Capital Market Investment Opportunities in Insurance Insolvency And Their Impact on Consumers

By Mark D. Steckbeck and Roger H. Schmelzer

There is growing interest among insurance regulators in finding market driven solutions to address the problems of troubled companies. Regulators are showing less interest in placing troubled insurers into liquidation, and troubled insurance companies seem to present investment opportunities for the capital markets.

These propositions were central to an in-depth series of panel discussions on capital markets investment opportunities at “Emerging Investment Opportunities: Bridging the Gap between the Capital Markets and Troubled Companies” hosted by the International Association of Insurance Receivers (IAIR) in October 2007. The one-day program explored the potential use of funding from the capital markets to address some of the issues and potential solutions to the serious financial challenges facing troubled insurance companies.

The program included insurance commissioners, reinsurers, attorneys and investment experts from the U.S. and abroad. The panels offered insights into the possible use of investment capital to assist regulators in their efforts to rehabilitate or runoff troubled insurers; it also reviewed the restructuring mechanisms available in other countries. In addition, the program examined some of the critical considerations and impediments potentially associated with these challenging investment opportunities. This paper summarizes highlights from these discussions.

Capital Market Opportunities in Troubled Insurance Companies. The first panel of speakers (Christopher Flowers of J.C. Flowers & Company, New York Insurance Superintendent Eric Dinallo and Forrest Krutter of Berkshire Hathaway) examined some of the issues and opportunities for investing in troubled insurance companies in the segment.

Flowers observed that while there is a growing appetite for investment opportunities, special challenges face potential investors in property and casualty liabilities, chiefly the need for adequate potential returns to interest investors.

There must be reasonable predictability of the investment returns, explained Flowers, adding this is something that is difficult to achieve with property and casualty claims in general, but especially so with the involvement of asbestos and environmental claims and natural disasters. Flowers went on to explain additional uncertainty is found where key assumptions used to evaluate company liabilities can be unexpectedly changed, for example, re-opening the statute of limitations on previously expired tort claims.

Another challenge facing investors is the high cost of collateral. Collateral posted by investors to cover property and casualty liabilities must be invested safely, which may limit the investor to relatively safe but modest investments. To an institutional investor seeking returns in the range of 20 percent, a five percent return on a treasury note is significantly below his required return threshold.

Structural Impediments Facing U.S. Investors. The second panel examined some of the structural impediments facing U.S. investors that are different from those faced by investors in troubled companies in Great Britain. The panel included Paul Dassenko, of azuRe Advisors, Inc., Oliver Horbelt formerly of Centre Group of Companies, Richard Whatton of Independent Services Group and Tim Graham, LaSalle Re.

Although both systems recognized the importance of making timely payments to policyholders and claimants, the comparison generally stopped there. While the U.S. system strongly favors policyholder protection, the British system would seek ways to bring finality to a company’s affairs, including its liabilities, thereby allowing investors to salvage part of their investment, and if possible, return at least some portion of their capital to the market.

For an institutional investor seeking an investment opportunity, the U.S. system creates several barriers. First and foremost, investors want to make money. With no benchmark for success acceptable to the regulators, investors may not be interested.

Second, there is a general lack of quality information to enable investors to evaluate troubled insurance companies. Additionally, there are a number of pitfalls for investors. These include a lack of understanding of the liability side of policy risks. Investors want to be able to extract their money quickly to pursue other investment opportunities. This may not be possible where the company has long tail exposures. Investors would want to accelerate liabilities in order to outrun adverse development. However, this approach would run contrary to the U.S. system’s strong preference for placing the interests of policyholders and claimants above the interests of investors.

Evaluating the Investment. In “Straight Talk from the Street,” the third panel addressed some of the key factors used by private equity investors when evaluating private investment deals. The panel included Bart Zanelli of Guy Carpenter, David Platter of Credit Suisse, Martin Alderson Smith of The Blackstone Group and Bill Goddard of Bingham McCutchen.

Time horizon. Private investors seek investments with a three to six year exit strategy. This strategy is at odds with the long-tail nature of property and casualty liabilities.

  • Potential rate of return. Equity investors are seeking investments that offer solid returns in the range of 20 percent for investment in a healthy company. To offset the greater risks associated with investment in a troubled company, investors may require expected returns as high as 30 percent. Returns of this magnitude may not be either achievable or politically palatable where a company is in the hands of a regulator and other creditors are receiving cents on the dollar. Investors are also concerned about reputation risk when they participate in deals that might draw damaging criticism.
  • Time and money required to close a deal. The longer it takes to close a transaction and the more money that must be spent, the less attractive the deal. This might occur where regulators are required to address objections or offer public hearings before approval is granted.
  • Difficulty in quantifying the level of investment risk. As the risk becomes less quantifiable, investors require greater returns or they will look for other opportunities. Finally, investors want to maintain at least an adequate level of control over the risks affecting the return on investment. Given the unpredictable nature of asbestos and environmental claims, natural disasters, and the ever-changing legal environment, it remains a challenge to control the risk factors affecting investment returns.

The panel examined how investors and regulators could close the gap on some of these obstacles. Four key elements to success were identified: the first issue is transparency. Parties must identify all issues and problems and exchange information to permit full evaluation of the transaction. Next, parties must have an open dialogue. The parties must identify and address all transactional elements including taking care of policyholder concerns and the investor’s profit expectations. Third, the value proposition for the transaction must be identified: all reasons for the company’s distress must be disclosed and all constituents must be represented at the bargaining table. Fourth, individual egos and private agendas must take a back seat to the transaction’s success.

Additional challenges facing potential investors include a poor institutional memory of the target company. By the time the trouble company is entertaining potential investors, many of its more experienced and knowledgeable employees have already departed. Another challenge is the inability to quickly access good quality information regarding the company’s operations and financial condition. There are also fragmented demands being made upon the company or the regulator from multiple constituents. Managing and reconciling these demands with regulatory imperatives while attempting to structure an investment deal adds another layer of complexity and cost. Moreover, there is no organized secondary market for the sale of troubled insurance companies. Without an established market, the transaction costs are higher. Finally, parties to the transaction must deal with fragmented claims. Stakeholders with competing interests each seek individual relief. Parties must find fair and effective ways to address these interests in order for the deal to proceed.

Regulatory Issues. The regulatory panel included Commissioner Al Gross of Virginia, Commissioner Thomas E. Hampton of D.C., Director Michael McRaith of Illinois, Deputy Commissioner Michael L. Vild of Delaware and Peter Gallanis, President of the National Association of Life & Health Insurance Guaranty Associations.

Mr. Gross stated his belief that insurance company receiverships should be managed with four principles in mind. First, policyholders have the right to have their claims paid timely and in accordance with their insurance contracts. Second, policyholders have the right to be protected against market abuses, for example, they should retain the protections that were granted by the state’s unfair claims settlement practices act. Third, claimants must be treated equitably. Fourth, the receiver is responsible for maximizing the value of the estate for the benefit of policyholders and other claimants.

Director McRaith believed that states are doing a better job of monitoring the financial condition of companies. He believed that if properly supervised, runoffs can benefit customers by avoiding some of the frictional costs of liquidation.

Deputy Commissioner Vild spoke of the desirability of early intervention on the part of regulators. He believed that the desired three to six year ideal investment horizon may not always be available and stated that he would be receptive to seeing proposals that addressed the issue of the investor’s withdrawal strategy up front. He further emphasized the need for transparency and full disclosure.

What Does the Future Hold? The final panel consisted of Howard Mills, Deloitte & Touche USA (and former New York Superintendent of Insurance), Nigel Montgomery, Sidley Austin and Chris Stroup, Wilton Re. The panel was asked if members expected to see an increased level of interest in investing in troubled companies by the capital markets. After summarizing some of the comments and themes voiced by the earlier panels, the presenters stated that the primary goal must be to protect consumers while still offering opportunities for investment of capital.

There is no one-size-fits-all approach to addressing the problems with troubled companies. Each company is unique and must be evaluated on its own merits. On the balance, however, the panel members did not expect to see a high level of interest by the capital markets in making investments in insurance company rehabilitations. For the capital markets to be interested in investing in troubled insurers, the insurance industry must be able to end runoffs within a reasonable timeframe.

