The insurance industry has several levels of regulation to prevent insurance carriers from falling down on their claims-paying, and even the last two options available are meant as a safety net more than anything: receivership and liquidation.
Every level of the solvency funnel is based on maintaining a carrier’s claims-paying ability, from underwriting, reinsurance, public ratings, and state audits all the way to guaranty funds. Yet, sometimes, either with mismanagement, poor market conditions, reinsurer failure, or any number of other factors, sometimes the “shoulds” earlier on will still fail.
To address these failings, the National Association of Insurance Commissioners guidance on receiverships, best practices for rehabbing carriers, and procedures for liquidating them are all outlined in the Insurer Receivership Model Act. The Act updates and incorporates elements of the earlier Insurers Rehabilitation and Liquidation Model Act as well as the Uniform Receivership Law. Most states are still operating under the older guidelines, although there are substantial similarities throughout.
Regardless of what draft a state is working from, mostly the legalese has to do with the ins and outs of settling law, who is or isn’t allowed to access information and when, what is or isn’t frozen during the receivership process, and how to deal with jurisdictional oversight. If you’re up for reading through the 160-plus pages, go for it. If not, then stick with us as we go through the basics of the receivership and liquidation process.
If you read through our earlier bit on the state auditing and financial report process, you know there are several ways the state can discover an insurer is in financial trouble. And, as we outlined, the board of directors and management for the company have the opportunity to present plans or explanations for how they intend to get in shape and continue to pay claims.
The state commissioner will look over those plans, and, if they decide the statement is insufficient, the commissioner will petition the courts to begin “receivership.” In this process, the insurance company is frozen and placed under a temporary new management system, or the receiver. In some states, the receiver is a member of the department of insurance, such as a deputy commissioner. In others, the state retains a third party like a bank or legal firm to act as a receiver.
In receivership, the “receiver” will do a more thorough inspection of assets, contracts, etc., to organize a plan to pay claims. The main goal of receivership is to pay claims, but, as the final step before a liquidation or bankruptcy, receivership is also the last opportunity to preserve the company.
While there are a lot of specifics and variables, the important thing about receivership is that it’s sort of a “limbo.” The receiver may decide the state is best-served in rehabilitating the carrier and providing additional oversight while it gets better footing to pay claims. Or, the receiver may decide the state is better off liquidating the carrier and finding a new company to cover contracts.
Role of outside agencies and the guaranty fund
When a carrier enters receivership, the receiver typically will contact the guaranty association fairly early on, as a best practice to give them a “heads up” that the fund may be tapped to pay claims and provide assistance.
The guaranty fund may not be the only entity called up for assistance. Since most states’ guaranty funds legally only pay claims to state residents, an insurer insolvency in a single state will often cross state lines. The National Organization of Life and Health Guaranty Associations and the National Conference of Insurance Guaranty Funds (which is an association of property and casualty associations) provide legal assistance or coordination in these cases by pulling experts from multiple states.
In the best-case scenario, rehabilitation is possible, and the state has only to target the riskiest cases to bring an insurer’s balance sheet to rights. However, if that’s not possible, the receiver will work in tandem with the guaranty association and other entities to decide the best process to unwind the insurer through liquidation.
While it is rare for insurers to reach the stage of liquidation, a few do every year. In some cases, it’s a matter of individual failure. In others, larger market conditions are significant factors.
For instance, the last decade saw a serious collapse of the long-term care insurance market after it became apparent that insurers had wildly mispriced the cost of insuring against a risk that has become a near certainty for about half of elderly Americans. For a deeper dive on this particular example, check out this article from The Prospect.
More recently, market conditions surrounding COVID-19 and climate change have been wreaking havoc on the property and casualty market.
Liquidation comes in many forms for insurers that are no longer able to find solid financial footing. If possible, the receiver may sell contracts to a stronger insurer while using the guaranty fund to pay any claims that are submitted in the interim between receivership and a sale. In more serious cases, where contracts are unable to be fulfilled or transferred to a new company, the receiver will instead terminate contracts and pay back premiums up to the amounts legally allowed by the state guaranty fund. The insurer’s assets will be sold and distributed, first in covered claims to policyholders. Only after the basic amounts have been covered for claims and outstanding contracts will the receiver pay any remaining capital to debtors, investors, or others the insurer owed.
For a number of reasons, the very first priority is given to preserving consumer benefits and shoring up contractual obligations. This is one area of insurance that continues to evolve as new ideas become mainstream and market conditions present new challenges.
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Insurance Receivership and Liquidation FAQs
What are some of the future trends for receivership and liquidation?
If we can pull out a crystal ball, we’d say standardization and interstate cooperation are in the future. Most states are operating off the older model regulation of the NAIC, and more widespread adoption of the new model is likely.
But also, several states including Arkansas have adopted an insurance business transfer model that allows an insurer to purchase contracts from troubled insurance carriers faster, even across state borders. Based on a law in the European Union, the model allows businesses to transfer large blocks of business smoother and with fewer trailing strings and waiting periods. This will likely continue as a trend.
What about reinsurance in the case of carrier insolvency?
Guaranty associations generally retain the reinsurer’s agreements, so excesses from individual claims may still go to the reinsurer. Although, sometimes reinsurer failures are the reason for an insurer insolvency, in which case consumers will just be subject to the guaranty limits.
How can carriers dispute the state’s assessment of their financial condition?
The NAIC’s Insurance Receivership Model Act is 160-plus pages to address these kinds of questions. Outlining specifics for what the receiver is limited to, and what carriers can do, and who can take everybody to court – all while providing provisions for how to handle claims during the dispute process – that’s what makes insurance an industry with such spectacular regulation.