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When the insurance company AIG, which was considered “too big to fail”, was on the verge of bankruptcy during the Great Recession, the US government stepped in to bail out the company in 2008. Bailouts like these- there don’t happen every day, however.
In fact, you probably shouldn’t rely on Uncle Sam to save your insurance company if its finances plummet. However, you’re totally out of luck if your insurer goes bankrupt.
States regulate insurers, and all 50 have systems in place to protect policyholders if an insurance company fails. It’s important to understand how the process works and what kind of protection you’ll get. Even better, you need to know what steps to take to avoid ending up with an insurance company that goes bankrupt so that you don’t have to rely on the state to come to your rescue.
Why insurance companies go bankrupt
Although the insurance industry is highly regulated, insurance companies fail for a variety of reasons. For example, they might underprice their products and have higher-than-expected insurance claims, as long-term care insurer Penn Treaty did. The company was declared insolvent in 2017 and its bankruptcy was considered one of the largest in US history.
According to a study by the Society of Actuaries and the Canadian Institute of Actuaries, US insurance company insolvency peaked in the early 1990s, with more than 50 companies becoming insolvent in 1992 alone. In recent years, this number has been less than 10 per year. For policyholders, however, even one failure per year is too much if their insurer goes bankrupt.
How States Protect Policyholders
When an insurance company runs into financial difficulties, the state guarantee scheme where the insurance company is headquartered will come to the rescue, so to speak. All 50 states, the District of Columbia and Puerto Rico have insurance guarantee associations, according to the National Conference of Insurance Guarantee Funds.
Most states have both:
- A life and health guarantee association that covers life, health, disability and long-term care insurance policies as well as annuities.
- A property and casualty warranty association that deals with auto and home insurance policies and workers’ compensation corporations.
Insurers licensed to sell insurance in a state must be members of the state guarantee association and contribute to a guarantee fund that protects policyholders.
If an insurance company becomes financially unstable and cannot pay policyholder claims, the state insurance commissioner can take over the business through a process called receivership. Initially, the commissioner will try to turn the company around to improve its financial situation. If that doesn’t work, the commissioner can declare the company insolvent and sell its assets, according to the National Organization of Life and Health Insurance Guarantee Associations.
What to expect if your insurance company goes bankrupt
If an insurance company is declared insolvent, the state guarantee association and the guarantee fund come into action. The association will transfer the insurer’s policies to another insurance company or continue to cover the insured itself. It is therefore important that policyholders continue to pay premiums if their insurer is taken over by the State.
Paying your premiums keeps your coverage intact. Or consider taking out a policy with another insurance company, although this is usually easier to do with auto and home insurance than with life insurance.
If an insurance company does not have sufficient funds to pay policyholder claims, the guarantee association will use company assets and guarantee funds to pay claims. However, states have a cap on the amount of claims they will pay. Most states limit benefit payments to the following amounts:
- $300,000 in life insurance death benefits
- $100,000 in cash surrender or withdrawal values for life insurance
- $250,000 in commuted value annuity benefits
- $500,000 in major medical or hospital benefits
- $100,000 in other health insurance benefits
- $300,000 in long-term care insurance benefits
- $300,000 in disability insurance benefits
- $300,000 for P&C claims
- There is no cap on workers’ compensation claims
If you have insurance policies whose benefits exceed these limits, it can be frustrating that you or your beneficiaries do not receive the full payment that you paid with the premiums for the policy. Keep in mind, however, that something is better than nothing.
Also, if you have a claim that exceeds the state limit, you may be able to file a claim with the company’s “estate” for full payment. But your claim will be lumped in with the claims of all of the company’s creditors, and it could take years to see any money, according to the National Insurance Guarantee Fund Conference.
How to avoid insurers that could close their doors
To avoid having to rely on a state guarantee association to protect you as an underwriter, you can check with insurance companies before doing business with them to make sure they are financially sound.
Insurance companies are rated on their financial strength by independent agencies that each have their own rating scale and standards. The five rating agencies are:
- AM Best, which rates companies on a scale of A++ to D-
- Fitch, which rates companies on a scale of AAA to D
- Kroll Bond Rating Agency, which rates companies on a scale of AAA to D
- Moody’s, which rates companies on a scale of Aaa to C
- Standard & Poor’s, which rates companies on a scale of AAA to D
The highest ratings are given to companies that, according to the rating agencies, are best placed to meet their financial obligations. Low ratings are given to companies that the agencies believe have a weak ability to meet their financial commitments.
You should check ratings from more than one agency because ratings can vary from agency to agency, according to the Insurance Information Institute. You’ll need to register with these agencies’ websites (and possibly pay a fee) to see your insurer’s ratings, but many insurers publish their ratings on their websites.
Pay close attention to press releases about rating downgrades and read the agency’s reasoning for lowering the company’s rating.
You can also check your insurer’s website for their ratings. Be aware, however, that he might feature his highest ratings rather than his most recent ratings.
If their financial situation changes and the rating agencies downgrade them to a low level, you will want to know this as soon as possible to decide whether to change insurers.
When is it time to change insurance company?
If your insurance company’s rating is still in the middle of the rating agencies’ scales, there’s no need for too much alarm. However, if your insurer’s ratings are really low, consider switching companies, depending on the type of policy you need to replace.
Switching to another auto or home insurance company can be relatively quick and easy. Keep paying your premiums until you’ve purchased a new policy so there’s no interruption in coverage. Once the new policy is in place, you can cancel your old policy and ensure you get a refund for the coverage you’ve already paid for but haven’t used.
Switching to a new life insurance company can be more complicated. If you drop a policy, you can expect to pay a higher premium for a new one due to your advanced age. Any health issues you have developed will also increase your new costs.
If you are looking to give up a permanent life insurance policy, you may be able to recover the cash value minus the surrender charge.
To help you weigh your options if you’re considering switching life insurance policies, talk to a financial advisor or life insurance agent you trust. If you decide to replace a life insurance policy, don’t give it up until you have a new one in place to avoid the possibility of being left without any coverage.
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