The Morningstar Rating, often called the "star rating," is a quantitative assessment of the past performance of a subaccount and its underlying fund. The rating measures both return and risk. Subaccounts are rated from one to five stars against focused peer groups based on Morningstar Categories, with separate calculations run for variable annuity and variable life products.
The methodology accounts for all variations in a subaccount's monthly performance, with more emphasis on downward variation. It rewards consistent performance and reduces the possibility of strong short-term performance masking the inherent risk of a subaccount.
Significant changes were made to the rating methodology, effective 7/31/03. Previously, subaccounts were rated within one of three broad asset classes--U.S. stock, international stock, or taxable bond. The risk-adjustment method was also updated at that time.
How Does It Work?
The Morningstar Rating for subaccounts is a measure of a subaccount's risk-adjusted return, relative to its category peers. Subaccounts are rated from one to 5 stars, with the best performers receiving five stars. Ratings are based on subaccount returns since the inception date and extended performance prior to the subaccount inception date; extended performance is based on the performance of the underlying fund, adjusted for all insurance fees at the subaccount level. For example, if the subaccount is four years old, but the underlying fund is 10 years old, we will calculate 10 years worth of fee- and risk-adjusted returns and use those as the basis for the Morningstar Rating.
Risk-adjusted return is calculated by subtracting a risk penalty from each subaccount's total return. The risk penalty is determined by the amount of variation in the subaccount's monthly returns, with emphasis on downward variation. The greater the variation, the larger the penalty. Subaccounts are ranked within their categories and types (VAs or VLs) and stars are assigned as follows:
Top 10%: five stars
Next 22.5%: four stars
Middle 35%: three stars
Next 22.5%: two stars
Bottom 10%: one star
Subaccounts are rated for up to three periods, the trailing 3, 5, and 10-years, and ratings are
recalculated each month. For subaccounts that remain in the same Morningstar Category for the entire evaluation period, the following weights are used to calculate an overall rating:
Age of Fund Overall Rating
At least three years, but less than five: 100% three-year rating
At least five years, but less than 10: 60% five-year rating/40% three-year rating
At least 10 years: 50% 10-year rating/30% five-year rating/20% three-year rating
If a subaccount changes Morningstar Categories, its long-term historical performance is given less weight, based on the magnitude of the change. (For example, a change from a mid-cap category to a large-cap category is considered less significant than a change from small-cap to large-cap.) Doing so ensures the fairest comparisons and minimizes any incentive for companies to change the subaccount's style in an attempt to receive a better rating by shifting to another Morningstar Category.
Using the Rating
The star rating is best used as an initial screen to identify subaccounts worthy of further research, those that have performed well on a risk-adjusted basis relative to their peers. It's a strictly quantitative measure--a high rating doesn't imply the approval or endorsement of a subaccount by a Morningstar analyst.
Also, because subaccounts are rated within their respective categories, it's also important to note that not all 5-star subaccounts are equal or even interchangeable. A 5-star sector subaccount, for example, might have the best risk-adjusted return within its specific category, but it's probably far more risky than a highly rated diversified subaccount.
Rather than selecting subaccounts based solely on their ratings, investors should decide on an overall portfolio strategy and then seek the best subaccounts for each portion of their portfolio.
Benefits
Morningstar recognizes that no rating system can take into account all factors that one must consider before deciding to invest in a subaccount. The Morningstar Risk-Adjusted Rating is intended as a way of identifying subaccounts that have produced the highest level of returns relative to the risks they've taken. Investors should keep in mind that while it serves as an initial screen, the rating is only the first step toward a more comprehensive evaluation.
Origin
Morningstar calculates this data in-house on a monthly basis.