You and your clients may be worrying about whether they can really count on those hefty life insurance policies they’ve got. Just this Monday, the government scrapped an earlier $123 billion bailout plan for AIG only to replace it with a new $150 billion lifeline while numerous other insurers have required capital injections to shore up their balance sheets. MetLife, for example, raised capital by issuing $2 billion in new stock. The Hartford received a $2 billion investment from Allianz, a Germany-based insurer. And a Goldman Sachs report warned that Prudential Life Insurance Company’s exposure to mortgage-backed securities and real estate loans could result in up to $4 billion in losses and reserves.

Back in October, N.Y.-based Fitch Ratings downgraded the life insurance industry outlook to negative from stable primarily due to mortgage-related investments. “While less exposed [to mortgage-related investments] … life insurers are experiencing a significant deterioration in investment results, which has negatively impacted earnings and capital,” the Fitch report said.

Moody’s Investors Service, also based in New York, issued a negative outlook on the life insurance industry as well, though it said insurers are in better financial shape than banks and brokerage firms. But profitability and capital adequacy are declining due to losses in asset-backed securities, stocks, bonds and loans, as well as the increasing cost of hedging variable annuity principal guarantees.

“Rising investment losses, falling equity markets and weakening economic conditions will pressure the profitability, financial flexibility and capital adequacy of these insurers over the next 12 to 18 months,” says Laura Bazer, Moody’s vice president. “Life insurers’ top and bottom lines will both be under pressure as the economy continues to slow.”

Does this mean we could see some brand-name insurers go belly up? Bazer says that while life insurers face a negative outlook, she is not expecting a raft of bankruptcies. Insurers are “healthier than most other troubled financial services sectors.”

Nevertheless, profitability and capital adequacy will suffer as insurance company investments in asset-backed securities, corporate bonds and loans suffer over the next few years, resulting in higher losses. The high cost of hedging variable annuity principal guarantees is also hurting the bottom line, she says.

Whatever shape the future takes, the recent near-collapse of the financial system and the deterioration of insurance companies broadcasts a message of prudence to financial advisors. They should recommend insurance companies with the strongest ratings—while watching out for higher premiums. Financially weak companies may carry A.M. Best ratings below B+, Fitch ratings below BBB-, Moody’s ratings below Baa3 and S&P ratings below BBB-, say analysts. If a company goes belly-up, policy owners get limited protection from state guarantee associations, which are funded by insurance companies. State laws vary, but the most they’ll typically cover is $300,000 in life insurance and death benefits, $100,000 each in cash surrender or withdrawal value for life insurance; withdrawal and cash values for annuities; and health insurance policy benefits.

Be advised the state guarantee associations only cover insurance that is a direct obligation of the insurance company. They do not cover variable annuity principal guarantees.

There are several companies that evaluate the financial strength of life insurers. But only a small percentage carried top financial strength ratings, according to an analysis published in September, 2008 by the Insurance Forum, an Ellettsville, Ind.-based monthly newsletter. The publication reported:

* A.M. Best (www.ambest.com) rates 965 life insurance companies, but only 3.8 percent or 37 companies carry the top A++ (Superior) ratings. Another 149 companies, or 15.4 percent, are rated A+ (Superior).

* Standard & Poor’s (www.standardandpoors.com) rates 361 life insurance companies, but only 5.8 percent or 21 firms get its top rating, AAA (Extremely Strong). Another 23 companies, or 6.4 percent, achieve AA+ (Very Strong) ratings.

* Moody’s Investors Service rates 188 life insurance companies, but only 3.2 percent, or six firms, carry Aaa (Exceptional) ratings. Another 11 companies, or 5.9 percent, carry Aa1 (Excellent) ratings.

* Fitch (www.fitchratings.com) rates 317 life insurance companies, but only 3.2 percent, or 10 firms, get its highest AAA (Exceptionally Strong) rating. Another 46 companies, or 14.5 percent, carry AA+ (Very Strong) ratings.

Each month, the Insurance Forum publishes a “Watch List” of insurance companies that have developed problems due to capital inadequacy.

The publication is an excellent source of information on insurance company strength. But it’s still prudent for people with large multi-million dollar estates to place funds in a couple of different insurance companies that have registered high financial strength ratings over the long term.

The following insurance companies, according to the July issue of A.M. Best Review, have maintained their high financial strength ratings of A (Excellent) to A++ (Superior) for 75 years:

  • Aviva Life and Annuity Company, rated A+.
  • Beneficial Life Insurance Company, rated A.
  • Country Life Insurance Company, rated A+.
  • Genworth Life and Annuity Insurance Company, rated A+.
  • John Hancock Life Insurance Company, rated A++.
  • Metropolitan Life Insurance Company, rated A+.
  • Nationwide Life Insurance Company of America, rated A.
  • New York Life Insurance Company, rated A++.
  • Northwestern Mutual Life Insurance Company, rated, A++.
  • Penn Mutual Life Insurance Company, rated A+.
  • Principal Life Insurance Company, rated A+.
  • Prudential Insurance Company of America, rated A+.
  • Standard Insurance Company, rated A.
  • Union Security Insurance Company, rated A.
  • Western Southern Life Insurance Company, rated A++

Although the rating agencies provide valuable services to investors and consumers, there are caveats.

“They (rating agencies) are concerned more with corporate bondholders than with insurance policyholders,” says Moshe Milevsky, finance professor at York University, Toronto. “It is also very difficult to summarize the complexity of an insurance company’s liabilities with just one letter or number.”

Milevsky also stresses that in today’s unstable economic environment, rating agencies are in a difficult situation.

“They are balancing on a knife’s edge,” he says. “If they downgrade a company too early or prematurely, they can actually cause (the company’s) financial downfall. If they wait too long, they will be accused of reacting as opposed to forecasting. The bottom line is that rating agencies are no longer mere observers in the financial process, they are actually impacting what they are supposed to be observing.”

One long-time critic has been Martin Weiss, Ph.D., of Jupiter, Fla., who sold his insurance rating services to The Street.com in 2006. His chief criticisms:

  • The ratings are purchased by insurance companies from the rating agencies.
  • Companies can shop for the most liberal ratings.
  • Rated companies get to preview their ratings before they are published so that they can appeal downgrades and delay their publication. Or they can fire the rating agency and look elsewhere.

The main thing, perhaps, is to do as much of your own homework as possible—and find an insurance expert or agent you can trust to evaluate your clients’ policies.