What to do when your life insurance company goes bankrupt

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What to do when your life insurance company goes bankrupt

In general, when it comes to life, there are consequences when you can’t pay what you owe.

Can’t pay your credit card bill? Expect huge penalties.

Can’t pay a loan? Your stuff is going to be repossessed.

Can’t pay for a restaurant meal? You’ll have to clean dishes in the kitchen, assuming what sitcoms have taught me is true.

Can’t pay your term life insurance premiums? You lose coverage.

But what about when your life insurance company can’t pay you?

You put years and thousands of dollars into your term life insurance policy. The last thing you want to hear is that a company went bankrupt, and oh by the way now you’re not covered anymore and even if you were, they can’t pay the death benefit. Sorry!

Luckily there are several safeguards in place to make sure consumers aren’t left holding the bag if a life insurance company goes bankrupt. Here’s why you can be assured that bankruptcy won’t derail your life insurance plans.

Life insurance companies must follow reserve requirements

Any personal finance expert or advisor worth his or her salt will tell you that you need an emergency fund. You need three to six months’ worth of savings to help you make ends meet or take care of the unexpected if a job loss or car repair blindsides you.

Insurance companies work the same way, but on a scale of billions of dollars. And under the mandate of the government.

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

Life insurance companies have to take into account their number of policyholders, the amount of potential benefits they’d need to pay out, the revenue they’re bringing in, and more to determine the amount of risk they’re opening themselves up to, and therefore the amount of capital they need to have in reserve.

If a life insurance company files for bankruptcy, their reserves should help in making sure that outstanding claims don’t go unpaid.

Life insurance companies have (re)insurance

Insurance works best as a financial safety net: if worst comes to worst, you or your family can make ends meet.

Insurance companies have their own safety net, and it, too, is insurance. That’s right: Insurance companies have insurance. In this case, it’s known as reinsurance. It’s like the turducken of insurance.

Insurers in the US are only allowed to issue policies with a maximum limit of 10% of the company’s net worth unless policies are reinsured. That means if a life insurance company wants to grow, they essentially have to have reinsurance.

And that’s good news for consumers. Reinsurance reduces the liability a single company has by spreading the risk out among multiple companies.

Let’s say you take out a million dollar policy. If you die, your insurer pays out a million dollars to your beneficiary.

But an insurance company might cede part of the policy to a reinsurer. The premiums payments are split between the insurance company and the reinsurance company (probably unbeknownst to you) and if you were to die, both companies would pay $500,000 rather than one company paying the full million.

Now, imagine this, but across all insurance policies rather than with your single policy.

In the case of an insurer going bankrupt, it’s very unlikely that they'll be on the hook for all of their policies, with reinsurers picking up the rest of the slack.

Life insurance companies are part of guaranty associations

Okay, so to recap:

Life insurance companies have an "emergency fund," just like you.

Life insurance companies have "insurance," just like you.

Life insurance companies have "guaranty associations," just like...wait, no that’s not right.

Organizations like the National Organization of Life and Health Insurance Guaranty Associations are an important final step in making sure that if a life insurance company goes bankrupt, everyone else doesn’t go down with the ship.

Guaranty associations are typically funded by a portion of the collective insurers’ profits, and membership in a guaranty association is mandatory for life insurance companies. If it’s determined that a life insurance company can’t be turned around and becomes insolvent, a guaranty association steps in to help manage liquidated assets. A guaranty association has one main purpose: They provide for the continuation of contracts that might otherwise be abandoned with the loss of the insurer. In other words, they make sure policyholders are protected.

This happens in two ways. First, the guaranty association directs liquidated assets to pay out claims before any other corporate debts or liabilities. Second, they’ll help transfer policies that are still active to other insurers so that the policyholders will continue to have coverage.

Guaranty associations act as a sort of last resort: An insurer can’t pay what’s needed from their reserves, and they can’t cover everything even with their reinsurance, so a guaranty association steps in. While this is a true worst case scenario, you can rest assured that you’re covered even then.

Choose a life insurance company with strong financial ratings

So now you know that if your life insurance company goes bankrupt, you have surprisingly little to worry about.

But you know what’s even better? Choosing a life insurance company that probably won’t go bankrupt in the first place.

The easiest way to do this is through businesses that track the financial health of insurers and provide credit ratings for those carriers. Companies like A.M. Best assess the financial stability of insurance companies. Grading works basically the same way it did when you were in school – ie, an A+ is better than a B – but when you’re looking up ratings, make sure you look at the details of how they’re coming to those determinations, since one company might weigh some characteristics more heavily than others.

A.M. Best’s Financial Strength Rating Scale

Rating Categories Rating Symbols Rating Notches Category Definitions
Superior A+ A++ "Assigned to insurance companies that have, in our opinion, a superior ability to meet their ongoing insurance obligations."
Excellent A A- "Assigned to insurance companies that have, in our opinion, an excellent ability to meet their ongoing insurance obligations."
Good B+ B++ "Assigned to insurance companies that have, in our opinion, a good ability to meet their ongoing insurance obligations."
Fair B B- "Assigned to insurance companies that have, in our opinion, a fair ability to meet their ongoing insurance obligations. Financial strength is vulnerable to adverse changes in underwriting and economic conditions."
Marginal C+ C++ "Assigned to insurance companies that have, in our opinion, a marginal ability to meet their ongoing insurance obligations. Financial strength is vulnerable to adverse changes in underwriting and economic conditions."
Weak C C- "Assigned to insurance companies that have, in our opinion, a weak ability to meet their ongoing insurance obligations. Financial strength is very vulnerable to adverse changes in underwriting and economic conditions."
Poor D - "Assigned to insurance companies that have, in our opinion, a poor ability to meet their ongoing insurance obligations. Financial strength is extremely vulnerable to adverse changes in underwriting and economic conditions."

From http://www.ambest.com/ratings/guide.pdf

Now, this isn’t a 100% guarantee that a company with an A++ rating won’t ever go belly up, but it’s as close as you can get without a crystal ball. We include financial ratings in our term life insurance company reviews, and an independent agent or broker can help you get the right policy with the right company. The best term life insurance company is the one that has the policy that fits your need at a rate you can afford. But that doesn’t mean you shouldn’t be aware of the financial rating of your insurer.

There are a lot of safeguards in place to ensure that you don’t suffer in the event of your life insurance company going bankrupt. That’s great news for a product that you’ll be using for decades to come, and it means that you can truly have peace of mind when it comes to your life insurance.