Insolvencies/Guaranty Funds
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THE TOPIC
MAY 2007
The regulation of insurance company solvency is a function of the state. State regulators monitor the financial health of companies licensed to provide insurance in their state through analysis of the detailed annual financial statements that insurers are required to file and periodic on-site examinations. When a company is found to be in poor financial condition, regulators can take various actions to try to save it. Insolvencies do occur, however, despite the best efforts of regulators.
All states have procedures through which the property/casualty insurance industry covers claims against insolvent insurers. New York has a pre-assessment system, which requires insurers to contribute to a permanent insolvency fund, while the other states have established insurance guaranty associations (known as guaranty funds). Insurers are required to be members of guaranty associations as a condition of licensing. When there is an insolvency, they are assessed based on business they do in that state, so that claims can be paid.
The National Association of Insurance Commissioners (NAIC) moved to strengthen solvency regulation in the 1980s. It developed an accreditation program that requires state insurance departments to meet certain prescribed standards. It also established minimum capital requirements for insurers, based on the riskiness of their business, and it continues to refine regulations.
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RECENT DEVELOPMENTS
- Insolvencies/ Impairments: Under an order from the court, Florida insurer Vanguard Fire and Casualty Company is to be liquidated. The company entered receivership in January 2007 but its assets–cash and reserves–were insufficient to pay claims. The company’s 57,000 homeowners policies will be assumed by other insurers, under an agreement worked out by the court.
- A February 2007 report by Standard & Poor’s noted that the number of property/casualty insurance company failures dropped from 10 in 2005 to eight in 2006 and the number of companies placed under regulatory supervision fell to 11, a new low. Standard & Poor’s attributes the decrease in insolvencies and troubled companies to improved earnings, which strengthened balance sheets, low levels of reserve deficiencies and an increased emphasis on enterprise risk management that focuses on the financial operations of the entity as a whole. Earnings were enhanced by a less active hurricane season than had been anticipated at the start of the summer. Serious reserve deficiencies can significantly reduce a company’s policyholder surplus, leading to reduced growth and rating downgrades. There were 13 insolvencies in 2004. In most years, property/casualty insurers make up the bulk of insurance industry insolvencies. According to industry observers, many factors combine to cause companies to fail, including inadequate pricing during soft markets when competitive forces lead to price cutting, periods of low investment income, inadequate reserves and rising losses.
- In a report on 2006 impairments (companies in financial trouble) A.M. Best lists 15 property/ casualty insurers. This is half the historical rate of impairments over the past 37 years, according to A.M.Best. Two-thirds of the companies reported impaired were members of the Poe Financial Group or the Vesta Group, see below. A.M. Best tracks impairments over the years 1969 to 2006. During that period, deficiencies in loss reserves, funds set aside to pay claims and claim expenses, were the primary cause of financial difficulties, followed by rapid growth. Catastrophe losses were the leading culprit for the single year of 2006.
- Vesta Fire Insurance Corp. of Texas and the companies belonging to the Poe Financial Group of Florida were the largest insolvencies in 2006. Claims stemming from the very active hurricane seasons of 2004 and 2005 were largely responsible for the insolvency of Poe, which was Florida’s third largest insurance group. Vesta Fire Insurance Corp. was the sixth largest homeowners insurer in Texas. Regulators had been monitoring the condition of these companies and were concerned when reinsurers would not sell them reinsurance for the 2006 hurricane season because of their poor financial health. Without reinsurance, insurance for insurance companies, in an active hurricane season they might not be able to pay their policyholders’ claims. Lack of reinsurance will trigger an immediate reaction from the insurance department, regulators say. Eventually, both were deemed insolvent after efforts to rehabilitate them failed. Unpaid claims for the Poe companies totaled 39,000, according to the Florida Insurance Guaranty Association.
- In Florida, in an unusual move that had to be approved by the courts, the policies of all three Poe companies were transferred to the state-run Citizens Property Insurance Company so that there was no lapse in coverage when the new hurricane season began. Policyholders will not have to pay Citizens’ higher rates until their policies come up for renewal. The state imposed a 2 percent surcharge on all property insurance policyholders to help cover Poe’s outstanding claims. Poe was unable to meet the state’s capital requirements and pay outstanding claims after $2 billion in storm losses. In Texas and other states in which Vesta’s subsidiaries operated, insurance agents found new insurers for Vesta’s former customers.
