When to Bail on Your Insurer

Some companies are in financial distress, but most policyholders should stay put.

By Kimberly Lankford, Contributing Editor

From Kiplinger's Personal Finance magazine, June 2009

As if the past nine months haven't been hairy enough for your finances, now your insurance company may be making the headlines. If your insurer is struggling, should you stay or should you bail?

American International Group policyholders have been asking that question since last fall, when AIG got an infusion of funds from the U.S. government. Customers with insurance or annuities from Hartford and Genworth started to worry when those companies' share prices plummeted a few months ago.

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Meanwhile, Penn Treaty's long-term-care insurance business has been taken over by state regulators, and Conseco's has been placed in a separate trust because of its financial problems.

Whether you should ditch your insurer depends on the kind of insurance or annuity you have, how bad the company's financial troubles really are, and what you might give up by switching. In some cases, a failing insurer could tie up your money for months. In the worst case, your claim might not get paid. However, it could cost you a lot more to buy a new policy.

And if someone tries to rush you into making a change, consider the source: "I think agents have an incentive to encourage people to overreact," says Glenn Daily, an independent insurance consultant in New York City. He advises caution when agents try to persuade you to change companies because they get a commission for selling a new policy.

There's a big difference between an insurer's tumbling stock price and its ability to pay claims. Insurance companies are subject to special reserve requirements that state insurance regulators impose to make sure they can pay up. AIG's insurance subsidiaries, for example, are separate from the troubled holding company and still meet regulators' reserve requirements. "The insurance aspects of AIG are sound financially, and the products it's selling are sound," says Thomas E. Hampton, commissioner for the Washington, D.C., Department of Insurance, Securities and Banking.

Although many insurers have been downgraded by the ratings agencies, they're still in good shape (see the box at the bottom of the page). But even when an insurer's ratings are cause for concern, finding a replacement policy may be too expensive -- or even impossible. Stay or go? Here's what's at stake.

Life insurance. People with term policies have the least to worry about. "If you have a policy with no cash value, then your risk is substantially reduced," says Martin Weiss, president of Weiss Research Inc. and founder of a ratings agency known for its tough analysis (now part of TheStreet.com). Even if the insurer becomes insolvent, the state guaranty association will cover up to $300,000 in death benefits (or $500,000 in several states; see www.nolhga.com for links to your state's association). Death benefits historically have been paid promptly and in full.

KIP TIP

How to Read the Ratings Agencies that rate insurers look specifically at a company's (or a subsidiary's) ability to pay claims. And even though many insurers have been downgraded, they're still in good shape. "For the most part, we're seeing some of the higher-rated companies get downgraded to ratings that are still relatively high -- such as A+ to A or maybe A to A-," says Andrew Edelsberg, a vice-president in the life and health division of A.M. Best. The insurance subsidiaries of American International Group are currently rated A with negative implications, which means there could be additional downgrades. The lead companies for Genworth and Hartford also have A ratings. (Go to A.M. Best for more financial-strength ratings.) TheStreet.com, which has the toughest ratings scale, still puts Genworth, Hartford and AIG's life-insurance subsidiaries in the B and C range (click on the site's "Portfolio & Tools" tab to look up insurers' ratings). To Martin Weiss, of Weiss Research, the big red flag comes when a company's rating by TheStreet.com falls to D+ or below. "That's when the scale is generally tipping in the direction of getting out," he says. However, even if your company's ratings are lowered, it still might not be worthwhile to switch. Conseco is rated D+ and Penn Treaty gets an F from TheStreet.com. But it may be too expensive -- unrealistic, even -- to find a replacement policy.

If you still want to switch, you may have to pay higher premiums because you're older and may not be as healthy. If you're still in good health, however, and you bought the policy just a few years ago, you could find a decent deal on a replacement policy.

People with cash-value policies -- which have both an insurance and a savings component -- have a lot more at stake. The guaranty association would cover death benefits for these policies, too, plus $100,000 or more in cash value. But that cash value could be virtually inaccessible for six months or more if the insurer becomes insolvent. This is an issue for universal- and whole-life policies but not for variable-life policies (the money for them is held in mutual fund-like subaccounts and kept in a separate trust).

If you decide to cash out now, you could be hit with a surrender charge -- often up to 7% of the cash value in the early years of the policy. And you could owe taxes on any gains in the policy.

One alternative, says Daily, is to withdraw a lot of the cash value as a policy loan, which would avoid a tax bill while keeping the policy in force. In that case, the death benefit would be reduced by the amount of any outstanding loan.

Annuities. With a variable deferred annuity, the money invested in subaccounts is held in a separate trust and isn't affected by an insurer's financial situation. But if you have a variable annuity with guaranteed minimum income benefits or withdrawal benefits, that guarantee could be at risk if the insurer goes under. In addition, fixed annuities and equity-index annuities could be at risk because they are covered by the insurer's general account.

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