With recent announcements that Berkshire Hathaway (a holding company for many insurance companies) has received a credit downgrade, and that federal TARP funds will be made available to life insurance companies, it is becoming apparent that no sector of the insurance industry is completely immune from the financial meltdown that has affected nearly all financial service companies. As a result, many policyholders are starting to consider their options should their insurance company face financial difficulties.
Supervision, Rehabilitation, and Liquidation
Insurance companies are not subject to the federal bankruptcy law, and their financial health is monitored by state regulators. The rules vary by state, but the first step in a regulatory process for financially troubled insurance companies is often an order of supervision. This often does not involve court intervention but does mean increased regulatory oversight. If formal supervision is unsuccessful, an insurance commissioner may seek an order of Rehabilitation. Such an order is generally issued by a court, upon motion of the Insurance Commissioner. A Rehabilitation proceeding is similar to a Chapter 11 bankruptcy. Insurance companies under both supervision or Rehabilitation should continue to pay claims subject to regulatory approval. Usually, however, companies in Rehabilitation cannot be sued, and disputes with policyholders are usually handled by a referee.
The final step is an order of Liquidation, similar to a Chapter 7 proceeding. The Insurance Commissioner gathers the assets of the insolvent company, collects proof of claim forms from policyholders and other creditors, and eventually (often many years later) pays out the company's remaining assets to the policyholders and other creditors. In addition to the delay, policyholders can expect to receive only a limited percentage of their claim value.
Under all three of these proceedings, policyholders can expect some level of increased delay and outright refusal to pay claims, with the delay problem, in particular, getting worse at each stage. That some recovery might be afforded years away is of small comfort to policyholders who were counting on insurance to protect them from their own troubled times.
Liquidation Claim Process
Policyholders can obtain a direct distribution from the estate of the liquidating insurance company by filing a proof of claim, often subject to a strict deadline. The Liquidator will create a blank proof of claim form and send it to policyholders and known claimants. Usually, proof of claim forms can be obtained on the Insurance Department's website in the state where the insurance company was domiciled and is being liquidated.
Eventually, often after years have passed, the Liquidator will begin making distributions to policyholders. It is not unheard of for domestic insolvencies to wait 20 years before paying claims (as one would expect foreign insolvencies are subject to different procedures). If the Liquidator rejects the claim a policyholder may object, often within 30 or 60 days.
Guaranty Associations
When an insurance company enters liquidation, or in some instances whenever a finding of insolvency is made, guaranty associations in the various states can respond. Guaranty associations are generally charged by statute to avoid excessive delay in payments and to alleviate financial loss to claimants and policyholders because of an insurance company insolvency. Although the requirements for obtaining recovery from state guaranty associations vary, there are many similarities. The website for the National Conference of Insurance Guaranty Funds (www.ncigf.org) is very helpful.
Note, however, that there are usually severe limitations to the relief afforded by guaranty funds. While multiple state funds might possibly respond, many provide limited or no protection for out-of-state residents. Guaranty relief might also be subject to per claim limits, and larger business policyholders might not be eligible under net worth limitations. Another area of concern is that policyholders who buy policies from insurance companies that do business in a particular state on a "surplus lines" basis might not have any guaranty fund protection whatsoever.
Other Issues
Other areas for policyholders to consider when their insurance company is financially distressed include:
(1) potential recovery from brokers who are usually considered to have some duty to advise their clients as to the financial health of the companies with whom they place their insurance;
(2) special considerations concerning captive companies who might have relationships with financially distressed "fronting" insurance companies; and
(3) potential recovery directly from reinsurance — although somewhat rare, cut-through clauses that allow direct recovery against reinsurance do exist and should be investigated.
In short, policyholders have a variety of options, and possible paths to recovery, when their insurance company is in financial trouble, but none of them offer the same protection as a fully solvent company.