Tommie Monez of Focus Wealth Management in Middleburg, Virginia, is keeping an eye on current conditions in the insurance industry on behalf of two of her firm's clients. Client A, 79 years old, has a long-term care policy purchased long ago from Penn Treaty, currently in voluntary rehabilitation with the state of Pennsylvania. Client B has an annuity, also purchased years ago, from Shenandoah Life, currently in receivership.
Monez has to watch the situation closely, because Client A would most likely no longer be able to afford to purchase LTC coverage from another company. Monez is also concerned about protecting Client B's investment in the annuity–an investment now potentially at risk. However, fortunately for both clients, at present neither needs the product each bought in prior years: Client A is still in good health, despite her age, and Client B is in solid financial shape and is not relying on the income from the annuity.
But what about your clients and their insurance choices, whether they were made before they came to you for planning, or are currently under review? Particularly as economic and market circumstances change, you'll have to keep close tabs on what they have and what they're thinking of getting. Whether you're an agent or a fee-only advisor making recommendations, you're going to be watching a whole new set of indicators these days. If worse comes to worst, do you know what to do to protect your clients from losses due to their insurance choices?
Rules and Regulations
Fortunately, insurance companies don't operate in a vacuum. Insurance is regulated in one way or another either by state regulators, legislation, or rulings by a court that may clarify, void, or otherwise modify existing regulations.
State insurance departments are, of course, the boots-on-the-ground regulators for day-to-day business, and their commissioners all belong to the National Association of Insurance Commissioners (NAIC). These departments have the power to undertake a number of actions when an insurance company's ability to deliver products is in doubt, as the Pennsylvania Department of Insurance has done with Penn Treaty.
In that case, after a petition by the insurance commissioner, the court approved the commissioner as rehabilitator and work began to help the company recover, if possible, while honoring its commitments to policyholders.
Beyond that, many insurers are required to belong to at least one of the state guaranty associations, which provide a kind of last-resort protection should a company fail. The company must belong to the association in the state in which it is licensed. These associations function somewhat like the FDIC in that they collect funds from healthy insurers to offset policy obligations of unhealthy ones. There are several differences in how they operate, and in fact they can levy special assessments if necessary. (More about them later.)
No insurer or agent, by the way, can use the existence of a state guaranty association as an inducement to sell or promote a policy.
That's What It's For
According to Claude Thau, of Target Insurance Services in Overland Park, Kansas, insurance companies are "basically conservatively financed," and the states require that they set aside reserves "intended to be redundantly excessive." Beyond that, he adds, states also require the companies to hold a certain amount of risk-based capital. The amount reflects not only the types of policies they sell–life insurance may be more profitable than annuities and require less capital on hand, for instance, if annuitants live, and collect, for a long time–but also the types of investments they make. If companies invest in stocks rather than bonds, he explains, the higher their risk-based capital balance must be.
Currently, says Thau, the news is full of companies' risk-based capital decreasing. That's exactly how it's supposed to work, he points out, since companies can still pay claims. Just because an insurance company's capital is decreasing "does not translate to the sky is falling," he says. He adds that insurance companies are relatively safe havens in today's economic climate compared to banks and brokerages. This is because people who cash out annuities must pay surrender charges, and much of the life insurance sold is term, with no cash surrender value; thus lapsed term policies involve no cost to the insurer. The only way to cash in a long-term care policy, he points out, is to use it, so the whole benefit isn't taken at once; instead it "dribbles out."
Even impaired assets held by these companies can recover, such as investments in bonds, which currently may be undervalued. So even if companies don't look healthy in the press, due to lower valuations on assets that they hold, if they don't have to divest themselves of those assets immediately, the values may recover with time and the companies will once again have strong-looking balance sheets.
If despite all that a carrier doesn't have 100% of its mandated risk-based capital, "the state will tell you you have to cease and desist writing new business," says Thau. Such companies still pay claims, and still have a surplus, just not enough of a surplus. When a company writes new business, Thau explains, there's a strain on that surplus because of underwriting expenses and commissions. So if a company is showing signs of trouble, it will be forbidden from writing new business to decrease that strain. That doesn't necessarily mean, however, that it can't pay its claims.
What Am I Looking For?
Thau says there's plenty advisors can do to keep apprised of the health of client coverage. If a company fails, find out whether the policy is reinsured, and if so, to what degree and whether the reinsurer is healthy. If there is reinsurance, another question to ask is whether the reinsurer's money "goes into general coffers, and therefore is liable to be claimed by anyone with a claim against the company, or whether it's to reimburse the company to make the payment."
Next he suggests looking at the state's guaranty association and its limits on policies (those limits differ, depending on the type of insurance, and they also vary from state to state). The National Organization of Life and Health Insurance Guaranty Associations (www.nolhga.com), has a complete listing of association Web sites for all 50 states, as well as the District of Columbia and Puerto Rico. It also offers a wealth of information on everything from what happens when a company is in trouble to what the guaranty associations do when it's time for them to get involved.
He also reminds advisors to look beyond the headlines about reserves and stock prices. Just because a company's reserve is falling, or its stock price is getting pummeled, it does not necessarily mean, again, that the company does not have enough reserves to pay its claims. It may simply mean that its profits are decreasing. "It's really important to differentiate the issue of profit from the ability to pay claims," he says, pointing out that companies are required to invest, even though currently some of those investments are in question. Under those circumstances, a company's profitability will fall because it cannot take reserves from its subsidiary companies, because the states have locked up those funds "for claim purposes." As mentioned previously, it must put up additional reserves, which affects its profitability but not its ability to pay claims. While an advisor should track any company about which she has concerns, she may not have to do anything else unless the situation worsens.
Another factor to consider is the variable annuity. Companies that sold VAs may also be carrying a lot of exposure because of clauses that promised to pay the maximum value of the policy as a death benefit. "So when those assets drop down all of a sudden, there's a lot of death benefit exposure," Thau explains. "Your assets were worth $500,000 and now they're only worth $300,000, and the insurance company only has $300,000 worth of assets but has to pay you $500,000." That's a lot of reserves, he adds, pointing out that insurers have to put up the money to cover that, and that's "killing their earnings – but if [annuitants] don't die right away, the assets will build back up and be released back into earnings."
Watch Out for the Fine Print
Thau reminds advisors that companies also have other options open to them that the advisor must keep in mind while assessing his clients' overall financial situation. These include changing the terms of contracts–raising rates for a class of insureds, for instance, which can be problematic for clients with long-term care policies; lowering the interest rate on annuities; or increasing monthly deductions on the amount at risk on universal life policies.