- The failure of the three insurance companies that made up the Poe Financial Group represented the largest loss of insurance capacity in Florida since Hurricane Andrew in 1992 when 10 Florida insurance companies became insolvent. Poe had assumed high-risk property insurance policies from Citizens in return for a bonus payment under a program designed to reduce the size of the pool. Texas Select, a Vesta homeowners insurance subsidiary, became one of the largest property insurers in Texas when it was one of the few insurers in the state that would sell to new customers at a time when many larger companies were refusing new business because of the rapidly growing problem of mold claims. The last major failure of an insurance company in Texas was in 1988 when an auto insurance company became insolvent after its chief executive stole from the company’s coffers.
- Guaranty Funds: Under a provision in the residential property insurance bill passed by Florida lawmakers the end of April 2007, the Florida guaranty fund will be able to use emergency assessments for payment of any claims covered by insurers rendered insolvent by the impact of a hurricane, not just homeowners claims. In addition, all municipalities and counties in the state will be able to issue bonds to assist the guaranty fund in expediting the handling and payment of insolvent company claims, not just the municipalities and counties most affected by the storm.
- In Massachusetts the legislature passed HB 5216, a law that allows the state’s guaranty fund to exclude payments to commercial policyholders and claimants with a high net worth, defined as in excess of $25 million, when an insurer becomes insolvent. The definition excludes government entities. The November 2006 law was the first amendment to the state’s guaranty fund law since it was created. More than 20 states have similar net worth provisions, see Background section.
- The New York Insurance Department issued a report on the condition of the state’s three guaranty funds in May 2006 and made several recommendations to help correct their weaknesses, including greater access to actuaries to better manage existing funds and project future funding needs. The report indicates that the workers compensation account will remain impaired for several years to come and suggests adding the State Insurance Fund, the state-administered provider of workers compensation coverage, to the entities that can be assessed. The Fund provides a large portion of the workers compensation insurance purchased by the state’s businesses. The report also suggests lowering the cap on claims payments. At $1 million, New York has the most generous payments of all the guaranty funds. Workers compensation guaranty funds in a number of states have experienced financial problems due to the high number of insolvencies in this line or type of insurance in the early part of the decade.
- State guaranty funds assessed insurers $916.1 million to pay for insolvencies in 2005, the last year for which complete data are available, see below. Assessments on insurance premiums may fund earlier insolvency expenditures as well as current year costs.
- The National Conference of Insurance Guaranty Funds, an association set up more than 10 years ago to facilitate and promote cooperation among state guaranty funds, has developed an alternative to litigation for resolving disputes. Disputes are more likely to arise when large commercial insurers become insolvent because of the nature of the claims and the geographic span of some companies. Under the new process claimants would be paid and any disputes concerning which state was liable for what would be decided later. About 35 states now participate in this alternative dispute resolution program.
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GUARANTY FUND NET ASSESSMENTS, 1978-2005 (1)
Year |
Net assessment (2) |
Year |
Net assessment (2) |
| 1978 | $139,349,343 (3) | 1993 | $520,215,101 (4) |
| 1979 | 46,222,805 | 1994 | 497,752,370 (4) |
| 1980 | 17,771,834 | 1995 | 66,562,926 (4) |
| 1981 | 49,772,896 | 1996 | 95,320,605 |
| 1982 | 41,109,087 | 1997 | 236,319,208 |
| 1983 | 30,619,239 | 1998 | 239,212,254 |
| 1984 | 97,435,034 | 1999 | 179,283,004 |
| 1985 | 292,417,521 | 2000 | 306,444,534 |
| 1986 | 509,409,508 | 2001 | 712,776,721 |
| 1987 | 903,228,359 | 2002 | 1,184,153,880 (5) |
| 1988 | 464,840,383 | 2003 | 874,499,309 (5) |
| 1989 | 713,869,682 | 2004 | 952,695,278 |
| 1990 | 433,562,308 | 2005 | 916,130,812 |
| 1991 | 434,845,812 | Total | $11,351,202,780 |
| 1992 | 383,735,932 | | |
(1) Excludes New York and Workers Compensation Security Funds in New Jersey and Pennsylvania.
