What happens if an insurance company goes bankrupt?

In the early 1980s, the issue of an insurance company becoming bankrupt or insolvent was a relative rarity. By the early 1990s, however, there were some well-known insurance companies that were placed into receivership.

Because insurance companies are regulated by the states, federal bankruptcy law is not applicable to insurance receivership proceedings. In fact, insurance companies typically do not declare bankruptcy in the way that we normally use the word. Instead, they are placed into insolvency receivership or liquidation by the state’s insurance department.  State liquidation courts then rule on the many complex issues involved in an insurance company insolvency, including what becomes of the insurance policies and cash values.

Often, the policies can be bought by other insurers with the death benefits remaining the same, but this may involve a lowering of cash values and/or an increase in premiums.

Insurance companies are regulated by individual states, and it is ultimately the responsibility of the states to safeguard the solvency of insurers licensed to do business in their state. When states determine that an insurer is insolvent, the mechanism used to protect policyholders is the guaranty association system. All 50 states, the District of Columbia, and Puerto Rico have guaranty associations to which licensed life and health insurers must belong.

The best resource for information on this issue is the National Organization of Life and Health Insurance Guaranty Associations (www.nolhga.com). The following information is from their web site.

The National Organization of Life and Health Insurance Guaranty Associations (NOLHGA) is a voluntary association composed of the life and health insurance guaranty associations of all 50 states, the District of Columbia, and Puerto Rico. When an insolvency involves multiple states, NOLHGA assists its state guaranty association members in quickly and cost-effectively fulfilling their statutory obligations to policyholders.

NOLHGA was founded in 1983 after the state guaranty associations determined that there was a need for a coordinating mechanism to assist affected guaranty associations in effciently meeting their statutory obligations in the face of the often-complex issues resulting from the insolvency of an insurer licensed to do business in multiple states.

State guaranty associations provide coverage, up to certain statutory limits, for resident policyholders of insolvent member insurers.

NOLHGA provides its member state guaranty associations with a method for quickly and cost-effectively fulfilling their statutory obligations to policyholders in the event of a multi-state life and health insurer insolvency.

When an insurer licensed in multiple states is declared insolvent, NOLHGA, on behalf of affected member state guaranty associations, assembles a task force of guaranty association officials. This task force — with the support of NOLHGA staff, legal experts, actuaries, and financial experts — develops a plan for meeting member association obligations. Typically, the task force analyzes the company’s commitments; ensures that covered claims are paid; and, where appropriate, arranges for covered policies to be transferred to a healthy insurer. The task force may also support the efforts of the receiver to dispose of the company’s assets in a way that maximizes their value. When there is a shortfall of estate assets needed to fulfill all of the covered policyholder obligations of the insolvent insurer, guaranty associations assess the licensed insurers in their states a proportional share of the funds needed.

At all steps in the process, the affected state guaranty associations, working together through NOLHGA, cooperate with the receiver and other interested parties to build consensus on the steps needed to resolve an insolvency equitably and efficiently.

There are several key benefits that the state guaranty associations seek to achieve by working together through NOLHGA. The first is to decrease costs to the member insurers that fund state guaranty associations. Rather than each state association hiring its own legal and financial experts, the associations work together through NOLHGA and use one team of experts, significantly reducing costs to guaranty associations. This coordination of effort also helps reduce the length of time a receiver may require to develop a plan of rehabilitation or otherwise resolve a multi-state insolvency.

Since its creation in 1983, NOLHGA has assisted its member guaranty associations in guaranteeing more than $20.1 billion in coverage benefits for policyholders and annuitants of insolvent companies.

The language from NOLHGA’s web site is reprinted with the permission of NOLHGA, all rights reserved. Information on NOLHGA’s web site is not intended as legal advice; no liability is assumed in connection with its use. Consumers should seek advice from a qualified attorney when considering any questions relating to guaranty association coverage.