Insurance Guaranty Funds
Insurance Guaranty Funds
Updated February 27, 2008
Analyst in Economics
Government and Finance Division
Insurance Guaranty Funds
Some constituencies are urging Congress to allow insurers to become federally
regulated, like banks. Other constituencies are urging Congress to instead ratify its
1945 delegation of insurance regulation to the states. In the past few years, various
pieces of legislation have been introduced to implement some form of federal charter
for insurance companies. The latest such legislation is the National Insurance Act
of 2007 (S. 40 and H.R. 3200).
How to protect insurance policyholders in the event of their insurer’s insolvency
is among the thorniest issues in insurance regulation, whether federal or state-based.
The current system of protection for insurance policyholders is called “insurance
guaranty funds.” This interdependent system is a cooperative effort among regulators
and insurers in the states where the insolvent insurer operated. It is administered
state-by-state and funded by assessments on insurers. Though it has developed
relatively recently, the system has provided some protection for policyholders of both
large and small insolvent insurers.
If Congress were to consider regulating insurers federally, it would confront the
issues of whether and how to provide that policyholder protection. Should Congress
wish to protect insurance policyholders in an insolvency, it might choose to establish
or expand a federal program like the Federal Deposit Insurance Corporation, the
Pension Benefit Guaranty Corporation, or the National Credit Union Share Insurance
Fund. Another option would be to require federally regulated insurers to participate
in the state-based guaranty fund system.
Establishing federal protection for policyholders of insolvent federally regulated
insurers would have costs and benefits. Direct costs would include, at the least, the
costs of establishing and administering the system. Costs could also include funding
of catastrophic shortfalls, as happened in the savings and loan crisis in the 1980s.
Indirect costs could include inefficiencies that might result from dampening market
discipline. The measure of benefit to policyholders would depend on the scope of
protection offered. The potential benefit to the U.S. economy would require further
Requiring federally regulated insurers to participate in state guaranty funds
would have costs and benefits as well. The costs would include the economic
inefficiencies created by externalizing the costs of ineffective solvency regulation.
The benefits would be simplicity and a consolidated assessment base.
This report describes generally how state-based insurance guaranty funds
operate currently. It also compares the extant insurance system to protections offered
bank depositors, potential and current pensioners, and credit union participants. It
was originally prepared by Carolyn Cobb, Insurance Consultant, Government and
Finance Division, and will be updated as warranted by legislative events.
Revising Insurance Regulation: The Debate.............................1
How Insurance Guaranty Funds Work..................................1
Other Financial Intermediaries’ Protection Systems.......................4
Appendix. Comparing Features of Various Protection Systems..............9
Insurance Guaranty Funds
Revising Insurance Regulation: The Debate1
Proponents of federal regulation of insurers make analogies to banks and their
regulation. They argue that insurers, like banks, should be allowed to elect whether
to hold a state or a federal charter and to reap the perceived benefits of choosing their
regulator. The analogy of insurers to banks is useful — insurers and banks are both
financial intermediaries performing similar important functions in the U.S. economy.
They are also both so important that our society has constructed protection for
consumers holding contracts with insolvent financial intermediaries of both types.
The federal insurance funds of the Federal Deposit Insurance Corporation (FDIC),
the Pension Benefit Guaranty Corporation (PBGC), and the National Credit Union
Share Insurance Fund (NCUSIF) provide similar protections. They operate
differently, however, than the state-based system of insurance guaranty funds.2 These
differences may gain significance if Congress considers federal regulation of insurers.
How Insurance Guaranty Funds Work
Provision for policyholders of insolvent insurers began slowly in the late 1930s.
By the 1950s, some states had security funds for disabled workers covered by
insolvent workmen’s compensation insurers, and a few had similar provision for
policyholders of insolvent automobile insurers. Then, in the late 1960s, Congress
considered creating a federal fund, similar to the FDIC, to protect all property-
liability policyholders. State regulators and insurers objected to federal regulation,
and they cooperated to create a model law that at least 47 states had enacted in some
form by 1974.3 Most states did not enact life and health insurance guaranty fund
laws until after the Baldwin-United insolvency in 1983 and the Executive Life
1 For the more complete information on this debate and current legislation, see CRS Report
RL32789 Insurance Regulation: Issues and Background, by Baird Webel.
