When something new and out of the ordinary is introduced, there are usually one of two reactions. It is either accepted or hated, yet some of the same questions come from both sides. Asking about the safety and security of a life insurance company is a very important question to examine and it’s one that often gets overlooked.
Why Life Insurance Companies are Different than Banks
The life insurance sector is entirely different from the banking system. Life insurance companies are obligated to fulfill their promises as written in their contracts, whether it is now or 50 years from now. Much like banks and the securities industry (i.e. stocks, mutual funds, etc.), life insurance companies are among the most heavily regulated sectors. However, unlike banks and the securities industry, who are regulated at the federal level, individual states oversee the insurance industry. Each state provides rules and requirements for how companies should manage their finances.
One of the primary duties of state insurance departments is protecting policyholders from risk at the company level. State regulations require that insurance companies have adequate reserves to pay their obligations. Auditors from each state regularly review the financial books of these companies. Insurance companies are also forbidden from investing their reserves in any speculative investments.
But what about AIG in 2008?
While it is true that AIG was at the center of the financial crisis in 2008, it’s crucial to understand what really happened, not the only part of the story you likely remember or are told about.
AIG was a lot more than just an insurance company. In fact, The National Association of Insurance Commissioners released a statement detailing exactly what AIG was1. “AIG is an international financial holding company with businesses ranging from aircraft leasing through investment services through insurance. The policy you hold is written by an insurance company that is an operating subsidiary of AIG. Those insurance companies are financially sound. State insurance regulators and federal regulators, in cooperation with the new management of AIG, are taking steps to make sure that insurance customers of AIG subsidiaries are protected.”
In layman’s terms, the insurance company that may have issued a life insurance contract or annuity contract was financially solvent and able to pay claims. The NAIC went on to state that “The trouble with AIG is largely with AIG’s non-insurance parent company, which is not regulated by the states and therefore not held to the same investment, accounting and capital adequacy standards as its state-regulated insurance subsidiaries. The insurance subsidiaries are solvent at this time and able to pay their obligations. State regulators make sure the assets of the companies are walled off, protected from the parent company’s troubles and available to pay covered claims. The state insurance departments closely monitor the financial condition of the insurance companies they regulate.”
The Financial Strength of Life Insurance Companies
Many life insurance companies were started over 100 years ago and are still going strong today. The combined assets of the five largest life insurance companies in the U.S. totals nearly two trillion dollars. Beyond sheer financial strength, there are several layers of protection in place that simply does not exist within the banking or securities sectors.
These layers include, but are not limited to:
- Each and every life insurance company is audited on a regular basis.
- Each State Insurance Commissioner’s Office can take over an insurance company in the event it gets into financial trouble.
- Each life insurance company not only is audited by regulators but also several independent ratings agencies.
- Each state has a state guaranty association. This is offered in every state to protect contract owners against the insolvency of an insurance company that has issued certain contracts, including annuities.
The Federal Deposit Insurance Corporation (FDIC) shows 528 banks on its Failed Bank List that have failed since the beginning of 20082. Compare that to the 17 insurance companies that the National Organization of Life & Health Insurance Guaranty Association (NOLHGA) lists as failed since 20083. It’s also important to point out that not all 17 on that list were life insurance companies.
While that may sound bad, the Deposit Insurance Fund (DIF) balance might shock you. As of the end of June 2018, the FDIC had $97.58 billion on hand. As of that same date, there were $7.3 trillion in DIF-insured deposits4. That works out to 1.33% of all insured deposits that the FDIC actually has on hand. Sure, they could always ask the federal government to print more money, but for all practical purposes, they are not in the business of paying off the bank’s debt to you.
The main difference between insurance companies and banks is that while banks do keep a small percentage of their deposits on hand as reserves, an insurance company is required to keep at least 100% of their premiums received as a minimum reserve. To further protect your money, insurance companies are not allowed to buy investments with borrowed money (leverage). Banks, on the other hand, can utilize customer deposits for loans. This is precisely what triggered the financial crisis in 2008 as it was discovered that many banks were stretched far too thin. It’s crucial to understand that if you hold a contract with an insurance company (life insurance, annuity, long-term care, etc.), you are relying on the financial strength and claims-paying ability of that company and there are many safeguards in place to ensure your financial safety and peace of mind.
Adam M. Sutton is the founder and president of Cornerstone Financial Partners. Adam is a financial planning professional, specializing in retirement income planning and wealth optimization strategies. He is a Series 66 licensed Investment Advisor Representative (IAR), as well as life, accident & health insurance licensed and is certified to address long-term care. Cornerstone Financial Partners is a privately held, independent financial planning firm.
Full Disclosure: This information does not constitute investment advice. This article is published and provided for informational purposes only. None of the information contained in the article constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. To the extent any of the information contained in this article may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Guarantees rely on the financial strength and claims-paying ability of the issuing insurance company. Cornerstone Financial Partners does not provide legal or tax advice, and the contents of this message are not intended to constitute such advice. Please seek an appropriately licensed individual for legal or tax advice in relation to your individual situation.
Sources: 1 http://www.pciaa.net/docs/default-source/default-document-library/NAIC_AIG_FAQ.pdf?sfvrsn=2