(2) Assessments less refunds.
(3) Includes pre-1978 net assessments.
(4) Includes separate assessments for insolvencies due to Hurricane Andrew totaling $248,542,070.
(5) Excludes data for the Louisiana Insurance Guaranty Association.
Source: National Conference of Insurance Guaranty Funds. |
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GUARANTY FUND NET ASSESSMENTS BY STATE, 2005 (1)
State |
Net assessment |
State |
Net assessment |
| Alabama | $3,397,539 | Nebraska | $2,360,000 |
| Alaska | 10,758,303 | Nevada | 0 |
| Arizona | 0 | New Hampshire | 3,819,548 |
| Arkansas | 6,740,734 | New Jersey | 233,290,014 |
| California | 321,711,800 | New Jersey Workers Compensation | 15,613,640 |
| Colorado | 6,500,000 | New Mexico | 2,226,013 |
| Connecticut | -15,038,354 | New York | 0 |
| Delaware | 504,400 | North Carolina | 19,978,000 |
| D.C. | -1,437,440 | North Dakota | 0 |
| Florida | 0 | Ohio | 40,000,000 |
| Florida Workers Compensation | 114,505,450 | Oklahoma | 28,508,625 |
| Georgia | 19,956,662 | Oregon | 11,000,000 |
| Hawaii | 32,170,568 | Pennsylvania (2) | -7,850,000 |
| Idaho | 0 | Pennsylvania Workers Compensation | 0 |
| Illinois | -26,926,027 | Rhode Island | -4,749,288 |
| Indiana | 2,500,000 | South Carolina | 8,185,602 |
| Iowa | 0 | South Dakota | 0 |
| Kansas | 0 | Tennessee | 17,671,355 |
| Kentucky | 0 | Texas | 0 |
| Louisiana | 0 | Utah | 0 |
| Maine | 1,997,813 | Vermont | 1,557,313 |
| Maryland | 0 | Virginia | 13,282,045 |
| Massachusetts | -6,580,210 | Washington | 803,220 |
| Michigan | 12,600,720 | West Virginia | 0 |
| Minnesota | 0 | Wisconsin | 0 |
| Mississippi | 31,160,000 | Wyoming | 0 |
| Missouri | 7,227,710 | United States | $916,130,812 (3) |
| Montana | 0 | | |
(1) Assessments less refunds. Negative numbers represent net refunds.
(2) Excludes Workers Compensation Security Funds.
(3) Includes Puerto Rico.
Source: National Conference of Insurance Guaranty Funds. |
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Chart Notes: The two charts above are the yearly totals for insurance company payments to state post-assessment guaranty funds and a state-by-state chart showing assessment amounts. (The figures do not include assessments made under New York's pre-assessment insolvency fund nor payments made by individual companies under the insolvency provision of the uninsured motorist endorsement to auto insurance policies. They also do not take into consideration recoupments available through premium tax offsets and policyholder surcharges.) Net assessments in 2003 represented only 0.2 percent of the property/casualty insurance industry's net premiums written. Assessments include monies needed to pay claims against companies that became insolvent in the past as well as current insolvencies.
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BACKGROUND
Regulation for Solvency: State insurance departments monitor the financial health of insurance companies through regular in-depth financial analyses and periodic on-site examinations. The National Association of Insurance Commissioner’s (NAIC) uses a series of tests—the Insurance Regulatory Information System (IRIS)—to help identify companies in trouble. All insurers are required to file annual financial statements with regulators in all states in which they are licensed to do business. Statistical data taken from these statements are run through IRIS tests. If the tests indicate a company's financial ratios are outside the normal range in more than four areas, its finances are reviewed in greater detail to determine whether it is in need of immediate regulatory attention.
