Why insurance companies need a credit rating?

Hi all,

I am wondering what is the purpose for the insurance companies to pay for the services of credit rating agencies? For the corporations and banks the purpose is quite clear: they need ratings in order to attract investment. But in the case with insurance companies they do not need to attract investments as they have enough money (from the underwriting activity) and they are actually one of the biggest institutional investors themselves.

I searched in the internet but didn't find any clear answer to this question.

Will be very interesting to read your thoughts.

Comments (6)

Jul 26, 2016 - 12:45pm

Because insurance companies have an obligation to their clients to (x) be able to pay out claims when they arise and (y) remain solvent in case of temporary stresses.

This is extremely important when it comes to commercial insurance, as you see that some companies can have claims payout equal in the 8/9/10 figure range. That means they need to show their ability to pay out in case of a catastrophe like that (or even something like a hurricane leveling a geographic region) without it adversely affecting the future of the company.

Check out AMBest some time and it gives great explanation on the credit ratings, their purpose and understand exactly how big some of these companies.

"It is better to have a friendship based on business, than a business based on friendship." - Rockefeller. "Live fast, die hard. Leave a good looking body." - Navy SEAL
Jul 26, 2016 - 12:50pm

One reason I can think of right off the top of my head is that insurance co's do derivatives. Another one is that when you buy an insurance policy from a company, your future payout is determined, among other factors, by the ability of a given insurance company to pay. So, actually, in a way you can think of a policy as a bond which the insco sells to the policy holder in exchange for periodic payments. Obviously, in this context, if you're a policy holder, the insco's credit rating may be of interest to you.

Jul 26, 2016 - 3:50pm

Regulatory purposes especially when you come to calculate Market and Credit MCRs.
Some countries impose the use of external ratings for your counterparties.
For intra-company transactions, they matter.

Jul 27, 2016 - 10:45am

What UTD said and similar to Martinghoul raising the topic of derivatives. You're taking counterparty risk. Most people don't think about it when they get car insurance, life insurance etc. but there is a possibility that when you have a trigger event, the insurance co may not be able to pay out. CDS is the easy comparison. When you buy protection, you're promising a series of payments in return for the obligation to pay you some amount upon a trigger. That's insurance. Accuracy aside, the ratings are supposed to help you gauge your insurance co's ability to pay out a claim when shit hits your fan.

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