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| October 2008, Volume 22 |
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311.1GUARANTY FUNDS(January, 2008) Insurance Words (a product of The Rough Notes Co., Inc.) defines a guaranty fund as "an amount of money assessed certain insurers in a given state to reimburse policyholders and claimants of an insolvent insurer in that state.” The fund may be created before an insolvency occurs (pre-assessment, as in New York) or afterward (post-assessment). Fund
Purpose
Each state has a guaranty fund with a similar mission that is grounded in the concept of serving a public interest. Their purpose is to minimize the loss to their citizen policyholders that are caused by an insurance company’s inability to fulfill its obligation to provide ongoing insurance protection and/or to pay due claims. This common purpose is, typically, mandated by various state laws and they usually target the same niche of policyholders, personal lines and small business insureds. These groups are seen as the most vulnerable to insurance carrier instability; whereas large commercial insureds are perceived to be more capable of handling insurance-related crises without state government assistance. However, typically by default, guaranty fund payments are often made to address losses suffered by larger, commercial insureds. Assessments
Nearly all states
collect assessments from participating insurers on a post occurrence
(insolvency) basis. In other words, an assessment is made once a state has a
need for funds due to an insurer’s fatal, financial impairment creating an
obligation to its policyholders and/or claimants. While the details differ,
assessments generally: ·
Are initiated
via formal notices such as assessment letters ·
Apply to
certain lines of P&C business, such as auto, homeowners and small-sized
commercial business (often Worker’s Compensation is exempt) ·
Are based on
written premium ·
Are limited to
a given percentage of written premium (typically no more than 2%) ·
Only apply to
admitted/authorized insurers; further non-traditional entities such as captive
insurers and risk retention groups are exempt from funds ·
Are based upon
a given insurer’s share of market in the lines of business that are subject to
collections Coverage
Trigger
A state fund is
usually called upon to handle payments once the applicable state’s insurance
authority (commissioner’s office) formally determines and declares that a given
insurer is insolvent. Once that declaration is made, the state takes over
operations and management of the company. However, in some states, a mere
determination that an insurer is too impaired to handle its financial
obligations may be sufficient to initiate guaranty fund payments. Fund
Vulnerability
The largest problem
faced by any state’s guaranty fund is its vulnerability due to inadequate
resources. Regardless the state, insolvency of an insurer of any significant
size can easily deplete available funds and leave many unpaid obligations. The best and most
unfortunate illustration of this is the Reliance Insurance Company. Shortly
after the turn of the new century, Pennsylvania’s insurance regulators declared
the insurer insolvent. The insurer was placed in liquidation after several
months of effort by insurance authorities to salvage the operations. The
failure of the regional insurance company set off negative financial dominoes
throughout the insurance industry. The unprecedented
level of claims forced high assessments to help cover Reliance’s financial
obligations. In fact, the year that Reliance and several other insurers were
placed into liquidation still marks the highest level of nationwide assessments
recorded in the past 25 years. For more
information, please refer to PF&M Section 311.1-5, Guaranty Fund
Challenges.
The
National Conference of Insurance Guaranty Funds
This organization
(NCIGF for short) promotes research, cooperation and uniform standards to
assist state and regional organizations that administer guaranty funds. The
NCIGF urges the development and adoption of risk based capital (RBC) standards
as well as the F.A.S.T. method for evaluating insurer financial health. Most state guaranty
funds enabling legislation and subsequent program structure are modeled on the
act developed and promoted by the NCIGF. Headquartered in Indianapolis, IN, it
is not a lobbying organization, but it does champion the concept of public
guaranty funds, including spurring public discussions on issues that affect the
purpose of guaranty funds and insurer solvency. For more information, please
refer to PF&M Section 311.4, Guaranty Fund Definitions.
The
Monitoring Process
In general (and
simplified) terms, the process a state goes through with monitoring property
and casualty insurers involves the following: ·
Collecting
annual financial statements from all insurers ·
Examining the
information and, using some selection basis, running key information through a
set of financial tests ·
Evaluating information
on insurers with financial statements that raise warning signals ·
Perform audits
on selected companies ·
Depending Upon
Audit Results: - Let the company operate as usual (if audit results are positive) - Create a program of corrective action (typically requiring quarterly
or monthly financial reports instead of annual) - Follow-up on corrective action - If situation deteriorates, consider more drastic action ·
Place company
under conservatorship ·
Attempt
rehabilitation (if conservatorship does not work or if rehab is selected
instead) ·
If
rehabilitation fails, consider finding the company insolvent ·
If applicable,
issue a Final Order of Liquidation ·
Liquidate the
insurer’s assets and use it to fund insurer’s obligations ·
Collect
assessments to fund any shortfall Monitoring
Tools
As already
mentioned, state regulators receive insurer financial statements each year.
These statements are often evaluated against a set of tests. One test standard
is the Insurance Regulatory Information System (IRIS) ratios. It consists of 11
(P&C insurers) or 12 (Life insurers) ratios that can be developed using any
insurer’s financial statement data. The ratio results can be compared to
established, benchmarks that may indicate financial problems. The ratios are:
Generally, failure
to meet benchmarks of four or more ratios is an indicator that the applicable
insurer may be having financial problems. Corrective action then takes place,
such as more frequently reporting and evaluating subsequent financial data
and/or insurance audits. Risk
Based Capital Standards
While use of
financial tests is quite helpful with identifying problems, evidence arose that
the method, without other tools, was still inadequate for monitoring insurers.
After years of effort, the NAIC instituted risk based capital standards or RBC.
This method is seen to be an improvement since it is more dynamic. For more
information, please refer to PF&M Section 311.3, Monitoring Insolvencies –
Risk Based Capital.
Run
offs
This is an
alternative to the use of guaranty funds. Under a run off, a company is kept in
active operation, but it no longer processes new business or renewals. The goal
is to dispose of business in an orderly fashion, without triggering guaranty
funds reimbursements or assessments. Run offs are becoming an increasingly used
method to deal with impaired insurers. For more information, please refer to
PF&M Section 311.6, Run Offs.
Major
Reasons for Insolvencies
Various studies reveal that the largest factor in insurer insolvencies tends to be some form of mismanagement. Typical reasons include: ·
Fraud
(including falsified reports, concealing or altering key information, etc.) ·
Uncontrolled
(rapid) expansion ·
Improper
assignment of underwriting authority ·
Inadequate
pricing ·
Lack of
management expertise ·
Improper
reserving ·
Insider
activity ·
Inadequate or
improper Reinsurance Agreements Current
Guaranty Fund Issues
The National Conference of Insurance Guaranty Funds (NCIGF) takes the lead on the discussion of issues that may affect the continued viability of the state-level, guaranty fund system. Today, there are a number of issues that will have a serious impact, including the following: ·
Limits on
reimbursements on individual policyholder/claimant losses ·
Caps on
maximum assessments made against individual insurer ·
Clarifying
model legislation on eligibility of commercial policyholders/claimants ·
Reaffirming
the inability of receivers (controlled insurers) to question guaranty fund
payment decisions
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