In recent months, life insurance companies have been the subject of a steady stream of scary headlines: "State insurance regulators take over North Carolina's London Pacific Life & Annuity," or "Conseco files for bankruptcy," or "Investors bail from Allmerica Financial." Indeed, the life insurers are having a rough time. Last year for instance, most of the major ratings agencies downgraded one-quarter or more of the companies they covered. Should you be worried? Depends on what company backs your policy and what kind of policy you have.
If you haven't given any thought to the financial condition of your insurer, you should do so now--and figure out if there are any steps you need to take. Canceling a policy can be costly, and, depending on your age and health, it may be not be easy to replace.
The danger, of course, is that if your company goes bust, you or your survivors may not be able to get immediate access to the money and may even lose a portion of it. In 1991, when several life insurance companies became insolvent, state regulators in many cases placed a moratorium on payouts, which lasted as long as three years. Some people received only about half of what their policies were worth.
What you should do depends on the kind of life insurance policy or annuity that you own. The most vulnerable are products tied to the company's balance sheet: permanent life insurance policies that earn interest and build a value over time, and fixed-rate annuities.
FINANCIAL CHECK-UP. The first thing to do is to check your insurer's financial health. Start with the company's ratings, which are published by one or more of five ratings agencies. The news isn't good there. Collectively, the insurers have just come off their worst year in a decade. A.M. Best--the largest insurance ratings service--downgraded 51 of the 1,074 companies it rates. Standard & Poor's (like BusinessWeek, a unit of The McGraw-Hill Companies) and Moody's Investors Service both dropped the ratings of 20 life insurers, or 25% of the companies they rate. And in one fell swoop, Fitch Ratings downgraded 35 life insurers, 42% of its clients, in September.
Why the bad marks? "Many of those criteria (for rating insurers) are under pressure," says Kevin Ahern, director of life insurance ratings at Standard & Poor's. Insurance companies have lost billions from their investments in bonds of such companies as WorldCom, Enron, and numerous others that stumbled or defaulted last year. At the same time, stock market losses have hurt the sales of popular products such as variable annuities. Interest rates are hurting the insurers, too, since many have to fund policies with interest-rate guarantees much higher than today's rates. The result: Less capital is set aside for payouts.
At the same time, majors such as Prudential (PRU), MetLife (MET), Principal Financial (PFG), and John Hancock (JHF) have gone public since the insurance industry's last bust. Their earnings have to be shared with shareholders as well as policyholders. "All these new usages of earnings reduce the cushion," says Robert Riegel, managing director at Moody's.
The ratings agencies have negative outlooks on almost a third of these companies, which means more downgrades are likely. If your company was in the top two tiers but has dropped to the middle category, you don't need to panic--but you should keep close tabs, or ask your insurance agent to do so. In fact, if that describes your situation and your agent or financial adviser is pushing you to change, you should ask why. "Find out the financial interest of the adviser before making a decision," says Joseph Belth, professor emeritus of insurance at Indiana University and editor of The Insurance Forum newsletter. A big sales commission could be awaiting him or her if you switch.
WHEN TO CHANGE. If your company has one of the "vulnerable" ratings, in most cases it pays to change. The exception: if you own a term life policy, one that accumulates no cash value and pays only a death benefit. During the Mutual Benefit Life bailout in 1991, death benefits for term life policyholders were paid. In some rare cases when the state takes over a company, the payments might be limited to $100,000. If you aren't comfortable with that, you can shop around. "But remember that you are a few years older, and if your medical and family (mortality) history isn't too good, you might have to pay more," says Wayne Gardner, a personal financial representative for Allstate Financial in Mobile, Ala. However, if you're fairly young, say 40 or less, and in good health, you might be able to extend the period of time covered and even get a lower premium, since companies are giving more attractive rates each year as people live longer.
With permanent life insurance, which comes in the form of whole, universal, variable, or variable universal life, it gets more complicated. These products are more expensive and build up cash values, which can offer more protection to your beneficiaries when you die. A popular use for them is as a supplement to pension income during retirement. However, they come with surrender charges in the first 10 to 20 years of the policy. So if you have a $1 million policy with a $3,000-a-year premium, there's little to reclaim if you switch companies in the first three to five years. That's because little cash value has been built and the surrender charges are high. Still, if you believe that the finances of your company are deteriorating fast, get out now--it would be better to lose a few thousand dollars and get a new policy for your heirs.
The fifth year is usually the inflection point at which cash values start building and the penalties diminish. If you're at the 20th year in the policy, you are likely near retirement. Your premiums might double if you switch companies. "As you age, the cost of insurance increases at 4% to 6% each year, and with additional medical problems it may not be as easy to find coverage," says Mark Wecker, a life insurance agent and vice-president at lifeinsurance.net.
The Internal Revenue Service will want its take, too. If you cancel a policy, you will be taxed on the gains in cash value at your current income-tax rate and, if you are younger than 59 1/2, you'll get hit with a 10% penalty.
If you don't trust your company and want to take out the money but not pay taxes, there's another option: Withdraw your premiums and take out a loan on the balance or the accrued interest, then place the money in a money-market account and monitor the company for six months to a year. If the financial situation improves, you can put it back. Of course, you have to pay a 2%-to-4% interest charge for the loan, but you don't have to pay taxes on it.
ANNUITY STRATEGIES. With a fixed annuity, surrender charges could apply for five to eight years. Getting into another annuity could mean earning less interest, and you will also enter a new surrender-charge period. Of course, if you've had the annuity for years and you have a low surrender charge, say 2%, it would be advisable to move. You can also take advantage of the penalty-free withdrawal provision most annuities have that allows you to take out 10% to 15% of your money without incurring surrender charges. With variable annuities, your funds are not in danger, since they're in separate mutual-fund-like accounts, not on the insurer's balance sheet. But even variable annuities have a death benefit--you're usually guaranteed to get whatever you put in--and that could be endangered if the company is in trouble.
The bottom line is that the federal government does not guarantee life insurance reserve funds, and state guarantee funds are too small to protect most of the assets. The best guarantor of an insurance policy is an attentive policyholder. By Pallavi Gogoi