What happens if your life insurance company files bankruptcy?
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UPDATED: Jul 26, 2011
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With the economy driving more and more companies into financial hardship, many people worry about the stability of their investments. Life insurance is an investment; it provides security for your family if something happens to you. What will happen if you pay your premiums for years, and your life insurance company goes bankrupt? Will you lose your investment? Will your family not receive the money you intended for them to have?
As a consumer, you have some protection. Each state has a security fund set up, called a state guaranty fund, into which all insurance companies which offer life insurance in that state must pay a sum every year in case of financial insolvency. These funds are held by the state for distribution to policyholders.
In many cases, however, life insurance companies facing bankruptcy are bought by larger insurance companies with the funds to pay claims. This makes good business sense for two reasons. First, the purchasing company gains good will from the customer base of the defaulting company; second, the purchasing company acquires a new client pool without the expense of paying agents a commission for selling policies.
How the state fund kicks in
The states have another way of preventing companies from defaulting. Each state has a department dedicated to the regulation of insurance transactions. This agency has the responsibility of setting standards and rules for doing business in the state. As a first line of defense, this agency will require any company wishing to do business in the state to meet certain requirements, or face denial of a business license. One of the requirements the state imposes is that the company show a balance sheet that indicates that it can meet its financial obligations, at least in the short term.
If the very worst happens, and your insurance company files for bankruptcy, you will receive notification telling you what they plan to do to settle their debts. If another company is purchasing them, you will learn the name of the new company. This company will probably contact you as well, confirming the details of your account and giving new contact information. Be sure to check the terms carefully, so that you can spot any discrepancies right away. In most cases, there will be no changes to your policy, except that you will not pay your premiums to the new company.
If your old company is turning the policies over to the state to be paid under the state guaranty fund, you will receive a letter giving you this information. It is very important for you to pay attention to the details of this letter, as it will contain information needed to protect your policy terms.
The state fund will send you a payout equal to the amount you have paid in premiums. You will want to immediately put this money into another policy. The reason to do this is that if you wait, or spend that money on something else, then try to buy a new policy, you will be subject to whatever age and medical limitations exist at that time, rather than being “grandfathered” into a new policy under your old terms.
For example, suppose you take out a policy at 25 and have a medical exam which shows you are very healthy. You pay your premiums for 15 years, then your company goes bankrupt. You receive a refund of your premiums from the state. If you immediately, under the terms of the state guaranty fund, find a company and reinvest your premiums, that company is obligated to honor your original terms, and guarantee your rate as if you applied with them at 25 and in good health. If you do not reinvest those funds immediately, you may find yourself applying with a new company at 40 and in poorer health, resulting in higher premiums.
The best way to protect yourself from a bankrupt insurance company is to carefully choose your provider. While the largest companies are not automatically the best, they do have the financial stability to enable them to weather economic downturns. Standard and Poor’s and A.M. Moody’s websites offer detailed financial information on companies – a poor rating means that the company is not financially sound.
You can also contact your state insurance commissioner’s office for a list of insurers operating in your state. This list will include all companies which pay into the state guaranty fund, a good sign that you will get your money in case of bankruptcy of the company. Remember that the financial stability of a company is not based on its size, but on its financial planning and available capital.