What would happen if your insurance company became insolvent, and wasn't able to pay its obligations to you? As the global financial crisis began to unfold, I started asking that question in relation to my own insurance coverage. Two insurance policies were of particular concern: a professional liability policy issued by a subsidiary of American International Group (AIG) and a cash-value life insurance policy issued by Phoenix Life Insurance (PNX).
AIG, of course, is a poster child for the global financial collapse. Beginning a decade or so ago, AIG underwrote billions of dollars of credit default swap contracts and other questionable obligations. You know the rest of the story: since late 2008, the U.S. government has pumped nearly US$200 billion into AIG to keep it solvent. Even so, it's stock is trading only slightly north of US$1/share, compared to nearly US$50 less than a year ago.
PNX isn't as prominent as AIG. However, its fall from financial grace has been nearly as spectacular. Its credit rating is now well into "junk" territory. Credit analysts say its ability to pay claims could be affected by continuing investment losses. In the last year, the share price fell from US$14 to US$0.20, although it's now rebounded to nearly US$2.
Nor are AIG and PNX alone: credit rating agencies have downgraded dozens of insurance companies in recent months.
To deal with these concerns, I've replaced the AIG policy with another one from a company with a much higher credit rating. In the case of PNX, I've borrowed most of the cash value of my policy and have applied to replace it as well. Unfortunately, I'm 20 years older than when I first purchased the policy, so my premiums will be much higher.
I've also reviewed the financial status of the companies with which I maintained health insurance and property & casualty insurance coverage. Fortunately, both are still rated "excellent" with a stable ratings outlook.
However, it's no time for complacency. That's particularly true if you own an annuity policy from an insurance policy with a high guaranteed payout. Regardless of global financial conditions, the insurance company must continue to pay whatever amount is guaranteed.
I don't own any domestic annuities, but I have a friend who owns one with a 6.5% annual guaranteed payout. Returns this high aren't easy to come by these days. Stocks have lost nearly 50% of their value, and government bond yields are at all-time lows. How will this company—whose debt is now rated "junk" by credit rating agencies—continue to pay my friend his 6.5% guaranteed payout. That's anyone's guess, but I'm glad I'm not in his shoes.
You might think the equivalent of a Federal Deposit Insurance Corporation guarantee for insurance companies exists, but it doesn't. One small consolation is that some of your insurance policy may be guaranteed by the state in which you live. These guarantees vary from state to state. In most states, the guarantees are for US$300,000 in death benefits, US$100,000 in cash values from life insurance policies, US$100,000 in cash withdrawals from annuities. There's generally a limit of US$300,000 total per person.
But here's the rub: no state actually has these guaranteed sums readily available. The money is supposed to come from the insurance companies themselves. In other words, insurance companies basically guarantee themselves. If one company goes under, others are supposed to step in and honor its obligations. If the economy is weak, it's possible that one failure could lead to others, like a chain of dominos.
Of course, the government could always step in with cash infusions to prevent this result. But the cost of bailing out the U.S. financial system is already approaching US$15 trillion. If the economy continues to deteriorate, how much more money can you count on Congress and the Fed to make available if insurance companies start going belly up in droves?
Fortunately, there are some steps you can take to protect yourself. In my next blog entry, I'll present some practical suggestions to evaluate the health of the companies you rely upon for insurance—and suggest some alternatives to consider if they don't pass financial muster.
Copyright © 2009 by Mark Nestmann
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