What Happens When an Insurance Company Goes Out of Business?

Insurance premiums can be a sizable expense. We make monthly payments with the expectation of receiving substantial benefits later on in life. But what do you do if your insurance company goes out of business?

Getting a refund isn’t always going to be an option. The impact can be worse for life, long-term care, and disability policies. Here are some options if your insurance company declares bankruptcy.

Can an Insurance Company Go Out of Business?

In recent memory, one of the more notable insurance company failures was American International Group, or AIG, back in 2008. The 2016 bankruptcy of long-term care provider Penn Treaty American is another high-profile example. A report from the Society of Actuaries mentions that approximately ten insurers go out of business each year. Because most of these companies are smaller in size, it doesn’t make the national news headlines.

Insurance companies make money by charging premiums, investing a portion of their cash reserves, and keeping expenses (and claim payouts) to a minimum. However, no industry is risk-free. Poor accounting, a series of catastrophic events, and regular market events can impact the bottom line.

Here are several reasons why an insurer may become financially insolvent:

• Poor underwriting: Insurers offering too many high-risk policies that file claims may be unprofitable.
• Excessive benefit payouts: A higher-than-expected number of qualifying claims can deplete cash reserves.
• Low investment returns: Insurers may invest their cash into assets, including bonds, stocks, and mortgage-backed securities. Paltry returns can present cash flow problems.
• Competition: A crowded insurance market means lower premiums. While policyholders pay less, insurers have a slimmer profit margin and less room for error.

Insurance Company Ratings

Several rating agencies grade the financial health of insurance companies. Lower ratings indicate the company has a higher risk of bankruptcy. As you might expect, higher credit ratings can give the industry and policyholders more peace of mind. Here are the rating scales for the major insurance rating agencies. The systems rate the likelihood an insurer can meet their financial obligations.

AM Best

AM Best may be the most widely recognized rating agency for life insurance and other insurance companies.

• Superior: A+ to A++
• Excellent: A to A-
• Good: B+ to B++
• Fair: B to B-
• Marginal: C+ to C++
• Weak: C to C-
• Poor: D to –

Ideally, you will want an insurer with a Superior or Excellent rating. In addition to the above ratings, the AM Best non-financial designations can alert you about an insurance company with financial difficulty.

• E: Companies that are currently in court-ordered conservation or rehabilitation
• F: Companies currently in court-ordered liquidation after the finding of insolvency
• S: A suspension of the AM Best Financial Strength rating due to “sudden and significant events”
• NR: Companies without an active AM Best rating

*Source: AM Best rating guide

S&P Global Ratings

The S&P Global Ratings range from AAA to D, with AAA as the best rating. Investors are familiar with these ratings, but the reports can present the financial risks for policyholders too. Here are the S&P Global rating tiers and the likelihood of meeting their financial obligations:

• AAA: Extremely strong capacity
• AA: Very strong capacity
• A: Strong capacity but somewhat susceptible to economic conditions
• BBB: Adequate capacity and more risk to economic conditions
• BB: Somewhat vulnerable near-term obligations but ongoing challenges present an extra risk
• B: Can meet financial obligations but more risk to business, financial, and economic conditions
• CCC: Currently vulnerable and depends on favorable market conditions
• CC: Highly vulnerable with default almost certain
• C: Currently highly vulnerable to non-payment. Projected financial recovery is less likely than higher-rated firms.
• D: A payment default happens or after filing a bankruptcy petition

Source: S&P Global Ratings AAA-BBB has an investment-grade rating. You will want an insurer with an AAA or AA rating to have the lowest credit risk.

Moody’s

Moody’s provides long-term and short-term financial strength ratings for insurance companies. Long-term ratings are from Aaa to C:

• Aaa: Lowest level of credit risk
• Aa: High-quality companies with a very low credit risk
• A: Upper-medium company with very low credit risk
• Baa: Medium grade company with moderate credit risk
• Ba: Speculative with substantial credit risk
• B: Speculative with a high credit risk
• Caa: Speculative and poor standing with a very high credit risk
• Ca: Highly speculative and in (or near) default with some prospect of recovery
• C: Companies that are typically in default and the lowest prospect of recovery

These short-term ratings can also apply:

• P-1 (Prime-1): Superior ability to repay short-term obligations
• P-2 (Prime-2): Strong ability to repay
• P-3 (Prime-3): Acceptable ability to repay
• NP (Not Prime): No short-term rating applies

Source: Moody’s

Insurance Company Bankruptcy Process

There is a multi-step process that insurance companies follow if they declare bankruptcy. Your experience most likely won’t be like a pre-Great Depression bank failure when accountholders lost everything. At a glance, your state insurance commission will steer your insurance company through the bankruptcy proceedings.