State insurance departments must meet certain standards to ensure they have the capacity to oversee the financial condition of the insurers they regulate. Under state accreditation program rules, accredited states are subject to a full review every five years and a lesser audit every year. However, accreditation may be suspended at any time, after notice to the state and a hearing, if regulators become aware that a state is no longer in compliance with certification standards.
Risk-based Capital Standards: The NAIC has been strengthening solvency regulation since the early 1990s. Among other things, it adopted risk-based capital (RBC) standards for the property/casualty industry that took effect for the 1994 annual financial reports filed with regulators in March 1995. RBC standards replaced individual state surplus and capital requirements, which varied widely from state to state and had been criticized as being too low and too simplistic to be meaningful thresholds for capital adequacy. In some states, a large insurer could have been insolvent while still meeting the minimum requirements.
The old blanket minimum requirements were replaced with standards geared to the specific characteristics of the company and its business, a move designed to improve solvency regulation. With formulas that reflect individual capital needs, examiners can more quickly identify insurers that are under financial pressure and take action earlier to avert insolvency.
Capital adequacy is linked to the riskiness of an insurer's business activities. An insurance company that insures medical device manufacturers or high rise buildings along California's earthquake faults needs a larger cushion of capital than a company specializing in Main Street businesses in Michigan, for example. A company that is heavily reinsured may have more security than a similar one that is not, but what happens if its reinsurer is in poor financial health when it comes time to honor the reinsurance contract?
RBC formulas therefore set out minimum levels of capital that will help maintain solvency in the event of a serious miscalculation. The likelihood and extent of these errors are built into the formulas for various elements of an insurer's business. These include the risk that loss reserves set aside for future claims will be inadequate. (Loss reserve risk is tied to the kind of business the company underwrites. There is more uncertainty in liability than property lines of insurance because of the long tail nature of claims, where it may take years to arrive at a settlement for injuries.) In addition there is credit risk—the chance that an insurance agent or reinsurer will default on monies owed under contracts. Premium risk assesses the degree to which insurance policy prices may inadequately reflect the cost of claims. Capital levels are also established for investment and off-balance sheet risks. An allowance is made in the calculations for the fact that everything is unlikely to go wrong at the same time.
The adequacy of a company's capital is assessed by comparing its total adjusted capital, which is basically its net worth, with its RBC—an amount of capital that reflects the level of risk the company has assumed. The greater the total riskiness, the greater the minimum financial cushion must be. The result is expressed as the company's RBC ratio. Ratios are categorized in six levels or zones that run from adequate (125 percent and higher) to mandatory control or below 35 percent, at which point the insurance commissioner is authorized to seize the company unless there is some reasonable expectation that the circumstances that caused the depletion of capital will be remedied within 90 days.
Insurance companies are required to disclose in financial statements filed with regulators their total adjusted capital and their “authorized control level” of risk-based capital. This is one level above mandatory control, the point at which a regulator may take control of the company if it is deemed to be in the best interests of the policyholders, creditors and the general public. However, when RBC ratios are published outside of the annual statement, they usually refer to the "company action level," (75-99 percent) where a company is required to file a plan with regulators to correct its capital deficiencies.
RBC data are not a measure of financial performance. They are designed to help identify companies whose capital has fallen below regulatory-determined minimums rather than assess the financial strength of adequately capitalized insurers as rating agencies do from reviews of both financial data and discussion with company management. A company that fails the RBC tests may not be on the brink of insolvency and it is possible for a company in poor financial shape to pass the tests.
Insolvencies: A 1987 General Accounting Office (GAO) report on insolvencies noted that insolvencies generally follow the property/casualty insurance company profitability cycle. The GAO report also pointed out that the profile of insolvent companies has changed over the years. In the late 1960s and 1970s, insolvencies occurred mainly among small auto insurers with a limited geographical span. Since that period, the characteristics of insolvent insurers has become more diverse and has included some large multistate companies. The incidence of large company insolvencies has raised concerns over the ability of the guaranty fund system to pay all covered claims.
