Who's insuring the insurers?

When an insurance company goes under, a little-known state guaranty-fund system comes into play.

As the sun set last month for Fort Wayne-based Mutual Security Life Insurance Co., a busy day dawned at the Indianapolis office of Phil Hammond's organization. Make that a busy year.

Hammond

is executive director of Indiana's insurance guaranty funds. His office goes into action when an insurer serving Hoosiers is declared insolvent, as Mutual Security was in early December. Hammond's job is to pay claims to the company's policyholders as the insurer is eased into non-existence, with as little pain as possible on the part of the insureds.

The guaranty-fund system operates like bank-deposit insurance, but differs in several ways, including the way its funds are accumulated. "The banks have to pay premiums into the fund to support deposit insurance," Hammond notes. "We assess other insurance companies only as we need the money. We don't have a standing bank account with lots of money sitting there not doing anything."

Also unlike deposit insurance, which is administered by a single federal agency, the insurance guaranty-fund system is a network of state-based organizations, created by state statutes but funded and operated by the insurance industry. There are funds for property/casualty insurance and funds for life/health insurance.

"There are property/casualty guaranty funds in every state," says Dale Stephenson, president of the National Conference of Insurance Guaranty Funds, an Indianapolis-based organization serving the nation's property/casualty guaranty funds. He once served in Hammond's position, running the Indiana guaranty funds. "On the life/health side, there are guaranty funds in all of the states, though there is not a life/health guaranty fund in Washington, D.C., as of yet."

The guaranty funds in each state protect insurance consumers in that state, regardless of the location of their insurance carriers. Hoosiers, whether they are dealing with an Indiana company or one in New Jersey, are protected by the Indiana Insurance Guaranty Association and the Indiana Life and Health Guaranty Association. The two funds have separate boards of directors, but operate just one office and have the same executive director, Phil Hammond. They cover most standard types of insurance products, with only a few exceptions.

The guaranty fund's mission begins when a court declares an insurance company insolvent. "That is, in fact, controlled by the department of insurance in the state of domicile of the insurance carrier," Stephenson explains. "With receipt of that notice and receipt of the files, the guaranty fund will immediately begin the process as if it were the insurance company at that point in time."

How long the guaranty fund holds onto that status depends on a number of things. In the case of property/casualty insurance, Stephenson says, the board overseeing liquidation often will order all policies canceled within a month or so. The policyholders must then seek insurance elsewhere. "On the life/health side, it does vary; in many cases the guaranty fund becomes an insurer for a period of time because of things like guaranteed renewal contracts, wherein the individual is assured that they will have continuation of coverage available."

Some policyholders may end up avoiding the guaranty-fund process if the state's liquidators succeed in finding a buyer for their policies. "Typically, a lot of blocks of business are sold to other companies," Hammond says. "If the blocks aren't sold, that's when we step in and make sure that people get the benefits they have coming to them."

Liquidators also try to sell other company assets, Hammond adds. "They take the proceeds and try to convert them to cash, but they try to avoid a fire sale." That's because some of the proceeds from liquidation could help defray the costs incurred by the guaranty funds. Whatever costs are left are passed along to other insurance companies still operating in the state.

"We assess the companies that operate here by line of insurance," he explains. "So if a company like Mutual Security goes down, it had a lot of annuity business and that's where the big losses were. So we assess companies that write annuities in Indiana, and we don't assess for other lines."

The amount each company is assessed depends upon what its Indiana market share in that line was in the year prior to the assessment. In the assessment for Mutual Security, a company that wrote 5 percent of the annuity business here in 1990 would pay less than a company with a 10 percent share. Companies are protected by a 2 percent cap, based on premiums written in Indiana; in the above example, no company's assessment would be more than 2 percent of the total annuity premiums it wrote in Indiana.

While the 2 percent cap protects insurers from being hit with too many of their competitors' losses in any given year, it means it isn't always possible to raise enough money in one year to cover an insolvency. That's happening with regard to Mutual Security's annuity business. Annuity assessments relating to that company's insolvency hit the cap last year, and may come near the cap again this year. If the fund needs more money in a given year than it can raise through assessments, it must borrow the money and repay it with assessments in future years.

The so-called "post-assessment" arrangement serves to keep regulators more on their toes, Stephenson believes, which is good for the health of the industry. "My major concern about pre-assessment funding is that the accumulation of any substantial money has a tendency to reduce the amount of attention. A problem can get bigger before anybody does anything about it."

Though the guaranty fund system exists to protect consumers, it still is possible to sustain a loss if your insurer goes under. As does the deposit insurance offered by the Federal Deposit Insurance Corp., insurance guaranty funds set caps on how much they will pay each claimant if a company is declared insolvent. The limits vary by state.

Indiana's life/health fund sets the maximum at $300,000 per life per insolvency. The fund will pay up to $300,000 on a life policy or a medical plan, and up to $100,000 in cash values or on annuities. The $300,000 per life per insolvency cap means that if an insured runs up $500,000 in medical bills, then dies, triggering a $1 million life policy written by the same insolvent carrier, the total benefit from the fund will be only $300,000.

The property/casualty fund in Indiana sets a limit of $100,000 per loss and $300,000 per insured event. That means the fund would pay up to $100,000 to each of two claimants involved in a two-car accident, but if there were five cars involved, not everyone would be able to claim that maximum.

What do you do if you want $1 million in life insurance coverage and are worried that $700,000 of that coverage would not be protected if the carrier were to become insolvent? You might sleep a little better if you spread that coverage around between a number of different carriers. For one thing, it's highly unlikely that all the carriers would go broke, and even if they all did, you'd have $300,000 in protection per insolvency.

"There is much more of that going on now," Hammond says, referring to the practice of spreading coverage around between different carriers. "I get considerable numbers of calls from agents asking to make sure they understand that."

Stephenson acknowledges that there are ways in which the system could work better, though some flaws aren't necessarily the fault of the guaranty funds. For example, it is common for a troubled carrier to spend some time in "rehabilitation," and if it can't be saved, then it is declared insolvent. The guaranty fund isn't triggered until the company is declared insolvent, but the state may choose not to pay claims during the rehabilitation period. And when the guaranty fund is called in, it can take up to three months to gather the necessary files from the insolvent carrier before claims are paid.

The industry is willing to make changes in its system, but is wary about the calls from some to scrap the whole state regulatory and guaranty-fund system and get the federal government involved, Stephenson says. "There are those who say the insurance industry is the next impending crisis. I'm not going to tell you that there are not problems in the industry, but they are not of the size of the banking and savings and loan situations. There are something like 600 companies currently in liquidation in savings and loans, with a shortfall of somewhere near $500 billion; in the insurance industry, we are looking at somewhere in the neighborhood of 50, with total liabilities in the neighborhood of $2 billion."

What's more, insolvencies involving Indiana carriers are particularly rare. Before Mutual Security came along last month, there were just two in the previous three years, Hammond says. "If I asked 1,500 people the names of those companies, they wouldn't have any idea what I was talking about." (The answer: Lumbermens Life and Life of Indiana).

Hammond says the insurance industry does a good job of protecting customers, in ways that are not common in most other industries. "If you go down to the lumberyard and write a check for $25,000 for lumber to build your new house but in the meantime he goes belly-up, do the other lumber companies step forth and make up the lumber that you purchased? No. You're just out of luck."