Members of the 

U.S. Advisory Commission on Intergovernmental Relations 

(December 1992) 

Private Citizens 

Daniel J. Elazar, Philadelphia, Pennsylvania 

Robert B. Hawkins, Jr., Chairman, San Francisco, California 

Mary Ellen Joyce, Arlington, Virginia 

Members of the U.S. Senate 

Daniel K. Akaka, Hawaii 

Dave Durenberger, Minnesota 

Charles S. Robb, Virginia 

Members of the U.S. House of Representatives 

Donald M. Payne, New Jersey 

Craig Thomas, Wyoming 

Vacancy 

Officers of the Executive Branch, U.S. Government 

Lamar Alexander, Secretary, U.S. Department of Education 

Andrew H. Card, Jr., Secretary, U.S. Department of Transportation 

Bobbie Kilberg, Deputy Assistant to the President, 

Director of Intergovernmental Affairs 

Governors 

John Ashcroft, Missouri 

George A. Sinner, North Dakota 

Stan Stephens, Montana 

Vacancy 

Mayors 

Victor H. Ashe, Knoxville, Tennessee 

Robert M. Isaac, Colorado Springs, Colorado 

Bruce Todd, Austin, Texas 

Vacancy 

Members of State Legislatures 

David E. Nething, North Dakota Senate 

Samuel B. Nunez, Jr., President, Louisiana Senate 

Ted L. Strickland, Colorado Senate 

Elected County Officials 

Ann Klinger, Merced County, California, Board of Supervisors 

D. Michael Stewart, Salt Lake County, Utah, County Commission 

Barbara Sheen Todd, Pinellas County, Florida, 

Board of Commissioners 
A Commission Report 

State Solvency Regulation 

of Property-Casualty 

and Life Insurance Companies I 

Advisory Commission on 

Intergovernmental Relations 

A-I 23 

December 1992 
U.S. Advisory Commission on 

Intergovernmental Relations 

800 K Street, NW 

South Building 

Suite 450 

Washington, DC 20575 

(202) 653-5640 

FAX (202) 653-5429 
Acknowledgments 

Sandra B. McCray was the principal investigator for 

this project and wrote the report. 

Special thanks go to Henry A. Coleman, former 

ACIR director of Government Finance Research. 

The Commission wishes to thank the following persons 

who read and commented on various drafts: James Barrese, 

Robert D. Bischoff, John Booth, Jack Blaine, David J. 

Brummond, Carolyn Cobb, Darren Cook, Pat Foley, Sen. 

Donald M. Halperin, Kevin Harris, Robert Hunter, James 

Jackson, Carolyn Johnson, Ed Kelly, Robert Klein, Kevin 

Kronin, Vicent Laurenzano, William McCartney, William 

C. Marcoux, Susan Martin, Franklin W. Nutter; Jana Lee 

Mtt, Paul Reardon, Dale Stephenson, Laura F? Sullivan, 

William Waren, and Edward Zimmerman. 

The willingness of these individuals to help in this 

project should not be viewed as an endorsement of all or 

any particular portion of this report. ACIR and its staff are 

responsible for the content of the report. 

John Kincaid 

Executive Director 

... lu 

Executive Summary 

Since the late 18th century, states have exercised 

virtually exclusive regulation of the property-casualty and 

life insurance industries. A recent rash of insolvencies, 

however, has called into question the ability of state regu- lators to supervise insurers doing interstate business and 

the capacity of state guaranty funds to reimburse policy- holders for losses resulting from insolvencies. 

The purpose of this report is to inform policymakers 

of the options available for improving state solvency regu- lation of the property-casualty and life insurance indus- tries. The report examines the entire range of issues in 

state solvency regulation, including regulatory accounting 

and finance, the role of reinsurance, multistate insurance 

holding companies, state liquidation proceedings, and 

state guaranty funds. The study identifies 18 areas in 

which state solvency regulation could be improved, de- scribes state efforts to implement needed reforms, and 

examines several federal proposals for reform. 

The number and size of insurer insolvencies have 

increased dramatically. For example, the number of prop- erty-casualty insurer insolvencies rose from four in 1980 

to 25 in 1985, and, nationwide, the guaranty fund assess- ments rose from $19 million in 1980 to $292 million in 

1985. Life/health guaranty fund assessments tripled from 

$154.8 million in 1990 to $469.7 million in 1991. Some 

estimates place the cost of the recent failure of Executive 

Life of California at $400 million per year over five years. 

These figures have prompted calls for federal regula- tion of the insurance industries. Among the problems in 

state regulation of insurance noted by the Congress and 

the U.S. General Accounting Office are differences in 

quality due to disparities in resources and regulatory phi- losophy, inconsistent solvency laws and the failure of 

states to coordinate their efforts, the failure of state regu- lators to enforce their solvency laws in a timely fashion 

and to pursue wrongdoers, the failure or inability of states 

to oversee holding companies and foreign reinsurers, and 

insufficient capacity of state guaranty funds. 

Congressional proponents of federal regulation pro- pose various forms of intervention. For example, a bill 

introduced by Sen. Howard M. Metzenbaum in 1991 

would create a federal insurance regulatory commission 

with authority to certify state insurance departments. 

Without federal certification, a state could not issue a 

license to insurance companies engaged in interstate 

commerce. In order tobecome certified, a state insurance 

department would have to adopt certain uniform mini- mum federal standards. The certification program would, in 

effect, transform state regulators into administrators of a 

federal program. A bill introduced by Rep. John D. Dingell 

in 1992 would establish an independent federal agency to 

regulate insurers that choose a federal license. According to 

the Dingell bdl, federally licensed insurers would remain 

subject to certain state laws, including those regulating un- fair trade and claims settlement practices. Yet, because the 

Dingell bill would give the federal agency broad authority to 

preempt all state laws, the ability of states to enforce their 

laws would be questionable. 

States have countered the calls for federal regulation 

of insurance by pointing to recent efforts to tighten state 

regulation. Many states have passed laws that address 

areas of weakness. For example, recent investigations 

identified several factors, such as the use of unregulated 

managing general agents to underwrite insurance, that 

contributed to large property-casualty insurer failures. 

States responded by adopting laws to license managing 

general agents and to prohibit companies from delegating 

their underwriting function to such agents. 

To the extent that some insurance problems spill over 

state lines, the National Association of Insurance Com- missioners (NAIC) has established a program to accredit 

state insurance departments that have adopted certain 

uniform model laws to ensure solvency and have met 

certain standards for staffing. NAIC believes that this 

program will produce a nationwide insurance regulatory 

system. Other NAIC efforts to overcome the limited juris- dictional reach of state regulators include the establish- ment of a centralized working group to monitor the finan- cial health of large multistate insurers. The National 

Conference of Insurance Legislators has drafted an inter- state compact that would centralize and coordinate the 

administration of state liquidations and guaranty funds. 

This study concludes that proposals for federal regu- lation of insurance are premature. The recent savings and 

loan crisis and continuing bank defaults serve as powerful 

reminders that federal supervision has not eliminated 

industry failures, whether those failures result from insuf- ficient regulatory resources, lack of regulatory will, indus- try manipulation of the political process, or fraud. All of 

these problems were present in the recent crises in our 

depository institutions. Although there have been failures 

in state insurance regulation for similar reasons, all of the 

state regulatory lapses combined have not produced a 

taxpayer bill comparable to the federal bill (over $500 

billion) for the savings and loan crisis. Given the present 

efforts of states, individually and collectively, to seek solu- tions to serious regulatory problems, the substitution of 

federal for state regulation appears unwarranted. 

V 
vi 
Contents 

Findings and Recommendations ....................................................................... 

Findings ................................................................................ Recommendations ....................................................................... 

Recommendation I-Limit Federal Intervention in State Regulation of the Insurance Industry ............. 

Recommendation 2-Encourage States to Become Accredited under the NAIC Program ................... 

of Their Guaranty Funds ...................................................................... Recommendation 3- States Should Consider Various Options to Increase the Capacity 

Recommendation 4-NAIC and State Commissioners Should Avoid Appearances of Impropriety ........... 

Recommendation 5-States Should Consider Entering into Interstate Compacts to Ensure 

Uniform Application of Liquidation and Guaranty Fund Proceedings ............................... 

Introduction ......................................................................................... 

The States as Regulators .......................................................................... The Report ...................................................................................... 

Part I-Property-Casualty Insurance 

Chapter I -History of State Regulation of Property-Casualty Companies ................................... 

Early History of Property Insurance ................................................................ 

The Birth of State Regulation of Property Insurance .............................................. 

Early History of Casualty Insurance ................................................................ 

Automobile Insurance and Workers’ Compensation 

Legal Challenges to State Regulation ............................................................... 

Rate-Making Bureaus and Anticompact Laws .................................................... 

Industry Campaigns for Federal Regulation of Insurance .............................................. The McCarran-Ferguson Act ...................................................................... 

Chapter 2-Overview of the Modern Business of Property-Casualty Insurance .............................. 

Definition of the Business of Insurance ............................................................. Structure of the Property/Casualty Market .......................................................... 

Regulatory Requirements ..................................................................... Legal Forms of Ownership .................................................................... 

.............................................. 

Is Insurance Commerce? ...................................................................... 

Rate RegulationExperiments .................................................................. 

Marketing Channels .......................................................................... 

4 

4 

4 

5 

5 

5 

9 

9 

10 

10 

11 

11 

11 

12 

13 

13 

14 

17 

17 

17 

18 

18 

19 
Chapter 3-Critical Issues in State Regulation of Property-Casualty Insurance: Solvency ..................... 

Balance Sheet Liabilities: Policyholder Surplus and Loss Reserves ................................. Balance Sheet: Assets ......................................................................... 23 

23 

Purposes and Forms of Traditional Reinsurance .................................................. 24 

Problems with Reinsurance .................................................................... 24 

Financial Reinsurance ........................................................................ 26 

27 

State Solvency Regulation ......................................................................... 27 

27 

28 

28 

29 

29 

29 

30 

Could Be Improved .......................................................................... 32 

and State Guaranty Funds ..................................................................... 35 

State Delinquency Proceedings .................................................................... 35 

Marshaling General Assets: Reinsurance ....................................................... 35 

The Effect of Misrepresentations Made by the Ceding Insurer ..................................... 37 

21 

21 

21 

Regulatory Accounting and Finance ................................................................ 

The Role of Reinsurance .......................................................................... 

GAO Criticism of Statutory Accounting and Summary ................................................ 

State Minimum Capital and Surplus Requirements ............................................... Fronting and Managing General Agents ......................................................... Monitoring the Financial Health of Insurers ..................................................... Monitoring Reinsurers and Reinsurance ......................................................... 

Multistate Insurance Holding Companies ........................................................... 

NAIC’s Model Holding Company Act 

State Regulatory Resources and Insurer Failure Rates ................................................ 

.......................................................... 

Summary of Major Areas in Which State Solvency Regulation of Property-Casualty Companies 

Chapter 4- Critical Issues in State Regulation of Property- Casualty Insurance: Liquidation Laws 

Set Offs (Offsets) ............................................................................ 38 

Cut-Through Clauses ......................................................................... 38 

StatelFederal Clashes ......................................................................... 39 

Lack of Uniformity among State Liquidation Laws ............................................... 40 

State Property-Casualty Guaranty Funds ............................................................ 40 

Procedures for Payment of Covered Claims ...................................................... 41 

Problems with the Guaranty Fund Model Act .................................................... 41 

Who Pays the Assessments? ................................................................... 45 

The Capacity of State Property-Casualty Guaranty Funds ......................................... 45 

Summary of Major Areas in Which State Liquidation and Guaranty Fund Law Could Be Improved ........ 46 

Chapter 5-History of State Regulation of Life Insurance Companies ...................................... 

Early History of Life Insurance .................................................................... 

Early Life Insurance in the United States ....................................................... The Armstrong Committee Investigations and Regulatory Reform ................................. New York as Super Regulator: The Appleton Rule ............................................... 

Chapter 6-Overview of the Modern Business of Life Insurance ........................................... 

Types of Life Insurance ........................................................................... 

Part ZZ-Life Insurance 

53 

53 

54 

55 

56 

59 

59 

Term Life ................................................................................... 59 

Whole Life .................................................................................. 59 

Annuity ..................................................................................... 60 

... 

Vlll 
Chapter 7-Critical Issues in State Regulation of Insurance: Life Insurance Solvency ........................ 

Regulatory Accounting ............................................................................ 

Balance Sheet Liabilities: Surplus and Reserves .................................................. Balance Sheet: Assets ......................................................................... 

The Role of Reinsurance .......................................................................... 

Transfer of Business .......................................................................... Interaffiliate Reinsurance ..................................................................... Financial Reinsurance ........................................................................ 

State Solvency Regulation ......................................................................... 

Multistate Insurance Holding Companies ....................................................... 

State Life Guaranty Associations ................................................................... 

Coverage .................................................................................... Statutory Prohibitions on Guaranty Fund Disclosure .............................................. Who Pays the Assessments? ................................................................... The Capacity of Life Guaranty Funds ........................................................... 

Chapter 9-Improving State Regulation ................................................................. 

Chapter 10-State Efforts to Strengthen Solvency Regulation .............................................. 

NAIC’S Early Warning System .................................................................... 

Analysis of Proposals for Improving State Liquidation Procedures and Guaranty Funds ................... 

Prefunded State Guaranty Funds ............................................................... 

Chapter 11-Cooperative State Regulation through an Interstate Compact ................................. 

Strengths and Weaknesses of Interstate Compacts and Conditions for Success ........................... The NCOIL Proposal ............................................................................. 

Chapter 12-Proposals for Federal Oversight/Regulation ................................................. 

Chapter 8-Critical Issues in State Regulation of Insurance: Life Insurance Liquidation Laws and Guaranty Funds . 

Part III-Proposed and Alternative Solutions 

NAIC’S Accreditation Program .................................................................... 

The Compact Clause ............................................................................. 

61 

61 

61 

62 

63 

63 

63 

63 

64 

64 

67 

67 

68 

68 

68 

68 

73 

75 

75 

76 

77 

77 

79 

79 

80 

81 

85 

The Stewart Economics Proposal ................................................................... S . 1644: Proposal of Senator Metzenbaum 

85 

86 

86 

88 

Conclusion ...................................................................................... 89 

18 

31 

36 

42 

47 

60 

69 

91 

........................................................... H.R. 4900: Proposal of Representative Dingell ....................................................... Summary: State v . Federal Regulation of Insurance .................................................. 

Table 1 -Property-Casualty Companies by State of Domicile .............................................. Table 2-1990 Regulatory Resources by State ............................................................ Table 3-UILA and the Model Act Compared ........................................................... Table 4-State-by-State Comparison of Property-Casualty Guaranty Fund Provisions ......................... Table 5-PropertylCasualty Guaranty Assessments and Capacity ........................................... Table 6-Life Insurance Companies by State of Domicile July 22, 1992 ..................................... Table 7-Life/Health Guaranty Funds in 1990: Assessments and Capacity ................................... 

Appendix A-State Requirements: Minimum Capital and Surplus Required of Insurers ...................... Appendix B-Financial Regulation Standards and Accreditation Program .................................. 125 

Tables 

ix 
X 
Findings and 

FINDINGS 

Recommendations 

1. States have long demonstrated a commitment to effective 

and efficient regulation of insurance. 

States have been virtually the sole regulators of the 

insurance industry since the establishment of the first 

state insurance department in 1851. The historical record 

demonstrates that, since the mid-19th century, states 

have experimented actively with various regulatory mechanisms, ranging from laws regulating rates, solvency, and 

liquidation to the establishment of guaranty funds to protect policyholders. Regulatory innovations by individual 

states, such as the establishment of risk-based capital 

standards, are now being refined for adoption by all states. 

Current regulatory innovations include the establishment 

of central working groups to identify and monitor nationally significant troubled companies. 

2. Insolvencies anwng insurance conylanies have risen in recent years, The anwun~ of money assessed by state guaranty 

finds to pay for insolvencies has increased as well. 

Historically, life company failures and guaranty fund 

assessments have been low. For example, from 1975 to 1982, 

those assessments averaged $6.2 million a year. Recently, 

however, life company failures have increased significantly. 

For example, life guaranty fund assessments tripled from 

$154.8 million in 1990 to $469.7 million in 1991. The problem 

of insolvency of life companies is not limited to small companies. In April 1991, the California Department of Insurance seized Executive Life Insurance Company of California. Assessments for Executive Life of California could 

reach $400 million per year over five years. Although it is difficult to find a trend in the number and size of propertycasualty insolvencies, guaranty fund assessments have been 

significant in recent years. From 1986 through 1991, 106 

property-casualty companies failed, and guaranty fund 

assessments totaled $3.3 billion. Studies suggest that the insolvency of a large national property-casualty insurer could 

exceed the guaranty fund capacity of most states. 

3. Although the history and current status of state regulation 

of insurance demonstrates a record of strength, some areas could be improved. 

Some of the areas in which state regulation could be 

improved include: 

a. 

b. 

C. 

d. 

e. 

f. 

g. 

Adoption of tighter regulatory controls on reinsurance, including 

(i) limitations on the conditions under which a 

reinsurer may rescind its contract with insolvent insurers, 

(ii) limitations on the conditions under which 

balances due from an insolvent insurer can 

be offset against the amount the reinsurer 

owes as reimbursement for the liabilities of 

the insolvent insurer, and 

(iii) limitations on the use of cut-through clauses 

that grant some policyholders special treatment by allowing them to receive payments 

directly from the reinsurer without complying with state liquidation procedures; 

Adoption of minimum capital and surplus requirements that are related to risk (risk-based 

capital requirements); 

Adoption of methods to increase the efficiency of 

field examinations and decrease the delays in 

their completion; 

Restrictions on the extent to which fronting can 

be used to circumvent state licensure and regulatory requirements; 

Adoption of uniform liquidation and guaranty 

fund laws to 

(i) mitigate disagreements among state guaran- ty funds as to which fund must pay a particular claim, and 

(ii) decrease the ability of multistate policyholders to engage in forum shopping by bringing 

their claims to the state guaranty fund that 

offers the broadest coverage; 

Adoption of more meaningful investment standards for life insurance companies. 

Introduction of market discipline into state guaranty fund plans by limiting the guaranty fund cov1 
h. 

i. 

j. 

erage that is provided to policyholders with net 

high worth and requiring that a portion of the 

plan’s cash be based on prior assessments; 

Adoption of laws requiring public disclosure of 

situations in which insurers recover their guaranty fund assessments by state tax offsets and/or 

policyholder surcharges and publicizing the effects of such recoveries on state revenues and/or 

the price of insurance, respectively; 

Adoption of more effective regulations of transactions between insurers and their parent and 

among insurers and their affiliates; and 

Adoption of measures to increase the capacity of 

state guaranty funds. To do so: 

(0 

(ii) 

states could increase their assessment limits to 

at least 2 percent, or all states could increase 

their assessment limits beyond 2 percent, 

states could reduce guaranty fund coverage 

by, for example, restricting payments to all 

policyholders to 80 percent of state maximums, or excluding/limiting coverage for 

policyholders with high net worth, 

(iii) states could adopt a partially prefunded 

guaranty fund program, and/or 

(iv) state guaranty funds could jointly establish a 

reinsurance or excess insurance mechanism. 

4. To improve their ability to regulate the insurance industty, 

the states created the National Association of Insurance 

Commissioners (NAIC). As an instrument for coordinating state regulation of insurance, NAIC has both 

strengths and weaknesses. 

With the formation of the National Association of Insurance Commissioners in 1871, states began to coordinate their regulatory efforts by, for example, adopting 

uniform accounting standards, model laws, and regulations. Recently, NAIC established an accreditation program to strengthen state solvency regulation. To become 

accredited, a state must comply with NAIC’s financial 

regulation standards. NAIC has identified 16 model laws/ 

regulations that a state must adopt before becoming accredited. An accreditation team tests compliance with the 

NAIC standards by reviewing a state insurance department’s laws and regulations, past examination reports, organizational and personnel policies, and assessing the department’s levels of reporting and supervisory review. If 

adopted by all states, this program will establish a nationwide system of consistent regulation. 

As a voluntary organization, NAIC’s principal weakness is its lack of enforcement powers. For example, as of 

August 1992, only 13 states had adopted the necessary 

laws and regulations for accreditation. 

In addition, industry practices at NAIC’s conferences 

tend to weaken public confidence in state regulation. 

These practices have included hosting of luncheons and 

dinners, establishment of hospitality suites, and distribution of gifts to commissioners by representatives of regulated industries. While some states prohibit commissioner 

acceptance of industry gifts or require full disclosure, 

other states have no policy. NAIC has established a fund 

to underwrite the travel expenses to NAIC conferences of 

consumer representatives, and NAIC members voted to 

have its conference dinners paid for by NAIC rather than 

by industry. 

5. Some state groups have proposed to increase the uniformity of state insurance regulation through the use of a legislative interstate compact. 

One area that may benefit from legislative coordination through an interstate compact is the administration 

of liquidation and guaranty fund proceedings. A legislature-based compact would be in a position to work with and 

exploit the experience gained by the states through NAIC. 

Usually, interstate compacts have a greater chance 

for success if they (1) focus on two or three specific problem areas in which the states are individually ineffectual, 

(2) provide for accountability through an independent and 

publicly available audit of the compact’s activities, and (3) 

contain incentives to encourage participation. 

In addition to providing a mechanism to coordinate 

the activities of states, a compact could have another 

important benefit. During the 1970s and 1980s, the bright 

lines separating insurance from banking and from securities activities began to blur. The distinctions among these 

financial industries will continue to blur in the foreseeable future. A realistic assessment of state/federal relations suggests that federal regulators faced with regulating the interstate and international aspects of the 

financial industries will be strongly motivated to preempt 

state regulation of insurance, rather than deal with 51 

regulatory systems. However, if states establish a structure for coordinated regulation of the interstate aspects of 

insurance, they have a greater ability to restrain federal 

preemption and to enter into a regulatory partnership 

with the federal government, if necessary. 

6. Two federal statutes, the Federal Priority Statute and the 

Federal Arbitration Statute, have been interpreted by 

some courts to preempt state laws regulating insurance. 

These interpretations appear to conflict with the McCarran-Ferguson Act, which provides that no Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any state for the purpose of 

regulating the business of insurance, “unless such act specifically relates to the business of insurance. ” 

The Federal Priority Statute provides that a claim of 

the federal government will be paid first when the debtor 

is insolvent. In contrast, many state priority statutes grant 

federal and state government claims lower priority than 

those of policyholders. The Federal Priority Statute does 

not relate specifically to the business of insurance. Yet, 

two federal circuit courts of appeal have interpreted the 

McCarran-Ferguson Act narrowly in connection with insurer insolvencies, finding that the liquidation of an insurance company is not the “business of insurance.”The Federal Priority Statute reduces the size of the insolvent 

insurer’s estate available for policyholders. 

2 
Most reinsurance agreements contain arbitration 

clauses. These clauses typically require the use of arbitration in the event there is any difference of opinion between the reinsurer and the primary company with respect to the interpretation of their agreement. 

Sometimes, reinsurers dispute the amount due upon the 

insolvency of the ceding insurer and invoke their right to 

settle their dispute in arbitration rather than before the 

state insurance liquidator. 

Both of these federal statutes reduce the effectiveness of state regulation of insurance. 

7. Since the inception of state insurance regulation, some inwance companies have urged federal regulation. The Congress has not done so; however; congressiond investigations 

into state regulation of insurance have ofen stimulated 

states to strengthen and coordinate their regulatoty systems. 

As early as 1866, bills were introduced in Congress to 

create a national bureau of insurance. Although all of the 

bills introduced to preempt state powers have failed to become law, congressional debates have often stimulated 

states to strengthen regulation. For example, recent congressional investigations identified several factors, such as 

the use of unregulated managing general agents to underwrite insurance, that contributed to several large property-casualty insurer failures. States responded by adopting 

laws to license managing general agents and to prohibit 

companies from delegating their underwriting function to 

such agents. The history of state insurance regulation illustrates the beneficial effects of congressional investigations and reports. 

8. The justification and potential scope for federal intervention in the regulation of the insurance industry are very 

limited. Regulatory failures in connection with financial 

institutions have increased dramatically in recent years. 

The recent savings and loan crisis (at a cost to taxpayers 

of over $500 billion) and continuing bank failures serve 

as powe&l reminders that federal supervision has not 

eliminated industry failures, whether those failures result 

from insujjicient regulatory resources, lack of regulatory 

will, industry manipulation of the political process, or 

fraud. All werepresent in the recent crises in our depository institutions. Although there have also been failures in 

state insurance regulation for reasolts similar to thosepresent in fedend supervision of depository institutions, all of the 

state regulatory lapses combined have not produced a taxpayer bill comparable to the federal bill. 

Many states have adopted laws that address the areas 

of weakness in current state regulation of insurance. 

NAIC, through its accreditation program, and the National Commission of Insurance Legislators, through its proposal for an interstate compact, are attempting to find so- lutions for those areas in which collective state action is 

needed. Given the willingness of states, individually and 

collectively, to seek solutions to serious regulatory problems, the substitution of federal for state regulation 

would appear to be premature and unwarranted. 

RECOMMENDATIONS 

Recommendation 7 

limit Federal Intervention in State Regulation 

of the Insurance Industry 

There are problems in the U.S. insurance industry. 

Both the number of insolvencies and the resulting level of 

guaranty fund assessments are high compared to their 

pre-1981 levels. Several factors may have contributed to 

this situation. For example, the combination of product 

underpricing and significant unforeseen emergencies has 

contributed to difficulties for property-casualty companies. Alternatively, the lack of asset portfolio diversifica- tion, especially with respect to large holdings of junk 

bonds and real estate, has been among the major factors 

creating a crisis-like situation for life insurance companies. 

Although problems in the insurance industry have 

increased significantly since 1981, these problems are not 

similar in scale to the problems in other industries, such as 

banking and savings and loans. In addition, problems in 

the insurance industry appear to be more isolated and 

sporadic among firms. Indeed, there is significant variation in the number of insolvencies and the level of guaranty fund assessments on a state-by-state basis. 

Although some reforms in state regulation of insurance 

are necessary to reduce the likelihood of future problems 

and to improve the ability of states to implement appropriate 

responses to the current situation, the recent difficulties 

experienced in the regulation of the insurance industry, 

including both insolvencies and liquidation and guaranty 

fund proceedings, do not require federal government inter- vention. State governments have regulated insurance for 

nearly ux) years and have cooperated through the National 

Association of Insurance Commissioners for 121 years. State 

governments have also demonstrated a growing ability and 

willingness to seek innovative solutions in response to prob- lems. Moreover, recent experiences with federal regulation 

of depository institutions, health care, and other industries 

suggest that the federal government is less well suited, rela- tive to the states, to monitor this industry. 

Therefore, the Commission recommends that (1) the federal government not preempt state government regulation of 

insurance; (2) the Congresspass laws to clarify that the Feder- al Priority Statute and the Federal Arbitration Statute do not 

take precedence over the McCarran-Ferguson Act, which 

gives states the sole authority to regulate the insurance indus- try; and (3) the federalpresence be limited to an investigatory 

role, including, for example, conducting basic research and is- suing reports on both the property -casualty and life insurance 

industries so as to help alert citizens to problems and assist 

states to strengthen and coordinate their regulation. The Congress should also (4) defer to the judgment of the states and 

move expeditiously to approve proposals for interstate compacts, where states demonstrate that these compacts represent 

the most appropriate tool for achieving desired uniformity of 

regulatory procedures among states. 

Recommendation 2 

Encourage States to Become Accredited 

under the NAIC Program 

The National Association of Insurance Commissioners (NAIC) recently established an accreditation program 

3 
to strengthen state solvency regulation. NAIC has devel- oped 16 model laws and/or regulations that reflect its 

financial standards; a state must adopt these model laws 

and/or regulations to become accredited by NAIC. A nationwide system of consistent state regulation would result if all states were accredited. As of August 1992, only 

13 states had completed the steps necessary for accreditation. In 1994, NAIC plans to ask accredited states to penalize those that do not become accredited. 

The Commission strongly encourages all states to become 

accredited under the NAIC program. 

Recommendation 3 

States Should Consider Various Options 

to Increase the Capacity of Their Guaranty Funds 

The number of property-casualty insurer insolvencies and the level of guaranty fund assessments nationwide increased significantly between 1980 and 1985. 

Although the patterns have been less consistent since 

1985, neither the number of insolvencies nor the level 

of assessments has returned to the lows that prevailed 

prior to 1981. Recent reports by the Illinois Department 

of Insurance and the U.S. General Accounting Office 

suggest that the insolvency of one or more large proper- ty-casualty insurers could exceed the guaranty fund capacity in a majority of states..With respect to life-health 

insurers, assessments have tripled from $154.8 million 

in 1990 to $469.7 million in 1991. 

Therefore, the Commission recommends that states con- sider various options to increase the capacity of theirpropertycasualty and life guaranty funds. 

Recommendation 4 

NAIC and State Commissioners 

Should Avoid Appearances of Impropriety 

Industry practices of providing meals, entertainment, 

and gifts to state insurance commissioners create appearances of impropriety that can weaken public confidence in 

state regulation of the insurance industry. Some states 

prohibit insurance commissioners from accepting any gifts 

or other services from regulated industries, and other 

states require full disclosure of any gifts or services, but 

still other states have no policy on these matters. Although NAIC recently voted to fund commissioners' conference dinners rather than to accept industry funding, 

only the states can regulate the conduct of their own 

insurance commissioners. 

The Commission recommends, therefore, that NAICtake 

all steps necessv and possible to avoid appearances of impropriety at NAIC conferences and that states adopt policies 

to ensure that public confidence in the integrity of their insurance commissioners is not compromised by industry practices 

that can create appearances of impropriety. 

Recommendation 5 

States Should Consider Entering 

into Interstate Compacts to Ensure 

Uniform Application 

of liquidation and Guaranty Fund Proceedings 

Problems in at least two areas are difficult to solve on 

an individual state basis, including (1) the liquidation of 

insolvent companies, and (2) guaranty fund assessments 

and disbursements. For example, the lack of uniformity 

among state liquidation proceedings can lead to costly conflicts among states. Similarly, the lack of uniform guaranty 

fund procedures can lead to disputes over the division of 

fund assets and gaps in coverage. These problems can best 

be addressed by increasing regulatory cooperation among 

states, rather than through federal intervention. 

Therefore, the CommisSon recommends that states com'der entering into interstate compacts to mre uniform application 

of liquidation and guaranty fund proceedings, 

4 
Introduction 

Property-casualty and life insurance companies are 

among the last of the regulated industries over which 

states exercise virtually exclusive regulatory control. Ear- lier in the history of the United States, state agencies were 

typically the sole regulators of such diverse industries as 

banks and telephone companies. Gradually, the Con- gress, convinced of the need for federal regulation of 

industries whose activities crossed state lines, passed leg- islation creating federal regulatory agencies. For some 

industries, federal regulation became the norm, displac- ing state regulation entirely. For others (e.g., banking), a 

dual system of federal and state regulation was formed. 

Insurance regulation did not follow either path-primarily 

because of an early decision by the U.S. Supreme Court that 

the business of insurance was not interstate commerce. 

THE STATES AS REGULATORS 

The continuing role of states as sole regulators of the 

property-casualty and life insurance industries is at a 

crossroads. Congressional investigations and U.S. General Accounting Office (GAO) studies into the recent rash 

of insurance company insolvencies have prompted many 

commentators to call for federal regulation of insurance. 

These commentators have concluded that state regulation of the insurance industry is an anachronism that the 

country can no longer afford. Among the problems noted 

are differences in the quality of state regulation due to 

disparities in available resources as well as variances in 

regulatory philosophy, inconsistent solvency laws and the 

failure of states to coordinate their efforts, the failure of 

state regulators to enforce their solvency laws in a timely 

fashion and to pursue wrongdoers, the failure or inability 

of states to oversee holding companies and foreign reinsurers, and insufficient capacity of state guaranty funds. 

Proponents of federal regulation propose various 

forms of intervention, ranging from replacement of state 

regulation of insurance with a federal agency, to a dual 

regulatory scheme in which multistate insurance companies would have the option to choose a federal license and 

regulation by a federal agency, to federal preemption of 

state solvency laws that fall below federal minimums, and 

to disclosure requirements for foreign reinsurers without 

setting up a federal regulatory bureaucracy. 

States have countered the calls for federal regulation 

of insurance by pointing to recent efforts to tighten state 

regulation as well as the failure of federal regulation in 

connection with the savings and loan industry. To the 

extent that some insurance problems spill over state lines, 

the National Association of Insurance Commissioners 

(NAIC) has established a program to accredit state insurance departments that have adopted certain uniform 

model solvency-related laws and have met certain standards for staffing. NAIC hopes that this program will 

produce a nationwide insurance regulatory system. 

GAO has reported on the weaknesses in NAIC’s 

program. According to GAO, although NAIC has established standards for insurers and regulators and has 

adopted model laws and regulations, it cannot compel 

states to implement those standards or adopt the model 

laws. States can legislatively cede some authority to NAIC 

through an interstate compact, but because they can also 

revoke that authority at any time, GAO argues that NAIC 

might be a weak regulator, serving at the pleasure of those 

it regulates. The problems created by regulators who 

serve the industry they regulate, sometimes at the expense of the public, is not, however, peculiar to states. On 

numerous occasions, GAO and others have reported on 

similar problems with federal regulation of banks and 

savings and loan associations. 

’ 

THE REPORT 

The purpose of this report is to examine the critical 

areas of state solvency regulation of property-casualty and 

life insurance and to describe and evaluate proposals for 

reform. The report concludes that states face a formidable task if they are to continue as sole regulators of the 

property-casualty and life insurance industries. States will 

have to implement a system that assures a new level of 

intra- and intergovernmental cooperation, requiring ongoing collaboration between state regulators and legislators in a state and across state lines. At least with regard to 

safety and soundness regulation, state “beggar-thy-neighbor” policies adopted in the name of economic development must be put to rest. 

If, on the other hand, the federal government is to 

have a role in the regulation of property-casualty and life 

insurance companies in a dual regulatory scheme, it is 

essential that congressional legislation be drafted in a 

manner to ensure that states are genuine partners in such 

5 
a scheme. In some dual regulatory schemes, such as banking and telecommunications, federal agencies have used 

their power to preempt state laws, thereby undermining 

the statutory dual regulatory system. 

Part I of this report reviews the history of propertycasualty insurance regulation and describes issues in state 

solvency regulation of property-casualty insurance, focusing on the areas in which state regulation has been heavily 

criticized. Part I1 follows the same structure, focusing on 

state solvency regulation of life insurance. Finally, Part I11 

summarizes the findings of Parts I and I1 and analyzes 

proposed solutions to the problems in the current regulatory system, including reform of the state system and 

federal legislative and/or regulatory involvement. 

6 
Part I 

Property-Casualty Insurance 

7 
8 
History of State Regulation 

of Property-Casualty Companies 

Little is new in the rash of insurance company failures, consumer outcries against perceived price gouging 

by insurance companies, charges of industry collusion in 

fixing contract rates and terms, industry complaints about 

inconsistent and restrictive state laws, and calls for federal 

control of the business of insurance. The history of government regulation of property-casualty insurance illustrates the long history of these criticisms. 

EARLY HISTORY OF PROPERTY INSURANCE 

Maritime trade among foreign countries provided the 

impetus for creating marine insurance, the earliest form 

of property insurance.’ Insurance in the modem sense, as 

a contract between risk takers and risk bearers, began in 

Genoa, Florence, and Pisa in northern Italy about 1300.2 

Early legislation (1435- 1523) regulating marine insurance 

restricted the activities of insurance brokers, prescribed 

the content and form of policies, and created administrative agencies with insurance commissioners who were empowered to fix the rates of premiums3 

Until the late 1500s, most marine insurance policies, 

even those on foreign ships, were written in the cities of 

northern Italy.4 By 1600, however, the English were writing their own sea risks. Shipowners, merchants, and brokers in goods often met at Edward Lloyd’s coffeehouse to 

trade information on the nature and value of the cargo on 

ships preparing to set sail and to solicit participants in 

insuring the ships and their cargo. Participants would sign 

their names on a sheet of paper under a statement identifying a particular ship, its destination, and the ship’s value 

including contents, indicating how much of the total value 

they would personally insure. In return, these “underwriters” received commissions in the form of cash advances 

from the owners of the ship or cargo. The safe return of 

the ship ended the transaction. If the voyage ended in 

disaster, the underwriters lost what they had pledged. 

Sometimes, these underwriters were not able to pay the 

amount they had ~ledged.~ 

During colonial times in America, these Lloyd’s underwriters and other foreign insurers provided most of the 

marine insurance on ships carrying goods to and from the 

colonies. With the rise of the shipbuilding industry in 

Massachusetts, colonial merchants began to argue against 

“local merchants and traders paying London underwriters 

for a service which might be performed as well at home, . . . [keeping] the money . . . on this side of the water.”6 By 

1760, two home-grown marine insurance offices, one in 

Philadelphia and one in New York, conducted a Lloyd’stype underwriting bu~iness.~ 

Philadelphia was also the home of the first successful 

fire insurance company, organized by Benjamin Franklin 

in 1750.8 Named the Philadelphia Contributionship for 

the Insurance of Houses from Loss by Fire: the company 

consisted of members who chipped in equal shares to 

build a fund that was used to indemnify members whose 

homes were destroyed by fire. For three decades, the 

Philadelphia Contributionship was the only fire insurance 

company in America. Two early practices of the Contributionship marked the beginning of modem risk rating. 

First, prior to insuring a home, the directors would inspect 

the property and require the owner to provide a safe 

access to the roof for fire fighters and to remove any 

hazards. Second, the Contributionship set rates individu- ally in accordance with the quality of the risk insured. 

9 
Because an act of the English Parliament in 1719 

prohibited the organization of stock insurance companies 

other than those existing on that date, colonial efforts to 

compete with English insurance were limited to underwriting by individuals and to the organization of two mutual insurance companies.’O These early forms of colonial 

insurance were not regulated by government. 

The Birth of State Regulation 

of Property Insurance 

The rise of government regulation of insurance in the 

United States began after the adoption of the Constitution and coincided with the incorporation of stock insurance companies. In 1794, the Insurance Company of 

North America (INA) became the first stock insurance 

corporation.” INA was created with capital stock of 

$6OO,OOO by a special act of the Pennsylvania legislature, 

which required that (1) the company’s funds be invested in 

certain stock, (2) all deposits of money be made in the 

Bank of Pennsylvania, (3) the company not hold real estate of a yearly value exceeding $lO,OOO, and (4) ready 

money be reserved to pay losses.’* 

Soon after the creation of INA in Pennsylvania, the 

Massachusetts General Court (legislature) passed an act 

incorporating the Massachusetts Fire Insurance Company with capital stock of $300,000.13 The Massachusetts law 

required the company to invest its stock in the debt of the 

United States or Massachusetts, or in the stock of the 

Bank of the United States or any incorporated Massachusetts bank, and provided for an assessment of $10 per 

share on the stockholders if losses exceeded capital. 

Early state regulation served multiple purposes. For 

example, the Pennsylvania and Massachusetts provisions 

requiring conservative investments and safeguarding the 

company’s solvency were enacted to protect the policyholders. States adopted other regulatory requirements to 

raise revenue. For example, some states required domestic companies to file reports of their financial condition, 

listing the total premium on which taxes were levied. 

Other states levied a license tax on insurance agents, and 

still others imposed a stamp tax on insurance p01icies.l~ 

Finally, some states passed legislation designed to protect 

local companies. Pennsylvania and South Carolina had 

statutes restricting the activities of alien insurers (insurance companies domiciled in another country); and New 

York became the first state to enact a discriminatory tax, 

with a low rate on New York-based companies and a 

higher rate for foreign companies (insurance companies 

domiciled in another state).15 

By the early 19th century, over half of the states (most 

along the eastern seaboard) had one or more fire and 

marine insurance companies, and most of these states had 

adopted laws imposing general regulatory requirements 

on domestic companies. The requirements included minimum initial capitalization, investment restrictions, provision for reserves, and periodic public financial reports. 

Yet, because no state agency was charged with overseeing 

compliance with the law and examining the condition of 

the companies, these early systems of regulation were not 

very effective, and “unscrupulous sales propaganda, fictitious stocks, and phantom capital were the ready weapons 

employed in the bitter fight for insurance profits.”16 A Missouri insurance superintendent described the situation prior 

to the passage of that state’s regulatory laws as follows: 

. . . there were no police regulations governing 

either home or foreign companies. Some kept 

but a few books of any kind, and these in so slovenly a manner that even the officers could tell 

nothing about the entries. The agents covered 

the State, wrote on specious and novel plans, and 

defrauded without fear of penalty. The mutuals 

were most productive of fraud and mischief. 

There was nothing to prevent their organization 

by any poverty-stricken adventurer. Any five or 

more persons could procure a license from the Sec- retary of State by merely filing the corporate name 

and number of directors. Parties by insuring for 

twelve months became members, and ignorantly 

gave liens on their property. Premium notes were 

obtained in that and other States from unwary par- ties on false pretenses, and assessed without stint, 

while losses would be fought off in the courts.” 

In 1851, New Hampshire established the first board of 

insurance commissioners.18 The duties of the commissioners included examining the financial affairs of all insurance companies each year and reporting the results to 

the legislature. Massachusetts followed one year later 

with a board of insurance commissioners, which examined 

the annual reports of insurance companies and generally 

enforced the state’s insurance laws. In the same year, Vermont created two boards with similar duties. Typically, the 

members of these insurance boards consisted of existing 

officers of the state, who fulfilled other duties as well as 

enforcing insurance legislation. In 1859, the New York 

legislature established an independent administrative 

agency headed by an insurance superintendent with licensing and inquisitorial powers. By 1919,36 states had established similar independent administrative agencies to 

regulate insurance.lg 

EARLY HISTORY OF CASUALTY INSURANCE 

Generally, casualty insurance covers accidental injury to persons and property. The term also includes liability 

insurance coverage for accidental injuries to third parties. 

