Life Insurance: Can It Fail Or Not?

Yes, life insurance companies can and have failed in the past. While insurance company failures are rare, several dozen insurance companies, including big names in the business, have gone bankrupt in the United States in the last 30 years. In the event that a life insurance company goes bankrupt, consumers are protected by statutory reserves, reinsurance requirements, and guaranty associations.

What protections are in place for consumers?

While insurance company bankruptcies have occurred before, it is a rare event. The industry has also learned from previous economic crises, which has helped it to better prepare for market instability.

If an insurance company does go bankrupt, there are several protections in place for consumers:

Statutory Reserves

Life insurance companies are legally required to maintain a specified amount of cash reserves to pay out claims in a worst-case scenario. This amount varies from state to state and risk to risk, but it is typically between 8% and 12% of the insurer's total revenue. The actual amount kept in reserve is determined by factors such as the number of policyholders, potential benefits, revenue, and access to stocks and bonds.

Reinsurance Requirements

Life insurance companies buy reinsurance, which is a form of protection for their ability to pay out claims. By insuring their policies with another company, they spread the risk of financial loss among several companies instead of just one. Reinsurance helps life insurance companies pay out during a surge in the death rate, whether due to a natural disaster or a global health crisis. For policyholders, this means that if their insurer goes bankrupt, the reinsurer can step in, limiting risk and ensuring beneficiaries still receive the death benefit.

Guaranty Associations

Guaranty associations, such as the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), protect your policy if an insurance company goes bankrupt. These associations are funded by a portion of insurers' profits, and membership is mandatory for life insurance companies. If an insurer becomes insolvent, the guaranty association manages any liquidated assets and fills any obligations to creditors. The association will transfer coverage for living policyholders to another insurer, and beneficiaries will still receive the death benefit, although the amount may vary depending on the state.

State Regulations

State regulations are in place to ensure that insurance company failures occur only in rare instances. In the event of a failure, the state may try to move your policy to more stable insurers. If this is not possible, the state guaranty association will step in to fulfill the policy, with limitations that vary by state. The state may also seize the company and liquidate its assets, using the proceeds to pay any outstanding claims or to repay the state guaranty association for any claims paid on behalf of the failing company.

How to evaluate the financial health of an insurer

Insurance company failures, also known as insolvencies or liquidations, are rare. However, it's still a good idea to evaluate the financial health of a prospective insurer before buying a policy. Here are some ways to do that:

Check the Insurer's Financial Strength Rating

Five independent agencies—A.M. Best, Fitch, Kroll Bond Rating Agency (KBRA), Moody's, and Standard & Poor's—rate the financial strength of insurance companies. Each has its own rating scale, standards, population of rated companies, and distribution of companies across its scale. These agencies look at financial leverage, management stability, recent performance, and the rated company's overall financial situation.

Understand the Rating System

Each agency's rating code is different, so it's important to understand the differences. For example, an A+ from A.M. Best is the next-to-top rating of its 15 categories, but an A+ from Fitch, Kroll, or S&P is their 5th-highest rating. Additionally, Moody's doesn't have an A+ rating. It's prudent to check the ratings of any company you're interested in annually and consider ratings from two or more agencies.

Check for Complaints

The National Association of Insurance Commissioners (NAIC) website features a section on complaints and a Consumer Information Source (CIS) that presents key information about insurance companies that you can use before purchasing insurance, such as closed complaints, licensing information, and financial data.

Analyze the Insurer's Financial Statements

Analyzing the balance sheet, income statement, and cash flow statement can provide insights into the financial health of an insurer. The balance sheet shows a company's financial position at a specific point in time, including its assets, liabilities, and owners' equity. The income statement reflects financial performance over a period by looking at revenue, expenses, and profits earned. The cash flow statement details how a company used its cash during an accounting period, showing sources of cash flow and areas where money was spent.

Conduct a Financial Ratio Analysis

Financial ratios are powerful tools for determining the overall financial health of a company. Ratios fall under categories such as profitability, liquidity, solvency, efficiency, and valuation. Some key ratios to consider include gross profit margin, net profit margin, coverage ratio, current ratio, quick ratio, debt-to-equity ratio, inventory turnover, total asset turnover, return on equity (ROE), and return on assets (ROA).

What to do if your insurance company goes bankrupt

While insurance company bankruptcies have happened before, they are rare. If your insurance company goes bankrupt, there are protections in place to safeguard consumers and pay claims. Here are the steps and measures to be aware of:

Statutory Reserves

Life insurance companies are legally required to maintain a specified amount of cash reserves to pay out claims in a worst-case scenario. The exact amount varies from state to state, but it is typically between 8% and 12% of the insurer's total revenue. This helps ensure that even if the insurance company goes bankrupt, there will be funds available to pay out claims.

Reinsurance Requirements

Life insurance companies buy reinsurance, which means they purchase insurance from another company. This spreads the risk of financial loss among multiple companies, rather than just one. In the event of bankruptcy, the reinsurer can step in and cover the claims. Reinsurance also helps life insurance companies manage a surge in the death rate, such as during a global health crisis.