2 See the Appendix of this report for a brief overview of the similarities and differences
among these protection systems. For more information, see CRS Report RS21987, When
Financial Businesses Fail: Protection for Account Holders, by Walter W. Eubanks.
3 See National Association of Insurance Commissioners, “Post-Assessment Property and
Liability Insurance Guaranty Association Model Act,” Model Laws, Regulations and
Guidelines (Kansas City, MO: National Association of Insurance Commissioners, October
2007), vol. III, pp. 540-1 through 540-20 for the text of the model and citations to analogous
insolvency in 1990.4 All states had enacted life and health insurance guaranty fund
laws by late 1992.5
Three principles guided the drafters of both model laws: policyholders should
not lose their risk protection upon insolvency; losses due to insolvency should be
shared; and claim payments should not be unduly delayed by an insolvency. These
principles operate differently in property-liability insurer insolvencies than they do
in life and annuity insolvencies, as discussed below. Property and liability coverages
are short-term contracts, usually no longer than one year, while life and annuity
contracts are long-term contracts, often for the life of the insured.6
Under both model laws, once the home state insurance commissioner
determines that the insurer — whether property-liability or life — is financially
troubled, the commissioner is required to take steps to protect policyholders and
claimants. The commissioner can order the insurer to take corrective steps and to
suspend business. The commissioner can petition a state court either for an order of
rehabilitation, if it is determined that the insurer’s problems can be corrected, or for
an order of liquidation, if it is not. The court’s order of liquidation appoints the
commissioner as liquidator, and the commissioner appoints a receiver. The receiver
takes possession of the insurer’s offices, records, and assets. Assuming the records
are adequate, the receiver advises policyholders and claimants of the insurer’s
liquidation and of the process for filing a claim against the insurer’s estate.7
Cooperation among the states where the insolvent insurer operated is essential.
Usually the insurance commissioner in the insurer’s state of incorporation — known
as its “domicile” or “domiciliary state” — petitions first for an order of liquidation
from a state court in that domicile, and that court retains principal jurisdiction over
the insurer’s liquidation. The domiciliary insurance commissioner also appoints the
lead receiver. Insurance regulators in the other states where the insurer operated will
appoint ancillary receivers, after entries of orders of liquidation in those states. The
4 See National Association of Insurance Commissioners (NAIC), “Life and Health Insurance
Guaranty Association Model Act,” Model Laws, Regulations and Guidelines (Kansas City,
MO: National Association of Insurance Commissioners, October 2007), pp. 520-1 through
520-51, for the text of the life and health guaranty fund model and citations to similar state
laws. For information on these insolvencies, see U.S. General Accounting Office, Insurance
Regulation: Weak Oversight Allowed Executive Life to Report Inflated Bond Values, GAO
GGD-93-95 (Washington: GPO, December 1992), available at [http://184.108.40.206/d36t11/
148197.pdf]; U.S. General Accounting Office, Insurer Failures: Life/Health Insurer
Insolvencies and Limitations of State Guaranty Funds, GAO GGD-92-44 (Washington:
GPO, March 1992), available at [http://220.127.116.11/d32t10/146456.pdf].
5 See Spencer L. Kimball and Noreen J. Parrett, “Creation of the Guaranty Association
System,” Journal of Insurance Regulation, vol. 19, winter 2000, pp. 259-273.
6 Christopher J. Wilcox, “The U.S. Guaranty Association Concept at 25: A Quarter-Century
Assessment,” Journal of Insurance Regulation, vol. 14, spring 1996, pp. 370-404.