Thus, casualty insurance provides protection against direct losses from an accident suffered by a policyholder and 

indirect losses arising from an accident that causes injury 

or loss to some other person but for which the policyholder is liable. Compared to marine and fire insurance, casualty insurance is a newcomer. Few casualty companies 

existed before 1900. The first mutual casualty company, 

called the Mutual Boiler Insurance Company of Boston, 

was formed in Massachusetts in 1877.20 As its name suggests, the company insured all types of boilers and similar 

hazards, as well as property damaged as a result of accidents like boiler explosions. Other kinds of casualty coverage offered in the late 19th century included personal 

accident insurance (offered to travelers), health insurance, bank burglary, messenger robbery, and elevator in10 
surance. Like that of fire insurance companies, the lifetime of the early casualty companies was frequently short. 

Most did not survive more than a few years.21 Moreover, 

some casualty polices promised more than they delivered. 

One insurance historian noted that “the policy promised 

liberally on the initial page and on its reverse side reconsidered the generous impulse.”22 

Automobile Insurance 

and Workers’ Compensation 

The two most common modem forms of casualty 

insurance, automobile insurance and worker’s compensation, had very different beginnings. The first automobile 

policy was a liability policy issued in 1898 to a physician in 

Buffalo, New York, who owned one of only 200 automobiles manufactured in the United States. Two years later, 

12 American companies manufactured 4,000 vehicles.23 

As the number of automobiles increased, so did the number of casualty companies and the kinds of coverage offered. In addition to liability coverage, companies offered 

automobile fire-and-theft insurance. 

Worker’s compensation insurance had a less auspicious beginning in the late 19th century. The industrial 

revolution brought an increase in foreign trade and raised 

the national standard of living. The price paid for these 

benefits was high, including a phenomenal growth in industrial accidents. Although the common law gave an 

employee the right to sue an employer for negligence that 

resulted in job-related injuries, the employer had three 

defenses that made it virtually impossible for the employee to win such a lawsuit. Thefellow-servant rule held 

that an employer was not liable for the injuries caused by 

the negligence or carelessness of fellow employees; the 

contributory negligence rule relieved the employer of liability if the employee contributed (even incidentally) to the 

cause of the accident, and the assumption-oFthe-risk rule 

held that an employee had accepted all the customary 

risks of the occupation. 

To correct the inequities in the common law, some 

states adopted so-called employer’s liability laws. Alabama adopted such a law in 1886, and Massachusetts followed suit in 1887. Although these laws were designed to 

hold employers liable for injuries resulting from defective 

machinery, they did not provide injured employees with 

adequate compensation. For example, employers often 

resisted payment, claiming that the accident resulted 

from the worker’s negligence, and the worker was forced 

to litigate the claim. Litigation delays of six or seven years 

were common, and stories abounded of lawyers fees of up 

to 50 percent of the judgment or ~ettlement.~~ 

Other states turned to worker’s compensation legislation. Typically, these laws required employers to pay 

compensation to employees injured in the course of their 

employment according to a prescribed schedule without 

regard to fault. Employer payment was assured by various 

means, including premiums paid into a state insurance 

fund or to a private insurance company, or by the deposit 

of securities with the state. Maryland passed the first such 

law in 1902, and Montana and New York soon followed. 

The New York Court of Appeals (the state’s highest 

court) struck down the worker’s compensation law, finding that in depriving employers of property without regard 

to fault the law violated the due process clause of the state 

constitution and the Fourteenth Amendment to the U.S. 

constitution.” Thereafter, New York adopted a constitutional amendment, effective in 1914, declaring that nothing in the constitution “shall be construed to limit the 

power of the legislature to enact laws for the protection of 

the lives, health, or safety of employees; or for the payment . . . of compensation for injuries to employees or for 

death of employees resulting from such injuries without 

regard to fault as a cause thereof. . . .” In 1917, the U.S. 

Supreme Court upheld the New York law against a contention that it violated the due process clause of the Fourteenth Amendment.26 The Court noted the deficiencies 

in the common law and concluded that compulsory compensation was within the police power of the state. The 

Supreme Court’s decision paved the way for general acceptance of worker’s compensation legislation. 

LEGAL CHALLENGES TO STATE REGULATION 

From the beginning, some insurance companies and 

agents opposed state attempts to regulate them.27 Frequently, companies facing state regulatory restraints 

would threaten to leave the state. Big companies, at least, 

rarely followed through on these threats. Companies and 

agents also fought state regulation through lawsuits. 

Is Insurance Commerce? 

In one of the earliest lawsuits, Samuel Paul, an insurance agent for several New York companies, challenged a 

Virginia law that prohibited a foreign insurance company 

(a company incorporated in another state) from soliciting 

business in Virginia without depositing a bond with the 

state treasurer and receiving a license. When Paul refused 

to post the required bond, he was denied a license. Paul 

continued to solicit business on behalf of the New York 

companies and was fined $50. The Virginia Supreme 

Court affirmed Paul’s conviction, and he appealed to the 

U.S. Supreme Court, where he maintained that the Virginia statute burdened interstate commerce in violation 

of the commerce clause. The Supreme Court disagreed, 

ruling in 1869 that insurance contracts 

are not articles of commerce in any proper meaning of the word. They are not subjects of trade 

and barter offered in the market as something 

having an existence and value independent of the 

parties to them. They are not commodities to be 

shipped or forwarded from one State to another, 

and then put up for sale. They are like other personal contracts between parties which are completed by their signature and the transfer for the 

consideration. Such contracts are not inter-state 

transactions, though the parties may be domiciled in different States. The policies do not take 

effect-are not executed contracts-until delivered by the agent in Virginia. They are, then, local transactions, and are governed by the local 

law. They do not constitute a part of the com11 
merce between the States any more than a contract for the purchase and sale of goods in Viiginia by a citizen of New York whilst in Virginia 

would constitute a portion.= 

The decision of the Supreme Court in Paul v. Mrghia 

not only cleared the way for states to regulate insurance 

but also thwarted federal regulation. Shortly after Paul v. 

Virginia, when it became clear that the states had exclusive 

authority to regulate insurance, the state insurance commissioners formed a national organization. Although it 

had no independent legal authority, the National Convention of Insurance Commissioners (now National Asso- ciation of Insurance Commissioners or NAIC) provided a 

coordinating influence on regulation. 

Rate-Making Bureaus and Anticompact Laws 

The actions of fire-rating bureaus set the stage for 

two other landmark Supreme Court rulings upholding 

state insurance regulation.m The first ruling upheld state 

anticompact laws, which were passed in response to industry rate-making bureaus. The bureaus emerged out of the 

intense competition and unprecedented increase in the 

number of insurance companies that followed the Civil 

War.30 Start-up companies, led by the promise of large 

profits, cut prices in order to attract the best risks away 

from their competitors. The low premiums, coupled with 

deficient reserves and capital and inadequate regulatory 

oversight, left many companies in a weakened condition. 

Two great fires proved disastrous to the underfunded 

companies. On the eve of the Chicago Fire of 1871, there 

were about 4,000 fire insurance companies. After the 

Boston fire of 1872, there were only 1,000 companies, and 

many claimants were unreimbursed because their insurers were bankrupt. 

Having suffered enormous losses from these fires, 

companies turned to concerted rate making. National, 

regional, state, and even city boards were organized, “all 

directed to the restraint of anarchic competiti~n.”~~ The

national board was soon joined by regional organizations, 

which set rates by compact. States enacted anticompact 

laws that made such rate fixing illegal. Alabama passed 

such a law in 1896, which prohibited rate fixing by company bureaus by providing that an insured who suffered a 

loss covered by a policy of insurance issued by a company 

that belonged to and set its rates in agreement with a 

rating bureau could recover the actual loss plus a penalty 

of an additional 25 percent. The German Alliance Insurance Company challenged the Alabama statute as depriving it of property in violation of the Fourteenth Amendment to the U.S. Constitution. The U.S. Supreme Court 

upheld the Alabama statute in 1911, ruling that: 

meet the evils of such combinations or associations, 

the State is competent to adopt appropriate regulations that will tend to substitute competition in the 

place of combination or monopoly. . . . Regulations, 

having a real, substantial relation to that end, and 

which are not essentially arbitrary, cannot properly 

be characterized as a deprivation of property without due process of law.32 

Another landmark Supreme Court case arose out of 

consumer complaints about the arbitrary rates set by the 

Clarkson rating bureau in Topeka, Kansas. After the Kansas legislature failed to pass an anticompact law, the 

state’s populist governor, John W. Leedy, issued an order 

requiring the companies to cease using the bureau rates, 

which he deemed to violate the state’s antitrust law.33 

Governor Leedy’s order was upheld on appeal, and for a 

short time the cost of fire insurance protection in Kansas 

decreased. Yet, within two years, a new rating bureau was 

established, and the cycle of rate hikes and consumer outcry began again. A similar scenario, including rate hikes by 

rating bureaus, consumer complaints, and passage and 

enforcement of antitrust laws, was played out in Missouri, 

Texas, and New York. 

When the Kansas antitrust legislation proved unsatisfactory, the state insurance commissioner drew up a 

rate-control proposal that required fire insurance firms to 

file rate schedules and gave the commissioner the power 

to pass on the rates and to decrease excessive ones or 

increase inadequate ones. The proposal became law in 

June 1909. Shortly thereafter, responding to complaints 

from small businesses, the Kansas commissioner ordered 

a flat 12 percent reduction in the rates on all business 

property. A lawsuit challenging the constitutionality of 

the statute followed. 

The German Alliance Insurance Company claimed 

that the Kansas statute violated the Fourteenth Amendment to the Constitution because 

its business of fire insurance is a private business 

and, therefore, there is no constitutional power in a 

State to fbr the rates and charges for services rendered by it. . . [the attempted] exercise of such right 

. . . is a taking of private property for a public use.34 

The lower court upheld the Kansas statute and the 

company appealed its cause to the U.S. Supreme Court. 

The Supreme Court upheld the law, noting that under the 

Fourteenth Amendment, private property is not always 

constitutionally immune from state regulation. When private property has become “clothed with a public interest 

[because it is] used in a manner to make it of public consequence, and affect the community at large. . . [the owner] 

must submit it to be controlled by the public for the common g00d.”~~ The Court acknowledged that it had ruled in 

Paul v. Mrginia that a contract for fire insurance is personal, but it found that the personal character of insurance did 

not preclude regulation. To illustrate the public interest nature of insurance, the Court focused on its efect: 

We can well understand that fire insurance companies, acting together, may have owners of 

property practically at their mercy in the matter 

of rates, and may have it in their power to deprive 

the public generally of the advantages following 

from competition between rival organizations engaged in the business of fire insurance. In order to 

The effect of insurance-indeed, it has been 

said to be its fundamental object-is to distribute 

the loss over as wide an area as possible. In other 

12 
I words, the loss is spread over the country, the disaster to an individual is shared by many, the disaster to a community shared by other communities; great catastrophes are thereby lessened, 

and, it may be, repaired. . . . the companies have 

been said to be the mere machinery by which the 

inevitable losses by fire are distributed so as to 

fall as lightly as possible on the public at large, . . . not the companies. Their efficiency, therefore, 

and solvency are of great concern.36 

1 

I Rate Regulation Experiments 

With Paul v. Virginia, the Supreme Court affirmed the 

primary right of states to regulate insurance by removing 

congressional control under the commerce clause. With 

German Alliance v. Kansas, the Court cleared the way for 

states to experiment with various forms of rate regulation. 

State experiments proliferated. For example, a 1911 Missouri statute allowed companies to set charges through a 

fire rating association, but granted the superintendent of 

insurance the power to lower rates when they were 

deemed exce~sive.~’ 

In New Yokk, the legislature appointed the Merritt 

Commission to hold hearings during 1910-1911 on alleged industry abuses. The commission found numerous industry wrongdoings, including customerboycotts, 

exorbitant rates, unfair challenges of loss claims, and 

discriminatory rating practices.38 Although the commission found the antitrust acts “utter failures,” it did not 

recommend state rate-making. Instead, it favored allowing New York’s regional rating association to continue to 

set rates, in return for certain public disclosures. Not 

until the 1920s did the New York legislature give the 

insurance superintendent power to fix rates. In 1917, 

the Wisconsin legislature passed a rate-making act, 

which allowed the state’s insurance commissioner to fix 

a reasonable rate after establishing the inequity of any 

charge and to order the newly created statewide rating 

bureau to correct any discriminatory rates. 

i 

INDUSTRY CAMPAIGNS 

FOR FEDERAL REGULATION OF INSURANCE 

Early advocates for federal regulation of insurance 

argued for congressional intervention in order to stem the 

“[clhaos [that] reigns through the land. . . [because] most 

states lack any type of regulatory bodies . . . and insurance 

Yet, as states began to establish insurance 

regulation, proponents of congressional action changed 

their tune and argued for federal intervention to “nullify 

most, if not all, [of3 the obnoxious laws on the statute 

books of the several 

Bills were introduced in the Congress in 1866 and 

1868 to create a federal bureau of insurance, in 1869 to 

create the position of federal commissioner of insurance, 

and in 1897 to declare that insurance companies doing 

business outside their state of incorporation were engaged in interstate commerce.4l None of the bills passed, 

and two were never reported out of committee. Congressional debate over federal regulation continued during 

the following years. In 1906, the judiciary committees of 

the House and the Senate concluded that the Congress 

did not have the constitutional power to regulate the 

business of marine, fire, and life insurance.42 According to 

the House committee, “the question as to whether or not 

insurance is commerce has passed beyond the realm of 

argument, because the Supreme Court of the United 

States has said many times for a great number of years that 

insurance is not commerce.”43 In an attempt to overcome 

this constitutional bamer, resolutions were introduced in 

the House and the Senate in 1914-1915proposing aconstitutional amendment that would give the Congress power 

to regulate the business of insurance.44 The resolutions 

were not reported out of the judiciary committees. A 

similar resolution was introduced in 1933, but this resolution also failed in committee. 

This state of affairs changed dramatically in 1944 with 

the decision of the Supreme Court in US. v. South-Eastern 

Underwriters Ann. 4s The South-Eastern Underwriters case 

arose when Missouri Attorney General Roy McKittrick 

filed suit accusing more than 100 insurance companies of 

conspiring to fix prices and limit competition. In this suit, 

McKittrick sought assistance from U.S. Attorney General 

Nicholas Biddle. Biddle authorized grand jury proceedings to investigate criminal violations of federal antitrust 

law. The South-Eastern Underwriters Association (SEUA), 

which was considered one of the most flagrant monopolists, was chosen as the target.46 In November 1942, a 

grand jury returned criminal indictments against SEUA. 

The indictment alleged that the members of SEUA (200 

private-stock fire insurance companies and 27 individuals) 

conspired to restrain trade “by fixing and maintaining 

arbitrary and non-competitive premium rates on fire . . . insurance in Alabama, Florida, Georgia, North Carolina, 

South Carolina, and Virginia,”47 and conspired to monopolize trade and commerce in fire insurance in the same 

states. SEUA argued that it was not subject to the Sherman Antitrust Act because the business of fire insurance 

was not commerce. The U.S. Supreme Court disagreed, 

holding that the Sherman Act applied to the fire insurance 

business. According to the Court: 

This business is not separated into 48 distinct 

temtorial compartments which function in isolation from each other. Interrelationship, interdependence, and integration of activities in all the 

states in which they operate are practical aspects of 

the insurance companies’ methods of doing business. . . . The result is a continuous and indivisible 

stream of intercourse among the states composed 

of collections of premiums, payments of policy obligations, and the countless documents and communications which are essential to the negotiation and 

execution of policy contract^.^^ 

With its decision in South-Eastern Underwriters, the 

Supreme Court acknowledged that insurance constitutes interstate commerce, thus ending three-quarters 

of a century of judicial deference to exclusive state authority over insurance. 

13 
THE MCCARRAN-FERGUSON ACT 

For different reasons, the industry and the states 

immediately began lobbying efforts to reestablish state 

control over insurance. In his dissenting opinion in 

South-Eastern Underwriters, Justice Robert Jackson had 

intimated that state regulation and taxation of insurance 

may henceforth be deemed unlawful-“The Court’s decision at very least will require an extensive overhauling of 

state legislation relating to taxation and supervision. The 

whole legal basis will have to be re~onsidered.”~’ 

Although in previous eras some people in the insurance industry had favored federal regulation as a less 

onerous alternative to vigorous state regulation, by 1944, 

the New Deal ushered in an era of federal activism leading the industry to favor state regulation. An industry bill 

that would have exempted insurance companies from the 

Sherman and Clayton Antitrust acts was defeated when 

President Franklin D. Roosevelt threatened to veto it. 

Justice Jackson’s dissent also spurred the industry to challenge state premium taxes. Within one year after the 

South-Eastern Underwriters decision, insurers had filed 

lawsuits challenging premium taxes in 11 Because 

premium taxes made up a significant fraction of state tax 

revenues, the states reacted quickly. Through NAIC, the 

states proposed a bill to: 

1) Declare state regulation and taxation acceptable 

under the commerce clause; 

2) Exempt insurance from the Federal Trade Com- mission Act; 

3) Exempt insurance from the Robinson-Patman 

Act; and 

4) Limit the insurance exemption from the Sherman 

and Clayton Antitrust acts.51 

Senators McCarran and Ferguson introduced an amended 

version of the states’ bill. The McCarrun-Ferguson Act was 

signed into law in March 1945. 

Broadly, the act gave primacy to state regulation of 

the business of insurance. Section 1 of the act contains a 

statement of this underlying policy: 

Congress declares that the continued regulation 

and taxation of the business of insurance is in the 

public interest, and that silence on the part of the 

Congress shall not be construed to impose any 

barrier to the regulation or taxation of such business by the several States.52 

Section 2 provided that no act of Congress would be interpreted to impair state regulation of the business of insurance, except to the extent that such business was not regulated by state law. An exception in section 3 made it clear 

that the Sherman Antitrust Act would continue to apply to 

agreements by insurers to boycott, coerce, or intimidate 

other firms or consumers. 

States responded to McCarran-Ferguson by adopting 

new legislation to comply with the terms of the act. For 

example, by 1950, all states had approved some form of 

rate regulation; later, states adopted unfair trade practice 

statutes. Some insurers responded by litigating the scope of 

the federal antitrust exemption under McCarran-Fewon. 

This litigation continues. 

NoteW.R. Vance, “The Early History of Insurance Law,” Columbia 

Law Review 8 (19081 1,6; and see Marquis James, Biography of a Business, 1792-1942 (Indianapolis: Bobbs-Memll, 1942). 

Edwin W. Patterson, Thelnsumnce Commissionerin the United 

States (Cambridge, Massachusetts: Harvard University Press 

1923, p. 514. 

Ibid., p. 515. 

James, Biography of a Business, p. 19. 

Ibid. 

Ibid. 

Ibid., p. 20. 

John Bainbridge, Biography of an Idea: The Story of Mutual Fire 

and Casualty Insurance (New York Doubleday & Company 

1952), pp. 41-45. ’ Ibid. 

lo Patterson, The Insurance Commissioner in the United States, 

l1 Ibid.; and see Kenneth 3. Meier, The Political Economy of Reg- ulation: The Case of Insumnce (Albany: State University of 

New York Press, 1988), p. 49. 

l2 Patterson, 77ie Insurance Commissioner in the United States, p. 

523. 

l3 Ibid., p. 527. 

l4 Meier, The Political Economy of Regulation, p. 51. 

l6 Peter Nehemkis, “Paul v. Virginia: The Need for Reexaminal7 Ibid., p. 521 n.13. 

l8 Patterson, The Insurance Commissioner in the United States, p. 

l9 Ibid., p. 536. 

2o Bainbridge, Biography of an Idea, p. 259. 

21 Ibid., p. 261. 

22 Ibid. 

23 Ibid., p. 317. 

24 Ibid. 

25 Ives v. South Buffalo Ry. Co., 201 N.Y. 271 (1911). 

26 New York Central RR v. White, 243 U.S. 188 (1917) 

27 Meier, The Political Economy of Regulation, p. 53; H. Roger 

Grant, Insurance Reform, Consumer Action in the Progressive 

Era (Ames: Iowa State University Press, 1979), p. 73. 

Grant, Insurance Reform, Consumer Action in the Progressive 

Era, p. 77. 

30 Nehemkis, “Paul v. Virginia: The Need for Reexamination,” 

31 Spencer L Kimball and Ronald N. Boyce, “The Adequacy of 

State Insurance Rate Regulation: The McCarran Ferguson 

Act in Historical Perspective,” Michigan Law Review 56 (1958): 

548. 

32 German Alliance Ins. Co. v. Hale, 219 U.S. 219, 316 (1911). 

33 Grant, Insurance Reform: Consumer Action in the Pmgmsive 

34 German Alliance Ins. Co. v. Kansas, 233 U.S. 389,405 (1914). 

35 233 U.S., 408, quoting Lord Chief Justice Hale. 

pp. 522-523. 

Ibid. 

tion,” Georgetown Law Review 27 (1939): 519,521. 

534. 

28 8 Wall. 168, 183 (1869). 

p. 520. 

Em, pp. 84-85. 

14 
36 233 U.S. 412-413. 

37 Grant, Insurance Reform: Consumer Action in the Progressive 

Em, p. 132. 

38 Ibid., p. 126. 

39 Ibid., p. 157. 

4o Ibid., p. 158. 

41 A complete list of the bills is set forth in U.S. v. South-Eastern 

Underwriters Ass’n., 322 U.S. 533,592, n. 15. 

42 U.S. v. South Eastern Underwriters Ass’n., 322 U.S. 576, citing 

Senate Report 4406,59th Congress 1st Session; House Report 

2491, 59th Congress, 1st Session, 12-25. 

43 Ibid. 

44 322 U.S. 592, n. 15. 

4s 322 US. 533 (1944). 

47 322 US. 533, 534-535. 

48 322 U.S. 541. 

49 322 U.S. 590. 

50 Meier, The Political Economy of Regulation, p. 67. 

51 Ibid., p. 69. 

52 15 U.S.C. sea. 1011 et seq. 

Meier, The Political Economy of Regulation, p. 65. 

15 
16 
Overview of the Modern Business 

of Property-Casualty Insurance 

Descriptions of the business of insurance differ, depending on whether the term is used in its technical sense 

for purposes of construing the exemption under McCarran-Ferguson or to portray what it is that insurers do. This 

chapter examines the business of insurance from the latter perspective. 

DEFINITION OF THE BUSINESS OF INSURANCE 

A leading commentator defined insurance as follows: 

It is the characteristic of insurance that a number of 

risks are accepted, some of which involve losses, 

and that such losses are spread over all risks so as 

to enable the insurer to accept each risk at a slight 

fraction of [its] possible liability.’ 

Thus, the primary characteristic of the business of insurance 

is underwriting or spreading of risk among policyholders. 

Def~tions of the terms “risk” and “undekting” are es- sential to understanding the business of insurance. 

Insurers class@ risks as either “pure” or “speculative.” 

Traditionally, insurers have covered only “pure” risks (i.e., 

those that involve the possibility of loss but not the possibility of profit). The risks of damage to or destruction of 

property, the loss of possession of property, and the loss of 

income or increased expenses are examples of pure risks. 

The risks of gambling or investment, which involve the 

possibility of profit as well as loss, are examples of speculative losses not ordinarily covered by insurance.* 

Underwriting a policy of insurance is a complex process that involves several steps, including: 

1) An evaluation of the dimensions of the loss ex- posure; 

2) A determination of the premium; 

3) A review of the contract conditions; and 

4) An evaluation of the company’s capacity to as- sume the entire exp0su1-e.~ 

In step 1, the insurer examines the information submitted and the coverage requested by the individual or entity seeking insurance in order to estimate the probability 

and cost of a potential loss. This step may require a safety 

inspection and credit and financial reports. Steps 2,3, and 

4 require similar reviews. The four steps are related. For 

example, a risk that appears unacceptable on its face may 

become acceptable if priced differently or if the contract 

terms are modified. 

In sum, underwriting involves determining whether 

to accept a particular risk and the terms on which the risk 

will be accepted. As is described in the next chapter, the 

failure of insurance companies to implement and enforce 

underwriting standards and the practice of turning this im- portant function over to managing general agents has played 

a sigruficant role in recent insurance company failures. 

STRUCTURE 

OF THE PROPERTY/CASUALTY MARKET 

Roughly 3,900 domestic property/casualty insurers 

operate in the United States. nble 1 shows the average 

number of companies by state of domicile during the years 

1969-1990. Of these, only about 1,900 firms play a significant role in the market, and 1,300 of these are clustered 

together in about 340 insurance groups under common 

~wnership.~ Thus, only about 1,OOO independent entities 

operate in the property/casualty market. These insurers differ in the categories of risks they cover, as well as in the legal 

form of their ownership and their methods of distribution. 

17 
Table 1 

Property-Casualty Companies by State of Domicile 

(average number 1969-1990, in descending order) 

State Number 

Illinois 

Texas 

New York 

Pennsylvania 

Wisconsin 

Minnesota 

Iowa 

Ohio 

Missouri 

California 

Indiana 

Nebraska 

Delaware 

Florida 

Michigan 

North Carolina 

South Dakota 

Massachusetts 

New Jersey 

Vermont 

Oklahoma 

Virginia 

Tennessee 

Connecticut 

North Dakota 

Georgia 

Colorado 

Kentucky 

Kansas 

New Hampshire 

South Carolina 

Maryland 

Maine 

Alabama 

Arkansas 

Louisiana 

Washington 

Arizona 

West Virginia 

Rhode Island 

Oregon 

Washington, DC 

Hawaii 

New Mexico 

Idaho 

Mississippi 

Montana 

Utah 

Alaska 

Wyoming 

Nevada 

29 1 

211 

210 

209 

201 

178 

173 

150 

129 

120 

100 

71 

68 

60 

59 

56 

55 

48 

46 

46 

45 

45 

42 

40 

39 

39 

38 

36 

35 

30 

30 

29 

25 

24 

24 

24 

22 

20 

20 

18 

14 

13 

12 

11 

9 

9 

8 

8 

I 

4 

3 

Source: A.M. Best Company Special Report, June 1991. 

Regulatory Requirements 

Historically, the structure of risk categories was 

heavily influenced by state regulatory requirements. For 

example, for many years, state regulators did not allow 

insurers to underwrite more than one kind of insurance, 

obliging companies to specialize in a particular line of 

business, such as fire insurance or casualty. Following the 

enormous losses suffered as a result of the 1871 Chicago 

fire, NAIC recommended legislation to separate casualty 

insurance from fire and life insurance. This regulatory 

restriction, which is called the monoline requirement, required businesses to purchase separate insurance policies 

for fire protection, theft, broken glass, etc.’ Another effect of the monoline requirement was to insulate companies from competition. 

States no longer enforce these specialization requirements, now allowing companies to write multiple-peril 

coverages, but many firms continue to specialize. Moreover, state reporting requirements continue to influence 

much of the structural terminology of the business. In 

order to analyze the profitability of the business sold by 

insurers, states require companies to break down their 

coverages into subcategories and allocate premiums, 

losses, loss adjustment expenses, commissions, taxes, and 

other expenses to each of the subcategories. These calculations are entered on separate lines on the standard 

form Annual Statement. Thus, the term “line of business” also refers to one of the lines on the standard 

form. Following this regulatory scheme, property, casualty, and multiline companies write “personal lines” 

and/or “commercial lines” insurance. 

Legal Forms of Ownership 

The legal forms of ownership of insurance companies 

under U.S. law fall into two groups-proprietary and 

cooperative. 

Proprietary Insurers. These include stock insurance 

companies, Lloyds-type syndicates, and insurance exchanges. In the late 1980s, stock insurers accounted for 

nearly 63 percent of the property/casualty market. American Lloyds are, like their British relatives, insurance marketplaces in which insurance is written by or on behalf of 

individual members. Most American Lloyds are domiciled in Texas. The members of the Texas Lloyds syndicates are liable for losses only to the extent of their investment in the Lloyds. In the early 1980s, three insurance 

exchanges were organized in New York, Florida, and IIIinois. Like Lloyds, insurance exchanges are marketplaces 

where the insurance purchased is underwritten by members who may be individuals, partnerships, or corporations. The New York and Florida exchanges are no longer 

in business due to financial problems. The Illinois exchange continues to write primary insurance but has discontinued its reinsurance operations. 

Cooperative Insurers. These companies are owned, 

at least nominally, by their policyholders and include mutual insurance corporations, reciprocals, captive insurers, 

and fraternal organizations. Mutuals are managed by officers and employees chosen by a board of directors elected 

18 
by the policyholders. Fraternal organizations are similar 

to mutuals, but they typically limit their policyholders to 

members of a common social club. Reciprocals are associations of buyers who agree mutually to insure one another. 

Captive insurers are formed to insure the risk of the owners of the captive. “Pure” captive insurance is sometimes 

referred to as “formalized self-insurance.” Another form 

of captive, known as an association captive, insures the 

risks of other unrelated businesses. In the late 1980s, mutuals and reciprocals accounted for approximately 30 percent of the total property/casualty market. The share of 

mutuals and reciprocals is over 50 percent in the private 

passenger auto, homeowners, and medical malpractice lines. 

Marketing Channels 

Insurance companies initiate and maintain contact 

with their policyholders through one of three types of 

marketing channels: independent agents, exclusive 

agents, and direct writers. 

In the independent agency system, the companies 

have little direct contact with the buyers. Contact with the 

policyholder is handled primarily by independent contractors, either agents who represent the insurance company 

or brokers who represent the insurance applicant. An 

independent agent may represent several unrelated insurers. Because the independent agent owns the “expirations” (or renewals)6 on the business it produces, it can 

move the business to another insurance company without 

fear that the original company will solicit the business. 

Personal contact with the insured and ownership of the 

expirations on the business they write have given independent agents significant control over the companies they 

represent. For example, independent agents often prefer to 

write a single commercial policy covering multiple risks even 

when several smaller policies could be written for a competitive premium. Packaging insurance into one policy 

increases the need for the primary insurer to have a large 

capacity, which in turn fosters the use of rein~urance.~ 

In contrast to the traditional independent agent, the 

exclusive agent represents only one insurer or group of 

insurers. Exclusive agents may be independent contractors 

or employees, but they do not own the expirations on the 

business they produce. A direct writer is an insurer that does 

not operate through agents but relies on the mail, telephone, television, and other mass media to sell insurance. 

To a large extent, differences in insurance products 

determine what method of distribution an insurer will use. 

For example, policies in the private passenger auto and 

multiple-peril homeowners market are typically uniform 

and mass marketed; the policies are seldom customized. 

Under these conditions, the use of direct writers or exclusive agents enables companies to keep prices down. Direct 

writers and exclusive agents control approximately 65 percent of this market. In contrast, the independent agency 

system dominates the commercial market where large 

corporate buyers shop for customized policies. 

Note- 

’ 1 G. Couch, Cyclopedia of Insurance Law, section 13 (2d ed. 

1959). 

* Bernard L. Webb, Howard N. Anderson, John A. Cookman, 

and Peter R. Kensicki, Principles of Reinsurance (Malvern, 

Pennsylvania: Insurance Institute of America, 1990), pp. 2-3. 

Teme E. Troxel, George E. Bouchie, and Lowell S. Young, 

Property-Liability Insurance Accounting and Finance (Malvern, 

Pennsylvania: American Institute for Property and Liability 

Underwriters, 1990), p. 136. 

Best’s Aggregates and Averages, 1990 Edition (Oldwick, New 

Jersey: A.M. Best, 1990). 

Kenneth J. Meier, The Political Economy of Regulation: The 

Case ofInsurance (Albany: State University of New York Press, 

1988), p. 9. 

“Expirations” are copies of an agency’s insurance policies in 

force, which contain information that enables the agency to 

attempt to renew the policies on expiration. The rule in the 

insurance business that the agent owns the expirations is an 

exception to the general legal rule under which the principal 

owns the agent’s records. John Alan Appleman and Jean Appleman, Insurance Law and Practice (St. Paul: West Publishing 

Company, 1981), sect. 9026, p. 352. 

William H. Rodda, Properfy and Liability Insurance (Englewood Cliffs, New Jersey: Prentice-Hall, 1966), p. 88. 

19 
20 
Critical Issues in State Regulation 

of Property-Casualty Insurance: Solvency 

State regulatory mechanisms to measure and monitor 

the financial health of insurers depend heavily on the 

validity and accuracy of the accounting principles used by 

companies to report their financial data. Thus, property-casualty accounting is the obligatory starting point for a 

discussion of insurer solvency. 

REGULATORY ACCOUNTING AND FINANCE 

For regulatory purposes, property-casualty insurance 

company accounting is governed by statutory accounting 

principles.' Many of the assumptions of statutory accounting principles and the more commonly used generally 

accepted accounting principles (GAAP) are the same; 

where differences exist, the statutory accounting principles are said to emphasize current solvency. For example, 

according to accounting terminology, assets minus liabilities equals net worth. In insurance accounting, this relationship is expressed as admitted assets minus liabilities 

equals policyholder surplus, or surplus. Statutory accounting principles are designed to measure policyholder 

surplus conservatively by requiring companies to limit the 

assets that are recognized for balance-sheet purposes. 

Given the recent increase in insurer insolvencies and 

weakness in the balance sheets of many others, some 

observers question whether statutory accounting principles are fulfilling their purpose.2 

Property-casualty insurance companies report the details of their assets, liabilities, policyholder surplus, and 

operating results according to statutory accounting principles on an Annual Statement filed with insurance regulators in every state in which they do business. The Annual 

Statement or Convention Blank is a 61-page document 

that was developed by the National Association of Insurance Commissioners (NAIC). The financial information 

required in the Annual Statement includes a balance 

sheet (assets, liabilities, and policyholder surplus), statement of income, capital and surplus account, and underwriting and investment information by line of business, as 

well as other financial data. 

Balance Sheet Liabilities: 

Policyholder Surplus and Loss Reserves 

It is easiest to understand an insurance company's 

balance sheet by beginning with the liability side. The 

liability side of the Annual Statement balance sheet (or 

claims against assets) consists primarily of loss reserve 

funds and policyholder surplus. 

The purpose of policyholder surplus is to provide a 

cushion against fluctuating investment values and underwriting results. These fluctuations can render a company 

statutorily insolvent unless there is an adequate surplus 

account. Over the years, actuaries have developed several 

ratios to determine the appropriate relationship between 

premium and surplus. Although these ratios have served 

as informal guidelines for regulators, none of them has 

gained the status of law. 

An early set of guidelines devised for property business, known as the Kenney rules, prescribed that policyholder surplus be greater than or equal to premium. That 

is, every dollar of premium written must be covered by a 

dollar of policyholder surplus. For casualty business, the 

Kenney rules dictated that every dollar of premium written must be covered by two dollars of policyholder surplus? Expressed as ratios, the Kenney rules, required 

policyholder surplus 

premiums writ ten 

2 1 (property) 
policyholder surplus 

premiums written 

2 2 (casualty) 

Another ratio, developed in Great Britain and known as 

the “cover ratio,” related premiums to loss reserves plus 

policyholder surplus and required loss reserves plus policyholder surplus to cover net premiums by 2.5 times or 

more. Expressed as a ratio, this rule required 

loss reserves + policyholder surplus 

premiums written 

2 2.5 

NAIC’s Insurance Regulatory Information System (IRIS) 

threshold level for further examination of an insurer’s 

premium to surplus ratio is three-to-one, which can be expressed as 

policyholder surplus 

premiums written = .33 

A surplus-to-premium ratio should have the beneficial effect of limiting a company’s ability to increase its premium 

volume until the company has sufficient surplus to ensure 

its continued solvency. As shown, over the years, the rules 

have been relaxed so that states accept a far lower surplusto-premium ratio than formerly was found necessary. 

Moreover, no state has codified even this lesser standard, 

so the ratios continue to serve only as informal guidelines. 

NAIC believes that ratio analysis as a means of measuring the financial health of insurers is crude at best. A 

better measure, according to NAIC, would be a risk-based 

capital formula. NAIC is developing such a formula, 

which it believes will replace surplus-to-premium ratios as 

a screening device to detect company problems, as well as 

providing for progressively stricter levels of regulatory 

action when a company’s adjusted capital and surplus fall 

below specified levels. Because the program is still being 

developed, it is not possible to evaluate its effectiveness. 

NAIC is testing a life risk-based capital formula, which it 

hopes to finalize and adopt in December 1992. The target 

date for a property-casualty formula is June 1993. 

Loss reserve funds and policyholder surplus are intimately related. Insufficient reserves create the illusion of 

reduced liabilities and, thereby, can give the appearance 

of a healthy policyholder surplus account (assets minus 

liabilities equals policyholder surplus). Thus, insufficient 

reserves mask impending solvency problems. Propertycasualty companies must set up three categories of loss 

reserve funds: an unearned premium reserve, an estimated loss reserve, and a loss expense reserve. 

The Unearned Premium Reserve Fund. The unearned premium reserve fund, which typically represents 

about 25 percent of a company’s liabilities, is the most 

straightforward of the three reserve funds. Typically, insurance premiums are paid in advance. Thus, an insured 

may pay a premium of $500 for a one-year policy covering 

loss to a home. According to statutory accounting principles, the insurer may not recognize premium income 

when it is paid and the policy is issued. Rather, the insurer 

must “earn” the premium pro rata over the policy period. 

Thus, the insurer must set up an unearned reserve fund 

consisting of the total premium payment at the time it issues a policy. As the premium is earned over the life of the 

policy, like amounts are released from the unearned premium reserve. For example, assume as above that an insurer issues a homeowner’s policy for one year at a premium of $500. The insurer will set up an unearned 

premium reserve fund for that policy of $500 on the day it 

is issued. After one month, the insurer will have earned 

l/12 of the premium or $41.67, and its unearned premium 

reserve will be reduced by $41.67 to $458.33. 

Because the calculation of the unearned premium 

reserve is straightforward, underreserving in this area 

seldom creates a problem for regulators. The verification 

of the other two loss reserve funds is far more difficult. 

The Estimated Loss Reserve Fund. The estimated 

loss reserve fund, which covers losses that have been incurred but not yet paid, is the largest single liability of insurance companies. Thus, an accurate estimate of policy 

losses is key to insurer solvency. If these reserves are set 

too high, the company’s profits will appear to fall and premium rates may be increased unnecessarily. If the reserves are set too low, the company’s financial condition 

may appear better than it is, and premium rates may be 

reduced unwisely. In computing loss reserves, companies 

consider four different kinds of losses: 

1. Reported and settled but not yet paid; 

2. Incurred and reported but not settled; 

3. Liabilities to third parties incurred and reported 

but not yet settled; and 

4. Incurred but not reported. 

Category 1 losses create no problems because they 

are known and definite. Category 2 losses, which arise 

from so-called “short tail” lines of business (i.e., coverage 

for property damage in which the amount of loss can be 

determined within a short time period), can be estimated 

with a high degree of accuracy. For an average insurer, 

losses falling within this category make up most of an insurer’s loss reserves. Category 3 losses, which arise from 

so-called “long tail“ lines of business (i.e., coverage for auto 

bodily injury liability, worker compensation, and medical 

malpractice), are difficult to estimate with the same degree of accuracy as is possible for the first two categories 

because it may take several years to determine the ultimate cost of an injury. Although they are not yet reported, 

Category 4 losses can be estimated with some degree of 

accuracy based on a company’s past history. Sometimes, 

however, these losses defy all historical data, for example, 

the massive losses for asbestos-related injuries that were 

undetected and unreported for several decades. 

Insurers use several methods to calculate their loss 

reserves. For losses within the first three categories, the 

two most common methods are individual estimates made 

by claims adjusters (called the case reserve method) and an 

average value method based on the insurer’s experience 

with various types of claims. For Category 4 losses, insurers must estimate the number and amount of unreported 

22 
claims. Generally, this estimate is made on the basis of 

experience, modified for current conditions, such as rising 

claim costs and severity and frequency of recent claims. 

The Loss Expense Reserve Fund. The third fund is 

the loss expense reserve fund. The estimated loss reserve 

fund itself does not include the loss adjustment expenses 

associated with a loss payment. Instead, insurers establish a 

separate loss expense reserve fund. These expenses, which 

consist of the costs of investigating, adjusting, and processing claims, as well as legal fees, make up from 5 to 20 

percent of an insurer’s total reserves. Insurers calculate 

loss expense reserves using one of two methods: individual estimates made by claims adjusters and a formula method. 

Balance Sheet: Assets 

Like any other U.S. corporation, a property-casualty 

insurer’s assets include stocks and bonds, real estate, 

mortgages, collateral loans, and cash. Unlike other corporations, insurance company assets are limited by the concept 

of “admitted assets.” State insurance laws designate which 

assets are “admitted” and can therefore appear on a company’s balance sheet. The admitted asset concept reflects 

the insurance regulator’s concern that if a company becomes insolvent, its assets should be available to pay claims 

(i.e., of certain value and easily liquidated). For example, 

states typically deem office furniture a nonadmitted asset, 

and many states limit the amount of real estate that an 

insurer can claim as an asset. Investments in excess of 

statutory limitations are deemed “nonadmitted assets.” 

Bonds typically make up the largest categoq of an 

insurer’s investments. NAIC’s securities valuation office 

classifies bonds into one of six risk categories. Medium and 

lower quality bonds (categories 3 through 6) are valued at 

market. The highest grade bonds (categories 1 and 2) are 

valued at amortized cost. Stocks constitute the second largest category of property-casualty insurance company investments. Stocks are valued at current market value at year’s 

end as set forth in the “Valuation of Securities.” 

Because of the need for liquidity, real estate, mortgage loans, and collateral loans are not usually a significant portion of a property-casualty company’s investments. In connection with their real estate holdings, most 

state regulators require insurers to value land at cost and 

buildings at cost less depreciation. First mortgages (and 

second mortgages under certain limited conditions) are 

valued at cost, but, in most states, ifa mortgage exceeds 75 

percent of the appraised value of the property, the excess 

is considered a nonadmitted asset. Collateralized loans 

are an admitted asset if the unpaid balance does not exceed the market value of the collateral and the collateral 

itself is an authorized investment. 

