Some companies are in financial distress, but most policyholders should stay put. By Kimberly Lankford, Contributing Editor May 7, 2009 As if the past nine months haven't been hairy enough for your finances, now your insurance company may be making the headlines. If your insurer is struggling, should you stay or should you bail? American International Group policyholders have been asking that question since last fall, when AIG got an infusion of funds from the U.S. government. Customers with insurance or annuities from Hartford and Genworth started to worry when those companies' share prices plummeted a few months ago. RELATED LINKS Get the Best Rates on Life Insurance QUIZ: Your Insurance Policy I.Q. NEW! Visit Our Insurance Center Meanwhile, Penn Treaty's long-term-care insurance business has been taken over by state regulators, and Conseco's has been placed in a separate trust because of its financial problems. Whether you should ditch your insurer depends on the kind of insurance or annuity you have, how bad the company's financial troubles really are, and what you might give up by switching. In some cases, a failing insurer could tie up your money for months. In the worst case, your claim might not get paid. However, it could cost you a lot more to buy a new policy. Advertisement And if someone tries to rush you into making a change, consider the source: "I think agents have an incentive to encourage people to overreact," says Glenn Daily, an independent insurance consultant in New York City. He advises caution when agents try to persuade you to change companies because they get a commission for selling a new policy. There's a big difference between an insurer's tumbling stock price and its ability to pay claims. Insurance companies are subject to special reserve requirements that state insurance regulators impose to make sure they can pay up. AIG's insurance subsidiaries, for example, are separate from the troubled holding company and still meet regulators' reserve requirements. "The insurance aspects of AIG are sound financially, and the products it's selling are sound," says Thomas E. Hampton, commissioner for the Washington, D.C., Department of Insurance, Securities and Banking. Although many insurers have been downgraded by the ratings agencies, they're still in good shape (see the box at the bottom of the page). But even when an insurer's ratings are cause for concern, finding a replacement policy may be too expensive -- or even impossible. Stay or go? Here's what's at stake. Life insurance. People with term policies have the least to worry about. "If you have a policy with no cash value, then your risk is substantially reduced," says Martin Weiss, president of Weiss Research Inc. and founder of a ratings agency known for its tough analysis (now part of TheStreet.com). Even if the insurer becomes insolvent, the state guaranty association will cover up to $300,000 in death benefits (or $500,000 in several states; see www.nolhga.com for links to your state's association). Death benefits historically have been paid promptly and in full. Advertisement KIP TIP How to Read the Ratings Agencies that rate insurers look specifically at a company's (or a subsidiary's) ability to pay claims. And even though many insurers have been downgraded, they're still in good shape. "For the most part, we're seeing some of the higher-rated companies get downgraded to ratings that are still relatively high -- such as A+ to A or maybe A to A-," says Andrew Edelsberg, a vice-president in the life and health division of A.M. Best. The insurance subsidiaries of American International Group are currently rated A with negative implications, which means there could be additional downgrades. The lead companies for Genworth and Hartford also have A ratings. (Go to A.M. Best for more financial-strength ratings.) TheStreet.com, which has the toughest ratings scale, still puts Genworth, Hartford and AIG's life-insurance subsidiaries in the B and C range (click on the site's "Portfolio & Tools" tab to look up insurers' ratings). To Martin Weiss, of Weiss Research, the big red flag comes when a company's rating by TheStreet.com falls to D+ or below. "That's when the scale is generally tipping in the direction of getting out," he says. However, even if your company's ratings are lowered, it still might not be worthwhile to switch. Conseco is rated D+ and Penn Treaty gets an F from TheStreet.com. But it may be too expensive -- unrealistic, even -- to find a replacement policy. Advertisement If you still want to switch, you may have to pay higher premiums because you're older and may not be as healthy. If you're still in good health, however, and you bought the policy just a few years ago, you could find a decent deal on a replacement policy. People with cash-value policies -- which have both an insurance and a savings component -- have a lot more at stake. The guaranty association would cover death benefits for these policies, too, plus $100,000 or more in cash value. But that cash value could be virtually inaccessible for six months or more if the insurer becomes insolvent. This is an issue for universal- and whole-life policies but not for variable-life policies (the money for them is held in mutual fund-like subaccounts and kept in a separate trust). If you decide to cash out now, you could be hit with a surrender charge -- often up to 7% of the cash value in the early years of the policy. And you could owe taxes on any gains in the policy. One alternative, says Daily, is to withdraw a lot of the cash value as a policy loan, which would avoid a tax bill while keeping the policy in force. In that case, the death benefit would be reduced by the amount of any outstanding loan. Advertisement Annuities. With a variable deferred annuity, the money invested in subaccounts is held in a separate trust and isn't affected by an insurer's financial situation. But if you have a variable annuity with guaranteed minimum income benefits or withdrawal benefits, that guarantee could be at risk if the insurer goes under. In addition, fixed annuities and equity-index annuities could be at risk because they are covered by the insurer's general account. State guaranty associations provide at least $100,000 of coverage for withdrawals and cash values for annuities; more than a dozen states cover $300,000 or more. One option is to spread large balances among several annuity companies, each of which carries separate coverage limits. If you cashed out the annuity, you'd owe income taxes on any gains plus a 10% penalty for early withdrawal if you're younger than 59. You can make a tax-free exchange to another company's annuity and avoid the tax bill and penalty. But in that case you could get hit with a surrender charge, which typically starts at about 7% of the account balance and gradually decreases. RELATED LINKS Get the Best Rates on Life Insurance QUIZ: Your Insurance Policy I.Q. NEW! Visit Our Insurance Center And if you have an annuity with guaranteed minimum income or withdrawal benefits that are worth more than the current value of your account, you'll lose the value of those benefits if you switch. Bottom line: If the guarantee is worth a lot more than the current value of the account, it usually makes sense to hang on. That's especially true now because "the guarantees from two to three years ago are way better than the guarantees companies are issuing now," says Hampton, the D.C. commissioner. On the other hand, if you're past the surrender period and your annuity doesn't offer any guarantees, there's much less downside to switching. Long-term-care insurance. Some long-term-care insurers are in trouble because they priced their policies too low initially. Most of Conseco's policies have been transferred to a state-supervised trust, and Penn Treaty has been taken over by state regulators. But both continue to pay claims. If the insurers became insolvent, state guaranty associations would cover at least $100,000 in long-term-care benefits (half the states cover more). A bigger problem for people who hold policies with troubled long-term-care insurers is perpetual rate hikes. "Conseco and Penn Treaty will probably have further rate increases," says Claude Thau, a long-term-care insurance consultant. It can be difficult to replace a long-term-care policy. Insurers have raised rates for new policies across the board to avoid financial problems in the future. Plus, you're older, you may have medical conditions, and you'd have to buy a bigger benefit to keep up with inflation adjustments. If your health is poor, you might not qualify for a new policy at all. Thau thinks it pays to stay put, even with Penn Treaty and Conseco. "It does make sense to keep these policies in almost every circumstance," he says. "It also makes sense in some cases to supplement the policy," by buying additional long-term-care insurance, if you're still healthy, or by boosting your savings. If you can't afford the rate increase -- or don't want to pay the insurer more money -- you can save on premiums by lowering the benefit period from lifetime to three or five years, which still covers most claims.