NCIGF Analysis. The NCIGF suggests that the primary purpose of any alternative approach to insolvency be protection of the public from financial loss.

The state-based property and casualty guaranty fund system affords covered claimants a statutory remedy in the event of insolvency – many claims of the average consumer are paid in full. Based on existing state liquidation statutes and priority distribution laws, the needs of consumers, who are generally unsophisticated in insurance matters, are placed ahead of nonpolicyholder claimants and everyone with the same level or type of claim is treated equally.

It is imperative to know how and to what extent fundamental consumer protections would be affected under any alternative to outright liquidation. Would policy claims be reduced below their contract value in certain scenarios without the consent of claimants? Would consumers still receive timely payments, the full benefit of their insurance contract, fair treatment in the claims settlement process and availability of a meaningful claims appeal process? All of these are protections afforded in a traditional liquidation administered under existing state law. If they are not maintained, exactly what is the public policy objective in support of such a change?

Property and casualty insurance is a necessary ingredient to development of a civilized society by impacting the ability of commerce to develop and flourish within a free market economy. It is a contractually specified and validated agreement to transfer risks tied to virtually all personal and business investment decisions. This in turn allows individuals and businesses to confidently manage their risk and make investments, important actions that spur economic growth.

Legislators and regulators have already established the guaranty fund system to make good on the insurance promises of failed property and casualty companies by providing at least a partial remedy for insurer insolvency. That remedy retains the sanctity of the insurance contract by affording a measure of protection to those claimants state legislatures have deemed most in need of protection. Any decision to modify the existing level of consumer protection should be undertaken with the utmost of thought and deliberation.

The Fruits of Cooperation: Joint Receivership, Guaranty Funds Effort Set To Streamline Insolvency-related Financial Reporting

By Jim Hamilton
Vice President of Claims Systems, Home Insurance Co in Liquidation and member of the NAIC UDS Technical Support Group and the NAIC UDS Financial Technical Support Group

Mark Might
Vice President of Internal Operations, Ohio and West Virginia Insurance Guaranty Funds, and Chairman of the NAIC UDS Technical Support Group and the NAIC UDS Financial Technical Support Group

Sometimes it seems that a world of difference divides the receivership and guaranty fund communities. Look a little closer, though, and you’ll see these two groups often share a common cause.

Understandably, there can be great disparity of opinion between the “two houses” of the insolvency structure. But it is also true the groups share a spirit of cooperation that often brings measurable benefits to the system.

The fruits of this cooperation are evident in the National Association of Insurance Commissioners’ (NAIC) adoption last year of a new version of the Uniform Data Standards (UDS) D-record. The adoption capped years of diligent and dedicated work by the members of the NAIC UDS Technical Support Group (UDS TSG) and the NAIC UDS Financial Technical Support Group (UDS FTSG). The members of these groups included claims, IT and financial professionals from the receiver and guaranty fund communities.

Upon implementation on January 1, 2009, the revised D-record will provide a uniform method of presenting quarterly guaranty funds’ financial data to receivers. It will contain information on losses, loss adjustment expenses, other administrative expenses and revenue amounts received from an inception to date, year-to-date and quarter-to-date perspective. Also included is a feature to address large deductible data as well as other enhancements.

The D-record will bring to insolvency-related financial reporting greater uniformity and standardization, better efficiency and related cost-savings, and will help strengthen and streamline the insolvency system that has protected tens-of-thousands of policyholders and claimants over the years.

Prior to any uniform data standards, processing claims for both guaranty funds and receivers was cumbersome and labor intensive. It required manual input of information from original claim files, had no standardization of forms; also there was no specified reporting timeframe. For receivers, the lack of a standard format meant that processing claims information from the more

than 50 property and casualty guaranty funds was often a heavy-lift exercise in shifting mountains of paper and key stroking claims data into a database. Every receiver was left to negotiate the best they could with guaranty funds about what to report and reporting frequency. For guaranty funds, the lack of a standard format brought other challenges: they had to report payment and reserve data in as many different formats (mostly hard copy) as there were estates.

Members of the UDS TSG originally tried to promote UDS as the format of choice in the early 1990s. The initial intent was to use the protocol to efficiently transfer claims data only. The volume of data generated by the spate of large, multi-state insolvencies a few years later showed receivers and guaranty funds the value of finding ways to efficiently gather data receivers needed to bill and collect from reinsurers. The claims protocol, the C-record, was successful, and prompted a growing consensus that it was time also to standardize financial reports; this in turn led the UDS TSG and UDS FTSG to take up development of the D-record.

The NAIC’s adoption of the D-record is an important success; it underscores the fact that guaranty funds and receivers can and often do work together to develop solutions that enable the system to better and more efficiently serve policyholders and other receivership creditors. For receivers, the D-record facilitates compilation of financial data from the various guaranty funds. The receiver uses the D-record as a control mechanism and reconciliation point with the claims detail in the C-record, plus it is the only method for reporting guaranty fund administration expenses and other revenues not included in the C-record. It also speeds up reconciliation with the claims detail in the C-record. In addition, the D-record facilitates the review and analysis of individual guaranty funds Proofs of Claims and claim servicing expenses. The upgrades also reduce expenses of guaranty funds and receivers by automating what had been a costly and tedious manual process of transmitting financial information between funds and receivers.

The revised D-record brings added efficiency and uniformity to insolvency financial reporting by replacing the various forms of hard copy reporting receivers used in the past, including financial information questionnaires (FIQs), with a uniform financial report that can be filed via hard copy or electronically. This creates a standardized system of reporting with which receiver and funds are familiar. It is an important step in the ultimate goal of users migrating to full electronic filing capability.

For guaranty funds, the D-record standardizes reports, eliminating the past situation where they might be asked to complete different reports to provide the same information to various estates. It also leverages the speed and cost advantages of automation; it speeds up the preparation and issuance of financial reports, and it reduces manpower needed to compile reports while increasing accuracy.

As the D-record came to fruition, the National Conference of Insurance Guaranty Funds (NCIGF) created Secure UDS (SUDS), a secure electronic clearinghouse for UDS data exchange between receivers and guaranty funds. Prior to SUDS, many organizations transferred their UDS files in unencrypted and unsecure methods such as email, postal mail, and FTP (File Transfer Protocol). While these methods have been reliable in the past, the recent changes in security and compliance laws led the NCIGF to reevaluate how its members send sensitive, non-public personal information such as names, addresses, and social security numbers. 1

SUDS delivers a range of benefits. It provides a secure means by which guaranty funds and receivers transfer claims data in a manner that protects sensitive personal information from interception, theft, and unauthorized access. It also offers a single standardized point of data exchange between receivers and guaranty funds. The NCIGF makes SUDS available to receivers and guaranty funds at no cost.

Coinciding with the rollout of the D-record, the UDS TSG and UDS FTSG is undertaking a new UDS training program for the guaranty fund and receivership communities. The goal is to increase the general understanding of the D-record and UDS overall through a new generation of on-line, modular and interactive UDS and SUDS training materials.

In addition to the obvious educational benefits these materials will bring to UDS users, the materials will help promote uniform UDS reporting practices and help users gain maximum benefit from the tools. Development of the training materials, which is being overseen by the UDS TSG and UDS FTSG, draws on the expertise of UDS experts from the guaranty fund and receivership communities. Target completion of the D-record portion of training is August; the remainder of the project will be completed in 2009.

At the end of the day, a key part of the D-record success lay in the fact that the UDS TSG and UDS FTSG was made up of receiver and guaranty fund representatives. These professionals know first-hand the mutual advantages that arise from taking a joint, solutions-based approach to addressing issues.

Indeed, the effort is something of a casebook example of the benefits that come when the receivership and guaranty fund communities work together. The UDS TSG and UDS FTSG knew early on that if the D-record was to succeed, the effort had to be spearheaded by receiver and guaranty fund representatives. It is the front-line claims, IT and financial professionals from receiverships and guaranty funds on the UDS TSG and UDS FTSG who are best-placed to recognize the benefits of uniformity and standardization the D-record and UDS overall.

If the D-record’s adoption has accomplished nothing else, it has shown the value of good communication between the receivership and guaranty fund communities. Those of us who have served on the UDS TSG and UDS FTSG committees have seen first-hand the mutual benefits that arise when a spirit of unity and cooperation guides an effort and issues are resolved openly through good communication.

