People who buy immediate annuities or life insurance are looking for guarantees.
When you buy life insurance, you want to be certain that the death benefit will be paid when the insured dies. With an immediate annuity - often a good way to finance your retirement - you want a guarantee that the monthly payments will continue for life.
In either case, the "guarantee" is a contractual responsibility of the insurance company that issues the product. But an insolvent company might not have funds to meet those obligations in full.
Most insurance agents will tell you not to worry about the company's solvency. I agree. Don't worry about it. Just be aware that insolvency can occur and be prepared.
The life insurance industry remains one of America's most highly rated business sectors, says Peter Gallanis, president of the National Organization of Life and Health Insurance Guaranty Associations. But, as Gallanis points out, even highly rated companies can find themselves in unexpected situations.
Take Enron or Greenwich, Conn., manipulator Marty Frankel, who stole an estimated $200 million from insurance companies through a fraudulent enterprise resembling a Ponzi scheme.
You might find it reassuring that insurance regulation lessens the likelihood of insolvencies and that policyholder insurance comes into play when insolvency does occur.
Insurance companies are regulated by the states and are required to calculate reserves. These are estimates of all future benefits required to be paid on all types of policies, including annuities and life insurance, says Roger Harbin, executive vice president of Safeco Life & Investments.
Companies need to have assets equal to reserves plus a cushion, called "surplus."
If the surplus falls below minimum levels, state regulators require the company to correct the problem by means that can include arranging for the infusion of capital, reducing operating expenses and restricting the writing of new business.
If that fails, insurance regulators seize the company and the company is operated by a state-appointed receiver. For a list of insolvencies affecting policyholders in multiple states, go to the insurance association's Web site at www.nolhga.com and click on "insolvency corner."
If assets actually fall below reserves, a form of insurance comes into play to provide some protection to the policyholder.
Each state has a life and health insurance guaranty association that provides continuing coverage to policyholders of failed insurers. The associations pay for this coverage by assessing the healthy insurance companies in their states to make up for shortfalls of failed companies.
There are limits to coverage, however, just as there are on bank deposit insurance through the FDIC.
Next week, we'll talk about coverage limits and how they work.
Attorney Julie Jason is a money manager and retirement finance author who writes for The Advocate, a Tribune Publishing newspaper in Stamford, Conn. E-mail her at email@example.com.