The human brain was wired to protect us from impending doom by falling into a state of fear and avoidance.
Even after you start grasping the indisputable power of building your own bank with life insurance, your brain may eventually meander to the worst case scenario even though you’re on the right track.
You may find yourself asking things like:
- “What if my insurance company goes bankrupt?”
- “What if my policy becomes worthless?”
- “Is there something like FDIC insurance to protect me?”
These are perfectly valid concerns, and a totally normal reaction before committing large dollar amounts to a financial product and company that’s new to you.
This article will discuss both the explicit and implicit protection mechanisms in place for permanent life insurance.
The Mutual Company Advantage
The insurance companies that we recommend happen to be some of the oldest, biggest, most conservative, and usually most solvent companies with the largest surplus ratios you can find among insurers. Most importantly, they are mutual companies owned by policyholders. There is no external pressure from stockholders or executives trying to maximize the stock’s short-term value by taking on additional risk with the company’s investment portfolio.
Therefore, these mutual companies are much less likely to partake in risky investment schemes to appease the short-term whims of stockholders and Wall Street’s quarterly evaluations.
Conversely, since the executives of stock companies are often compensated with gobs of stock options, it’s feasible that they may be jockeying for shorter-term spikes in valuations to coincide with the vesting of their options.
A mutual company’s executive team is appointed by votes from their policyholders. With no stock or stock price to distract from their duties, the elected executives of a mutual company can avoid these conflicts of interest while acting as stewards of the mutual company’s balance sheet.
National and State Life and Health Guaranty Associations
There actually is something similar to FDIC insurance for cash value life insurance. In every state there is something called a State Life and Health Guaranty Association protecting policyholders. They are all overseen by the National Organization of Life and Health Guaranty Association (NOLHGA). You can find more info at www.nolhga.com.
Collectively these associations are in place as a last resort to help the policyholders if insurance companies become insolvent similar to how FDIC does for failed banks.
Here are 2 reasons why these Guaranty Associations probably will never come into play for you!
- Size matters (and so do ratings): You can click here to view NOLHGA’s list of “impairments and insolvencies.” You’ll find that many of the companies listed are smaller, lesser-known, rinky-dink companies that didn’t have the backing nor the law of large numbers on their side to spread the risks they were backing. In fact, a lot of them weren’t even selling life insurance as their primary business. Companies focusing on riskier lines of insurance business such as health insurance, disability insurance, and long-term-care insurance tend to be much more volatile than companies where a large and stable block of permanent life insurance is their primary offering.
- Other Life Insurance Companies Often Step in: If you click on any of the companies NOLHGA has listed on “impairments and insolvencies,” you can clearly see that the Guaranty Association only played a temporary leadership role before brokering the insolvent insurance company’s block of business to other life insurance companies that are much more stable. Outside insurance companies are happy to step in a buy up these policies. Adding them to their existing block of business will spread their risk and produce long-term profits.
Let’s Now Discuss the 2 Major “Near Failures” of our Time:
The fact that these two major insurance companies failed should actually make you feel more comfortable parking large sums of money in life insurance; based on the actual outcomes that occurred for policyholders.
Near Failure #1 – Executive Life Insurance Company of California
During the 1980’s a younger but rapidly growing life insurance company called “Executive Life Insurance of California” captured a ton of market share, and became incredibly popular. Unfortunately, they invested too heavily in “High Yield Bonds” which soon became known as “Junk Bonds.” During the infamous S&L scandal, their balance sheet exposed that they were heavily allocated to these types of bonds that rapidly shriveled in value.
In 1991 the company was deemed insolvent, meaning they didn’t have enough assets to back the liabilities to policyholders.
You’re probably asking, “If they didn’t actually fail, then who bailed them out?”
Actually, it was a group of the other major life insurance companies. This group stepped in to form a holding company backing every single one of the promises made by the insolvent insurance company. “Aurora National Life Assurance Company” is still in existence today and still servicing some of these old policies.
Here’s the irony of this situation: since prevailing interest rates were much higher back then, the lowest guaranteed crediting rate on those old policies is actually higher than most of the non-guaranteed crediting rates offered today. So owners of these policies written by an insolvent insurance company are actually earning higher fixed interest rates than policies written by the top companies today since those original guarantees transferred over through insolvency.
The Self-Interest of Insurance Companies Actually Helped Society.
Why did that group of life insurance companies choose to step in and bail out Executive Life of California?
There are two reasons:
The first reason we already discussed is that a block of life insurance will almost always turn a net long-term profit for the acquiring company. It’s similar to how hedge funds today are paying out “life-settlements” to policyholders and absorbing abandoned life insurance policies.
But that is not the main reason why these other insurance companies went through the trouble of forming this entity to buy this big insolvent insurance company
Here is the primary reason: if other insurance companies didn’t step in and honor those promises to policyholders, the industry as a whole would start to unravel. Who would feel comfortable putting substantial sums of money with any insurance company if even one single policyholder got stiffed.
It’s hard enough today for the insurance industry to train and retain agents. Imagine if this kind of egg was on the face of the insurance industry in general. I probably would’ve become a mortgage broker instead.