The most important of other insurance-specific assets 

are agents’ balances or uncollected premiums, reinsurance recoverables on loss payments, and investments in 

affiliates. The agent balance asset account represents insurance premiums (net of agent commissions) due from 

agents. Virtually all states treat such balances or premiums overdue more than three months as nonadmitted 

assets. Many insurance companies reinsure a portion of 

their loss exposure by entering into a contract with another insurance company (the assuming company) which accepts a portion of the premium and promises to pay a 

proportionate share of the losses to which the primary (or 

ceding) insurer is exposed. The primary insurer then reduces its loss reservesby the amount ceded to the reinsurer. When a policyholder’s claim is settled, the primary 

insurer issues a draft for all of the loss to the policyholder 

and then bills the reinsurer for its portion of the settlement. Disputes frequently arise in reinsurance due accounts. To the extent that these disputes reduce the 

amount received by the primary insurer, the insurer’s 

assets and policyholder surplus are overstated, misleading 

regulators and market analysts. 

Insurers often invest in the securities of affiliated 

companies (i.e., companies under the common control of 

a parent holding company). Because these securities may 

not be publicly traded, no accurate method exists to value 

them.4 The value for such securities will be set by the 

parent holding company and may reflect financial goals of 

the parent rather than a market-based price. 

THE ROLE OF REINSURANCE 

Insurance companies purchase reinsurance in order 

to spread their risk, reduce their reserve liabilities (thereby allowing them to increase their policyholder surplus 

and write more business), and for other purposes described in the next section. The treatment of reinsurance 

under statutory accounting principles may not present an 

accurate picture of an insurer’s true financial condition. 

Current statutory accounting principles (like GAAP) allow a primary insurer to take credit against its reservesfor 

reinsurance ceded to reinsurers. The effect of this provision is to increase the primary insurer’s policyholder surplus, allowing it to write more busine~s.~ Yet, the picture 

of financial health created by statutory accounting for 

reinsurance may be illusory for several reasons. 

First, the direct insurer remains responsible for the 

entire amount originally insured, regardless of the fact 

that some fraction has been ceded to a reinsurer.6 In 

practice, therefore, the direct company has not reduced 

its legal liability to its policyholders, although accounting 

principles (both statutory and GAAP) make it appear as 

though it has, and the insolvency of a reinsurer can trigger 

the insolvency of a primary insurer. Second, in most 

states, judicial interpretations and/or statutory law allow a 

reinsurer to rescind its contract with the primary insurer if 

the latter has misrepresented a material term or condition 

of the insurance ceded.’Third, states do not directly regulate unauthorized alien reinsurers (domiciled in a foreign 

country and unlicensed in any state), requiring instead 

collateral to cover losses either in the form of earmarked 

trust funds or letters of credit. Fourth, reinsurers often 

cede a portion of their business to retrocessionaire companies, but states do not even collect data on alien retrocessionaires. Fifth, reinsurers are sometimes late in reimbursing the ceding company for their share of the losses, 

creating severe cash-flow problems for the ceding company. Sixth, some forms of reinsurance agreements, called 

financial reinsurance, do not transfer any risk of loss to 

23 
the reinsurer and appear to be loans rather than reinsurance. Nevertheless, some state regulators allow ceding 

companies to “dress up” their financial statements by 

using these financial reinsurance agreements to reduce 

reserves and increase stated profit and policyholder surplus. These problems are described in more detail below. 

Purposes and Forms of Traditional Reinsurance 

In law and in practice, reinsurance is a financial transaction between the primary insurer and its reinsurer or between a reinsurer and its retrocessionaire.8 Commentators 

cite several reasons for and purposes of reinsurance. Among 

the most immrtant are that the use of reinsurance: 

Serves as a means of leveling earnings (underwriting income) by protecting ceding companies 

from shock losses and placing a cap on the maximum losses of a ceding company from any one 

risk or occurrence; 

Facilitates the departure of a company from business or from one of its lines of insurance by allowing it to cede that business or line of business to a 

reinsurer, which then becomes the primary insurer, 

Enables the reduction of reserves, a concomitant 

increase in policyholder surplus, and the writing 

of new business; 

Increases the profits of a primary insurer; 

Enables a small or new company to expand or 

write nonstandard risks by relying on an experienced reinsurer to counsel it; and 

Affords the ceding company a better spread of 

risk. That is, a company with reinsurance can 

spread its risk over a larger number of units, insuring each unit for a smaller net amount. 

There are two basic forms of reinsurance, facultative 

and treaty. 

Facultative reinsurance This is a system whereby a 

primary insurer offers to cede to a reinsurer one or more 

specific risks. The primary insurer and reinsurer negotiate 

the terms under which the reinsurer will accept the particular risk(s) offered. Facultative reinsurance is optional; 

that is, the reinsurer is not bound to accept the offer made 

by the primary insurer. 

’I;ieaty reinsurance. This reinsurance is negotiated in 

advance of actual coverage. The treaty covers all risks 

written by the primary company that fall within the class of 

risks contemplated by the treaty. For example, a treaty 

may cover an insurer’s entire worker’s compensation business or its entire business in a particular state? Treaty reinsurance is obligatory. That is, a reinsurer may not refuse 

to accept any class of insurance that comes within the 

terms of the treaty. Treaties typically remain in force for a 

long time and are frequently renewed automatically. Areinsurer does not underwrite each risk individually in a 

treaty reinsurance contract as it does with facultative reinsurance; instead, the reinsurer relies on the underwriting 

expertise and good faith of the primary insurer. In property-casualty insurance, treaty contracts account for most of 

the reinsurance sold. 

Both facultative and treaty reinsurance are issued in 

one of two forms, excess of loss or pro rata. Under an excess-of-loss agreement, the primary company pays all 

losses up to a predetermined amount, called the “retention.” The reinsurer then reimburses the ceding company 

for the losses it pays in excess of the retention up to the 

limits of their agreement. The reinsurer receives a portion 

of the original premium paid to the primary insurer. Under a pro rata agreement, the primary insurer and the reinsurer split all premiums, liabilities, and losses on a predetermined basis. lo 

Problems with Reinsurance 

Overdue Balances. The failure of reinsurers to pay 

their agreed share of the losses in a timely manner can be 

a significant problem for state regulators. Late payments 

can signal that a reinsurer is having solvency problems. 

Even when the reinsurer is solvent, late payments can 

create trouble for the primary insurer, which has already 

paid the losses and may be experiencing severe cash-flow 

problems. Some fraction of overdue reinsurance receivables is umollectible and should be written off by the 

primary insurer. Few statistics exist on the magnitude of 

the problem, however. 

In 1989, NAlC issued an Annual Statement instruction that it hopes will shed light on the magnitude of the 

problem and encourage ceding companies to speed up 

their recovery efforts. The instruction requires a primary 

insurer to reduce its surplus in an amount equal to 20 

percent of reinsurance owed and overdue by more than 90 

days. (In contrast, generally accepted accounting principles require an evaluation of the collectibility of the entire 

amount recoverable and could result in a 100 percent 

write down. According to the U.S. General Accounting 

Office (GAO), GAAP accounting would reflect the 

“amount of reinsurance ultimately expected to be collected, a better measurement than the arbitrary percentage required by statutory accounting principles.”“) 

All licensed insurers must report overdue reinsurance 

balances on their Annual Statements. Data compiled from 

the Annual Statements on overdue reinsurance balances 

indicated that in 1990, U.S. property-casualty insurers 

could have incurred penalties (reductions in their surplus) 

totaling $382 million, less than 1 percent of industry-wide 

surplus.12 Industry-wide statistics tell only a partial story, 

however. According to GAO, the insolvencies of the Mission, Transit, and Integrity insurance companies were a 

direct result of the inability and/or refusal of theirreinsurers to pay amounts due the ceding in~urers.’~ 

Loopholes in the Annual Statement instruction make 

the data suspect, however. First, in most cases, the instruction does not require insurers to report (or reduce 

their surplus by) overdue reinsurance that is in dispute.“ 

In one reported case, the amount of overdue reinsurance 

balances was doubled when disputed balances were included. According to a report in Business Insurance, Crum 

24 
& Forster’s United States Fire Insurance Company unit 

reported $100.9 million in unauthorized reinsurance balances more than 90 days past due in its 1990 Annual 

Statement. Yet, only $44 million of this amount was undisputed and therefore subject to ~ena1ty.l~ 

Second, under many contracts, reimbursement from 

the reinsurer is not “due” the primary insurer until 30 days 

after proof of loss is presented to the reinsurer.16 Thus, 

the 90-day period in the model rule does not begin to run 

until 30 days after proof of loss, increasing the penalty 

threshold to 120 days. 

Third, primary insurers can extend the payment period “simply by asking reinsurers if they have all the information they need to complete a proof of loss filing. If the 

answer is no, as ceding insurers expect it would be, the loss 

is not officially payable . . . and the 90-day clock hasn’t 

started running.”” 

Fourth, NAIC has not adopted a model law or regulation that would require states to take some regulatory 

action to correct the problem. At least in connection with 

property-casualty insurance, NAIC apparently believes 

that reporting overdue balances on the Annual Statement 

is sufficient protection without mandatory state regulatory action. Yet, NAIC’s faith in the use of uncodified accounting procedures and/or instructions in the Annual 

Statement as an effective regulatory tool may be misplaced. A recent audit of the New York state insurance 

department’s procedures and practices for monitoring insurer solvency criticized the department’s failure to follow NAIC standards.I8 Because the New York department is considered by many to be among the strongest in 

the nation, the criticisms are particularly significant. 

Given the loopholes in the 90-day penalty rule for 

overdue reinsurance recoverables, a better solution to the 

problem may be to adopt a rule that treats overdue reinsurance balances (balances that are not paid within 90 

days after payment is due under the terms of the contract) 

as nonadmitted assets. This is apparently the solution 

adopted by the Illinois Department of Insurance. Such a 

rule would give a truer picture of a company’s financial 

health because “dubious reinsurance claims” would be 

eliminated from the company’s financial ~tatements.’~ 

Unauthorized Alien Reinsurers. The problem of 

overdue reinsurance balances is potentially even more intractable in connection with unauthorized alien reinsurers. An unauthorized reinsurer is one that is domiciled 

outside the United States and not licensed in any state. 

Estimates of the size of the unauthorized alien reinsurer 

market vary. According to the Reinsurance Association of 

America, in 1990, unauthorized reinsurers comprised approximately 40 percent of the property-casualty reinsurance market.20 State regulators exercise no direct control 

over unauthorized alien reinsurers and do not even analyze their financial statements. Instead, regulators in the 

29 states that have adopted a NAIC Model Law on Credit 

for Reinsurance prohibit primary insurers from taking 

credit for reinsurance ceded to unauthorized alien reinsurers unless the reinsurer has demonstrated that it will 

be able to meet its obligations. For this purpose, the model law requires an unauthorized alien reinsurer to set up a 

trust account or establish a letter of credit21 with an approved U.S. bank in favor of the ceding insurer. 

Both methods have weaknesses. The value of the 

assets in the trust account or the amount of the letter of 

credit must be equal to the reserves ceded to the reinsurer. To the extent that ceded reserves are understated, the 

collateral supporting the reinsurers’ obligation to the ceding company will be insufficient.22 Also, according to an 

industry official, ceding insurers are reluctant to draw 

down their letters of credit when reinsurance balances are 

overdue because they do not want to disrupt an ongoing 

relationship with their reinsurer.23 

State reliance on indirect regulation of alien reinsurers can create serious problems. When the indirect remedies prove inadequate, state regulators may not be able to 

pursue direct legal remedies against alien reinsurers because they lack the requisite jurisdictional power as well 

as political clout to get a U.S. judgment recognized by a 

non-U.S. court. 

In recognition of the regulatory problems with unauthorized alien reinsurers, NAIC has drafted a proposed 

federal Non-U3 Reinsurers Act. According to the draft 

act, the Congress would authorize NAIC to maintain a list 

of eligible non-U.S. primary insurers and reinsurers. 

Non-U.S. primary insurers would not be permitted to 

write business in the United States unless listed as an 

eligible direct writer by NAIC. In addition, domestic companies would not be permitted to take credit for reinsurance from a non-U.S. company unless that company was 

listed as an eligible reinsurer by NAIC. In both cases, a 

non-U.S. insurerlreinsurer wishing to do business in the 

United States would have to comply with certain requirements, including submitting to NAIC’s authority to examine its books and records, maintaining a certain net 

worth, and appointing a U.S. agent for service of process. 

NAIC’s draft law presumes the need for some federal assistance with alien insurers and reinsurers, while attempting to 

retain state control over the examination process. The particular form of the draft is awkward, however. 

Another option that might accomplish the same 

goal-to utilize the greater jurisdictional reach and political clout of the federal government while recognizing the 

greater insurance regulatory expertise of state governments-would be for the federal government to maintain 

a list of alien insurers and reinsurers who agree to subject 

themselves to state regulation, as well as agreeing to the 

entry and enforcement of a valid U.S. judgment in the 

courts of the country of their domicile. Such a list would 

be consistent with the developing international norm of 

national treatment. The principle of national treatment 

requires countries to allow foreign entities to compete on 

essentially equal terms with domestic institutions in the 

host country. Under the existing insurance regulatory setup, foreign entities are allowed to compete on morefavorable terms than are domestic and/or licensed entities in 

that they need not subject themselves to state regulation. 

25 
Financlal Reinsurance 

’Itaditional reinsurance contracts cover losses that 

occur after the effective date of the contract and transfer 

a portion of the risk of those losses to the reinsurer. In 

contrast, financial reinsurancez4 contracts typically cover 

losses that occurred before the effective date of the contract. The objectives of financial reinsurance are to improve the stated profit of the reinsured and/or the stated 

policyholders’ surplus of the reinsured company. 

These goals are accomplished by selling reserves to a 

reinsurer at their discounted present value. For example, 

under a common form of financial reinsurance-loss 

portfolio transfer-the reinsurer may agree to accept $7 

million worth of loss reserves in return for a premium 

payment from the ceding insurer. The parties set the 

premium by calculating the present value of $7 million 

using an appropriate interest rate and time period over 

which the losses will be paid. Assuming that the parties 

agree on a 5-year period over which the losses will be paid 

and an average interest rate of approximately 11.25 percent (compounded monthly), the premium paid would be 

$4 million, which is the discounted present value of the $7 

million of loss reserves removed from the ceding company’s balance sheet. Through the use of financial reinsurance, insurers can in effect discount their reserves, a practice that is prohibited by state regulators. 

In the example above, the reinsurer assumed two 

risks: the risk that the primary insurer would in fact pay 

claims sooner than anticipated and the risk that the interest rate earned on the $4 million would be lower than 

expected. Some financial reinsurance contracts-called 

finite risk reinsurance-eliminate all risk to the reinsurer 

by building a “contingency loading” into the contract. The 

contingency loading may provide for an increase in premium or a reduction in the amount the reinsurer must pay 

if claims are paid sooner than anticipated or the interest 

rate earned is less than expected. The exhibit below illustrates the effect of financial reinsurance on the balance 

sheet of an insurance company.” In this example, the 

Quaking Casualty Company purchased $7 million of financial reinsurance. Because the parties anticipated a 

delay in settling the claims and high interest rates, the 

premium for the financial reinsurance was $4 million. 

Balance Sheet for Quaking Casualty Company 

Before Purchase of Financial Reinsurance 

Assets 

Cash 

Investments 

s 5,000,000 

50,000,000 

Total Assets 

Liabilities 

Unearned Premiums 

All loss reserves 

$55,000,000 

$7,000,000 

45,000,000 

Total Liabilities 

Policyholder Surplus 

$52,000,000 

3,000,000 

Total Liabilities and Policyholder Surplus $55,000,000 

Balance Sheet for Quaking Casualty Company 

After Purchase of Financial Reinsurance 

Assets 

Cash 

Investments 

Total Assets 

Liabilities 

Unearned Premiums 

All loss reserves 

$ 1,000,Ooo 

50,000,OOO 

$51,000,000 

$7,000,000 

38,000,000 

Total Liabilities 

Policyholder Surplus 

$45,000,000 

6,000,000 

Total Liabilities and Policyholder Surplus $51,000,000 

The reduction of reserves by an immediate $7 million in 

return for a $4 million premium doubled the company’s 

policyholder surplus in a single transaction. Many accountants view financial reinsurance as a loan rather than as a 

reinsurance agreement and conclude therefore that insurance companies should not be permitted to dress up 

their balance sheets through the use of financial reinsurance. Some states agree and prohibit primary insurers 

from taking a credit against their reserves for financial re- insurance transactions. For example, under New York 

law, if a contract of financial reinsurance does not transfer 

undenun‘ting risk, the primary insurer may not record the 

transaction as an underwriting transaction. 

Recently, NAIC established a property-casualty 

accounting requirement that would eliminate the use of 

financial reinsurance. According to the new requirement, 

every contract of reinsurance must include a transfer of 

underwriting risk, as well as timing and investment risks. 

A primary insurer who enters into a contract of reinsurance that does not contain the requisite risk transfers 

would not be permitted to take credit for the insurance 

ceded. This new accounting requirement could resolve 

many of the problems with financial reinsurance. 

Yet several problems remain. First, NAIC’s requirement that a contract of reinsurance must include a transfer of underwriting risk has not been codified and adopted 

by the states. Unless states adopt NAIC’s accounting requirement as a regulation or law, industry abuses in connection with financial reinsurance will remain. Second, 

according to Vincent Laurenzano, Assistant Deputy Superintendent and Chief of the Property Companies Bureau for New York, some problems remain even in those 

states that have adopted a law similar to NAIC’s accounting requirement.z6 For example, reinsurance contracts are 

very difficult to interpret and require actuarial analysis. 

Moreover, insurers are not required to provide copies of 

their reinsurance agreements to state insurance departments in connection with reinsurance among affiliated 

companies. Laurenzano does not advocate a requirement 

that states must receive copies of all reinsurance contracts, however, noting that it would be nearly impossible 

to review all such contracts. 

26 
GAO CRITICISM 

OF STATUTORY ACCOUNTING AND SUMMARY 

In addition to the problems descriied in the previous 

sections, GAO has noted several areas in which state 

statutory accounting principles hinder effective monitoring of an insurer’s financial condition. Although all states 

require insurance companies to file a standard Annual 

Statement developed by NAIC, some states allow accounting practices that differ from those codified in NAIC’s practices and procedures Because a multistate insurer prepares its Annual Statements in accordance with 

the statutory accounting principles of its state of domicile, 

the financial data filed may not be consistent with or 

comparable to that of other states.= Frequently, other 

states in which a multistate insurer is licensed may require 

the insurer to file supplements in accordance with their 

own statutory accounting principles. Two NAIC working 

groups (for life insurance and for property-casualty insurance) are attempting to codify statutory accountingprinciples, which then could be adopted by all states. NAIC 

expects the project to be completed by 1994. 

NAIC maintains that a second GAO criticism-that 

most states do not require independent verification of the 

data or actuarial certification of the adequacy of reserves 

-has been corrected. Independent CPA audits and actuarial certification (the actuary need not be independent) 

of reserves are now required as part of the uniform Annual Statement filed by all licensed insurers. 

In summary, the conservatism of statutory accounting 

principles is undermined by lack of uniformity and the 

failure to place meaningful limits on reinsurance as an 

admitted asset. These omissions weaken the usefulness of 

the Annual Statements to states and rating agencies. 

STATE SOLVENCY REGULATION 

The primary goal of state solvency regulation is to 

ensure the financial health of insurance companies. Because a contract of insurance protects policyholders 

against future losses, state regulators must not only prescribe initial capitalization but also monitor the ongoing 

ability of companies to pay future claims. 

In theory, an insurer cannot operate in a state without 

a license from the appropriate state administrative 

agency, usually a division or department of insurance. 

Each state is responsible for the financial health of insurers operating within its boundaries. State licensure requirements are the same for domestic insurers (incorporated in the regulating state) and for foreign insurers 

(incorporated in another state). Prior to receiving a license, all companies must meet miniinum capital and 

surplus requirements. Once the companies are in operation, most states monitor the ongoing financial health of 

only their domestic insurers by reviewing their Annual 

Statements and conducting field examinatiomm NAIC 

aids states in this taskby administering a statistically based 

early-warning system that identifies companies that 

should receive close regulatory scrutiny. Unfortunately, 

as described below, problems exist in each of these areas 

of state solvency regulation. 

State Minimum Capital and Surplus Requirements 

Appendix A lists the state minimum capital and surplus requirements for licensure, which vary from state to 

state and by line of business. For example, the capital and 

surplus required of a domestic life insurer varies from a 

low of $400,000 ($200,000 capital plus $200,000 surplus) in 

Montana to a high of $6 million ($2 million capital plus $4 

million surplus) in New York. Capital and surplus serve 

different purposes. Capital is not used to pay off the 

obligations of an ongoing company. In fact, state insurance laws provide that a company’s capital may not be 

drawn down without throwing the company into statutory 

in~olvency.~~ Rather, capital is a “last ditch” fund to permit “an orderly receivership and liquidation [if the] insurer does not succeed, with minimal or no loss to policyholders and other claimant^."^' 

Given this purpose, it is readily apparent that current 

minimum capital requirements are inadequate. For example, in a high-volume business like automobile insurance, 

a new company can easily acquire 20,000 policyholders 

and a premium volume of $4 million in a year or two. If the 

new company’s premium structure turns out to be 15 

percent inadequate, a capital of $600,000 would be needed 

to absorb the loss. Expenses, unwise investments, and the 

cost of receivership could easily raise the deficiency to $1 

million or more.32 Moreover, the required minimum capital is unrelated to the quantity and quality of risk assumed 

by a company. A large insurer with a high-volume and/or 

high-risk business is subject to the same capital requirements as a small insurer with a low-volume and/or 

low-risk business. Moreover, even the minimal capital of 

many companies is overstated because the insurer’s loss 

reserves are under~tated.~~ 

Most states view the initial surplus requirement as a 

working fund to pay expenses until the new company has a 

sufficient volume of business to pay its expenses and cover 

losses. In most states, insurer surplus can drop below the 

initial statutory minimum without triggering the statutory 

definition of insolvency, but some state laws tie their 

definitions of insurer insolvency directly to their minimum capital and surplus standards. 

Some states justify the low capital and surplus requirements as a method of encouraging new competitors 

to enter the business. The low barriers to entry into the 

property-casualty business do appear to encourage new 

entrants, and in doing so, they provide a response to critics 

who argue for removal of the McCarran-Ferguson federal 

antitrust exemption for insurers. Antitrust experts cite 

low bamers to entry as an important measure of the 

competitiveness of a market, where prices are set competitively. Thus, minimum capital and surplus requirements 

serve two different goals. The minimums must be set high 

enough to protect policyholders in the event that the 

company fails, yet low enough to encourage new entrants 

and convince critics of the insurance antitrust exemption 

that the industry is competitive. 

Many state regulators recognize that minimum capital requirements are not an appropriate measure of capital adequacy for established concerns. A NAIC committee is drafting risk-based capital standards, based on the 
size and risk of each insurer, for property-casualty and life 

insurers. A company that falls below the standard would 

be subject to differing levels of mandatory regulatory action, depending on the level of deficiency. The target date 

for adoption of the property-casualty risk-based capital 

standard is June 1993. 

Fronting and Managing General Agents 

A serious problem with state licensure standards for 

insurers is the failure of states to enforce them. For example, despite state laws requiring insurers to obtain a license prior to beginning operations, an unlicensed insurer 

can operate in most states through the use of “fronting.” 

Fronting is a “rent-a-license” arrangement, whereby a 

duly licensed fronting insurer writes policies for another, 

unlicensed insurer. The fronting insurer then cedes a 

large fraction of the business to the unlicensed insurer. 

The fronting insurer also cedes control over all of its 

primary duties to the unlicensed insurer, including underwriting, claims handling, and reserve setting. Because the 

fronting insurer has ceded all control, it is unable to adjust 

premiums to match experience. Nevertheless, legally, the 

fronting insurer remains liable for a11 losses. 

Working through NAIC, a statelindustry committee 

is drafting a model law to limit fronting. Industry representatives on the committee have rejected several drafts 

that would have prohibited a fronting insurer from delegating reserving, underwriting, and claims handling to a 

reinsurer except in connection with fronting arrangements for captive Some observers believe that 

even stronger restrictions on fronting are needed, such as 

prohibiting licensed insurers from ceding more than 50 

percent of their business to unlicensed insurers and re- quiring fronting insurers to set underwriting standards 

and calculate the appropriate reserves.35 

Such restrictions on fronting appear to comply with 

the basic, common sense notion that the company under- writing insurance and setting reserves should be subject to 

state solvency examinations. Some industry representatives, however, cite two examples to illustrate the need for 

fronting. First, it is far more efficient for an insurer based 

outside the United States that wants to insure its U.S. 

operations but does not want to wait the five to ten years 

necessary to become licensed in all 50 to pay an 

American insurer to front for it. Likewise, a multistate 

U.S. business that does not want to buy workers’ compensation insurance in every state may set up a captive insurance company and pay a licensed insurer to front for it. 

Although some industry representatives maintain 

that fronting should be viewed as just another form of 

reinsurance, there are significant differences between the 

two arrangements. Under a typical reinsurance agreement, the licensed insurer cedes only a portion of its 

business to a reinsurer and retains control over underwriting standards, sets its own reserves, and adjusts premiums 

as needed. In contrast, licensed insurers who front for 

unlicensed companies may cede 100 percent of their business to an unlicensed company and do not retain responsibility for underwriting standards, reserving, and premiums. 

Similar problems exist with the use of managing general agents (MGAs). Primary insurers use MGAs as inter- mediaries to negotiate reinsurance agreements. Although MGAs are not licensed as insurance companies, 

primary insurers frequently grant them authority to perform all of the essential tasks of insurance companies, 

including underwriting, pricing, and billing. In return for 

their services, MGAs receive commissions based on the 

volume of business they write and earn interest on the 

premiums that they collect and hold for the primary insurer. Both GA037 and the House Subcommittee on Over- sight and Investigations (the Dingell Report) have noted 

that this fee structure gives MGAs “strong incentives to 

operate recklessly or di~honestly.”~~ 

In 1991, NAIC issued its amended Managing General 

Agents Act. The act requires an MGA to be licensed as a 

producer in any state in which it performs certain defined 

acts.)9 Further, the act requires insurers and MGAs to 

enter into written contracts that contain the provisions 

listed in the act. As of September 1992, approximately 29 

states have adopted the model act or similar legislation. 

Monitoring the Financial Health of Insurers 

States monitor the financial health of insurance companies by reviewing their licensees’ Annual Statements 

and by conducting field examinations of domestic companies, Both methods have defects, as described below. 

All states require licensed insurers to submit a 

year-end Annual Statement by March of the following 

year. The lack of uniformity in state accounting rules was 

noted in the previous section. Another shortcoming of the 

use of the Annual Statement as a monitoring tool is the 

time lag in state review of the data. For year end 1991, for 

example, state laws required licensed insurers to submit 

their Annual Statement by March 1,1992. Typically, state 

reviews of the financial data in the report take from six 

weeks to three months. As noted by GAO, a company can 

have a problem for more than a year before a state regulator is aware of it.‘”’ NAIC maintains that the time lag is not 

a problem because many states require companies to file 

abbreviated (and unaudited) quarterly financial reports, 

which contain sufficient data to allow states to observe any 

significant changes in a company’s financial condition. As 

of September 1992,27 states require insurers to file quarterly financial reports; 24 of these states require companies to file with NAIC and three require companies to file 

with the state directly. 

Through field exams, state regulators can detect 

problems that do not show up on Annual Statements. 

Most state statutes provide for periodic (from three to five 

years) field exams of domestic companies. Depending on 

the size of the insurer, field exams can take ayear or more 

to complete. NAIC has recently taken several steps to 

remedy this problem. For example, NAIC’s Examination 

Processes Committee has substantially revised the official 

Examiner’s Handbook, begun work on a comprehensive 

training program to teach examiners about the new approach, and developed a training program for senior level 

financial regulators. 

Another new project recently initiated by NAIC is the 

Financial Analysis Working Group (FAWG). FAWG first 

28 
identifies insurance companies of national significance, 

using as measurement criteria gross premium written and 

the number of states in which companies are licensed. 

Then, the financial statements of those companies 

deemed nationally significant are analyzed, and the companies are classified as needing either immediate, prior- ity, or routine regulatory attention. Finally, FAWG moni- tors the actions taken by the domiciliary state regulator to 

ensure that the domiciliary state is aware of the nature of 

the company’s problems, has a corrective plan of action in 

place, and has communicated with other states whose 

policyholders may be at risk. 

Detecting serious problems in the financial condition 

of insurers is only half of the regulatory equation, howev- er. Regulators also must be willing to take timely supervi- sory actions to stem losses when an insurer’s financial 

condition has become perilous. In a recent joint audit 

report, the National State Auditors Association reviewed 

state regulatory treatment of 16 insurers, all of which 

were domiciled in either New York or California and were 

eventually the subject of state delinquency actions. The 

report found that, frequently, 10 or more years elapsed 

from the time of the initial discovery of serious financial 

problems until the reguIators initiated formal delinquen- cy proceeding^.^^ 

Monitoring Reinsurers and Reinsurance 

Like primary insurers, licensed reinsurers file Annual 

Statements with regulators in the states in which they are 

but unlicensed alien reinsurers do not. Reinsurers also purchase reinsurance (i.e., retrocede a portion of 

their business to another insurer, which becomes the retrocessionaire). Although licensed reinsurers list their retrocessionaires on their Annual Statements, the retrocessionaires 

are not required to file fmancial data, and regulators cannot 

assess the financial condition of each retrocessionaire 

from the financial statements of the reinsurer^.^^ 

Moreover, as each party deducts its commissions and 

fees from the original premium, the layers of retrocessions can reduce funds available to the reinsurers in the 

chain to cover losses. GAO has noted that the insolvency 

of retrocessionaires can “ripple through the reinsurance 

chain to affect the original ceding companies.”” As an 

example, GAO cites the recent failures of Integrity Insurance Company and its reinsurer Mission Insurance Company. The inability of Mission Insurance Company to collect the amounts due it from its retrocessionaires led to 

the failure of Mission to make reinsurance payments to 

Integrity and brought down both companies.45 

MU LTISTATE 

INSURANCE HOLDING COMPANIES 

Special problems exist for states attempting to ensure 

the solvency of insurers that operate through multistate 

holding companies, whereby a parent holding company 

domiciled in one state controls separate insurance subsidiaries operating in several states. Insurers form holding 

companies6 for many reasons, including diversification of 

their business. In many states, insurers are prohibited 

from engaging in non-insurance activities. Through the 

use of a holding company, an insurer can diversify into 

other activities through separately incorporated affiliates. 

Another reason for an insurer to form a holding company 

is to circumvent state regulatory restrictions on investments. Once funds are transferred to a holding company, 

they are not subject to state regulatory restrictions. 

The problems associated with supervising a financial 

company that operates through a holding company struc- ture in several jurisdictions are well known. Although 

separately incorporated, the parent holding company 

tends to treat subsidiaries that are engaged in the same or 

similar businesses as one economic enterprise. Most as- sets held by financial companies consist of intangible 

property that can be moved with ease among affiliates 

located in different jurisdictions. In most cases, a change 

in a book entry will suffice to transfer assets from one 

affiliate to another. Moreover, the affiliated group typically receives shared administrative services from its common parent holding company, and the prices for such 

services are not necessarily those that would be charged 

by an unrelated company. That is, the price that the par- ent holding company charges its subsidiaries for such ser- vices may be set to serve goals, such as tax avoidance, 

other than the efficient provision of services. 

Intercompany transactions and intermingling of assets make it nearly impossible to estimate the solvency of 

an insurer without looking at thevarious entities that are a 

part of the holding company, including the parent. Effec- tive regulation of insurance holding company systems re- quires state regulators to review consolidated financial 

statements with uniform accounting standards and to examine the financial transactions among the parent holding 

company and its affiliates as a unitary economic enterprise. 

GAO has noted that only 13 states require companies to file 

consolidated financial statement~,~’ and no state regulates either non-insurance holding company parents or 

noninsurance affiliates.‘”’ A NAIC working group is attempting to develop reporting guidelines for the preparation of consolidated group Annual Statements. 

NAIC’s Model Holding Company Act 

The most recent version of NAIC’s model act on 

holding company systems requires an insurer to notify its 

domestic regulator at least 30 days in advance of its intention to engage in any one of certain transactions with its 

parent or an affiliate if the transaction will equal or exceed the lesser of 3 percent of the insurer’s admitted 

assets or 25 percent of its surplus (property-casualty companies), or 3 percent of the insurer’s admitted assets (life 

companies). The statute covers the following transactions: sales, purchases, exchanges, loans, or extensions of 

credit, guarantees, or investments. A NAIC model regulation sets forth the rules and procedural requirements 

necessary for the state insurance commissioner to carry 

out the provisions of the model act. It also includes the 

forms used by insurers to notify the insurance department 

of specified affiliate transactions. As of March 1992, 28 

states had adopted the most recent version of the model 

act and 14 states had adopted the model regulation!’ 

29 
The restrictive language in the model act appears 

conservative at first glance; in practice, the restrictions 

have little force. First, the restriction is not self-executing. 

The transactions described are not forbidden unless and 

until a state regulator disapproves them using a “reason- ableness” standard. Second, the restrictions are applied 

transaction by transaction and affiliate by affiliate. That is, 

in calculating the percentage limits, neither the transac- tions nor the affiliates are aggregated over a given time 

period. Thus, insurers can easily avoid the threshold level 

for notification by splitting a large transaction into two or 

more smaller ones or by engaging in several transactions 

with more than one affiliate. 

The model act makes some attempt to close this loophole by giving the commissioner authority to penalize a 

company that enters into a series of transactions “if the 

purpose of those separate transactions is to avoid the 

statutory threshold amount and thus avoid the review that 

would otherwise occur.” Not only are such after-the-fact 

penalties difficult to enforce, but they may also be too late. 

It is instructive to compare NAIC’s model law covering transactions with affiliates with the federal laws restricting transactions among bank holding company affiliates. For example, subsection 1 of 12 U.S.C. section 321c 

contains a restriction on interaffiliate transactions that 

prohibits a bank from engaging in certain transactions 

with (1) any one affbte unless the aggregate amount of all 

such transactions does not exceed 10 percent of the capital 

stock and surplus of the member bank, and (2) all affiliates 

unless the aggregate amount of covered transactions of 

the member bank and its subsidiaries will not exceed 20 

percent of the capital stock and surplus of the bank. 

Federal regulators have found even this tough, 

self-executing standard insufficient to solve the perennial 

problem of abusive transactions among affiliated companies within a holding company structure that includes regulated industries. In addition to the statutory restrictions 

on interaffiliate transactions, federal regulators have two 

other important tools to control holding company abuses. 

One is a system of congressionally mandated cross guarantees. In 1989, the Congress enacted the Financial Institutions Refom, Recove?, and Enforcement Act (FIRREA). 

Section 206 (e)(i) of FIRREA was designed to prevent 

multibank holding companies from abandoning failing 

insured affiliate^.^^ The act accomplishes its purpose by 

overcoming the judicial wall between separately incorporated but commonly controlled depository institutions 

and establishing a system of cross guarantees among affiliated This congressional mandate links depository affiliates across state lines in a web of warranties, 

treating the affiliates as branches of one bank rather than 

separately chartered banks. 

FIRREA does not extend the cross-guarantee liability to bank holding company parents or to nonbank affiliates. Another tool used by federal regulators, however, 

does extend responsibility to holding company parents. 

The federal reserve board’s “source-of-strength” doctrine 

makes bank holding company parents responsible for the 

financial health of their bank subsidiaries. GAO has recommended that the Congress enact a law codifying the 

source-of-strength doctrine. According to GAO, 

it is keeping with market realities to view holding 

companies as consolidated entities for operating 

purposes. Market reaction.. . assumes that serious financial problems associated with a holding 

company subsidiary are likely to negatively affect 

the health of the holding company and all of its 

other subsidiaries. . . . The holding company parent is the “nerve center” of the company and determines how its subsidiaries are operated.52 

Of course, the activities of bank holding companies 

are limited by federal statute to businesses deemed closely related to banking. In contrast, insurance holding company parents and their subsidiaries are frequently engaged in businesses unrelated to insurance. Some state 

regulators and industry representatives contend that a 

source-of-strength doctrine may be impractical in connection with such diversified holding companies. Yet, recently, the Bush administration’s bank restructuring bill (S.713) 

proposed a similar requirement for so-called diversified 

holding c0mpanies.5~ 

The federal experience with abusive interaffiliate 

transactions in national and international holding company structures illustrates the depth of the problem. 

STATE REGULATORY RESOURCES 

AND INSURER FAILURE RATES 

It would be helpful to compare the number of insolvencies per state with state regulatory resources, including budgetary dollars and number of examiners. Unfortunately, no such studies exist. A recent special report from 

A.M. Best Company contains some intriguing correlations that deserve further study. According to the study, 

six states accounted for 187 or 50 percent of the 372 insolvencies from 1969 to 1990.54 The six states are Texas (47), 

California (35), Pennsylvania (33, New York (30), Illinois 

(22), and Florida (18). Four of these states-Illinois, Texas, New York, and Pennsylvania-also were among the 

top six in the average number of domiciled companies per 

state. It is not surprising that the states with the largest 

number of domiciliary companies should have the largest 

number of insolvencies. What is surprising is that when 

the number of failures was adjusted to take into account 

the average number of domiciled companies in each state, 

only four of the six had a failure frequency rate above the 

all-state average of 0.68 percent-California (1.33%), 

Florida (1.63%), Pennsylvania (0.76 percent), and Texas 

(1.01%). The average failure rate for Illinois at 0.34 percent was well below the all-state average, while the average failure rate for New York at 0.65 percent was just 

below the average. 

As nble 2 shows, the apparently superior performance of Illinois and New York does not appear to depend 

on greater regulatory resources in terms of budget dollars 

per domiciliary company or in the number of domiciled 

companies per examiner. Nevertheless, this table (as well 

as other similar tables in the A.M. Best Company report) 

may be misleading. A better measure of the relationship, 

if any, between regulatory resources and failure rate 

would focus on the size (by premium dollar) of the domi30 
Table 2 

1990 Regulatory Resources by State 

State 

Number Budget Domiciled Average 

Budget Number of Domiciled per Domiciled Companies Failure Frequency 

(millions) of Examiners Companies Company per Examiner 1969-1990 

Alabama 

Alaska 

Arizona 

Arkansas 

California 

Colorado 

Connecticut 

Delaware 

District of Columbia 

Florida 

Georgia 

Hawaii 

Idaho 

Illinois 

Indiana 

Iowa 

Kansas 

Kentucky 

Louisiana 

Maine 

Maryland 

Massachusetts 

Michigan 

Minnesota 

Mississippi 

Missouri 

Montana 

Nebraska 

Nevada 

New Hampshire 

New Jersey 

New Mexico 

New York 

North Carolina 

North Dakota 

Ohio 

Oklahoma 

Oregon 

Pennsylvania 

Puerto Rico 

Rhode Island 

South Carolina 

South Dakota 

Tennessee 

Texas 

Utah 

Vermont 

Virginia 

Washington 

West Virginia 

Wisconsin 

Wyoming 

State Average 

$3.2 

2.0 

2.7 

3.0 

60.4 

3.1 

4.3 

2.7 

2.1 

39.0 

6.3 

2.0 

3.2 

13.2 

3.3 

4.2 

4.5 

5.3 

5.7 

3.1 

7.5 

5.9 

6.7 

4.3 

2.6 

2.1 

1.0 

3.5 

6.2 

1.9 

12.1 

2.3 

54.2 

18.7 

1.0 

11.8 

4.3 

4.6 

11.3 

2.1 

2.0 

5.5 

1.0 

3.7 

50.7 

2.0 

1.5 

8.9 

6.2 

1.7 

4.9 

1.0 

$ 8.2 

11 

5 

30 

8 

89 

20 

19 

33 

6 

35 

12 

3 

12 

67 

20 

33 

13 

16 

21 

14 

43 

6 

36 

13 

16 

26 

9 

14 

24 

13 

36 

3 

220 

38 

3 

49 

23 

13 

44 

14 

14 

15 

2 

18 

83 

9 

6 

30 

14 

5 

22 

5 

26 

99 

14 

894 

90 

260 

293 

137 

193 

32 

182 

13 1 

37 

34 

445 

186 

243 

70 

71 

229 

33 

96 

99 

146 

220 

65 

220 

21 

150 

18 

43 

115 

34 

364 

112 

62 

278 

136 

89 

347 

68 

39 

63 

60 

103 

745 

58 

188 

99 

94 

23 

304 

9 

157 

$32,267 

139,743 

3,040 

33,164 

232,392 

10,432 

31,095 

13,942 

64,406 

214,490 

47,937 

52,209 

92,771 

29,689 

17,733 

17,225 

64,108 

74,586 

24,843 

94,599 

78,285 

59,790 

45,930 

19,373 

40,000 

9,571 

46,186 

23,235 

342,532 

43,859 

105,104 

67,553 

148,928 

167,312 

13,770 

42,354 

31,518 

51,755 

32,490 

31,082 

50,33 1 

86,530 

12,482 

35,489 

68,019 

35,107 

7,923 

89,862 

65,842 

73,806 

16,268 

111,847 

$ 64,323 

9 

3 

30 

11 

3 

15 

7 

6 

5 

5 

11 

12 

3 

7 

9 

7 

5 

4 

11 

2 

2 

17 

4 

17 

4 

8 

2 

11 

1 

3 

3 

11 

2 

3 

21 

6 

6 

7 

8 

5 

3 

4 

30 

6 

9 

6 

31 

3 

7 

5 

14 

2 

8 

0.38% 

0.67 

1.13 

0.19 

1.33 

0.71 

0.00 

0.73 

0.00 

1.63 

0.70 

0.37 

0.00 

0.34 

0.41 

0.13 

0.00 

0.38 

2.10 

0.18 

0.31 

0.66 

0.31 

0.05 

0.00 

0.42 

1.76 

0.32 

1.61 

0.00 

0.79 

1.29 

0.69 

0.16 

0.00 

0.36 

1.20 

1.00 

0.76 

1.64 

1.55 

0.91 

0.16 

0.54 

1.01 

0.56 

0.10 

0.20 

0.41 

1.13 

0.18 

3.75 

0.68% 

Sources: National Association of Insurance Commissioners and the A.M. Best Company. 