In the final analysis, electronic systems such as UDS allow guaranty funds and receivers to save time, effort and resources while allowing us to bring new levels of uniformity and accuracy in reporting. For some there are initial “birthing pains” associated with adapting to these changes. However, the overall capabilities and mutual benefit brought to receivers and guaranty funds alike make it well worth the investment of time and resources.

Admittedly there are – and always will be – differences of opinion between guaranty funds and receivers. But the successful adoption of the D-record clearly shows what can happen when differences are set aside in favor of exploring what will work best for all.


1Portions the foregoing text is drawn from “UDS Overview” prepared by Dale Stephenson. The authors thank Dale for contributing this material.

The authors would also like to thank the members to the UDS Technical Support Group and the UDS Financial Technical Support Group whose talents and dedication have done so much to improve insolvency reporting.

Members of the UDS TSG and UDS FTSG groups are available to answer questions about UDS, the D-record and related issues. The group invites readers to e-mail questions to the UDS Help Desk at

Recent Insolvency Activity Indicates Guaranty Funds Provide Extensive Coverage on Commercial Line Claims

By Kevin Harris

The property and casualty guaranty funds know better than anyone that the increased insolvency activity that occurred starting in the late 1990s resulted in a record payout for the guaranty funds. The vast majority of this work for the guaranty funds arose from the insolvency of insurers that wrote primarily commercial lines business such as workers’ compensation, liability and commercial auto. An analysis of the data for this recent period provides a good opportunity to address some lingering questions concerning the property and casualty guaranty funds, and the extent of coverage they provide on these commercial lines claims.

This paper explores and explains some rather surprising conclusions suggested by a review of this data: first, the recent high level of claims activity further establishes that the guaranty funds, in fact, do provide extensive coverage on commercial lines claims, second, guaranty fund claims comprise the vast majority of policyholder class claims even in insolvencies involving commercial lines carriers, and finally the recent high payout indicates that a significant portion of related costs may be borne by personal lines insureds.


The latest batch of insolvencies caused the busiest period ever for the guaranty funds. This recent period was somewhat unique in that the vast majority of the payout was driven by a small number of large commercial insurers that for the most part wrote workers’ compensation insurance. Exhibit A lists the 10 largest 2000-05 insolvencies along with their respective payouts. (While only 10 insolvencies in total are listed here, a number of these insolvencies actually involved groups of affiliated insurers. The 10 items listed here actually involved the insolvencies of almost two dozen individual insurers.) Seven of these insolvencies wrote workers’ compensation as a major or exclusive line of business. Two wrote personal lines in Florida, and one wrote medical malpractice coverage.

Things got rolling with the insolvency of the Superior National companies in 2000. A total of five different workers’ compensation insurers were a part of this group, for which most of the responsibility came to rest with the California Insurance Guarantee Association. Reliance Insurance Company, the largest property and casualty insolvency to date, followed in 2001. The total payout to date through 2005 for these 10 insolvencies represents 84 percent of the total net payout that occurred during this period, and already comprises 35 percent of the total net payout on an inception-to-date basis. If payout for the personal lines insolvencies is excluded, the remaining eight commercial lines insurers still accounted for 79 percent of the total net payout for 2000-05. What is somewhat surprising is that these recent insolvencies already by themselves comprise a significant component of guaranty fund payout even though the data represents only the first few years of activity.

This recent period in which commercial lines claims dominated payout provides some interesting and rather surprising new information concerning the guaranty funds’ extent of coverage and level of protection provided to commercial insureds.

Guaranty Funds’ Coverage of Commercial Lines Claims

The guaranty funds published late last year the first-ever comprehensive review of guaranty fund expenses. The review, which compared guaranty fund and industry expenses, provides extensive information on guaranty fund and insurance industry claims activity by line of business, albeit for a smaller four year slice of the recent busy period – 2001-2004. The review nonetheless proved to be quite informative and relevant.

The data developed in connection with the review indicates heavy payout on commercial lines claims. The study reported that guaranty funds paid in total for 2001-04 claims of $6.1 billion and LAE of $1.1 billion, for a total of $7.2 billion. A total of $6.8 billion, or 94 percent of the total payout was on claims involving commercial lines. Two thirds of total payments related to workers’ compensation claims.

The latter is significant if for no other reason because it indicates a very significant flow of policy benefits to commercial insureds. This is true despite the fact that the guaranty fund laws of well over a majority of the states (in number) limit coverage of commercial lines claims through some combination of provisions that establish independent filing deadlines for claims (“bar dates”) or limitations based upon the net worth of the insured.

Admittedly, one challenge that almost always exists in analyzing insolvency data is that we only have part of the picture. We have data on the claims the guaranty funds actually cover, but we don’t really know much about claims they don’t cover. Not surprisingly, guaranty funds do not maintain data on claims they don’t pay. Most receivers, while responsible for evaluating all policyholder claims, don’t publish any such data. Many receivers would likely say that they don’t know the extent of non-covered claims because claims have not adequately developed. The obvious question is: how can we actually know how much guaranty funds actually cover if we don’t have any data on what they don’t cover? This practical difficulty has in the past usually frustrated any kind of meaningful analysis in this area.

hings may be changing. The Reliance liquidation, discussed below, may prove to be an important exception to the above rule.

Interestingly, the “line of business mix” of guaranty fund payments differs dramatically from the industry, as indicated by the expense review data, and tends to further establish that guaranty funds do in fact protect commercial insureds. For the insurance industry, according to the expense review data, commercial lines claims comprised only 52 percent of total payments (personal lines account for the remaining 48 percent), in contrast to the guaranty funds’ 94 percent. Again according to data from the expense review, workers’ compensation only represented 9 percent of total payout, in contrast to guaranty funds’ two thirds of total payout.

Does a 6 percent payout on personal lines mean something is wrong? Probably not. Statutory limitations that require all other applicable coverage by solvent insurers to first be exhausted likely significantly reduced guaranty fund payout on at least personal auto claims. Further, the nature of the business written by insolvent insurers themselves would tend to result in relatively low payout on personal lines claims.

There may be some good reasons for the significant differences in guaranty fund and industry claims profiles when viewed in the aggregate that would make it difficult to draw any conclusions from the above. Although Reliance, Aries and American Superior each presented personal lines exposure, these insolvencies together with the others probably don’t present a mix of business that is representative of the industry’s mix when taken as a whole, so overall comparisons may have limited value.

However, Reliance when viewed on its own does provide some interesting information concerning the guaranty funds’ coverage of commercial lines claims.

Reliance Data Provides Further Evidence of Guaranty Funds’ Extensive Coverage of Commercial Lines Claims

The liquidator of the Reliance estate has done a very commendable job of publishing financial data that in many respects is quite extensive. Quarterly financial reports are filed with the receivership court, and can be found at This, together with the availability of pre-liquidation loss reserves for Reliance, permits a new kind of analysis to be done with respect to the extent to which policyholder claims are covered by guaranty funds.

The last year in which Reliance filed annual statements was 1999. The annual statement data for that year indicated that on a consolidated basis, total loss reserves including IBNR on direct business gross of reinsurance and excluding surplus lines totaled $4.7 billion. This amount represents the closest proxy for overall guaranty fund exposure that can be found in an annual statement.

According to the Reliance liquidator’s most recent status report, the guaranty funds in total have paid out through June 30, 2007 a total of $2.4 billion in losses and LAE, with $1.8 billion in Loss/LAE reserves for total of $4.2 B in paid/incurred. The liquidator so far has allowed $391 million in other (non-covered) policyholder level claims. This means that in terms of pre-liquidation reserves, guaranty fund paid claims and reserves comprise 89 percent of the total. When guaranty fund paid/incurred is combined with non-covered claims so far allowed by the liquidator, the resulting total of $4.6 billion comes surprisingly close to total pre-liquidation reserves. This tends to indicate that guaranty funds have paid or will pay an amount equating to roughly 90 percent of the company’s pre-liquidation reserves for its entire book of direct, admitted business. This provides some support to indicate that guaranty funds are covering the vast majority of policyholder claims.