7 See NAIC, Model Laws, Regulations and Guidelines, vol. 3, pp. 555-1 through 555-67.
lead and ancillary receivers cooperate, with the assistance of the guaranty funds and
the national associations of guaranty funds.8
The order of liquidation in each state generally triggers the operation of that
state’s guaranty fund, though the trigger varies by state. Each guaranty fund is a
mandatory association of all licensed insurers doing business in that state. Each fund
has a board of those insurers, and the board governs the fund. An accumulation of
money does not actually exist until after the insolvent’s liabilities and assets are
evaluated, each participating insurer is billed for its proportionate share of the
shortfall, and each insurer remits its allocated share for that particular insolvency.9
The “fund” is the sum of those remittances. The term “guaranty fund” can also refer
to insurers’ statutory obligation to participate in this protection system.10 In general,
each state’s guaranty fund is responsible for the policyholders residing in that state,
and the protection extends only to policyholders of licensed insurers within the limits
of statutory coverage in that state of residence.
The entry of an order of liquidation of a property-liability insurer typically
terminates all existing property-liability policies within 30 days, though the insurer
remains liable for any claims that arose before the order. The order usually prohibits
the insurer from issuing any new policies, and it suspends all claims payments to
allow an orderly and equitable evaluation of the insurer’s liabilities and assets. State
laws give policyholders’ claims on the assets precedence over general creditors, but
not over the expenses incurred by the liquidator, receiver, and guaranty associations.
The entry of the order of liquidation obligates that state’s property-liability
guaranty association to begin processing claims from residents, though it is not
obligated to cover all claims. For example, most states’ laws usually cap coverage
at $300,000 and exclude claims for punitive damages. The property-liability insurers
that are members of the guaranty association assess themselves proportionate to their
premium volume in that state to fund the difference between the insolvent’s assets
and the residents’ claims. The assessments are imposed first on the particular type
of property-liability insurance that occasioned the insolvency and are limited to 1%
to 2% annually of each insurer’s premium volume in that line in that state. If that
assessment proves insufficient, then other types of property-liability insurance —
known as “accounts” — may be assessed as well. Most states allow assessed insurers
8 Ibid. The National Organization of Life and Health Guaranty Associations (NOLHGA),
assists in coordinating administration of insolvencies of life insurers. See
[http://www.nolhga.com/]. The National Conference of Insurance Guaranty Fund (NCIGF)
assists in coordinating administration of insolvencies of property and liability insurers. See
9 The New York property-liability insurance guaranty fund is the exception. Property-
liability insurers licensed in New York must quarterly pay 5% of that quarter’s total
premium into the New York guaranty fund, if necessary to maintain the fund’s balance of
at least $150 million but not more than $200 million. See N.Y. Ins. Law §7601 et seq.
10 See generally Insurance Information Institute, “Insolvencies/Guaranty Funds,” in Hot
Topics & Insurance Issues, at [http://www.iii.org/media/hottopics/insurance/insolvencies].
to include the assessments in their rates, though some states allow insurers to
surcharge policyholders or offset the assessment against their premium taxes.11
The entry of an order of liquidation of a life insurer, in contrast, does not cancel
life or health insurance policies or annuity contracts. The rationale is that, unlike
property-liability coverage, which an insured may replace easily, life and health
insurance and annuity contracts may be difficult to replace. The model law’s drafters
decided that, to preserve the policyholder’s risk protection through an insolvency,
coverage issued by a life insurer should be continued through an insolvency. In
practice, life insurance guaranty associations often meet this obligation collectively
by selling or transferring the covered policies to another life insurer.
As with property-liability insurance, there are limits on life insurance guaranty
fund protection. Generally, $300,000 is the limit on life insurance death benefits,
$100,000 is the limit on cash values in life insurance and annuity contracts, and
$100,000 is the limit on health insurance policy benefits. Most states’ laws cap
coverage for any one life at $300,000, though some states have higher limits.
Guaranty association coverage usually extends neither to any policy or portion of a
policy in which the policyholder bears the investment risk, nor to HMOs.
