qualitative judgments.

Because statutory blue blank reports are available for all life insurance companies, the quantitative analyses of the rating services are presently based on data drawn from these reports. GAAP financial statements are used to provide certain supplementary information for stock life insurance companies. When GAAP reporting becomes required for mutual companies, it is likely that GAAP financial information will take on more importance in the rating process.

A claims-paying ability rating must measure the company�s present financial strength (relative to its obligations for future policyowner claims) and whether the company�s financial performance is likely to increase or decrease this financial strength in the future. In describing the elements that are taken into account by the rating services, it is useful to categorize them into elements that are used principally to measure the company�s current financial strength and elements that are used principally to form an opinion about the company�s future financial performance. (Of course, most of these elements will, at least to some extent, affect both a company�s present position and its future performance.)

The elements that principally measure a company�s current position are

Capital is required to provide the safety margin (over and above the amount of reserves and other liabilities) to assure that the company will be able to invest (in its businesses), to grow, and to meet its commitments. The amount of capital depends on the size of the company and on the riskiness of the company�s investment portfolio and insurance lines. For example, an investment strategy that emphasizes high-yield bonds requires more capital than a strategy that emphasizes government bonds. Similarly, Guaranteed Investment Contracts (GICs), which guarantee a return to contract owners, require more capital than variable contracts in which the investment earnings of a separate account are passed through to policyowners.

Liquidity is the company�s ability to make large and unpredictable payouts to policyowners or to meet other obligations. To determine if a company is in a good liquidity position, the rating service looks at the amount of the company�s cash and short-term investments (usually those maturing in less than one year) and the likelihood of sudden cash calls. For example, a company with a large block of annuity contracts on which the cash surrender values are available without penalty presents a greater risk than a company whose book of business consists largely of life insurance policies sold to meet estate planning needs.

Asset/liability values are a key element. Because the company�s asset and liability values are taken into account in measuring the amount of the company�s capital, the degree of conservatism in their measurement is a very important factor to the rating services in reaching a decision. The key question on assets is the degree to which the asset values reflect appropriate reserves for likely or potential losses; in the case of liabilities, the question is whether the reserves have an adequate margin for future interest requirements and/or insurance losses. For example, if the company�s investment earnings are currently insufficient to cover the interest requirements of its GIC contracts and are not expected to be sufficient in the future, a reserve equal to the contract funds would not, by itself, be adequate. (A judgment about reserve and liability adequacy should be made with respect to the aggregate of all reserves and liabilities because a shortage in one area may be covered by excesses in others.)

Other insurance/investment risks include the degree of asset or insurance concentration risk, the use of reinsurance to reduce risk, and the company�s vulnerability to reinsurer default. A concentration of investments in a particular geographical area or business/industry or a concentration of life insurance in force on a relatively small number of insureds increases risk and is the subject of rating agency review. Reinsurance ceded can reduce large life and health insurance risks to the company but only to the extent that the reinsurer is financially strong.

The following are the key elements that the rating services focus on to form opinions about the company�s future financial performance: