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Understanding the importance of financial ratings

You've pored over dozens of life insurance policies and settled on three policies from three different companies as your finalists. The companies all have reassuring names like "American," "Safety," or "National."

Before you take the cheapest route, check out each company's financial ratings. Each of the major rating services now offer at least some of their information on their Web sites or through other sites, such as Insure.com. Links to each of them is on the left.

Insurance ratings essentially are letter grades assigned to insurers based on the financial strength of those companies. The ratings are important because they can make a difference in whether you can be assured that you'll get paid if you ever file a claim.

There are five large insurance rating services in America. Their ratings are just like grades in school, with A being the best, then B, and so on. But talk about grade inflation!

Look for those 'A' ratings

Virtually all of the companies get an "A" of one form or another, while any company with a B or lower shouldn't be considered. It makes more sense if you think of life insurance ratings as comparable to bond ratings, which usually hover in the A-B range.

The oldest of the five major rating services is A.M. Best Co., established in 1899 and named after an insurance agent who was frustrated at the lack of financial information about insurance companies.

So what do you do when you need to buy that life insurance policy? Start by finding out what you can from the individual Web sites. Some, like A.M. Best, provide only a small fraction of the information available through professional life insurance agents, who pay for the information.

Once armed with the publicly available information, try testing both the life insurance company and the agent.

The company:

  • Call the insurance company's customer service line and ask for all of the company's ratings from all of the different ratings services. If you find the company less than truthful, don't buy any products from it.

  • Ask the insurance company for copies of its ratings reports. If the company complies, it gets extra points for consumer-friendliness.

The agent:

  • Ask the agent to give you the ratings on all the companies she recommended. If she doesn't know the ratings or can't get them during the conversation, you should question her due diligence (how well she has researched the companies and her judgment in presenting these particular ones to you).

  • Ask for a copy of the rating service reports from all of the services that have reviewed the insurance companies in question. If the agent has recommended the policy, she should have the ratings reports on hand.

  • Ask your agent to explain each rating service report to you in simple terms. Here is where you can tell if your agent knows what she's talking about. If she can't explain the various ratios and terms, find another agent.

The bottom line:

Once you've done your own research and you're familiar with the ratings the various services have given, how do you choose? If you're buying a permanent (cash value) policy or an annuity from the company, it should be rated by at least three of the five rating services and have one of the top three ratings by at least two of those services. No rating should be below that service's fifth-best score.

Many of the top-ranked companies have the best products anyway, so you're not sacrificing performance for security (an interesting change from the investment world, where more risk is supposed to equal a higher return).

Remember that life insurance is primarily a death benefit, not an investment vehicle. You want to be secure in knowing that when you or your heirs deserve the money, you'll get it.