Key Takeaways
- Insolvency is when a company’s assets cannot cover its debts.
- Insurance companies, although conservatively managed, can be subject to normal business risks that can jeopardize policyholders.
- All 50 states, the District of Columbia and Puerto Rico have state regulators that oversee insurers.
- State guaranty associations will backstop consumer claims but have state-imposed limitations.
- Consumers can research insurance company ratings and regulator reports to stay informed.
What Is Insurer Insolvency?
Insolvency occurs when the company’s available assets are not enough to cover its liabilities, which include policy claims, accounts payable and other debt obligations. Although rare, life insurance companies can fall into financial difficulties.
Bankruptcy and insolvency are not the same. Bankruptcy is a court order often declaring insolvency, whereas insolvency is a state of economic distress and an inability to pay debts. A company can be insolvent and not bankrupt, but those who file bankruptcy are often considered insolvent.
Only in the direst circumstances will an insurance company be deemed so troubled that it must be liquidated, meaning it must cease operations and sell its assets. This would occur only after supervision or rehabilitation efforts are taken to place the company on stronger financial footing.
According to the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), with liquidation, the goal of the insurance commissioner is to take possession of all the company’s records and assets to ensure an orderly and complete accounting and distribution of the company’s liabilities.
Following a liquidation, policyholders will receive their share of the funds raised. In the event of a shortfall, the commissioner will utilize the state guaranty association to close the funding gap to the extent specified by state law.
The insurers that are least likely to experience insolvency have well-established track records, superb balance sheets and highly resilient operations. Their financial strength is signified by an AM Best financial strength rating of at least “A-: Excellent.”
Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting ProfessionalThomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.
Causes of Insolvency
Despite the high level of regulatory oversight, insurance company failures can occur. Insolvencies have been far less common since the 1990s, averaging less than two per year between 2009-2019.
Common drivers of insolvency include:
- Dwindling sales
- Excessive expenses
- Underpriced products and services
- Unexpectedly high frequency and/or severity of claims within a year or series of years
- Financial mismanagement
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What Happens to Your Policy if Your Insurer Fails?
If your insurance company is declared insolvent, your state insurance guaranty association will step in to provide coverage to policyholders with active claims and transfer existing policies to other insurance companies. In these circumstances, it is essential to continue to pay your premiums because that will keep your coverage in force while you settle your claim for benefits or attempt to move your policy to another insurer.
The state guaranty association will first use the insurance company’s own assets to pay claims. Then, the association will use its funds, which are accumulated via assessments charged to all the insurance companies conducting business within the territory. Most states have legal limits on the benefit amounts that can be paid by the guaranty association.
For example, a payout for disability insurance benefits could be capped at $300,000 according to state law.
Do Policyholders Have Protections?
The primary reason state insurance departments exist is to maintain strong consumer protections for policyholders. Most states have both a life and health guaranty association and a separate property and casualty guaranty association, each of which act as a backstop for policy claims when an insurer does not have enough assets to cover their liabilities.
All insurers are required to be members of these associations and contribute money to ensure a degree of consumer protection.
If you receive a notice of receivership or liquidation from your insurance provider, consider contacting your state insurance department to file the proper paperwork for a claim against the company. The National Association of Insurance Commissioners (NAIC) has resources to find your state’s information.
How To Avoid and Switch From At-Risk Insurers
When shopping for insurance, it is important to consider the rating of a company, not just the cost of the premium. Many independent agencies rate insurers and give consumers a better idea of a company’s financial standing.
Popular financial rating companies include:
- AM Best
- Fitch Ratings
- Kroll Bond Rating Agency (KBRA)
- Moody’s Investor Services
- Standard & Poor’s Insurance Ratings Services
Most insurance companies will proudly display their ratings, but you can ask to see a company’s ratings before purchasing a policy. Each agency has a slightly different scoring method, so it is important to understand how to compare each score.
Moving a life insurance or annuity from one company to another is called a 1035 exchange and allows you as the policyholder to move your policy or contract without paying taxes on the distribution. Discuss this process with both your new and old insurance companies to make sure you take the right steps.
Anytime you move a policy, consider what fees and/or replacement costs you may incur. It can be beneficial to discuss this process with an unbiased financial advisor.
Resources for Policyholders
The best resource for policyholders or insurance consumers will be your state department of insurance. The National Association of Insurance Commissioners is a robust organization that monitors and coordinates the activities of the various state insurance departments and fosters standardized reporting practices for insurance companies throughout the nation. Its website includes consumer protection notices, educational materials and resources for submitting questions or complaints. For state-specific information, NAIC will direct consumers to their state resources.
The National Organization of Life and Health Insurance Guaranty Association contains information for policyholders specific to dealing with insurance company insolvencies. If you are going through an insurance company insolvency, you can find resources on this site to try to rectify the situation.
Before reaching out to these resources, consider reading your individual policy’s language to understand its terms.
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