Also as with property-liability insurance, licensed life insurers in each state
assess themselves for the shortfall. Typically, assessments up to 2% of each life
insurer’s premium volume, by type or “account,” are imposed annually. If that
assessment proves insufficient, then other types or accounts may be assessed. Most
states allow life insurers to recoup those assessments by offsetting up to 20% of the
assessment against their premium taxes for five years.12
Other Financial Intermediaries’ Protection Systems
The FDIC protects deposits in banks and savings associations. The Pension
Benefit Guaranty Corporation (PBGC) protects participants in defined benefit
pension plans. The National Credit Union Share Insurance Fund (NCUSIF) protects
“share” accounts in credit unions. Each represents legislative interest in maintaining
confidence in financial intermediaries and legislative choices about how to spread
potential losses should a financial intermediary fail, as does the insurance guaranty
11 For further information, see National Conference of Insurance Guaranty Funds, “Guaranty
Fund Laws Summary,” 2007 Summary of Property & Casualty Insurance Guaranty
Association Acts of the Various States and U.S. Territories, available at
12 For further information, see National Organization of Life and Health Guaranty
Associations, “Facts & Figures: Guaranty Association Laws,” available at
[http://www.nolhga.com/ factsandfigur es/main.cfm/location/stateinfo].
Unlike the insurance protection system, however, the FDIC, PBGC, and
NCUSIF are all congressionally created protection plans and are administered
federally. There are other differences among the protection systems, too, including
whether the protection fund exists before the insolvency, whether the contributors to
the fund pay based on the risk each presents to the system’s solvency, and whether
those contributors can recoup the costs of their payments to the system.
The similarities and differences among the various protection systems are
summarized in a chart in the Appendix.
Opinions differ markedly over whether the current insurance guaranty fund
system functions well or poorly. Supporters say that the current system has been very
effective. The President of the National Conference of Insurance Guaranty Funds
(NCIGF) notes that funds have paid out about $21 billion in claims that would have
gone unpaid in the last four decades.13 The National Organization of Life and Health
Guaranty Associations (NOLHGA) indicates that, since 1983, guaranty funds have
protected 2.2 million policyholders by guaranteeing more than $21.2 billion in
benefits and contributed $4.4 billion to ensure that policyholders received their
benefits.14 Some critics of the current state insurance guaranty fund system say it is
inefficient, slow, parochial, and fragmented, and they urge that it be replaced with a
federal system or significantly reformed.15 Other critics say the existence of guaranty
funds distorts incentives by allowing some insurers to increase risk-taking behavior
and by imposing the costs of that behavior on more conservative insurers.16 The
critics say that the current system “provide[s] a powerful risk subsidy incentive that
[solvency] monitoring does not entirely offset.”17 That effect is exacerbated by flat-
13 National Conference of Insurance Guaranty Funds, The Property and Casualty Guaranty
Fund System: Paying Claims, Protecting Policyholders, available at
14 National Organization of Life and Health Guaranty Associations, Facts & Figures,
available at [http://www.nolhga.com/factsandfigures/main.cfm].
15 Debra J. Hall and Robert M. Hall, “Insurance Company Insolvencies: Order Out of
Chaos,” Journal of Insurance Regulation, vol. 12, winter 1993, p. 145 et seq. See also
Martin F. Grace, Robert W. Klein, and Richard D. Phillips, Managing the Cost of Property-
Casualty Insurer Insolvencies, Center for Risk Management and Insurance Research,
Georgia State Univ.,Executive Summary Research Report 02-1, December 2002, available
at [http://rmictr.gsu.edu/Papers/RR02-1_abstract.pdf] and David A. Skeel, Jr., “The Law and
Finance of Bank and Insurance Insolvency Regulation,” Texas Law Review, vol. 76, March
16 William R. Feldhaus and Paul M. Kazenski, “Risk-Based Guaranty Fund Assessments:
An Allocation Alternative for Funding Insurer Insolvencies,” Journal of Insurance
Regulation, vol. 17, fall 1998, pp. 42-64.
