Insurance Contracts are Not Forever

Do not be lulled into the notion that insurance contracts are sacred.  There was a time when I believed this to be true.  The word insurance brought to mind phrases like “safe” or “locked in.”  Experience has shown, however, that significant risks exist.

Insurance companies can make unilateral changes to a contract.  Two of my family members had term life insurance coverage.  They took it out after the birth of a child and paid premiums for many years.  One day they were shocked to receive a notice saying the company was going to raise their premium payments significantly.  By that time the child had grown and they decided to let the policy lapse.

It is unclear if there was a guaranteed period in the policy.  Perhaps the agreement stated that premiums could not be raised for a certain number of years.  Perhaps the increase came when that period expired.  But if that was the case it was not made clear during the sales process.

Another acquaintance took out long-term care coverage while they were still relatively young.  Premiums were dutifully paid for about fifteen years.  In the meantime insurance companies were sustaining heavy losses on long-term care.  Apparently actuarial models used industry-wide were terrible and the business ended up being unprofitable.  Insurance companies make money by investing premiums.  So plummeting interest rates were also eating into their return on investment.  The company in this case, CNA, went to state regulators and received permission to raise premiums by about 75%.

In a third situation an acquaintance was recently forced to take payout from an annuity bought in the 1980′s.  It paid 5.5% and she let it sit there for decades building up.  Recently a letter was received stating that either a lump sum had to be taken or annuitization would begin.  She is 85 and that is more than likely the policy maturity date.  But, even though it may have been communicated during the signing many years back, the letter came as a surprise.  She took annuitzation, $1,000 per month, because a lump sum would have caused her to lose a senior property tax freeze.  Her children are named beneficiaries.

Sometimes insurance companies will try to get people to voluntarily make changes.  An acquaintance has a fixed annuity bought from Allstate in 2008.  It has a guaranteed minimum rate of 3%.  In 2012 correspondence was received from Allstate offering to surrender the annuity penalty free, even though the surrender period had not expired.  It was not difficult to see what was going on: the financial crisis ensued right after policy issuance.  As a result interest rates plummeted.  Under this pressure Allstate wanted the 3% guaranteed obligation off their books. Duplicating a 3% interest rate somewhere else in 2012 at a comparable level of risk would have been difficult.  So the offer was declined.

Insurance companies can also fail.  Since 1987 there have been 74 such incidents.  No large company with international brand recognition appears on that list.  But always remember that being large is no guarantee.  The only reason AIG did not fail during the financial crisis is because the U.S. Government took it over in an $85 billion bailout.

Each state has a guarantee association that backstops insurers doing business in that state.  They are funded by assessments on those insurers.  But, as with FDIC and SIPC, coverage has limits.  They vary from state to state.  But examples are $300,000 for life insurance death benefits, $100,000 for cash surrender values of life insurance policies, and $250,000 for annuity contracts.

Buyers should beware.  Insurance products certainly have their uses.  People should not be afraid to use them in the proper situation.  But always get an understanding of what can happen.  Otherwise any plan you make could be blown out of the water at some point in the future.


© 2017 – Essentials of Investing

Articles presented here are general opinions for your own consideration. They are not specific advice for any one investor.

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