How Safe is Your Insurance Policy?

Published on 09/18/2008 via San Francisco Chronicle

The federal takeover of insurance giant AIG has consumers wondering: How safe is my insurance policy?

If you have an AIG policy, it's probably safe. Although the parent company needed an $85 billion loan from the government to stay afloat, its 71 state-regulated U.S. insurance subsidiaries have always been well capitalized and were in no danger of not being able to pay their claims, according to the National Association of Insurance Commissioners.

The company got in trouble mainly by buying and guaranteeing mortgages and mortgage securities in other subsidiaries.

The company plans to repay the government loan by selling assets, which means your AIG policy could be sold to another company. AIG sells virtually every type of insurance, including auto, home, life and health under names such as American General, 21st Century and the Variable Annuity Life Insurance Co. (known as Valic).

What about other companies? It's very hard to tell whether other major insurance companies have similar exposure to mortgage debt and could be in trouble. To date, no other major insurers have emerged in the cavalcade of troubled financial firms caught up in the ongoing global credit crisis.

But it's good to know what happens when insurers go under.

If any regulated insurer could not pay its claims, the regulator in the company's home state - usually the state insurance commissioner - would start a process known as rehabilitation. If rehab fails, the company is liquidated and claims would be paid, up to a certain limit, by a guaranty agency in each policyholder's state. This money comes from companies still doing business in each state.

The limits vary somewhat by state, but in California they are $500,000 for property/casualty insurance, $200,000 for health policies, $250,000 in life insurance death benefits, $100,000 in cash surrender value on life insurance and $100,000 on the present value of annuity benefits. There is no limit on workers' comp.

If a property/casualty company fails, its policies are usually canceled and the customer can go out and get a new one from another company. The guaranty covers claims that have already arisen but have not been paid.

In the case of life or annuity policies, state regulators usually try to transfer in-force policies to a new company. They also transfer the failed company's assets and enough money from the guaranty fund to make sure the new company can pay the failed company's claims, at least up to the guaranty-agency limits.

"Normally, there are enough assets in the failed company that the new company will take it over with the same benefits and the same premium," says Pete Gallanis, director of the National Organization of Life and Health Insurance Guaranty Associations.

For AIG customers, its subsidiaries are neither in rehab nor liquidation. Some will probably be sold to other companies, which will take over the policies. The new companies can't change policies' terms. However, they can raise premiums or fees or make other changes to the extent allowed in the original contract. Customers can stay with the new companies or cancel their policies.

In the case of home, auto and term life insurance, it's fairly easy to switch companies, although people who had a level-term policy might pay higher premiums if they are older or in worse health than when they took it out.

Replacing a whole or universal life policy is harder. They are very complicated and consumers might pay surrender charges when they cancel a policy and hefty sales commissions, which are often hidden, when they buy a new one. Their costs also might go up if they are older or sicker.

It won't be long before agents, who make commissions on every sale, start urging AIG customers to switch policies.

"You're going to have agents who will take advantage of the situation," says Peter Katt, a fee-only life insurance adviser.

In the past, when a company has failed, been recapitalized or sold, pricing has gotten worse for consumers, he says. But he's not sure if that will happen with AIG.

Robert Hunter, director of insurance with the Consumer Federation of America, says, "I don't think AIG is a good company for consumers. Maybe if they get sold, policyholders will be better off."

Scott Witt, a fee-only insurance adviser, says he would encourage most AIG customers "to wait and see. If you take action now, you are incurring a significant and certain loss in most situations."

Witt is not worried about AIG's claims-paying ability at this time. "You don't lose anything by waiting a few months for the dust to settle," he says.

Witt says all consumers should check the health of their insurance company. If it is low-rated, consider switching. Companies such as A.M. Best rate insurance companies. You can also check them out at www.naic.org (click on Consumer Information Source), although it's tricky because insurers go by so many different names.

But "you can't conclude that just because a company is highly rated it's OK," Witt warns.

"The usual diversification logic that investors use for their portfolios should also be applied to insurance. If you have a monster death benefit, a multimillion-dollar policy, it would be prudent to have that coverage across several companies" rather than just one, he says.