When it comes to personal financial planning, buying life insurance is a common task. Some individuals want to assure their family is financially covered when they die, while others use life insurance as an investment plan for their children’s college expenses. There is no shortage of life insurance companies available to consumers, and many of them promise the lowest rates and biggest returns.
But, buying insurance based on price alone is risky. This is especially true when you want to invest in a long-term life insurance policy. Financially stable life insurance companies are more likely to still be in existence when it is time for your family to claim the death benefit from a policy, 20 or even 50 years from now.
In addition to the death benefit, permanent life insurance policies, such as whole life, promise a return on your premium in the way of cash value. The cash value increases as you pay additional premiums and interest accumulates. As the policyholder, you can withdraw this cash value or borrow from it to pay for expenses like tuition fees or a new car.
Yet not every insurance company is sufficiently stable to make sure your loved ones won’t be left with less than you’d planned after you go. Here are three risks you need to consider before you select a life insurance company.
Handling unexpected expenses
Life insurance companies invest a large portion of premiums they receive from policyholders in order to increase their profits. These investments are in the form of stocks and bonds in the public market, as well as other assets that can be more difficult to sell quickly. Putting too much in illiquid investments, such as infrastructure, runs the risk that the company will be unable to meet short-term financial requirements. Known as liquidity risk, this can threaten the company’s ability to process, say, a large number of policy surrenders or death benefit claims. If they can’t, they risk litigation costs, a damaged reputation and, ultimately, a decline in clients.
Requests to surrender policies can spike almost overnight, especially if a catastrophic event or change in the stock market occurs. These high-volume requests can leave the insurance companies short of the cash they need to meet the high demand. If a company doesn’t have the financial resources to pay surrenders or requests to borrow money, you risk not having your money available when you need it.
Weathering market changes
The market is an unpredictable force that impacts life insurance companies. It fluctuates based on economic factors, politics, and natural disasters. When something negative occurs that affects the economy, particularly for an extended period of time, your insurer’s stability can be significantly affected.
Depending on the event and widespread the impact is, the insurer’s investments can take a negative hit, making it difficult for them to operate smoothly. When an investment loses money, it can leave the company with fewer resources to pay surrendered policies or claims. In these cases, the insurer may borrow money to make payments, but large amounts of borrowing impacts their financial stability. Choosing an insurance company that has a stable and well-diversified portfolio is important, since otherwise the company can become insolvent.
The strict regulations that are the norm in other financial sectors are generally lacking in the insurance industry. With little regulation, it is difficult to compare one company to another or to identify when a company is starting to fail financially. Little supervision also means there is no guaranteed fund that will pay you the cash value if an insurance company fails.
How to protect yourself
The good news is there is a vast amount of information available about life insurance companies, and it allows you to learn a lot about the company’s fiscal health. Rating services like A.M. Best, Moody’s, Standard and Poor’s (S&P), and Fitch, facilitate comparing the financial stability of multiple companies, and more easily than you could do so yourself. You can easily access ratings by visiting their websites and entering the insurer you are researching in the search field.
What is a rating service?
Rating service companies are independent agencies that review and report on the financial stability of insurance companies. Because of that, sing a third-party agency rather than relying on the company’s financial statements and promises allows you to see an unbiased analysis of corporate performance.
What do they do?
Every rating service has a formula for calculating a company’s financial health. The majority of services review profitability, liquid resources, and investments. After a thorough analysis, each rating company assigns a grade or a financial stability rating (FSR).
These grades are similar to traditional educational marks: A, B, C, & D. A C-rated company is less strong than an A-rated one and, according to the rating service, is not as likely to meet its financial obligations. Like individual credit scores, financial stability ratings can differ across companies. A company with an “A” rating may be in the top tier for one agency, but be ranked in a lower tier by another. Given such variation it’s best to check multiple ratings and review how each arrives at its scores before making a decision.
Do ratings change?
The factors that affect the financial industry change almost by the day. At any given time, these forces can influence the stability of a life insurance company. Consequently, the FSR of a company may change too, from time to time. It’s wise, then, to periodically check in on the financial health of your insurance company after you purchase a policy.
Reviewing financial strength is just the first step to choosing the right life insurance provider. To get a well-rounded view of a company, it’s also important to look at a company’s business history, online reviews, and length of service. Paying for a life insurance policy that eventually pays nothing, is, of course, a worthless investment. Taking some time today for due diligence will help avoid financial stress later, for you and your beneficiaries.