31 
ciled companies and compare the number of examiners 

(or budget) per premium dollar to a weighted failure rate 

(i.e., the sum of the premium dollars of all failed domiciliary companies divided by the sum of the premium dollars 

of all domiciliary companies). 

SUMMARY OF MAJOR AREAS 

IN WHICH STATE SOLVENCY REGULATION 

COULD BE IMPROVED 

OF PROPERTY-CASUALTY COMPANIES 

This study has reported on nine areas in which state 

solvency regulation falls short and could be improved: 

The lack of uniformity of accountingprinciples for purposes of financial reporting; 

Accounting for reinsurance in a manner that may provide 

an inaccuratepicture of an insurer’s true financial condition; 

The fairure to regulate alien reinsurers effectively; 

Minimum capital and surplus requirements that are unrelated to the size of a company or the risk it assumes; 

The use of fronting and managing general agents to circumvent state licensure and regulatory requirements; 

A significant time lag in examining insurance companies; 

The failure to initiate formal proceedings aster discovery 

that an insurer is operating in a perilous financial condition, thus increasing the costs to consumers and taxpayers of the eventual demise of the company; 

The use (in areas in which laws are needed) of uncodijied 

accounting requirements and reporting requirements as regulatory tools in lieu of model laws and regulations; and 

The failure to effectively regulate transactions between insurers and their parent and among insurers and their affiliates. 

All of the above problems, with the possible exception of the last one, could be corrected through individual 

state action without federal intervention. Indeed, NNC 

has adopted model laws that address many of these problems and has instituted an accreditation program, described 

in Part Three. The adoption of the new model laws by states 

would be a step in the direction of strengthening state regulation. To date, many states have not adopted the models, 

and only a handful of states has become accredited. 

With respect to the last problem listed above, effective regulation of insurance holding company systems is 

difficult to accomplish on a state-by-state basis. Lax regulation and weak laws in a few states (or in even one state) 

can lead to insolvencies that affect policyholders in many 

states. Given that domiciliary states are the primary regulators of their domestic multistate insurers, the consequences of inadequate regulation by one state are exported to all states. Coordination among states is thus an 

essential ingredient for effective state solvency regulation 

of multistate insurance holding companies. 

Notes 

’ The discussion of insurance accounting in this section is taken 

primarily from Tenie E. Troxel and George E. Bouchie, Ptvperly-Liability Insumce Accounting and Finance, 3rd ed. (Malvern, Pennsylvania: American Institute for Property and Li- ability Undenwiters, 1990). 

Many of the accounting problems discussed in this section are 

not peculiar to statutory accounting principles but exist also 

with GAAP (generally accepted accounting principles). 

Roger Kenney, Fundamentals of Fire and Casualty Strength 

(Dedham, Massachusetts: Kenney Insurance Studies Press, 

1957) p. 29. 

NAIC believes that the method used by its securities valuation 

office to value investments in affiliated companies--book value-is an accurate method. 

The Reinsurance Association of America (RAA) notes that 

not every reinsurance transaction results in immediate surplus 

relief. For example, neither an excess of loss treaty without a 

ceding commission nor a catastrophe treaty would have such a 

result. 

In some few cases specific contract terms change this general 

rule. Two such cases, assumption reinsurance and cut-through 

clauses, are discussed later in the report. ’ The Reinsurance Association of America (RAA) correctly as- serts that general contract law allows parties to rescind their 

contract if it contains a material misrepresentation. Yet, rein- surance contracts, like insurance contracts, are not contracts 

ktween private parties. Rather, they are contracts with a pub- lic purpose, subject to the police power of the state to regulate 

in the public interest. 

* Except where specifically noted, the information in this sec- tion is taken from Bernard L. Webb, Howard N. Anderson, 

John A. Cookman, and Peter R. Kensicki, Principles of Rein- surance, Volume 1 (Malvern, Pennsylvania: Insurance Institute 

of America 1990). 

Statement of Franklin W. Nutter, President, Reinsurance As- sociation of America, submitted to the U.S. Senate, Govern- mental Affairs Committee, Permanent Subcommittee on Investigations, June 26, 1991. 

lo Ibid. ’’ Statement of Richard L Fogel, Assistant Comptroller General, before the U.S. House of Representatives, Committee on 

Energy and Commerce, Subcommittee on Oversight and In- vestigations (Washington, DC U.S. General Accounting Office, May 1991), p. 10. Industry observers note that statutory 

accounting principles do not differ significantly from GAA€? 

An Annual Statement instruction requires that, if experience 

has shown that a greater amount will be uncollectible, a great- er provision should be established. 

l2 Douglas McLeod, “‘Late Payer’ Penalties to Get Tougher: 

NAIC Proposal to Extend Sanctions to Unauthorized Rein- surance Recoverables,” Business Insurance, November 4,1991, 

p. 16. 

l3 U.S. General Accounting Office (GAO), Insurance Regulation: State Reinsurance Oversight Increased but Problems Re- main (Washington, DC, May 1990), p. 21. 

l4 According to NAIC, amounts in dispute are “added back to 

the calculation of the penalty if overdue recoverables represent. . . more than 20 percent of paid loss recoverable plus 

amounts actually recovered during the calendar year preced- ing the date of the statement.” NAIC letter to ACIR, April 24, 

1992. 

l5 McLeod, “ ‘Late Payer‘ Penalties to Get Tougher,” p. 16. The 

Reinsurance Association of America has noted that in 1990, 

overdue reinsurance owed represented only 2.3 percent of the 

net premiums written by 26 members of RAA. According to 

32 
RAA, this percentage, which is calculated from data reported 

on Schedule F of the reinsurers’ 1990 Annual Statements, in- cludes amounts in dispute. Letter of Franklin W. Nutter to 

ACIR, September 15, 1992. Yet, according to NAIC, reinsurers were not required to report amounts in dispute on their 

1990 Annual Statements. Even the new reporting requirement (for 1992) requires reinsurers to report only a fraction of 

the amounts in dispute. Phone conversation with Ed Kelly of 

NAIC, October 9,1992. See also Douglas McLeod, “Overdue 

Reinsurance Penalties to Tighten: Regulators Want to Close 

Loopholes in Current Regulations, Business Insurance, Octo- ber 26, 1992, p. 19. 

l6 Ibid. 

l7 Ibid. 

l8 State of New York, Office of the State Comptroller, Division 

of Management Audit, State Insurance Department Monitoring 

of Insurer Solvency (Albany, April 8, 1992). 

l9 National Association of Independent Insurers, InsurerSolvency: Public Policy Recommendations for Improvement (Des 

Plaines, Illinois: 1989). This excellent report contains a wealth 

of information for regulators and policymakers. 

2o Statement of Franklin W. Nutter. In contrast, one law firm 

notes that the alien reinsurance market constitutes only 25 

percent of the U.S. market. Letter to ACIR from William 

Marcoux of LeBoeuf, Lamb, Leiby & MacRae, September 1, 

1992. 

The letter of credit must be irrevocable and unconditional and 

have at least a one-year term. 

22 Some state regulators, recognizing the problem of under- stated reserves, require an actuarial certification of an insur- er’s gross reserves (ceded reserves as well as retained reserves). 

This new practice may improve the accuracy of ceded reserves 

reported by primary companies. 

23 In fact, some observers note that “the vast majority of [letters 

of credit] were negotiated with the bank with the understand- ing that they would not be drawn on. If banks are. . . forced to 

honor these LOCs, they will demand more money from rein- surers for the instruments, and reinsurers will pass the costs 

along to ceding companies. . . .” McLeod, “ ‘Late Payer’ Penalties to Get Tougher,” p. 16, quoting Edmond Rondpierre, Se- nior Vice President and General Counsel, General Reinsurance Corporation. 

24 Except where specifically noted, the information in this sec- tion is from Webb et al., Principles of Reinsurance, Volume 1. 

25 The exhibits are taken from Webb et al., Principles of Reinsur- ance, Volume 1, p. 163. 

26 Phone conversation with Vincent Laurenzano, May 11,1992. 

27 Statement of Richard L Fogel. 

*’ Ibid., p. 9. 

29 National Association of Insurance Commissioners (NAIC), 

Insumnce Department Resources Report (Washington, DC, 

1990). NAIC notes that the data in its report do not include 

zone examinations. 

30 See, for example, Colorado Revised Statutes section 10-3-212, 

“A stock insurance company is deemed insolvent when its admitted assets are less than all of its liabilities, excluding from 

such liabilities the aggregate amount of its capital stock, and is 

deemed impaired when its admitted assets are less than its lia- bilities, including as a liability the aggregate amount of its outstanding capital stock. . . .” 31 Spencer L Kimball and Herbert S. Denenberg, eds., Insurance, Government, and Social Policy: Studies in Insurance Regulation (Homewood, Illinois: Richard D. Irwin, Inc., 1969), p. 

15 1. 

32 Ibid., p. 154. 

33 Robert E. Litan, “Back to Basics: Solvency as the Primary Objective of Insurance Industry Regulation,” August 1991. 

34 The history of the various NAIC drafts of fronting laws and 

industry opposition has been reported in Bminess Insurance 

over several years. For example, see Meg Fletcher, “NAIC to 

Reconsider Fronting Restrictions” (December 10,1990, p. 1); 

Michael Bradford, “States Seek Middle Ground on Fronting” 

(May 13,1991,~. 36); Meg Fletcher, “Latest Frontingkoposal 

Eases Rules for Captives” (October 14,1991, p. 2); “RIMS, In- surers Criticize Clauses in Fronting Bill Widening Oversight” 

(June 8, 1992, p. 1); Michael Bradford, “AIG Execs Leery of 

Fronting Law” (March 23, 1992, p. 18); Michael Schachner, 

“Fronting Act Challenged, RIMS, Others Press for Changes 

to Draft As Group Readies it for NAIC Approval” (March 16, 

1992). 

35 One draft of a proposed “Limitations on Reinsurance Activities Insurers Act” would have prohibited a licensed insurer 

from ceding to an unlicensed company if the reinsurer as- sumed 50 percent or more of the risk and received authority 

over underwriting, marketing, or policyholder services. See 

Meg Fletcher, “NAIC to Reconsider Fronting Restrictions.” 

36 See Robert M. Hall, “Fronting: Here We Go Again!” Best’s 

Review, Properiy-Casualty Edition, December 1990, p. 52. 

37 GAO, Insumnce Regulation: State Reinsurance Oversight Incmased but Problems Remain, p. 20. 

38 U.S. House of Representatives, Committee cn Energy and 

Commerce, Subcommittee on Oversight and Investigations, 

Failed Promkes, Insurance Company Insolvencies, February, 

1990, p. 30. 

39 Basically, a managing general agent who meets the act’s definition must be licensed. The act defines a managing general 

agent as a person, firm, association, or corporation that nego- tiates and binds ceding reinsurance contracts on behalf of an 

insurer or manages all or part of the insurance business of an 

insurer and underwrites an amount of gross direct written pre- mium equal to or more than 5 percent of the policyholder sur- plus of the insurer in any one quarter or year. 

See GAO, Insurance Regulation: Problems in the StateMonitoring of ProperiylCasualty Insurrr Insolvency (Washington, DC, 

September 1989), p. 13. 

41 National Association of State Auditors, Comptrollers and 

Treasurers, Regulation of Insurance Company Solvency (Lex- ington, Kentucky, June 1992), pp. 11-13. 

42 GAO, Insumnce Regulation: State Reinsurance Oversight Increared, but Problems Remain, p. 14. 

43 In some cases, however, the retrocessionaires are themselves 

licensed primary insurers who file annual reports in the states 

in which they are licensed. Also, like alien reinsurers, the re- trocessionaires are generally required to set aside collateral to 

cover the reserves ceded to them by a reinsurer. 

44 GAO, Insurance Regulation: State Reinsurance Oversight In- creased, but Problems Remain, p. 21. 

45 bid. 

46 Insurance companies can form upstream holding companies 

by transferring a portion of their surplus funds to the newlyformed parent. 

47 GAO, Insumce Regu1ation:Assmment of the National Association of Insurance Commissioners (Washington, DC, May 22, 

Ibid. 

49 American Council of Life Insurance, Status Report on Implementation of the Recommendations of the ACLI Task Force on 

Solvency Concerns (Washington, DC, March 27, 1992). 

Testimony of L William Seidman, Chairman, Federal Deposit 

Insurance Corporation, before the U.S. House of Representatives, Committee on Banking, Finance and Urban Affairs, 

Subcommittee on Financial Institutions Supervision, Regula- tion, and Insurance, March 14, 1990. 

1991). 

55 
51 Subsection 206 (e) of FIRREA provides: 

(A) LIABILITY ESTABLISHED -Any insured depository 

institution shall be liable for any loss incurred by the [Federal 

Deposit Insurance] Corporation, or any loss which the Corporation reasonably anticipates incurring, after the date of the 

enactment of the . . . Act in connection with- 

(i) the default of a commonly controlled insured depository 

institution; or 

(ii) any assistance provided by the Corporation to any commonly controlled insured depository institution in danger of default. 

52 “Expanded Powers for Banking Organizations,” Statement of 

Charles A. Bowsher, Comptroller General of the United 

States, before the U.S. House of Representatives, Committee 

on Energy and Commerce, Subcommittee on Telecommuni- cations and Finance (Washington, DC: U.S. General Accounting Office, July 10, 1991). 

53 The Bush administration apparently believed that the use of a 

source of strength or analogous doctrine would be both practi- cal and necessary in connection with a national regulatory 

scheme. The Bush administration’s 1991 bank regulatory restructuring bill (which failed to become law) would have per- mitted nonbank parents to own bank subsidiaries and would 

have regulated the transactions among the affiliates of such 

diversified holding companies. The administration’s bill (S. 

713) would have regulated transactions between a bank sub- sidiary and a nonbank subsidiary of a diversified holdingcompany. In fact, the bill would have allowed federal bank regula- tors to examine (under certain circumstances) the nonbank 

affiliates of diversified holding companies as well as the bank 

affiliates. 

54 Best’s Solvency Study, PmpertylCasualty Insurers 1969-1990, 

(Oldwick, New Jersey: A.M. Best Company, June 1991), pp. 

19-20. 

34 
Critical Issues in State Regulation 

of Property-Casualty Insurance: 

Liquidation Laws and State Guaranty Funds 

All states have laws speclfyrng the actions that an insurance commissioner can take to protect the policyholders of a 

financially troubled insurance company. These laws give 

insurance commissioners authority to institute delinquency 

proceedings against financially troubled companies. Permissible delinquency proceedings range from supervision to 

liquidation. As is the case with solvency regulation, liquidation of an insolvent insurer, even a multistate insurer, is 

handled primarily by the domiciliary state. In contrast, state 

guaranty funds, which provide protection for policyholders 

and claimants of an insolvent insurer, must be activated in 

the nondomiciliary states where policyholders or claimants 

of the insolvent multistate insurer reside. 

STATE DELINQUENCY PROCEEDINGS 

Virtually every state delinquency law is based on either 

or both of two acts, the Uniform Insurers Liquidation Act 

(UILA) and the Insurers Supervision, Rehabilitation, and 

Liquidation Act (Model Act). UILA was promulgated in 

1939 by the National Conference of Commissioners on Uniform State Laws and the American Bar Association. As its 

title implies, UILA is targeted specifically at liquidation 

proceedings and is designed to solve the problems that arise 

in connection with the liquidation of insurers that have 

assets and liabilities in more than one state. Approximately 

24 states have adopted UILA. The Model Act, issued by the 

National Association of Insurance Commissioners (NAIC) 

in 1969, is broader, covering delinquency proceedings short 

of liquidation as well as liquidation of multistate insurers. 

Roughly 29 states have adopted the Model Act. 

The purposes of the two acts are similar-to protect 

the interests of insureds, claimants, creditors, and the 

public and to reduce the problems of interstate liquidation by facilitating cooperation among states. To accomplish these purposes, the acts limit where delinquency 

proceedings can be brought and control the disposition of 

the assets of the insolvent insurer. The two acts have 

many similar provisions. For example, both acts vest exclusive authority to institute delinquency proceedings in 

the insurance commissioner, both designate the domiciliary state as the primary location for all delinquency proceedings, and both specify that all delinquency proceedings be administered under the supervision of a court. 

'hble 3 compares pertinent provisions of the two acts. 

In addition to differences between UILA and the Model Act, several other problems have arisen in delinquency 

proceedings. Not surprisingly, many of the problems involve 

reinsurance. Other difficulties arise from the lack of uniformity among state laws and state/federal clashes over claim 

priorities. These problems and the litigation they engender, 

along with the lawsuits of third-party claimants against 

policyholders of the insolvent insured, increase the time and 

expense of liquidations. 

Marshaling General Assets: Reinsurance 

As was described in Chapter 3, insurance companies 

purchase reinsurance in order to reduce their reserve 

liabilities, thereby allowing them to increase their 

policyholder surplus and write more business. Insurers 

that have purchased reinsurance are permitted to reduce 

their reserve liabilities because the reinsurer has agreed 

35 
Table 3 

UILA and the Model Act Compared 

UILA 

State in which U.S.-based insurer is incorporated; 

domiciliary state is deemed to be the primary location 

for delinquency proceedings 

Any state other than a domiciliary state, where 

delinquency proceedings parallel to those of domiciliary 

state may be instituted because assets of delinquent 

company are located there 

Any state that has enacted the substance of UILA 

No provisions 

No provisions 

___~ ~ 

Claimants residing in reciprocal states may bring claim: 

against delinquent company in either domiciliary 0, 

ancillary proceeding; if no ancillary proceeding i 

commenced, then must bring claims in domiciliary stat1 

Claimants have priority in special deposits held for thei 

All property not specifically mortgaged, pledged, or 

deposited for benefit of specified persons or a limited 

class of persons; reinsurance proceeds are general assets 

Any deposits made pursuant to statute for benefit of 

limited class of persons 

Commissioner of domiciliary state 

Domiciliary 

State 

Ancillary State 

Reciprocal State 

Summary 

Proceedings 

Rehabilitation 

General Assets 

Special Deposits 

Domiciliary 

Receiver 

Ancillary 

Proceedings 

Federal 

Receiver 

Stays and 

Injunctions 

Control Over 

Assets 

Filing Claims 

Priority of 

Preferred 

Claims 

Commissioner of domiciliary state must petition courl 

for appointment of an ancillary receiver if (1) there are 

“sufficient” assets of the company located in the 

ancillary state, or (2) ten or more state residents petitior 

commissioner requesting receiver 

No specific provision, but courts have allowed when the 

state of domicile was unable or unwilling to condud 

delinquency proceedings 

I controls I 

No provision 

Same 

Domiciliary receiver given title to all property, contracts 

and rights of action of delinquent company wherever 

situated as of date of entry of an order giving receive] 

possession of company; ancillary receiver in a reciproca 

state has sole right to recover assets of company ir 

ancillary state; assets not needed to satisfy secure6 

claims in ancillary state must be returned to domiciliaq 

receiver 

Same 

Any state that has enacted certain sections of the Model 

Act 

Allows commissioner to petition court for possession of 

insurer’s property while ascertaining what further actions are needed; protects property until formal proceedings are initiated; petition is confidential. 

benefit, according to the particular state provisions; in 

all other cases, priority scheme of domiciliary state 

Commissioner of domiciliary state may petition the 

court for order of rehabilitation of a company, allowing 

commissioner to take possession of all assets and administer them under court supervision and to take all actions 

necessary to reform and revitalize insurer 

Model Act 

Same 

Le 

Same 

Same 

Commissioner of ancillary state may initiate proceedings if “the protection of creditors or policyholders in ancillary state requires” 

No provision 

After entry of order of liquidation, all prosecution 01 

claims stayed; other states must give full faith and credil 

to anti-injunction orders entered in liquidation proceed- ings ifdomiciliary state would do likewise 

Same 

Same, but specifically allows claimants in nonreciproca‘ 

states to file claims with domestic state 

36 
to share the risk of loss. Given that insurers purchase reinsurance for the purpose of indemnifying the primary insurer for its losses from policyholder claims, it would be 

reasonable to assume that on the insolvency of the primary insurer the reinsurance proceeds would be used solely 

to satisfy the claims of policyholders. This is not the case, 

however. In fact, until 1939, reinsurers often refused to 

pay the claims of policyholders left stranded by the insolvency of their insurer, claiming that their duty to indemnlfy 

arose only on payment of the claim by the primary insurer. 

Legally, a reinsurance policy is a contract of indemnity between a primary company and its reinsurer. The 

policyholder has no rights in the reinsurance contract. 

These legal principles led early reinsurers to argue that 

they had no duty to pay the losses of the policyholders of 

an insolvent company. Because the primary company was 

insolvent and could not pay policyholder claims, there 

were no losses to indemnify. After the U.S. Supreme 

Court upheld a similar argument based on the contractual 

language in the reinsurance agreement between a New 

York-based primary insurer and its reinsurer,’ the New 

York legislature passed a law that prohibited a primary 

insurer from taking credit for reinsurance unless the reinsurance was payable undiminished by the insolvency of 

the ceding insurer. 

Most states followed the lead of New York and 

adopted similar statutes. These laws effectively obligated 

reinsurers to indemnify the primary insurer even in the 

event of insolvency of the primary insurer, but the laws did 

not require that reinsurance proceeds be used solely for 

the protection of policyholders. In all states, reinsurance 

proceeds are treated as general assets that are subject to 

the control of the liquidator and distributed according to 

the state’s priority scheme. A typical priority scheme requires the liquidator to pay the creditors of the insolvent 

insurer in the following order: 

Costs and expenses of the administration of the 

estate by the liquidator and the administrative 

expenses of the state guaranty funds; 

Employee wage claims, subject to certain limitations; 

Claims by policyholders, beneficiaries, insureds, 

and liability claims against insureds covered under insurance policies issued by the company, and 

claims by state guaranty funds and associations 

for payments of covered claims; 

All other claims of general creditors not falling 

within any other priority, including claims for 

taxes and debts due the federal government or 

any state or local government which are not secured claims; 

Preferred shareholders; and 

Proprietary claims. 

Thus, although the amount of payments made by the reinsurer is based on its liability to indemnify the primary insurer forpolicyholder losses, policyholders are at best third 

in line for reimbursement; in some states, policyholder 

claims are fourth priority, following state tax claims. Typically, policyholders receive only a small fraction of their 

claims from the liquidating estate. 

Litigation over the fate of reinsurance proceeds on 

the insolvency of the reinsured involves four key issues: 

(1) the effect of misrepresentations made by the ceding 

insurer, (2) set offs, (3) cut-through clauses, and (4) state/ 

federal clashes involving federal tax liens and arbitration 

agreements. 

Curiously, state laws and judicial decisions favor reinsurers in liquidation proceedings by treating them as players in need of special protection.’ State laws and judicial 

rulings favoring reinsurers on the above issues can diminish drastically the size of the insolvent insurer’s estate 

available for distribution to policyholders. State guaranty 

funds cover some, but not all, of the losses of policyholders of an insolvent insurer. In addition, unlike the case 

with reinsurance proceeds, taxpayers and policyholders 

ultimately bear the burden of the payments initially made 

by the funds to cover policyholder losses. 

The Effect of Misrepresentations Made 

by the Ceding Insurer 

The legal principles governing reinsurance were developed largely in the 18th and early 19th ~enturies,~ an

era in which insurers and reinsurers dealt with each other 

on a handshake. The relationship between the two was 

said to be one of “the utmost good faith.” Judicial interpretations of this phrase vary. Most state courts have 

interpreted the duty of utmost good faith to require the 

ceding insurer to disclose all known information material 

to the risk and to file timely notice of claims. The failure of 

a ceding company to comply with either of these conditions will absolve the reinsurer of its duty to reimburse the 

ceding insurer, if the reinsurer can prove that the failure 

of the ceding insurer to disclose information or to file 

timely notice of claims prejudiced it in some material 

way.4 These courts have followed the general rule that, “A 

basic duty of the reinsured is to disclose to the reinsurer 

all known information touching on the risk of loss. Failing 

in that duty. . . the reinsurance contract may be rescinded 

or cancelled.”’ 

In contrast, some state courts have denied reinsurers 

the right to rescind their contracts even with evidence of 

fraud. These courts have found a duty in the reinsurer to 

monitor the business practices of its ceding insurer. For 

example, in Glacier General Assux Co. v. Casualty IndemnityExchange,6 a federal district court refused to allow Glacier, a reinsurer, to rescind its contract even though the 

ceding insurer had deliberately understated its loss reserves. The court noted that “if the . . . agreement were 

rescinded, then the reinsurance obligations undertaken in 

it would be discharged, the preexisting reinsurance would 

not be reinstated, and the burden of open claims would 

fall on the policyholders or claimants, or some statecreated fund. . . . Glacier entered into the. . . agreement 

with information which should have warned it of the precarious nature of the venture it was undertaking.”’ In the 

majority of states, then, reinsurers can rescind their agree37 
ments if the ceding insurer misrepresents a material term of 

the contract or does not provide timely notice of claims. 

Set Offs (Offsets) 

Set off has been defined as the right between two 

parties to net their respective debts when each party owes 

the other an obligation? In the context of insurance liquidations, the bulk of set offs involve incurred but not reported (IBNR) claims and occur in connection with assumed-ceded reinsurance, a situation in which the 

insolvent insurer has both ceded some business to a reinsurer and assumed some business from the reinsurer. A 

NAIC model law prohibits set offs in such a situation, but 

few states have adopted the NAIC model. 

Most states allow set offs either by statute or judicial 

interpretation? A small number of courts have denied 

offsets in order to retain the reinsurance proceeds for 

policyholders.'O These courts have noted that reinsurers 

have the right to terminate their contracts with ceding 

insurers who are overdue on their premiums. Thus, reinsurers that choose not to pursue that remedy while the 

primary insurer is solvent may not do so to the detriment 

of policyholders after an insolvency. In the recent case of 

Bluewater Ins. Ltd. v. Balzano, the Colorado Supreme 

Court found that the commissioner of insurance had the 

power to regulate reinsurance contracts by excluding offset clauses. The court focused on the accounting treatment of reinsurance and overdue premiums. According to 

the court, primary insurers are permitted to take a credit 

for reinsurance because the reinsurance makes up the 

difference, maintaining the reserve at a prescribed minimum. Allowance of set offs would destroy the statutory 

quid pro quo. 

In general, the legal theories for set offs in the setting 

of an insurance liquidation are murky. The Reinsurance 

Association of America (RAA) makes the case for setoffs, 

contending that they have their basis in common law, as 

well as in federal bankruptcy law. The allowance of set 

offs provides a kind of security interest for reinsurers, 

thereby assuring the continued financial health of reinsurers in the event of the insolvency of the primary insurer. In the long run, RAA maintains, a state prohibition 

against set offs will disrupt the market and make reinsurance more expensive and less available. According to 

RAA, if states restrict set offs, reinsurers will simply demand another form of security interest from the ceding 

insurer, such as a letter of credit. 

From a liquidator's point of view, a reinsurer's assertion of the right of set off is a preference. Reinsurance 

proceeds are often the primary asset of an insolvent insurer; therefore, the grant of set off rights to a reinsurer not 

only gives the reinsurer (and other general creditors) a 

priority status in the estate of the insolvent insurer but 

also decreases the size of the estate available for distribution to all other claimants and increases the burden on 

state guaranty funds. Opponents of set offs maintain that 

the common law basis for set offs is not clear; in fact, some 

courts have specifically denied the existence of such a 

common law right. Moreover, insurance regulatory statutes are frequently said to be in derogation of the common law. For example, many insurance statutes specifically require or forbid certain contract terms between an 

insurer and its policyholder, an insurer and its agents, and 

an insurer and its reinsurer. Thus, examples abound to prove 

that a state can, through its police power, prohibit set offs by 

statute in order to protect policyholders. Analogies to federal bankruptcy law are not relevant because insurance insolvencies are spdically excluded from that law. 

Both sides can claim judicial victories for their theories, and a definitive judicial resolution of this issue is 

unlikely. One way to address the set off issue is to analyze 

the effects of allowing or restricting set off rights. RAA 

may be correct in asserting that a restriction on set offs 

will be disruptive for a period of time. Yet, all government 

regulation can be said (and has been said) to disrupt the 

market. Inevitably, markets adjust and pass the costs 

along as competition allows. 

RAA may also be correct that a restriction on set offs 

will increase the cost of reinsurance, and that such increase may be passed along to consumers of insurance. 

Yet, state taxpayers (through the premium tax offset) and 

policyholders (through recoupment laws) are paying the 

costs of guaranty fund payments now, and those costs are 

higher when set offs are permitted to reduce an insolvent 

insurer's estate. Moreover, the current system results in 

costs that are hidden and not subject to public scrutiny 

because state taxpayers and policyholders are seldom 

aware that they are picking up the tab for guaranty fund 

payments. Nor does the current system subject the costs 

of increased taxes to the competitive pressures of the 

marketplace. In contrast, if states restricted set offs, any 

resulting increased costs would be open, exposed to public 

scrutiny, and subject to the competitive forces of the marketplace. A basic premise of free markets is that economies operate most efficiently when costs are openly assigned to those who incur them. 

Cut-Through Clauses 

Cut-through clauses change the general rule that no 

legally enforceable agreement exists between a reinsurer 

and the original policyholder. A cut-through clause is an 

agreement between a reinsurer and the ceding insurer 

made for the benefit of a third-party policyholder. The 

agreement, entered into at the request of the policyholderheneficiary, obligates the reinsurer to pay any loss due 

under the policy directly to the policyholder in the event 

that the ceding insurer becomes insolvent. One reason 

that a policyholder might seek a cut-through clause is to 

cover for uncertainty about the financial health of the 

primary insurer. Cut-through clauses allow some policyholders to be paid in full (in an amount that is not limited 

by state statutes) without having to file a claim in liquidation, thereby gaining a priority over other, less knowledgeable policyholders and reducing the estate of the insolvent 

insurer. Some state laws implicitly allow cut-through 

clauses; other state laws explicitly allow them." At least 

one court, the Supreme Court of Puerto Rico, has held 

cut-through clauses unenforceable, finding them to be a 

preference unauthorized under UILA.'* 

Again, no studies exist that measure the size of the 

38 
problem, including the effect of cut through clauses on an 

insolvent insurer’s estate. Such a study might enable regulators to craft a solution. 

State/Federal Clashes 

statute was regulation of the business of insurance and 

reached a different conclusion. Given Ohio’s “comprehensive scheme for orderly liquidation of Ohio insurance 

companies” and the importance of state regulation “to the 

protection of the insurance consumer,” the court found 

The McCarran-Ferguson Act provides that state laws 

regulating the “business of insurance” prevail over conflicting federal laws when a particular federal law does not 

specifically address insurance.13 Conflicts between state 

and federal laws in the context of insurer insolvencies 

arise mainly in two areas, federal claims against the insolvent insurer’s estate and attempts by reinsurers to enforce 

their arbitration clauses. 

Priority of Claims. Typically, the clash between state 

and federal law in the context of priority-of-claims’ payment arises from federal government claims either as a 

policyholder or for back taxes. The statute governing 

priority of federal claimsI4 provides that a claim of the federal government will be paid first when the debtor is insolvent. In contrast, many state priority statutesgrantfederal 

and state government claims lower priority than those of 

policyholders. At first glance, the McCwan-Ferguson Act 

appears to solve the potential clashbetween the two laws: 

No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any 

State for the purpose of regulating the business 

of insurance, . . . unless such Act specifically relates to the business of insurance. . . .15 

The federal claims priority statute does not specifically relate to the business of insurance. Yet, federal circuit 

courts of appeal in the 9th and 4th circuits have interpreted the McCarran-Ferguson Act narrowly in connection 

with insurer insolvencies, finding that the liquidation of 

an insurance company is not the ‘%business of insurance.” In 

Soward v. United Sta~e.s,~~ the 9th Circuit Court of Appeals 

reviewed the conflict between Idaho state law, which 

treated federal govemment claims as Class 5 (the lowest 

priority status) claims, and the federal claims priority statute. 

According to the 9th circuit court, state priority statutes do 

not constitute regulation of the business of insurance because a liquidation is not the business of insurance. 

The court applied the three-part test announced by 

the U.S. Supreme Court in an antitrust case, Union Labor 

Life Insurance Company v. Pireno.” According to that test, 

a state law purporting to regulate the business of insurance must (1) involve the spread or transfer of risk, (2) 

relate to the policyholder/insurer relationship, and (3) be 

limited to entities solely within the insurance industry. 

The Soward court found that the Idaho priority statute 

failed all three tests. Accordingly, the court allowed the 

federal tax claims against the insolvent insurer to be reclassified from Class 5 to Class 1. Using similar reasoning, 

the 4th Circuit Court of Appeals in Gordon v. United 

States,18 allowed the federal government to increase its 

priority status under Maryland law from Class 3 to Class 1.’’ 

In Fabe v. US. Department of Treasury?O the 6th Circuit Court of Appeals also applied the three-prong test of 

Pireno to determine whether the Ohio liquidation priority 

that the state’s priority statute was the business of insurance. Accordingly, the court held that the claim of the 

United States was governed by Ohio law, not by the federal priority statute. The U.S. Supreme Court has agreed to 

review the decision. 

The effect of treating the federal government as a 

“super creditor’’ is, of course, to reduce the amount of the 

insolvent insurer’s estate that is available to pay policyholders. The reduction can be dramatic.z1 Recently, IRS 

pIaced a $643 million lien against the insolvent Executive 

Life Insurance Company of California. Some commentators have suggested that the Congress should amend the 

law to treat policyholders of insolvent insurers similarly to 

depositors of defunct banks. In the latter situation, the 

Internal Revenue Code provides that the federal government’s claims are subordinate to those of depositors of 

banks in liquidation.2z 

Reinsurance Arbitration Clauses. A second area in 

which state insurance laws often clash with federal law or 

international convention involves the arbitration clauses 

generally found in reinsurance agreements. These clauses 

typically require the use of arbitration in the event of “any 

difference of opinion between the Reinsurer and the [ceding] Company with respect to the interpretation of this 

[reinsurance] certificate or the performance of the obligations under the certificate. . . .”23 Reinsurers frequently 

dispute the amount due upon the insolvency of the ceding 

insurer and invoke their right to settle their dispute in arbitration rather than before the liquidator. Courts in such 

cases must determine whether the Federal Arbitration 

Actz4 or the McCarran-Ferguson Act controls. The arbitration act provides that: 

If any suit or proceeding be brought in any of the 

courts of the United States upon any issue referable to arbitration under an agreement in writing 

for such arbitration, the court in which such suit is 

pending, upon being satisfied that the issue involved in such suit or proceeding is referable to 

arbitration under such an agreement, shall on 

application of one of the parties stay the trial of 

the action until such arbitration has been had in 

accordance with the terms of the agreement. . . .25 

The issue in these cases is similar to that in the federal 

priority statute cases. State liquidators maintain that liquidation is the regulation of the business of insurance and 

that arbitration proceedings would “invalidate, impair, or 

supersede” state laws that typically vest exclusive jurisdiction over insolvent insurers in the state liquidator. The 

conclusions reached by courts differ, some holding that 

the McCarran-Ferguson Act bars application of the Federal 

Arbitration and others finding that the arbitration 

act takes precedence over McCarran-Ferguson.z’ In the 

most recent case on arbitration clauses, the 9th Circuit 

Court of Appeals upheld a contractual arbitration agree39 
ment against a state liquidator, finding that the McCarran-Ferguson Act did not take precedence over the Federal 

Arbitration Act.28 

Lack of Uniformity among State Liquidation Laws 

As noted, approximately 24 states have adopted 

UILA and 29 states have adopted the Model Act. These 

laws define a reciprocal state as one that has adopted the 

substance of UILA or one that has adopted certain key 

provisions of the Model Act. If all of the assets of an 

insolvent insurer are located in the domiciliary state or in 

an ancillary state which is a reciprocal state (a state that 

has adopted the same law as the domiciliary state), then 

an injunction issued by a domiciliary receiver will be honored by the courts in the ancillary state. If the domiciliary 

state and an ancillary state are not reciprocal states, then 

the ancillary state is not obligated by state law to honor an 

injunction issued by the domiciliary receiver. Such situations can lead to protracted litigation over rights to assets, 

depleting the estate of the insolvent insurer. Domiciliary 

receivers have relied on three doctrines to convince courts in 

nonreciprocal states to enforce their anti-lawsuit in’uncComity. Literally, comity means courtesy or civility. 

Under the doctrine of comity, courts may recognize the 

legislative, executive, or judicial acts of another jurisdiction. Although the comity doctrine is discretionary, some 

courts have found that states should honor the judicial decisions of a foreign state unless to do so would contravene 

strong local public policy or prejudice local citizens. Other 

courts have refused to apply the doctrine. For example, in 

Fuhrman v. United American the Minnesota Supreme Court considered the validity of an injunction issued by the Iowa domiciliary receiver of United American. The injunction purported to restrain all nonresident 

claimants, including Fuhrman, from pursuing claims 

against United American. Relying on the “general rule. . . that an injunction operates in personam, and a court 

therefore may not enjoin persons who are not within its 

territorial jurisdiction,” the Minnesota court ruled that 

the Iowa injunction had no effect on Fuhrman’s lawsuit in 

Minnesota. According to the Minnesota Supreme Court, 

the Iowa court could not enforce its injunction against 

Fuhrman because he did not have sufficient contacts with 

Iowa. That is, Fuhrman was not present in Iowa and did no 

business in Iowa. 

Full Faith and Credit. Full Faith and Credit is a constitutional principle31 that requires a court in one state to 

honor the decision of a court in another state if the court 

in the first state had jurisdiction over the relevant parties 

and the subject matter of the suit. Few courts have 

deemed themselves bound by the Full Faith and Credit 

Clause to honor injunctions issued by a domiciliary receiver. Typically, courts in the second state refuse to be bound 

by the injunction, finding that the out-of-state issuing 

court lacked jurisdiction over its resident policyholder^.^^ 

Abstention. Abstention is a discretionary doctrine under 

which federal courts refrain from hearing cases in order to 

tions, comity, full faith and credit, and abstention. 21 

avoid piecemeal litigation, allow state courts to interpret 

their own state statutes, and/or refrain from interfering 

with judicial proceedings that have already begun in a 

state court. Several federal courts have abstained from 

hearing claims when a state court has taken jurisdiction 

over an insolvent insurance company. Other federal 

courts have refused to abstain, particularly when a reinsurer invokes the provisions of the Federal Arbitration Act. 

None of these doctrines, alone or in combination, has 

been adopted by courts in a majority of states, and so 

litigation over rights to the multistate assets of an insolvent insurer continues. The Model Act attempts to deal 

with this problem by penalizing claimants who reside in 

states in which an ancillary receiver fails to transfer assets 

(other than special deposits) to the domiciliary receiver. 

The UILA has no penalty provisions. The penalty imposed under the Model Act for noncooperation is the 

subordination of the claims filed in the ancillary proceeding to the next-to-last priority status. 

STATE PROPERTY-CASUALTY GUARANTY FUNDS 

The estate of an insolvent property-casualty insurer is 

seldom sufficient to pay more than a small fraction of the 

claims of policyholders and third-party claimant^.'^ Consequently, prior to the enactment of legislation creating 

state guaranty funds, policyholders and third-party claimants often went ~ncompensated.~~ Media coverage of this 

situation in the 1960s led first to congressional investigations, then to calls for federal intervention, and finally to 

the creation of state guaranty funds. 

Thus, as with a number of reforms implemented by 

state regulators and legislators, state guaranty funds arose 

out of congressional investigations (196P) and the introduction of federal legislation (196636 and 1969’). For several years prior to the congressional investigations, state 

regulators had discussed proposals for an industry-funded 

backup plan for paying claims of insolvent insurers, but 

the insurance industry had strongly opposed such proposals. Some industry representatives objected to being required to pay for the mismanagement of their competitors. Others believed that the funds might create a 

disincentive to effective regulation, in a manner akin to 

the moral hazard of bank deposit insurance. 

Faced with the threat of federal regulation, the industry chose what it “considered the lesser of two evils,”38 and 

worked with NAIC to prepare a model insurance guaranty 

fund act. Fearing that federal regulation would lead to the 

loss of their regulatory control and tax revenues, states 

rushed to adopt the model legislation. Between 1970 

(when NAIC issued the Model Act) and 1972, 45 states 

passed guaranty fund legi~lation.~~ All states now have 

some form of property-casualty guaranty fund legislation, 

most of them patterned after NAIC’s model law. 

The purpose of the Post-Assessment Property and 

Liability Insurance Guaranty Association Model Act 

(Guaranty Fund Model Act), is to: 

provide a mechanism for the payment of covered 

claims under certain insurance policies to avoid 

excessive delay in payment and to avoid financial 

loss to claimants or policyholders because of the 

40 
insolvency of an insurer, to assist in the detection 

and prevention of insurer insolvencies, and to 

provide an association to assess the cost of such 

protection among insurers. 

As its full name suggests, the Guaranty Fund Model Act 

establishes a mechanism to collect funds from assessments on solvent insurers and to disburse those funds to 

policyholders and claimants of an insolvent insurer. 

The National Committee on Insurance Guaranty 

Funds, an industry committee, was organized in 1971 to 

assist states in implementing their guaranty fund laws. 

Funded by three industry trade associations and some 

unaffiliated insurers, the committee developed uniform 

accounting procedures, issued assessment reports, and 

served as a clearinghouse of information on insurer insolvencies and related litigation. In 1989, the National Conference of Insurance Guaranty Funds (NCIGF) replaced 

the committee. Membership is mandatory for all insurers 

who are licensed to write lines of property-casualty insur- 

-ance covered by the guaranty association in the state. 

The work of the guaranty funds is handled by individual states. The Guaranty Fund Model Act calls for an 

insurance guaranty association in each state. Each association is headed by a board of directors chosen from the 

member insurers.4o The primary duty of the board is to 

oversee payment of covered claims and includes assessing 

member insurers the amounts necessary to pay the obligations of the association. 