Granted, there are limitations in this comparison. Troubled companies are notoriously under-reserved, and Reliance was probably no exception. Further, the comparison does not consider that bar dates vary from jurisdiction to jurisdiction. Some guaranty associations are required to continue to honor certain new claims that may be reported. Therefore, guaranty fund incurred claims will continue to grow. However, and conveniently, each of these factors would tend to cancel the other out.

Also, the liquidator has only evaluated 36 percent of policyholder proof of claim filings. This would tend to drive up the non-covered portion. However, even if the non-covered portion were “grossed up” to estimate fully developed non-covered claims ($391 million divided by 36 percent), the resulting non-covered component would represent only 20 percent of total policyholder claims, meaning that guaranty funds would cover the remaining 80 percent.

While the above could not be considered a definitive analysis, it does shed some light on the extent of coverage actually provided by the guaranty funds for all admitted business of a commercial lines insurer. It would be interesting to expand the analysis to some of the other insolvencies, to the extent such data could be made available, to see if they provide the same result. Significantly, the above comparison uses a very simple, objective approach and hard data from at least the post-liquidation side.

It is important to note that the three largest states in terms of gross guaranty fund payout, California, New York and Florida, do not have one or both of a net worth or bar date provision. The three states together made 62 percent of the total 2000- 05 net guaranty fund payments nationwide. While it may be likely that this alone had a significant impact on the overall extent to which guaranty funds covered policyholder claims, it would not change the bottom-line result that significant coverage, in fact, existed.

Despite various statutory limitations on coverage, it appears that, based upon recent data, guaranty funds are providing quite extensive coverage on commercial lines claims. Yet the guaranty funds’ statutorily prescribed method of passing on costs for paying these claims places a heavy burden on personal lines insureds.

Over 50 percent of inception-to-date guaranty fund costs are recouped by means of the inclusion of a factor in premium rates. In most of these states for assessment and recoupment purposes, three accounts are used. The workers’ compensation line has its own separate account. Personal auto premiums are mixed with commercial auto premiums in the auto account, and homeowner premiums are mixed with non-auto/non-workers’ compensation commercial lines premiums in the “All Other” account. In a small number of these states, there are no separate accounts, meaning that all premiums are mixed together for assessment and recoupment purposes. The effect in either case is that non-workers’ compensation commercial lines claims costs from these recent insolvencies were passed on to both commercial lines insureds and personal lines insureds. Given that personal lines premiums would have represented over half of total non-workers’ compensation premiums written, and that $2.4 billion in non-workers’ compensation commercial lines claims costs were involved, the likely result is that a substantial portion of the cost associated with the significant non-workers’ compensation commercial lines claims payout was borne by personal lines insureds.

It may be worthwhile to consider a more in-depth study concerning the extent of the guaranty funds’ coverage of commercial claims. If receivers from some of the recent large insolvencies would be able to provide the same kind of data that the Reliance liquidator has seen fit to regularly make public, it would enable us to develop a broader-based analysis. If in fact guaranty funds are paying most commercial lines claims, as the above tends to suggest, this is a matter that should be communicated to policymakers and other interested parties.

Remaining Ready: Preparedness is the Key to Effective Insolvency Management by the Property and Casualty Guaranty Fund System

By Barb Cox and Nick Crews
National Conference of Insurance Guaranty Funds

If the high insolvency activity of the early 2000s 1 confirmed anything, it showed a need for a prepared guaranty association system. For a state guaranty fund—just as it is for the local firehouse—future effectiveness exists in direct proportion to the degree of preparedness it maintains. Standing ready to deal with the next insolvency, or series of insolvencies, is basic to the property and casualty guaranty fund system’s continued ability to deliver on its statutory charge of paying the covered claims of policyholders and claimants quickly and efficiently, thereby preserving the sanctity of the insurance contract.

Preparing for future insolvencies: the guaranty association rapid response. After a company is declared insolvent, state guaranty funds step into the shoes of the failed insurer and immediately begin paying covered claims.

But the ability of the guaranty fund system to perform its statutory mandate to pay claims promptly requires that guaranty associations be prepared to respond quickly when new insolvencies – expected or not – occur. Moreover, the state guaranty fund system must work within the confines of the structure and business practices of the insolvent company to ensure a smooth transition to the state funds of their claims handling function.

The liquidation of the Reliance Insurance Company in October of 2001 illustrates just how suddenly insolvency can hit. It also provides a compelling “case study” of how preparation can ready guaranty associations to manage the challenges of a major insolvency.

Prior to the Reliance liquidation, the guaranty associations and the Pennsylvania regulator had worked together to closely monitor the situation and prepare for a possible liquidation. However, among the fallouts of September 11, 2001 was a disruption of ongoing reinsurance collections by Reliance that were critically important to its cash flow.2 The disruption was the death knell for the company; within weeks, the Pennsylvania Court ordered its liquidation. Fortunately for policyholders who awaited payment of outstanding claims against the company the property and casualty guaranty funds had invested both their professional talents, skills and coordinated efforts to prepare for this sudden and unpredictable event.

Groundwork performed by the guaranty fund system prior to the Reliance insolvency did much to help the system respond quickly in the weeks following the failure. Experienced professional guaranty association staffs provided a depth of institutional knowledge for the intense work of the insolvency. Also enabling the system to bear up under the taxing demands of Reliance was Uniform Data Standards (UDS), an electronic communication protocol with defined computer file formats allowing a fast and efficient reporting of policy and claim information. The standardized reporting that UDS provided was developed in 1995 and allowed the funds to “hit the ground running” in a period of unprecedented claims volume. In addition, state statutes had been updated in key areas – specifically regarding net worth and bar dates.

The demands of the Reliance insolvency were daunting: the liquidation required that more than 80,000 claim files be moved to the guaranty funds. The guaranty funds were ready, due in large part to pre-Reliance investment in facilities, information technology resources and its proactive efforts to develop and maintain core professional staffs of claims adjustors, coupled with uniform standards for communicating claim and policy information.

The scope and magnitude of the Reliance insolvency and its sudden liquidation is not typical. However, Reliance clearly showed that effective preparation for unknown “short-fused” insolvencies is essential. It also showed this level of preparedness is only possible when the guaranty fund system strategically works to maintain a state of readiness.

“Working to remain ready” with a core professional guaranty association staff. Guaranty fund staffing generally contracts and expands depending upon the number of claim files a particular fund has under review. However, even in times of relatively light insolvency activity, state funds must maintain core professional staffs; there is a certain staffing level under which it would be unwise to fall. By maintaining adequate staffing, funds ensure continuity of practice and institutional knowledge of systems, laws and policies and the ability to train newly hired staff when activity increases. Standing professional staffs serve as repositories of important guaranty fundrelated information, and encourage positive working relationships with receivers. It is the foundation on which the work of a state guaranty fund rests.

A standing, professional guaranty fund staff is also essential because often, the last few, usually older, claims are the most complex and offer the highest potential for litigation. In addition to supporting ongoing claim activity, staff must pursue and report subrogation recoveries, and prepare and file claims and other reports with the estate’s liquidator, necessary actions to marshal the reinsurance recoveries that reduce company assessments. These and other tasks exist over the life of an insolvency – a period that can extend 20 years or more.

Preparing for the next insolvency in the constantly evolving insurance environment. While the insurance industry is dynamic and ever-changing, the central charge of the guaranty fund system is not; covered claims must be paid efficiently notwithstanding insolvency’s challenges or complexities.

State guaranty associations were formed in the late 1960s around the principal that the insurance contract into which a consumer enters should be honored within defined limits as a matter of public policy. Relief was intended for insolvencies of companies that, at that time, wrote mostly personal line policies in single states. Insolvencies of these companies tended to be generally smaller and simpler, and were easier to administer. The most common claims were those related to substandard auto and house fires. 3 Much has evolved in the insurance marketplace and the realm of insurance insolvencies since the 1960s.

The 1980s witnessed a growing number of large insolvencies among insurers writing significant amounts of commercial insurance. Recent insolvencies occurring mostly in the early 2000s have involved complex commercial insurance products, such as large deductible policies and policyholders doing business (and consequently presenting claims with the funds) in several states. In addition, many of these insolvencies, such as Reliance, Fremont Indemnity Company and Legion Insurance Company, were larger than any the system had before absorbed.

