When Insurers Go Bankrupt, Who Gets Paid?

Dear Alpha Consumer,

With all of the upheaval in the financial sector, I'm worried my insurance company -- which provides my life insurance -- will go under. If that happens, will my family be left with anything?

I took your question to Sean McKenna of the National Organization of Life and Health Insurance Guaranty Associations, which represents the state associations that guarantee insurance policies in the event that an insurer becomes insolvent. He had mostly good news for you.

First, some background on how these guaranty associations work: Every insurance company is required, by law, to participate in (and pay into) its state's guaranty association to ensure its policyholders are protected. Anyone who takes out insurance is automatically protected. Many companies, of course, operate in multiple states, so if you want to know which state's association is protecting you, give your state insurance department a call. If an insurer goes bankrupt, the guaranty associations step in make sure the insurance contracts are honored, either by moving the policies to a different insurer or administering the policies themselves.

Here's where it gets a little wishy-washy. The guaranty associations don't necessarily back up 100 percent of the policies in question. The specifics vary by state, McKenna says, but in general, the associations guarantee up to $300,000 in life insurance death benefits, $100,000 in "cash surrender" or withdrawal value for life insurance, $100,000 in withdrawal and cash values for annuities, and $100,000 in health insurance policy benefits.

Many people take out policies that well exceed those limits. So what happens to someone with a $1 million life insurance policy who dies after his insurer becomes insolvent? McKenna says that while the guaranty association would likely only cover up to $300,000 (some states cover more), the rest of the claim would be made against the failed insurer. Policyholders are first in line to any remaining assets (which are usually quite significant), which means the $1 million policy holder's family could end up with his full payment, or at least a high percentage of it.

Just make sure you continue paying your insurance premiums, even if your insurer goes under. Otherwise, your coverage could be cancelled.