Hopefully, the company can reverse course and exit bankruptcy. If not, reserve funds can cover unpaid claims, and another insurer may pick up your policy. However, even with these safeguards, you may still decide to abandon ship and switch insurers. Let’s take a closer look at each step of insurance bankruptcy.

Insurance Company Rehabilitation

The insurance industry is highly regulated at the state level. For example, the state insurance commissioner gets involved when an insurer files for bankruptcy or cannot pay its short-term obligations. The first step is the state insurance commission assuming receivership of the insurance company to help it exit bankruptcy or liquidate its portfolio.

A default or bankruptcy declaration doesn’t automatically cancel your coverage benefits. Continue making payments until the proceedings finalize or you find a replacement policy. Your state commissioner will also send additional correspondence on what you need to do and how to submit a claim.

Transferring Insurance Products

Once the state commission determines the insurance company cannot exit bankruptcy, they will attempt to transfer your policy to another insurer. There is no guarantee another company will assume your policy. If this happens, your existing policy cancels after a specific date and you will need to find a new policy. If the state orders liquidation, the insurance company can no longer issue new or renewal policies.

Insurance Company Draws on Its Cash Reserves

States require each insurance company to maintain a minimum cash reserve to pay claim benefits. If you need to file a claim, the state will have the insurance company exhaust these funds first.

Reinsurers

Insurance companies also have the backing of reinsurance companies. Reinsurers are essentially insurance for insurance companies. If your insurer cannot pay your claim, the reinsurer may step in to fulfill the financial obligations. Your policy terms and the insurance website may list the reinsurance partners. It’s also essential to verify the credit ratings of the reinsurance companies too.

State Guaranty Funds

After exhausting all private insurance pools, the state insurance commission taps its guaranty fund to pay claims. This feature is similar to FDIC Insurance for bank deposit accounts and SIPC Insurance for brokerage accounts. However, the state guaranty fund may only cover life insurance and health insurance benefits. Long-term care policies and annuities are also eligible.

Guaranteed Insurance Benefits

Maximum coverage amounts apply to eligible insurance products. You may not receive your full benefit if you have a qualifying claim. Many states follow the National Association of Insurance Commissioners (NAIC) Model Act benefit levels (listed below), which depend on the insurance product.

• Life insurance death benefits: $300,000
• Cash surrender value of life insurance: $100,000
• Annuity benefits: $250,000
• Major medical or basic hospital, medical, and surgical insurance: $500,000
• Long-term care insurance: $300,000
• Disability insurance: $300,000
• Other health insurance benefits: $100,000

Source: National Organization of Life and Health Guaranty Associations (NOHLGA)

What To Do If Your Insurance Company Goes Out of Business?

If your insurance company officially files for bankruptcy, here is what you should do:

Keep Paying the Premium

Continue making your monthly insurance premiums to maintain coverage. Your present insurer may exit receivership or another insurance company may obtain your policy depending on the circumstances.

Monitor Insurance Communications

You will receive correspondence by mail and possibly by email about what you need to do to maintain coverage and file claims. If your insurance company must liquidate, they will cancel your policy soon. The liquidation notice should list your policy expiration date and the deadline to file a claim.

Consider Switching Insurance Products

You may decide to switch insurance carriers if you don’t want to risk losing coverage. But, unfortunately, you will need to apply and qualify under your present circumstances to complete the underwriting for life and health-related policies. Depending on the age of your existing policy, you may be several years older or have a notable change in health.

These factors can increase the cost of your new policy with similar coverage amounts. In addition to comparing your premium price and coverage benefits, you should look at the financial strength ratings. You can check out our recommendations for these insurance products:

An insurance company going out of business will have a significant adverse effect on life insurance and long-term care products that you buy once and pay into for years expecting a benefit. For short-term products like auto, homeowners, and rental insurance, I recommend using an insurance comparison tool, like Insurify. Of course, it’s a good idea to compare rates on these policies each renewal, or at least once a year.

You may start comparing insurance credit ratings along with your price and coverage amounts. If the provider happens to non-renew your policy, you can also easily switch providers and get similar coverage at a competitive price.

Final Thoughts

Thankfully, several safety measures exist to protect your policy and coverage benefits if your insurance company goes out of business. But replacing your longer-term insurance solutions can be stressful as you must undergo the underwriting process using your current health situation. Using an insurer with the highest credit ratings will reduce the odds of liquidation and losing coverage.