Let the Guaranty Fund Genie Out of the Bottle

If you buy a certificate of deposit or open a checking or savings account at a bank, you are told that your deposit is backed by the U.S. government through the Federal Deposit Insurance Corporation (FDIC).

If you open an account with a broker-dealer, you are told it belongs to the Securities Investor Protection Corporation (SIPC).

If you buy an annuity or life insurance product, however, typically you are told nothing about any financial backup beyond the financial strength of the issuing life insurer.

Wait, it gets more confusing for the consumer.

If they buy the annuity, when they receive the physical annuity contract, they may find a technically worded disclosure about something called a guaranty association or guaranty fund. In many states, this is likely the first time that the consumer has heard about such an organization.

Why wasn't the consumer told about the existence of the fund and what it covers as part of the buying process?

For reasons considered important to the insurance regulators and many in the insurance industry, state laws and regulations have imprisoned the guaranty fund in a bottle and only let it out once a consumer buys the product.

Why are guaranty funds treated in this manner?

Guaranty Fund Background

Guaranty funds are one of the best kept secrets in the life and annuity insurance industry.

Unfortunately, guaranty fund coverage is poorly explained and poorly understood, and current public policy casts a shadow instead of sunshine on this valuable consumer protection.

In an increasingly fluid marketplace, the insurance industry operates at a competitive disadvantage compared to banks and securities firms, which as noted above are not prohibited from mentioning the existence of FDIC and SIPC protections during the sales process.

Guaranty funds are nonprofit legal entities created under state laws to provide coverage if the issuing life insurer becomes impaired or insolvent and is unable to pay its policy benefits.

The basic life insurance and annuity coverages, which vary by state, are $300,000 in life insurance death benefits ($100,000 in net cash surrender or withdrawal values), $300,000 for disability income insurance or long-term care insurance, and $250,000 in the present value of annuity benefits.

Guaranty funds receive their financial support from assessments against all life insurers writing business in their state.

In these times of high inflation, there is no formal mechanism in the state laws for indexing these coverage amounts for inflation or otherwise adjusting the limits.

Instead, the National Association of Insurance Commissioners (NAIC) sporadically revisits the issue of coverage limits as part of the model law revision process.

It takes years, however, for changes to work their way through the state-by-state approval process, and to be formalized and implemented.

Also, despite notable progress in recent years, coverage limits and other benefits are not uniform among the states.

Prohibition Against Pre-Sale Discussion of Guaranty Funds

Almost every state prohibits insurers and producers from using even the existence of state guaranty funds as a sales inducement.

This position is based on concern that irresponsible industry parties will sell flimsy products by hyping the guaranty funds, relying on solvent insurers to clean up the mess by ponying up assessments during the insolvency process.

Others maintain that guaranty fund coverages and limitations are too complex to explain to the typical insurance consumer.

In any case, because even mentioning the existence of guaranty funds could be considered a sales inducement, the practical effect of these rules is to stifle any discussion of what happens in the rare case when an insurer fails.

More than half of the states mandate the delivery of a summary document about coverage, but this document is more of a disclaimer than a description, and in many states cannot be delivered until the policy or contract is issued.

Some states, such as Minnesota, have tried to lead the way with a provision allowing producers to "explain verbally" guaranty fund coverage at any time during the application process, but other states have not followed this lead.

How Should the Industry Improve Disclosure to Consumers?

It is time to let the guaranty fund genie out of the bottle.

The existing laws and regulation need to be reconsidered and revised with consumer understanding a higher priority.

Today, as we have noted, insurers and producers are effectively prohibited from even mentioning guaranty funds during the application process.

How, for example, should producers respond when a prospect inquiries about available protections? Doesn't the inability to provide this information create tension with evolving standards of best interest and fiduciary responsibilities, both of which have disclosure components? Is this lack of information a disservice to the consumer?

In our view, state laws and regulations should not prevent producers from providing accurate information about the existence of guaranty funds and the basics of coverage.

Insurance departments could help by confirming that a simple statement about the existence of guaranty funds, or responding to a consumer inquiry, does not in itself constitute an illegal inducement.

States should also uniformly require delivery of a standardized disclosure document before the policy or contract is delivered in order for consumers to understand their protection as they make purchase decisions.

Not after.

Harry N. Stout has been the president of Fidelity & Guaranty Life, deputy chief executive of Old Mutual Financial Network and managing director of Insurance Insight Group. He is host of the "FinancialVerse" podcast and author of The FinancialVerse personal finance books and of Today's Annuities — A Tool to Create Protected Lifetime Income.

Bruce H. Saul is the principal of Saul Consulting Services, a consulting practice focused on financial services regulation. His experience includes partnership in a business law firm, chief counsel roles at leading life and property-casualty insurance companies, and service as a senior analyst at the Federal Insurance Office.