The insolvency of a large commercial insurer then was viewed as almost impossible to occur. There was certainly no “track record” available at the time to inform the decision to extend coverage to the commercial market segment, with policyholders as varied as main street storefronts to Fortune 500 conglomerates. Additionally, subsequent developments in commercial lines products were difficult, if not impossible, to foresee at that time, and the state guaranty fund laws were never expected to cover such products. The report on the hearing of the U.S. Senate Subcommittee held on June 25, 1968 discussing the need for a safety net to cover insurer insolvencies suggests that such a safety net was intended to protect individual policyholders and claimants rather than large commercial insureds. For example, in that hearing, Senator Dodd advocated the need for the safety net by stating that individuals who are driven by the unstable market force to high risk insurers “must face the fact that their families can never be secure by their fireside knowing that the insurance company standing between any judgment and their home may become insolvent.” See Hearings on S. Res. 233, Part 13, Automobile Liability Insurance before the Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary United States Senate, 90th Cong. (1968). These factors have significantly changed the landscape for guaranty funds, requiring that they adapt to this new world. Recently, the guaranty funds have been faced with:

  • High volume of claims resulting from large, multi-state, multi-line insolvencies;
  • Claims operations that have been delegated to various third party administrators;
  • Paperless record-keeping by companies that become insolvent;
  • and

  • Pockets of capacity strains that resulted from insolvencies of significant size – either as large, multi state companies or as companies with significant presence in discrete states.

These challenges have brought renewed focus on the need for policymakers to examine guaranty fund operational practices and statutes with an eye toward strengthening their protections for those whom they were originally intended – the average citizen and small business policyholders and claimants.

Guaranty funds continue to develop the electronic systems and legal and operational structures to enable them to deliver protections in a changing insurance world. Human and financial investment greatly enhances the ability of the guaranty fund system to address the changing industry.

Many recent enhancements to the functionality of the guaranty fund system and its statutory underpinnings have their origins in “lessons learned” from periods of heavy activity dealing with complex multi- line, multi-state insolvencies. Today, Reliance and other insolvencies are seen as the catalyst for many of the statutory and operational developments which are viewed as “cutting edge” in insolvency practice.

Currently, the funds are proposing solutions to such matters as privacy protection for claims data, and dealing with imaged files. At the end of the day. Common wisdom suggests that good preparation today ensures success tomorrow. The truth of this axiom is borne out by the statebased guaranty funds.

Like a local firehouse, the occupants of which stand ready to rush to the assistance of a property owner, the guaranty fund system is prepared to step into the shoes of an insolvent insurer and protect policyholders by paying outstanding covered claims, the role policymakers and industry envisioned for the system nearly 40 years ago.

The strength of the guaranty fund system – today and tomorrow – rests on preparedness. Because of the funding mechanism that shifts the costs of insurance insolvencies to policyholders, and in some states taxpayers, it is critical that the guaranty fund system works efficiently and cost-effectively.

With insolvency activity at a relatively low ebb, state guaranty funds are refining and streamlining their systems, adding tools and working to strengthen their readiness for tomorrow while protecting policyholders today. By doing so, the state property and casualty guaranty fund system is undertaking the important ongoing work necessary to meet its statutory duties to policyholders and claimants while ensuring that the sanctity of the insurance contract will be preserved.

1Between 1999 and 2005 the guaranty funds paid out about $10 billion as a result of such mega insolvencies as Reliance, Legion, PHICO and Fremont in the early 2000s – almost half of the $21 billion paid by the system since its inception in the late 1960s.
2In a press release dated October 3, 2001, then Commissioner Diane Koken states “[t]he ongoing shortfall of cash receipts — especially those of reinsurance — needed to pay policyholder claims and administrative expenses has been exacerbated significantly by the terrorist attack on the World Trade Center. Recent output from the financial model shows that Reliance will be unable to pay policyholder claims as early as the fourth quarter of 2001.”

The NCIGF is a nonprofit association incorporated in December 1989 and designed to provide national assistance and support to the property and casualty guaranty funds located in each of the fifty states, Puerto Rico and the District of Columbia.

NCIGF Strategic Planning Initiative

SPC Initiative Set to Deliver Comprehensive Recommendations to the NCIGF and State Guaranty Funds

“You should examine yourself daily,” wrote author Israel Zangwill. “If you find faults, you should correct them. When you find none, you should try even harder.”

Zangwill’s words could offer a tidy summation of the NCIGF’s Strategic Planning Committee’s (SPC) initiative to provide an overall assessment of the NCIGF and guaranty fund system.

Created by the NCIGF Board of Directors at its planning meeting in Orlando in January 2006, the effort has evolved into the most ambitious, comprehensive and in-depth selfexamination of the organization and guaranty fund system in its nearly 40-year history.

“The guaranty fund system has provided a broad and reliable safety net for policy holders for nearly 40 years,” said SPC co-chair Steve Durish. “Self-assessment is not always easy, but our hope is that this unprecedented effort to gather a wide range of input from our community and stakeholders will be the best-possible way to ensure that the guaranty funds are well-positioned to meet the challenges ahead.”

From Arizona to Portland to “self-knowledge”
The initiative traces its origins to the NCIGF’s Fall Workshop in Scottsdale, Arizona November 2005. There suggestions from guaranty fund managers, industry and trade representatives and others about how to improve the NCIGF and guaranty fund system were developed through four discussion groups. Comments at the meeting ranged widely, offering many perspectives on how the system and organization could work more efficiently to fulfill the mission of protecting policyholders.

From the workshop came many ideas related to key issues facing the organization and guaranty fund system. To continue the momentum begun by the discussions, the NCIGF board formed the Strategic Planning Committee during its January 2006 meeting in Orlando, Florida.

The committee’s charge was to take the board’s fact-finding to the next level through a formal and systematic process of self-examination. The board asked the SPC – a group of 16 volunteers from all walks of the insurance industry and the guaranty funds – to spearhead research that would provide data for future strategic planning and chart the future of the NCIGF and guaranty fund system.

The discussions with NCIGF members and other stakeholder groups continued during breakout sessions at the NCIGF 2006 Annual Meeting in Portland, Oregon in April 2006. During these sessions, guaranty fund managers and staff, insurance company representatives, guaranty fund counsel and NCIGF staff addressed questions regarding what the guaranty funds do well and what the guaranty funds could improve by doing differently.

“Fundamentally, the guaranty system has functioned well,” said NCIGF President Roger Schmelzer. “Much of the informal input collected in Arizona, Orlando and Portland suggested that the time was right for a formal, candid, clear-eyed self-assessment. That’s just what the Strategic Planning Committee set out to do.”

Consultants join effort
To ensure that the rigorous assessment reflected best practices in surveying, data collection and tabulation, the NCIGF Executive Committee approved funding to retain consultants.

Dr. Terri Vaughan and Dr. Robert Cooper, faculty members from Drake University, brought to the effort proven research skills and a solid grounding in the insurance industry. Vaughan, a former Iowa Insurance Commissioner, had served as president of the National Association of Insurance Commissioners (NAIC).

Vaughan and Cooper prepared surveys and interview questions as a first step in carrying out an objective assessment of the NCIGF, its services and current roles and the guaranty fund system. They gathered input from the guaranty funds’ stakeholders, including suggestions about how the NCIGF and guaranty fund system could best meet future challenges. They also identified factors viewed by stakeholders as inhibiting the efficiency of the guaranty fund system and the NCIGF.

The assessment also included a literature review and analysis to identify the key issues facing the guaranty fund system.

Study casts wide net
The data collection process cast its nets wide, eliciting input from a broad base of respondents that included regulators and receivers and staffs, guaranty association board members, managers and staffs, insurance producers and agents and brokers.

The study also targeted insurers, trade association and other industry representatives, the NCIGF’s management and staff and consumer representatives.

The surveys probed virtually all key aspects of the guaranty funds. Questions invited input on everything from state guaranty fund laws to NCIGF board make-up.

Questions sought feedback on runoffs and net worth, resource-sharing, consolidation of fund operations and a broad range of receiver-related questions. Overall, the surveys, which safeguarded the anonymity of participants, probed deeply into the guaranty fund system. The fact-finding process focused on obtaining as much information as possible about what participants thought worked – and what worked less well.

