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.

Introduction

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 www.reliancedocuments.com. 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.