Membership in the national conference is limited to 

guaranty funds that are post-insolvency assessment funds 

based on the model act. NCIGF continues to perform a 

clearinghouse function and attempts to increase cooperation and coordination among state guaranty funds and 

liquidators involved in multistate insolvencies. 

Procedures for Payment of Covered Claims 

The primary duty of state guaranty fund associations 

is to pay covered claims up to the limits set forth in state 

law. According to the Guaranty Fund Model Act, a covered claim is one that: 

arises out of. . . an insurance policy to which the 

Act applies issued by an insurer, if such insurer 

becomes an insolvent insurer after the effective 

date of the Act and: 

(a) The claimant or insured is a resident of this 

state at the time of the insured event,. . . for entities other than an individual, the residence of a 

claimant or insured is the state in which its principal place of business is located at the time of the 

insured event; or 

(b) The property from which the claim arises is 

permanently located in this 

The Guaranty Fund Model Act has both a deductible 

and a statutory cap. Thus, the guaranty funds typically 

pay covered claims in excess of $100 up to a limit of 

$300,000 per claim. As Table 4 shows, actual state statutory caps vary considerably. 

After a state guaranty fund association has investigated the covered claims arising out of an insolvency, it 

assesses member insurers an amount sufficient to pay the 

settled claims. These initial assessments are based on 

estimates of ultimate guaranty fund liability and the par- ticular insurer’s proportionate share of the premiums 

written in the state, subject to a cap. State assessment caps 

range from 1-2 percent of an insurer’s total annual premium written in the state. Depending on the number and 

size of claims, the cap may require assessments to be made 

over a number of years. Rather than basing assessments 

on market share, some commentators have suggested that 

guaranty fund assessments should be based on the riskiness of an insurer’s pera at ion.^^ 

Problems with the Guaranty Fund Model Act 

At first glance, the relatively simple language defining a covered claim obscures the difficulties with the conceptual basis of host-state coverage as well as the potential for forum shopping built into the definition. Three of 

the most serious problems will be discussed here-the 

territoriality principle, coverage, and forum shopping. 

Territoriality Principle of the Guaranty Funds. Payments under the Guaranty Fund Model Act are based 

solely on a territoriality principle. That is, the act places 

responsibility for payment of a covered claim with the 

state of residence of the policyholder or claimant. Thus, 

concurrent guaranty funds can be triggered and payments 

administered (but not duplicated) in each state in which 

the insolvent insurer was licensed and a policyholder or 

claimant resides. Not only does the multiplication of guaranty fund proceedings increase the administrative expenses, but it can also lead to disagreements among guaranty funds as to which fund must pay a particular claim. 

Moreover, policyholders and claimants in some states will 

be paid a greater portion of their debt than similar creditors in other states. Both statutory caps and the breadth of 

coverage differ from state to state. 

Some critics contend that these state-law variances 

violate a basic principle of fairness that requires similarly 

situated policyholders to be treated equally. Under the 

present system, two policyholders with identical coverage 

from the same insolvent insurer receive different guaranty fund payments because they live in different states. A 

U.S. General Accounting Office (GAO) example illustrates the potential inequity. Consider a small business 

with $500,000 theft coverage which is burglarized and has 

a $500,000 claim against its insolvent insurer. The business 

could collect the entire claim if it were located in Rhode 

Island, more than half ($300,000) if in Ohio, and one-fifth 

($100,000) in Others maintain that different 

state coverage limits reflect legitimate differences in economic policies. For example, because state taxpayers and/ 

or policyholders bear the ultimate burden of insurer insolvencies, a state may decide to limit guaranty fund 

coverage so as to limit the cost to resident taxpayers.44 

As noted previously, the domiciliary or home state is 

primarily responsible for examining its insurers and monitoring their financial health. Although an out-of-state 

insurer must receive a license in the host states in which it 

41 
Table 4 

State-by state Comparison of Property- Casualty Guaranty Fund Provisions 

NAIC standard coverage plus Ocean 

marine 

NAIC standard coverage 

I I I I Maximum 

$500,OOO per claim and unlimited workers’ compensation 

$100,000 per claim, workers’ compensation covered 

through other provision 

2.0% 

1.0% 

I Lines of Insurance Covereda 

Delaware 

District 

of Columbia 

Florida 

Claim limits 

NAIC standard coverage $300,000 per claim and unlimited workers’ compensation 

NAIC standard coverage plus surety $300,000 per claim and unlimited workers’ compensation 

and fidelity, credit, and Ocean marine 

NAIC standard coverage except ex- $300,000 per claim and unlimited workers’ compensation 

cludes wet marine 

2.0% 

2.0% 

2.0% 

Annual 

Assessments I I 

Hawaii 

Idaho 

Illinois 

I Alabama I NAIC standard coverage I $150,000 per claim and unlimited workers’ compensation I 1.0% I 

NAIC standard coverage $300,000 per claim and unlimitedworkers’ compensation 2.0% 

NAIC standard coverage $300,000 per claim and unlimitedworkers’ compensation 1.0% 

NAIC standard coverage plus title and $300,000 per claim and unlimited workers’ compensation 1.0% 

credit 

I *lash 

NAIC standard coverage except excludes 

general damages 

NAIC standard coverage 

r Arizona 

$100,000 per claim and $300,000 per occurrence; both 

limits apply to workers’ compensation claims 

$300,000 per claim and unlimited workers’ compensation 

1.0% 

2.0% 

Kentucky NAIC standard coverage plus surety $100,000 per claim and unlimited workers’ compensation 1.0% 

Louisiana NAIC standard coverage $150,000 per claim and $300,000 per Occurrence and un- 2.0% 

and fidelity - 

limited workers’ compensation 

I Arkansas I NAIC standard coverage I $300,000 per claim including workers’compensation I 2.0% I 

NAIC standard coverage plus surety 

and fidelity and some marine 

NAIC standard coverage plus surety and 

fidelity, title, credit, and ocean marine 

NAIC standard coverage 

I California I NAIC standard coverage I $500,000 per claim and unlimited workers’ compensation I 1.0% I 

$300,000 per claim and unlimited workers’ compensation 

$300,000 per claim and unlimited workers’ compensation 

2.0% 

2.0% 

$300,000 per claim including workers’ compensation 2.0% 

I Colorado I NAIC standard coverage I $l00,OOO per claim and unlimited workers’ compensation I 1.0% I 

- - and fidelity 

NAIC standard coverage 

NAIC standard coverage except excludes 

general damages 

NAIC standard coverage 

I Connecticut I NAIC standard coverage I $300,00 per claim and unlimited workers’ compensation I 2.0% I 

$300,000 per claim and unlimited workers’ compensation 

$300,000 per claim and unlimited workers’ compensation 

$300,000 per claim and unlimited workers’ compensation 

1.0% 

1.0% 

2.0% 

I Georgia I NAIC standard coverage I $100,000 per claim and unlimited workers’ compensation I 2.0% I 

17 

Indiana 

I 2.0% I NAIC standard coverage plus surety $300,000 per claim and unlimited workers’ compensation I and fidelity and Ocean marine l Kansas I 

Pine 

1 

Maryland 

Michigan 

Minnesota 

(Mississippi 

Missouri 

Montana 

I I NAIC standard coverage plus surety 

and fidelity, title, credit, mortgage guarof 1 percent of aggregate premiums written bymeminsurers during the preceding year, and unlimited 

anty, and Ocean marine workers’ compensation I 

NAIC standard coverage plus surety I $300,000 per claim and unlimited workers’ compensation I 2.0% 1 

42 
Table 4 (cont.) 

State-by state Comparison of Property-Casualty Guaranty Fund Provisions 

2.0% 

2.0% I= 2.0% 

Maximum 

Annual 

Assessments 

1.0% 

.- 2.0% 2.0% 

State 

Yebraska 

NAIC standard coverage except ex- $300,000 per claim and unlimited workers’ compensation 

cludes transportation 

NAIC standard coverage $300,000 per claim, workers’ compensation covered 

I through other provision 

Lines of Insurance Covered‘ 

NAIC standard coverage except excludes 

general damages 

Yevada 

Claim limits 

$300,000 per claim and unlimited workers’ compensation 

NAIC standard coverage plus credit $300,000 per claim including workers’ compensation I claims 

NAIC standard coverage 

NAIC standard coverage 

2.0% 

$300,000 per claim and unlimited workers’ compensation 

$300,000 per claim, workers’ compensation covered 

through other provision 

Yew Hampshire 

Yew Jersey 

NAIC standard coverage 

NAIC standard coverage plus surety 

and fidelity, and Ocean marine 

$100,000 per claim and unlimited workers’ compensation 

$1 million per claim including workers’ compensation 

2.0% 

2.0% 

NAIC standard coverage 

NAIC standard coverage 

Vew Mexico 

Vew York 

$300,000 per claim including workers’ compensation 

claims 

$3OO,ooO per claim including workers’ compensation claims 

NAIC standard coverage 

NAIC standard coverage 

NAIC standard coverage 

2.0% 

2.0% 

$300,000 per claim and unlimited workers’ compensation 

$300,000 per claim and unlimited workers’ compensation 

$300,000 per claim and unlimited workers’ compensation 

Vorth Carolina 

NAIC standard coverage 

NAIC standard coverage 

$300,000 per claim, workers’ compensation covered I through other provision 

NAIC standard coverage 

$300,000 per claim and unlimited workers’ compensation 

$300,000 per claim and unlimited workers’ compensation 

2.0% 

2.0% 

Wyoming NAIC standard coverage $150,000 per claim and unlimited workers’ compensation 1.0% - 

Vorth Dakota 

NAIC standard coverage 

NAIC standard coverage 

$300,000 per claim, unlimited workers’ compensation 

covered through other provision 

$300,000 per claim, unlimited workers’ compensation 

covered through other provision 

2.0% 

Dhio 1.5% 

Oklahoma NAIC standard coverage $150,000 per claim and unlimited workers’ compensation The lesser 

of 2 percent 

of net 

premiums 

or 1 percent 

of surplus 

Oregon 2.0% 

Pennsylvania 2.0% 

Rhode Island 2.0% 

South Carolina 

South Dakota 

1.0% 

1.0% ~~ 

Tennessee NAIC standard coverage except excludes $lOO,OOO per claim and unlimited workers’ compensation 

general damages I 1.0% 

Texas I NAIC standard coverage I $100,000 per claim and unlimited workers’ compensation 

Utah 

Vermont 

Virginia NAIC standard coverage I $300,000 per claim and unlimited workers’ compensation 

Washington 

West Virginia 

Source: National Conference on Insurance Guaranty Funds; updated by U.S. General Accounting Office, April 1990. 

43 
does business, most host states do not monitor nondomiciliary insurers. Under the territoriality theory of the Guaranty Fund Model Act, the host state must nevertheless 

“pick up the pieces” of the regulatory failures of a sister 

state. That is, the cost of insolvency of a multistate insurer 

is borne by each state in which a policyholder resides rather than by the state of the primary regulator (the insolvent 

insurer’s domiciliary state). For this reason, the domiciliary state has little incentive to work with other states to 

reduce the potential cost of an insolvency. In fact, the insurer’s home state may even have a motive to withhold information about its troubled insurers from sister states. If 

such information is disclosed to a sister host state, the host 

state may require the troubled insurer to stop writing new 

business in the state, cutting off a flow of new funds to the 

troubled insurer and hastening its demise. Thus, only a 

few states provide their sister states with regular reports 

on the condition of their domestic multistate companies. 

In contrast, the use of a universality theory, by which 

the guaranty fund of the home state would pay all covered 

claims of a domestic insolvent insurer, would increase the 

incentive for the home state to take prompt action. The 

incentive would be increased even further in those domiciliary states that allow insurers to recoup their assessments through either a credit against their premium 

taxes or a surcharge on policyholders. The loss of revenue 

from premium tax credits and/or the political pressure 

from policyholder surcharges, ifpublicired, can be strong 

incentives for effective regulation, counteracting the tendency for insurance companies to choose to domicile in a 

state with lax regulatory standards. 

The primary argument against requiring the guaranty 

fund of the domiciliary state of an insolvent insurer to pay 

the claims of policyholders wherever situated is that such 

a policy would severely restrict capacity. That is, assessments on domiciliary state insurers at the present level 

would not be sufficient to cover the policyholders of a 

large multistate insurer, and if the assessments were increased, they would have a dangerous effect on company 

surplus. Moreover, the attendant premium tax offsets 

would drain state coffers. Given the current state guaranty fund system, the territoriality principle of guaranty fund 

payments appears to be the only practical way to assure 

sufficient capacity and minimize the effects of premium 

tax offsets on state revenues. Nevertheless, states could 

adopt provisions to mitigate some of the negative effects 

of the territoriality principle. For example, a prefunded 

plan could solve both the capacity problem described below and the state revenue problems. Part Three of this 

report describes several proposed solutions to the exclusive reliance on post-assessment guaranty funds. 

Coverage. A second problem with the Guaranty Fund 

Model Act is that it provides the same protection to sophisticated, high-net-worth consumers of insurance as it 

does to unsophisticated consumer^.^^ Lessons learned 

from the Savings and Loan crisis have taught us that guaranty funds create a “moral hazard”; that is, 

high-net-worth corporate insureds, who know that they 

will not bear the full loss if their insurer fails, feel free to 

shop by price and ignore quality. (Given the complexity of 

insurance coverages, individual consumers of insurance 

are seldom able to gauge the financial strength of insurance companies. Moreover, the entities that could provide unsophisticated consumers with valid information 

about the financial stability of a company-e.g., state insurance departments-will not do so, usually citing confidentiality requirements.) 

Using agency theory, one commentator, Arthur M.B. 

Hogan, has found a correlation between the existence of 

guaranty funds and the degree of risk acceptable to corporate insurers. According to Hogan, in the absence of guaranty fund protection, corporate insurers balance their 

desire to benefit stockholders by investing in higher yield, 

higher risk products with their need to minimize the risk 

of loss to their policyholders by investing conservatively. 

The presence of guaranty funds upsets the balance by 

“reduc[ing] the risk that claims will not be paid, thereby 

reducing the conflict of interest between stockholders and 

policyholders. . . . [rlational consumers . . . will not seek 

information regarding the risk of the insurer, since there 

will be no effect upon their wealth.”* 

Market discipline could be reintroduced into guaranty funds by excluding or restricting the coverage of sophisticated corporate insurers. Large multistate corporations 

with professional benefits officers are well able to shop for 

stability as well as price and should be encouraged to do 

SO. As some states have recognized, these corporate consumers of insurance can exert market pressure on insurers to remain financially sound. For example, Michigan 

and Colorado have enacted laws that deny guaranty fund 

coverage to high-net-worth policyholders. 

The Michigan law excludes from coverage insureds 

whose net worth exceeds one-tenth of 1 percent of the 

aggregate premiums written by member insurers in the 

state in the preceding calendar year.47 In 1989, Borman’s 

Inc., the corporate owner of a supermarket chain in Michigan, challenged the law when its insurer became insolvent and the Michigan guaranty fund refused to pay a 

$1.15 million tort judgment against Borman’s even 

though the judgment was covered under Borman’s policy 

with the insolvent insurer. The Michigan guaranty fund 

association rejected Borman’s claim because the company’s net worth exceeded the statutory limits. Borman’s 

filed suit against the guaranty association, maintaining 

that the law violated the Equal Protection Clause of the 

U.S. Constitution. The 6th Circuit Court of Appeals 

upheld the Michigan law, finding that the state had a 

reasonable basis for the classifications in the law.@ 

The Colorado law excludes from guaranty fund coverage all persons who have a net worth in excess of $50 

million.49 In all, nine states have adopted similar net 

worth exclusion^.^^ A common criticism of these exclusionary laws is that third-party claimants would be unable 

to tap the liability coverage of a corporate multistate policyholder, although such claimants are neither sophisticated nor in control of the purchase of insurance. This 

criticism has some merit, but it may go too far. 

A loss of guaranty fund coverage does not mean that 

the third party has lost a claim against the corporate entity. Other options are available, including excluding from 

44 
guaranty fund coverage only the first-party claims of 

high-net-worth policyholders and/or extending guaranty 

fund coverage to third-party claimants if the corporate 

policyholder is bankrupt. Another way to introduce market discipline into the process would be to require insurers 

to prefund some portion of state guaranty fund programs. 

Many commentators believe that the exclusive reliance 

on post-assessment guaranty funds reduces market discipline and subsidizes the riskiest Part Three describes several options for prefunded plans. 

Forum Shopping. A third problem with the property-casualty Guaranty Fund Model Act is the potential for 

forum shopping. The combination of coverage of large 

corporate multistate policyholders, variances among state 

statutory caps on coverage, and the imprecise definition of 

residence creates opportunities for policyholders and 

claimants to seek to have their claims settled in states with 

larger statutory limits. For example, in the Guaranty Fund 

Model Act, the claim of a corporate claimant or insured is 

said to be covered by the state of its “principal place of 

business,” a phrase that may allow a multistate business to 

choose where it will request payment. 

Some states have attempted to limit the circumstances under which their guaranty funds are a potential 

forum for payment of claims by directing their domiciliary 

corporations to file their claims elsewhere. According to 

Delaware law: 

. . . if the insured is a corporation which transacts 

business outside of the state of incorporation, recovery shall be sought in that jurisdiction where a 

principal place of business most closely related to 

the claim is located.52 

Other states have gone to great lengths to limit the coverage 

of their guaranty funds. The Connecticut guaranty fund will 

pay only if the claimant (rather than the policyholder) is a 

resident of Connecticut. The statute contains one exception 

to the rule: if the claimant is not a resident of Connecticut, 

the state’s guaranty fund will pay if the policyholder is a Connecticut resident and the claimant has been refused coverage by another state’s guaranty fund because the insolvent 

insurer was not licensed in the other state. 

Who Pays the Assessments? 

Although member insurers must pay the assessment 

in the short run, taxpayers and/or many policyholders pay 

the assessments in the long run.53 The federal govern- ment and many states allow guaranty fund payments as a 

deduction from corporate income taxes. For an insurance 

company that pays federal taxes, 34 percent of the asses- sment is offset through a reduction in federal taxes. In 

addition, approximately 15 states allow insurers a state 

premium tax credit against the assessments. As with all 

deductions/credits from federal and state taxable income, 

the governmental entity makes up for the loss of revenue 

by looking to other revenue sources. In states that allow a 

premium tax credit, the federal deduction is lower than 34 

percent because the state tax credit reduces a company’s 

state income tax and that reduction increases the firm’s 

federal income tax (state income taxes are deductible 

against federal income taxes; therefore, a reduction in 

state income taxes results in a corresponding increase in 

federal taxes). NAIC’s Model Act provides insurers with 

an offset of 20 percent of an assessment per year for 5 

years. The actual amounts of credit vary among states, 

although most of the 43 states that allow a credit for life 

companies grant those companies a full credit. James 

Barrese and Jack M. Nelson of the College of Insurance 

estimate that the weighted average tax offset for proper- ty-casualty insurers is 51 percent, a 10 percent federal tax 

offset and a 41 percent state tax 

In addition to these federal and state tax deductions 

and credits, section 16 of the Model Act allows member 

insurers to include in their rate structure “amounts sufficient to recoup a sum equal to the amounts paid to the 

Association.” Thirty-four states provide recoupment 

through rates and premiums, and four states require a 

policyholder sur~harge.~~ Model regulations instruct insurers how to calculate the recoupment. No studies exist 

that measure the amounts recouped by insurers through 

policy rate increases under the Model Act. 

Insurers often argue that a benefit of the premium tax 

offset is that it creates an incentive for the public to 

pressure states to regulate more effectively. Yet, the failure to publicize either the existence of guaranty funds or 

the amount of the loss of revenue from offsets nullifies 

any such incentive. Moreover, under the current 

state-by-state guaranty fund scheme, it is the host (nondomiciliary) state that grants the premium tax credits and 

must make up the shortfall by increasing taxes on its 

residents. The primary regulator of a failed insurance 

company resides elsewhere. Public pressure against weak 

regulation is unlikely either to materialize or to be effective in a host state that is not the primary regulator of the 

insolvent company. 

Finally, a direct relationship exists between reinsurance offsets, rescissions, cut-through clauses, coverage 

limitations, and tax credits. To the extent that the estate of 

an insolvent insurer is increased through prohibitions or 

limitations on reinsurance offsets and cut-through 

clauses, etc., the assessments made against host state 

insurers (which give rise to the tax credits) will be reduced. 

The Capacity 

of State Property-Casualty Guaranty Funds 

The number of property-casualty insurer insolvencies 

rose from four in 1980 to 25 in 1985, and the nationwide 

guaranty fund assessments rose from $19 million in 1980 

to $292 million in 1985?6 Trends in property-casualty insolvencies are hard to find after 1985. For example, according to data collected by NCIGF, the number of insolvencies and the amount of assessments for the years 1985 

through 1991 were: 

1986 

1987 

1988 

1989 

1990 

199 1 

Number 

of Insolvencies 

16 

14 

12 

23 

14 

27 

Assessments 

(millions) 

$525 

$902 

$427 

$716 

$455 

$408 

45 
Neither the number of insolvencies nor the level of 

assessments has returned to the pre-1985 lows. A recent 

GAO report suggests that most state guaranty funds do 

not have the capacity to handle the insolvency of a large 

property-casualty insurer. According to GAO, the insolvency of one or more large property-casualty insurers 

could outstrip the guaranty fund capacity of 33 to 38 state 

guaranty funds.57 A 1985 study by the Illinois Department 

of Insurance was only slightly more optimistic, concluding 

that the insolvency of a large national property-casualty 

insurer could exceed the guaranty fund capacity in a majority of states5* Xble 5, which lists state property-casualty 

guaranty fund assessments and capacity in 1991, lends support to these studies. NCIGF maintains that the federal 

claims priority statute, which gives the federal government a 

“super priority” status, has reduced the “early access” payments (made by the liquidator from the estate of the insolvent insurer to the guaranty funds) made to guaranty funds. 

According to NCIGF, the result has been a decrease in state 

guaranty fund capacity because “early access funds have the 

effect of a dollar-for-dollar increase in guaranty fund capacity.”59 No data exist to prove or disprove this claim. 

States have at least four options to increase the capacity 

of their guaranty funds. First, all states could increase 

their assessment limits to at least 2 percent, thereby increasing the nationwide capacity, or all states could increase 

their assessment limits beyond 2 percent. Second, states 

could reduce coverage by, for example, restricting payments to all policyholders to 80 percent of state maximums 

or excluding coverage for large corporations. Third, states 

could adopt a prefunded guaranty fund program. Such a 

program would increase the capacity of the guaranty sys- tem and would introduce some market discipline into the 

system. Under a fourth option, state guaranty funds would 

jointly establish a reinsurance or excess insurance mechanism.60 The latter two options would involve joint action 

and might be best accomplished through the mechanism 

of an interstate compact, discussed in Chapter 11. 

SUMMARY OF MAJOR AREAS 

IN WHICH STATE LIQUIDATION 

AND GUARANTY FUND LAW 

COULD BE IMPROVED 

This report has identified eight areas in which state 

liquidation and guaranty fund laws could be improved as 

follows: 

1) The treatment of reinsurers under state law as players in 

need of special protection when a ceding insurer becomes 

insolvent. The effect of this treatment is to reduce the 

assets available for distribution to policyholders (and 

thereby increase state taxes) by allowing reinsurers to: 

Rescind their contracts with insolvent insurers 

when the reinsurers can prove a material misrepresentation; 

Offset (without limitation) balances due from an 

insolvent insurer against the amount the reinsurer owes as reimbursement for the liabilities of the 

insolvent insurer; and 

c) Use cut-through clauses granting some policy- holders special treatment by allowing them to receive payments directly from the reinsurer without complying with state liquidation procedures. 

Clashes between federal and state law that diminish the 

amount of reinsurance proceeds available forpolicyholders. The federal priority statute allows the federal 

government in its status as policyholder and/or tax 

collector to take first priority in liquidation proceedings, despite state laws to the contrary. The Federal 

Arbitration Act allows reinsurers to bring their disputes over coverage to a private forum outside of the 

state liquidation proceedings. 

A lack of uniformity among state liquidation laws, leading to conflicts among states and gaps in coverage. 

The failure to disclose to the public that insurers may recover their guaranty fund assessments by state tux offsets 

andlor policyholder surcharges and publicizing the effects of such recoveries on state revenues andlor theprice 

of insurance. 

The failure to adopt measures to mitigate the negative effects of the use of a territoriality (or host-state) concept in 

the administration of state guaranty funds, whereby responsibility for payment of claims rests with the state 

of residence of the policyholder or claimant. The negative effects of the use of this concept include: 

a) Concurrent guaranty fund proceedings in each 

state in which a policyholder or claimant resides; 

b) Disagreements among state guaranty funds as to 

which fund must pay a particular claim; 

c) The regulatory failures of the domiciliary state 

(the primary regulator) being paid for by host 

states, reducing the incentive for domiciliary 

states to regulate effectively; and 

e) Multistate policyholders being able to forum 

shop by bringing their claims to the stateguaranty 

fund that offers the broadest coverage. 

The failure to introduce market discipline into stateguaranty fund plans by disallowing or limiting guaranty 

fund coverage for high-net-worth policyholders and 

adopting a fully or partially prefunded guaranty fund 

plan. 

7) The failure to adopt measures to increase the capacity of 

state guaranty funds. Options to increase the capacity 

of state guaranty funds include: 

a) All states could increase their assessment limits 

to at least 2 percent or beyond 2 percent, thereby 

increasing nationwide capacity; 

b) States could reduce guaranty fund coverage by, 

for example, restricting payments to all policyholders to 80 percent of state maximums, or excludingllimiting coverage for large corporations; 

46 
Table 5 

Property/Casualty Guaranty Assessments and Capacity 

Estimated Assessments Estimated Assessments 

1991 Net Maximum Assessable 1991 as a Percent Capacity as a Percent of 

State Assessments Rate Premiums Capacity of Capacity at 2% Capacity at 2% 

Alabama 0 

Alaska 2,185,089 

Arizona 0 

Arkansas 0 

California 0 

Colorado (5,000,000) 

Connecticut 16,456,050 

District of Columbia 425.717 

Delaware 

Florida 

Georgia 

Hawaii 

Idaho 

Illinois 

Indiana 

Iowa 

Kansas 

Kentucky 

Louisiana 

Maine 

Maryland 

Massachusetts 

Michigan 

Minnesota 

Mississippi 

Missouri 

Montana 

Nebraska 

Nevada 

New Hampshire 

New Jersey 

New Mexico 

North Carolina 

North Dakota 

Ohio 

Oklahoma 

Oregon 

Pennsylvania 

Puerto Rico 

Rhode Island 

South Carolina 

South Dakota 

Tennessee 

Texas 

Utah 

Vermont 

Virgin Islands 

Virginia 

Washington 

West Virginia 

Wisconsin 

Wyoming 

Totalb 

8,239;000 

48,119,360 

0 

0 

(1,0oo,rn) 

(4,516,835) 

1,900,000 

0 

5,793,462 

62,65 1,940 

7,509,874 

10,500,000 

30,000,000 

(810,599) 

13,425,000 

0 

7,072,147 

(4,500,000) 

112,839 

(1,037,228) 

4,869,688 

20,502,256 

0 

6,000,000 

0 

31,400,000 

(66,834) 

1,998,621 

0 

0 

19,661,783 

4,740,588 

0 

0 

110,855,184 

0 

501,13 1 

0 

10,736,440 

7,500,000 

2,645,000 

(3,473,008) 

(750,000) 

407,646,215 

(7,000,000) 

1.0% 

2.0 

1.0 

2.0 

1.0 

1.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

1.0 

1.0 

1.0 

2.0 

2.0 

1.0 

2.0 

2.0 

2.0 

2.0 

1.0 

2.0 

1.0 

1.0 

2.0 

1.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

1.5 

2.0" 

2.0 

2.0 

2.0 

2.0 

2.0 

1.0 

1.0 

2.0 

2.0 

2.0 

3.0 

2.0 

2.0 

2.0 

2.0 

1.0 

2,658,521,000 

580,181,250 

2,982,706,000 

1,621,973,100 

3 1,525,837,000 

2,650,544,600 

4,277,326,000 

721,014,050 

764,683,150 

10,767,426,350 

5,356,100,050 

1,131,530,400 

662,873,700 

9,764,438,500 

3,844,880,100 

1,946,635,950 

1,846,896,400 

23 17,960,600 

3,168,253,150 

1,128,976,950 

4,290,168,200 

6,755,55 1,750 

7,873,618,400 

1,748,600,000 

3,565,777,500 

530,859,750 

1,140,544,800 

932,100,650 

1,090,063,550 

3,147,332,100 

1,073,821,000 

3,882,714,100 

491,584,000 

6,452,150,467 

2,123,456,350 

2,310,807,700 

8,897,692,000 

626,958,550 

1,008,089,150 

1,354,260,750 

4673 11,800 

3,425,443,700 

14,836,797,250 

898,829,700 

521,027,450 

62,395,985 

4,342,246,250 

3,233,432,700 

3,743,369,800 

3,500,513,000 

188,372,093,752 

3,850,758,950 

274,860,100 

26,585,210 

11,603,625 

29,827,060 

32,439,462 

315,258,370 

26,505,446 

85,546,520 

14,420,281 

15,293,663 

215,348,527 

107,122,001 

22,630,608 

6,628,737 

9 7,644,3 8 5 

38,448,801 

38,932,719 

36,937,928 

25,179,606 

63,365,063 

22,579,499 

85,803,364 

135,111,035 

78,736,184 

77,015,179 

17,486,000 

35,657,775 

10,6 17,195 

11,405,448 

18,642,013 

2 1,80 l,27 1 

62,946,642 

21,476,420 

77,654,282 

9,831,680 

96,782,257 

42,469,127 

46,216,154 

177,953,840 

12,539,172 

20,161,783 

27,085,215 

4,675,118 

34,254,437 

296,735,945 

17,976,594 

10,420,549 

1,871,880 

86,844,925 

64,668,654 

74,867,396 

70,010,260 

2,748,601 

2,984,763, 

0.0% 

18.8 

0.0 

0.0 

0.0 

-18.9 

19.2 

3.0 

53.9 

22.3 

0.0 

0.0 

-15.1 

-4.6 

4.9 

-18.0 

0.0 

23.0 

98.9 

33.3 

12.2 

22.2 

-1.0 

17.4 

0.0 

19.8 

-42.4 

1.0 

-5.6 

22.3 

32.6 

0.0 

7.7 

0.0 

32.4 

-0.2 

4.3 

0.0 

0.0 

97.5 

17.5 

0.0 

0.0 

37.4 

4.8 

0.0 

12.4 

11.6 

3.5 

-5.0 

-27.3 

13.7 

0.0 

53,170,420 

11,603,625 

32,439,462 

630,516,740 

53,010,892 

85,546,520 

14,420,281 

15,293,663 

215,348,527 

107,122,001 

22,630,608 

13,257,474 

195,288,770 

38,932,719 

36,937,928 

50,359,212 

63,365,063 

22,579,499 

85,803,364 

135,111,035 

157,472,368 

77,015,179 

34,972,000 

71,3 15,550 

10,671,195 

22,810,896 

18,642,013 

21,80 1,271 

62,946,642 

2 1,476,420 

77,654,282 

9,83 1,680 

129,043,009 

42,469,127 

46,216,154 

177,953,840 

12,593,172 

20,161,783 

27,085,215 

9,350,236 

68,508,874 

296,735,945 

17,976,594 

10,420,549 

1,871,880 

86,844,925 

64,668,654 

74,867,396 

5,497,202 

3,768,065,836 

59,654,120 

76,897,602 

70,010,260 

0.0% 

18.8 

0.0 

0.0 

0.0 

-9.4 

19.2 

3.0 

53.9 

22.3 

0.0 

0.0 

-7.5 

-2.3 

2.5 

-18.0 

0.0 

11.5 

98.9 

33.3 

12.2 

22.2 

-0.5 

17.4 

0.0 

9.9 

-42.4 

0.5 

-5.6 

22.3 

32.6 

0.0 

7.7 

0.0 

24.3 

-0.2 

4.3 

0.0 

0.0 

97.5 

17.5 

0.0 

0.0 

37.4 

0.0 

4.8 

0.0 

12.4 

11.6 

3.5 

-5.0 

-13.6 

10.8 

"Oklahoma's cap is the lesser of 2 percent of premiums or 1 percent of surplus. This table uses 2 percent of premiums as the cap. 

bNew York has a pre-insolvency assessment guaranty fund and is not included here. Therefore, the total system capacity is understated. 

Source: National Conference on Insurance Guaranty Funds and National Association of Insurance Commissioners. 

47 
c) States could adopt a prefunded guaranty fund 

program that would increase the capacity of the 

guaranty system and introduce some market discipline into the system; and 

d) State guaranty funds could jointly establish a re- insurance or excess insurance mechanism. 

A solution to the problem of clashes between federal 

and state law may require the Congress to exempt state 

insurance liquidations from the effects of the federal 

priority statute and the Federal Arbitration Act. These laws 

sharply curtail the ability of state liquidators to collect and 

distribute the assets of the insolvent insurer’s estate in an 

orderly manner. 

All of the other problems listed above could be corrected through individual or coordinated state action 

without federal intervention. Problems 1, 4, and 6 could 

be handled by states individually; indeed, states are experimenting with remedies. Problems 3, 5, and 7 may be 

difficult to solve without coordinated state action. Part 

Three examines alternative methods for coordinated 

state action, as well as proposals for federal intervention. 

Notes 

Fidelity &Deposit v. Pink, 302 U.S. 224, reh’g denied, 302 U.S. 

780 (1938). 

Reinsurers maintain that they are not given special protection. Instead, they claim that recognition of their right of set 

off is in line with federal bankruptcy law. There are, however, 

important distinctions between the private corporations and 

creditors seeking protection under the federal bankruptcy law 

and insurance companies being liquidated under state insur- ance laws. Using their police power to protect policyholders, 

states supervise all aspects of the business of insurance, includ- ing contract terms. A state can, thus, eliminate or restrict set 

offs in the context of liquidations. 

Note, “Distribution of the Proceeds of a Reinsurance Policy 

upon the Insolvency of the Reinsured,” Harvard Law Review 

50 (1936): 93. 

See, for example, Highlands Ins. Co. v. Employers’ Surplus 

Lines Ins. Co. 497 E Supp. 169 (E.D. La. 1980); Fortress Re, 

Inc. v. Jefferson Ins. Co. of New York, 465 E Supp. 333 

(E.D.N.C. 1978), affd. 628 E2d 860 (4th Cir. 1980); Great 

American Ins. Co. v. C. G. Tate Construction Co., 279 S.E.2d 

769 (1981); and see Donald W. Rees and Carol E. Reese, “Reinsurance: The Basics and Bad Faith Considerations,” FICC 

Quarterly 39 (Summer 1989): 351 “The duty of utmost good 

faith requires the ceding insurer to disclose all known information material to the risk”; and see cases cited in Jonathan E 

Bank and Karen L Bizzini, “ ‘Fraud’ in the Context of Reinsurance,” FICC Quartetfy 40 (Winter 1990). 

Kramer, ”The Nature of Reinsurance,” in Robert N! Strain, 

ed., Reinsurance (New York Strain Publishing Co., College of 

Insurance, 1980). 

435 E Supp. 855 @. Montana, 1977). 

435 E Supp. at 861. 

R. Mabey, “Setoff in a Non-Insurance Commercial Setting,” 

quoted in Stephen W. Schwab, Debra J. Anderson, Carolyn S. 

Reed, and David E. Mendelsohn, “Onset of an Offset Revolution: The Application of Set Offs in Insurance Insolvencies,” 

Dickinson Law Review 95 (1991): 449. 

See, for example, O’Connor v. Insurance Company of North 

America, 622 E Supp. 611 (1985). 

lo Hager v. Davis Transport, 901 E2d 1470 (1990); Bluewater Insurance Ltd v. Balzano, 823 P2d 1365 (1992). 

See, for example, Illinois Revised Statutes, ch. 73, section 

785.3 (1988); New York Insurance Code Section 1308 (1989); 

California Insurance Code, Section 922.2 (1989); Florida Insurance Code Section 631. 205 (1988). 

I2 Warranty Association v. Commonwealth Ins. Co., No. 

80-330-4, slip. op. (Sup. Ct. PR., April 13, 1983). 

l3 15 U.S.C. sec. 1011-1015. 

l4 31 U.S.C. sec. 3713. 

l5 15 U.S.C. sec. 101w). 

l6 858 F 2d 445 (9th cir., 1989), cert. denied, sub. nom. Fagiano v. 

United States, 109 S. Ct. 2063 (1989). 

l7 Union Labor Life Ins. Co. v. Pireno, 458 US. 119 (1982); and 

see Group Life & Health Insurance Co. v. Royal Drug Co., 440 

U.S. 205 (1979). 

I’ 846 E2d 272 (4th Cir., 1987), cert denied, 109 S. Ct. 390 (1988). 

l9 Maryland Code Ann. art. 48A secs. 158 and 158A. 

2o 939 F 26 341 (6th Cir., 1991); cert. granted, 118 L Ed 2d 541, 

112 S. Ct. 1934 (1992). The National Conference of Insurance 

Guaranty Funds notes that a recent decision from an Iowadistrict court has followed the Fabe ruling. See Lyons v. U.S., No. 

4-91-10209, S.D. Iowa, Cen. Div.). 

21 The National Conference of Insurance Guaranty Funds notes 

that “in addition to the impact of the amount claimed as a 

right for ‘super priority,’ the federal government also claims to 

not be bound by the liquidation court ordered requirements 

for the timely filing of claims. . . . This assertion would, if carried to the ultimate, require a liquidator to obtain a release 

from every potential federal claimant or, simply, not close the 

estate and make not distribution of any estate assets on the as- sumption that there might ‘someday’ be aclaim.” Letter from 

Dale E Stephenson to Sandra B. McCray, August 18, 1992. 

22 26 U.S.C. 7507. 

23 Cited in Bernstein v. Centaur Ins. Co., 606 E Supp. 98 (1984). 

24 9 U.S.C. sec.1 et. seq. 

26See, for example, Washburn v. Corcoran, 643 E Supp. 554 

“See, e.g., Bernstein v Centaur, 606 E Supp. 98 (1984). 

28 Bennett v. Liberty Fire Insurance, 1992 U.S. App. LEXIS 

15088 (9th Cir., July 6, 1992). 

29 This subsection of the report relies heairily on James R. Stinson, “Insurance Insolvency-Jurisdiction of the Federal and 

State Courts,” in Francine L Semaya ed., Law and Practice of 

Insurance Company Solvency Revisited (Chicago: American 

Bar Association, 1989), pp. 262267. 

U.S.C. sec.3. 

(1986). 

30 269 NW2d 842 (1978) 

31 U.S. Constitution, Art. W, sec. 1. 

32 Matter of Kenilworth Ins. Co., 428 So. 2d 1187 (La. App., 

1983); Insurance Affiliates, Inc. v O’Connor, 522 E Supp. 703 

(198 1). 

33 The National Conference of Insurance Guaranty Funds notes 

that this statement may not be entirely accurate. In a letter to 

the author, NCIGF cited 14 insolvencies handled by the Indiana Guaranty Association from 1975 to 1986. For these insolvencies, the percentage of claims and expenses recovered 

from the assets of the insolvent estates ranged from 18percent 

to 100 percent, with amean of 58.8 and a median of 61 percent. 

These figures would be more meaningful if they were 

weighted according to the size of the insolvency; however 

these data were not available to the author. Letter from Dale 

E Stephenson to Sandra B. McCray, August 18, 1992. 

34 In 1935, Wisconsin created the first state guaranty fund, covering only worker’s compensation. In 1937, New York also 

48 
created a worker’s compensation fund, and in 1939, New York 

was the first state to establish an automobile insurance guar- anty fund. But by 1960 only two states had guaranty funds for 

auto insurance, and only five states had such funds for worker’s compensation. See GAO, Insurer Failures: PmpertylCasualty Insurer Insolvencies and State Guamnty Fun& (Washington, DC, July 1987). 

35 “High-Risk Automobile Insurance,” Hearings before the U.S. 

Senate, Committee on the Judiciary, Subcommittee on Antitrust and Monopoly, 89th Congress, 1st Session (1965); see 

Paul G. Roberts, “Insurance Company Insolvencies and In- surance Guaranty Funds: A Look at the Nonduplication of 

Recovery Clause,” Iowa Law Review 74 (1989): 927; Bernard E. 

Epton and Roger A. Bixby, “Insurance Guaranty Funds: A 

Reassessment,” De Paul Law Review 25 (1976): 227. 

36 S. 3919,89th Congress, 2d Session (1966). The bill, introduced 

by Senator Dodd, would have created a federal fund to pay 

pending claims against insolvent insurance companies. 

37S. 2236, 91st Congress, 1st Session (1969), this would have 

created a federal insurance guaranty corporation. 

38 Roberts, “Insurance Company Insolvencies and Insurance 

Guaranty Funds” pp. 927,933. 

39 Ibid., p. 934. 

The National Conference of Insurance Guaranty Funds notes 

that in some states the boards of directors are appointed by the 

commissioner of insurance and are public representatives 

chosen from outside of the insurance industry. 

41 The National Conference of Insurance Guaranty Funds notes 

that a covered “claim must be an unpaid claim covered by a 

policy to which the guaranty fund act applies, and that such 

claims are typically required to be timely filed with the receiver 

or guaranty fund, and are not covered claims to the extent that 

they are covered by other insurance.” Letter from Dale Stephenson to Sandra B. McCray, August 18, 1992. 

42 David Foppert, “Can the State Guaranty Fund System Hold 

Up?” Best’s Review, Property-Casualty Insumnce Edition, Octo- ber 1991, p. 22. 