The insolvencies of four large insurers and the fallout from the savings and loan crisis in the 1980s prompted a Congressional study, which culminated in the February 1990 report "Failed Promises: Insurance Company Insolvencies." Known as the Dingell report, after the chairman of the committee that investigated the insolvency cases, Rep. John Dingell (D-MI), the study looked at the insolvencies of four companies: Mission Insurance Co. and Transit Casualty Co., both with headquarters in California, although Transit Casualty was chartered in Missouri; Integrity Insurance Co. of New Jersey; and Anglo-American Insurance Co. of Texas. The report found what it called "disturbing" parallels between the mismanagement and fraudulent activity that led to the four insurer insolvencies and the factors that precipitated the savings and loan crisis. Specifically, it attributed the insurance company failures to rapid expansion, unsupervised delegation of authority, extensive and complex reinsurance arrangements, underpricing, reserve problems, false reports, reckless management, incompetence, fraud, greed and self-dealing.
According to a November 2005 A.M. Best study of insolvencies from 1969 to 2005, the leading cause of collapse was inadequate reserves for claims, which accounted for more than 38 percent of impairments among the 984 insolvencies studied. Rapid growth also played a major role, accounting for 16.5 percent of failures over the period studied, particularly during soft markets. Most insolvencies, Best says, were related to some form of mismanagement. Data for the period 2003-2005 which was also analyzed separately shows that fraud can play a substantial role.
Solvency Oversight Process: Regulators monitor the financial condition of all insurance companies. If a company appears to be in poor financial health, regulators are empowered to take certain steps to strengthen the insurer's position and, if all else fails, to liquidate it.
The first indication of a possible problem frequently is a company's failure to pass four or more of the 11 financial tests that regulators administer as part of the normal monitoring process. Failure may trigger special audits or a requirement that the company begin to report its financial data on a quarterly basis instead of annually. These initial steps are precautionary in nature and serve as a warning to the company to put its financial affairs in order.
If there is no improvement, more formal steps may be taken to bolster the company's financial condition. The regulator may order the company to raise its rates, increase its capital, restructure its investments or take other corrective measures, depending on the nature and severity of the problem. To protect the company from "run-on-the-bank" type reactions, these remedial actions are not made public except at the company's request. If the deterioration continues, the next step is rehabilitation, a move that becomes part of the public record. The insurance department in the company's domiciliary state, the state in which the insurer is incorporated or organized, obtains a court order allowing it to take more specific steps to shore up the troubled company. These may include suspending claim payments, placing a stay on lawsuits against the company and searching for additional sources of capital—a merger prospect, for example.
The final step is liquidation, which enables the insurance department, as liquidator, or the department's appointed deputy, to wind up the company's affairs by selling its assets and settling claims upon those assets. After obtaining the liquidation order, the liquidator notifies insurance departments in other states of the liquidation proceedings. State guaranty associations also will be notified. Since liquidations of insurance companies are not subject to the provisions of Federal Bankruptcy Code but to each state's liquidation statutes, the process of liquidation may vary from state to state.
Insolvency Data: The National Association of Insurance Commissioners considers a company insolvent when the state insurance commissioner has taken legal action against a company to place it in conservatorship, rehabilitation or liquidation. (The difference between conservatorship and rehabilitation is one of degree. According to the NAIC, the state insurance department guides the operations of a company in conservatorship but directs the operations of one in rehabilitation.) Each state has laws that govern what triggers the guaranty funds, generally a final order of liquidation and/or a finding of insolvency.
There is a wide variation among states as to what is included in their list of insolvencies. Some states count ancillary receiverships, for example. Ancillaries are set up because when an insurer domiciled in another state becomes insolvent an ancillary receivership order is needed to release guaranty funds. Some states charge insurance departments with the task of liquidating insurance-related entities such as insurance agencies and home and auto warranty firms. These, too, may be included in the state’s list of insurer insolvencies. In addition, due to the complexity of the issues involved, litigation and other problems, some companies remain on a state’s receivership list for many years.
