It happens oh so innocently.
There you are, one moment, buying insurance like any responsible adult would. You’ve dotted the Is and crossed the Ts, about to make your purchase before a random thought stops you cold in your tracks.
What is the credit rating of this insurer ah? You ask your financial planner for a response – but nothing coherent comes out.
Then it is back to “let me think it over” mode – where nothing else ever happens anymore, while the supposed “thinking” is taking place.
Should you really let the Credit Rating of an insurer influence your purchase?
Does an insurer with a better credit rating deserve to command a higher premium, or vice versa?
As usual, we handle the problem by starting with the most obvious question:
What is a credit rating?
Simply put, it is an estimate of the ability of an organization to fulfill its financial commitments, based on several factors. It assesses the the creditworthiness of a borrower in general terms, or with respect to a particular debt or obligation.
Key word: estimate. Because no one knows the future (that’s how it works). We will be returning to the significance of that word later.
Who gives these credit ratings?
Why, a credit rating agency of course! The 3 most famous ones are Standard & Poor’s (S&P), Moody’s, and Fitch. Interestingly, the company that seeks to be rated has to engage the services of these rating agencies – and pay them for their services.
What are the considerations for a credit rating?
There are two broad considerations here, financial vs non-financial considerations.
Amount of debt or liabilities held by the company in relation to its overall asset base
Any defaults or late payments to suppliers, loans, bills, etc
The working capital of the company
Cash flow and cash on hand
These financial considerations, though not exhaustive, are pretty commonsense. If a company spends money or has liabilities, we want to know if it has a good ability to repay all these loans.
Non Financial Considerations
This is where industry knowledge and more conjecture work comes to the forefront. (ie. Opinions matter more here than in financial considerations)
Overall industry outlook
Business Reputation of the company
History and background of the company
Key staff and board members
There will be more guess work and hypothesis that goes in here which is subject to debate. Which factors matter more? How much weight do we assign to the competitive advantage of the company? What if the CEO is a good looking chap – do we give them more leeway because of that?
(Incidentally, if you think that last point was made up – here is the study that was conducted. So if you think that finance is all about numbers, you are ignoring the human bias towards attractive looks. Politically incorrect, but its true.)
So, do credit ratings matter or not?
Ok, we’ve gotten the background straight. Lets answer the million dollar question you came here to seek an answer for.
As with any analyst worth their salt, we are going to say yes – and no, it depends.
A casual glance says yes
Yup, credit ratings do matter when choosing an insurer to buy your policies from. Because insurance is a long term commitment, so it is only natural that we want to do business with companies that will be around for the long term. An insurer that goes bust means that our policies will be worthless!
Without any other yardsticks around, we agree that credit ratings do matter.
A deeper look says no
Lucky for us, we happen to be located in this quaint little place called Singapore. And in the land of Singapore, there are these quaint little things called Laws. And in Singapore, the government seems to be a big fan of a quaint little concept called Regulation.
One of these Regulators is known as MAS – the Monetary Authority of Singapore. It is run by a delightful band of people whose primary concern is to ensure that our financial system is more stable than a fat cat on your couch – totally immovable.
A combination of Laws and Regulation means that Insurers in Singapore have to demonstrate a high level of capitalization, a solid board of directors, an impeccable process flow, and regular audits.
For insomnia sufferers, the cure can also be found in the Statute which we call the Insurance Act. It prescribes the law that insurers in Singapore have to be subject to.
And of course that is not good enough for us Singaporeans. Cue the SDIC – Singapore Deposits and Insurance Corporation – an entity set up by guarantee under the Companies Act, and reports directly to MAS. You can think of it as insurance for your insurer – in case they go bust.
Participating insurers (last we heard, basically any insurer doing business in Singapore) have to pay SDIC premiums so that in event of a default by an insurer, SDIC will step in to pay the sum assured.
(Up to 100k per life assured per insurer for life policies, with a cap of 500k across all insurers)
While this may not pay out your sum assured beyond 100k, it acts as a security blanket for common folk like us going about our daily lives.
And finally, we return to the credibility about the credit rating agencies themselves. (oh, the irony!)
Famously, they were also the ones that rated AIG triple A before the whole house of financial cards collapsed in 2008. Regardless of their proclaimed accuracy, experience, and proprietary knowledge, they have shown themselves to be fallible. Their ratings are an estimate at best!
Putting the Pieces together
So really, should you decide to buy a policy based on some letters doled out by a credit ratings agency?
Personally, I think it isn’t the most logical thing to do, given the tight regulatory controls we have here, and the fail-safe system which is SDIC.
Far more crucial factors to consider:
Am I buying the right insurance?
Am I buying the right amount of insurance?
Does the policy suit my needs?
Am I happy with the price that I have to pay?
Am I confident about my advisors’ recommendation?
So yeah, let us treat credit ratings like we treat our O level results: It only matters if no other information is available to us, and many a time an arbitrary letter on a piece of paper has absolutely no bearing on how we do in life or business.
(I hope this absolves me from my C5 in higher Chinese)
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