“We wanted to take a good look at the overall guaranty fund system and NCIGF and gather feedback on how the funds and others assess the system’s effectiveness and value,” said Debra Wozniak, the SPC’s co-chair.

“Our consultants reported that the overall response rate for the surveys and interviews was very good. The SPC believes the report provides a good ‘feel’ for how the various stakeholders view the guaranty fund system and NCIGF.”

“The results of the Vaughan survey are extraordinarily revealing,” said Schmelzer. “The guaranty fund system clearly has an unprecedented opportunity to provide an even higher level of service and protection to property/casualty insurance consumers. This is the right process, at the precise right moment in our history.”

Initial results are tabulated; strategic planning begins
By December 2006, Vaughan and Cooper had received and tabulated most of the study’s data. The team met with the SPC in December and January to discuss their preliminary findings.

Following the initial work of surveying, interviewing and compiling results, the SPC committee convened that month to begin the strategic planning phase of the project. The consensus of the 16-member group was that focusing on seven key areas provided the best and most efficient means of examining, evaluating and making recommendations in important areas of potential improvement. The areas were:

  • Gaining a consensus on the primary guaranty fund mission
  • Communications/public relations/education
  • Preparing guaranty funds for change
  • Operations and support
  • Board of directors issues
  • Uniformity
  • Coordination and cooperation

In total, the workgroups conducted more than 30 meetings. Drawing from issues identified by the SPC’s Final Report in their respective areas, the groups conducted wideranging discussions on issues and offered recommendations for improving performance in these areas.

The workgroups compiled working group reports as the final fruit of extensive discussions. These reports, which chronicle the discussions about issues and document related recommendations, provide a window into the thinking and strategic direction of the workgroups. Taken together, the reports also were the genesis for the overall strategy that later would be embodied in the SPC’s final strategic plan and many of the plan’s supporting tactics.

Moving Forward Together… and Strategically
From the working groups report emerged the SPC’s strategic plan, Putting Consumers First: The State Guaranty Funds Moving Forward Together. The plan, which received an enthusiastic approval by the NCIGF board in November 2007, voices a strategic and tactical vision for the guaranty fund system and the NCIGF, the system’s support organization.

In January 2008 the SPC committee returns to the birthplace of the SPC initiative, Orlando, to present the strategic plan to guaranty fund managers, a milestone that formally kicks off the implementation phase of the project.

“By undertaking this initiative, the state Property and Casualty guaranty funds have firmly embraced their statutory obligation to serve policyholders as efficiently and effectively as possible,” said Schmelzer. “While tried and tested, the system recognizes its obligation to meet the challenges of the increasingly complex 21st Century insurance marketplace.”

“The effort put forth by our community to create this course of action has been unprecedented, impressive and well-timed,” said Durish. “Our challenge has been to evaluate a considerable amount of stakeholder feedback and chart a path for our national insurance safety net. This endeavor was accomplished with extensive input from participants who generated the many tactical considerations which are the essence of the plan. The plan’s focus on improvement in key areas will serve to greatly enhance the associations’ fulfillment of their mission.”

In 2008 and beyond, the plan will inform an ongoing assessment and evolution of the guaranty fund system and the role of the NCIGF. It will also drive many of the changes that will continually improve the system’s ability to deliver on the mandate that was given to it by policymakers nearly 40 years ago – to protect policyholders and claimants.

Questions and answers about the Strategic Planning initiative

Why is the NCIGF board pursuing this project?

For nearly 40 years, the guaranty fund system and NCIGF have worked effectively to protect property and casualty insurance policyholders faced with insolvencies of insurance companies with a broad and reliable safety net. In that time, however, many changes have transformed the insurance industry. After taking extensive input in the NCIGF Workshop and other meetings over the past two years, the NCIGF board asked: Can the guaranty fund system – and the NCIGF – work better? Are we positioned to face future challenges and manage future insolvencies efficiently and cost-effectively?

The work of Strategic Planning Committee is essential to ensuring the guaranty funds and the NCIGF continue to deliver protections to policyholders and work efficiently and economically while maintaining productive partnerships with receivers and other key stakeholders.

Why did the Strategic Planning Committee (SPC) work with consultants in this effort?
Early on, the committee decided that employing outside consultants was the best way to structure the project and keep it objective and goal-focused. Use of outside consultants brings an independent outlook to the assessment process, one that delivers insight and
produces on-target and practical recommendations.

The SPC recognized that hiring consultants enabled us to bring on-board partners that were knowledgeable about strategic planning and insurance and insurance regulation – yet independent of the guaranty fund system.

Former Iowa Insurance Commissioner and NAIC President Dr. Terri Vaughan, and her colleague Dr. Robert Cooper, who teach insurance at Drake University, have proven to be ideal in assisting the SPC in this effort.

What role have the consultants played in the process?

Vaughan and Cooper developed surveys, helped identify stakeholders and used their contacts to obtain feedback from regulators. On the backend, they assembled survey results and prepared reports summarizing the survey’s results. During the project’s strategic planning phase, they also offered input and guidance.

Vaughan and Cooper have a proven track record in the kind of research the project demands. Use of objective “non-system” experts who are independent of the guaranty fund community brings more credibility to study results, a key factor in acceptance by the regulatory community.

Vaughan and Cooper’s objectivity establishes this survey as a solid benchmark, one that will help shape future direction of NCIGF and guaranty funds.

How has the SPC been conducting this work?

SPC – working with our consultants – began by establishing a benchmark of stakeholders’ views on NCIGF and the guaranty funds system through surveys and personal interviews with stakeholders in and beyond the guaranty association system.

The data collection process gathered input from regulators and receivers and staffs, guaranty association board members, managers and staffs, insurance producers and general agents, brokers and others.

We also solicited feedback from insurer, trade association and other industry representatives, the NCIGF’s management and staff, and consumer representatives.

The surveys and interviews sought to obtain information on virtually all aspects of the guaranty funds and the NCIGF.

With the completion of the surveys and interviews, the NCIGF board approved the SPC’s plan to develop working groups to discuss seven broad topics and develop recommendations for the NCIGF and the guaranty fund system.

The work of the working groups lead to the development of a broad-based strategic plan, which the NCIGF board adopted in November 2007.

Who developed the strategic plan?

The guaranty fund managers, staff and other members of the insolvency community participated in the working groups. The working reports and recommendations served as the foundation for the development of the strategic plan.

When will the strategic plan be made available to NCIGF members and other interested parties?

The Strategic Planning Committee will present the plan to guaranty fund managers January 2008.

How much impact will the work of the SPC have on the guaranty fund system or the NCIGF going forward?

The NCIGF board has invested considerable time and resources to this project. While it yet is unknown what exact degree of influence the work ultimately will have, it’s safe to say the NCIGF board views the survey and related work as critically important.

Who is on the Strategic Planning Committee?

The 13 members of the SPC come from the insurance industry and the guaranty funds. Industry members work for large and small companies. Collectively, the group has a wide array of experience, including managers from single state funds, multiple funds, multiple entities, large and small states and varying years in guaranty fund management.

Ultimately, what does the NCIGF Board hope to achieve with the strategic planning initiative?

The Board asked the SPC to complete an objective, candid and realistic assessment of the NCIGF – its services and current roles – and the guaranty fund system. The hope is that the strategic planning initiative will give guaranty funds and the NCIGF guidance to better position them to provide effective and efficient service in the foreseeable future.

What has been the NCIGF’s involvement?

The SPC was created by the NCIGF board. The NCIGF staff supports the committee in a variety of ways, including meeting logistics, technical issues, committee meetings and data collection. NCIGF staff also assists the SPC with expertise on guaranty fund matters. Although NCIGF is one of the key stakeholders, the SPC’s assessment is independent and objective and does not operate “at the service” of the NCIGF or any other entity.

Why does the study encompass such a broad field of insurance professionals?

Receivers, agents, brokers, consumers, regulators and even NCIGF board members each bring to the table differing perspectives and insights on the guaranty fund system and the NCIGF. These perspectives contain a wealth of information, much of it valuable in helping us look critically through “new eyes” at the guaranty fund system and the NCIGF to gain insights that will drive new and innovative solutions.

The SPC used the results of the surveys prepared by its consultants along with the results of the prior NCIGF discussions to assess and benefit from the understanding these groups have about the various aspects of the guaranty fund system and the NCIGF.

