What is the responsibility of the producer to give advice to clients concerning the financial strength of insurance companies? This was one of the topics at the American Society�s Agent and Broker Liability Conference held in June 1990.

The question is very timely. Conference luncheon speaker Thomas B. Wheeler, CLU, president and CEO of Massachusetts Mutual Life, observed that the rate of insurance company insolvencies is increasing. In the event of policyowner loss arising from company insolvency, the producer is a natural litigation target. Material prepared for the conference by Thomas J. Ziomek, a partner in the Philadelphia law firm of White and Williams, noted that in the past 10 years the frequency of errors and omissions claims against insurance producers has increased, and the severity of those claims has become greater.

Conference speakers noted that, to lessen the danger of being sued, a producer should exercise care in selecting insurance companies to represent and in providing advice to clients insured by companies whose financial condition has deteriorated.

To emphasize the significance of insurance company insolvency to the producer, Dr. Joseph Belth pointed out that many producers carry errors and omissions coverage which does not protect the producer against claims based upon losses incurred due to an insurer insolvency.

It is the writer�s opinion that, in communications to clients concerning the financial fitness of an insurer, a producer should follow the general principle of remaining within one�s area of expertise and not pose as an expert in the financial analysis of insurance companies. In giving advice to clients concerning the financial strength of insurance companies, the producer should rely solely on published sources which have been prepared by industry specialists.

The initial step in any communication of this nature should be to inform the client of the insurance company�s rating by A. M. Best Company and also, if available, of the ratings of other rating services�Duff & Phelps, Inc., Moody�s Investors Service, and Standard & Poor�s Corporation. The producer can help the client understand the ratings by providing each rating service�s explanation of the applicable rating category. These rating categories assess the company�s ability to meet its policy obligations.

Another published source is the National Association of Insurance Commissioners (NAIC), which calculates the Insurance Regulatory Information Systems (IRIS) ratios. Ratios applicable to 1989 results were published by NAIC in May 1990, and can be obtained for $50.00 by writing to the NAIC. Dr. Belth explained if a company has several ratios outside the usual ranges, that�s a warning signal that should prompt the producer to obtain further information about the company.

A good source of additional information is the report provided by the rating services in connection with the issuance of (or change in) a company�s rating. Should a cloudy picture of the company emerge, the producer may be wise to recommend another carrier. If the client is presently a policyowner of the company in question, the producer should review the facts with the client and consider recommending replacement of the product to protect the client�s investment and/or insurability. At the same time, the producer is lessening the likelihood of being the target of a successful lawsuit.

If the producer is recommending the sale of a participating life insurance policy, Best�s 10- and 20-year dividend comparisons indicate how the company performed in the past and how close it came to its illustrations.

The writer believes that a producer should limit communications to clients regarding the fiscal soundness of insurance companies to published facts which have been compiled by experts. This will minimize the risk of being accused of posing as an expert in areas where the producer lacks specific expertise. If the client desires some evaluation of these facts, the producer should respond by seeking additional published data. If appropriate data is not available, the producer should refrain from being tempted to "guess." For the client who persists in posing technical questions which are beyond the producer�s expertise, the producer should attempt to locate an expert in insurance accounting.

The producer who provides clients with conclusions based on personal analyses of the annual statements of insurance companies is treading on dangerous ground. Even a professional in this field cannot perform a competent analysis of an insurance company�s statement without a substantial amount of supplementary information.

An annual statement does not disclose a number of items which are important in assessing the financial strength of an insurer. For example, it does not reveal the extent to which the surplus position and earnings of the company are distorted by reinsurance arrangements. Many of these arrangements are very complex. A professional analysis requires not only a copy of the reinsurance agreement but also a numerical illustration showing its financial effect on the insurance company.

Should a producer rate companies on the basis of their ratio of surplus funds to liabilities? No. One company may have a higher surplus ratio than another but be in poorer financial condition for a number of reasons�it may have received surplus relief from reinsurance arrangements or from transactions involving premium loadings or first-year commissions. In addition, surplus needs differ between lines of business. The producer who wishes to review adequacy of surplus should consider using Moody�s Risk Adjusted Capital Ratio. This is a more sophisticated measure than the pure ratio of surplus funds to liabilities and has the advantage of having been compiled by an expert. Company ratios along with Moody�s company ratings for 1989 appear in Moody�s Industry Outlook�Life Insurance, which was published in July 1990. Copies can be obtained by writing to Moody�s Investors Service.

Should a producer rate companies on the basis of the quality of their investment portfolio? Not unless some reliable published material is available. More refined studies are becoming available on junk bonds. But how can the producer assess the quality of the mortgage portfolio or of the real estate portfolio? And what about investments in the company�s affiliates?

Company insolvency can result in the policyowner recouping nothing unless the policy is taken over by another insurer or is covered by a state guaranty association. Evaluation of financial strength is also important because a company in poor financial condition is more likely to fail to perform as illustrated even though it may remain solvent. A producer who acted as an expert in analyzing the financial statements of such a company runs a greater risk of being held liable for the failure in performance.

Failure to perform as illustrated can also arise from overly optimistic illustrations in instances where the insurance company is of unquestioned financial strength. Here again, the producer who assumes the role of an expert adviser and creates a reasonable expectation by the insured that the illustration is a guarantee could be held liable. The risk to the producer could be lessened through use of the information contained in a company�s reply to the American Society�s Professional Practice Guideline.¹ This information can assist the producer in obtaining a better understanding of the underlying assumptions and in communicating these to the client.