Sunday, February 1, 2009

The Risks of Life Insurance: Anxiety About Industry Complicates Consumer Choices

By David S. Hilzenrath and Nancy Trejos in the Washington Post:

It was a head-spinning week for anyone with a life insurance policy.

First, the industry lobby argued that some insurers are in such dire shape that they need immediate relief from requirements meant to keep them solvent. Then, when regulators denied the relief, the industry lobby was quick to issue a more soothing message: Don't worry, there is plenty of money to pay claims.

The mixed messages may have left you hoping you never need life insurance. But if you already have a policy or need to buy one to protect your spouse and children, how nervous should you be?

The hard truth is . . . it's hard to know.

But we do know this: there's a safety net that could protect you if your insurer fails. However, there are limits to the benefits it covers, and the safety net has distinct vulnerabilities of its own.

If this doesn't comfort you, beware that dumping your policy could have serious consequences. For example, depending on your age and health, you might have trouble replacing it, or you could end up paying much more for a new policy.

Going without insurance carries a separate set of risks.

When you buy life insurance, or an annuity guaranteed by an insurance company, you're counting on the insurer to keep its commitment years or decades from now. The insurance industry's wherewithal is closely tied to the health of the broader financial system. If the investments that insurance companies make with your premium dollars don't perform well enough over the long run -- or even the not-so-long run -- insurers could have trouble keeping their promises.

(Then again, if the financial markets don't recover, we'll all have much bigger problems to worry about, said one economist who works with insurance companies.)

The president of the American Council of Life Insurers, former Oklahoma governor Frank Keating, last week conveyed a sense of the uncertainty in a statement after state regulators handed his group a resounding defeat.

"To date, the industry's capital and reserve levels have weathered the financial turmoil currently gripping our nation and life insurers remain well-positioned to meet their obligations to policyholders," Keating said. "However, no one knows when this current market turmoil will end or what effect it ultimately will have on our economy."

So how is the health of the insurance industry?

Generally strong, and generally deteriorating, according to firms that specialize in rating companies' credit.

Like almost anyone else with an investment portfolio, life insurers are feeling the markets' pain. Some are particularly squeezed because they promised to deliver at least minimum annuity payments, yet those guarantees are no longer supported by the investments underlying them.

For insurers, and for the economy as a whole, the downward trend can be self-reinforcing. Shrinking assets can lead to credit downgrades, higher borrowing costs and the loss of business. To meet obligations, companies can be forced to sell assets at a loss. Meanwhile, to stay in compliance with regulatory standards, they can be forced to shore up their capital by raising money from investors on extremely unfavorable terms.

Insurers invest in assets as varied as corporate bonds and commercial mortgages, and if the recession leads to increasing defaults, they stand to lose.

Nonetheless, in rejecting the industry's plea for relief Thursday, members of the National Association of Insurance Commissioners said they saw no evidence of an emergency.

The ACLI says it is worried that a coming wave of headlines about insurers' year-end financial results could prompt consumers to drop policies or annuities in a panic. But if you're tempted to run for the exit, stop and study the question carefully.

Canceling your policy or annuity might trigger a surrender charge.

If the policy has a cash value, you can indeed ask your insurer for the cash. But that might cost you, too. "If the amount is greater than the amount you paid in premiums, you could then experience a taxable gain and have to pay income tax on the gain that was reported for that policy," said Brian H. Ashe, past chair of the Life and Health Insurance Foundation for Education, a group founded by insurance companies.

If you cash out an annuity, you could also end up with a 10 percent early withdrawal penalty if you're under age 59, said Cathy Weatherford, chief executive of NAVA Inc., the Association for Insured Retirement Solutions, a trade association. If you're receiving one of those guaranteed annuities that is causing insurers so much trouble, you might count yourself fortunate, because the annuity may be paying a return you'd be hard-pressed to duplicate elsewhere. Of course, you're only fortunate if the insurer can continue to deliver.

If you get rid of a life insurance policy but later decide you need one, you could have a hard time getting one or you could end up paying substantially more, because policies are issued based on age and health.

Instead of dumping your policy, you may have the option of selling it. "There are companies that purchase life insurance policies in the secondary market," said Evan H. Farr, an attorney in elder law at the Farr law firm in Fairfax. "You might be able to get more by selling the policy rather than taking the cash value."

