Insurers, Financial Strength and the Insurance Contract Applied
An insurance policy is only as good as the insurer’s ability to pay it, and a claim is only as safe as the contract’s rules about who must say what, and who may change what. Independent agencies grade an insurer’s financial strength, and a producer is limited in what may be said about those grades. The contract’s distinct characteristics and its legal interpretations (representations, warranties, concealment, waiver, estoppel and apparent authority) are decided in claims on life and health policies.
Financial Strength and the Rating Agencies
A policy may not be tested for thirty years, so rating agencies give buyers an independent opinion of whether the insurer will still be paying then. AM Best describes its financial strength rating as an independent opinion of an insurer’s ability to meet its ongoing policy and contract obligations, based on the insurer’s balance sheet strength, operating performance and business profile. Fitch’s insurer financial strength rating is an assessment of the financial strength of an insurance organization and is assigned to its policyholder obligations. Moody’s and S&P also rate insurers, each on its own scale, and a producer should read the agency’s own definitions rather than assume that letters match across agencies.
Two Scales Compared
AM Best uses letter grades with a descriptor for each.
| AM Best rating | Descriptor |
|---|---|
| A++, A+ | Superior |
| A, A- | Excellent |
| B++, B+ | Good |
| B, B- | Fair |
| C++, C+ | Marginal |
| C, C- | Weak |
| D | Poor |
| E | Under regulatory supervision |
| F | In liquidation |
| S | Suspended |
AM Best groups A++ through B+ as secure and B through F as vulnerable, and its definitions for B and below warn that financial strength is vulnerable to adverse changes in underwriting and economic conditions. A rating can carry an outlook (positive, negative or stable) that points to its likely direction over an intermediate term, generally 12 to 36 months, and a modifier such as “u” for under review.
Fitch uses letters from the top of its scale down.
| Fitch rating | Descriptor |
|---|---|
| AAA | Exceptionally strong |
| AA | Very strong |
| A | Strong |
| BBB | Good |
| BB | Moderately weak |
| B | Weak |
| CCC | Very weak |
| CC | Extremely weak |
| C | Distressed |
Fitch treats BBB- and higher as secure and BB+ and lower as vulnerable. The same letter means different things on the two scales. A “B” from Fitch is weak and a “B” from AM Best is fair, so quote an agency by name every time.
What a Rating Does Not Say
A rating is an opinion about the ability to pay, and the agencies say what it leaves out. AM Best states that its rating is not assigned to specific policies and does not address the insurer’s claims-payment policies or procedures, or whether the insurer will dispute or deny a claim for misrepresentation or fraud. It is also not a recommendation to buy, hold or end a policy, and it says nothing about suitability. Fitch’s rating excludes obligations in separate accounts and unit-linked products, where the policyholder bears the investment risk, though it includes any guarantee given on them. It also does not count recoveries from a government guaranty fund.
Michigan’s life and health guaranty association exists to protect certain policyholders, subject to limits, if an insurer becomes impaired or insolvent (MCL 500.7702(1)). That protection is a separate backstop that the agencies do not count as strength.
A Case: Choosing Between Two Insurers
Dana Whitcomb, 41, is choosing between two guaranteed renewable disability income policies she would hold for 25 years. Insurer One is rated A by AM Best with a stable outlook. Insurer Two is rated A- with a negative outlook and is cheaper by $14 a month. Both grades fall in “Excellent.” The negative outlook means a downgrade is possible, not certain. A sound recommendation gives both ratings with the agency’s name and date, explains the outlook, notes the price difference and leaves the decision to Dana. Neither insurer is called “safe” or “guaranteed.”
Michigan limits what a producer may say: it is an unfair or deceptive practice to make a misleading statement or misrepresentation as to the financial condition of a person engaged in the business of insurance (MCL 500.2005(d)). Telling Dana that Insurer Two “is about to fail” when the agency has only issued a negative outlook is such a statement. A statement about a competitor’s financial condition that is false, or maliciously critical, and calculated to injure it is also an unfair practice (MCL 500.2009).