Guaranty Funds: The first guaranty funds were narrow in focus and covered a particular line or area of insurance such as workers compensation, which was the first coverage to be made compulsory. In the 1940s and 1950s a few states created auto insurance guaranty funds. Among them was New York, whose Motor Vehicle Liability Security Fund, created in 1947, was expanded to cover other areas of insurance in 1969 when the NAIC proposed its model guaranty fund program. The guaranty fund concept was gradually adopted and by the end of 1982, all 50 states, the District of Columbia and Puerto Rico had established procedures under which solvent property/casualty insurance companies absorb losses of claimants against insolvent insurers.
The NAIC's Model Property/Casualty Guaranty Association Act recommended that states adopt a post-assessment, or post-insolvency, approach to financing the program, under which assessments are made only after an insurer has been declared insolvent. When a company becomes insolvent, other insurers doing business in the state are assessed the amount needed to pay policyholders and claimants of the insolvent company.
New York is the only state that does not use the post-assessment system for any line of insurance. New York has a "pre-assessment" arrangement. Insurance companies are assessed in advance, according to a percentage of net direct premiums written, and contributions are held against future claims on insolvent companies. The fund halts contributions when the amount held exceeds $200 million and does not call for new payments until the balance falls below $150 million. (Some states, including New Jersey, New York and Pennsylvania, have pre-assessment funds for workers compensation and, in April 1989, Maine created a pre-insolvency fund to pay the claims of insolvent insurers for the first 60 days, by which time funds would have been collected through the regular post-assessment fund system.)
In most post-assessment states, companies can be assessed annually up to a maximum of 2 percent of net written premiums. A few states still have a limit of 1 percent. About one-third of guaranty funds have three accounts, although the number may vary from one to five. The three accounts are automobile, workers compensation and all other lines of insurance covered by the funds. In Florida, auto is separated into liability and physical damage. Assessments are made separately for each account. State legislation is generally required to impose higher assessments temporally if additional monies are needed to pay claims after a surge in insolvencies.
Insurers may recoup guaranty fund assessments. Sixteen states offset insolvency assessments through a reduction in premium taxes—a state tax levied on the amount of insurance premiums paid by the policyholders in the state. California, Hawaii and New Jersey raise the money through an insurance policy surcharge. The remaining states recoup insolvency assessments through changes in insurance premium rates.
While all state funds cover homeowners and auto insurance claims, some other types of insurance may not be covered. The NAIC model law excludes annuities, life, disability, accident and health, surety, ocean marine, mortgage guaranty and title insurance, but some states that do not follow the guidelines of the model law in its entirety may include some of these types of insurance. There also may be other differences. For example, claims may be subject to a deductible, usually $100. Coverage limits exist in most states and these too vary. In Georgia the maximum covered claim, or the largest payment that state's insolvency fund will make, is $100,000. In Arkansas it is $300,000 and in California the maximum figure is $500,000. Most states have no limits on the amount paid to cover workers compensation claims.
State guaranty funds do not generally cover groups that self-insure (assume the financial risk of loss instead of transferring it to an insurance company—see Captives report). Thus, participants in risk retention groups and purchasing groups, such as those established under an amendment to the Risk Retention Act of 1981, would not be able to call on state guaranty funds if their group became insolvent.
There has been discussion about the need or the advisability of establishing a guaranty fund for surplus lines insurers, whose claimants would not be covered by established guaranty funds in states where these companies are not licensed. Although lawmakers have considered such legislation, the only state so far to establish a special fund for surplus lines is New Jersey.
Another question is whether guaranty funds should cover "commercial lines" policyholders. Businesses generally are better-equipped than individual consumers to evaluate the financial condition of insurance companies. They often have the in-house expertise to evaluate an insurer's financial data or they can ask a broker to assist them. Responding to the idea that the claims of large, sophisticated commercial policyholders should not be covered by state guaranty funds, in 1986 the NAIC adopted a model law that requires any corporation with a net worth of more than $50 million to reimburse state guaranty funds for liability claim payments made on its behalf. About 20 states use net worth, though not necessarily as set out in the NAIC model act, to determine eligibility for guaranty fund coverage, and other states have been considering similar measures. In Missouri, for example, under a law that took effect in August 1989, the guaranty fund will not pay the claims of corporate policyholders with a net worth in excess of $25 million.