43 The example is given in GAO, Insurer Failures: ProperlylCasualty Insurer Insolvencies and State Guaranty Fun&, p. 29. 

44 According to a recent survey of several guaranty funds by the 

National Conference of Insurance Guaranty Funds, less than 

0.2percent of all claims against guaranty funds equalled or exceeded the statutory cap. Letter from Dale E Stephenson to 

Sandra B. McCray, August 18, 1992. 

45 Section 11 of the NAIC Model Act allow a state guaranty 

fund to recover payments made to insureds with a net worth in 

excess of $50 million. This “solution” is less than ideal, however, because it places an after-the-fact burden on the guaranty 

fund to litigate coverage. 

46 Arthur M.B. Hogan, “Guarantee Funds and Regulation: The 

Case of the Insurance Industry” (1991). 

47 Michigan Comp. Laws, sec. 500.7925(3). The National Conferenceofhurance Guaranty Funds notes that 15states have 

net worth provisions. Letter from Dale E Stephenson to 

Sandra B. McCray, August 18, 1992. 

48 925 E 2d 160 (6th Cir., 1991). 

49 C.R.S., 1987, sec. 10 4 504, cum. supp. 1991. 

Foppert, “Can the State Guaranty Fund System Hold Up?” p. 22. 

51 The National Conference of Insurance Guaranty Funds notes 

that many believe that exclusive reliance on post-assessment 

guaranty funds enhances regulatory discipline. “Because of 

the limited capacity available to protect individuals, regulators 

must be conscious of the point at which that protection would 

be compromised and seek to identify financially impaired insurers before that capacity is breached.” Letter from Dale E 

Stephenson to Sandra B. McCray, August 18, 1992. ’* Delaware Insurance Code, sec. 4212. 

53 The following summary of the tax consequences of guaranty 

fund assessments against member insurers is based on calcula- tions made by James Barrese and Jack M. Nelson, Professors 

of Economics at the College of Insurance in New York City. 

54 James Barrese and Jack M. Nelson, “The Consequences of In- surance Insolvencies,” June 1991. 

55 National Conference of Insurance Guaranty Funds, letter 

from Dale E Stephenson to Sanrda B. McCray, August 18, 

1992. 

56 National Conference of Insurance Guaranty Funds. 

57 GAO, Insum Failures: Differences in PropertylCasualty Guaranty Fund Protection and Funding Limitations (Washington, 

DC, March 1992). The National Conference of Insurance 

Guaranty Funds disagrees with the GAO report and notes 

that some of the assumptions made by GAO rendered its con- clusions suspect. For example, GAO assumed that insurer as- sets were unavailable to guaranty funds during the first year, 

while in fact in many cases “early access” funds would be available. GAO also assumed that losses incurred but not reported 

were included in the expected first-year payout, which, accord- ing to NCIGF, is unlikely. Moreover, GAO failed to recognize 

the borrowing ability of state guaranty funds. National Con- ference of Insurance Guaranty Funds Response to General 

Accounting Office Report, June 17, 1992. ’* Robert Klein, “Issues Concerning Insurance Guaranty 

Funds,” June 5, 1992, p. 22. Klein deems the Illinois study 

more reliable. He questions the assumption in the GAO study 

that state guaranty funds would have to pay all or a significant 

portion of the claims incurred by a major insurer in one year, 

rather than over a number of years as is generally the case. 

Further, Klein notes that the estate of an insolvent insurer frequently pays a portion of covered claims. 

59 Letter from Dale E Stephenson to the General Accounting 

Office, June 17,1992. 

Ibid. 

49 
50 
Part I1 

Life Insurance 

51 
52 
History of State Regulation 

of Life Insurance Companies 

Like property-casualty insurance, the early life insurance industry was subject to abuses, consumer complaints 

about dishonest practices and insolvencies, and calls for 

federal regulation. The abuses in the industries differ, however. Unllke the typical property-casualty company, life insurance companies receive large cash payments and have 

predictable, deferred liabilities. Consequently, life companies have less need for liquidity and can make long-term 

investments. Not surprisingly, problems in the life insurance 

industry have, from the beginning, typically involved investments in speculative ventures followed by worthless securities and, finally, insurance company insolvencies. 

EARLY HISTORY OF LIFE INSURANCE 

The first contracts providing for payments on death 

covered masters of ships. One early law provided that “if 

the merchant obliges the master to insure the ship, the 

merchant shall be obliged to insure the master’s life 

against the hazards of the seas.”’ These early forms of life 

insurance were known as wager policies and were usually 

temporary, lasting for the duration of a particular voyage. 

Wager policies were outlawed as a form of gambling in the 

16th century in France, the Netherlands, and Spain.2 

In England, Queen Elizabeth I encouraged the development of life insurance by granting persons the right to 

make and register all kinds of insurance policies. By the 

late 16th century, a life insurance regulatory system existed in England, including a Chamber of Insurance that 

registered life policies and a group of commissioners appointed to settle disputes. The early life policies in England were, like early property insurance policies, 

Lloyds-type agreements made by individual underwriters 

who agreed to pay a fraction of the total insured amount in 

return for a proportionate share of the premium. These 

early policies were typically of short duration, and the 

proceeds were used to protect creditors against the death 

of a debtor or to protect families and friends against the 

failure of a voyager to return from his j~urney.~ 

Life insurance in the modern sense, as a contract 

whereby in return for a premium an insurer agrees in 

advance to pay a certain sum of money to the insured’s 

estate or chosen beneficiary, developed in England in the 

latter half of the 16th century. Nearly a century passed 

before the individual life insurance contract evolved into a 

life insurance industry based on distribution of risk. The 

scientific basis for such an industry was given a boost in 

1693 when Edmund Halley (the astronomer who discovered the comet later named after him) constructed the 

first mortality tables. The tables provided a basis on which 

to determine the value of life annuities, which were the 

most common form of life insurance at the time. Halley 

developed his tables by comparing the number of deaths in 

the population of Breslau, Silesia, at different ages. He 

published the resulting table in 1693 in a paper entitled “An 

Estimate of the Degree of Mortality of Mankind, et~.”~ 

In 1706, the first life insurance organization that survived beyond the lives of the original members was chartered in England. The Amicable Society for a Perpetual 

Assurance Office was a mutual assessment society, but 

unlike other mutual assessment societies in which each 

member paid a stipulated sum only when a death occurred, each member of the Amicable Society paid a fixed 

amount per year. Then, the beneficiaries of the members 

who died each year would divide a fraction of the total 

amount paid in.5 

Other life insurance projects followed, most of which 

had strong elements of speculation. For example, several 

53 
mutual assessment societies were formed between 1708 

and 1721 in which all persons, particularly those in poor 

health, were encouraged to join. The managers of these 

organizations, who were not financially responsible for 

claim payments, were thus able to reap quick fortunes by 

taking fees from the initial premiums and deductions from 

the death claims paid. Moreover, many of these societies 

also invested in highly speculative ventures. One favorite 

investment was in the South Sea Company! In 1721, the 

failure of the South Sea Company rendered most of the 

securities held by these societies worthless and led to the 

downfall of all of the existing mutual assistance societies 

except the Amicable.’ 

Meanwhile, several works published between 1725 

and 1742 advanced the “science of life contingencies.” 

These works included generalized formulas for calculating the value of life annuities, interest tables, and accurate 

mortality tables for London.8 The new formulas and 

tables made it possible for companies to base their premiums on the probability of death at the age of insuring. In 

1762, the Society for Equitable Assurances on Lives and 

Survivorships (the Equitable) became the first company to 

take advantage of the new information. Unlike prior mutual 

assessment societies, the Equitable functioned like a modem insurance company, by having a stipulated premium, 

using mortality tables to measure average risk, and investigating the health and occupation of the insured to evaluate 

individual risk. The company charged extra for women under age 50 and for men who engaged in hazardous occupations. If an insured misrepresented the state of health or 

occupation on the application, the policy was deemed void. 

A different form of life insurance developed on the 

European continent. In 1653, Lorenzo Tonti, an Italian 

physician, developed a plan by which the government of 

France could raise money by selling annuities to its citizens. The first so-called tontine plan worked as follows: 

Subscribers purchased their annuities from the state; in 

return for an initial payment, the government promised to 

pay subscribers a life annuity at dividend periods of 10,15, 

and 25 years. Tontine plans had no cash surrender value, 

and the subscribers who died before the dividend payment 

period received nothing. The plan participants were divided into classes according to age. On the death of a 

subscriber in a particular class, the payments formerly 

paid to that member increased the amounts paid to the 

remaining members of that age group. The state’s obligation ceased on the death of the last survivor in the group. 

The tontine plans differed from traditional annuities in 

that the surviving annuitants, rather than the insurer, 

benefited from the early death of an annuitant. Tontine 

plans differed also from the typical life insurance policy in 

that plan members who survived the longest received the 

largest benefits9 

Early Life insurance in the United States 

The use of life insurance in the colonies began in the 

same manner as it had in England, with Lloyds-type policies on lives of maritime traders. The first life insurance 

associations formed were religious societies. In 1759, the 

Presbyterian Synod of Philadelphia established “The Corporation for the Relief of Poor and Distressed Presbyterian Ministers and for the Poor and Distressed Widows and 

Children of Presbyterian Ministers.” As its name suggested, the corporation supported needy ministers, as 

well as the surviving families of deceased ministers. In 

return for a minister’s yearly contribution, his widow and 

children would receive an annuity for life. The amount of 

the annuity depended on the contribution and was reduced if the minister died before he had contributed to 

the plan for 15 years. Over the following decade, other 

churches formed similar life insurance corporations. Until the adoption of the U.S. Constitution, these religious 

corporations were the only entities organized in America 

to provide life insurance.’O 

The first commercial insurance companies formed in 

the United States covered marine and fire risks. Although 

most of these companies had the right under their charters to underwrite life insurance policies, few did so. Before the 19th century, The Insurance Company of North 

America was the only private corporation in the United 

States to issue life insurance policies, and did not write 

more than a half-dozen policies.” About 1790, tontine 

plans were introduced into the United States. Several 

cities used the plans to finance public and private buildings, as well as to raise money for charitable purposes. 

Because most of them failed after a short time, tontine 

plans fell into disrepute. Although the life insurance industry failed to flourish in pre-industrial 18th century 

America, scholars from Yale and Harvard universities 

were paving the way for a viable industry by preparing 

mortality tables. For example, in 1789, Edward Wigglesworth of Harvard University presented a paper to the 

American Academy of Arts and Sciences that contained 

the first American mortality table,’* enabling insurers to 

calculate reserves. 

Companies began to make use of this work in the 

early to mid-19th century. The first commercial company 

organized to engage solely in the business of selling life 

insurance to the public at large was The Pennsylvania 

Company. Chartered in 1810 with $500,000 of capital 

stock, the company offered term and whole life insurance 

policies, as well as deferred annuities. As general business 

prospered in the 1820s and 1830s, the number of new 

insurance companies mushroomed. 

These new companies introduced new methods of 

marketing life insurance that signaled the birth of the 

modem life insurance company. For example, The New 

York Life and Trust Company, chartered in 1830, was the 

first to market its products actively through advertising 

and the use of an agency system. TheNew England Mutual Life Insurance Company, which was the first chartered 

mutual life insurance company, introduced a “part-note” 

premium plan in 1843.13 According to the part-note plan, a 

policyholder paid part of the premium in cash and gave a 

note for the remainder. Because mutual companies 

shared their surplus earnings with their members/policyholders, the policyholder could redeem the premium note 

with policy dividends. 

Some observers condemned this premium financing 

plan, arguing that it encouraged persons to purchase more 

54 
life insurance than they could afford. Other critics of the 

burgeoning industry complained that companies failed to 

maintain adequate reserves and to allow policyholders 

who were unable to maintain premium payments and let 

their policies lapse to share in the reserves (i.e., the premium payments made by the policyholder) on forfeiture. 

One of the most vocal critics was Elizur Wright, who 

in 1853 published 203 pages of net valuation tables showing the reserve that should be held at the end of each year 

during the life of various kinds of life insurance policies. 

Wright used his work to advocate the passage of regulatory legislation in Massachusetts. Specifically, Wright 

sought a nonforfeiture law, which would require life companies to provide lapsed policyholders who had paid premiums for at least two years with a paid-up policy in the 

amount of the policyholder’s reserve, less an 8 percent 

surrender charge. The Massachusetts General Court 

passed the law in 1880. 

During this period, companies also developed a new 

form of life insurance policy. In 1875, the Prudential 

Friendly Society began selling industrial life insurance. 

Unlike regular life insurance, which was sold primarily to 

the middle and upper classes, industrial life insurance was 

sold to lower and lower middle class people. These policies had a low face value, with a minimum as low as $25 in 

contrast to the $500 minimum face value on regular policies.14 Company salesmen sold industrial life policies door 

to door and collected premiums weekly. 

The “new” life insurance policy that generated the 

most interest, then criticism, and finally major reforms in 

the industry, was the tontine investment policy issued first 

by the Equitable. The new policy was based on the original 

tontine principle and, like the original policies, offered 10, 

15, and 25- year dividend periods, depending on the age of 

the policyholder. The Equitable’s modified version of the 

tontine contained several limitations. If the policyholder 

died before the end of a designated period, the beneficiary 

received the face value of the policy but no dividends. 

Everything was forfeited if the policyholder failed to continue premium payments to the end of the designated 

period. Policyholders who paid premiums to the end of 

their periods, however, shared in the division of the dividends, including those of lapsed policyholders. Henry B. 

Hyde, president of the Equitable, appealed to the selfinterest and gambling instincts of the population by advertising the tontine investment policy as one under which 

the investor could win by living rather than by dying. The 

advertising ploy paid off as the Equitable sold millions of 

policies and received a “pyramiding income.”15 

Tontine policies became the rage in the early 1880s, 

and most other life insurance companies began selling 

them. The so-called “tontine wars” erupted between the 

Equitable and the Mutual Life Insurance Company (the 

Mutual), each of which was determined to be the leader in 

sales. The tontine wars were waged in New York newspapers, the insurance press, and in pamphlets. To gain the 

upper hand, the Mutual offered its new policyholders a 

rebate of 30 percent on the first two premiums on whole 

life policies.16The tontine wars focused the public’s attention on the insurance industry and eventually led the 

muckrakers of the early 20th century to scrutinize the 

industry in general and the Equitable in particular. What 

they found was internal squabbling among the officers of 

the Equitable, fueled by speculative investments, manipulation of investment funds through subsidiary companies, and schemes to build a huge insurance trust through 

mergers with other life and oil companies.17 News of the 

growing scandal was widely reported in the press. 

The Armstrong Committee Investigations 

and Regulatory Reform 

With public confidence in the life insurance industry 

at an all-time low and with newspapers advocating prosecution of the managers and officers of the Equitable, the 

company was soon reorganized under new management. 

Almost immediately, critics complained that some of the 

new managers had histories of unethical conduct. Finally, 

the New York insurance department issued the Hendricks 

report, which described numerous shady dealings between the Equitable and its subsidiaries. A public outcry 

for further investigations followed, and in 1905 the New 

York legislature appointed an investigating committee to 

examine the “affairs of the life insurance companies authorized to do business in the state of New York, the 

investments of said companies, the relation of their officers to such investments, the relation of the companies to 

subsidiary organizations and to their policyholders, the 

expenses of the companies. . . .’,I8 

The Armstrong Committee (named after its chairman, New York State Sen. William Armstrong) asked 

Charles Evans Hughes to become its counsel. Hughes 

began the hearings with the testimony of the officers of 

the largest insurance companies. The practices that captured the public’s interest and generated the most public 

ire seem commonplace today: use of the companies’ enormous cash surpluses to pay large sums to lobbyists in Albany, 

cash contributions to political campaign funds, and lavish 

salaries paid to company officers and managers. l9 

Abuses in the use of the agency system were strongly 

criticized by the Armstrong Committee. The committee 

noted that the practice of competing for the loyalty of 

general agents by paying them large bonuses and raising 

their commissions increased the cost of life insurance to 

the public. Moreover, the pressure on agents for sales led 

to rebating (whereby agents would engage in price discrimination by discounting the cost of policies for certain 

policyholders), and twisting (whereby agents would encourage a policyholder of one company to forfeit his policy 

and purchase a policy from another company). The New 

York Department of Insurance came in for its share of 

criticism, too. Characterized as ignorant, evasive, neglectful, 

and subject to political manipulation, the department’s reputation was badly damaged by the Armstrong hearings. 

The Armstrong Committee submitted its report to 

the New York legislature in February 1906. Among the 

recommendations were: a prohibition of investments in 

stocks, a limitation on new business to $150 million a year for 

the largest companies, standard policies for all companies, 

annual distniution of dividends, a limitation on agents’commissions, an amendment to the anti-rebate law to make the 

55 
receiver equally guilty with the giver, and caps on the salaries and pensions of company officers.2o 

Some of the recommendations became law in April 

1906, including the limitation on newbusiness, annual distribution of dividends, a ban on political contributions, prohiiition of rebating, nonforfeiture provisions, standard policy 

forms, prohibition of investments in common stock and real 

estate, and caps on the salaries and pensions of the officers. 

The Armstrong Committee report stimulated activity 

in other states, among industry representatives, and 

among advocates for federal intervention. Surprisingly, 

few states followed the lead of New York; Iowa, Massachusetts, Indiana, Texas, and Wisconsin did take some 

action. To the consternation of the life insurance industry, 

the Texas legislature passed the Robertson law, which 

provided that 75 percent of the reserves on Texas policies 

must be invested in Texas securities, and that such securities must be kept on deposit in Texas where they would be 

subject to the state’s ad valorem taxes. Only the Wisconsin 

legislature adopted reforms that rivaled those of New 

York, enacting legislation in 1907 to limit premiums, expenses, and salaries of company officers, as well as to 

require an annual apportionment of dividends. 

The life insurance industry, too, was active following 

the Armstrong Committee investigations. The American 

Life Convention, an organization of the smaller western 

and southern life companies,21 grew into a national group 

that began to play a leadership role in the life insurance 

industry. In November 1906, some representatives of this 

industry group met in Chicago with a number of state 

commissioners and members of the Iowa and Wisconsin 

investigating committees. The purpose of the meeting 

was to draft model laws, 16 of which were endorsed by the 

industry. These model laws covered such subjects as standard policy forms, annual apportionment of dividends, 

prohibition of discrimination and rebating, and prohibition of political contributions. The models were introduced in a dozen or so states, but few were passed.22 

Another effect of the Armstrong Committee investigations was a call for federal supervision of the insurance 

industry. President Theodore Roosevelt recommended in 

April 1906 that the Congress provide for federal regulation of interstate transactions of insurance. Several bills 

were introduced, but they died when the congressional 

committees determined that, given the opinion of the 

U.S. Supreme Court in Paul v. Virginia, the Congress had 

no authority under the Constitution to supervise and regulate the business of insurance. 

The period from approximately 1910 to the 1960s was 

characterized primarily by the growth of state regulatory 

bureaucracies and a more conservative style of management 

by life insurers. When major life insurance scandals surfaced 

again in the lWs, they involved the use of the holding 

company structure and the formation of conglomerates. 

New York as Super Regulator: 

The Appleton Rule 

It is thought that New York adopted the Appleton 

Rule a short time before the Armstrong Committee investigations. The real power of the rule was not felt, however, 

until the New York legislative reforms of 1907 were complete. The rule, issued by New York Deputy Superintendent of Insurance Henry Appleton, provided that 

. . . no foreign insurer and no United States 

branch of an alien insurer shall be or continue to 

be authorized to do an insurance business in this 

state if it fails to comply substantially with any requirement or limitation of this chapter, applicable to similar domestic insurers hereafter to be 

organized, which in the judgment of the superintendent is reasonably necessary to protect the interests of the people of this state. 

The rule applied all aspects of New York regulatory law to 

foreign as well as domestic companies. Thus, a foreign life 

insurance company that chose to do business in New York 

would have to comply with the state’s investment restrictions. At least with regard to foreign companies that did 

business in New York, the effect was to extend New York’s 

regulatory law to all companies wherever domiciled.23 For 

that reason, the Appleton Rule was not popular with the 

insurance commissioners of other states. 

The Firemen’s Insurance Company of New Jersey 

challenged the Appleton Rule, claiming that New York’s 

attempt to exercise extraterritorial power violated the 

Fourteenth Amendment to the U.S. Constitution. Judge 

Learned Hand, writing for a three-judge federal district 

court, upheld the rule. Judge Hand found that, practically, New York had two choices: to accept the judgment of 

other insurance superintendents as to the safety of certain 

investments and practices or to apply its own regulatory 

law to protect New York policyholders. According to 

Hand, the former choice would result in differential treatment between New York-based and foreign insurers and 

allow “each state to set the standard of security for the 

rest of the Union, an intolerable limitation upon the autonomy of each community.”24 The latter choice would 

have some extraterritorial effects, but those would be 

“ancillary to the accomplishment of genuinely local purposes. . . .”25 In upholding the constitutionality of the 

Appleton Rule, Hand appeared to limit the court’s ruling 

to extraterritorial laws that related to solvency: 

Perhaps the power may be limited by the purpose and the fitness of the measure to accomplish 

it. . . . As we have said, scarcely any condition can 

be imposed touching the financial stability of a 

foreign corporation, which will not involve some 

results elsewhere. . . .26 (emphasis supplied) 

The U.S. Supreme Court affirmed Hand’s opinion in a 

memorandum opinion. 

Eventually, New York enacted the Appleton Rule as 

part of the state insurance code, and New York was the 

super regulator of the insurance industry. By the 1960s 

however, insurers had found a structural way to avoid the 

effects of the Appleton Rule. If a foreign insurer did 

business in New York through a separate subsidiary incorporated there, it could confine the rule’s impact to that 

subsidiary, leaving the parent and affiliated companies 

free from strict New York reg~lation.~’ 

56 
NoteR. Carlyle Buley, The American Life Convention: A Study in the 

History of Life Insumnce (New York Appleton-CenturyCrofts, 1953), p. 13. 

Charles Kelley Knight, The History ofLife Insurance in the US. 

to 1870 (Philadelphia: University of Pennsylvania, 1920), p. 11; 

Buley, The American Life Conventions, p. 13. 

Knight, The History of Life Insurance, p. 23. 

Ibid., p. 20. 

Ibid., p. 30. 

The South Sea Company, the brain child of Daniel Defoe, was 

incorporated in 1711. The English Parliament granted the 

company a monopoly on trade with South America and the 

Pacific Islands. In return, the South Sea Company agreed to 

take over the national debt of 5 1 million pounds and to pay 3.5 

million pounds. The national debt consisted primarily of an- nuities held by thousands of citizens. The company hoped to 

induce the annuity holders to exchange their annuities for its 

own watered stock. When the company failed, the stock be- came worthless. 

Knight, The History of Life Insurance, p. 33. 

Ibid., p. 37. 

Buley, The American L$2 Convention, p. 6. 

lo Knight, The History of Life Insurance, pp. 60-65. 

Ibid., p. 68. 

I2 Ibid., p. 70. 

l3 Ibid., p. 106. 

l4 James E. Post, Risk and Response (Lexington, Massachusetts: 

D.C. Heath and Company, 1976), p. 51. 

Buley, The American Life Convention, pp. 98-100. 

I6 Ibid., p. 100. 

l7 Ibid., p. 200. 

l8 Ibid., p. 206. 

Ibid., p. 221. 

2o Ibid., p. 169. 

21 bid., p. 284. 

22 Ibid., p. 300. 

23 Kenneth J. Meier, The Political Economy of Regulation: The 

CaseofInsurance (Albany: State UniversityofNew YorkPress, 

1988) p. 58; Steven N. Weisbart, Extmtenitorial Regulation of 

Life Insurance (Homewood, Illinois: Richard D. Irwin, 1975), 

24 Firemen’s Ins. Co. of Newark, N.J. v. Beha, 30 E2d 539 (1928); 

* Ibid. 

26 30 E2d 539 (1928). 

2’ Weisbart, Extratenitorial Regulation of Life Insurance, p. 47. 

p. 4. 

aff‘d mem. opinion, 278 US. 580 (1929). 

57 
58 
Overview of the Modern Business 

of Life Insurance 

Like property-casualty insurance, the function of 

life insurance is to protect against the financial effects 

of loss. Like all insurance, life insurance involves transferring risk from the individual to a group and sharing 

losses among members of the group. Life insurance is 

big business in the United States, with 2,228 U.S. life 

insurance companies operating in 1990. Table 6 (page 

60) shows the number of life insurance companies by 

state of domicile as of mid-1991. In 1990, these companies had assets valued at $1.4 trillion, received over $76 

billion in life insurance premiums and over $129 billion 

in annuity considerations, and paid out over $88 billion 

worth of life insurance and annuity benefits.’ 

TYPES OF LIFE INSURANCE 

Typically, life insurance is classified into one of three 

broad groups, depending on how the promised benefits 

are delivered. The three groups are term life insurance, 

whole life insurance, and annuities.2 Insurers define subgroups within each of these groups, based on whether the 

premium and/or the face amount of the policy increases, 

decreases, or remains level during the policy period. 

Term Life 

The purchaser of a term life policy receives protection (i.e., a cash payment for a designated beneficiary) 

only if the insured dies during the stipulated policy period. 

If the insured lives beyond the policy term, there is no 

benefit. The term of the policy may range from one year to 

several decades. Rrm life policies usually have level death 

benefits and increasing premiums over the policy period. 

Whole Life 

In contrast to term insurance, whole life insurance 

pays the face amount of the policy on the death of the 

insured regardless of when death occurs, hence the name. 

Most whole life policy premiums are constant throughout 

the payment period, and most are based on mortality 

tables that assume all insureds die by age therefore, 

most whole life policies are prefunded. That is, the likelihood of death is slight at the beginning of the policy 

period, and the premium paid is more than needed to fund 

the promised death benefits. For this reason, whole life 

policies have cash values, in the amount of the prefunding. Policyholders can use the cash value either by surrendering the policy or borrowing the cash from the life 

company. In the latter case, the insurer will charge interest and deduct the amount of the loan from the remaining 

cash value of the policy or from the death benefit. 

Two types of whole life insurance have become very 

popular recently, variable life insurance and universal life 

insurance. A variable life insurance policy differs from an 

ordinary policy in that its death benefits and/or cash values vary to reflect the investment experience of a separate 

pool of asset^.^ The policyholder chooses among several 

investment options, including money market funds, common stock funds, and bond funds. The death benefits and 

cash values are tied to the investment performance of the 

policyholder’s chosen funds, although the benefits/values 

cannot fall below a guaranteed minimum. 

Universal life insurance has a flexible premium and 

an adjustable death benefit. The premiums are flexible in 

that after making an initial minimum payment, policyholders may “pay whatever amounts and at whatever 

59 
Table 6 

Life Insurance Companies by State of Domicile 

July 22,1992 

(in descending order) 

State Number State Number 

Arizona 

Texas 

Louisiana 

New York 

Illinois 

Delaware 

Pennsylvania 

Indiana 

California 

Missouri 

Ohio 

Oklahoma 

Florida 

Iowa 

Arkansas 

Wisconsin 

Alabama 

Colorado 

Minnesota 

Mississippi 

Georgia 

Michigan 

Nebraska 

Connecticut 

Tennessee ~ ~ 

Source: American Council of Life Insurance. 

668 North Carolina 

217 Washington 

102 Maryland 

86 South Carolina 

79 Kentucky 

Massachusetts 

Utah 

Kansas 

New Jersey 

Virginia 

59 

56 

52 

50 

48 

48 

46 

44 

36 

34 

32 

28 

27 

27 

27 

26 

26 

25 

24 

24 

North Dakota 

Hawaii 

South Dakota 

Washington, DC 

Idaho 

New Mexico 

Oregon 

Rhode Island 

Vermont 

Montana 

Maine 

New Hampshire 

Nevada 

Alaska 

West Virginia 

Wyoming 

23 

20 

19 

19 

18 

17 

16 

15 

12 

12 

11 

6 

6 

5 

5 

5 

5 

5 

5 

4 

3 

3 

2 

1 

1 

1 

times they wish, or even skip premium payments as long as 

the cash value will cover policy charges. . . . Also policy 

owners may raise. . . or lower their policies’ death benefits 

as they deem appr~priate.”~ 

Annuity 

An annuity is an insurance policy that promises to 

make a series of payments for a fixed period or over a 

lifetime. A life annuity is a contract in which the insurer 

agrees, in return for a cash “deposit” or premium, to make 

lifetime payments to an annuitant. An annuity safeguards 

the annuitant against the possibility of outliving income 

and/or savings. 

Under a “pure” life annuity, the insurer is deemed to 

have earned the entire premium at the death of the annuitant; thus, no payments or refunds are made after death, 

even if the annuitant dies before the age of life expectancy.6 In contrast, a “refund” life annuity provides a refund if 

the annuitant dies shortly after the payments have begun. 

part of the purchase price of a refund life annuity is invested 

to meet the cost of the refund, lowering the periodic income 

payments to the annuitant. Like variable whole life policies, 

the amount of variable annuity benefits changes according to 

the investments chosen by the annuitant. 

NoteThe data are from American Council of Life Insurance, “1991 

Life Insurance Fact Book Update” (Washington DC, 1991). 

Some include a fourth group-endowment insurance. By 

1984, however, endowment insurance accounted for only 1 

percent of all life policies sold in the United States. Endowment insurance is like term insurance in that it pays the face 

amount of the policy on the death of the insured during the 

policy term. Unlike term insurance, endowment policies also 

pay the face amount of the policy at the end of the term if the 

insured is still living. See Kenneth Black, Jr., and Harold Skip- per, Jr., Life Znsumnce (Englewood CWS, New Jersey: PrenticeHall, 1987), p. 59. 

Ibid., p. 61. 

Ibid., p. 69. 

Ibid., p. 85. 

Ibid., p.100. 

60 
7 I 

Critical Issues in State Regulation 

of Insurance: Life Insurance Solvency 

Some of the issues involved in state life insurance 

solvency regulation were discussed in detail in Part I in 

connection with property-casualty regulation. Except 

where noted in this chapter, the prior discussion is relevant to life insurance as well. This chapter focuses on 

those aspects of solvency regulation that are unique to the 

life insurance industry. 

REGULATORY ACCOUNTING 

Like property-casualty insurance, life insurance accounting is governed by statutory accounting principles. Life 

insurers, too, report the details of their assets, liabilities, 

surplus, and operating results according to statutory accounting principles on an Annual Statement filed with insurance regulators in every state in which they are licensed. 

Balance Sheet Liabilities: 

Surplus and Reserves 

Life companies have far fewer problems than do 

property-casualty companies with estimating their losses 

because life company liabilities are typically certain in 

time and fixed in amount. Nevertheless, the current permissible methods of valuing reserves for claim payments 

have been subject to much criticism. 

Policy Reserve. In terms of size, the most important 

reserve fund of a life insurer is the policy reserve-the 

amounts deemed necessary to provide the benefits promised in the company's life and annuity contracts.' All 

states have laws controlling the bases on which reserves 

are calculated. The widely used net-level premium method 

defines the needed reserves at a valuation date as the excess of the present value of future death benefits over the 

present value of future premiums. This method requires 

the use of net-level premiums even if the policy contract 

calls for a variable premium. If, for example, the present 

value of future death benefits is $2,557,900 and the present value of future premiums is $1,589,988, then the 

net-level premium reserve would be $967,912. To calculate the present values, a life company must make certain 

assumptions about the interest rates on its investments 

and the mortality rates of its policyholders. Insurers that 

use the net-level premium method must comply with state 

laws that prescribe the maximum rate of interest that can 

be assumed and the mortality tables that can be used. If the 

assumed rate of interest is increased, the size of the reserve 

fund will decrease; or, in other words, larger anticipated 

earnings can be supported by a smaller fund and vice versa. 

Although the allowable interest rates and mortality 

tables are said to be conservative, the net-level premium 

method does not necessarily produce conservative levels 

of reserves. Critics of the net-level premium method note 

that the unrealistic assumptions used-hypothetical rather 

than actual premiums, the disregard of expenses, and the 

failure to take into account policy dividends and lapse rates 

-undermine the conservatism of the interest and mortality 

rates.* According to some observers, the conservative margin in the interest rate assumptions is not sufficient to cover 

the disregarded expenses, dividends, and lapse rates. 

Two other permissible methods used to calculate 

policy reserves typically produce lower reserve funds than 

the net level premium method. The full preliminary term 

method assumes that the first year of a whole life insurance policy is term insurance, which requires no policy 

reserves. The original contract then goes into effect at the 

beginning of the second policy year, and the reserve is 

based on a policy issued in that latter year. The deferred 

first-year reserve is amortized over the period of the contract; nevertheless, the yearly additions to reserves re61 
main lower throughout the policy period than under the 

net-level premium method. The commissioners’ reserve 

valuation method is similar to the full preliminary term 

method, but requires higher reserves for plans with higher 

premiums due to greater expense^.^ 

Asset Valuation Reserve. The second largest reserve 

required for life insurers is the new asset valuation reserve (AVR). Beginning with their 1992 Annual Statements, life companies are required to set up a reserve to 

absorb potential losses on all of their assets. The AVR 

grew out of an earlier mandatory securities valuation reserve (MSVR), which was designed to absorb potential 

losses on only the common and preferred stocks and 

bonds held by life companies. 

Changes in the financial climate in the late 1970s and 

early 1980s led some state regulators and the National 

Association of Insurance Commissioners (NAIC) to reevaluate the effectiveness of MSVR. For example, when 

interest rates soared in the early 1980s, many of the assumptions built into MSVR (e.g., that fluctuations in 

bond prices were not significant) became untenable. 

Moreover, to remain competitive, some life companies 

introduced new interest-sensitive products and shifted 

their investment strategies to shorter term, higher yield 

assets. To meet the regulatory challenges of these changes 

in company strategies, NAIC and state regulators developed AVR, a comprehensive reserve that covers all life 

company assets. AVR has two components-default and 

equity. The default component provides for future creditrelated losses on fixed-income investments, such as 

bonds, preferred stock, and farm, commercial and residential mortgages. The equity component contains the 

reserve provisions for all types of equity investments, 

including common stock and real estate. 

Interest Maintenance Reserve. The interest maintenance reserve (IMR), like AVR, is required of all life companies beginning with the 1992 Annual Statements. The 

reserve grew out of a realization by regulators that the traditional method used by valuation actuaries to calculate 

policy reserves was deficient. Typically, policy reserves are 

calculated on the assumption that future yields on 

fixed-income investments will be available to support liabilities. If these fixed-income investments are sold, IMR 

requires companies to amortize the resulting capital gains 

that represent future interest yields needed to support policy 

liabilities over the remaining life of the in~estment.~ 

Ba\ance Sheet. Rssets 

Until recently, life insurance premiums received for 

traditional whole life policies were far larger than the 

considerations received for annuities. For example, in 

1955, life insurance premiums were seven times as large as 

annuity consideration^.^ By 1980, however, life premiums 

were only 1.8 times as large, and by 1989, the situation was 

reversed, with annuity considerations 1.6 times the size of 

life insurance premiums? Prior to 1980, then, life insurers 

received large sums of cash from whole life policyholders 

and had deferred, non-interest-sensitive liabilities. 

The problem for life insurance regulators was to assure 

that a company’s surplus was sufficient to absorb a decline 

in investment values over time. Historically, state regulators handled this problem by restricting the investments 

of life companies. For example, at the close of the Armstrong Committee investigations, New York amended its 

insurance code to limit life insurance investments to government bonds, secured corporate debt, mortgages, and 

policyholder loans. Investments in common stock and real 

estate were prohibited. Because of New York’s Appleton 

Rule, the New York investment limitations applied to all 

companies, wherever domiciled, doing business in the state. 

After 1980, with the growing popularity of new investment products and interest-sensitive annuities, life companies began to change their investment strategies. Data 

from the American Council of Life Insurance illustrate 

the shift in aggregate life insurer investments between 

1980 and 191.’ 

Aggregate Life Insurer Holdings- 1980 

Corporate bonds 38.3% 

ComrnerciallResidential mortgages 

(traditional fixed rate) 29.4% 

Policy Loans 9.3% 

Government Securities 

(including agency issues) 6.9% 

Stocks (common and preferred) 6.7% 

Real Estate (directly owned) 2.6% 

Other 6.8% 

Aggregate Life Insurer Holdings- 1991 

Corporate Bonds 43.5% 

Commercial/Residentil mortgages 

(traditional fived rate) 19.4% 

Government Securities 

(including agency issues) 17.8% 

Stocks (common and preferred) 5.0% 

Policy Loans 4.9% 

Real Estate (directly owned) 2.1% 

Other 6.7% 

An important shift in life insurer investments took 

place between 1980 and 1991. In 1980,15 percent of the 

life companies’ aggregate gross acquisitions of government and corporate bonds and mortgage-backed securities were in medium- and short-term instruments (i.e., 

those with maturities 510 years). In 1991,62 percent of 

all such gross acquisitions of bonds were in mehmand short-term instruments. This shift illustrates the 

desire of life companies to match their assets with their 

newer, interest-sensitive liabilities and to increase their 

liquidity as consumer confidence waned in the face of 

some well publicized failures8 In recognition of the 

changes in life insurance products, many states relaxed 

their prior investment restrictions. Most states allow insurers to invest in government bonds, corporate stocks 

(common and preferred) and bonds, policy loans, stocks 

and bonds of subsidiaries, commercial and residential 

62 
mortgage loans, and real estate. Some states place percentage limitations on these investments in order to encourage portfolio diversification. No commonality ex- ists among state investment laws, however. 

In contrast to the aggregate investment figures listed 

above, some companies have a far greater percentage of 

their assets in low quality bonds and risky real estate 

ventures. For example, investments in junk bonds were a 

significant factor in the recent failure of the Executive 

Life Company of California. According to California regulators, approximately $6.4 billion of the company’s $10.4 

billion of assets was invested in junk bonds? In 1991, 

NAIC issued a model regulation restricting insurer investments in ‘%elow investment-grade bonds.” Only eight 

states have adopted the model regulation.’O 

Similar concentrations in risky real estate loans led to 

the seizure of Mutual Benefit Life by New Jersey officials.” 

The role played by risky investments in recent life insurer 

failures illustrates the pressing need for stricter state investment laws. NAIC is developing a model investment law that 

it hopes will bring greater uniformity and greater safety. 

In all states, regulatory percentage limitations are 

disregarded for assets held in separate accounts where the 

policyholder participates directly in the investment risk. 

Investments funded by premiums received from variable 

life and variable annuity contracts are held in separate 

accounts and are segregated from all other company as- sets. State laws restricting insurer investments do not 

apply to separate accounts. Thus, the funds in a separate 

account may be invested in common stocks, in bonds, or in 

real estate, or in any combination of the three.’* Separate 

accounts are used generally to handle variable life insur- ance, variable universal life insurance, and pension funds. 

The first two accounts are subject to some Securities and 

Exchange Commission (SEC) standards, and the pension 

account is subject to provisions of the Employee Retirement 

Income Security Act. 

THE ROLE OF REINSURANCE 

Reinsurance use in the life insurance industry is simi- lar to the property-casualty industry, but with some nota- ble differences. For example, unlike the situation with the 

property-casualty business, the majority of life reinsurers 

are licensed in at least one state. Also, because every state 

requires life companies to compute their reserves accord- ing to a statutory formula rather than through the esti- mating techniques used by property-casualty insurers, un- derreserving is less of a problem. Finally, unlike the 

property-casualty business, catastrophic events (such as 

an earthquake or industrial accident) are rare in the life 

insurance business. In some cases, these differences in the 

life and property-casualty businesses dictate different reg- ulatory responses. For example, overdue reinsurance bal- ances are rare in the life insurance industry, eliminating 

the need for a rule requiring a reduction in surplus. Three 

problems with reinsurance are relevant to life companies 

and are considered here-transfemng business, interaffiliate reinsurance, and financial reinsurance. 

Transfer of Business 

The use of reinsurance to transfer blocks of business to other companies has created special problems 

for the life insurance industry. Sometimes called assumption reinsurance, these transfers have been used 

by some companies to remove an entire block of business from its balance sheet and cancel its obligations to 

the policyholders. This result is in contrast to the usual 

situation in which an insurer, who cedes indemnification to a reinsurer, remains legally liable to its policyholders. Because the reinsurer or transferee assumes 

the liability of the primary insurer without the consent 

of (and sometimes without the knowledge of) the policyholder and without regulatory oversight, the transaction is subject to abuse. Joseph M. Belth, a long-time 

commentator in the insurance industry, cites the following example of an abusive transfer. 

Many individuals bought single-premium deferred 

annuities from First Pyramid Life of Arkansas. A 

block of these annuities was transferred three 

times through assumption reinsurance agreements. The first transfer was to Security Benefit, 

and the second to Life Assurance Company of 

Pennsylvania. The third transfer was to Diamond 

Benefits Life of Arizona. Shortly thereafter Diamond Benefits was taken over by Arizona insurance regulators. . . . Life of Pennsylvania was recently taken over by Pennsylvania regulators. 

The affected annuitants have been unable to get 

at their funds for almost three years.13 

NAIC has developed, but not adopted, a model act that 

would require life insurers to notlfy consumers of a pending 

assumption reinsurance transaction and given them the opportunity to remain covered by their current insurer. 

lnteraffiliate Reinsurance 

Interaffiliate reinsurance, whereby a group of affiliated insurance companies agrees to reinsure each other’s 

risks, has also created problems for state regulators. According to the U.S. General Accounting Office (GAO), 

“[Iln a group of affiliated insurers, intercompany reinsurance may serve to obscure one insurer’s financial condition by shifting loss reserves from one affiliate to another. 

Improper support or subsidy of one affiliate at the expense of another may adversely affect the financial condition of one or more companies within the group.”’4 For 

example, “an affiliate reinsurer may receive exorbitant 

premiums, or an affiliated ceding company may receive 

excessive commissions.~715 

Financial Reinsurance 

The use of financial reinsurance (described in Chapter 3), is widespread in the life insurance industry. For 

example, in 1991, the Equitable Life Assurance Society of 

the U.S. boosted its total capital by $600 million using 

surplus relief reinsurance.16 A relatively weak NAIC 

Model Regulation on Life Reinsurance Agreements issued in 1988 prohibits a company from taking a credit for 

financial reinsurance if the reinsurer does not comply 

with certain accounting requirements: the reinsurer must 

accept some risk, such as mortality or investment risk, 

and/or the reserve credit taken by the ceding insurer must 

63 
not be greater than the underlying reserve of the ceding 

company supporting the obligations transferred. 

