Whenever you are shopping for an annuity you must consider the financial strength of the insurance company you purchase from.
After all, an annuity has contractual guarantees. These are guarantees to provide you certain benefits. And those guarantees are only as good as the company that backs up those guarantees.
It is possible for any company to go bankrupt. This includes an insurance company that provides annuities. So what happens when an annuity company goes bankrupt?
Let’s take a look.
What You Can Do BEFORE A Potential Annuity Company Bankruptcy
First of all, it is preferable to stick with an “A” rated company. But I would feel comfortable in certain circumstances going with an upper “B” rating.
And one of the most common rating scales for annuities is A.M. Best. On their website you can see their rating scale. Here it is: http://www.ambest.com/ratings/guide.pdf
If you are buying an annuity for a long term period, then it is very important to pick a strong insurance company.
What do I mean by “long term?”
Well, think of this way: All other things being equal, if I’m buying a single premium immediate annuity that will pay me an income for the rest of my life (and my life expectancy is another 30 years), I’m going to be much more concerned about partnering with a strong insurance company than I would be if I was just buying a 3-year multi-year guaranteed rate annuity.
Thirty years is a long time, and a lot more can happen over that period than is likely to happen over just a 3-year period.
You have to consider this before making a decision. Yet even still when the contract term is shorter, say only 3 years, it is still wise to go with a financially strong company.
Are Insurance Companies Very Risky?
First of all, insurance companies are generally financially more stable than banks. This is because they use less leverage than banks.
Also, many of the obligations that an insurance company has are typically not immediate. For example, the death benefit obligations on their balance sheet for life insurance policies they issued will not all be due at one time. It only comes due when individuals die. This takes place over time.
Also, obligations under many annuity payments are not due in a lump sum generally. They are spread out over the remaining lifetime of the individual receiving payments.
Contrast this with banks. If everyone goes down to the bank and pulls out their money, the bank can be hit immediately with a crisis.
These reasons contribute to reduced failure risk associated with insurance companies.
Who Insures the Insurance Companies?
But the question still arises, “Are there any additional protections in place if my annuity company goes bankrupt?”
Yes, there is.
Is it the FDIC that provides additional protection for annuities? No. The FDIC protects bank accounts.
Instead of the FDIC, insurance companies are backed up by a thing called “state guaranty associations.”
These associations help pay for claims if your annuity company goes bankrupt.
A couple of things to note first of all:
#1: Not all annuities are covered under the state guaranty associations. Annuities issued by “fraternals” are typically not covered. What’s a fraternal? It’s a society that offers insurance to its members. And its members may all share a common bond. Many times you can recognize fraternals typically by their names. It will often mention something about “woodmen” or maybe have something religious in the title.
Does this mean annuities issued by fraternals are inherently unsafe? Not necessarily. They can also be very financially strong. Check their AM Best rating just like you would any company before you do business with them.
#2: Any portion of an annuity contract that is not guaranteed by the insurance company will not be covered. This means if you have a variable annuity and experience losses in the underlying market investments, you are not protected from these losses. The insurance company never guarantees that you won’t have losses in the underlying investment sub-accounts. Therefore the guaranty association will not cover investment losses inside a variable annuity.
#3: You should never buy from a poorly rated insurance company just because there is a state guaranty association protection. Always consider the strength of the annuity company you are considering purchasing from. In fact, in most states it is illegal for an insurance agent to use the state guaranty protection as a “selling point” to get you to buy from a particular company.
Lesson: Always consider the strength of the company as part of your purchasing decision.
Protection Is Different In Every State
Each state guaranty association has different levels of protection. No state offers less than $100,000 in annuity protection. And some states, like New York, offer up to $500,000. You can check with your state to see the limits of protection by clicking here and choosing your state in the top box.
A quick check on this site shows that my home state of Tennessee provides $250,000 in annuity protection. Check out your own state to see what type of protection you have.
Just as the FDIC has limits ($250,000), so do the guaranty associations.
Any values above the guaranty association protection limit that you may have in your annuity can be submitted against the estate of the now defunct insurance company. When the failed insurer’s assets are liquidated you may receive some of the proceeds. I wouldn’t hold your breath though.
When The Annuity Company Goes Bankrupt
If an annuity company gets into financial trouble there are couple of ways the existing annuity contracts can be handled.
First, the company will go through a rehabilitation period. The insurance commissioner of that company’s state will initiate this. Every effort is made to help the company become financially sound again.
If rehabilitation does not work, the company will be liquidated.
When there are not enough funds in the liquidation process to meet the insurance company’s obligations the state guaranty association steps in to protect up to the limits I discussed above.
The state guaranty association raises the necessary funds from the financially sound insurers that operate in the state. Their share will be based on the amount of premium they collect in the state.
In this way the state guaranty association acts similar to a re-insurer. It allows other insurance companies to bear each other’s risk when one fails.
What You Can Do
The most important thing you can do to help avoid partnering with an annuity company that eventually goes bankrupt is to stick with financially strong insurers.
BEFORE you make an annuity purchase be sure to check out the A.M. Best Rating of the company you are considering.
Your goal is to never have to experience the protection that the state guaranty association provides. You want to be with a company that is strong and never fails.
It is easy to check the financial stability of an annuity company before purchasing an annuity from them. Many of the companies will put their A.M. Best rating on their brochures.
But if you’d like, you can go to their website by clicking here and searching for the company you are considering.
Or just do a Google search for “XYZ company A.M. Best Rating.”
It’s that easy.
Another thing you can do is purchase annuities from separate insurance companies instead of just buying one big one from a single company. This is another way of diversifying. You don’t put all your eggs in one insurance company’s basket.
You could even keep the size of your various annuities underneath the protection limit for the state that you live in.
And also keep in mind that your protection is usually based on the state you currently reside in. If you purchase an annuity while a resident of a state that has a high protection level, such as New York’s at $500,000, you will have a higher level of protection. But if you later move to a state with a lower protection level, such as $250,000, in most cases you will only have the $250,000 in coverage.
Conclusion – If My Annuity Company Goes Bankrupt
Hope that helps. It is wise to stick with stronger rated annuity companies. And the good news is the stronger rated companies provide comparable, oftentimes better, benefits than the weaker companies.
And a stronger rated company will give you more peace of mind for your retirement.