Back in the day, the probability of a life insurance company becoming bankrupt was quite low. Nonetheless, in the mid-1990s, a few major life insurance companies began the process of insolvency. As a result, a commonly asked question among prospective buyers is, “What happens if my life insurance provider goes bankrupt?”
Were you aware that insurance companies cannot file for bankruptcy like other types of businesses? Instead, they undergo a liquidation or insolvency receivership process supervised by the insurance department of the state where they are registered.
What does this liquidation process look like?
The state insurance department closely oversees and regulates life insurance companies to ensure that policyholders are safeguarded from any financial difficulties that may arise within the company. If a life insurance company experiences financial distress and cannot meet its claim obligations, the insurance commissioner will step in and initiate the insolvency process.
The laws governing insolvency proceedings for life insurance companies vary by state. Many states offer financial rehabilitation programs to help struggling carriers get back on track. However, if rehabilitation efforts fail, the life insurance company is deemed insolvent. At that point, the state’s insurance commissioner will request that the court commence the liquidation process of the life insurance company.
State insurance commissioners are responsible for regulating and overseeing all insurance activities within their state. They are appointed or elected by the governor of the state. As part of their responsibilities, insurance commissioners must determine if an insurance company operating in their state should be declared insolvent. If so, they will seek authorization from the state court to commence the process of seizing the company’s assets and operations during the liquidation or rehabilitation period.
Given the many responsibilities of the state insurance commissioner, they may appoint a Special Deputy Receiver to oversee the activities of a carrier. This individual may be an independent professional or an employee of the state’s insurance department. If an independent professional, the Special Deputy Receiver is typically an expert in accounting or legal issues.
The Special Deputy Receiver takes control of the company’s accounting, assets, and liabilities. They are responsible for administering the company’s estate and aim to increase its assets that can be converted to cash. If successful, the receiver will distribute the cash to all creditors with valid claims. The claims are prioritized according to payment hierarchy, which varies by state law. However, policyholders generally receive payment before other creditors.
Every state has a guaranty association that provides protection for policyholders in the event that their insurer becomes insolvent. These associations are typically funded by insurance companies and are required by law to provide coverage for certain types of policies up to a certain limit, determined by state laws.
Every licensed life insurance company must be a member of the state’s guarantee association. The guaranty association, in cooperation with the Special Deputy Receiver and the insurance commissioner, assists in the planning of the liquidation process.
If a life insurance company becomes insolvent, the amount of guaranteed coverage you could receive depends on the state in which you reside. Most states provide coverage that is consistent with the National Association of Insurance Commissioners (NAIC) Model Act. However, the maximum limits of coverage can vary by state, and you would need to contact your state’s guaranty association to confirm the specific benefit available to you.
In most states, the aggregate benefit level for individual life insurance is up to $300,000 for death benefits, up to $100,000 for cash surrender or withdrawal values, and up to $300,000 for life insurance death benefits.
When a life insurance company becomes insolvent and is unable to meet its financial responsibilities to policyholders, state guaranty associations are activated to provide coverage. After the guaranty association’s share of any remaining assets is used to pay covered claims, the remaining covered claims are then assessed to insurance companies in the state. Each company’s share is determined by the amount of premiums they have collected in the state.
Life insurance companies are not immune to the need for insurance themselves. Reinsurers provide an extra layer of protection to these companies, which benefits the insurers and provides consumers with increased security. In fact, without reinsurance, life insurance companies cannot issue policies that exceed ten percent of their net worth. This means that all insurers must obtain reinsurance in order to grow financially.
It’s important to choose a life insurance company with strong financial ratings. Companies like A.M. Best, Moody’s, and Fitch grade life insurance companies, so it’s helpful to look for companies with a rating of “A” or higher. While it’s not impossible for an “A” rated company to declare bankruptcy, it’s highly implausible.
