Situation: In the financial meltdown of 2007-2008, a startling number of financial institutions failed disastrously. The collapse of these banks and mortgage companies left an impact that is still felt by many over a decade later. Fortunately, the life insurance industry is one financial sector where such failure is rare. Insurance carriers do periodically fail and go out of business, however. When that happens, I receive many inquiries from advisors questioning what exactly happens when a life insurance company does fail.
Solution: States regulate insurance companies though their respective insurance departments. The insurance department in each specific state is responsible for regulating and monitoring the financial stability of all carriers doing business in that state. Before a carrier can conduct business in a state, it must be individually licensed to do business in that state. All insurance companies licensed to do business in a given state are required to be members of the state’s guaranty association. For example, a carrier licensed for business in 50 states will be a member of 50 different state guaranty associations. Ultimately, it is the state guaranty associations which protect policyholders in the event of failed insurance companies.
What happens when an insurance company becomes financially unstable?
When a state insurance department determines that a carrier is financially unstable, the first step is for the department to step in and take control of the carrier. This begins the receivership process. When an insurance company is taken over by the state’s insurance department, the policyholders will be notified. During this step, the insurance department attempts to improve the company’s financial status through a variety of strategies. Most often, an ailing carrier’s active policies are taken over by a different, financially sound insurance carrier.
If the company’s financial difficulties are too great, the department declares the company insolvent and the receivership would move to the next stage – liquidation. When a company is liquidated, the state guaranty associations are triggered to provide coverage and benefits to policyholders of the insolvent company who reside in that state. If the insolvent company does not have enough assets to meet its obligations to the policyholders, each state guaranty association assesses member insurers in its state writing the same type of life insurance to meet the covered claims of the resident policyholders.
Which guaranty association provides coverage?
Generally, the guaranty association in the policy owner’s state of residence at the time that the original insurer fails will provide coverage regardless of where the policy was purchased. In the case of a non-natural entity policy owner (such as a business or a trust), residency is determined by the principal place of business test. If a guaranty association does not cover its residents because the insurer is not licensed in the state, the guaranty association in the insolvent insurer’s home state will usually provide coverage.
Who is eligible for the coverage?
Typically, the guaranty association provides coverage to the owner of the policy.
What is covered?
The guaranty association laws of each state spell out what specifically is covered. Generally, individual and group life insurance products are covered. However, exclusions or limitations on coverage may apply. For example, guaranty association coverage does not extend to non-guaranteed portions of policies. Much like the FDIC coverage of the banking industry, the state guaranty associations provide benefits up to a specified level. Specifically, guaranty association coverage benefits are limited to the lesser of (1) the contractual obligations of the insurer and (2) the statutory dollar limit. The law in each state spells out the maximum level. While the amount of life insurance covered can vary by state, most are consistent with the NAIC Model Act and provide at least the following coverage:
- $300,000 of life insurance death benefits
- $100,000 of cash surrender or withdrawal values for life insurance
These coverage benefits are floors not ceilings. If an individual’s life insurance policy is less than or equal to the guaranty association benefit level, then the policy is fully covered. If the policy is more than the guaranty association benefit level, the policy owner will get at least the state level of coverage. Any amount above the guaranty association benefit level becomes a claim against the assets of the insolvent carrier. In conjunction with the state guaranty association, the state may also seek to negotiate a transfer of some of the benefits in excess of the guaranty association coverage to another, financially sound insurer. While the above amounts could theoretically result in partial coverage for larger face amounts, the odds of a full death benefit payout are in the policyholder’s favor. According to the National Organization of Life & Health Insurance Guaranty Associations, more than 96% of life insurance policyholders have been covered in full in recent cases of insolvency.
In Summary: The failure of a life insurance company is a rare occurrence. However, when a life insurance company does fail, the state guaranty associations play a critical role in fulfilling the promises made by the industry and ensuring that policyholders remain covered.