The Contract’s Distinct Characteristics, Applied
Every insurance contract shares five characteristics, and each shows up in a claim.
| Characteristic | What it means in practice | A life policy | A health policy |
|---|---|---|---|
| Conditional | The insurer’s promise to pay depends on the insured meeting stated conditions | The first premium is paid and the policy is in force when the insured dies | Notice and proof of loss are given on time |
| Personal | The contract is with a particular person, not with whoever holds the paper | The insurer underwrote one insured’s life, and changing the owner does not change whose life is covered | Benefits go to the people the policy covers, so a nephew who moves into the insured’s home is not covered unless the policy includes him |
| Unilateral | Only the insurer makes a legally enforceable promise | The owner may stop paying, and the insurer cannot sue for the premiums | The insured may let the coverage lapse without owing the rest of the term |
| Aleatory | Values exchanged may be unequal, and the outcome depends on chance | A $38 first payment may be followed by a $250,000 death claim | Premiums paid over ten years may be far less, or far more, than the claims paid |
| Adhesion | One side wrote it and the other accepts it as written | An ambiguous clause is read against the insurer | Unclear benefit wording is read in the insured’s favor |
The contract is unilateral because only the insurer is bound to perform, even though both sides have duties. It is aleatory because the exchange is not equal in any single case, which is not a defect.
The conditional nature decides many claims. Marcus Bell is disabled by a stroke and gives his insurer written notice of claim three months later. Michigan’s required wording for an individual disability policy asks for notice within 20 days, or as soon after the loss as is reasonably possible (MCL 500.3412(1)). The insurer’s duty to pay depends on the condition, so the claim examiner checks the notice first. Whether three months was reasonably possible, given his stroke, is then a question about the facts, and the policy wording decides the rest.
Representations, Warranties and Concealment
A representation is a statement of past or present fact made to the insurer by or on behalf of the applicant as an inducement to the contract, and a misrepresentation is a false representation (MCL 500.2218(2)). A warranty is a guarantee that a statement is true in every respect. Michigan life policies must say that statements by the insured, in the absence of fraud, are representations and not warranties, and a statement cannot avoid the policy unless it is in a written application attached to the policy (MCL 500.4016(1)). An application taken electronically counts if the information is attached (MCL 500.4016(2)). A producer may not alter a written life or disability application without the applicant’s written consent, except for administrative insertions marked as the insurer’s (MCL 500.2216). Concealment is withholding a fact the other party needed to know, such as an answer left blank or a condition not mentioned.
Michigan sets the test for whether a misstatement matters. No misrepresentation avoids a contract or defeats recovery unless it was material, and none is material unless the insurer’s knowledge of the true facts “would have led to a refusal by the insurer to make the contract” (MCL 500.2218(1)). Michigan’s Supreme Court reads “the contract” as the contract actually issued, at the premium agreed, so a misstatement is also material if the truth would have led the insurer to charge more (Oade v Jackson National Life Insurance Co, 465 Mich 244 (2001)). The insurer’s own practice on similar risks is admissible evidence (MCL 500.2218(3)). A false answer that there was no earlier treatment, consultation or hospital care is treated, for materiality, as a false statement that there was no disease or impairment for which the care was given. If the insured or a claimant then prevents full disclosure and proof of the impairment, the misrepresentation is presumed material (MCL 500.2218(4)).
A Life Case
Elena Ruiz applies for $300,000 of whole life insurance and answers “no” to a question about treatment in the past five years. She had been seen twice for chest pain. She dies of a heart attack 14 months after issue. The insurer rescinds. Four questions decide it.
- Is the policy still contestable? Michigan requires incontestability after 2 years in force during the insured’s lifetime, so at 14 months it is (MCL 500.4014).
- Was the answer a representation in a written application attached to the policy? If the application was not attached, it cannot avoid the policy (MCL 500.4016(1)).
- Was it false? Treatment for chest pain contradicts “no.”