17 David H. Downs and David W. Sommer, “Monitoring, Ownership, and Risk-Taking: The
Impact of Guaranty Funds,” Journal of Risk and Insurance, vol. 66, September 1999, pp.
rate assessments, they say. These critics argue for risk-based assessments similar to
that required by the FDIC.18 One critic has observed that incentives are further
distorted by “the existence of tax offsets and by the insurers’ ability to pass some of
these costs to policyholders.”19
Whether to change the current system of policyholder protection would be a
significant policy issue in any legislation to authorize or require federal regulation of
insurers. In the 110th Congress, Senators John Sununu and Tim Johnson introduced
the Senate version of the National Insurance Act of 2007 (S. 40), and Representatives
Melissa Bean and Ed Royce introduced a House version (H. R. 3200). Both bills
would require all federally licensed insurers to participate in state guaranty funds,
with the possibility of a federal guaranty fund if the state guaranty funds do not treat
national insurers in the same manner as state insurers. Versions of the National
Insurance Act (S. 2509 and H.R. 6225) were also introduced in the 109th Congress,
by Senators Sununu and Johnson and Representative Royce.20
In the 108th Congress, Senator Ernest Hollings introduced legislation (S. 1373)
to require all interstate insurers to be federally licensed and regulated. It would have
established a pre-funded national insurance guaranty association and required all
interstate insurers to pay into the fund. In the 107th Congress, Representative LaFalce
introduced legislation (H.R. 3766) to allow insurers to elect federal licensing and
regulation. It would have required all insurers electing federal regulation to
participate in state guaranty associations. Senator Chuck Schumer proposed similar
legislation in the 107th Congress to create an optional federal charter for insurers.21
It also would have required federally regulated insurers to participate in a state-based
system of policyholder protection operating generally as it does now.
Some of the policy issues that Congress might confront should it consider
federal chartering for insurers are as follows:
!Should federal legislation create a federally based protection system
for federally chartered insurers, or instead require them to
participate in the state-based guaranty fund system?
18 Feldhaus and Kazenski, “Risk-Based Guaranty Fund Assessments,” pp.48-63.
19 James Barrese and Jack M. Nelson, “Some Consequences of Insurer Insolvencies,”
Journal of Insurance Regulation, vol. 13, fall 1994, p. 3 (noting that the present value of
guaranty fund costs actually retained by surviving life and health insurers was 15% of the
total costs and the present value of such costs retained by property-liability insurers was
20 See CRS Report RL34286, Insurance Regulation: Optional Federal Charter Legislation,
by Baird Webel.
21 Senator Schumer’s bill did not receive a number during the 107th Congress. See Michelle
Heller, “In Brief: Senator Schumer Proposes Optional Charter,” American Banker, vol. 167,
issue 247, December 28, 2001, p. 3.
Creating a federally based protection system would entail direct federal costs at
least for establishing and maintaining its administrative infrastructure, even if
the system were administered by the FDIC. Requiring federally regulated
insurers to participate in a state-based protection system would entail
significant, though unquantifiable, indirect costs to policyholders, insurers, and
taxpayers. This is because incentives would be misaligned: that is, the costs of
insolvencies would fall on the states, not on the federal regulator, and the states,
though bearing the financial burden, would have no control over the
effectiveness of federal regulation for solvency. These conflicting objectives
could create the potential for significant economic inefficiencies.22
!If Congress considers federal regulation of insurers, should it also
consider creating a federal system of policyholder protection?
Creating a federal policyholder protection system for federally regulated
insurers might stress the federal budget and arguably undermine market
discipline. On the other hand, it might more directly align behavioral
incentives, because a federal regulator would have both the responsibility for
regulating for solvency and the responsibility for all or some portion of the
unfunded claims of an insolvent insurer, as well as for administering the
!Should any federal system of policyholder protection include or
exclude state-regulated insurers?
Including state-regulated insurers in any federal policyholder protection system
could distort incentives, because it would bifurcate the responsibility for
solvency regulation of state-charted insurers from the consequences of any
failure of that regulation. On the other hand, excluding state-chartered insurers
from any federal system might destabilize either or both of the federal and state
protection systems. This is because fewer insurers would be members of either
system, which would mean that any assessments would be imposed on a
reduced premium base.
!If Congress were to create a federal protection system, what limits
The principal issues would be deciding what types of policyholders would be
protected in the event of an insurer’s insolvency and what the limits on their
recovery should be. This would be challenging, especially for property
coverages for regional disasters, such as earthquakes and hurricanes, and for
business liability coverages. Also, if Congress wished to protect only
policyholders of federally regulated insurers, then constituents might have
different levels of protection depending on whether their insurers were state-
regulated or federally regulated. Alternatively, Congress might require states
to adopt levels of protection identical to the federal levels.
