In today’s turbulent economy, there’s little left to hang your hat on. Jobless claims are at a 25-year high, stocks continue their volatile course and the housing market remains in the doldrums.
For many families, the only port in the storm are the life insurance products they purchased to reduce their exposure to risk — from life insurance policies, which provide for their loved ones if the breadwinner passes away, to annuities, which create guaranteed income during retirement.
Trouble among life insurers
With all the ratings downgrades and investment losses plaguing the insurance industry, however, even those seem suddenly vulnerable.
“I’ve gotten quite a lot of calls from clients,” says Brion Harris, an independent financial adviser with Premier Planning Group in Annapolis, Md. “They’ve seen the news about all the banking failures and are worried the insurance industry is going to be next to say, ‘We’re not going to be able to honor our commitments.'”
Indeed, in recent weeks the financial strength and creditworthiness of several leading insurers — including The Hartford Financial Services Group, Genworth Financial and Conseco — have been downgraded by credit rating agencies Standard & Poor’s, Moody’s, A.M. Best and Fitch Ratings. They are among several life insurers that have taken steps to apply for funds from the Troubled Asset Relief Program.
And one insurer, Shenandoah Life Insurance Co., in Roanoke, Va., which was licensed to do business in 31 states plus the District of Columbia, announced in February it had been placed into receivership by state regulators to protect policyholders and will attempt to rehabilitate its cash-strapped business.
A moratorium has been placed on the payment of certain claims and benefits, pending review of the company’s financial position.
The ongoing high-profile bailout of insurance giant American International Group, or AIG, has only compounded fears of a widespread industry collapse, though its trouble stemmed from losses on bad derivatives bets rather than its insurance division.
So how safe are your life insurance policies and annuities — and what happens if your insurance company goes belly up?
Industry highly regulated
First, a little perspective.
In most cases, insurance companies under financial duress are simply snapped up by a competitor, and the policies and annuities transfer seamlessly to the new company, with terms and guarantees intact.
Since 1983, when the National Organization of Life & Health Insurance Guaranty Associations, or NOLHGA, was created, at least 70 multistate life insurance companies that were taken over by state insurance departments were ultimately liquidated — a better track record than most industries. Others were either sold or rehabilitated.
Regardless of outcome, however, the industry itself is highly regulated to protect policyholders.
For starters, every company that sells insurance is regulated by the state in which it does business. State insurance commissioners require those companies to maintain a reserve fund large enough to meet the majority of its obligations to policyholders.
Steps state regulators take
When a company enters a period of financial difficulty, the state insurance department initiates a process whereby every attempt is first made to help the company return to profitability.
If the company cannot be rehabilitated and is declared insolvent, the insurance commissioner can seek authority to seize its assets and operate the company pending liquidation.
The state then conducts an accounting of the company’s assets and liabilities, transfers those assets to cash and distributes it among creditors with valid claims against the insurer. Policyholders can then make claims through their state guaranty association, sometimes referred to as a liquidation bureau.
“In essence, the state becomes the administrator of your insolvent insurer,” says Mike Barry, a spokesman for the Insurance Information Institute. “Consumers should feel confident that their life insurance policies are safe. We have a very strict system of state regulation in the U.S. which sees to it that life insurers are adequately capitalized, and that has kept the number of insolvencies to a very minimal level.”
Barry says most state insurance departments would first try to convince a healthy life insurer to accept some or all of the insolvent insurer’s “book of business,” providing yet another safety net for policyholders.
Guarantees in place
As an added layer of protection, all companies selling life or health insurance policies must also be members of their state guaranty association, which collects fees from insurers and provides coverage to resident policyholders in the event of insolvency, up to specified limits.
Laws governing those limits and the types of policies covered can vary by state, but most set basic limits of $300,000 in life insurance death benefits and $100,000 in cash surrender or withdrawal value for life insurance.
The overall benefit cap in most states for an individual life is $300,000, though some states set higher maximums, NOLHGA reports.
If your policy value is higher than that amount, you won’t necessarily suffer a loss.
According to NOLHGA, the value of your policy in excess of guaranty association benefit limits is eligible for submission as a policyholder claim against the estate of the failed insurance company. The contract holder may receive distributions as the company’s assets are liquidated by the receiver.
“These companies usually have substantial assets even when they’ve become insolvent. So if your policy is over the guaranteed limit, that amount becomes a claim and because you’re a policyholder, those claims get paid out first,” says Sean McKenna, a NOLHGA spokesman.
Don’t head for the exits
Just because your insurance company gets downgraded or placed under the control of state regulators does not mean you should run out the door, says Rita Cheng, a Certified Financial Planner for Ameriprise Financial Services in Bethesda, Md., who says she’s received calls from concerned clients.
And whatever you do, don’t cancel your policy until you’ve got a new one in hand, she says. Who’s to say you still qualify for the same rates — or any insurance coverage at all — if your health has changed for the worse?
“If you’re not comfortable, do your due diligence and apply for coverage with another company, but don’t make hasty decisions,” says Cheng. “The last thing you want to do is be walking around uninsured.”
Another piece of advice? Don’t stop making payments to your current policy, even if your company is in receivership (under state regulatory control). Nonpayment of your premium may cause your policy to be canceled or reduced in value.