Unlike banks and securities firms that are regulated by the federal government, insurance companies are regulated by the states. Each state has established a guaranty association to handle life insurance insolvencies. The guaranty associations do provide a level of protection for policyholders, but the protection is limited and is not the same for all states.
The state guaranty associations are funded by each insurance company licensed to do business in that state, not by the taxpayers. However, since they are state administered, the guarantees provided by the associations are not uniform and vary from state to state. New Jersey’s limits are $500,000 for death benefit and $100,000 for cash value.
The existence of state guaranty associations does not mean that you cannot lose money if your insurance company becomes insolvent. There are still three potential ways a policyholder can suffer a financial loss if their company goes belly up.
First, the state guaranty associations only provide coverage up to the point of insolvency. Nothing post-insolvency is guaranteed, even though your company guaranteed it at the time you purchased the policy. Depending on how long the rehabilitation process takes, that could be significant.
For example, if you owned a policy that had $100,000 of cash value and $10,000 of death benefit at the time of insolvency and was projected to have $125,000 and $25,000 in 10 years, only the former amounts are covered under the state guaranty association.
Second, the time value of money when the company is in receivership is not considered. To prevent a “run on the bank”, receivers will often restrict access to the policy’s value for a certain period of time. That limited access has a cost that is not compensated by the state guaranty associations.
Third, because of the limits imposed by each of the state guaranty associations, a given policy may only receive partial coverage (or no coverage). For example, if you owned a policy in New Jersey with $1,000,000 death benefit and $200,000 cash value, your protection under New Jersey’s state association would be limited to $500,000 death benefit and $100,000 cash value.
Alternatively, if you own two policies with the same company, each with a face amount of $500,000 and a cash value of $100,000, your protection would be the same as the $1,000,000 policy. However, if those same two policies were with different companies, you would be covered for the full amount.
This highlights the need for due diligence instead of blindly relying on the state guaranty associations. In fact, New Jersey’s own website states “The guaranty association is not and should not be a substitute for your prudent selection of an insurance company that is well managed and financially stable.” This is particularly true when procuring a policy that develops cash value.
Please feel free to contact me with any questions regarding life insurance due diligence.