The limitations on the use of financial reinsurance in 

the 1988 version of the model law are weaker than the 

accounting rule recently issued by NAIC in connection 

with property-casualty insurance. In June 1992, NAIC issued 

a revised model rule that would require life insurers to 

transfer all significant risks on the business ceded to a rehsurer. Insurers who fail to do so would be denied a credit. 

The 1992 model rule has not been formally adopted by 

NAIC, but it has been adopted by Califomia and Colorado. 

STATE SOLVENCY REG U LATl ON 

Many of the problems with solvency regulation of 

property-casualty insurers described in Part I are relevant 

to life insurance companies. For example, state capital 

and surplus requirements for life insurers are unrelated 

to either the size of the company or to the riskiness of its 

sive reviews: “The stock of Baldwin-United represents an 

interesting special situation. We do not believe its outstanding management team is being accorded a proper 

multiple.”*’ A.M. Best Company gave the National Investors Life Insurance Company (NILIC), a Baldwin-United 

subsidiary, an excellent rating.” 

In large part, Baldwin’s phenomenal growth was fueled 

by sales of a life insurance/investment/tax shelter product 

known as a single premium deferred annuity (SPDA), underwritten primarily by NILIC. The Baldwin SPDA had the 

following features, which made it attractive to purchasers: 

The purchaser of an SPDA paid a one-time premium deposit, eliminating the need for a recurring financial commitment. 

The SPDA was similar to a ten-year certificate of 

deposit in that the purchaser received interest 

payments from NILIC or another Baldwin subsidiary issuing the SPDAs. 

assets. Life companies also use managing general agents 

(called third-party administrators) as intermediaries to 

negotiate reinsurance agreements. A NAIC model law 

imposes many of the same restrictions on third-party 

administrators that the managing general agent model 

law imposes on MGAs. Approximately 20 states have 

The SPDA had a death benefit and two tax advantages: (1) the capital (premium deposit) and 

accumulated reinvested interest were not taxed 

and (2) an investor could withdraw interest as a 

tax-free policy loan. 

adopted the model law. Fronting appears to be less of a 

problem with life companies. Apparently, some of the 

draft model laws on fronting have included life companies, and others have not. Finally, the failure of most states 

to adopt meaningful investment limitations affects both 

industries. Multistate life insurers have created unique 

problems for state regulators and deserve special mention. 

Multistate Insurance Holding Companies 

The American Council of Life Insurance (ACLI) recently examined 68 lifelhealth insurance company insolvencies that occurred between January 1985 and September 1989. Affiliate transactions were a significant factor in 

69 percent of the companie~.’~ 

GAO found similar problems with holding companies 

in both the banking and insurance industries. According 

to GAO, the largest life insurer failure in history was 

caused by “abusive interaffiliate transactions”1s orchestrated by the parent holding company of several insurance 

subsidiaries. The story of the failure of Baldwin-United is 

instructive, proving once again that the pyramid is not far 

from the tomb. 

The Baldwin Phenomenon. Baldwin began as a piano 

company in 1862. Baldwin entered the insurance business 

in 1968 when it bought National Farmers Union Life and 

Casualty companies. From 1970 to 1980, Baldwin-United 

developed rapidly into a large financial conglomerate, acquiring commercial banks, savings and loan associations, 

mortgage banks, real estate firms, and life and property-casualty insurers around the co~ntry.’~ In1981 and 

1982, Baldwin-United was praised in financial publications as a “well-managed, diversified financial services 

company with an impressive growth rate and high profitability.”” Baldwin’s management also received impresThe SPDA contained a guaranteed growth of 

principal. If Baldwin earned less than the guaranteed rate (i.e., 0.75percent below the initial rate), 

the company would refund the investor’s initial 

deposit without levying a surrender charge.23 

Although the SPDAs were not a new product (being 

based loosely on the old tontine principle), Baldwin’s 

method of selling them was new. SPDAs were sold 

through national securities brokerage houses, such as E.F. 

Hutton and Merrill Lyn~h.2~ 

The Baldwin Failure. Even before weaknesses in 

Baldwin’s financial empire began to surface, the company 

had manipulated its tax liability by shifting assets among 

its subsidiaries. For example, Baldwin funnelled holding 

company profits to subsidiaries that were in a low tax 

bracket and shifted paper losses to subsidiaries that were 

in high tax brackets. As its SPDA premium deposits increased, NILIC needed more regulatory surplus to support its new business. In order to increase its surplus, NILIC 

turned first to reinsurance, ceding business to an affiliated reinsurer, National Investors Pension Insurance 

Company (NIPIC). 

When NILIC’s need for capital and surplus outgrew 

this reinsurance arrangement, Baldwin exchanged securities and other assets among its affiliates and engaged in 

interaffiliate loan transactions to pump up the apparent 

net worth of NILIC and NIPIC. In summer 1982, Arkansas insurance department examiners reappraised the assets of reinsurer NIPIC and lowered their value. The 

reevaluation rendered NIPIC statutorily insol~ent.2~ 

Once NIPIC was found to be insolvent, the affiliated 

companies it reinsured could no longer claim a reinsurance credit for the risks ceded and had to cover the risks 

themselves. Without reinsurance, these ceding compan64 
ies (including NILIC) were also statutorily insolvent. 

Baldwin reacted by reinsuring its SPDA premiums in an 

Arizona subsidiary because Baldwin recognized Arizona 

as “one of the least regulated insurance states in the 

Union.”26 Nevertheless, neither Arkansas as the primary 

domiciliary regulator of both NIPIC and NILIC, nor Indiana, as the domiciliary regulator of three other Baldwin 

subsidiaries underwriting SPDAs, took any supervisory 

action against the Baldwin subsidiaries until spring 1983, 

when state regulators petitioned their state courts for a 

rehabilitation order. In fall 1983, the insurance commissioners of Arkansas and Indiana imposed a moratorium 

until November 1987 on surrender of Baldwin SPDAs. 

Not until February 1988 did the holders of SPDAs of the 

now-bankrupt Baldwin receive their final distribution^.^^ 

NAIC and other commentators have listed the lessons 

that states should learn from the Baldwin failure. A common regulatory weakness cited was the excessive investment 

in affiliate securities, over $650 million in the investment 

portfolios of NILIC and NIPIC.28 On several occasions, 

NILIC paid cash for the securities of affiliates. Yet, thevalue 

given to these securities was speculative at best. Because 

these shares were not publicly traded and earned no income, 

their value could not be verified independently. 

Another regulatoly weakness was the practice by 

NILIC of reinsuring 100 percent of its SPDA business with 

affiliated reinsurance companies. NAIC reacted to the 

Baldwin-United failure by amending the model holding 

company act. The amended act, which is described in Chapter 3, is one of the model acts that states must adopt in order 

to become certified under NAIC’s accreditation program. 

Executive Life of California. As the recent experience with Executive Life of California illustrates, serious 

problems remain with interaffiliate transactions in insurance holding company systems. In its investigation of the 

company just prior to the failure, the California insurance 

department uncovered deceptive transactions among 

company affiliates. For example, in one series of transactions, Executive Life transferred over $700 million of junk 

bonds in exchange for the securities of six newly formed 

affiliated partnerships. After this transaction, Executive 

Life reduced its mandatory securities valuation reserves 

and increased its surplus by $120 million.2g On completion 

of its examination two years after the transaction, the California department ordered Executive Life to recalculate 

its MSVR and to disclose the substance of the junk bond 

transactions in its Annual Statement. 

Notes 

Ibid., p. 555. 

* Spencer L. Kimball and Herbert S. Denenberg, Insurance, 

Government, and Social Policy: Studies in Insurance Regulation 

(Homewood Illinois: Richard D. Irwin, 1969), p. 119. NAIC 

notes that the some problems with the net level premium 

method exist under both statutory and GAAP accounting. 

Kenneth Black, Jr., and Harold Skipper, Jr., Life Insurance 

(Englewood Cliffs, New Jersey: Prentice Hall, 1987), pp. 

I am indebted to John Booth, Vice President and Chief Actuary with the American Council of Life Insurance, who pro35 1-352. 

vided the language of this sentence and patiently educated me 

during a phone conversation on July 16, 1992. Any errors are 

my own. 

Kenneth M. Wright, “The Structure, Conduct, and Regula- tion of the Life Insurance Industry,” in Richard W. Kopcke 

and Richard E. Randall, eds., The Financial Condition and 

Regulation of Insurance Compania, Proceedings of a confer- ence sponsored by the Federal Reserve Bank of Boston, June 

1991, p. 80. 

Bid. 

The data were provided to the author by Paul Reardon, Direc- tor, Investment Research, American Council of Life Insur- ance, phone conversation, July 14 and 27, 1992. 

* Kenneth M. Wright, “The Structure, Conduct, and Regula- tion of the Life Insurance Industry”; and phone conversation 

with Paul Reardon, July 14 and 27, 1992. 

Joseph M. Belth, The Insurance Forum, June 1991. 

lo As noted, however, New York acted on its own to restrict socalled high yield-high risk bonds. Illinois imposed a cap on 

such bonds in 1990. Other states have followed. 

According to New Jersey regulators, Mutual Benefit had $1.1 

billion of its $14 billion of assets tied up in four problem loans. 

Susan Pulliam, “Mutual Benefit Life Took Plenty of Risks, and 

Is Paying the Price,” Wall Street Journal, July 26, 1991. 

l2 Black and Skipper, Life Insurance, p. 557. 

l3 Joseph M. Belth, ed., “The Current State of Affairs in the Life 

Insurance Business,” The Insurance Forum, March 1992, p. 10. 

l4 U.S. General Accounting Office (GAO), Insurance Regula- tion: State Reinsurance Oversight Increased, but Problems Remain (Washington, DC, May 1990), p. 17. 

l5 Ibid. 

l6 Susan Pulliam, “Insurance Regulators Mounting Attack on 

Controversial Financial Technique,” Wall Street Journal, June 

l7 American Council of Life Insurance, ‘Rlternatives and Enhancements to the Current Guaranty Association Mechanism,” Report of the Study Group to the Legislative Committee, October, 1991, p. 17. 

Statement of Richard L. Fogel, Assistant Comptroller General, before the U.S. House of Representatives, Committee on 

Energy and Commerce, Subcommittee on Oversight and In- vestigations (Washington, DC: U.S. General Accounting Office, May 22, 1991), p. 21. 

l9 Report of the Conference of Insurance Legislators Task Force 

on Regulatory Initiative, “Risk . . . Reality . . . Reason . . . in 

Financial Services Deregulation, A State Legislative Perspective” (1983), p. 33. 

2o Quoted in John E Fitzgerald, “Regulatory Lessons Learned 

from Baldwin-United Corporation,” Journal of Insurance Regulation (March 1988): 284. 

Ibid. 

22 Ibid. 

23 Ibid. 

24 Conference of Insurance Legislators, “Risk . . . Reality . . . Reason. . ., p. 34. 

25 National Association of Insurance Commissioners, “The 

Baldwin-United Corporation Bankruptcy: Its Significance for 

Insurance Regulation.” 

26 Richard L. Stem and Paul Bornstein, “What Happens When 

the MusicStops?,” Forbes, December 20,1982, p. 33; quoted in 

Fitzgerald, p. 303. 

27 Fitzgerald, “Regulatory Lessons Learned from BaldwinUnited Corporation,” pp. 294-299. 

28 Ibid., p. 300. 

2g Joseph M. Belth, “A Disastrous January for Executive Life,” 

7, 1991. 

The Insumnce Forum, March 1990, pp. 91,95. 

65 
66 
I Critical Issues in State Regulation 

of Insurance: Life Insurance 

Liquidation Laws and Guaranty Funds 

The state laws that specify the actions that an insurance commissioner can take to protect the policyholders 

of a financially troubled insurance company are the same 

for property-casualty insurers and life insurers. Chapter 4 

of this report describes state delinquency proceedings for 

property-casualty insurers and the two acts governing 

such proceedings, the Uniform Insurers Liquidation Act 

and the Model Act. These laws also apply to life insurers; 

therefore, their provisions are not described again here, 

nor are such other common problems as the impact of 

federal tax lien priorities, arbitration clauses, and the lack 

of uniformity among state liquidation laws. 

STATE LIFE GUARANTY ASSOCIATIONS 

Like property-casualty guaranty funds, state life guaranty associations protect policyholders of insolvent life 

insurers.’The structure of the two model laws is similar in 

several respects. For example, all insurers licensed in a 

state are required to be members of the state’s guaranty 

association. When a life company becomes insolvent, the 

association first estimates how much will be needed to pay 

claims and benefits and then assesses member companies 

a percentage of their premium income. State annual 

assessment caps range from 1-4 percent, but most states 

have a 2 percent cap. For large insolvencies, the assessment process is repeated in subsequent years until all 

covered claims are paid up to the state’s limit. State coverage limits range from $100,000 to $500,000 per life for 

individual life and annuity benefits. 

Like property-casualty guaranty fund coverage limits, 

the differences in state life guaranty association coverage 

can result in inequitable treatment among similarly 

situated policyholders. For example, a New York resident 

who purchases an annuity with a cash value of $200,000 

from a California company that was not licensed in New 

York (and therefore not eligible for coverage by the New 

York guaranty fund) would receive $100,000 from the 

California guaranty fund. In contrast, a resident of Washington with an annuity from the same company and with 

the same cash value would receive $200,000 from the 

Washington guaranty fund.2 Some observers maintain 

that such differences represent legitimate public policy 

choices by states. 

Unlike property-casualty contracts, life and annuity 

contracts are long term. When a life company fails, the 

policyholder may be in bad health and unable to find new 

coverage. Therefore, life guaranty associations are required to continue life, annuity, and health insurance 

coverage in effect, as well as pay claims. When a multistate life insurer fails, the National Organization of Life 

and Health Insurance Guaranty Associations (NOLHGA) coordinates the activities of the state guarantyassociations, all of which are members of the organization. 

Formed in 1983, NOLHGA also provides information on 

guaranty fund laws and provides others services to member guaranty associations. 

Prior to the early 1980s, life insurance insolvencies 

were infrequent, averaging about five per year from 1975 

to 1982.3 Moreover, the failed companies were typically 

small; most had assets and premiums of less than $50 

million. From 1975 to 1982, guaranty fund assessments 

totaled $50 million. Recently, life insolvencies have increased dramatically in number and size; for example, 

67 
guaranty fund assessments tripled from $154.8 million in 

1990 to an estimated $469.7 million in 1991. 

Coverage 

Virtually all life insurance policyholder claims are 

covered by state guaranty funds up to the typical limits of 

$300,000. Most guaranty associations do not, however, 

cover the newer, investment-type products sold by life 

companies to governmental agencies and pension funds. 

Approximately 19 state guaranty funds cover the unallocated annuity contracts of insolvent insurers, while 18 

states specifically exclude such contracts: NAIC’s model 

act defines an unallocated annuity contract as “any annuity contract or group annuity certificate which is not issued 

to and owned by an individual, except to the extent of any 

annuity benefits guaranteed to an individual by any insurer under such contract or certificate.” Typically, unallocated annuity contracts are purchased by private and governmental entities (to fund their retirement plans) that 

are advised by professional (albeit sometimes dishonest) 

money managers. Coverage of such products is, of course, 

intimately related to the capacity of guaranty funds to 

cover large life company insolvencies. 

One form of an unallocated annuity contract, the 

guaranteed investment contract or GIC, constituted a 

significant portion of the policy liabilities of the recently 

failed Executive Life Insurance Company of California. 

At the time of its failure in 1991, Executive Life had over 

$1.8 billion of muni-GICs outstanding. The typical Executive Life muni-GIC worked as follows: 

A municipal agency would issue bonds, which 

were then purchased by investors. The agency 

would use the proceeds of the bonds to buy a GIC 

from Executive Life. Because the rate of interest 

on the GIC was higher than the interest rate on the 

municipal bonds, the agency received extra money 

in the amount of the interest rate differential.5 

The California conservatorship court ruled that the 

state’s guaranty fund would have to grant the holders of 

Executive Life muni-GICs the same priority status asindividual policyholders in the assets of the insolvent estate. 

This ruling will affect the capacity of state guaranty funds. 

Granting the holders of muni-GICs the same priority status as policyholders limits the amounts that traditional 

policyholders can recover from the insolvent insurer’s estate, thereby increasing the amount that guaranty funds 

must contribute to compensate policyholders for their 

covered claims. The court’s ruling was based on the ambiguous state of California law at the time of Executive 

Life’s insolvency. California has since amended its law. 

A recent report by NAIC describes a serious gap in 

life guaranty fund coverage. According to the report, a 

policy owner who lives in a state in which the insolvent 

insurer was never licensed may not be covered by any state 

guaranty fund. According to the model act, a state guaranty fund is required to provide coverage to nonresidents if: 

1) The insolvent insurer is domiciled in the state; 

The insurer was never licensed in the state in 

which a policyholder resides; 

The state in which the policyholder resides has an 

association similar to the domiciliary state’s association; and 

The policy owner is not eligible for coverage by 

the guaranty fund in the state in which he or she 

resides. 

Some state guaranty fund laws do not have this reciprocal 

provision and offer no coverage to nonresidentse6 

Statutory Prohibitions 

on Guaranty Fund Disclosure 

One provision in the Guaranty Fund Model Act prohibits disclosure of guaranty fund coverage. Insurers argue that disclosure would invite unscrupulous insurers to 

encourage consumers to shop for price rather than for 

price plus company stability. The argument is faulty in 

several respects. First, in a competitive industry, it is assumed that consumers should and will shop primarily for 

price. Second, in a regulated competitive industry, unso- phisticated consumers have the right to assume that the 

primary duty of monitoring the financial solvency of insurers belongs with taxpayer-funded state departments of 

insurance, not with the consumer. Indeed, state departments of insurance are the best source of information for 

consumers on the financial health of insurers; yet statt 

commissioners are generally precluded from or unwillinl 

to share their information with policyholders. Third, tc 

ensure effective state regulation, consumers must be in 

formed of all aspects of guaranty fund coverage, including 

the amount of coverage, the amount of assessments, and the 

amount of revenue lost due to state premium tax offsets. 

Who Pays the Assessments? 

Few states allow property-casualty insurers to recover 

their guaranty fund assessments by taking a credit against 

state premium taxes. Rather, most property-casualty 

insurers recoup their assessments by increasing their policy 

rates or levying a surcharge on policies. In contrast, 43 

states grant life insurance companies a state premium tax 

credit for assessments paid to the state’s guaranty fund. 

The dissimilar treatment reflects the differences in property-casualty and life contracts. Unlike property-casualty 

contracts, life and annuity agreements are long term, 

making it difficult for life companies to recover guaranty 

fund assessments through policy rate increases. 

The effect of state premium tax offsets is to shift the 

cost of life insolvencies to taxpayers. James Barrese and 

Jack M. Nelson have calculated that for life companies, 

approximately 79 percent of the guaranty fund assessment 

is borne by state taxpayers and 7 percent by federal taxpayers; 14 percent is allocated by insurers to policyholders, 

equity holders, and employees.’ 

The Capacity of Life Guaranty Funds 

Table 7 lists the life/health guaranty fund assessments 

and capacity in 1990. According to NOLHGA, nationwide 

68 
Table 7 

Life/Health Guaranty Funds in 1990: Assessments and Capacity 

Estimated Assessments Estimated Assessments 

Net Maximum Assessable 1990 as a Percent Capacity as a Percent of 

State Assessments Rate Premiums Capacity of Capacity at 2% Capacity at 2% 

Alabama 

Alaska 

Arizona 

Arkansas 

California 

Connecticut 

Delaware 

Florida 

Georgia 

Hawaii 

Idaho 

Illinois 

Indiana 

Iowa 

Kansas 

Kentucky 

Maine 

Maryland 

Massachusetts 

Michigan 

Minnesota 

Mississippi 

Missouri 

Montana 

Nebraska 

Nevada 

New Hampshire 

New Mexico 

New York 

North Carolina 

North Dakota 

Ohio 

Oklahoma 

Oregon 

Pennsylvania 

Puerto Rim 

Rhode Island 

South Carolina 

South Dakota 

Tennessee 

Texas 

Utah 

Vermont 

Virginia 

Washington 

West Virginia 

Wisconsin 

Wyoming 

Total 

60,000 

0 

46,001,000 

165,300 

0 

159,300 

0 

11,146,000 

0 

0 

0 

(16,715,140) 

1,800,000 

546,840 

1,823,842 

1,994,790 

0 

252,122 

520,000 

112,585,000 

(892,000) 

5,607,450 

3,941,000 

8,793,502 

399,000 

1,101,250 

0 

145,700 

0 

(505,377) 

176,500 

3,738,800 

5,513,027 

10,983,614 

0 

0 

2,500 

0 

0 

500,000 

61,852,195 

343,891 

0 

194,746 

45,200 

0 

(6,164,538) 

0 

256,115,514 

1.0% 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

1.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

20 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

4.0 

2.0 

2.0 

4.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

3.0 

4.0 

2.0 

2.0 

1.0 

20 

2.0 

2.0 

2.0 

2.0 

2.0 

2.0 

2,201,405,671 

362,640,745 

2,186,005,402 

1,336,408,772 

17,457,965,401 

3,455,424,390 

732,935,946 

9,949,287,740 

4,332,929,989 

646,970,256 

462,858,665 

10,667,609,569 

4,845,178,850 

1,820,947,754 

1,542,600,473 

2,256,577,033 

743,270,259 

3,079,131,342 

4,155,827,366 

6,899,225,732 

2,930,613,000 

1,254,022,73 1 

4,128,269,062 

646,558,246 

1,s 18,533,408 

643,805,162 

709,529,642 

1,089,399,940 

14,347,863,722 

5,054,063,658 

452,751,366 

9,049,285,568 

1,798,375,842 

1,903,301,989 

8,347,170,576 

460,960,061 

55 1,116,9 17 

2,088,976,303 

572,575,659 

2,998,028,666 

12,373,281,185 

981,641,206 

344,065,042 

4,700,909,000 

2,785,953,345 

1,142,211,000 

3,528,115,667 

298,136,057 

165,834,735,375 

22,014,057 

7,252,815 

43,720,108 

26,728,175 

349,159,308 

69,108,488 

14,658,719 

99,492,877 

86,658,600 

12,939,405 

9,257,173 

213,352,191 

96,903,577 

36,418,955 

30,852,009 

45,13 1,541 

14,865,405 

61,582,627 

83,116,547 

137,984,s 15 

58,612,260 

25,080,455 

82,565,381 

12,931,165 

30,371,068 

12,876,103 

28,381,186 

21,787,999 

286,957,274 

202,162,546 

9,055,027 

180,985,711 

35,967,517 

38,066,040 

166,943,412 

9,219,201 

16,533,508 

83,559,052 

11,451,513 

59,960,573 

123,732,812 

19,632,824 

6,881,301 

94,018,180 

55,719,067 

22,844,220 

70,562,313 

5,962,721 

3,234,017,523 

0.3% 

0.0 

105.2 

0.6 

0.0 

0.2 

0.0 

11.2 

0.0 

0.0 

0.0 

-7.8 

1.9 

1.5 

5.9 

4.4 

0.0 

0.4 

0.6 

81.6 

-1.5 

22.4 

4.8 

68.0 

1.3 

8.6 

0.0 

0.7 

0.0 

-0.2 

1.9 

2.1 

15.3 

28.9 

0.0 

0.0 

0.0 

0.0 

0.0 

0.8 

50.0 

1.8 

0.0 

0.2 

0.1 

0.0 

-8.7 

0.0 

7.9 

44,028,113 

7,252,815 

43,720,108 

26,728,175 

349,159,308 

69,108,488 

14,658,719 

198,985,755 

86,658,600 

12,939,405 

9,257,173 

213,352,191 

96,903,577 

36,418,955 

30,852,009 

45,131,541 

14,865,405 

61,582,627 

83,116,547 

137,984,515 

58,612,260 

25,080,455 

82,565,381 

12,93 1,165 

30,371,068 

12,876,103 

28,381,186 

21,787,999 

286,957,274 

202,162,546 

9,055,027 

180,985,711 

35,967,517 

38,066,040 

166,943,412 

9,219,201 

16,533,508 

83,559,052 

11,451,513 

59,960,573 

247,465,624 

19,632,824 

6,881,30 1 

94,O 18,180 

55,719,067 

22,844,220 

70,562,313 

5,962,721 

3,479,257,269 

0.1% 

0.0 

105.2 

0.6 

0.0 

0.2 

0.0 

5.6 

0.0 

0.0 

0.0 

-7.8 

1.9 

1.5 

5.9 

4.4 

0.0 

0.4 

0.6 

81.6 

-1.5 

22.4 

4.8 

68.0 

1.3 

8.6 

0.0 

0.7 

0.0 

-0.2 

1.9 

2.1 

15.3 

28.9 

0.0 

0.0 

0.0 

0.0 

0.0 

0.8 

25.0 

1.8 

0.0 

0.2 

0.1 

0.0 

-8.7 

0.0 

7.4 

Source: NOLGHA and NAIC. 

69 
assessment capacity for life insurance and annuities was 

$2.68 billion in 1990 ($1.9 billion for life insurance and 

$784 million for annuities).8 Historically, net lifethealth 

assessments have been low. For example, from 1975 to 

1982, those assessments averaged $6.2 million a year. Recently, however, assessments increased dramatically, tripling from $154.8 million in 1990 to $469.7 million in 1991. 

Although the latter figure represents only 14.4 percent of 

1990 capacity, assessments made in 1991 for the Executive 

Life of California failure are preliminary and could reach 

$400 million per year over five years? Moreover, nationwide capacity figures tell only part of the story. In 1990, 

individual state assessment capacity ranged from $2.1 million in Vermont to $114.7 million in New Yorkfor life premiums and from $1.4 million in Wyoming to $91.3 million 

in Illinois for annuity considerations.’O 

As noted previously, states have at least four options 

to increase the capacity of the guaranty funds. First, all 

states could increase their assessment limits to at least 2 

percent, thereby increasing the nationwide capacity of 

life/health guaranty funds by 7.6 percent,” or beyond 2 

percent. Second, states could reduce coverage, for example, by excluding coverage for unallocated annuities or 

restricting payments to all policyholders. For example, 

California’s new lifelhealth guaranty fund covers the lesser of 80 percent of the contractual obligation or $250,000 

(life)/$lOO,OOO (annuities). Third, states could adopt aprefunded guaranty fund program. Such a prefunded program would not only increase the capacity of the guaranty 

system but also would introduce some market discipline 

into the system. Under a fourth option, state guaranty 

funds would jointly establish a reinsurance or excess insurance mechanism.12 The third and fourth options would 

involve joint action. 

Notes 

’ The funds also protect policyholders of failed health insurers, 

a subject not included in this report. 

See US. General Accounting Office (GAO), Insurer Failures: 

LifetHealth Insurer Insolvencies and Limitations of State Guar- anty Funds (Washington, DC, March, 1992, p. 27. 

Ibid. 

The remaining states have either no statutory provisions or 

ambiguous provisions. 

Summary is from Joseph M. Belth, The Insurance Forum, April 

1990. 

Robert Klein, “Issues Concerning Insurance Guaranty 

Funds,” p. 33. As of September 1990, Washington DC was the 

only jurisdiction that did not offer any life guaranty fund cov- erage. The American Council of Life Insurance notes that 

only five jurisdictions do not include the reciprocal provision. 

Letter from Edward J. Zimmerman, September 2, 1992. ’ “Distributing the Cost of Protecting Life-Health Insurance 

Consumers,” Statement of James Barrese and Jack M. Nelson 

before the US. Senate, Committee on the Judiciary, Subcommittee on Antitrust, Monopolies, and Business Rights, April 

28, 1992. 

Letter from Edward J. Zimmerman, American Council of 

Life Insurance, September 2,1992. 

Klein, “Issues Concerning Insurance Guaranty Funds.” 

lo GAO, Insurer Failures, pp. 46-47. 

l1 Klein, “Issues Concerning Insurance Guaranty Funds.” 

l2 Jbid. 

70 
Part 111 

Proposed and Alternative Solutions 

71 
72 
Improving State Regulation 

Parts I and I1 of this report identified and described 

several areas in state solvency regulation and liquidation 

and guaranty fund laws that could be improved. 

For state solvency regulation, these areas include: 

The lack of uniformity of accountingprinciples for fmancia1 reporting; 

Accounting for reinsurance in a manner that mayprovide 

an inaccuratepicture of an insurer's true financial con- dition; 

The failure to regulate alien reinsurers effectively; 

Minimum capital and su~lus mquirements that are too low 

and unrelated to the risk assumed by a company; 

The use of fronting and managing general agents by 

property-casualty insurers to circumvent state licensure and regulatory requirements; 

A significant time lag in examination of insurance 

companies; 

The failure to initiate formal proceedings after discovery 

that an insurer is operating in a perilous financial condition, thus increasing the costs to consumers and taxpayers of the eventual demise of the company; 

The use of uncodified accounting requirements and reporting requirements as regulatory tools in lieu of model 

laws and regulations (e.g., NATC has failed to adopt a 

model law restricting the use of financial reinsurance 

by property-casualty insurers, relying instead on accounting and reporting requirements); 

The failure to effectively regulate transactions between 

insurers and their parent and among insurers and their 

affiliates; 

10) The failure to adopt meaningfit1 investment standards for 

life insurance companies; and 

11) The failure to enact effective regulation of assumption reinsurance, whereby an insurer cedes business to a reinsurer (without the approval of the policyholder) 

who agrees to assume all liability for the business. 

Areas in which state liquidation and guaranty fund 

laws could be improved include: 

12) The treatment of reinsurers under state law asplayers in 

need of special protection when a ceding insurer becomes 

insolvent. The effect of this special treatment is to reduce drastically the assets available for distribution to 

policyholders by allowing reinsurers to: 

a) Rescind their contracts with insolvent insurers 

when the reinsurers can prove a material misrepresentation; 

b) Offset (without meaningful limitation) amounts 

due from an insolvent insurer against the amount 

the reinsurer owes as reimbursement for the liabilities of the insolvent insurer; and 

c) Use cut-through clauses granting some policy- holders special treatment by allowing them to receive payments directly from the reinsurer without complying with state liquidation procedures. 

13) Clashes between federal and state law that diminish the 

amount of reinsurance proceeds available for policy hold - ers. The federal priority statute allows the federal 

government in its status as policyholder and/or tax 

collector to take first priority, despite state laws to the 

contrary, in state liquidation proceedings. The federal arbitration statute allows reinsurers to bring their 

disputes over coverage to a private forum outside of 

the state liquidation proceedings. 

14) A lack of unifomu'ty among state liquidation laws, leading 

to conflicts among states and gaps in coverage. 

73 
15) The failure to introduce market discipline into stateguaranty fund plans by disallowing or limiting guaranty 

fund coverage for high-net-worth policyholders and 

adopting a fully or partially prefunded guaranty fund 

plan. 

16) The failure to disclose to thepublic that insurers may recover their guaranty find assessments by state tax offsets and/or policyholder surcharges and publicizing 

the effects of such recoveries on state revenues and/ 

or the price of insurance, respectively. 

17) The failure to adopt measures to mitigate the negative effects of the use of a tem'toriulity (or host state) concept in 

the administration of state guaranty finds, whereby responsibility for payment of claims rests with the state 

of residence of the policyholder or claimant. The negative effects of the use of this concept include: 

a) The existence of concurrent guaranty fund pro- ceedings in each state in which a policyholder or 

claimant resides; 

b) Disagreements among state guaranty funds as to 

which fund must pay a particular claim; 

c) The regulatory failures of the domiciliary state 

(the primary regulator) being paid for by host 

states, reducing the incentive for domiciliary 

states to regulate effectively; and 

d) Multistate policyholders forum shopping by 

bringing their claims to the state guaranty fund 

that offers the broadest coverage. 

18) The failure to adopt measures to increase the capacity of 

state guaranty finds. Options to increase the capacity . 

of state guaranty funds include: 

a) All states could increase their assessment limits 

to at least 2 percent or beyond 2 percent, thereby 

increasing nationwide capacity. 

b) States could reduce guaranty fund coverage by, 

for example, restricting payments to all policyholders to 80 percent of state maximums, or excluding/limiting coverage for large corporations. 

c) States could adopt a prefunded guaranty fund pro- gram. Such a prefunded program would increase 

the capacity of the guaranty system and would introduce some market discipline into the system. 

d) State guaranty funds could jointly establish a re- insurance or excess insurance mechanism. 

The following chapters describe and evaluate proposed solutions. 

74 
10 

State Efforts to Strengthen 

Solvency Regulation 

The National Association of Insurance Commissioners (NAIC) has a wealth of experience in working with 

states to increase the uniformity and efficiency of insurance regulation. NAIC has developed more than 200 

model laws and regulations. Until recently, many states 

did not adopt the models. However, the new NAIC accreditation program, described below, makes adoption of 

certain model laws mandatory. The organization also collects data on insurers, updates the uniform Annual Statement on which insurers report their financial data, and 

monitors the financial health of companies. This chapter 

describes and evaluates NAIC’s efforts to strengthen 

state solvency regulation. 

NAIC’S EARLY WARNING SYSTEM 

NAIC has attempted to fill the information void that 

arises from state-by-state regulation by conducting sol- vency analyses of multistate insurers and making the results available to all states. NAIC’s Insurance Regulatory 

Information System (IRIS) uses a system of financial ratios to identify potentially troubled companies so that 

regulators in states where these companies do business 

can resolve problems before they lead to insolvency. As of 

March 1992, 31 states mandated insurer participation in 

IRIS.’ The IRIS system uses 11 audit ratios to test the 

health of insurers. Insurers that fail four or more of the 

ratios are targeted for regulatory scrutiny. The ratios 

tested and the scores that result in failure for propertycasualty companies are: 

1. Net premium written divided by surplus (fail if 

the result is greater than 300 percent), 

2. Change in net written premium (fail if result is 

greater than 33 percent or less than -33 percent), 

3. Surplus aid divided by surplus (fail if result is 

greater than 25 percent), 

Two-year adjusted underwriting ratio (fail if result is greater than 100 percent), 

Net investment income divided by average invested 

assets (fail if result is greater than 5 percent), 

Change in surplus ratio (fail if result is greater 

than -10 percent or greater than 50 percent), 

Liabilities divided by liquid assets (fail if result is 

greater then 105 percent), 

Agents’ balances divided by surplus (fail if result 

is greater than 40 percent), 

9. One-year reserve development divided by surplus (fail if result is greater than 25 percent), 

10. Two-year reserve development divided by surplus 

(fail if result is greater than 25 percent), 

11. Estimated current reserve deficiency divided by 

surplus (fail if result is greater than 25 percent). 

NAIC sends a list of all companies that fail four or 

more of these tests to every state insurance regulator, 

along with the association’s recommendation for either 

no action or immediate regulatory attention. 

NAIC’s early warning system has been sharply criticized. Observers note that the capital and surplus of many 

insurers is probably overstated because loss reserves are 

understated and because a significant amount of reinsurance receivables will never be collected. For example, the 

U.S. General Accounting Office (GAO) cites one industry analyst’s estimate that as much as $20 billion in rein4. 

5. 

6. 

7. 

8. 

75 
surance, equivalent to 17 percent of the property-casualty 

industry’s 1988 surplus, may never be collected? James 

Barrese has summarized other criticisms as follows: 

. . . the problems of the IRIS ratio tests include 

their padfail nature, the fact that they are 

equally weighted in importance, and their dependence on surplus (which is easily manipulated). . . . If a firm is a borderline pass in all 11 tests, it may 

never be subject to scrutiny; it does not matter 

how poorly the company performed on any particular test. Moreover, the tests are internally inconsistent; if a firm’s surplus increases by over 50 

percent it fails one test. Since each test is equally 

weighted, the relative importance of failing the 

change in surplus test is exactly the same as having a ratio of net investment income to average 

invested assets of -200 percent. Yet, there is no 

reason to expect that the two ratios are equally 

correlated with financial difficulty, or that they 

work in the same direction. A final criticism is 

that there is a heavy dependence on surplus 

(seven of the 11 tests are computed using surplus), 

and surplus is easily manipulated within statutory 

accounting rules.3 

NAIC has initiated a project to test the effectiveness 

of its IRIS ratios. The Solvency Surveillance Research 

Project will test IRIS against alternative models using statistical techniques. NAIC has set March 1993 as the due 

date for its final results on the property-casualty section of 

the research and June 1993 as the due date for its report 

on life/health research. 

NAIC’S ACCREDJTATION PROGRAM 

NAIC has high hopes that its accreditation program, 

adopted in 1990, will accelerate state acceptance of at 

least those model laws that the association deems critical 

to financial regulation. The purpose of the accreditation 

program is to establish a consistent nationwide system of 

solvency regulation. To become accredited, a state must 

comply with NAIC’s financial regulation standards. As of 

September 1992, 13 states have become accredited. 

An accreditation team, made up of persons knowledgeable about insurance and not associated with (nor 

having represented insurers in matters before) the state 

insurance department under review, tests compliance 

with NAIC’s standards by reviewing a state insurance 

department’s laws and regulations, past examination reports, and organizational and personnel policies, and assessing the department’s levels of reporting and supervisory review. NAIC has identified 16 model laws and 

regulations that a state must adopt before becoming accredited. The accreditation team reports its findings as to 

state compliance to a NAIC committee of state insurance 

commissioners. (Appendix B contains a description of the 

accreditation program.) 

Beginning in January 1994, NAIC plans to ask accredited states to penalize states that do not become accredited. For example, an accredited state would not accept 

examination reports on insurers domiciled in nonaccredited states. It is thought that insurers in unaccredited 

states would find such a requirement burdensome because they would potentially be subject to examination in 

every state in which they did business. 

Unfortunately, such a penalty may be more burdensome for states than for insurers. Most state insurance 

regulators complain of chronic budgetary and staffing 

problems that make it impossible for them to monitor 

even domiciliary companies on a regular basis. An increase in supervisory duties over nondomiciliary companies may stretch state resources to the breaking point. If, 

however, accredited states would share the task of examining insurers domiciled in nonaccredited states, with 

perhaps the largest of the accredited departments conducting most of the exams and sharing the results with all 

other accredited states, the penalty might be viable. 

GAO criticisms of NAIC’s accreditation program include the following: 

1) The financial regulation standards are “gen- eral and have been interpreted permissively 

by accreditation review teams.” For example, 

states with weak regulatory authorities have 

been accredited, and, in numerous instances, 

accreditation teams found apparent compliance deficiencies but certified compliance 

2) The program has “too little focus on state in- surance departments’ implementation” of 

accreditation standards. For example, “accreditation teams are not required to assess 

insurance departments’ use of many required legal or regulatory authorities.” 

3) The “review teams’ documentation of their 

accreditation decisions did not consistently 

support their compliance decision^."^ 

Although the failure of regulatory agencies to comply 

with established formal rules is serious, it is not limited to 

state agencies. For example, GAO has on numerous occa- sions expressed similar concerns in connection with federal bank regulators. Most recently, GAO warned that national bank examiners were being asked to interpret 

national bank laws loosely to deemphasize current market 

conditions in evaluating real estate loans. In his recenl 

testimony before the House Committee on Banking, Finance, and Urban Affairs, Charles Bowsher, Comptrollei 

General of the United States, questioned the inconsisten. 

cy between the actions of federal regulators and the recently passed bank reform legi~lation.~ 

In addition to the shortcomings noted by GAO, 

NAIC’s accreditation program suffers from other problems in connection with the required model laws. For 

example, the model laws on reinsurance do not address 

many of the serious problems with reinsurance described 

in this report. Equally serious, as described in Chapter 3, 

the required model law on holding company systems contains several loopholes that could allow a parent holding 

company to shift assets among its subsidiaries, obscuring 

the true net worth of insurer subsidiaries in a manner 

. as acceptable. 

76 
similar to the abusive interaffiliate transactions that were 

implicated in the downfall of Baldwin-United and Executive Life of California. Moreover, NAIC’s proposal for improving state guaranty funds does not address any of the 

market and regulatory disincentives in the current system. 

The latter issue is descriid in the following sections. 

ANALYSIS OF PROPOSALS 

FOR IMPROVING STATE LIQUIDATION 

PROCEDURES AND GUARANTY FUNDS 

State compliance with NAIC’s accreditation process 

might soften some of the wasteful effects of state-by-state 

liquidation procedures and guaranty fund payments. For 

example, standard number 4 requires states to have a law 

authorizing the insurance department to order a company 

to take necessary corrective action or cease and desist 

certain hazardouspractices. Standards 10,12, and 13 compel states to prescribe minimum standards for the establishment of liabilities and reserves, require annual audits 

of domestic companies by independent certified public 

accountants, and require an actuarial opinion on the adequacy of reserves, respectively. Yet, as to guaranty funds, 

the NAIC program provides merely that state laws should 

provide for a statutory mechanism similar to NAIC’s 

model law, which will ensure payment of policyholder 

obligations when a company is deemed insolvent. The 

standard does not designate the provisions of the model 

guaranty fund law that states must adopt in order to become aqredited. Given the vague nature of the standards, even 100 percent compliance with NAIC’s guidelines would not eliminate significant variances among 

state liquidation procedures and guaranty funds. 

Moreover, NAIC’s accreditation program does not 

address any of the following issues that impact state liquidation procedures and guaranty funds: reinsurance set 

offs, forum shopping, coverage of high net-worth insureds 

and products, and the market and regulatory disincentives 

in the current system of guaranty fund payments. The 

latter two issues could be addressed effectively by requiring all insurers to participate in a prefunded plan. Such a 

plan would alleviate concerns about the capacity of 

post-assessment guaranty funds to cover the increasing 

number of large insolvencies. 

Prefunded State Guaranty Funds 

Many commentators note that the exclusive reliance 

on post-assessment guaranty funds reduces market discipline and subsidizes the riskiest firms. Curiously, although several commentators have suggested plans for 

prefunded catastrophic guaranty funds,.all such suggestions have been found wanting by the insurance industry. 