Guaranty Associations

Guaranty associations, such as the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), protect your policy if an insurance company goes bankrupt. These associations are funded by a portion of insurers' profits, and membership is mandatory for life insurance companies. If an insurer becomes insolvent, the guaranty association will manage any liquidated assets and transfer coverage for living policyholders to another insurer. The death benefit from a guaranty association is typically capped at $300,000, and the cash value is usually capped at $100,000.

State Guaranty System

All 50 states, the District of Columbia, and Puerto Rico have insurance guaranty associations, providing protection for policyholders if an insurance company goes out of business. The guaranty system in the state where the insurance company is headquartered will take over, transferring policies to another insurance company or continuing to provide coverage through the state's central guaranty fund.

Receivership

If an insurance company becomes financially unstable, the state insurance department can take over through a process called receivership. This involves trying to rehabilitate the company and improve its financial situation. If rehabilitation is unsuccessful, the state can declare the company insolvent and sell off its assets.

Research and Switch

To avoid the hassle of dealing with a bankrupt insurance company, it is important to research the financial health of a prospective insurer before purchasing a policy. You can check ratings from independent agencies such as AM Best, Fitch, Kroll Bond Rating Agency, Moody's, and Standard & Poor's. If you already have a policy with a company that is struggling financially, consider switching to another insurer, especially for auto and homeowners insurance. Switching life insurance policies can be more complicated, so consult a financial advisor or a trusted life insurance agent before making any changes.

What happens if an insurance company is bought by another company?

Insurance company failures, also known as insolvencies or liquidations, are rare. However, if an insurance company is bought by another company, it is likely due to financial instability. In this case, the state insurance department will first try to rehabilitate the company to improve its financial situation. If this is unsuccessful, the insurance company will be declared insolvent and its assets sold off.

If an insurance company is declared insolvent, the state guaranty association and guaranty fund will take over. The association will transfer the insurer's policies to another insurance company or continue providing coverage itself for policyholders. Policyholders should continue paying their premiums if their insurer is taken over by the state. If an insurance company does not have enough funds to pay policyholder claims, the guaranty association will use the company's assets and the guaranty funds to pay claims.

There are caps on the amount that states will pay out in claims. Most states limit benefit payouts 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 present 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 property and casualty claims

There are no caps on workers' compensation claims. If you have insurance policies with benefits that exceed these limits, you or your beneficiaries will not receive the full payout. However, you may be able to apply to the company's "estate" to receive full payment. This will involve waiting for the company's assets to be liquidated and your claim to be processed, which could take several years.

If your insurance company is bought by another company, it is important to keep up-to-date with any changes to your policy. You should also be aware of the protections in place if your new provider does not keep its promises. State regulators oversee the transfer of policies, and in the rare event that an insurance company does not fulfill your contract terms, you can file a complaint with your state's insurance commissioner.

How to protect yourself from insurance company failure

While insurance company failures are rare, it's still a good idea to be aware of how to protect yourself in the event of one. Here are some ways to safeguard yourself and your finances if your insurance company fails:

Research the Insurance Company

Before purchasing a policy, it's essential to research the financial health and standing of the insurance company. You can refer to credit agencies like AM Best, Standard & Poor's, and Moody's to assess the company's financial strength and stability. This will help you choose a reputable insurer with a low risk of bankruptcy.

Understand the Protections in Place

In the event of an insurance company's bankruptcy, there are built-in protections to safeguard consumers and ensure they receive their entitled benefits. These include statutory reserves, reinsurance requirements, and guaranty associations.

Statutory Reserves:

Life insurance companies are legally required to maintain a minimum cash reserve, typically ranging from 8% to 12% of their total revenue. These reserves are used to pay out claims in the event of a worst-case scenario, such as bankruptcy.

Reinsurance Requirements:

Life insurance companies purchase reinsurance, which means they buy insurance from another company. This protects the insurer's ability to pay out claims and spreads the risk among multiple companies. Reinsurance helps ensure that beneficiaries still receive the death benefit in the event of the insurer's bankruptcy.

Guaranty Associations:

Guaranty associations, such as the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), protect your policy if an insurance company goes bankrupt. These associations are funded by a portion of insurers' profits and are mandatory for life insurance companies. They manage liquidated assets, fulfill obligations to creditors, and transfer coverage for living policyholders to another insurer.

Understand Your Policy and Keep Records

Carefully read and understand your insurance policy. Know what is covered and what the process is for appealing a denial by the insurance company. Keep detailed records of all documents, bills, and correspondence related to your policy. This includes estimates, repair costs, and any other relevant information regarding your insurance claim.

Consult an Attorney

If you encounter issues with your insurance company, consider consulting an attorney, especially if you feel you are being treated unfairly or if the company is avoiding or delaying your claim. An attorney can provide legal advice and help you navigate the process to protect your rights and ensure you receive the coverage you are entitled to.

By following these steps, you can protect yourself from potential financial loss and ensure that your insurance policy remains secure even if the insurance company fails.

Frequently asked questions