What Happens If Your Life Insurance Company Fails?

“What Happens If Your Life Insurance Company Fails?” should be question that we all ask. In the rare case, a life insurance company fails, there is already a safety net ready to protect your policyholders.

Most life insurance companies stay financially strong, enabling them to live up to their promises, pay claims, and return their policy holder’s policy cash value, and annuity values. Fortunately, all the Insurance carriers that The Kaye Agency uses are financially strong. But in the rare case, an insurance company fails, a safety net is ready to protect policyholders.

All states have laws that govern what happens when a life insurance company gets into financial trouble, and each state has a life and health “guaranty association,” which guarantees that policyholders get the coverage and benefits they’re due, up to a limit.

To put this into perspective, the insurance company has three lines of defence before it actually goes under:

1. Statutory reserves

Life insurance companies are legally required to keep a specified amount of cash reserves on hand to pay out death benefits in a worst-case scenario. The exact amount varies from state to state and risk to risk, but it’s usually a minimum 8% to 12% of the insurer’s total revenue.

The actual amount kept in reserve depends on a company’s number of policyholders, potential benefits it might need to pay out, revenue, access to stocks and bonds, and more.

2. Reinsurance requirements

Reinsurance is protection that life insurance companies buy to insure their ability to pay out claims. By insuring their policies, insurance companies spread their risk of financial loss among several companies. Reinsurance also helps life insurance companies pay out when there’s a surge in the death rate — whether from a natural disaster or a global health crisis.

Unless their policies are reinsured, insurers in the US can only issue policies with a maximum limit of 10% of the company’s net worth. [2] So if a life insurer wants to grow, it has to be reinsured.

For policyholders, it means that if your insurer goes bankrupt, its reinsurer can pick up the slack. This limits risk for everyone and ensures that your beneficiaries still get the death benefit.

3. Mandatory membership in guaranty associations

Guaranty associations like the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA) protect your policy if a provider does go under. Guaranty associations are funded by a portion of insurers’ profits, and membership in a guaranty association is mandatory for life insurance companies.

If a life insurance company is deemed insolvent, a guaranty association manages any liquidated assets and fills any obligations to creditors. The association transfers coverage for any living policyholders to another insurer.

The basics of going under

State insurance departments regulate the insurance industry and monitor companies to make sure they’re financially sound.

When a company starts to falter and can’t meet its obligations, the state’s insurance commissioner steps in and takes control of the company’s operations. The state will notify all policyholders if that happens. The state Life and health insurance guaranty association work with the insurance department to help decide on one of two outcomes:

  1. Monitoring the company to see if it can get back on its feet (this is called “rehabilitation)
  2. Liquidating the company by selling off its assets.

If the company has to be liquidated, the guaranty association’s focus is on protecting policyholders. The association may provide coverage and pay claims directly or transfer the policies to a financially stable insurance company. It might also work with other state guaranty associations.

More than a decade ago, the process of moving policyholders to a sound company could take years; now when that strategy is used, it typically takes months, according to the National Organization of Life & Health Insurance Guaranty Associations.

During liquidation, the company’s assets are sold off and used to pay creditors, including policyholders. The guaranty association assesses its insurance company members to cover claims if there is a shortfall. All life insurance companies licensed to do business in a state must belong to that state’s guaranty association. Policyholders who live in states where the insurer was not licensed are typically covered by the association in the state where the liquidated company is based.

Guaranty association benefit

The amount of benefits that state guaranty associations can pay out or transfer to another company is capped. The limits vary among states, but the associations in every state offer at least the following for life insurance policies, according to the National Organization of Life & Health Insurance Guaranty Associations:

  • $300,000 in life insurance death benefits
  • $100,000 in cash surrender or withdrawals from permanent life insurance policies
  • $100,000 withdrawal from and cash values for annuities

You can get specifics about your state guaranty association on the national organization’s website.

If your policy promised benefits greater than what the guaranty association can provide, you may submit a claim against the estate of the failed insurance company for the difference.

Why you should check insurance company financial strength ratings.  Although states provide a safety net in case of insurance company failures, it’s far better to avoid the hassle in the first place. When you’re investing in life insurance, check the company’s financial strength ratings.

It only takes a few minutes to look them up on the websites of independent rating firms, such as:

A.M. Best,

Fitch Ratings,

Moody’s Investor Services or

Standard & Poor’s Ratings Services.

I trust that I have adequately answered the question “What Happens If Your Life Insurance Company Fails?”

(In some cases you may need to register for free to access ratings.) The rating agencies issue grades for insurers, and each has its own scale. An A+ is the fifth-best rating from Fitch, for instance, and the second-best rating from A.M. Best.

Now, to put this into perspective, in recent history, because of the heavy regulations and requirements, there has only been one life insurance company failure. That took place in 2008.

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