Many states have incorporated "early-access" provisions into their guaranty fund laws. These statutes require state regulators to share the assets of an insolvent company with guaranty funds at an early stage in the liquidation process so that claimants do not have to "stand in line" with other creditors. Some 40 states now have such provisions.
The size of insolvencies is increasing. In the 15 years from 1969 to 1984, the largest assessment was for an insolvency of $88 million for the Reserve Insurance Company, which became insolvent in 1979. Beginning in 1985, assessments for individual company insolvencies jumped into the $200 to $300 million range. The solvency that imposed the highest net cost on guaranty funds during the 1980s, according to data from the National Conference of Insurance Guaranty Funds, was Midland Insurance, which became insolvent in 1984. Funds paid out more than $453 million and only recovered $8 million from other parties. The 1985 insolvency of Mission Insurance was the largest, at $465 million, but recoveries at $362 million were also high. As of the end of 2004, the insolvency of Reliance Insurance Company in 2001 had cost more than $666 million. Payments exceeded $1.7 billion but recoveries were high too.
The Claim Payment Process: When state guaranty fund associations are notified about an insolvency by the liquidator or their state insurance department, they must first determine whether the company was licensed to do business in their state for any of the lines of insurance covered by their guaranty fund. Then they must decide how much to assess other insurance companies doing business in the state to pay the outstanding claims against the insolvent insurer, or, in the case of New York State, whether a new assessment must be made.
To come up with a figure, the association analyzes all available information on the insurer's business, including the financial data the company has submitted to the state's insurance department, claims files or a representative sample of claims, computer print-outs from the liquidator and any other material that would give some indication of outstanding claims and the amounts set aside by the company to pay them. After all the information has been factored in, each insurer is assessed its share of the total amount needed.
Claims are paid as information is received from the liquidator and as soon as each claim is resolved. Only hardship cases are given a priority. The time it takes to arrive at a settlement depends on the nature and complexity of the case, just as it does when a claim is filed with a solvent company. Liability claims tend to take longer to settle than first-party claims–those filed by the policyholder. Where necessary, the guaranty fund provides defense counsel to defendants.
In addition to providing information on the insolvent insurer to state insurance departments and guaranty fund associations, the liquidator is responsible for notifying all agents, policyholders and others who might have claims against the company of its insolvency. Policyholders are given an additional period of insurance coverage, typically 30 days from the date of liquidation, unless their policy would have expired prior to this. The policy period extension protects policyholders while they are shopping for a new insurance company. Policyholders also receive claim forms, known as proof of claim forms, and information on how to fill them out in the event that they have a claim against the insolvent company. (In states where the guaranty fund covers unearned premiums—premiums that the insurance company has collected from the policyholder but has yet to "earn" because the policy period has not yet expired—the majority of policyholders would have reason to file a claim.)
As mentioned earlier, the lines of insurance covered by guaranty funds and the maximum amount paid on any claim vary from state to state. Where the claim is not covered by the guaranty fund or only partially covered, policyholders must stand in line with other creditors to recover the outstanding amount from the insurer's estate.
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An Overview of NAIC Financial Regulation Standards:
Laws and Regulations.* (These standards outline the powers a state insurance department must have to obtain NAIC accreditation.)
- Examination Authority: The department should have authority to examine companies whenever it is deemed necessary.
- Capital and Surplus Requirement: State law should contain the NAIC's Risk-Based Capital Model Acts and the department should have the ability to require that insurers have and maintain a minimum level of capital and surplus to transact business. The department should also have the authority to require additional capital and surplus based on the type, volume and nature of the insurance business transacted.
- NAIC Accounting Practices and Procedures: The department should require that all companies reporting to the department file the appropriate NAIC annual statement blank which should be prepared in accordance with the NAIC's instructions handbook and follow those accounting procedures and practices prescribed by the NAIC's Accounting Practices and Procedures Manual.