Protect the Integrity Of State Guaranty Funds

From the National Underwriter, Final Say
By Roger H. Schmelzer

Property and casualty insurers and the mechanisms that support their consumers face quite a storm these days, and it’s not coming from the usual places. This one originates on Capitol Hill and from state capitals, with the prospect of fundamentally transforming every aspect of p-c insurance – including the state guaranty fund system.

Since the multiple hurricanes that ripped through Florida in 2004 and the 2005 Gulf Coast catastrophe, insurance has taken its shots from all quarters. As a result, a philosophical struggle seems to have developed that threatens to redirect the p-c industry away from its risk-sharing principles until it resembles something more like a mechanism for transferring income.

Even guaranty funds are not immune to these pressures, finding themselves on the defensive over nonlegislative attempts to stretch the legal definition of covered claims to mitigate the tragedy of company failure.

While representing different ends of the regulatory spectrum, these sorts of disputes invite potentially significant downsides to the very consumers policymakers are pledged to protect.

It’s easy to forget, but p-c insurance is based on a delicate public policy balance – one that allows property risk to be shared among millions of consumers under the supervision of state governments. A key to that balance is the state guaranty fund system, which has seamlessly paid out over $21 billion in statutorily covered claims to thousands of affected consumers since 1968.

Guaranty funds are the last line of defense for consumers. Critical to the array of protections is the solvency monitoring responsibilities of insurance regulators, who are intended to spot problems early on.

Underwriting restrictions, rate adequacy, loss mitigation and land-use regulations are also public-sector responses that affect an insurer’s ability to meet contractual obligations to its customers.

What has to be carefully watched for, however, are unintended consequences that may result from intervention into – rather than oversight of – the everyday business of insurance. Such acts could tip the balance intended to produce affordability, availability and dependability for consumers.

Consider the shot across the bow from U.S. Senator Trent Lott, R-Miss., and U.S. Rep. Gene Taylor, D-Miss., who propose to eliminate the insurance industry’s limited antitrust exemption under the McCarran-Ferguson Act – the decades-old foundation on which states have based their insurance regulatory structures. Sen. Lott is joined by Senators Patrick Leahy, D-Vt., and Arlen Specter, R-Pa., the chairman and ranking minority member of the Senate Judiciary Committee, respectively.

Assemblage of this formidable team of advocates suggests a serious attempt to at least get someone’s attention, if not to actually get something done.

State officials are also acting. Florida has enacted a variety of measures, including an “anti-cherry-picking” provision requiring carriers that write auto insurance in Florida – but homeowners elsewhere – to also write homeowners policies in Florida. (The attorney general of Mississippi later suggested the same idea for his state.)

In addition, Florida called for a rate rollback to reflect potential savings to a carrier created by cheaper reinsurance made available through the state’s subsidized hurricane fund. This latter initiative is characterized by The Wall Street Journal as “largely abandoning the insurance market in favor of a guarantee that, whatever happens, Florida taxpayers will cover the tab.”

With hundreds of millions of dollars at stake in a major company failure, guaranty funds are smack in the middle of the “risk-sharing versus income-transfer” conflict. If insureds can depend upon an ad hoc widening of the scope of guaranty fund coverages during administration of an insolvency, a purchaser’s motivation to buy coverage from the most financially sound companies will be reduced, thereby increasing the pool of potential guaranty fund payees.

Property and casualty guaranty funds are creatures of state law. They exist specifically to pay covered claims promptly.

However, the face of insolvency is changing. Reflective of this change is that state guaranty association policyholder claims and adjustment expenses stood at just half-a-billion dollars in 1997 but totaled $7.9 billion between 2001 and 2005.

This wave of insolvencies was so powerful because it didn’t come from the average personal- or small-business insurance consumer – for whom the system was designed to protect – but from carriers that wrote primarily commercial policies for sophisticated insureds, resulting in claims that were (and are) long-tailed, unpredictable and geographically broad.

But who actually pays these costs? Ideally, guaranty fund claims would be paid by distributions from remaining assets of the insolvent insurer company. Unfortunately, those assets are seldom sufficient, leaving a substantial amount of the cost to be footed by guaranty association assessments to insurers writing licensed business in the state where the fund operates.

Solvent carriers are then permitted to “recoup” these costs by various statutory mechanisms. This means that the more money guaranty funds pay out above their statutory obligation, the higher the burden on taxpayers and the insurance-buying public. This is why following statutory coverages matter.

As policymakers and the insurance industry engage on fundamental marketplace issues, a top priority should be assuring the integrity of the state-based p-c guaranty fund system. Legitimate public policy concerns ought to be addressed.

The National Conference of Insurance Guaranty Funds board of directors has outlined a series of policy recommendations that speak to the original mission of the guaranty fund system – including a net-worth ceiling, treatment of large deductibles and a reasonable cut-off period for claims against a guaranty fund.

To establish predictability for insureds, policyholders and claimants, it is imperative these and any other questions be resolved in the state legislatures responsible for public policies that allow the industry to compete in their states.

The era of mega-catastrophes and terrorism risk – not to mention political interest in the regulation of insurance markets – threatens to disturb the important policy balance that makes insurance work. It is critical to American consumers that it be preserved.

NCIGF Weighs in on Reinsurance Collateral Proposals

On October 22nd the NCIGF weighed in on the current debate about reinsurance collateral proposals in a letter to John Oxendine, chair of the NAIC Reinsurance Task Force.

“The success of reinsurance collections has a direct bearing on how much insolvencies ultimately cost the public,” wrote Barbara Cox, NCIGF’s vice president Legal & Regulatory Affairs. “For this reason, we are watching with interest the continuing debate over Reinsurance Collateral Proposals.”

Cox also wrote, “It stands to reason, based on the significant impact collateral appears to have on estate recoveries, that any reduction in current collateral requirements will directly and considerably add to the cost of guaranty association protection that is, by statute, ultimately passed on to the public.”

For Now, OFC Legislation Keeps P/C Guaranty Fund System Intact

By Roger H. Schmelzer

Sometimes the “buzz” on an issue can be gauged by the number of media clips about it that come though the NCIGF offices.

There is major ink being spilled editorializing about currently proposed Optional Federal Charter legislation. In one day alone, the NCIGF office received more than 25 clips from industry publications and mainstream news outlets about the issue. In the past month, it seems virtually every writer in the industry has examined, analyzed and vetted every conceivable facet and angle about the OFC.

The jury is still out on the fate of the bill introduced in the U.S. Senate by Senators Tim Johnson (D-SD) and John Sununu (R-NH) May 24. The NCIGF takes no position on OFC legislation. Our focus – and that of our members – is to deliver on our mission: to step into the shoes of a failed insurance company to pay property and casualty claims. This is our role as currently defined by state law. As introduced, the Johnson-Sununu bill would leave those responsibilities mostly untouched.

Of course, legislation as introduced usually has no relation to legislation as enacted. Inevitable political tradeoffs have a way of changing things, sometimes drastically. While I do not anticipate that the guaranty fund system will be the most important element of the bill to be discussed, it will receive its share of attention.

As lawmakers consider OFC or any other proposal that could call for a federalized guaranty fund system, we urge caution in deliberation. After all, for nearly 40 years the system has delivered on its statutory mandate, paying claims that otherwise would have gone unpaid due to insolvency. The system works well on behalf of consumers and would quite simply be a bear for a federal agency to manage.

Indeed, unlike many of the alternatives that some are eager to float, the guaranty fund system has a proven track record. And we believe that the state-run system is working well, providing, as it does, important insurance consumer protection.

Here’s a statement I’d like to see in the news clips that have been coming in: The GF system is financially healthy; it has and is able to step in for failed insurers to pay policyholder claims at state law-defined allowable limits, therefore Members of Congress are reluctant to disrupt it.

The Johnson-Sununu bill calls for the National Insurance Guaranty Corporation to step in when a state guaranty fund has not met the standards established by the federal legislation.

Presently each state legislature creates guaranty association rules for its own state. This OFC bill proposes a set of minimum qualification standards which state guaranty associations must satisfy to be classified as qualified and be allowed to protect consumers of both national and state insurers doing business in their state. As currently drafted in the National Insurance Act of 2007, the qualification standards closely track the NCIGF’s own model guaranty fund law, which many of our member guaranty association’s state legislatures have now adopted.

