Two types of insurance deserve serious consideration as part of a retirement plan. Should you purchase:
- An annuity to provide longevity insurance?
- Long-term care (LTC) insurance to protect you from large expenses if you can no longer care for yourself as you grow older?
Either requires giving up a sum of money that could be spent or invested now. In exchange, you receive the promise of a potential future benefit.
In each of these analyses, one implied assumption was that risk is transferred from yourself to an insurance company. They would be able to pay if and when the time came that you need the policy. However, I was recently contacted by a reader for whom that assumption has not worked out as planned.
How can you assess the quality of an insurance policy and the strength of the company backing it to assure you don’t end up in a similar position?
This reader paid premiums to Genworth Life Insurance Company (GLIC) for more than a decade for a LTC insurance plan. Then one day, he received a letter in the mail that he shared with me.
The letter informed him that he was one of approximately 207, 000 policyholders subject to this class action settlement ”to secure redress for alleged false representations made by Genworth when offering various contractual options to its policyholders and alleged failures to disclose anticipated premium rate increases.”
No Good Options
He was given a few options:
- He could keep the policy. This required paying higher than anticipated annual premiums to maintain the policy. However, the letter informed him that credit rating agency A.M. Best had downgraded the company, with the assessment of having “marginal ability to meet [its] ongoing insurance obligations.” Accepting this option meant he may face further premium increases and/or have a plan that is unable to pay out if he eventually needs it.
- He could also accept a settlement offer. Either of those options required drastically cutting the total lifetime benefit that he purchased.
- The first settlement option allowed him to keep the policy in effect at no additional cost, but decreased his total lifetime benefit by approximately 75%.
- The second settlement option reduced the total lifetime benefit by over 90% while providing a small cash payment (<$7,000) as compensation.
If he wanted to start over and buy a new plan with a similar benefit with a different provider, premiums would be much higher than what he originally agreed to due to his advanced age and changes to health status since buying the original policy. There is a possibility that he wouldn’t even be able to purchase a new policy at this point.
There was no good option. This reader is now out of over a decade of insurance premiums and potential compound growth they could have produced.
What can we do to avoid finding ourselves in a similar predicament?
How Do You Assess the Strength and Quality Of An Insurance Company?
I recently covered this topic in my CFP education program. The TLDR version, it’s really hard!
The CFP curriculum suggests that before considering any insurance policy, you should consider an insurance company’s:
- Financial strength,
- Fairness and promptness in processing claims and,
- Ability and willingness to provide service before and after a loss.
That is a great framework in theory. But how do you do it in practice?
Insurance Rating Agencies
There are five different financial ratings firms: A.M. Best Company, Duff & Phelps, Moody’s Investor’s Services, Standard & Poors, and Weiss Research. There is occasionally disagreement between agencies.
These ratings are difficult for consumers to find. For example, I attempted to check GLIC on A.M. Best’s site. Results are hidden unless you create an account.
When you do find the ratings, they are difficult to interpret. Each agency has a different rating system.
Each are imprecise at best, making understanding any one challenging and making an apples to apples comparison between the agency’s ratings nearly impossible for an average consumer.
For example, in the letter sent to the reader it stated that A.M. Best dropped Genworth’s rating to C++. Taking a closer look at A.M. Best’s rating system, this means their “financial strength is vulnerable to adverse changes in economic and underwriting systems.”
Most people assume an insurance policy is a 100% guarantee we will be compensated in the event an adverse insured event occurs. What does “vulnerable” mean? If the idea is purchasing a guarantee, is anything greater than 0% acceptable to you when buying a policy?
The ratings also can be wrong and they could change. For example, the letter the reader shared with me states that A.M. Best “downgraded its rating of GLIC’s financial strength.” So by definition at some point they were rated above C++.
Assume you can wade through the rating systems to make a fully informed decision today. You can buy a LTC policy or deferred annuity with a highly rated insurance company today. But circumstances can be completely different in 5, 10, even 20 or more years when you actually need to collect on the policy.
Assessing Customer Service
We’ve established that assessing a company’s financial strength is difficult. Assessing their customer service is equally challenging.
I searched Consumer Reports and tried general internet searches to find other unbiased sources of insurance company service reviews. My attempts were fruitless.
We often rely on a trusted insurance agent to help us find the best policy. But insurance is a commission based business. Agents are typically paid the most for plans that are not in your best interest.
There is a tremendous conflict of interest. It’s like asking your barber if you need a haircut.
Consumer Reports says “term life (insurance) is a better deal for most families.” The same article stated that whole life insurance premiums result in larger commissions for insurance salespeople.
In a more egregious recent example of perverse incentives, the SEC fined Ameriprise and their affiliate RiverSource $5 million. The fine was levied because they were found to have “implemented a sales practice that caused exchange offers to be made to holders of variable annuities to switch from one variable annuity to another which had the effect of increasing sales commissions for RiverSource employees, while also increasing RiverSource’s variable annuity related revenues.”
Again, assume you are able to navigate these conflicts successfully. Assume you manage to buy a deferred annuity or LTC insurance policy from an insurer with an outstanding reputation for customer service today.
You may not need their service for another decade or more. Things can change considerably by then.
State Guaranty Funds
One protection that consumers do have are state guaranty funds. These funds of U.S. states and territories will step in and pay claims in the event that an insurer becomes insolvent.
However, there are stipulations. Insurance companies pay claims only if they are licensed in that state.
It is also important to recognize that states cap the payments at different amounts. For example, most states cap the amount guaranteed on annuities at around $250,000 per customer, per company. However, outlier states may offer guarantees as little as $100,000 (Puerto Rico) or as much as $1 million (New York).
As this reader’s case demonstrates, a poorly underwritten plan may not actually become insolvent. Instead, the terms may be changed before insolvency occurs, when it becomes apparent than a plan was poorly underwritten.
In cases like that, a settlement may be deemed fair by a court of law. But that does the customer little good if they are left with higher premiums and/or reduced benefits than they were promised.
What To Do?
It is easy to find hard charging insurance sales pitches for any type of insurance. It’s not much harder to find dogmatic advice from bloggers and other financial “gurus” arguing insurance is nearly always a bad deal.
A good starting point before considering any policy is to have a solid understanding of what insurance is and a framework for when insurance products should be purchased. Insurance, in the right amounts and in the right situation, is an appropriate tool to keep in your tool box.
Diversify between insurance products and self-insuring as appropriate. If purchasing an insurance product, take the time to read and understand your policy.
Also, be aware of state limits to guarantees. Diversify among insurance providers as indicated so as not to exceed state guarantees.
Finally, remember that insurance does not eliminate risk. Purchasing a policy shifts risks from yourself to an insurance company. The vast majority of the time that works out as anticipated.
However, this case points out the real, even if very rare, case that despite strict state regulation and teams of actuaries on their side, insurance contracts are not infallible. It is one more risk to be aware of.
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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to email@example.com. Financial planning inquiries can be sent to firstname.lastname@example.org]
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