Retained Asset Accounts and Creditor Reactions to an A.M. Best Change

• Date: 01 December 2017
• Author: Kathleen McCullough,Jill Bisco
• Published date: 01 December 2017
• DOI: http://doi.org/10.1111/rmir.12087

Risk Management and Insurance Review

C

Risk Management and Insurance Review, 2017, Vol.20, No. 3, 277-307

DOI: 10.1111/rmir.12087

FEATURE ARTICLE

RETAINED ASSET ACCOUNTS AND CREDITOR REACTIONS

TO AN A.M. BEST CHANGE

Jill Bisco

Kathleen McCullough

ABSTRACT

A variety of research has investigated the impact of rating changes on stake-

holder and firm behavior. This article provides a unique setting to analyze the

effect for both stock and mutual firms and with a class of nontraditional in-

vestors, owners of retained asset accounts (RAAs). These individuals become

creditors of the insurer upon receipt of life insurance proceeds, which are held

in the general accounts of the insurer. The funds receive limited guaranty fund

and no Federal Deposit Insurance Corporation protection, thus subjecting the

owner to the financial risk of the insurer. Some owners of RAAs may not un-

derstand the risk; thus, it is unclear if these owners act as other creditors to

changes in the financial stability of the insurer. This provides a setting to ana-

lyze reaction to firm risk, as reflected in ratings changes, to stakeholders other

than stockholders or customers. We find that RAA owners do act in a manner

consistent with traditional investors. Specifically, we find that abnormal reten-

tion in the RAAs indicates significant declines in the level of accounts open and

funds deposited in the year following a threshold downgrade (falling below an

A–) of the A.M. Best rating.

INTRODUCTION

The impact that financial ratings have on investor and creditor behavior has been a

topic of significant research over the past several decades. Some research has shown

that ratings, specifically insurance company financial ratings, are driven by information

that was previously available to investors and has little impact on the returns of publicly

traded stock companies (Singh and Power, 1992). On the other hand, more recent re-

search has shown that such ratings do have an impact on the returns of publicly traded

insurance companies and that downgrades result in significant negative returns whereas

upgrades have varying impact on positive returns (Halek and Eckles, 2010).

Jill Bisco is an Assistant Professor of Finance in the Department of Finance, College of Business

Administration at The University of Akron; phone: 330-972-5436; e-mail: jbisco@uakron.edu.

Kathleen McCullough is Associate Dean for Graduate Programs and Research and State Farm

Insurance Companies Professor in Risk Management & Insurance, College of Business at Florida

State University; phone: 850-644-8358; e-mail: kmccullough@business.fsu.edu.

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278 RISK MANAGEMENT AND INSURANCE REVIEW

We extend this line of literature with a nontraditional type of creditor, the owners of

retained asset accounts (RAAs).1Prior to 1984, life insurers paid beneficiaries via a lump

sum or by a specified period or specified amount. After 1984, some insurers began

offering RAAs, which allowed the insurer to retain the life insurance proceeds and

utilize this capital in their operations (Lauria, 1997). An RAA is an account established

for the settlement of proceeds payable under a life insurance policy. The insurer retains

the death benefit proceeds in its general account for the benefit of the beneficiary and

credits interest on the money being held in the account. These accounts are held in

the general account of the insurer, leaving them subject to the financial strength and

claims-paying ability of the insurer, and more importantly, the proceeds are subject to

the creditors of the insurer (Evans, 2010). The accounts receive limited protection from

the individual state guaranty funds and no protection from Federal Deposit Insurance

Corporation (FDIC).2In essence, when a beneficiary leaves their funds with an insurer

through an RAA, they become a creditor of the insurer by loaning their funds to the

insurer for use in ongoing operations. Whether or not these beneficiaries understand

their role as a creditor is unclear. Since their inception, the use of RAAs has grown

significantly.

This research provides an important extension to the literature related to monetary

reaction patterns related to A.M. Best (Best) rating changes. It is one of the first articles

to quantify whether the reaction is consistent for different types of stakeholders beyond

traditional stockholders, bondholder, and customers. This provides insight into the

potential reactions of other stakeholders that are not typically tractable. Similarly, the

analysis is able to be conducted over a sample of both stock and mutual insurers, whereas

many related studies can only focus on investor and creditor reactions in publicly traded

firms due to data limitations. Further, thereare significant public policy concerns related

to this group of perhaps unintentional creditors. As Goldsholle and Price (1996) point

out, for beneficiaries, the time following the death of a loved one can be fraught with

emotion and many believe that this is not necessarily the time to be making financial

decisions. However, it is at this time when the owners of RAAs become creditors of

the insurer. The main question of this research is whether these owner/creditors act in

an informed manner by reacting to changes in the A.M. Best rating of the life insurer

holding the funds.

1Weutilize the term 2 “creditor” to refer to the RAA holder and “debtor” to refer to the insurance

company that holds the funds in the RAA. This is consistent with Faber v. Metropolitan Life

Insurance Company, 09-4901-cv.U.S. Court of Appeals, Second Circuit, 2011. In this case, the court

states, “We believe that, under ordinary notions of property rights, this relationship involves

MetLife simply as a debtor and the beneficiary-turned-account holder simply as a creditor . . . ”

2RAAs represent a death benefit under a life insurance policy, and therefore, they are provided

coverage under the guaranty fund. RAAs are provided the same coverage limit that is provided

to the underlying life insurance policy.The state that provides coverage is the state of residence

of the policy owner or certificate holder, whichever applies (National Organization of Life and

Health Insurance Guaranty Associations [NOLHGA], 2011). Coverage is generally limited to

$300,000 per insured; however, a few states provide limits of $500,000 (e.g., Connecticut, New

Jersey,and New York).