GUARANTY FUNDS

(March 2023)

Guaranty Funds are money pools authorized by state (usually insurance) regulators. They are created and maintained via monetary assessments from certain insurers that operate within that given state. The funds are used to reimburse policyholders and claimants of an insolvent insurer in that state.

Fund Purpose

Each state has a guaranty fund with a similar mission, which is to minimize the losses 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 which 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

Claims owed by insolvent insurance companies are paid from two primary sources: liquidation of defunct insurer assets and assessments from healthy insurers. 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

Related Article: Guaranty Funds Assessment Letter

Apply to certain lines of property and casualty business, such as auto, homeowners and small-sized commercial business (often Workers 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 (non-traditional entities such as captive insurers and risk retention groups are exempt from guaranty funds)
Are based upon a given insurer’s share of market in the lines of business that are subject to collections

Related Article: Guaranty Fund Assessments

Assessment Liability and Accounting

Insurers must financially assist impaired insurers. Assistance applies in every state in which the insurer operates. Therefore, this potentially substantial commitment has to appear in an insurer’s financial statements.

Information found in company statements should indicate the amount that the insurer has reserved for actual and accrued assessments. Further, such information should explain the percentages and/or premium amounts involved in building that account. These amounts appear as a liability. However, an insurance company may also set up an asset account consisting of any announced assessment refunds or related fee or expense returns.

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.

Related Article: Guaranty Funds Assessment Letter

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.

Example: One state’s insurance regulators declared ActNomore Insurance Company 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 ActNomore’s financial obligations.

Related Article: Guaranty Fund Challenges

The National Conference of Insurance Guaranty Funds

The National Conference of Insurance Guaranty Funds (NCIGF) 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 (Financial Analysis and Surveillance Tracking) 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.

Related Article: Guaranty Fund Definitions

The Monitoring Process

Most state insurance regulators have a detailed program for monitoring the insurance companies that operate in their state. They mandate financial reporting and use a variety of tools that allow them to ascertain a given insurer’s financial state. If done properly, a vulnerable company should be identified and steps be taken to address the situation. Typically, a well-established set of financial tests are available to assist in evaluating an insurer.

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 considers the overall risk level of the exposures held by a company. Therefore, it is perceived to be a more dynamic and accurate measure of an insurer’s financial position.

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 being used more often in handling impaired insurers.

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 (especially with new or different lines of business)
Improper reserving

Note: This is typically the most common cause of insolvency.

Insider activity
Inadequate or improper Reinsurance Agreements/Reinsurer Failure
Investment/asset valuation (overstatement) problems
Catastrophe Losses

Another issue seems ironic, but insolvencies may also be caused by overcapacity. In instances where too many financial resources are involved in the insurance market, pressures build to cut prices to carve out or to retain market share. This can lead to individual companies with insufficient resources to handle losses and, if the situation spirals downward, may fall into receivership and liquidation.

Guaranty Fund Issues

The National Conference of Insurance Guaranty Funds (NCIGF) continuously leads discussion on issues that may affect the viability of the state-level, guaranty fund system. Among the many issues that could have a serious impact are the following:

Limits on reimbursements on individual policyholder/claimant losses
May be counterproductive as, in some circumstances, a fund’s existence may encourage insurers to take excessive risks regarding premium growth
Process delays in accessing liquidated funds from insolvent insurer assets
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
The inability to hold companies financially responsible when business is transferred to another insurer via a restructuring and the latter entity becomes insolvent