!If Congress were to create a federal policyholder protection system,
should it be pre-funded or post-funded?
22 See generally Jean-Jacques Laffont and David Martimort, The Theory of Incentives: The
Principal-Agent Problem (Princeton, NJ: Princeton Univ. Press, 2002).
Insurers would likely argue strongly for post-funding, as they have been
historically averse to paying for any government-held fund. Their competitors
in the financial intermediation marketplace, such as banks and savings
institutions, might argue that insurers should be subject to pre-funding like
themselves. There would be technical issues, too, such as whether to maintain
separate funds for life insurers and property-liability insurers and how to
calculate an appropriate fund balance.
!If Congress were to create a federal policyholder protection system,
should an insurer’s assessments be based on its risk profile?
Though some argue that flat assessment rates dilute market discipline,
determining how to profile insurers’ risks could become technically complicated
and politically contentious. Insurers are required currently to hold additional
capital based on their risks. Very generally speaking, life insurers calculate that
additional required capital based on a categorization of the riskiness of their
investments, and property-liability insurers calculate it based on the types of
insurance they underwrite and their past experience in each line of insurance.23
Whether analogous calculations would be feasible for guaranty fund
assessments has not been studied.
Other issues would include whether insurers should have access to the Federal
Reserve Board’s discount window and the relationship of any federal system of
policyholder protection to the FDIC.24
Whether to maintain some level of policyholder protection against insolvency
may be a significant issue in any congressional consideration of federal regulation of
insurers. How to offer that protection will likely entail more difficult decisions.
Policy considerations could include whether to offer federal protection or to require
federally regulated insurers to participate in the existing state system. Should
Congress decide to offer federal protection, technical issues could include how to
fund the protection, its scope, the location of the administering agency in the
executive branch, and how to enforce market discipline fairly.
23 Dan Swanson, Insurance Accountant, National Association of Insurance Commissioners,
telephone conversation with Carolyn Cobb, December 1, 2003.
24 Based on Scott E. Harrington, Optional Federal Chartering of Property-Casualty
Insurance Companies (Downers Grove, IL: Alliance of American Insurers, 2002), pp. 43-46
and p. 70; and Bert Ely, “The Fate of the State Guaranty Funds After the Advent of Federal
Insurance Chartering,” in Peter J. Wallison, ed., Optional Federal Chartering and
Regulation of Insurance (Washington, DC: AEI Press, 2000), pp. 135-152.
Appendix. Comparing Features of Various
FeatureDepositPensionCredit Union Insurance
Protection Protection Protection Protection
AdministrationFederal agencySelf-supportingFederal agencyState-by-state
(Federal Depositfederal agency;(National Creditcooperation
Insurance Corp. receives no generalUnion Shareamong state
— FDIC)revenueInsurance Fund administrators
appropriation— NCUSIF)and non-profit
(Pension Benefitassociations of
Guaranty Corp.licensed insurers,
— PBGC)funded by
FundingAll national andEmployers payMember creditLicensed direct
state banks andassessments intounions (allinsurers pay after
thrifts payfund prior to anyfederal andan actual
assessmentsinsolvencyelecting state)insolvency; no
prior to anypay assessmentsfund exists
insolvency toprior to
maintain fundinsolvency to
balance, which ismaintain fund
part of the
Assessmentpay an additional
RecoupmentNone, other thanNone, other thanNoneLife insurers in
business expenseemployers’45 jurisdictions
deduction onbusiness expenseand property-
federal taxesdeduction onliability insurers
federal taxesin 20 may deduct
Product LineNoneOne program forNone forInsurers are
plans and anotherpurposesmarket share in
for multi-employerparticular types of
plans insur a nc e
Coverage Limit$100,000 perOnly basic benefits$100,000 perCoverage limits
standardare guaranteed upstandardvary by state
account,to federal statutoryaccount,
$250,000 permaximums$250,000 per