Millions of people depend upon annuities and life insurance for financial protection. For many years, life insurance companies have made good on the contractual guarantees that they have pledged to their annuity and life insurance policyholders.
Nevertheless, at various points in time, some life insurance companies go under. You might wonder about what can happen when your insurance company goes out of business. The good news is that this sort of event is relatively rare.
When they fail, banks have FDIC insurance and investment firms have SIPC coverage. Life insurance companies are regulated at the state level, so they don’t have federal insurance coverage, but there are other financial protections to guard policyholders against the risks of this scenario.
Here’s what you need to know if the life insurance company with which you have your policy becomes insolvent.
Life Insurance Companies Rarely Go Bust
According to historical data, very few life insurers have gone under in the past. An average of less than 20 insurers become insolvent every year, and many of these are either health or property-casualty insurance companies.
There are hundreds of life insurance companies in the marketplace. Because of that, the odds that your particular company will become insolvent are likely pretty small. All states require that every insurance company that does business within its borders meet certain financial requirements.
For example, all 50 states require life insurers to maintain at least one dollar in their cash reserves for every outstanding dollar of annuity premium that they issue. This requirement has helped the insurance carriers in the annuity market maintain their obligations to contract holders. Similar cash reserve requirements for life insurance policies have had the same effect for life insurance companies.
Why Do Life Insurance Companies Go Out of Business?
There are a handful of reasons why a life insurance company can become insolvent. Perhaps the most obvious reason is due to simple mismanagement of the company. Of course, all businesses everywhere in every industry are subject to this risk.
Another possible reason is an excessive rate of claims by contract holders. That can deplete the insurance company’s cash reserves below the state-required limit.
Yet another possible cause of bankruptcy is due to economic conditions, such as a period of low interest rates and high market valuations. Life insurance companies must invest most of their revenues into conservative, fixed-income investments.
When interest rates are low, the companies can get squeezed between reaping low returns and paying a ‘normal’ level of claims. This usually happens when the insurance company misprices the cost of its coverage to its annuity and/or life insurance owners, thus resulting in a negative cash outflow.
How Are You Protected if Your Life Insurance Company Fails?
Fortunately, some protection is available at the state level if your life insurer becomes insolvent.
All 50 states, plus Puerto Rico, have state guaranty associations that will step in and reimburse policyholders of insolvent insurers at least a set minimum amount for each type of insurance policy that they hold with the distressed insurer. All insurance companies in each state are required by law to be paying members of these associations.
There are also other forms of financial protection that are put in place to help distressed insurers. Most life insurance companies purchase reinsurance contracts from other commercial insurers. The reinsurance will kick in if the company’s cash reserves fall below a certain threshold.
Then, if the insurer still can’t solve their financial problems through reinsurance contracts, then the state or district insurance commissioner will step in and move the company into receivership. They will try to financially resuscitate the company, which sometimes works and sometimes doesn’t.
In some cases, the commissioner will sell off some or all of the company’s assets in an effort to pay the company’s policyholders. It’s only after all of these preliminary measures have been taken that the state guaranty associations will step in.
How Much Protection Do You Have If the Life Insurance Company Goes Under?
If your life insurance company reaches the point where the state guaranty association must step in, then one of two things will most likely happen.
The first possibility is that your company’s financial obligations will be transferred to another (financially solvent) carrier. The second possibility is that the state guaranty association will step in directly and reimburse all policyholders up to certain limits. Or, the guaranty association may be the one who liquidates company assets to meet policyholder needs.
If the state guaranty association directly reimburses the policyholders, certain limits per policyholder apply. These limits are broken down as follows:
- $300,000 in life insurance death benefits
- $100,000 in cash surrender or withdrawal values from life insurance
- $250,000 in present value annuity benefits
- $300,000 in disability insurance benefits
- $300,000 in long-term care insurance benefits
Of course, if you have more money than the limits listed above sitting in a policy, then it may be unpleasant to consider that you may not be fully reimbursed. But you do have the option of filing a claim against the estate of the company for full reimbursement.
However, there are no for-sures with this, and it could be a long time before you see any additional reimbursement. Keep in mind that your claim will also be pooled with the claims of all other creditors of the company, so that can affect how much you might receive, even if you do get an additional reimbursement.
How Can You Avoid Having Your Life Insurance Company Go Under?
Nothing is failproof, but one track is to look at the financial ratings of a given company before you give that company any of your money. There are several companies out there that rate insurers according to a specific schedule.
Fitch’s, Moody’s, Standard and Poor’s, and A.M. Best all rate insurance companies on a scale from A or A+ to D.
A-rated companies have less financial risk of becoming insolvent than those with lower ratings. Meanwhile, those with C or D ratings carry a much higher risk of insolvency. Even so, many savvy people look to insurers with ratings of B+ or BBB because these companies often offer more competitive products than higher-rated insurers.
What’s more, many financial advisors generally feel comfortable offering BBB or B+ rated companies to their clients because they often carry very high solvency ratios. In other words, these insurance companies have substantial cash reserves compared to the amount of premiums they have outstanding.
Your financial advisor can also be a valuable resource when it comes to choosing an insurance company. They will probably have business relationships with many very financially stable carriers, so you can lean on their guidance as a factor in deciding where you can put your money.
Your financial advisor is also as incentivized as you are to make sure that you don’t lose your money to an insolvent insurer. Chances are that they have already done their homework on which companies are likely to remain in business.
A third strategy is to spread your money out amongst several different life insurance companies, so that if one goes under, you can get fully reimbursed under the limits described above. If you buy different annuities from, say, five different companies, then you should be well-covered, even if some of them have lower financial ratings.
Some Final Thoughts About Life Insurance Companies
Statistics show that it’s unlikely that you will have to worry about your life insurance company going into insolvency, unless you commit to one that has a very low financial rating and a low solvency ratio.
Just be sure to do your homework (or make sure that your advisor has done this) before writing out a check to any given insurer. Don’t be afraid to ask your financial professional about any questions or misgivings you have about a specific life insurance company.
This is your money – you deserve to have peace of mind and confidence in knowing that the insurance company will take good care of it, and of you. Your financial professional can also help you think about these important questions in an overall scope of retirement and income planning strategies.
Are you looking for a financial professional to help you with your personal financial situation? Perhaps you want a second opinion of your current retirement plan or want to explore additional steps to reach your goals. For convenience’s sake, many independent and experienced financial professionals are available at SafeMoney.com, where they can be contacted for a complimentary initial appointment.
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