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Between a privatized healthcare system, requirements for homeowners and drivers and ever-present worry about an uncertain financial future, the average American likely owns at least one insurance policy. Paying monthly premiums can be well worth the price if it means sleeping a little easier at night. But what happens to your insurance policy if your provider goes belly-up?
When it comes to bank accounts or investment funds, federal protections are in place to ensure customers of failed financial institutions aren’t left completely in the cold. Just like with banks, protections are in place if your insurer fails, but these are administered at the state level.
Though the financial crash in 2008 put the biggest spotlight on insurer insolvency in recent memory, the truth is that insurance companies can — and do — become insolvent even in more stable economic times. Mismanagement of investments, taking on too much risk or simply the inability to cover an influx of claims after a natural disaster — all are reasons an insurance provider could be forced to close up shop.
In some cases, a company in distress may enter voluntary run-off, meaning it stops writing new policies in order to limit liability while working to stabilize its finances. In other cases, regulatory bodies have to step in to protect insurance customers from undue hardship.
The National Association of Insurance Commissioners is a non-governmental entity comprised of insurance regulators from all 50 states, the Washington, D.C., Puerto Rico, Guam, American Samoa, the Northern Mariana Islands and the U.S. Virgin Islands.
Individual insurance agencies, led by an appointed or elected insurance commissioner, are responsible for keeping tabs on the financial health of licensed providers and activating an intervention process for those that start to flounder. If the business can’t stabilize during a state-administered rehabilitation process, it is declared insolvent.
In addition to providing a unified structure under which individual insurance departments can communicate and collaborate on cross-border insurance regulation, the NAIC also directs each participating state to form and maintain guaranty associations.
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While insurance companies are required to maintain a cash reserve to ensure their customers’ claims are paid even in the event of bankruptcy, guaranty associations provide an additional layer of protection that can be activated if these reserves fall short.
First, the association may seek to place policies with another provider. Otherwise, the association itself will cover unpaid claims using funds from the liquidation of the failed insurer’s assets and, if necessary, contributions from other insurers that cover the same type of risk. All insurers licensed to do business in that state are required to participate in the association, with limited exceptions.
In most cases, each state has two primary guaranty funds: one for life and health insurance policies and one for liability insurance — like auto, property and workers’ compensation policies. It’s important to note that, while many annuity benefits are covered, all annuities are not created equal and coverage may vary.
Unfortunately, customers with unpaid claims won’t be made whole overnight. An insurer in troubled waters is not declared insolvent immediately, since it’s in everyone’s best interest for them to stay in business and pay their claims. In general, guaranty funds don’t cover unpaid claims if an insurer is under state-administered financial supervision or rehabilitation.
Even once insolvency is declared, the process of liquidating the provider’s assets can take time. If contributions from other association members are needed to cover claims, full compensation could take even longer. Still, the National Conference of Guaranty Associations indicates that a period of 60-90 days is fairly standard.
Since the association may be able to place policies with a new provider, it’s important to continue paying monthly premiums, even if your insurance company is declared insolvent, to ensure your coverage continues uninterrupted. If the association has to step in to cover claims itself, it will only cover those that either preceded the declaration of insolvency or arise within 30 days of the Order of Liquidation.
Just like their member insurers, guaranty associations place limits on how much they will pay for different types of claims. While each state sets its own limits, the National Organization of Life and Health Insurance Guaranty Associations says that most have limits that meet or exceed the guidance set out by the NAIC:
When it comes to liability policies, most states cover workers’ compensation claims in full, with some exceptions. Auto, property and other liability policy claims are typically covered up to $300,000, though individual limits per claim go as low as $50,000 in the U.S. Virgin Islands or as high as $1 million in New York.
The 2008 crash made clear that there are no guarantees — pun intended — when it comes to financial companies, no matter how big they might be. While it may be reassuring to know that the state has your back if your insurance company goes under, it’s all the better to never deal with your guaranty association at all.
Luckily, there are several resources for researching and analyzing an insurance company’s financial health.
AM Best is a credit rating agency that specializes in insurance companies. With ratings from D (Poor) to A++ (Superior), the AM Best website and provider profiles can help you understand what makes an insurer more or less trustworthy.
You can also approach this research as you would other financial investments, like buying a stock. Pull up a company’s Standard & Poor’s or Moody’s rating to help you assess its financial health. Companies with ample assets and lower debt may be less likely to fail than their higher-risk counterparts.
Lastly, check out any confirmed complaints against the company on the NAIC website before you pull the trigger on a new policy.
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