During the Great Recession, the insurance giant AIG, which was considered “too big to fail,” faced bankruptcy. However, this kind of bailout doesn’t happen every day. So, what would happen if your insurance company went out of business? Don’t worry, there are protections in place.
Why Do Insurance Companies Go Bankrupt?
Although the insurance industry is heavily regulated, insurance companies can still fail for various reasons. For instance, they might underprice their products and experience higher-than-expected insurance claims. One such example is the long-term care insurer Penn’s Treaty, which declared bankruptcy in 2017, making it one of the largest bankruptcies in U.S. history.
How Do States Protect Policyholders?
When an insurance company is in financial trouble, the state’s guarantee system steps in to help. Every state, including the District of Columbia and Puerto Rico, has insurance guarantee associations. These associations provide coverage for policyholders if an insurance company becomes insolvent.
Most states have two types of associations: the life and health guarantee association, and the property and casualty guarantee association. Any insurer licensed to sell insurance in a state must be a member of the respective guaranty association and contribute to a guaranty fund that protects policyholders.
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If an insurance company becomes financially unstable, the state insurance commissioner can take over the company through a process called receivership. The commissioner will first attempt to rehabilitate the company. If that fails, the company will be declared insolvent, and its assets will be sold to pay off policyholder claims.
What Happens If Your Insurance Company Fails?
If an insurance company is declared insolvent, the state guarantee association and guarantee fund will step in. The association will either transfer the policies to another insurance company or continue to provide coverage to policyholders. It’s crucial for policyholders to keep paying premiums if the state takes over their insurer. This ensures that their coverage remains intact.
In cases where an insurance company does not have enough funds to pay claims, the guaranty association will use the company’s assets and guaranty funds to cover the claims. However, there are limits on the amount that states will pay. These limits vary depending on the type of insurance policy.
How to Avoid Insurers That Could Go Bankrupt
To avoid relying on a state’s guaranty association, it’s essential to check the financial soundness of insurance companies before doing business with them. Independent rating agencies assess the financial strength of insurance companies using their own scales and rating standards.
The five major rating agencies are A.M. Best, Fitch, Kroll Bond Rating Agency, Moody’s, and Standard & Poor. These agencies give ratings ranging from the highest (indicating a strong financial position) to the lowest (indicating a weak ability to meet financial commitments).
It’s advisable to check ratings from multiple agencies, as they may vary. Although you may need to register on these agencies’ websites to view ratings, many insurers also advertise their ratings on their own websites.
When Should You Consider Changing Insurance Companies?
If your insurance company’s rating falls in the middle of the agency scales, there’s no need to panic. However, if the ratings are low, you should consider switching companies, depending on the type of policy you need to replace.
Switching to another auto or home insurance company is relatively quick and easy. Make sure to continue paying premiums until you have a new policy in place to avoid a gap in coverage. Once the new policy takes effect, you can cancel the old one and potentially get a refund for unused coverage.
Switching life insurance companies can be more complicated. Dropping a policy might result in higher premiums for a new one due to age and any health conditions developed since the previous policy was taken out. If you want to get rid of a permanent life insurance policy, you may be able to receive the cash value, minus any surrender charges.
To make informed decisions about life insurance policies, consult a trusted financial advisor or life insurance agent. Remember not to cancel your current policy until you have a new one to ensure that you remain covered at all times.