- Corrective Action: State law should contain the NAIC's Model Regulation to Define Standards and Commissioner's Authority for Companies Deemed to be in Hazardous Financial Condition or a substantially similar provision which authorizes the department to order a company to take necessary corrective action or cease and desist certain practices which, if not corrected, could place the company in a hazardous financial condition.
- Valuation of Investments: The department should require that securities owned by insurance companies be valued in accordance with those standards promulgated by the NAIC's Valuation of Securities Office. Other invested assets should be required to be valued in accordance with the procedures promulgated by the NAIC's Financial Condition Subcommittee.
- Holding Company Systems: State law should contain the NAIC Model Insurance Holding Company System Regulatory Act or an Act substantially similar and the department should have adopted the NAIC's model regulation relating to this law.
- Risk Limitation: State law should prescribe the maximum net amount of risk to be retained by a property and liability company for an individual risk based upon the company's capital and surplus which should be no larger than 10% of the company's capital and surplus.
- Investment Regulations: State statute should require a diversified investment portfolio for all insurers both as to type and issue and include a requirement for liquidity. Foreign companies should be required to substantially comply with these provisions.
- Admitted Assets: State statute should describe those assets which may be admitted, authorized or allowed as assets in the statutory financial statement of insurers.
- Liabilities and Reserves: State statute should prescribe minimum standards for the establishment of liabilities and reserves resulting from insurance contracts issued by an insurer; including life reserves, active life reserves and unearned premium reserves, and liabilities for claims and losses unpaid and incurred by not reported claims. The Standard Valuation Law and Actuarial Opinion and Memorandum Regulation shall be in place.
- Reinsurance Ceded: State law should contain the NAIC Model Law on Credit for Reinsurance. Also the NAIC's Credit for Reinsurance Model Regulation and the 1992 NAIC Life and Health Reinsurance Agreements Model Regulation.
- CPA Audits: State statute or regulation should contain a requirement for annual audits of domestic insurance companies by independent certified public accountants, such as contained in the NAIC's Model Rule Requiring Annual Audited Financial Reports.
- Actuarial Opinion: State statute or regulation should contain a requirement for an opinion on life and health policy and claim reserves and loss and loss adjustment expense reserves by a qualified actuary or specialist on an annual basis for all domestic insurance companies.
- Receivership: State law should set forth a receivership scheme for the administration, by the insurance commissioner, of insurance companies found to be insolvent as set forth in the NAIC's Insurers Supervision, Rehabilitation and Liquidation Model Act.
- Guaranty Funds: State law should provide for a statutory mechanism, such as that contained in the NAIC's model acts on the subject, to ensure the payment of policyholders obligations subject to appropriate restrictions and limitations when a company is deemed insolvent. Sections 3A and 5H of the Life and Health Insurance Guaranty Association Model Act (dealing with persons covered by the funds) should be included.
- Participation in IRIS: State statute should contain a provision similar to the NAIC model act requiring domestic insurance companies to participate in the NAIC Insurance Regulatory Information System (IRIS).
- Risk Retention and Purchasing Groups: State law should contain a provision similar to the NAIC's Model Risk Retention Act for the regulation of risk retention groups and purchasing groups.
- Producer Controlled Property/Casualty Insurers: State statute should contain the NAIC's model law for Business Transacted with Producer Controlled Property/Casualty Insurer Act or a similar provision.
- Managing General Agents: State law should contain the NAIC (1990 or 1993) Managing General Agents Act.
- Reinsurance Intermediaries: State law should contain the NAIC (1990 or 1993) Reinsurance Intermediaries Act.
- Diskette Filings: State statute or regulation shall mandate diskette filings, including quarterly statements, for all companies. States may exempt those companies that operate solely in their state.
- Disclosure of Material Transactions: State law should contain the NAIC's Disclosure of Material Transactions Model Act.
* Other standards set regulatory practices and procedures, and organizational and personnel practices.
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KEY SOURCES OF ADDITIONAL INFORMATION
"Failed Promises: Insurance Company Insolvencies," Subcommittee on Oversight and Investigations of the Committee on Energy and Commerce, U.S. House of Representatives, February 1990.
"Insurance Failures," General Accounting Office, 1987 (GAO/GGD-87-100).
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