While insurance is part of the fabric that underlies many social contracts – the expectation that, in case of disaster, someone will pick up the tab – frankly, most people don’t understand the inner workings of the contracts and regulations that buttress our everyday lives.
In no area is this more apparent than in the case of guaranty associations – the safety net under the safety net.
A guaranty association is a privately funded organization in each state that ultimately serves as a backup in case an insurer fails completely and is unable to pay its claims. They vary from state to state, so, of course, after you’re done reading our coverage, be sure to hunt down the specific regulations and coverages that apply to your state and your relevant lines of authority (LOAs).
Every state has a guaranty association, as do D.C. and Puerto Rico. The U.S. Virgin Islands also has one, but only for its property and casualty (P&C) businesses. Funded through fees paid by member insurers, this pool of money is available in the rare case that an insurer is unable to hold up its end of the contract. All insurers are required to be members of the association, so, essentially, all insurers (or MGAs/MGUs that agree to this duty in their contract with an insurer) must be members and pay into the association.
Many states have regulations about who is allowed to be on the board of a guaranty association, possibly requiring state regulators, insurance industry stakeholders, or members of the public to be involved with the board’s dealings.
State regulators audit insurers on a schedule, ensuring the business has enough in reserve to pay claims both in the present and in the future. If the business can’t, the state can take several remedial steps to avoid relying on the guaranty fund to pay claims. However, if those remedial steps are ineffective, the state notifies the guaranty fund.
One option in case of carrier failure is for the state to liquidate the insolvent company and use its remaining assets to help pay claims and future benefits – the guaranty fund in this case will only provide enough funding to shore up the funding gap while a future plan is established. In the case of total carrier failure, claimants and contract holders will not receive the full terms of their agreements, but this is a way to make sure they still get a portion of what is owed them for their premiums.
Once upon a time, insurers run by risk-takers (not a phrase you see often in insurance for good reason) could overleverage themselves by issuing contracts with rosily favorable terms that couldn’t come close to covering the cost of insurance.
In these conditions, market instability, mismanagement, or just a rough year with unexpectedly high losses could lead to the collapse of an insurance business, leaving insureds holding the (empty) bag. In a best-case scenario, the insurer could sell to a different business, which might then reduce the contract terms or decline to pay the clients’ contracts. Clients would then have to collect what they could on a piecemeal basis from the leftovers of the insurer’s sale. This setup was less than ideal (to say the least!) for the consumers and businesses relying on their insurance policies.
So, beginning with Wisconsin’s landmark law in 1969, which other states soon followed, states set up guaranty associations as a safety net in the event of carrier failure.
States needed consumer protections in the case of insurer insolvency not just because of the real cost to consumer finances, but also because states have a significant interest in assuring consumers that insurance is safe and encouraging them to purchase contracts.
There are the general economic boons of having thriving businesses to attract residents and levy taxes on, of course. But also, if people and businesses are unable to insure their homes, workspaces, and other assets from losses in fires, floods, or inclement weather events, then either people would just be SOL in the face of misfortune (which could lead to statewide depression-level events following each storm or significant event) or the state would be left picking up the tab.
In this way, states have a vested interest in maintaining confidence in the insurance industry. Thus, after Wisconsin’s cutting edge law took effect, the National Association of Insurance Commissioners soon followed with model laws that have been widely accepted.
Guaranty associations for P&C differ from those for life and health (L&H) lines. In fact, the NAIC has one model law for each. Among the differences are that the P&C guidelines suggest states allow P&C insurers to offset the cost of their guaranty fund fees by increasing the premiums and costs to consumers, while L&H guidelines favor paying guaranty fees in a tax exemption arrangement, using fees as a write-off at filing time.
While states have implemented these guaranty associations or guaranty funds differently, the basic premise is to cover consumers. The guidelines for L&H guaranty associations reflect the fact that P&C insurers historically had a higher likelihood of defaulting on their obligations. The risk of default was so high that rumors of federal legislation about P&C businesses were credited with the rise in popularity of guaranty associations as a solution to ward off federal meddling. Thus, guaranty associations for L&H are less active than those for P&C.
Still, variable and equity-indexed products such as indexed universal life insurance or variable or fixed-index annuities have at times caused some consternation. The NAIC and other guaranty groups have grappled with how states should calculate the value of guaranty coverage for these products, particularly whether there is a baseline of coverage to use or whether to wait until the policy value has been calculated based on its index.
Not everything insurable is covered by state guaranty funding. For one thing, state guaranty funds are the backup, not the Plan A. So, if you’re a consumer, always remember your best bet is to only agree to an insurance contract with insurers that have good credit histories and won’t dump you into a guaranty dilemma.
Some states guarantee coverage up to a dollar amount, based on a percentage of coverage, as a calculation of a return of premium, as a percentage of recovery from the insolvent insurer’s asset sales, or even as some combination thereof. One across-the-board coverage is that, according to the National Conference of Insurance Guaranty Funds, 100 percent of workers compensation contracts are covered across all states.
However, the NAIC’s model acts spell out some suggested coverage limits. Each of these is a per person limit, while there are also organizational limits. For instance, the L&H model specifies that a state guaranty shouldn’t pay out more than $5 million to a covered organization, no matter how many covered members are part of that organization.
L&H per person coverage limits:
P&C per person coverage limits:
Remember, those limits are just suggestions. Each state has its own variation on these, but it’s important to remember that guaranty liability to pay off any one insurer’s debts is capped.
If you haven’t heard of a guaranty association, it’s because guaranty laws often come with a restriction that prevents guaranty associations from being mentioned in the same breath or conversation as a solicitation or sale. From the NAIC’s Life and Health Insurance Guaranty Association Model Act:
“No person … shall make … any advertisement, announcement, or statement … which uses the existence of the Insurance Guaranty Association of this State for the purpose of sales, solicitation, or inducement to purchase any form of insurance or other coverage covered by the [State] Life and Health Insurance Guaranty Association Act.”
So, unless a consumer likes to read up on state legislation and insurance law, or they actually read their contract, it’s likely they won’t know the lengths state regulations and the industry go to for the sake of consumer protection.
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Insurance companies pay guaranty fund fees, but how much and when they pay varies state by state. Some states level an annual fee, assessed as a percentage of premiums paid or taxes owed. Others send members a fee assessment in the case of insurer failure, meaning the other insurer members of the guaranty association only pay when there are claims that need to be paid.
Guaranty funds are separate from state governments, but the states decide the criteria and composition of the boards that run them. Often, board members include elected or appointed officials, representatives of carriers and insurance agencies, and members of the public.
When a state has decided to liquidate an insurer, the state may sell the book of business in whole or in pieces to another insurer with the aim of retaining the contract provisions as closely as is reasonable. Most states try to limit guaranty funds to paying active claims during that process, although in the case of a total insurer failure, the guaranty fund may have to pay claims (up to the state-mandated limits) as well as paying back premiums (again, up to set limits).
This is a bit of a gray area and usually spelled out in specifics in an MGA’s contract with a carrier. While most contracts specify that guaranty fees remain the responsibility of the carrier, in instances where the MGA is taking on more carrier responsibilities, everyone should be diligent to ensure guaranty-relevant questions are resolved in the contract.
With a few nuanced exceptions, state guaranty funds only pay contract holders in their state, so each individual who is insured by a carrier that goes under should petition their resident state for coverage.