Is Your Life Insurance Money Good? Part 3: The State Funds

Copyright © 2009, Greenwich Financial Management Inc., a registered investment advisor.

In our previous two articles, we discussed the credit quality of life insurance companies and life insurance policies.

The insurance industry is regulated by the different states, a situation that was legislatively confirmed by the McCarron-Ferguson Act (1945). The patchwork of state laws and regulation creates many inefficiencies and impracticalities in the insurance business. However, federalists might argue that state oversight is preferable to maintain some offset against the increasingly mighty federal government. There is talk now to allow individual insurance companies to opt into federal oversight, but it hasn’t yet been legislated, and this move would provoke a vigorous lobbying battle.

What actually happens to a US insurance company when it falls onto financial hard times and is found by the state insurance department to be insolvent? The state insurance department (or its commissioner) will seize control of the insolvent insurer, for the purpose of either rehabilitation or liquidation. If rehabilitation fails, or is impossible, and liquidation is ordered, then the state guarantee funds provide coverage within the limits defined by law. If the state guarantee fund has a shortfall in covering policies of an insolvent entity, it will assess a charge against in-state insurers. (A different scheme, and a parallel set of state funds, covers the event of insolvency of a property and casualty insurance company, such as one that protects your home or auto against damages.)

An authoritative source of information on the state guarantee funds, and information on the fund in your own state, can be found at the Website of The National Organization of Life and Health Insurance Guaranty Associations: HOLHGA. Its members include representatives of all fifty states. Among other purposes, this organization seeks to coordinate things when an insurance insolvency affects more than one state, as frequently happens.

There are limits to the state guarantee. In most states, the limits are $300,000 for life insurance death benefit, $100,000 for cash or surrender value, $100,000 in withdrawal and cash value for annuities (and $100,000 for health insurance policy benefits). In most states, but not all, there is a $300,000 overall limit to recovery. Connecticut [Code Section §38a-860(g)] has a more generous coverage scheme: up to $500,000 in life insurance death benefit, $500,000 in cash surrender value, $500,000 in present value of annuity benefits--with an aggregate benefit limit of $500,000 per individual. If you have multiple policies from the same carrier, such as life insurance and annuities, keep in mind the aggregate limit per individual.

An individual might seek to diversify coverage by insurers in order to keep each policy within state guarantee limits. However, with larger policy sizes, such as we investment advisors often see in estate planning, this is not practical. Moreover, in many states, the individual carrier limit is also the overall recovery limit. Then too, I would not neglect the credit quality of the insurance company out of reliance on state guarantee coverage.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.

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