Imagine that you have a well seasoned whole-life insurance contract and you just read a headline announcing that your insurance company is on the verge of bankruptcy. This is not purely hypothetical in today’s economic environment.
Let’s assume this is your only life insurance and you still need the insurance coverage. What are your options?
If you are healthy, probably the best option is to re-qualify for life insurance with a new (and better) company and exchange the existing policy for a new contract. This can be done quite simply with a tax-free “1035 exchange”. You would need to work carefully with your insurance agent in selecting a financially sound company and executing the exchange properly to avoid any negative tax consequences.
Alternatively, you could cash in the current policy and use the cash value proceeds as an initial premium for a new contract. This option is probably best for those wishing to go from a whole-life to a term policy for a certain number of years. Choosing this option would create a tax liability if the cash value of the existing policy exceeds its tax basis (usually the premiums paid over the life of the policy).
Things get a bit trickier if you were healthy when you got the insurance but have since developed health issues, making it tough for you to re-qualify for another contract. You could cash out the policy, but that doesn’t meet your goal of maintaining coverage. The best solution would be the acquisition of your policy by another (presumably stronger) company through a merger or purchasing of that particular line of insurance. If this happens, your insurance contract would continue as initially written with the new carrier.
The insurance industry is heavily regulated at the state level. All 50 states have insurance commissioners whose responsibility is to protect policyholders and ensure that the companies that operate in their state are financially fit. If things got really bad financially at your insurance company, there is a system in place where the state may step in. The states have guaranty associations that exist to provide additional (albeit limited) protection to residents if their insurance company fails. Generally, if an insurance company is licensed to issue life and health insurance or annuities in a particular state, then by law they are members of the state’s guaranty association. Just like FDIC insurance for bank deposits, there is a limit to the coverage provided and it varies from state to state. Ohio has the following limits (the limits apply to spouses separately):
$300,000 Life insurance death benefit
$100,000 Life insurance cash surrender value
$100,000 Health insurance claims
$100,000 Annuity benefits (present value)
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If your insurance company really gets in trouble, it may be taken over by the state’s insurance commissioner as the receiver. If this occurs the state will work with the receiver to pay covered claims in an orderly liquidation or assist in transferring the policies to a healthy company with the goal of no lapse in insurance coverage. We spoke with several insurance professionals who indicated that it is very rare for an insurance company to go through the liquidation process and usually the policies are transferred to a healthy company.
As noted above, the state guaranty associations will also support certain health insurance, annuity, and long-term care contracts. The state guaranty associations are not widely known because most states have laws prohibiting insurance agents and companies from advertising this protection. For more information, you can go to the Ohio Life & Health Insurance Guaranty Associations’ website at www.olhiga.org.
If you have concerns about your insurance company, we recommend that you contact your insurance agent. They can review the financial health of each company and discuss in depth their ratings (A. M. Best, Standard & Poors, Moody’s etc.) From there, a game plan can be devised to meet your insurance goals. The key is not to procrastinate – the sooner you deal with an issue like this, clearly the better.