American International Group (AIG) is the largest business insurer in the world. On September 16, 2008, the Federal Reserve agreed to extend an $85 billion bridge loan to keep the insurer from declaring bankruptcy and giving it time to improve its financial position. As a business owner, this creates the fear that if the largest insurer can fail, then smaller insurers can fail. What happens if your insurer goes bankrupt?
This answer will be general in nature. This is because each state has a separate agency that regulates insurance in that state. State law and regulations differ from one state to the next and some states have greater protections for insureds. Check the link above and contact your state department of insurance for specific questions.
Insurers do fail. Insurers fail with some frequency. This is why it is critical to investigate an insurer's financial strength when considering business insurance.
Unfortunately, in some financial cycles and turmoil the reporting credit services cannot accurately reflect the stability of a company and a company can decline rapidly. AIG, as the most recent example, reported losses in its second quarter of 2008, but held a high credit rating and seemed unshakable in August 2008 when its stock was $26-8 per share. Six weeks later it faced bankruptcy and was downgraded by two credit levels. In the business insurance industry, insurers may fail after a disaster. In 1992, after Hurricane Andrew, 12 insurers failed.
Because insurers fail, all states have enacted substantial regulatory schemes to regulate insurers to protect insureds and to regulate the financial dealings of insurers. The heads of these state regulatory bodies form the National Association of Insurance Commissioners (NAIC). On September 16, 2008, the head of the NAIC, Sandy Praeger, issued this summary of the regulators' role in the wake of the AIG crisis:
"The No. 1 job of state insurance regulators is to make sure insurance companies operate on a financially sound basis. If needed, we immediately step in if it appears that an insurer will be unable to fulfill the promises made to its policyholders. This includes taking over the management of an insurer through a conservation or rehabilitation order, the goal being to get the insurer back into a strong solvency position."
"State regulators have numerous actions they can take to prevent an insurer from failing. Claims from individual policyholders are given the utmost priority over other creditors in these matters — and, in the unlikely event that assets are not enough to cover these claims, there is still another safety net in place to protect consumers: the state guaranty funds. These funds are in place in all states. If an insurance company becomes unable to pay claims, the guaranty fund will provide coverage, subject to certain limits."
"It is a state insurance regulator’s responsibility to protect policyholders and ensure a healthy, competitive market for insurance products. Strict solvency standards and keen financial oversight — based on conservative investment and accounting rules — continue to be the bedrock of state-based insurance regulation."
In summary, in most instances, your business insurer's bankruptcy will not result in unpaid claims. This is because:
- State regulators require insurers to maintain solvency (enough cash to cover potential claims).
- If the insurer becomes insolvent, the state can order a conservatorship or rehabilitation to restore solvency. Claims may be delayed, capped, or limited during such a period; but, rarely abandoned.
- If after state management the insurer remains insolvent, then state guarantee funds will provide claim coverage. Such coverage from the guaranty fund will be limited, but the claims will not be abandoned.
The business owner will need to obtain coverage from another insurer if the bankrupt insurer is out of business or leaves the market. Typically the business owner will have the current policy honored until the renewal date or will be given options by state regulators. This can be problematic in certain high risk or specialized markets. There may be a period where finding replacement coverage will be difficult. Other insurers will fill the gap as part of a market correction and working with a good insurance professional can lead you through this transition.