- Was it material? The insurer produces its underwriting guide showing that it declines applicants with a recent cardiac workup. That is admissible evidence that knowing the truth would have led to a refusal (MCL 500.2218(3)).
At 27 months, question one would end the matter unless an exception in MCL 500.4014 applied.
A Health Case
Sam Okafor applies for an individually underwritten disability income policy, leaves out two visits for back pain, and becomes disabled by a back condition 10 months later. The insurer denies the claim. The same questions apply, with different materiality wording. For a disability policy, a false statement does not bar recovery unless it materially affected either the acceptance of the risk or the hazard the insurer assumed (MCL 500.2218, first paragraph). The time limit on certain defenses in a disability policy other than a health insurance policy may not exceed 2 years, even if the form prints 3 (MCL 500.3408(2)). Sam is inside the period, so materiality decides it. If the insurer’s guide shows it issues such applicants only with a back exclusion, that is admissible evidence that the omission affected the hazard it assumed (MCL 500.2218(3)). If it issues them at standard rates, the omission is much harder to call material.
Waiver, Estoppel and Apparent Authority
A waiver is the voluntary giving up of a known right. Estoppel prevents a party from asserting a right that contradicts what it said or did before, when the other side relied on it to its harm. Both arise from the insurer’s conduct. As a general rule, a court more readily finds that an insurer gave up a condition, such as a due date, than that it created coverage the policy never provided.
Two Michigan rules limit what a producer can do. The required wording in a disability policy says that no change is valid unless an executive officer approves it and it is endorsed on the policy, and that “an insurance producer does not have authority to change this policy or to waive any of its provisions” (MCL 500.3407). A producer’s promise that a waiting period will be waived does not bind the insurer. In a dispute between an insured or beneficiary and the insurer, a person who solicited an application on another’s life is treated as the insurer’s agent, not the applicant’s (MCL 500.2220).
Apparent authority is different from both. It exists when the insurer’s conduct leads a client reasonably to believe the agent may act for it, as when a terminated agent keeps the insurer’s forms and stationery. It depends on what the insurer did, not on what the producer claims.
Take a case on each. Tomas Reyes pays the premium on his individual disability policy after the grace period has ended three times, and each time the insurer accepts it and keeps the policy in force without asking for reinstatement. When he pays late a fourth time and a claim follows, the insurer cites the lapse. The insurer’s repeated acceptance of late payment is conduct from which a court may find waiver of strict compliance, or estoppel, because Tomas relied on it. If a producer had merely told Tomas that late payment was fine, MCL 500.3407 means the statement does not bind the insurer.
Now apparent authority. Lucy Park buys a life policy from Gerald Moss, who was terminated by the insurer last year but still carries its application forms and a business card with its name. She pays him the first premium in cash and he keeps it. Whether the insurer is bound depends on what the insurer did, such as leaving him with forms and not telling customers, and whether Lucy reasonably relied on it. Gerald’s own statement that he can bind coverage proves nothing. Because Gerald solicited the application, MCL 500.2220 also treats him as the insurer’s agent, not hers, in a dispute over the claim.
Lesson summary
- Rating agencies give an independent opinion of an insurer’s ability to pay. AM Best and Fitch use different scales, so always name the agency.
- A rating is not a recommendation, does not measure claims practices, and does not count a guaranty fund as strength.
- It is an unfair practice in Michigan to misrepresent an insurer’s financial condition (MCL 500.2005(d)) or to circulate false or malicious statements about it (MCL 500.2009).
- Insurance contracts are conditional, personal, unilateral, aleatory and contracts of adhesion, and each affects how a life or health claim is decided.
- Statements on a Michigan life application are representations absent fraud. A misrepresentation avoids a contract only if material (MCL 500.2218(1)) and, for life, only within the incontestable period (MCL 500.4014, 500.4016).
- Waiver and estoppel arise from the insurer’s conduct, and a producer has no authority to waive policy provisions (MCL 500.3407).
- Apparent authority depends on the insurer’s conduct, not on the producer’s own claims.