Key Takeaways
- State guaranty funds protect life insurance policyholders if a company goes bankrupt.
- Life insurance failures are rare, with no bankruptcies since the 2008 financial crisis.
- Guaranty associations, reinsurance, and statutory reserves offer protection against insurance company failures.
- Variable annuities might not be covered unless guaranteed by the insurer.
- Spreading policies across multiple insurers can maximize state guaranty fund coverage.
What happens if your insurance company goes bankrupt? While failures are uncommon, state governments help protect policyholders through guaranty associations that step in when a company becomes insolvent. Additional safeguards, such as statutory reserve requirements and reinsurance, also reduce the risk of policyholder losses. Although rare, understanding how these protections work against insurer failure is essential for informed insurance decisions.
How State Protections Work If Your Life Insurance Company Fails
Failures and bankruptcies are uncommon. According to the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), no life insurance companies have filed for bankruptcy since the 2008 financial crisis.
But if a failure or bankruptcy does occur, then safeguards are in place to protect consumers. These include:
- Statutory reserves
- Reinsurance
- Guaranty association membership
Life insurance companies are required by state law to maintain capital reserves to pay out policyholder death benefits in the event that the business fails. The amount that’s required to be held back can vary from state to state, but these reserves, along with other company assets, can be used to fulfill claims if the company goes bankrupt.
Reinsurance is another strategy that allows insurance companies to mitigate the risk of potential losses if a business failure occurs. Essentially, life insurance companies purchase insurance policies from other insurers, which allows them to spread out risk. So if one company goes under, for example, then the other companies can take up the reins to ensure that any claims or death benefits are paid.
Guaranty associations, such as the NOLHGA, are another form of protection against losses. If a member life insurance company goes out of business, then the membership association can step in and guarantee payment of benefits. The amount that the association will pay may be capped at certain limits, depending on state law, and membership is typically mandatory.
Note
If your life insurance company fails, then you may first need to pursue financial remedies through reserves or reinsurance before a guaranty association will pay any benefits.
Understanding Coverage Limitations for Variable Annuities
When it comes to life insurance, determining whether you have coverage and how much coverage is provided by your state is pretty straightforward. Annuities, however, are different.
An annuity is a type of insurance contract in which you make payments to the annuity company, with the agreement that it will make payments back to you at a future date. A variable annuity delivers a rate of return that’s based on the performance of underlying investments.
If you have a variable annuity, you’ll need to review your annuity contract and read the fine print set forth by your state to know if you are protected. In Florida, for example, a variable annuity policy isn’t covered unless some aspect of the policy is guaranteed by the insurer. That means that the insurance company is being paid to cover some kind of liability associated with the policy. No liability to the insurer means no help for you.
If you want to get information about your state’s coverage, you can go to the NOLHGA website. Once you are on that website, you can click on the link for your state’s association. If you don’t fully understand what’s covered, call your state’s association directly for help regarding your situation.
Tip
Annuities can generate an additional income stream in retirement, but if you want to earn a guaranteed rate of return, then you might consider a fixed versus variable option.
How to Enhance Your Life Insurance and Annuity Protection
If you want to increase the size of your state guaranty fund security blanket, then you need to work within the limits of your state’s law. In the majority of states, you can increase coverage by doing business with multiple insurers. In most states, the individual coverage limit is doled out on a per-company basis, so if you have two policies with two different companies, then you will get double the coverage.
This technique of layering coverage through multiple insurance companies is similar to how people maximize their FDIC coverage by opening bank accounts through multiple banks. However, given the large face amounts involved with life insurance and the underwriting hassles that would be involved in getting multiple life insurance policies through different insurance companies, it isn’t practical in the real world and could end up costing you more money for the same amount of coverage.
On the flip side, doing business with multiple annuity companies to increase your state coverage limits can be a useful strategy. While it’s not practical for life insurance, most states will give your spouse a duplicate level of coverage if they own an annuity. For example, if you are looking to invest $200,000 into an annuity and your state’s guaranty is $100,000 per individual, then both you and your spouse could invest with the same company to get the $200,000 of cash value coverage.
Important
If you’re considering annuities to expand coverage, pay close attention to the fees you might pay, including surrender charges, early withdrawal charges, and administrative fees.
Tips for Choosing a Strong and Reliable Life Insurance Company
Finding the right life insurance company can go a long way toward minimizing your need for these protections. That means finding a licensed insurer that’s financially healthy and is able to pay out claims or death benefits for the foreseeable future.
There are some useful tools that you can use to find the best life insurance companies. The first is AM Best, a company that issues ratings for life insurance, annuities, and other financial products. AM Best ratings are assigned using a letter grade, similar to how a report card works. A rating of A+ or A++, for example, means that the company’s financial health is superior, while a D rating indicates that an insurer may not be equipped to pay out claims if it comes under financial strain.
You can also review other industry ratings, such as those issued by S&P Global or Moody’s, to get a better sense of a life insurance company’s financial strengths and weaknesses. Beyond that, you can take a closer look at the company’s financials by viewing its annual report or quarterly earnings report if those are made public. These reports can tell you a company’s cumulative assets and liabilities, how much it’s earning, and what it’s turning in profits.
From there, you can also look at online reviews from established websites, consumer reviews, and Better Business Bureau ratings. Together, these tools can help you narrow down the list of life insurance companies that you’re interested in doing business with.
Tip
Aside from financial health, consider the life insurance company’s range of products and what you’ll pay to get insured to find the right option for your needs and budget.
The Bottom Line
State protections help reduce the risk of losses if a life insurer fails. But they have limits, so don’t rely on them as a substitute for due diligence. Before you buy a life insurance policy or annuity, evaluate the insurer’s financial strength and credit ratings. Assessing an insurer’s stability can help you protect the long-term benefits and ensure that the policy obligations can be met.
