When Insurers Go Belly Up: Implications for Insurers, Policyholders and Guaranty Funds: It's Not Only the Insured Who Suffers When There Is an Insurer Insolvency; the Ripples May Cause Damage to Several Other Parties as Well

It's not only the insured who suffers when there is an insurer insolvency; the ripples may cause damage to several other parties as well RELIANCE, Frontier, Eegion, Phico and now Home. Not since the late 1980s has the insurance industry seen such a dramatic series of financial calamities. The recent insolvencies of major commercial insurance companies such as Home and Reliance have created a significant problem for other liability insurers, as both were significant players in many mass tort and environmental liability claims. State guaranty funds also are increasingly seeking to shift their obligations to other parties. Indeed, the collapse of these insurers has created a hole that no one seems anxious to fill. One or more of the following four candidates ultimately will be forced to bear responsibility: * Excess Carriers. In the absence of available underlying insurance, will the umbrella or excess coverage in that year "drop down"? * Other Primary Insurance. To the extent that primary insurers are deemed to have joint and several obligations for a shared loss, will the orphan shares be absorbed by the remaining solvent insurers? * State Guaranty Funds. State insurance insolvency funds were established more than 20 years ago to take responsibility for losses that would otherwise have been covered by insolvent insurers. Are there circumstances in which they can avoid that responsibility and shift the burden to other parties? * Policyholders. Insofar as the insolvency of a primary insurer results in a loss for which coverage is otherwise unavailable, will responsibility default to the policyholder? There are no clear answers to this conundrum. The resolution of the issue depends on state law, the wording of state insolvency statutes and, most importantly, the wordings of the insurance policies at issue. Nevertheless, it is possible to illustrate the likely outcome of these disputes depending on the particular configurations of wordings, statutes and case law. REGULATORY FRAMEWORK A. Why Do Insurers Fail? Insurers become insolvent for many reasons. An April 1989 analysis by the U.S. General Accounting Office concluded that Midland and Transit had failed because of a combination of over-aggressive growth strategies, particularly the use of managing general agents who aggressively promoted business in areas outside the insurer's traditional areas of expertise; unsecure reinsurance; inadequate state oversight and inconsistent auditing practices. An investigation by the U.S. House of Representatives Commerce Committee in 1990 also found disturbing parallels between recent insurer insolvencies and the collapse of many savings and loans companies. The Dingell Committee's report, Failed Promises: Insurance Company Insolvencies, concluded that insurers such as Anglo-American, Integrity, Mission and Transit had failed owing to a combination of rapid expansion; unsupervised delegation of authority; extensive and complex reinsurance arrangements; underpricing, reserve problems; false reports; reckless management; incompetence; fraud, greed and self-dealing. In June 1991, the A.M. Best Co. released a special report analyzing property and casualty insolvencies from 1969 through 1990. The Best report observed that of 3,200 property and casualty carriers in the United States, 372 were declared insolvent during this period. The failure rate was highest in California and Illinois. The report concluded that insolvencies were most likely to occur in companies that had deficient loss reserves and rapid growth, although internal fraud, changes in business models, and reinsurance failures also might contribute to insurer failures. Whatever their causes, insurer insolvencies are expensive and getting more so year by year. Data released by the National Conference of Insurance Guaranty Funds stated that in 1998, state guaranty funds assessed insurers $264 million to pay for insolvencies, an increase of 13. …