When insurer AIG, which was deemed "too big to fail", was on the brink of collapse during the Great Recession, the US government stepped in to bail out the company in 2008. Bailouts like that don't happen every day, however.
In fact, he probably shouldn't count on Uncle Sam bailing out the insurance company from him if his finances run out. However, you are not very lucky if an insurance company collapses.
States regulate insurance companies and all have regulations to protect policyholders in the event an insurer goes out of business. It is important that you understand how the process works and what kind of protection you will receive. Better yet, you need to know the steps to take to avoid ending up with a bankrupt insurance company so you don't have to rely on the state to remove you.
Why do insurance companies close?
Although the insurance industry is highly regulated, insurance companies fail for a number of reasons. For example, they could lower the prices of their products and have higher insurance claims than expected, just like their long-term care insurer, the Penn Settlement. The company filed for bankruptcy in 2017, and its bankruptcy is considered one of the largest in US history.
Bankruptcies of American insurance companies peaked in the early 1990s, and more than 50 companies went bankrupt in 1992 alone, according to a study by the Society of Actuaries and the Canadian Institute of Actuaries. In recent years, this number was less than 10 a year. However, for policyholders, even one failure per year is too much if it is their insurance company that fails.
How do countries protect policyholders?
When an insurance company faces a financial problem, the insurance system of the state the insurer is in will be bailed out, so to speak. All 50 states, the District of Columbia and Puerto Rico have insurance guarantee societies, according to the National Conference of Insurance Guarantee Funds.
Most states have a Life and Health Insurance Federation that covers life, health, disability, and long-term care policies in addition to annual premiums, and the Property and Injury Warranty Association that sponsors compensation policies for cars, homeowners and workers. Insurance companies licensed to sell insurance in a country must be members of the state insurance union and contribute to a guarantee fund that protects policyholders.
If the insurance company becomes financially unstable and cannot pay the insured's claims, the state insurance commissioner can take over the company through a process called sentencing. First, the Commissioner will try to rehabilitate the company to improve its financial position. If that doesn't work, the commissioner can declare the company bankrupt and sell its assets, according to the National Organization of Life and Health Insurance Underwriting Associations.
What to expect if your insurance company fails
If an insurance company files for bankruptcy, the State Guarantee Association and the Guarantee Fund go into business. The association will either transfer the documents from the insurance company to another insurance company or continue to provide the same coverage to the policyholders. Therefore, it is important that policyholders continue to pay premiums if the state seizes their insurance company.
Paying your insurance premiums keeps your coverage intact. Or consider getting an insurance policy from another insurance company, although this is generally easier with auto and home insurance than with life insurance.
If the insurance company does not have sufficient funds to pay the claims of the policyholders, the guarantee association will use the assets the company owns and the money from the guarantee to pay the claims. However, states have a limit on the number of claims they will pay. Most states limit benefit payments to the following amounts:
- $ 300,000 in life insurance death benefits
- $ 100,000 in cash or life insurance withdrawals
- $ 250,000 annual interest, in present value
- $ 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
- $ 300,000 for property and loss claims
There are no limits for workers' compensation claims
If you have insurance policies with benefits that exceed these limits, it can be frustrating that you or your beneficiaries do not get the full amount that you paid through the policy premiums. However, keep in mind that something is better than nothing.
Also, if you have an exaggerated claim, you may be able to ask the "property" company for a full refund. But your claim will be combined with claims from all the company's creditors, and it could take years to see money, according to the National Conference of Insurance Guarantee Funds.
How to prevent insurance companies from going bankrupt
To avoid having to rely on a state insurance association to protect you as an insured, you can check with insurance companies before doing business with them to make sure they are financially sound.
Insurers are rated on the basis of their financial strength by independent agencies, each with its own scale and rating criteria. The five rating agencies are:
- AM Best, which ranks companies on a scale from A ++ to D-
- Fitch, which rates companies on a scale from AAA to D.
- Kroll bond rating agency, which rates companies on a scale from AAA to D.
- Moody's, which rates companies on a scale from Aaa to C.
- Standard & Poor's, which ranks companies on a scale from AAA to D.
The highest ratings are given to companies that the rating agencies consider to be in the best position to meet their financial obligations. Low ratings are given to companies that the agencies believe have little capacity to meet their financial obligations.
You should check the ratings of more than one agency because ratings can vary from agency to agency, according to the Insurance Information Institute. You will have to register with these agencies' websites (and possibly pay a fee) to see your insurance company's ratings, but many insurance companies post their ratings on their websites.
Pay particular attention to press releases about demotion and read the agency's reasons for demoting the company.
You can also check the insurance company's website to find out its qualifications. However, keep in mind that you may be showing your highest grades instead of your most recent grades.
If your finances change and rating agencies downgrade them, you'll want to know as soon as possible to decide whether to change insurers.
When is the right time to change insurance companies?
If your insurance company's rating is still in the middle of the rating agency scales, it shouldn't cause much concern. However, if your insurer's ratings are already low, consider switching companies, depending on the type of policy you need to replace.
Switching to another auto or homeowners insurance company can be quick and relatively easy. Keep paying your premiums until you buy a new policy so there are no delays in coverage. Once you apply the new policy, you can revoke your old policy and make sure you get reimbursed for the coverage you already paid for but didn't use.
Switching to a new life insurance company can be more difficult. If you give up a policy, you can expect to pay a higher premium for a new policy because of your old age. The sanitary conditions it developed will also add to the new cost.
If you want to waive a permanent life insurance policy, you may be able to get a cash refund less surrender fees.
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