Problem with a bad bank? The FDIC has your back!
Had a brokerage account with Bernie Madoff? SIPC has you covered!

Your life insurance company goes bankrupt. Uh oh … now what?!

In spite of the federal takeover of AIG in September 2008, most people are surprised by the fact that the role of consumer protection against insurance company failures actually falls into the hands of state governments. State insurance regulators are responsible for monitoring the financial health of the insurance companies that are licensed to do business in their respective states. After regulators step in and everything blows up, it's the job of the state's guarantee fund to step in and protect the policyholders.

SEE: Financial Regulators: Who They Are And What They Do

Insurance Company Failure 101
When an insurance company fails and goes into liquidation, the state's insurance guarantee fund will kick in to protect the state's policyholders. If possible, the guarantee fund will try to transfer policies to other stable insurance companies; if that fails, the policy will continue to be administered by the central guarantee fund. When a state guarantee fund takes over an insurance or annuity policy, it will be subject to the coverage limitations set by each state.

In Florida for example, the limits for life insurance and annuity benefits are as follows:

Life Insurance

  • Death Benefit: $300,000 per insured life
  • Cash Surrender: $100,000 per insured life


  • Cash Surrender: $250,000 for deferred annuity per contract owner
  • Annuity in Benefit: $300,000 per contract owner

When it comes to life insurance, determining whether you have coverage and how much coverage is provided by your state is pretty straightforward. On the other hand, if you have a variable annuity, you will need to review your annuity contract and read the fine print set forth by your state to know if you are protected. In the case of Florida, a variable annuity policy isn't covered unless some aspect of the policy is guaranteed by the insurer. That means the insurance company is being paid to cover some kind of liability associated with the policy. No liability to the insurer means no help for you.

If you want to get information about your state's coverage, you can go to the National Organization of Life and Health Insurance Guarantee Associations website. Once you are on that website, you can click onto the link for your state's association. If you don't fully understand what's covered, call your state's association directly for help regarding your situation.

Maximizing Your Coverage
If you want to increase the size of your state guarantee fund security blanket, then you need to work within the limits of your state's law. In the majority of states, you can increase coverage by doing business with multiple insurers. In most states, the individual coverage limit is doled out on a per-company basis, so if you have two policies with two different companies, you will get double the coverage.

This technique of layering coverage through multiple insurance companies is similar to how people maximize their FDIC coverage by opening bank accounts through multiple banks. Given the large face amounts involved with life insurance and the underwriting hassles that would be involved in getting multiple life insurance policies through different insurance companies, it isn't practical in the real world and it could end up costing you more money for the same amount of coverage.

On the flipside, doing business with multiple annuity companies to increase your state coverage limits can be a useful strategy. While it's not practical for life insurance, most states will give your spouse a duplicate level of coverage if he or she owns an annuity. For example, if you are looking to invest $200,000 into an annuity and your state's guarantee is $100,000 per individual, both you and your spouse could invest with the same company to get the $200,000 of cash-value coverage. Guarantees on variable annuities during the 2008-2009 market downturn have been a major source of financial pain for most insurance companies that deal in the variable annuity market, and it's no coincidence that major insurers with large variable annuity portfolios sought money from the government (Hartford $3.4 billion and Lincoln $950 million). As a result, anything to help shore up your exposure to any one annuity company is probably a good idea.

SEE: The Cost Of Variable Annuity Guarantees

A Flaw in the System
The problem with the guarantee system in most states is that it lacks a prefunded reserve, meaning there is no rainy day fund set aside if one of them fails. Instead of having insurance companies pay into a fund every year like banks do for the FDIC to cushion the blow, the state guarantee funds divvy up the losses and pass them on to the other state licensed insurance companies in the same line of business according to their in-state market share. If you assess fees after a catastrophic failure of a major player, that is like asking Bank of America and Citgroup to cover Lehman's losses. If a large scale disaster were to occur, it is unclear whether the structure funding the current safety net system would be able to succeed without some type of taxpayer intervention.

While the state guarantee safety net has functioned successfully for many years, it does have potential flaws. In the end, people looking to purchase life insurance or an annuity should rely first on the insurer's ratings and their financial strength. However, spreading the risk and positioning yourself to be first in line if something goes wrong is always a good idea. This maxim holds especially true if you have a lot of money in variable annuities with guarantees on them.

SEE: Is Your Insurance Company Going Belly Up?

Related Articles
  1. Budgeting

    Preventing Medical Bankruptcy

    If you’re worried medical expenses could overwhelm you, there are some thing you can do to ease your concerns.
  2. Insurance

    Medicare 101: Do You Need All 4 Parts?

    Medicare is the United States’ health insurance program for those over age 65. Medicare has four parts, but you might not need them all.
  3. Insurance

    How Life Insurance Works in a Divorce

    Learn the implications of life insurance in a divorce situation, and identify the steps you should take to ensure your policies are sorted out post-divorce.
  4. Insurance

    What's The Difference Between Medicare And Medicaid?

    One program is for the poor; the other is for the elderly. Learn which is which.
  5. Entrepreneurship

    Identifying And Managing Business Risks

    There are a lot of risks associated with running a business, but there are an equal number of ways to prepare for and manage them.
  6. Insurance

    Cashing in Your Life Insurance Policy

    Tough times call for desperate measures, but is raiding your life insurance policy even worth considering?
  7. Insurance

    Avoiding The Modified Endowment Contract Trap

    To avoid MEC status, flexible-premium policies must cap the amount that can be paid into the policy over a period of seven years.
  8. Retirement

    Top Signs You Aren’t Ready to Retire Yet

    Think you are prepared to retire? These warning signs may indicate otherwise.
  9. Investing Basics

    Pairing Annuities and Target Date Funds: Top Tips

    The Treasury and the IRS have issued new guidance on pairing annuities with target date funds. Here's a look.
  10. Insurance

    Health Open Enrollment: Read This Before You Renew

    Time to renew your health plan – or shop for a new one for 2016. Here's how to get the most from marketplace open enrollment for the Affordable Care Act.
  1. Does a Flexible Spending Account (FSA) cover massages?

    Flexible Spending Accounts (FSAs) cover massages for certain medical treatments. These treatments must be approved and prescribed ... Read Full Answer >>
  2. Does a Flexible Spending Account (FSA) cover Lasik?

    Flexible spending accounts (FSA) can be used to pay for qualifying LASIK procedures. LASIK is not the only laser eye surgery ... Read Full Answer >>
  3. Are Flexible Spending Account (FSA) expenses tax deductible?

    Flexible Spending Account (FSA) expenses are not tax deductible. The U.S. Internal Revenue Service (IRS) states you cannot ... Read Full Answer >>
  4. Does a Flexible Spending Account (FSA) cover acupuncture?

    A Flexible Spending Account (FSA) covers acupuncture. The Internal Revenue Service (IRS) has defined acupuncture as a qualifying ... Read Full Answer >>
  5. Can I get dental insurance with Medicare?

    Medicare does not offer dental insurance that will cover dental care and medical supplies, such as cleanings, sealants, extractions, ... Read Full Answer >>
  6. Does money in a Flexible Spending Account (FSA) roll over?

    As of 2015, according to IRS regulations, the maximum amount of funds in a Flexible Spending Account (FSA) that can be carried ... Read Full Answer >>

You May Also Like

Trading Center