Despite all the uncertainty, there are many people who simply need life insurance, particularly if they have spouses or children who depend on them. Others might decide they need an annuity from a life insurance company for their retirement.

If you're one of them, be sure to shop around, and not just for the best price. You want an affordable policy, but you also want to make sure you're getting it from a sound company.

There are ways you can look into an insurer's health. For one, you ca,n see how the ratings agencies -- A.M. Best, Standard & Poor's, Moody's, and Fitch, among them -- have sized them up. But keep in mind that even ratings agencies don't always get it right. Some have come under fire for giving investors a false sense of confidence in mortgage-related securities, which helped cause the financial meltdown.

Farr, the elder law attorney, recommends looking at an insurance company's Comdex score, which shows on a scale of 1 to 100 how the company's combined ratings compare to its peers'. Say a company is rated 90. That means the insurer rates better than 90 percent of similar companies. In fact, Farr said you should take your business only to a company rated at least a 90.

"The problem with the individual rating agencies is that they all have different nomenclature. Some use A, some use Triple A. Even the ones with the same nomenclature, it may not mean the exact same thing from one company to another," Farr said.

Iowa Insurance Commissioner Susan Voss also suggests turning to your state insurance regulator, which can provide information about complaints leveled against insurers. Also look at the National Association of Insurance Commissioners' web site (, she said.

You can also seek advice from a professional such as a certified financial planner or an insurance agent or broker. While sales professionals can help you sort this all out, remember: they earn commissions from selling policies, and they may receive a cut of your premiums as long as the policy is in force.

Shopping for a life insurance policy is not easy. Not only do you have to research the company, you must also weigh the different types of policies available. For example, should you get term or whole life insurance? Term insurance is cheaper but also temporary. And once it expires, you don't get any money back. Whole life insurance is permanent but more expensive. It's a form of forced savings. Your money essentially goes into a tax-deferred account.

Keep in mind that the safety net for life insurers is very different from the federally chartered FDIC, which backstops your bank accounts. The safety net for life insurers consists of other life insurers. If one company fails, its competitors are called upon to contribute money to pay its obligations, subject to certain limits. Thus, the failure of one insurer can become a burden for the rest, and a big enough failure or wave of failures could strain both the safety net and the industry as a whole.

The safety net is made up of industry alliances in each state called guaranty associations. Combined, as of 2007, the associations had the ability to raise $4.7 billion annually from member firms. The National Organization of Life & Health Insurance Guaranty Associations, which helps coordinate the system, couldn't give a total dollar value for the insurance commitments that the system is responsible for backing.

To give some perspective, at the end of 2007, not including annuity guarantees, life insurers had $19.5 trillion of coverage in place in the United States, according to the ACLI.

In testimony Tuesday, the chairman of the ACLI, Pat Baird, expressed skepticism about the system's ability to do its job smoothly.

The individual benefits guaranteed by the associations vary from state to state. The guarantees in most states are $300,000 in death benefits, $100,000 in cash withdrawals from life policies, $100,000 in cash withdrawals from annuities, and $300,000 total per person, according to NOLHGA.

One way to hedge your bets is to buy multiple smaller policies from different insurers rather than one big policy, said Alfie M. Tounjian, a certified financial planner and founder of the Advantage Retirement Group in Eldersburg, Md. Make sure each policy does not exceed the maximum amount that your state guaranty association covers.

The problem with such a strategy, however, is that over time, you might end up paying a larger premium.

That said, several industry advocates said consumers need not worry so much.

"This is a highly regulated, highly monitored industry with an outstanding track record of delivery," Weatherford said.

The ACLI's Keating noted in an interview Friday that some life insurers have been around longer than your grandparents.

That's little comfort to Michael Zabko, who recently renewed his 14-year term life insurance policy. The 55-year-old Mechanicsville resident, who manages the Red Cross office in Southern Maryland, had a policy with one insurer but wanted to see if he could get a cheaper one with a more highly rated company. In the end, he stayed put but said he's not convinced that his insurer, or any other company, will be solvent years from now.

"In today's economy, there's no guarantees. You just have to make the best decision and the best guess," he said.

1 comment:

The Life Insurer said...

This is very sound advice. Take a look at the various ratings and check
with your state's insurance commissioner. You can also get financial information from an insurance company that delineates the types of investments the company has.