When insurance company AIG—which was considered “too big to fail”—was on the brink of failure during the Great Recession, the U.S. government stepped in to bail out the company in 2008. Bailouts like that don’t happen every day, though.
In fact, you probably shouldn’t count on Uncle Sam saving your insurance company if its finances take a nosedive. However, you’re not totally out of luck if your insurer goes under.
The states regulate insurers, and all 50 have systems in place to protect policyholders if an insurance company goes out of business. It’s important to understand how the process works and what sort of protection you’ll get. Better yet, you should know what steps to take to avoid ending up with an insurance company that goes out of business so you don’t have to rely on the state to come to your rescue.
Why Insurance Companies Go Out of Business
Although the insurance industry is highly regulated, insurance companies do 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 failure was considered one of the largest in U.S. history.
U.S. insurance company insolvencies peaked in the early 1990s, with more than 50 companies becoming insolvent in 1992 alone, according to a study by the Society of Actuaries and Canadian Institute of Actuaries. In recent years, that number has been less than 10 annually. For policyholders, though, even one failure a year is too many if it’s their insurer that goes under.
How States Protect Insurance Policyholders
When an insurance company runs into financial trouble, the guaranty system in the state 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 guaranty associations, according to the National Conference of Insurance Guaranty Funds.
Most states have both a life and health guaranty association that covers life, health, disability and long-term care insurance policies as well as annuities, and a property and casualty guaranty association that takes care of auto and homeowners policies and workers’ compensation companies. Insurers licensed to sell insurance in a state must be members of the state’s guaranty association and pay into a guaranty fund that protects policyholders.
If an insurance company becomes financially unstable and can’t pay policyholder claims, the state’s insurance commissioner can take over the company through a process called receivership. First, the commissioner will try to rehabilitate the company to improve its financial situation. If that doesn’t work, the commissioner can declare the company insolvent and sell off its assets, according to the National Organization of Life & Health Insurance Guaranty Associations.
What to Expect if Your Insurance Company Fails
If an insurance company is declared insolvent, the state guaranty association and guaranty fund swing into action. The association will transfer the insurer’s policies to another insurance company or continue providing coverage itself for policyholders. So it’s important for policyholders to continue paying premiums if their insurer is taken over by the state.
Paying your premiums keeps your coverage intact. Or consider getting a policy with another insurance company, although that’s generally easier to do with auto and homeowners insurance than life insurance.
If an insurance company doesn’t have enough funds to pay policyholder claims, the guaranty association will use what assets the company has and the guaranty funds to pay claims. However, states have a cap on the amount of claims they will pay. 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 those limits, it might be frustrating that you or your beneficiaries won’t get the full payout you paid for with policy premiums. Keep in mind, though, that something is better than nothing.
Plus, if you have a claim that exceeds the state limit, you may be able to apply to the company’s “estate” to get full payment. But your claim will be lumped in with claims from all of the company’s creditors, and it could take years to see any money, according to the National Conference of Insurance Guaranty Funds.
How to Avoid Insurers That Might Go Out of Business
To avoid having to rely on a state guaranty association to protect you as a policyholder, you can check up on insurance companies before doing business with them to make sure they’re 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:
- A.M. 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 from AAA to D
The highest ratings are given to companies that the ratings agencies believe are in the best positions to meet their financial obligations. Low ratings are given to companies that the agencies think have a poor ability to meet financial commitments.
You should check ratings from more than one agency because the ratings can vary from agency to agency, according to the Insurance Information Institute. You’ll have to register on these agencies’ websites (and possibly pay a fee) to see ratings for your insurer, but many insurers publicize their ratings on their websites.
Pay particular attention to press releases about ratings downgrades, and read the agency’s reasoning for lowering the company’s rating.
You also can check your insurer’s website for its ratings. Be aware, though, that it might be featuring its highest ratings rather than its most-recent ratings.
If their financial situations change and the ratings agencies downgrade them to a low level, you’ll want to know as soon as possible to decide whether you want to switch insurers.
When is it Time to Switch Insurance Companies?
If your insurance company’s rating still is in the middle of rating agencies’ scales, it’s not cause 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 homeowners insurance company can be relatively quick and easy. Continue paying your premiums until you have bought a new policy so there’s no lapse in coverage. Once the new policy is in place, you can cancel your old policy and make sure you get a refund for coverage you already paid for but didn’t use.
Switching to a new life insurance company may be more complicated. If you abandon a policy, you can expect to pay a higher premium for a new one because of your older age. Health conditions you’ve developed will also push up your new cost.
If you are looking to ditch a permanent life insurance policy, you might be able to get back the cash value, minus any surrender charge.
To help weigh your options if you’re considering switching life insurance policies, talk to a financial advisor or a life insurance agent you trust. If you do decide to replace a life insurance policy, don’t drop it until you have a new one in place to avoid the possibility of ending up without any coverage.