When it comes to corporate executives, their compensation often includes stock options. This means that they may prioritize short-term valuation spikes to align with their stock options’ vesting. On the other hand, mutual insurance companies elect their executive teams through votes from policyholders. Since they don’t have stock or stock prices to distract them, these elected executives can focus on their responsibilities without any conflicts of interest, acting as responsible custodians of the mutual company’s balance sheet. You can learn more about the difference between mutual insurance companies and stocks here.
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National and State Life and Health Guarantee Associations
Similar to FDIC insurance for cash value life insurance, every state has a State Health and Life Guarantee Association that safeguards policyholders. All these associations are overseen by the National Organization of Life and Health Guarantee Association (NOHLGA). For more information, you can visit their website at www.nolhga.com. These associations serve as a last resort to assist policyholders if insurance companies become insolvent, much like how FDIC helps failing banks.
Reading: Which insurance companies are safe
Now, let’s discuss two reasons why these collateral associations will likely never come into play for you!
Size Matters (and So Do Qualifications): You can check out NOLHGA’s list of “impediments and insolvencies” here. You’ll notice that many of the listed companies are smaller, lesser-known, and riskier. They lack the backing or the law of large numbers to spread the risks they support. Additionally, some of these companies don’t even primarily offer life insurance but focus on riskier lines of insurance like health insurance, disability insurance, and long-term care insurance. In contrast, companies that primarily offer a stable block of insurance, such as permanent life insurance, tend to be much more secure and stable.
Involvement of Other Life Insurance Companies: If you check the companies listed under “impediments and insolvencies” on NOLHGA’s website, you’ll see that the guaranty association only played a temporary leadership role before brokering the insolvent insurance company’s business to more stable outside insurance companies. These companies happily acquire those policies and add them to their existing business block, thereby spreading the risk and ensuring long-term profitability.
Near Misses: Lessons from the Past
Let’s now delve into the two major “near misses” in recent history. Understanding these incidents should help you feel more comfortable investing significant sums of money in life insurance, based on real outcomes experienced by policyholders.
Near Miss #1 – California Executive Life Insurance Company
During the 1980s, a rapidly growing life insurance company called “Executive Life Insurance of California” gained immense popularity and market share. However, they made a critical mistake by overinvesting in “high-yield bonds” that ultimately turned into “junk bonds.” When the infamous S&L scandal unfolded, their balance sheet revealed heavy exposure to these bonds, which rapidly depreciated in value.
In 1991, the company was declared insolvent, meaning they lacked sufficient assets to meet their policyholder liabilities. However, a consortium of major life insurance companies stepped in and formed a holding company to back the promises made by the insolvent insurer. Aurora National Life Insurance Company, which still exists today, acquired and serviced some of the old policies. Here’s an interesting twist: due to higher prevailing interest rates at that time, the lowest guaranteed credit rate on those older policies is actually higher than the rates currently offered by most insurers. Thus, policyholders of these transferred warranties are earning higher fixed interest rates than those offered by major companies today.
The self-interest of the insurance companies played a role here. Acquiring a block of life insurance policies almost always generates long-term net profits for the acquiring company. Just like today’s hedge funds that buy “life settlements” from policyholders, insurance companies recognize the value in absorbing abandoned life insurance policies. Moreover, if these insurance companies hadn’t honored the promises made to policyholders, it would have undermined trust in the entire industry, causing significant damage.
Near Miss #2 – AIG
Almost everyone remembers this one. AIG served as the canary in the coal mine before the 2008 financial crash. While AIG’s life insurance division remained financially stable, the company as a whole faced difficulties due to overallocating itself in risky derivatives related to mortgage-backed securities.
So, who came to the rescue this time? It was the United States federal government. AIG was considered “too big to fail,” and the government stepped in to prevent a larger crisis. From 2008 to 2013, AIG was humorously referred to as “government-insured Americans” (A.I.G).
Now you might wonder, why didn’t the insurance companies band together like they did in the past? Well, AIG was such a massive global insurance giant that even the surplus of all the other insurance companies combined couldn’t cover its liabilities.
The government’s involvement in the insurance business stemmed from the same reason that Aurora rescued Executive Life: maintaining public trust in the concept of insurance. If people stop trusting insurance altogether, it could have dire consequences for society. Fortunately, insurance is ultimately a profitable business. AIG managed to recover within five years, and all the taxpayer money used to support AIG was returned to the US Treasury at a substantial profit once AIG regained its independence.
It’s crucial to note that the insurance business itself wasn’t the problem; it was the greed and misrepresentation of risky assets that caused the crisis. As an insurance agent, I had minimal exposure to AIG policies during that period. However, the older AIG whole life policies I serviced for another client remained rock-solid throughout the debacle, honoring their commitments and allowing customers to access their cash values.
Insurance Companies’ Importance to our Society
The bottom line is that if insurance companies were to fail, we would face much larger problems. Considering the past 160 years of history, which included depressions, recessions, inflation, wars, bank failures, and insurance company bailouts, the likelihood of being scammed out of any amount is incredibly remote. In fact, the rewards of taking these small risks can be significant:
- Better parking for your liquid cash
- Growth opportunities without market risk
- Multiple tax advantages
- Additional protection benefits, such as chronic/critical illness benefits and protection against lawsuits, in addition to the standard death benefit, depending on your policy terms and conditions.
Moreover, the fact that the US federal government has previously intervened to save a large insurance company sets a precedent. It indicates that they are unlikely to allow another company to go bankrupt if the insurance industry can’t manage itself effectively.
So, even if your liquid paper assets are parked with an insurance company, should the unthinkable occur and the government can’t step in, the value of various documents like insurance policies, savings account statements, share certificates, and real estate deeds would likely become negligible. In such a scenario, their primary value might be as kindling for a fire or even as makeshift hygiene products.
Remember, while there is technically a risk of your insurance company becoming insolvent, it is an extremely remote possibility. The insurance industry has a vested interest in maintaining overall solvency, and if any large company shows signs of deterioration, a collective of insurance companies will likely step in to quickly bail them out.
In conclusion, life insurance companies have a strong track record of stability and trustworthiness. The few instances of near misses in the past highlight how the insurance industry has self-regulated and come together to ensure the well-being of policyholders. So, if you’re considering using permanent life insurance as a savings or investment vehicle, you can rest assured that the risks are minimal and the potential rewards are significant.