It’s important to note, an absence of uniform standards in the past has not prevented the system from working effectively. Insurance, including guaranty funds, has long been regulated by state statue; this means there is variation in law from state-to-state. This has given the states flexibility to craft laws that address their individual needs and reflect their specific circumstances. But this variation does not suggest that guaranty fund laws in any way are deficient. If anything, this variation makes the guaranty funds better able to protect policyholders in the states they serve.

In its current form, the proposed OFC legislation would give states four years to amend the state laws to meet federal standards. That’s what most, if not all, of the states would do if OFC legislation passes. Most guaranty funds already meet many of the proposed qualification requirements. If the current proposal were enacted, minor changes to state laws would be required to allow national insurers to become members of the state guaranty association. It will only be in rare instances that some funds will have to make further changes to their guaranty fund laws to meet the qualification standards and be considered a qualifying guaranty fund, or they will choose not to provide the guaranty fund mechanism for claims of national insurers, in which case the national corporation would take over all guaranty fund functions in the state.

The state-based property/casualty guaranty fund system can live with the Johnson/Sununu proposal, but that is not necessarily the end of the story; the legislative process is long, convoluted and unpredictable.

There will be a bill introduced in the U.S. House of Representatives that could have different provisions. Assuming the proposal gains momentum, there will be committee hearings in both chambers where changes can be made and potential amendments on the floor if the bill were to get that far. Finally, should the bill pass both houses, there will likely be a conference committee where the real dealing will take place.

The guaranty fund community should be pleased with where we stand, but should not take undue comfort from what is essentially a first draft that gets it right. Insurance regulation is not the hottest topic in Washington, but it is one cataclysmic natural disaster or huge insolvency away from becoming one. Additionally, proponents of an OFC are spending millions of dollars and thousands of human resource hours on getting this bill passed. Things could change dramatically for stakeholders affected by the bill, including the guaranty fund system.

For that reason, we must continue to concentrate on making the existing system work as well as we can. We need to focus on communicating the message of success and improving collaboration with our insolvency partners to underscore the value of the system to consumers. We must use this period to establish the innate strength of the guaranty fund system so that members of congress will be satisfied that it is in place rather than motivated to “fix” it.


Runoffs – Friend or Foe?
Runoff of a statutory insurer or a discontinued line of business has been a method used for years by typically large insurance organizations when exiting a market or a line of business. This kind of runoff has been managed internally within the organization and is largely invisible to the outside world. As of late, there seems to be a growing trend of insurance regulators running off troubled companies. At present, Kemper, Highlands and Frontier are in runoff, under the formal or informal supervision on their respective insurance departments. This article presents and discusses the issues raised by these regulator-supervised runoffs.

At first glance, runoff may appear, to at least regulators, to be an attractive alternative to attempting to rehabilitate an insurer, or liquidating an insurer through a formal, judicially supervised process. A liquidation is viewed by many regulators as something to be avoided at all costs. A troubled insurer is also an in-state employer providing local jobs that can, at least temporarily, be preserved with a runoff. Further, the bankruptcy of an insurer, although arguably a natural occurrence in an intensely competitive marketplace populated by a large number of companies selling a largely homogenous product, is still viewed by many as a regulatory failure. Runoff allows this negatively viewed outcome to be avoided.

As a good friend has pointed out to me, the fact that a liquidation has occurred does not by itself indicate a regulatory failure. A poorly run liquidation or poorly handled troubled company that results in higher costs passed on to the public is a regulatory failure. The goal should not be to avoid liquidation, it should be to minimize the cost of any liquidation that becomes necessary.

In any case, a regulator may see a runoff as attractive because it also means that guaranty funds are not triggered. Guaranty fund assessments are not required. If a state which allows premium tax offset for assessments is involved, premium tax revenues do not decrease.

My message to primary insurers is quite simple. We need to tell regulators to HOLD EVERYTHING! STOP! Please take a break. We need to ask whether runoffs are a good thing. Is the insurance consuming public better off with a runoff? The primary purpose of insurance regulation is to protect policyholders. All things considered, are runoffs in the best interests of policyholders?

These are all good questions that have not been answered. I would submit that an important step has been skipped. Has anyone looked at this on a public policy level? That is, what are the public policy implications of this change in approach? From a financial standpoint, is it clear that runoff provides a better result to those impacted by an insurance insolvency?

Decades ago, legislators in the many states acted in a surprisingly uniform way to address the problem of insurance insolvencies by putting in place a network of state insolvency laws. These laws embodied the measure of protection that would be provided to the various individuals and organizations impacted by an insurer insolvency. There were winners and losers – some parties would be protected, others would not. Legislators decided that
troubled companies that were insolvent, or operating in a way that was hazardous to policyholders or the public, would be taken out of the marketplace, with the policy claims of those most in need of protection paid by the state guaranty funds. Claims against the insurer including claims under policies were required to be substantiated, and would be paid subject to a priority of distribution scheme that preferred policyholders and claimants, and also the guaranty funds that protected those policyholders and claimants.

Guaranty funds would be administered by those who know best how to handle insurance claims – the insurers themselves. Guaranty funds would be examined and regulated just like insurance companies, since insurance regulators would have a similar interest in ensuring that policyholders were protected, whether or not an ongoing insurer is involved. Protection of policyholders was the pervasive theme and principal goal shared by insurance regulators and guaranty funds, with the goal achieved through the operation of the state system of
guaranty funds.

The benefits that are provided by runoffs are unclear. Runoffs are conducted without established regulatory standards (e.g., policyholder’s preferred status for protection and claims priority) similar to those that exist in insolvency laws. There seems to be little evidence available at least to the author that indicates that companies in runoff receive the same vigorous level of regulation as ongoing insurers. While writing this article, I have been trying to recall the last time I heard about a regulatory examination of a company in runoff. Whatever good public policy is represented by runoffs remains unclear.

Further, it is not at all clear whether a runoff (that is almost always followed by a liquidation) results in lower costs ultimately passed on to insurance consumers, state taxpayers, estate creditors and other stakeholders. The case really has not been made by way of financial analysis that runoff provides a better overall result to these important
stakeholder groups.

To address the matter from a practical standpoint, and from the guaranty funds’ perspective, it is critically important that regulators conduct a runoff in such a way as to be consistent with the overall goal of protecting policyholders. A runoff must meet certain minimum requirements to do this: (1) The same rules should apply on claims, insureds and claimants must be treated fairly, (2) A runoff cannot result in a “deepening” of insolvency, and (3) Any runoff must include a separate effort to work with the guaranty funds to plan for liquidation, should liquidation become necessary.

To explain, claims adjusted and paid in runoff should be handled in the same manner as claims handled by ongoing insurers. There should be no question about whether claims processed during runoff are being promptly and fairly investigated, adjudicated and paid. There is at least anecdotal evidence that different rules sometimes exist for settling claims in runoff.

A runoff should not result in higher costs passed on the public through the guaranty fund system. Runoffs almost always involve financially troubled insurers. A runoff should not result in a larger deficit or shortfall than what existed at the outset. Finally, the runoff should be conducted in such a way that an orderly transition to liquidation can occur, should liquidation be necessary. This is essential to ensuring that policyholders are protected, even when it is necessary to liquidate the insurer. Every effort should be minimize the disruption that results from placing an insurer in liquidation. With proper planning and consultation with the guaranty funds, a smooth transition to liquidation is achievable.

From an ongoing insurer’s perspective, a runoff can seem attractive – guaranty fund payout is postponed and possibly reduced. However, runoffs cut both ways. Guaranty funds in effect lose the benefit of their preferred position in the priority of distribution scheme, and are forced to “share” assets with all creditors, through the operation of the insurer while in runoff. The latter will almost certainly result in lower distributions to guaranty funds. To the extent that there is a double standard that applies from regulatory perspective, and policyholders suffer as a result, guaranty funds may easily be viewed as the problem even though not involved. So, while runoffs may seem superficially attractive, there may be a “cost” borne by industry that is not initially apparent.

Difficult issues are raised by the runoff of an insurer. Important questions have yet to be answered. Hopefully this article has helped these issues and questions to be seen more clearly.