Long story short is the industry itself has an ongoing vested interest in maintaining the overall solvency of the life insurance industry. Like they did in the past, a collective of insurance companies would most likely step in and quickly rescue any other large national company that showed the first hint of deterioration.
I believe you can count on the industry self-policing with a “no insurance company left behind” stance on insolvency.
Near Failure #2 – AIG
Most everyone remembers this one.
It was the canary in the coal mine before the financial meltdown of 2008. Similar to the junk bond debacle, AIG was over-allocated to risky derivative products involving mortgage-backed securities. American International Group was a huge international insurer collecting premiums from insureds all over the world for every single type of insurance coverage offered.
The life insurance division itself had nothing to do with the crisis that ensued. In fact, their life insurance division was and still is, one of the most financially stable components of that company.
Once it was exposed that the actual value of these complex financial products was virtually zilch, AIG was deemed insolvent because they had saturated their balance sheet with these investments hoping for excessive returns.
So, who bailed them out?
This time it was the United States Federal Government.
4 words: “Too big to fail.”
From 2008-2013, A.I.G. = “Americans Insured by Government.”
How come the insurance companies didn’t just join together like they did before?
AIG was such a huge global juggernaut of an insurance company in 2008, that the surplus from all the other insurance companies combined couldn’t back all the liabilities that AIG was insuring.
So, why exactly did the Federal Government step into the insurance business?
It’s the same reason that Aurora bailed out Executive Life.
If citizens stop trusting the entire concept of insurance, then Western Civilization as we know it will start to crumble.
Thankfully, insurance is ultimately a profitable business. So AIG as an organization quickly got back onto their own two feet within 5 years. All the U.S. taxpayer money that was infused to back AIG got paid back to the US Treasury with a substantial profit as AIG got back onto their feet and bought back their independence.
Remember, the insurance business wasn’t the problem. It was greed and the mischaracterization of assets on their balance sheet that turned out to be a lot riskier than they were portrayed to be.
Personal note: Throughout this period, I personally only sold one AIG policy helping a client convert his AIG term policy after he became uninsurable. The client became an avid skydiver and already owned an AIG term policy. We converted his existing AIG policy since he could no longer qualify after becoming an avid skydiver.
During this time I also serviced some older AIG Whole Life policies for a different client that I didn’t originally sell. While servicing these policies I noticed that they never missed a beat throughout that entire debacle. They continued to earn crediting just as they were supposed to, and the clients even accessed their cash value during this time.
If Insurance Companies Fail, We All Have Much Bigger Problems
Here’s the bottom-line. If you are considering using permanent life insurance as a saving or investment vehicle, we do have to disclose that technically there is always the risk of your particular insurance company could possibly become insolvent, however remote that risk actually is.
If the last 160 years of history (including depressions, recessions, inflation, world wars, bank failures, and insurance company bailouts) tell us anything, it’s that this occurrence is very rare. In fact, the risk of you getting stiffed for any dollar amount whatsoever is incredibly remote.
The rewards you get for taking these thin risks can be multi-fold:
- A better place to park your liquid cash
- A better opportunity for growth without market risk
- Multiple tax benefits
- Additional protection benefits ranging from chronic/critical illness benefits, to protection against lawsuit, to your standard death benefit (depending on how and where your policy is written).
Furthermore, the fact that the Federal Government has already stepped in to bail out a huge company that went off the rails, did they not set a precedent? Why would they now let another company fail if for some reason the insurance industry couldn’t police itself?
And if the US Federal Government couldn’t step in to save an insurance company, does it really matter where you have your liquid paper assets parked right now? Wouldn’t all your paper assets be essentially worthless? Things like:
- Insurance policies
- Savings accounts statements
- Stock certificates
- Deeds to real estate
Would any of these documents hold any value? Probably not, other than starting a campfire for you or doubling as a hygiene product.
Most likely, a financial meltdown of this magnitude would probably not unfold overnight. Just like in 2008 there would probably be some sort of “canary in the coalmine” event that signaled the coming crisis. You could feasibly have enough time to strip your life insurance policy of cash value ahead of time (by surrendering, withdrawing, or borrowing). You could then use the liquid assets to buy things like:
- Guns and ammo
- Camping Goods
- Canned Food and Liquid
I think it’s perfectly valid to carve off some of your total net worth anyway to own some of these “alternative asset classes” that will spike in value if something extreme happens to our global financial systems.
Do 99% of Your Planning for the 99% Probability
If you believe that Western Civilization and our financial paradigm will continue as we know it, then you will want to position yourself as optimally as possible. If the wild fluctuations of stocks, bonds, and mutual funds keep you up at night, then the solid and steady growth of Permanent Life insurance may be an ideal asset class to explore.
This is especially true if you are a business owner, real estate investor, or even someone who’s just ultra-conservative and keeps a lot of cash on hand to be mobilized for unique and timely wealth-building opportunities.
You can achieve a similar sense of safety and liquidity using life insurance while getting a rate of return that doesn’t start with a decimal point. You also still get all the other ancillary benefits that come with being a policyholder.
Click here to schedule a custom call with one of our team members. We can discuss the features and benefits that are most important to you, so you can be matched with the ideal policy and company for your unique situation.
John “Hutch” Hutchinson
ChFC®, CLU®, EA, AEP®, CExPs®