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Your Insurance Company Lands in Rehab—Will Your Annuity Survive?

July 31, 2014

Your insurance company probably won’t go under; however, one might have said the same of AAA bonds in 2007. As many investors found out, sometimes the unlikely suddenly becomes your very own nightmare.

In 2012 the Financial Guaranty Insurance Company with $2.1 billion in assets failed. Also, in 2009 the Shenandoah Life Insurance Company with $1.7 billion in assets went under. In 2008, Standard Life Insurance Company of Indiana with $2 billion in assets collapsed as well. Although these failures weren’t all national front-page news like the AIG fiasco, anyone who owns an annuity or is thinking of buying one should take note.

In the last few years, about a dozen or so insurance companies have failed per year. These failures are mostly of smaller institutions, but sometimes bigger players get wrapped up as well. In these cases, a larger company typically absorbed the failing company. There is no guarantee, however, that that will happen in the future.

Insurance Companies Depend on State-Level Safety Nets

So what happens when your insurance company fails? Unlike a CD (which is insured by the FDIC) or your brokerage account (which is covered by the SIPC), annuities are not protected by any national program. They depend on state-level safety nets that typically cover $100,000 in annuity contracts. However, the limits and products covered differ from state to state. The National Organization of Life & Health Insurance Guaranty Associations (NOLHGA) provides an easy way to search the specifics for your state.

Regardless of your annuity type, check your state on the NOLHGA website to learn about its specific protections. And if you’re buying a variable annuity, pay especially close attention to your state laws; some states treat them differently.

Much like with FDIC insurance, you can split annuities across several different companies to maximize your total insurance coverage. If your state covers $100,000, you could protect $300,000 in annuities with three separate contracts for $100,000 each in three different companies.

But there’s a catch whereby state insurance programs vastly differ from FDIC insurance. When an insurance company is having a problem, the state puts it into rehabilitation to try to save the company from becoming insolvent. If the insurance company fails from there, the state government will take it over and liquidate its assets to fulfill its obligations to policyholders.

If more money is still needed after that, the state guaranty associations will attempt to amass more funds. How do they do this? Get ready for your jaw to drop! The other insurance companies in the state must cover the failed insurance company’s obligations in proportion to their business in the state.

That’s right. There’s really no FDIC or federal government waiting to print money to save the policyholders. Instead, you’re relying on other insurance companies for the bailout. In most cases, this shouldn’t be a huge problem.

If that doesn’t bother you already, here’s the really scary part. What happens when there’s a systemic shock to the insurance industry? For example, if a large company goes down and every other company is facing major losses as well, who is left to bailout your policy? Well, unfortunately, at that point, you’d have to hope and pray that the state or federal government comes to your aid. It might – and it might not.

Is this scenario likely? Probably not. Is it a possibility that you should seriously consider? Definitely.

High-Dollar Policyholders Are The Most At-Risk

Since 1983, state guaranty associations have protected 2.8 million policyholders and have contributed $5.3 billion to make sure that people get their benefits. However, high-dollar policyholders unaware of the state limitations have lost money. As a result, only around 90% of benefits have been fully recovered in the cases of company failures.

So far, everything has worked out all right for the most part, but that certainly doesn’t guarantee the same result in the future. Once you’re in an annuity contract, you’re in it for the long haul.

It’s hard to say what might happen in the next few decades, especially considering the US’s weakening fiscal situation. Don’t ignore the risks by putting a sizeable portion of your funds into annuities. At the very least, understand the limitations on coverage in your state.

Default isn’t the only serious risk to consider when purchasing an annuity. Even modest inflation can eat away at your annuity’s buying power and drastically cut into your lifestyle. Then there’s that pesky issue of liquidity. That said, the right annuity can have a place in a broader, highly-diversified retirement plan.

As financial educators, my team of analysts at Miller’s Money Forever and I want you to have the plain facts about annuities. That’s why we’ve just released a free special report, The TRUTH About Annuities. Download your complimentary copy today.