If you remember the financial meltdown a few years ago, you probably also remember that a number of banks, mortgage companies and other financial institutions failed and went out of business during that unfortunate time. But one industry sector where failure was rare was life insurance companies.
Could a life insurance company fail and go out of business? And what would happen if it did?
What would happen to your policy if your life insurance company should fail?
In theory, if your life insurance company were to go out of business your coverage would end. On the surface, that may not seem so bad – after all, if the coverage terminates, that would also mean that you are no longer responsible to pay any more premiums.
But it may not be quite that simple.
Since life insurance premiums are based on your age and the state of your health at the time of application, you would have to pay more in premiums for a replacement policy than you did for the original policy. And if your health condition has seriously deteriorated, not only will your premiums be substantially higher than they were in the original policy, but it is also entirely possible that you will not be able to get life insurance at all.
Just as important, if you have a whole life insurance policy, or any other type of life insurance policy that includes cash value, that cash value could be in doubt. Though the insurance company is contractually obligated to refund any cash value when the policy terminates, if the company’s financial situation has deteriorated significantly they may be unable to pay all or even part of the cash value that you are due.
Both of these complications could leave you in a very difficult position as far as your life insurance is concerned.
What could cause a life insurance company to fail?
A life insurance company could fail for the same reasons any other business entity might. If it experiences a prolonged period in which its expenses exceed its revenues it could fail. And since insurance companies are essentially investment companies, that invest the premiums they collect in various common financial assets in order to pay future claims, they could also fail if the financial markets collapse.
There is no FDIC for insurance companies
You are probably aware of the Federal Deposit Insurance Corporation (FDIC), the Pension Benefit Guaranty Corporation (PBIC), or even the Securities Investment Protection Corporation (SIPC). These are government-sponsored insurance agencies that serve as backstops for banks, pensions, and brokerage firms, respectively, in the event of failure by any institution within the group.
It may come as a surprise to you then that there is no equivalent government sponsored agency that intervenes in the failure of insurance companies!
Does that mean that customers are unprotected in the event that their insurance company might fail? Not necessarily.
Though there is no FDIC equivalent in the insurance industry, individual states would coordinate the response to the failure of an insurance company within their jurisdiction. Assets of the failed insurance company – in addition to all of its clients – would be parceled out on a prorated basis to competing companies within the same state. This would enable your life insurance policy to remain in force even though your original insurance company has failed.
How to know if your life insurance company “makes the cut”
The failure of an insurance company is truly a rare event, so it isn’t as if the system is tested frequently. It does seem that it has worked well the past. The failure of an insurance company, and its impact upon its customers, hardly ever makes front-page news. But the best way to avoid the problem entirely is to make sure that the insurance company that you have your life insurance policy with is on solid ground to start.
The insurance industry has its own rating agency – A.M. Best. It functions in much the same way as Standard & Poor’s, Moody’s and Fitch do with corporations and bond issues, except that works primarily in the insurance industry.
A.M. Best provides financial ratings on each insurance company based upon evaluation of the company’s financial statements, their operating performance and business profile. Much like other rating agencies, they also use different ratings to indicate an insurance company’s relative strength.
The four top ratings are:
- A++, Superior
- A+, Superior
- A, Excellent
- A-, Excellent
If the financial strength of the insurance company that you are working with is important to you – and it should be – you should look for them to have a rating that is within these four levels. A slightly lower ranking does not mean that a company is a candidate for default, only that it is a greater possibility.