GUARANTY FUND CHALLENGES

(March 2023)

Editor’s Note: This section was adapted from Critical Issue Report articles (by Phil Zinkewicz) in Rough Notes Magazine and other sources.

Insurance company insolvencies are addressed specifically by the state insurance guaranty fund concept. Under such funds, solvent insurers provide the financial assistance to handle the financial consequences of a failed insurance company. Ever since the guaranty fund system was formed, it has performed well.

Existing Fund Approach

 

 

Each state has its own guaranty fund to handle the claims of insolvent insurers. Guaranty funds are acquired via assessments on all the other solvent insurers doing business in that particular state. Seldom are the guaranty funds ever 100% reimbursed. Since the inception of the guaranty funds, the industry has been assessed billions more to pay the claims of insolvent insurers than it has recovered from the estates of such insurers (via the liquidation of their assets).

When guaranty funds were first designed, their structure and assessment capability were aimed at the "middle"- in other words, small to medium-sized insurance companies. State laws cap insurers' assessments at 1% to 2% of their premium volume in each state.

Related Article: Guaranty Fund Assessments

Guaranty funds usually apply to one of the following areas:

Insurers are assessed within each line to address applicable insolvent insurers.

Capacity Concern

Only a relative handful of insurers become insolvent in a given year. A.M. Best reported 14 property and casualty insurers that were seriously financially impaired in 2013 and 25 in 2012.  While the average number of companies that eventually fail is typically low, it does not take much activity in order to test the capacity of the nation’s guaranty funds.

The NCIGF made available the following information about the system’s largest insolvencies involving property and casualty insurers.

 

U.S. Ten Largest Insurance Company Insolvencies

Year

Insurance Company

Payments

Recoveries

Net Cost

(in millions, rounded up to nearest million)

2001

Reliance Insurance Company

2,868

1,752

1,116

2002

Legion Insurance Company

1,482

453

1,028

2000

California Compensation Insurance Company

1,105

354

751

2000

Fremont Indemnity Insurance Company

1,405

724

321

2001

PHICO Insurance Company

777

247

529

2006

Southern Family Insurance Company

719

324

395

1988

American Mutual Liability Insurance Company

587

256

331

1985

Transit Casualty Insurance Company

568

389

179

1986

Midland Insurance Company

553

88

465

2000

Superior National Insurance Company

538

 -

 

 

Note: The NCIGF site advises that these figures are not complete as it depends upon the accuracy and timing of reports submitted by its participating states. Also, the figures in this version are rounded, so additional errors appear.

Vulnerability to State Legislative Actions

All states except New York use post-event assessments for their guaranty funds. New York, which uses a pre-assessment approach, also illustrates a problem. Recently, its state legislature attempted to handle a serious budget deficit by voting to use the guaranty funds it had already collected for other uses. It then proposed making additional insurance company assessments to replenish the fund. The move was, after a huge public and insurer protest, reversed. However, the fact that funds may be subject to redeployment can cause problems. State governments continue to deal with a harsh economy and both assessment approaches as well as assessment ceilings could be changed based on legislative will.

Structure of Funds

In most states, funds are broken into the major groups of Automobile, Workers Compensation and All Other Lines. Likewise, assessments are made according to insolvencies that affect these lines. Some failures could involve insurers that operate in uncovered lines; in particular, surplus lines offered by specialty carriers that do not contribute to funds. However, a state would still have to find a way to deal with losses caused by such an insurer that fails.

 

 

Data Management

Increasingly, claim data held by insolvent insurance companies exist in a digital format. The guaranty fund system faces substantial costs in acquiring the ability to transform its current data management system. It will also increase the amount of resources needed to create and maintain an adequate level of information security.

Change in Insurer Regulation

Insurance companies continue to push for greater flexibility, efficiency and reduced costs that they believe could be gained by federal as opposed to state regulation. Those assertations aside, the question of federal versus state charters for insurers may substantially affect state guaranty funds. If federal chartering becomes an option, it will be important that such insurers be required to participate in state funds. The nature of an insurer’s charter does not change the fact that it has the potential to fail, endangering the protection of it policyholders in a given state. Further, they should also maintain their liability for assisting in the event that other insurers become insolvent. To permit otherwise would substantially weaken the ability of state funds to act as a financial safety net.

There is another option, creating a separate, federal guaranty fund. However, it would have to deal with issues of expense, administration, taxes and other areas. Further, it would be duplicative of a viable, existing, system.

Need For A Different Approach?

There are several possible solutions that might be considered for addressing fund concept challenges. One would be to raise the cap, either temporarily or permanently, on assessments insurers pay into the guaranty fund system. Another would be to move to a single account system, which would mean that all insurers would be responsible via assessments for an insolvent insurer, regardless of what line that insurer was writing.

AAI pointed out its opposition to these. The first approach, the Alliance says, would give state regulators incentive to delay decisive action with respect to a financially troubled insurer. "Why take quick action to declare an insurer insolvent and limit the fallout if the industry's assessments are subject to expansion to clean up the mess. In addition, many times 'temporary' increases in assessments become permanent."

As for the second approach, the Alliance says that it is unfair to assess insurers for insolvencies in lines they do not write. Rather, the Alliance supports an approach already in place in Rhode Island. This approach, says the Alliance, provides that money be borrowed among the guaranty fund accounts when there are capacity problems. The money borrowed must be paid back to the accounts--with interest--within 10 years.

"If, for example," says the Alliance report, "the workers compensation account is maxed out, the auto account can be assessed; but the funds generated are considered a 'loan' to the workers compensation account. Under this system, after 10 years, if the loan is not paid back through continual assessments on the workers compensation account, the loan is considered uncollectible; but companies may still obtain some tax benefits in terms of deductions for uncollectible debts."

Other ideas could include creating a federal fund (discussed above), adding laws that control how funds are used (to make them less vulnerable to plunder during state budget shortfalls), creating a federal fund that supplements state funds and expanding or creating state funds that handle surplus lines insurer insolvencies.