The proposals range from: 

A state-chartered mutual reinsurance company 

from which all licensed insurers in a state must 

purchase insolvency reinsurance that would provide a backup fund to cover claims that exceeded 

a guaranty fund’s assessment limit (Nationwide 

Insurance Company proposal); 

2) Abackup trust fund prefunded by policyholder sur- charges (Hartford Insurance Company proposal); 

3) A Solvency and Financial Enforcement Trust 

(SAFE-T) account held by an independent custodian (State Farm Insurance Companies proposal); 

and 

4) A prefunded interstate compact. 

Any of these proposals would help alleviate the guaranty fund capacity problem. 

The first proposal has the added benefit of increasing 

insurer accountability by allowing for risk-based premiums. Although some insurers maintain that an equitable design of risk-based premiums would be nearly impossible to achieve and administer, others believe that it is 

possible to design such a system based on NAIC’s forthcoming risk-based capital standard. In contrast, the second proposal would decrease insurer responsibility by 

shifting the funding to policyholders for both prefunded 

and post-assessment plans. 

The third plan (the SAFE-T account) would require 

property-casualty insurers to maintain sufficient marketable securities to meet loss and loss adjustment reserves 

obligations determined at the end of the prior year. This 

plan would allow insurers to trade marketable securities 

in the account and to actively manage the portfolio. Withdrawals from the account would require prior approval of 

the insurance regulator, and insurers would be required 

to correct deficiencies in the account.6 Moreover, by basing the amount of assets required to be held in a security 

account on the company’s nationwide loss reserves, the 

plan mitigates some of the disincentives in the host-state 

concept. That is, under current state law, guaranty fund 

assessments are made in the states in which the policyholders of the insolvent company reside, even though 

these host states were not the primary regulators of the 

company. The host-state concept spares the domiciliary 

state from the full effect of the insolvency, reducing the 

domiciliary state’s incentive to regulate effectively. The 

State Farm plan would moderate this effect. The fourth 

plan, an interstate compact, could be used to resolve many 

of the wasteful effects of state-by-state guaranty funds 

and could incorporate some of the best features of the 

other plans for prefunding. 

Insurer objections to prefunded plans include the loss 

of tax offsets, fears that the funds accumulated would be 

appropriated by states for other purposes, and concerns 

that a preexisting fund would create an incentive for lax 

state regulation. The latter two fears do not appear to 

impose serious obstacles. Several proposals are designed 

to thwart state appropriation, and there is no reason to 

suspect that a prefunded plan contains any greater incentives for lax state regulation than does the present system. 

In fact, the primary impediments to the adoption of a 

prefunded plan appear to be the loss of premium tax 

credits and the loss of federal tax deductions for guaranty 

fund assessments. 

As descnied in this report, the amount of these state 

and federal tax offsets is very significant. The loss of some 

tax offsets (only for the prefunded portion of guaranty fund 

77 
plans) should not deter states from implementing a prefunded catastrophic fund, however. The alternative to responsible state regulation is, ultimately, federal intervention 

and the virtual certainty of a federal prefunded plan. Under 

federal regulation, states would continue to collect their 

premium taxes, but likely would not offer insurers a premium tax offset for payments into a federal guaranty fund. 

Because a prefunded guaranty fund plan (with or 

without risk-based premiums) would be effective only if a 

majority of states participated, such a plan may be im- plemented best through an interstate compact as de- scribed in the following chapter. 

Note- 

’ American Council of Life Insurance, Status Report on Implementation of the Recommendations of the ACLI Task Force on 

Solvency Concems, March 27, 1992. 

U.S. General Accounting Office (GAO), Insumnce Regulation: State Reinsurance Oversiglit Incremed, but Problems Re- main (Washington, DC, May 1990). 

James Barrese, “Assessing the Financial Condition of Insurers,” March 1990. 

GAO, Insurance Regulation: The Financial Regulation Standards and Accreditation Program of the National Association of 

Insurance Commissioners (Washington, DC, April 9, 1992). 

“Observations on the National Bank and Thrift Examiners’ 

Conference,” Statement of Charles A. Bowsher, Comptroller 

General of the United States before the U.S. House of Repre- sentatives, Committee on Banking, Finance and Urban Af- fairs (Washington, DC U.S. General Accounting Office, Jan- uary 3, 1992). 

Philip R. O’Connor and Zack Stamp, The Next Step in State 

Solvency Regulation: The Solvency and Financial Enforcement 

Trust (SAFE-T) Account, June 1992. 

78 
Cooperative State Regulation 

through an Interstate Compact 

Two areas in which state regulation could be improved would be difficult to solve on an individual state 

basis: state regulation of insurance holding companies 

and state administration of insurer liquidations, including 

guaranty fund payments to policyholders and claimants. 

The problems could be handled by increasing either the 

power of the federal government or cooperation among 

states. Many commentators argue for the first solution, 

noting that the inability of states to regulate the interstate 

insurance market on their own compels the creation of a 

centralized federal agency with nationwide jurisdiction 

and broad preemptive powers. 

Critics of centralization note that the current system 

of state regulation has by and large worked well, despite 

some recent large insolvencies. These critics cite the S&L 

debacle as a stunning example of the failures of centralization. In contrast to the losses from S&L failures, which 

current estimates place at from $200 billion to $500 billion 

without counting interest, losses in the insurance industry 

stand at less than $15 billion during the past 10years. On a 

more general level, opponents of centralization point to 

the need for strong, competent state governments in an 

increasingly complex regulatory environment and warn 

against turning states into “mere administrative divisions 

of the central government.”’ 

This chapter examines cooperative administration of 

state liquidations and guaranty fund laws through the use 

of an interstate compact. 

THE COMPACT CLAUSE 

Article I, section 10 of the U.S. Constitution provides 

that “No state shall, without the consent of Congress. . . enter into agreement or compact with another state or 

with a foreign power. . . .” Little legislative history exists to 

explain which agreements or compacts require congressional consent or how the Congress would signify its consent if it were deemed necessary. In the years immediately 

following the adoption of the Constitution, states used 

interstate compacts primarily to settle boundary disputes. 

Between 1789 and 1900, states entered into 21 such compacts2 Typically, these boundary-dispute compacts involved only two states, and none of the early compacts 

created a permanent administrative agency. 

In 1925, two influential legal scholars, Felix Frankfurter and James M. Landis, had published in the Yale Law 

Journal an article entitled “The Compact Clause-A 

Study in Interstate Adjustments,’’ which urged the use of 

interstate compacts for purposes broader than boundary 

disputes. The authors noted that “the combined legislative powers of Congress and the several States [combined 

in compacts] permit a wide range of permutations and 

combinations for governmental action.”3 This article led 

other groups, such as the Chamber of Commerce of the 

United States, and the National Governors’ Conference 

to advocate an expansive use of interstate compact^.^ 

As the use of interstate compacts became more commonplace, suits challenging this method of state cooperation increased. Many of the early suits involved interpretation of the phrase “agreements and compacts” and 

delineation of when congressional consent was needed. 

For example, in Holmes v. Jennison,’ the US. Supreme 

Court considered the validity of a Vermont law under 

which the governor sought to extradite an individual to 

Canada. Chief Justice Rogernney found that the extradition statute was an unconstitutional “agreement or compact” with a foreign power. Later, the Court took a less 

absolutist view of the compact clause. In Erginia v. TennesI 

79 
see,6 the Supreme Court considered an agreement between Virginia and Tennessee that settled a boundary 

dispute between the two states. Justice Stephen J. Field, 

writing for the Court, adopted a less literal reading of the 

compact clause and declared that not all agreements between states were compacts within the meaning of Article 1, 

section 10. In dicta, the Court went on to note that express 

congressional consent was not always required, even when a 

true compact was involved. Instead, such consent could be 

inferred from subsequent congressional actions, in this case 

congressional assumption that the agreed-on boundary line 

was correct. The Court also announced the so-called “political balance” doctrine, declaring that congressional consent 

was required for interstate compacts only if they “increase[d] . . . the political power or influence of the states 

affected and thus encroached . . . upon the full and free 

exercise of Federal a~thority.”~ 

Another important test of interstate compacts came 

in 1950 in the case of West Erginia exrel. Llyer et al. v. Sirns.” 

Dyer v. Sirns arose out of the refusal by the West Virginia 

state auditor to pay the state’s share of the expenses of a 

congressionally approved, eight-state compact to control 

pollution in the Ohio River system. The West Virginia 

Supreme Court had found that the state legislation, which 

delegated certain powers to an administrative agency 

created by the compact, was unlawful. On appeal, the U.S. 

Supreme Court held that a state may delegate the power 

to make rules and decide particular cases to an agency 

established by interstate compact as well as to a regular 

state agency. According to the Court, such a delegation is 

no more than a “conventional grant of legislative power.’* 

This case is also cited for the proposition that interstate 

compacts have “‘super’ status . . . in the hierarchy of the 

laws of the adopting state.”” Once enacted as a valid 

compact, the agreement “cannot be amended, altered or 

repealed [by subsequent state legislation] except in accordance with the terms of the compact itself.”” 

The most recent Supreme Court decision construing 

the compact clause is a 1978 opinion upholding an interstate tax compact. One commentator has noted the close 

analogy between the compact upheld in US. Steel v. Multistate Tax Commission and proposed insurance regulation 

compacts.12 U.S. Steel challenged the interstate tax compact, claiming that it was invalid because it had never 

received congressional approval. The compact consisted 

of a uniform law for apportioning the income of a multistate corporation, set up a commission to oversee the 

operation of that law, and provided for an audit staff to 

determine the tax liability of multistate corporate taxpayers. In upholding the compact, the Supreme Court elaborated on its earlier political balance doctrine by announcing a two-part test to determine when a compact must 

have congressional consent: 

1. Does the compact authorize member states “to 

exercise any powers they could not exercise in its 

absence”? 

2. Is there “any delegation of sovereign power to 

the Commission”? 

If both of these questions are answered in the negative, the compact would not be deemed to require congressional consent. The Multistate .mX Compact met the 

tests because “on its face the Multistate Compact contains no provisions that would enhance the political power 

of the member States in a way that encroaches upon the 

supremacy of the United States. . . . This pact does not 

purport to authorize the member States to exercise any 

powers they could not exercise in its absence. Nor is there 

any delegation of sovereign power to the Commission; 

each State retains complete freedom to adopt or reject the 

rules and regulations of the Commission. Moreover, . . . each State is free to withdraw at any time.”13 

A recent article published in the Journal of Insurance 

Regulation by James Jackson has sparked renewed interest 

in the use of the interstate compact for interstate insurance regulation. Jackson noted that an insurance regulatory compact that meets the dictates of the above two-part 

test would not need congressional consent, and that even 

if states were to delegate some “sovereign powers” to an 

administrative agency created by the compact, specific 

congressional consent may not be required. In the McCurran-Ferguson Act, the Congress declared that “the continued regulation and taxation by the several States of the 

business of insurance is in the public interest, and that 

silence on the part of Congress shall not be construed to 

impose any burner to the regulation or taxation of such 

business by the several States.”14 In addition to Jackson, 

other commentators have contended that the McCurrun-Ferguson Act provides all the congressional consent 

necessary under the compact clause for the states to enter 

into cooperative agreement^.'^ 

STRENGTHS AND WEAKNESSES 

OF INTERSTATE COMPACTS 

AND CONDITIONS FOR SUCCESS 

Over the years, several studies have looked at specific 

interstate compacts and analyzed their strengths and weaknesses. The authors of these studies have noted the following general and specific merits of the interstate compact: 

Compacts permit the formulation of one pattern 

of law for a particular subject and bind the compacting states to the uniform law until changedby 

joint action.I6 

1. 

2. Compacts bridge jurisdictional gaps. 

3. Compacts increase the capacity of the states to 

handle a larger share of the total task of government.17 

Compacts strengthen the states and reduce expansion of power and scope of jurisdiction of the 

national government.’” 

In contrast, critics of the interstate compact cite the following weaknesses: 

1. The agencies created by compact are undemocratic and unrepresentative. This problem is 

made more serious by the fact that the agencies 

tend to be dominated by their staff.lg 

4. 

80 
2. The compact device has been used by private enterprise groups to prevent regulations that they 

perceive as inimical to their interests. Thus, 

while the compacts ostensibly protect the authority of the states over the activities of such private 

enterprise groups, actual power tends to remain 

in the hands of private interests.20 

Compacts seldom contain mechanisms for independent evaluation or audit to measure whether 

the administrative agency created by the compact 

is doing a good job.21 

Compacts are difficult to amend and therefore 

tend to be overly rigid.22 

Successful compacts (i.e., those that have made significant contributions to the solution of the problems they 

were designed to meet) are said to have the following 

common characteristics: 

3. 

4. 

1. The compact and its administrative agency were 

created in the realization that the only way to 

handle the issues in question was to establish a 

compact agency to do the 

2. The compact agency was not assigned powers 

that threatened existing powers within the states. 

The compact received support from various other agencies, including federal agencies. 

4. The compact agency’s actions were limited to 

those areas in which the states are individually ineffectual.24 

3. 

THE NCOIL PROPOSAL 

In November 1992, the National Conference of Insurance Legislators (NCOIL) issued its third “exposure 

draft” of an Interstate Insurance Protection Compact. 

NCOIL believes that an interstate compact would bring 

greater uniformity in state solvency and guaranty fund 

laws, thereby deflecting congressional moves for federal 

intervention. As envisioned by NCOIL, the compact 

would not require congressional consent prior to becoming effective. The compact would operate through a regulatory commission comprised of the commissioners of the 

compacting states (one member per state). Although 

created for the limited purposes of enhancing state systems for liquidating insolvent insurance companies, paying claims, and establishing uniform operating procedures 

for guaranty associations, the commission actually would 

have broad powers to: 

Promulgate statutes and regulations relating to 

guaranty associations and the conservation, rehabilitation, and liquidation of insurers; 

Act as receiver of insolvent insurers; 

Oversee and coordinate the activities and functions of the insurance guaranty associations; and 

1. 

2. 

3. 

4. Establish minimum standards for the regulation 

of the financial condition of insurers. 

The compact classifies states as either “high premium 

states” (the compacting states that comprise the 30 percent of the compacting states with the greatest insurance 

volume), “low premium states” (the compacting states 

that comprise the 30percent of compacting states with the 

least insurance premium volume), or “median premium 

states” (those compacting states that are not either highor low-premium states). Each compacting state would be 

allowed one so-called member vote and an additional 

so-called premium vote based on its premium volume. 

Commission acts would become law only after an affirmative vote of a majority of both the member votes and the 

premium votes. Laws adopted by the commission would 

become binding on the compacting states at the earlier of 

(1) approval by a majority of the compacting states or (2) at 

the end of the second full legislative session of all of the 

compacting states. A compacting state could, however, 

enact legislation specifically rejecting the commission 

law. In that case, the commission law would not become 

binding on the rejecting compacting state(^).^' 

An executive committee, elected by and from the 

commission, would manage the affairs of the commission, 

oversee and evaluate the implementation and administration of commission acts, and recommend laws. The compact would be financed by commission assessments on 

each insurer authorized to do insurance business in a 

compacting state. States could withdraw from the compact by enacting a statute specifically repealing the statute 

by which it entered the compact into law. 

Although many of the details of the compact are 

sketchy, having been delegated to the commission, a preliminary assessment is possible. First, although the compact gives the commission and a majority of states power 

to adopt binding legislation, it would allow single states to 

opt out of any such “binding” law. This provision may 

undercut the effectiveness of the compact. Second, the 

compact fails to distinguish between those situations in 

which uniformity is essential and those in which state law 

variances would not decrease the efficiency of liquidation 

procedures and guaranty fund payments. For example, 

some states may decide to limit guaranty fund coverage 

(e.g., by dollar amount and/or by a net worth test) in order 

to reduce the expense to their taxpayers and policyholders 

who ultimately bear the burden of guaranty fund payments. For similar reasons, other states may decide to 

limit reinsurance set offs, rescissions, and cut-through 

clauses in liquidations. 

Third, the draft compact fails to provide for public 

accountability. Although the draft calls for an independent audit of the commission’s functions as receiver, it 

requires that the auditor’s report be kept from public 

view. Moreover, the compact makes no provisions for any 

public report of the activities of the commission, public 

access to commission data on liquidations and guaranty 

fund payments, or for formalized public input into commission projects. Finally, the draft contains no incentives 

to encourage states to join. Thus, the compact as currently 

drafted would appear to have some significant defects 

81 
when measured under the criteria set forth above. 

accountability of the compact would include: 

banks) provide periodic reports on its activities and such 

other information as is required of domestic institutions. 

If the branch does not comply with the laws that the host 

Some changes that might increase the viability and 

1. 

2. 

3. 

4. 

A mechanism to distinguish between those situations in which uniformity is essential and those in 

which state law variances would not decrease the 

efficiency of liquidations and guaranty fund payments; 

The addition of guidelines for evaluating commission activities, an independent and publicly 

available audit of the commission’s activities, and 

a requirement that the commission issue an annual report of its activities to state legislatures; 

The inclusion of public representation in commission activities; and 

The addition of an incentive to encourage states 

to 

One incentive that would benefit states and insurance companies would be to link NAIC’s accreditation 

program with the compact and to allow accredited state 

insurance departments in compact states to do business in 

other accredited compact states with a single license from 

the domiciliary state. The use of a single license need not 

eliminate the ability of host states to regulate nondomiciliary insurers. 

For example, the European Community provides for 

such a single license issued by the domiciliary country for 

banks operating in EC countries, while retaining certain 

regulatory oversight by the host country. The Second 

Banking Directive of the European Community prohibits 

a host member state from requiring an EC-licensed bank 

to enter its market through a separately capitalized subsidiary, but it does not ban the host state from regulating 

some aspects of branch activities. In particular, the host 

state may adopt legal rules “in the interest of the general 

good.” The process to establish a branch within a host 

member state is as follows: 

1. The bank that wishes to establish a branch within 

the territory of another member state must notify 

the proper authorities of its home member state 

and provide certain information, including the 

types of business envisaged and the structural organization of the branch, the address in the host 

member state from which documents may be obtained, and the names of the persons responsible 

for the management of the branch. 

2. The authorities of the home member state must 

communicate the above information to the authorities of the host member state. 

3. The host member state then indicates the conditions under which, in the interest of the general 

good, the branch activities may be carried on. 

After the branch has been established, the host member state may require that it (along with all domestic 

member state has adopted“& the interest of the general 

good,” the host member state first reports the violation to 

the home-state authorities, which must take “all appropriate measures” to ensure that the institution concerned 

ceases the offending conduct. Continuing noncompliance 

may lead to the host member state itself punishing the 

branch, including preventing the institution from initiating any further transactions within its territory. 

Similar rules could be adopted for accredited states in 

an interstate compact. If the use of a single license is 

deemed too radical a departure from current practice, 

compact states could agree to an accelerated licensing 

procedure. 

Note- 

’ The phrase is from Felix Frankfurter and James M. Landis, 

“The Compact Clause of the Constitution-A Study in Inter- state Adjustments,” Yale Law Journal 34 (1925): 685, 687. 

Richard H. Leach and Redding S. Sugg, Jr., ”’lie Administra- tion of Interstate Compacts (Baton Rouge: Louisiana State 

University Press, 1959), p. 5. 

Frankfurter and Landis, “The Compact Clause of the Constitution-A Study in Interstate Adjustments,” pp. 685,688. 

Leach and Sugg, ”’lie Administration of Interstate Compacts, 

p. 10. ’ 39 US. 540 (1840). 

148 U.S. 503 (1893). 

148 US. 503, 520 (1893). 

341 U.S. 22 (1951). 

341 U.S. 31. 

See, e.g., James M. Jackson, “Commerce, Compacts and Con- gressional Consent: Federalism and State Insurance Regulation,”JournalofInsuranceRegdation 10 (1991): 23; and Dyer v. 

Sims, 341 U.S. at 28. 

l1 Jackson, “Commerce, Compacts and Congressional Consent,” p. 6. 

l2 Ibid. 

l3 434 U.S. 452,472-473 (1978). 

l4 Jackson, “Commerce, Compacts and Congressional Con- 

’’ See Frederick L Zimmerman, The Interstate Compact (Chical6 Ibid. 

l7 Leach and Sugg, The Administration of Interstate Compacts, 

Weldon V. Barton, Interstate Compacts in the Political Process 

(Chapel Hill: University of North Carolina Press, 1965), p. 165. 

l9 Leach and SUB, ”’lie Administration of Interstate Compacts, p. 

222. The National Conference of Insurance Legislators notes 

that this criticism could be made of any agency. Phone conver- sation with New York State Sen. Donald M. Halperin, August 

18, 1992. 

sent.” 

go: Council of State Governments, 195l), p. 70. 

p. 225. 

2o Barton, Interstate Compacts in the Political Process, p. 164. 

21 Marian E. Ridgeway, Interstate Compacts, A Question of Feder- alism (Carbondale, Illinois: Southern Illinois University Press, 

1971), p. 295. 

22 The National Conference of Insurance Legislators believes 

that they have solved this problem by keeping their draft inter82 
state compact general. Phone conversation with New York 

State Sen. Donald M. Halperin, August 18, 1992. 

23 Leach and Sugg, The Administration of Intentate Compacts, p. 

213-214. 

24 Ibid., p. 221. 

25 The National Conference of Insurance Legislators notes that 

compact laws are not “statutes.” That is, a governor’s signature is not required. 

26 The National Conference of Insurance Legislators believes 

that the fact that states will be relieved of the headache of setting 

up liquidation and guaranty fund procedures will be a significant 

incentive, particularly for small states. Further NCOIL believes 

that the existence of the compact may cause the federal government to retreat from preemption legislation, at least for 

compact states. Phone conversation with New York State Sen. 

Donald Halperin, August 18, 1992. 

83 
84 
12 

Proposals for Federal Oversight/Regulation 

Since the mid-l800s, insurers have frequently argued 

for federal rather than state regulation of the industry. 

Bills were introduced in the Congress in 1866 and 1868 to 

create a national bureau of insurance, in 1869 to create 

the position of national commissioner of insurance, and in 

1897 to declare that insurance companies doing business 

outside their state of incorporation were engaged in interstate commerce.' None of the bills passed, and two were 

never reported out of committee. These and later bills 

failed primarily because the Congress concluded that, 

given the ruling of the Supreme Court in Paul v. Virginia 

that insurance was not interstate commerce, it did not 

have the power to regulate insurance. 

By 1944, when the Supreme Court changed its interpretation and acknowledged that insurance was interstate 

commerce, the New Deal had ushered in an era of federal 

activism leading the industry to favor state over federal 

regulation. Fearing that federal regulation would result in 

a loss of state premium tax revenue, states joined with the 

industry to lobby Congress to pass the McCarran-Ferguson 

Act, which allowed states to maintain exclusive regulatory 

control over insurance. 

At various times since 1944, insurers have renewed 

their efforts to encourage Congress to enact a federal 

insurance regulatory scheme. The recent spate of large 

insurer insolvencies has led some insurers to seek federal 

regulation again. This chapter examines some of the current proposals, including one in the form of a report by a 

consulting firm, another in the form of a bill introduced in 

1991 by U.S. Sen. Howard M. Metzenbaum, and a third in 

the form of a bill introduced by U.S. Rep. John D. Dingell. 

It is unlikely that Congress could preempt state authority 

over insurance companies that operate in only one state. 

Therefore, all of these proposals for federal regulation 

would involve a dual regulatory scheme, whereby states 

would regulate local insurance companies and, in some 

cases, the local aspects of interstate insurers (such as consumer protection laws), while the federal government would 

regulate the interstate activities of multistate insurers. 

THE STEWART ECONOMICS PROPOSAL 

In 1990, Stewart Economics issued a report describing 

a national system of liquidation and guarantees for property-casualty companies.' The Stewart proposal would 

require Congress to create a National Insurance Guaranty Corporation (NIGC). NIGC would not be a regulatory 

agency; its only function would be to act as rehabilitator or 

liquidator of companies placed in receivership by state 

regulators. Like current state practice, NIGC would be 

funded by assessments on insurance companies, but, unlike current practice, some of those assessments would be 

made as advance fees and used to pay for the initial operating costs in rehabilitating and liquidating companies. 

Membership in NIGC would be voluntary, unless mandated 

by states as a condition of licensure. States would not be 

required to turn over their insolvent member insurers to 

NIGC, but NIGC guarantees would only be available in 

liquidations conducted by NIGC. States would retain exclusive responsibility for market and solvency regulation. 

The proposal suggests several incentives to encourage insurers, states, and policyholders to safeguard the 

financial solvency of insurers. For example, the prefunded 

portion of the national fund could be assessed according 

to the quality of insurer assets. Also, NIGC would have a 

financial analysis staff that could request a special state 

examination of a particular company and also have the 

ability to withdraw fund coverage from states that fail to 

take action against troubled companies. 

Other incentives would encourage agents and bro- kers and reinsurers to be more watchful of the financial 

health of insurers. In the former case, agents and brokers 

would be given lower guaranty fund payment priority for 

unpaid commissions; in the latter case, reinsurers would 

not be permitted to offset the premiums owed them by an 

85 
insolvent ceding company against the reinsurance they 

owe it on losses. 

The Stewart proposal has much to recommend it. For 

example, the plan’s incentives to encourage agents, bro- kers, and reinsurers to watch over the financial health of 

insurers and to reduce the liabilities of guaranty funds are 

crucial ingredients to the financial health of insurers. Yet, 

the proposal falls short in that it fails to address the real 

problems that states have in regulating multistate insur- ers. Moreover, by divorcing the regulatory function from 

the liquidation and guaranty fund function and by turning 

over governance to the industry, the proposal sets up a 

very unstable situation. 

It is unlikely that a national guaranty fund would 

continue to cover a state with strict rate regulation. Rate 

regulation is a sensitive issue for insurers, who maintain 

that it either doesn’t work (i.e., studies show that rates in 

unregulated states are very close to those in regulated 

states) or that it works to keep rates artificially low (removing the flexibility of insurers to change rates with 

changed conditions at best and playing a role in insurer 

insolvencies at worst). Some consumer groups disagree, 

contending that rate regulation is important as long as 

insurers remain exempt from antitrust laws. A large state 

like California that regulates rates is unlikely to choose to 

join a national guaranty fund that is governed by insurers. 

Other states that do not regulate rates would likely be unwilling to give up their authority to monitor rates and intervene if they deemed it necessary. States that fall in either of 

these two categories would therefore likely maintain their 

state liquidation staff and guaranty fund provisions. 

S. 1644: 

PROPOSAL OF SENATOR METZENBAUM 

In August 1991, Senator Metzenbaum introduced S. 

1644, known as the “Insurance Protection Act of 1991.” 

The bill would create a federal insurance regulatory commission made up of five members appointed by the President. The commission would have authority to certify 

state insurance departments. Without such federal certification, a state could not issue a license to engage in 

insurance in interstate commerce. In order to become 

certified or accredited, a state insurance department 

would have to adopt certain uniform minimum federal 

standards in several areas, including the following: capital 

and surplus, accounting practices and procedures, investment regulations, liabilities and reserves, independent 

CPA audits, qualified actuarial analysis, restrictions ownership and transfer of owners of insurers, restrictions on 

transfer of policies, consumer disclosure, consumer protection, and maintenance of adequate resources by state 

departments of insurance, such. as a federally mandated 

minimum number of examiners and actuaries. 

The commission would periodically examine state in- surance departments to assure their enforcement of and 

compliance with the federal standards. States that failed 

to comply could lose their accreditation, forcing insurers 

in the state to lose their licenses to do business in inter- state commerce. 

In addition to the insurance regulatory commission, 

the Metzenbaum bill would create several new entities. A 

national guaranty fund would cover all insurers operating 

in interstate commerce. The cost of the guaranty program 

would be funded by pre-insolvency assessments against 

member companies. A national guaranty corporation 

would serve as the exclusive liquidator for insurers operating in interstate commerce. The bill would also create 

an Office of Reinsurance Regulation, which would grant 

or revoke licenses to reinsurers, and a Securities Valuation Office, which would value and establish quality ratings for insurer assets. Finally, the bill would create a 

central depository for insurance data for the purpose of 

studying the insurance industry. 

Like the proposal by Stewart Economics, the Metzenbaum proposal has much to recommend it. In particular, 

the plan to conduct studies of the insurance industry, to 

make reports to the public, and to make annual and special reports to Congress has merit. It is hard to overstate 

the value of ongoing federal studies of pertinent insurance regulatory issues. Both the history of state insurance 

regulation and the recent flurry of activity with NAIC’s 

accreditation program show that states cooperate to 

strengthen solvency regulation when pressured by the 

threat of federal preemption. 

Other provisions may be less sound. For example, 

the provisions for extensive federal control of 

state-funded insurance departments is unprecedented 

in state-federal relations. 

H.R. 4900: 

PROPOSAL OF REPRESENTATIVE DINGELL 

On April 9,1992, Representative Dingell introduced 

H.R. 4900, a bill to “ensure the financial soundness and 

solvency of insurers.” H.R. 4900 would establish an independent federal regulatory agency, the Federal Insurance 

Solvency Commission (the commission), made up of five 

members appointed by the President. The commission’s 

duties would include establishing standards to ensure the 

solvency of insurers and reinsurers “in or affecting interstate 

or foreign commerce” and issuing federal certificates of 

solvency for those insurers that choose federal regulation. 

A domestic insurer choosing federal regulation 

would be required to meet certain federal standards, including the following: 

1. Minimum capital and surplus (the minimum may 

not exceed $500,000); 

2. Appropriate standards for investments, reserves, 

and asset valuations; 

3. Limitations on the use of and credit for reinsurance; 

4. Requirements governing transactions with managing general agents; 

5. Limitations on the amount of risk that may be retained on a single risk; 

6. Accounting standards that would promote strong 

and appropriate financial monitoring of insurers; 

7. Annual examinations by independent accountants; 

86 
8. Certification of loss reserves by certified actuaries; and 

Regulation of financial transactions within holding company systems. 

H.R. 4900 would establish separate standards for foreign 

insurers (insurers domiciled outside the United States). 

Aside from listing the areas in which federally certified insurers would have to comply with federal requirements, the bill does not describe the content of the standards, leaving that duty to the commission. Because the 

mandated standards are vague, it is not possible to compare the federal regulatory system proposed in H.R. 4900 

to the current state system. The standards in H.R. 4900 

appear to be similar to the accreditation standards of the 

National Association of Insurance Commissioners 

(NAIC), however. Thus, a federal system operated by the 

federal government would appear to have an advantage 

over the existing state system only in those areas in which 

legislatively mandated uniformity and centralization are 

essential. In such areas, the needed uniformity and centralization could be achieved either through federal regulation or through an interstate compact. 

Federally certified insurers designated “highly capitalized” by the commission that provide commercial insurance for a “large insurance buyer” would be exempt 

from all state regulation, including state laws governing 

unfair trade and claims practices. Because the bill would 

not create federal unfair claims standards, third-party 

claimants injured by the actions of a large commercial 

insurance buyer may have no avenue for redress through 

either a state or federal regulatory system. Other federally certified insurers would continue to be subject to state 

laws regulating 

9. 

Rates and policy forms; 

Unfair insurance trade practices or unfair claims 

settlement practices; 

Participation in an assigned risk plan or joint underwriting association; 

Filing copies of annual and quarterly financial 

statements; 

Payment of state premium and income taxes; 

Incorporation, organization, and corporate governance of insurance companies; and 

Registration with and designation of the state insurance regulator as its agent for service of process. 

Yet, because H.R. 4900 would give the commission 

broad authority to preempt all state laws, the ability of 

states to enforce the above laws is problematic. Sections 

102(7) and 206(c)(l) would grant the commission authority 

to determine whether a state law is preempted under the 

act. For example, section 2060x6) would authorize the commission to preempt a state law if it finds that the law would 

place an insurer in an unsafe or unsound financial condition. 

If it is unclear whether a particular state law falls within the 

206(b)(6) category, the commission could issue a regulation 

defining the state law as one preempted by the act. 

Insurers often argue that state rate regulation, a power ostensibly retained by the states under the Dingell bill, 

places them in an unsafe and unsound financial condition. 

Although some consumer groups disagree, sections 

206(c)(l) and 206@)(6) would allow the commission to 

eliminate state rate regulation for a federally certified 

insurer if the commission found that state rate regulation 

was detrimental to the financial condition of an insurer. In 

effect, these sections would give the commission power to 

eliminate all state rate regulation because states are unlikely to subject state-licensed insurers to rate regulation 

when one or more federally certified insurers are exempt. 

Insurers that are part of a holding company system 

would be subject to dual regulation. Transactions within a 

holding company system that includes a federally certified 

insurer or reinsurer would be subject to federal requirements. Section 406 would require that such transactions 

be “fair and reasonable,” and certain transactions involving 5 percent or more of the assets of the insurer or 

reinsurer would require prior approval. If the holding 

company system included one or more insurers that are 

not federally certified, the insurance commissioner of the 

domiciliary state could also prohibit or approve, subject to 

conditions, any acquisition, merger, or other transaction 

as provided under state law. 

As to the regulation of reinsurers, the commission 

would have the sole power to regulate so-called professional reinsurers.) Other providers of reinsurance could 

apply for a federal certificate if they met certain conditions, including a minimum net-worth requirement and 

the establishment of a trust fund. Although one section of 

the bill would allow states to continue to license reinsurers other than professional reinsurers, all reinsurers 

would have to obey federal standards because another 

section would permit primary insurers to receive credit for 

reinsurance only if they contract with reinsurers that have 

a federal certificate. 

In addition to the commission, H.R. 4900 would establish two private, nonprofit industry entities, the National Insurance Protection Corporation (NIPC) and the 

National Association of Registered Agents and Brokers 

(NARAB). NIPC would guarantee property-casualty 

(personal and commercial), life and health, and annuity 

insurance claims in the event of an insolvency. Claims 

made against certain lines of insurance, such as title insurance and surplus lines insurance, would not be guaranteed. Other limitations would cap coverage for high interest-rate life policies and annuity contracts and prohibit 

coverage for unallocated annuities protected under other 

federal programs. 

The priority scheme for distribution of assets from 

the insolvent insurer’s estate would place reinsurers 

claims for unpaid premiums (set offs) ahead of policyholders. Membership in NIPC would be mandatory for all 

federally certified insurers and voluntary for other insurers. Subject to supervision of the commission, NIPC 

would be prefunded by assessments on members based on 

their net direct written premiums. 

87 
NARAB would be authorized to regulate insurance 

agents and brokers. Membership in NARAB would be 

voluntary and would not be limited to agents and brokers 

engaged in interstate business. Although section 616(a) 

states that “all State laws, regulations, provisions, or actions purporting to regulate insurance producers shall 

remain in full force and effect,” members of NARAB 

would not in fact be subject to most state laws. Section 

616(b) would preempt all state laws that impose requirements on members of NARAB that differ from the uniform provisions issued by NARAB. Moreover, section 

616(c) would give NARAB itself the power to preempt 

state laws, subject to commission review. 

Like other proposed federal solutions, the Dingell 

bill would subject alien reinsurers to federal regulation 

and would set up a process for ongoing federal research 

on matters “that may affect the financial condition and 

solvency of the insurance industry in the United States.” 

Other aspects of H.R. 4900 may create an unstable regulatory regime. For example, the system of dual regulation of 

insurers and reinsurers that are members of a holding 

company could lead to a situation in which the federal 

commission and one or more state regulators disagree on 

the permissibility of a particular merger, with the insurer 

caught in the middle. Moreover, the provisions for continued state regulation of rates may fall as insurers argue that 

state rate regulation conflicts with the commission’s duty to 

ensure the financial health of the industry. Finally, the broad 

preemption authority that H.R. 4900 would grant the commission and the private industry entities created by the bill 

could render continued state regulation illusory. 

SUMMARY: 

STATE v. FEDERAL REGULATION OF INSURANCE 

The recent savings and loan crisis and continuing rash 

of bank failures serve as powerful reminders that federal 

oversight cannot eliminate or even moderate industry 

failures, whether those failures result from insufficient 

regulatory resources, lack of regulatory will, industry manipulation of the political process, or fraud. All were 

present in the recent crises in our depository institutions. 

For example, congressional action raising the ceiling on 

deposit insurance from $40,000 to $lOO,OOO per account in 

1980 is frequently cited as a significant contributing factor 

in the savings and loan scandals. Stories of intervention 

into the regulatory process by members of Congress in 

order to procure forbearance for favored constituents, 

thereby increasing the ultimate cost of insolvencies to 

taxpayers, have been front-page news for several years. 

Despite tough federal antifraud statutes and well trained 

federal examiners, fraud played a major role in the downfall of several savings and loan institutions. Critics, including the U.S. General Accounting Office (GAO), have 

warned that recent efforts by the administration to weaken bank legislation passed by Congress could lead to more 

bank failures. 

If, as recent events illustrate, federal solvency regulation is not intrinsically superior to state solvency regulation, then the choice among the three regulatory systems-state, federal, or dual statelfederal-should be 

made by first identifying the specific regulatory successes 

and failures of the current system and, second, analyzing 

regulatory options for resolving the failures. 

This report has described 18 weaknesses in the system 

of state regulation of insurance. Many of those weaknesses can be addressed adequately by individual state 

action. Indeed, several states have adopted model legislation andlor regulations issued by the National Association 

of Insurance Commissioners to resolve the weaknesses. 

The resolution of other problems in the current system 

may require collective state action. Effective regulation of 

insurance holding companies, uniform procedures for insurer liquidations and a uniform guaranty fund system fall 

into the latter category. 

All current proposals for federal regulation of insurance advance a dual system of regulation, whereby both 

state and federal governments play an active role. None of 

the proposals provides for a true statelfederal partnership, however. In fact, a true statelfederal partnership 

may be difficult to achieve with insurance regulation because solvency regulation (an area that some believe 

should be supervised by the federal government) is so 

intimately related to rate regulation (an area that is intrinsically local). Of course, the Congress could preempt all 

state rate regulation, but such an action would nullify the 

states’ role in a dual regulatory scheme: 

As part of their desire to maintain authority over 

insurance regulation, states must not only coordinate and 

strengthen their laws but also adopt policies to ensure that 

regulators avoid the appearance of impropriety in their 

dealings with industry representatives. A recent article in 

the Washington Post described the “tradition” of NAIC 

meeting host states to solicit funds from the industry for 

the purpose of providing entertainment and conference 

receptions and dinners.5 

Other conference traditions include the distribution 

of gifts to commissioners and hospitality suites in the 

conference hotel. Official NAIC policy regarding the propriety of such industry involvement in meetings has 

evolved over the years. Recently, the organization has 

taken several steps to assure that the level of industry 

participation is appropriate. For example, in response to 

concern expressed by some interested consumer groups 

that the cost of travel to NAIC meetings was too great for 

some consumer organizations to bear, NAIC established a 

unique fund to underwrite the travel expenses of consumer representatives. In addition, NAIC members voted 

recently to have the commissioners’ dinner (held at each 

NAIC meeting) paid for by NAIC rather than by the 

industry. 

State policies regarding the acceptance of such gifts 

range from no policy to a requirement that all gifts received from the regulated industry be disclosed to a designated state official (the so-called legislative model) to a 

prohibition against acceptance of gifts and benefits. The 

official policy of the Texas Department of Insurance is an 

example of the latter. The policy prohibits the commissioner, state board of insurance officials, and employees 

from “accepting any benefit, gift, traditional holiday gifts 

88 
and foods, favor, service, or operations or activities that 

are provided to, or regulated by, the agency.” In connection with NMC meetings, this policy requires Texas regulators to pay their own way to special events, receptions, 

and hospitality suites sponsored by industry groups, pay 

for their meals unless included in the registration fee, and 

decline to attend industry-sponsored meals. Texas Insurance Board member Allene Evans believes that regulators have no business accepting gifts from industry representatives. According to Ms. Evans, the Texas ethical 

guidelines, along with an open door policy, strikes the 

proper balance by ensuring that industry representatives 

gave input into regulatory policy but in a business rather 

than a social setting. Ms. Evans believes that NAIC could 

eliminate the appearance of impropriety at its meetingsby 

refusing to sanction industry cash donations, receptions, 

and dinners, as well as by discouraging sponsorship of 

unofficial events and gift giving.6 

Although federal intervention into insurance regulation 

may be premature, Congress should continue to play a role 

in state regulation of insurance. Many of the most important 

reforms instituted by the states were a direct result of congressional investigations, which exposed state regulatoly deficiencies. Over the years, federal oversight, in the form of 

periodic congressional investigations and agency studies, has 

proved to be an effective stimulus to state action. 

CONCLUSION 

It is commonly presumed that decisions involving 

economic regulation (such as the decision whether to 

regulate insurance rates) should be vested in the political 

jurisdiction whose constituents directly reap the benefits 

and bear the costs of those decisions. The presumption 

suggests that regulatory authority over insurance should 

remain in state hands. The results of a recent ACIR Gallup Poll of public opinion indicate that there is significant 

public support for this proposition. When asked whether 

the federal government or each state government should 

regulate companies that sell life, fire, property, casualty, 

and automobile insurance, 51 percent voted for state regulation and 37.4 percent favored federal regulation.’ Recently, however, calls for federal intervention in insurance regulation have increased dramatically. Those 

urging federal regulation cite the growing number and 

size of insolvencies as evidence of the inability of states to 

regulate the interstate and international aspects of insurance. Thus, the continuing role of states as sole regulators 

of property-casualty and life insurance is in doubt today. 

This report has described the system of state regulation and identified areas for improvement. Most of the 

weaknesses identified could be resolved by the states. 

Indeed, some states have adopted effective corrective 

measures. Two of those weaknesses may require federal 

intervention, however, and four may require coordinated 

state action. Congress could strengthen state regulation 

by passing legislation exempting state insurance liquidations 

from the effects of the federal priority and federal arbitration statutes. These two federal statutes sharply curtail the 

ability of state liquidators to collect and distribute assets of 

the insolvent insurer’s estate in an orderly manner. 

The four areas that would benefit from coordinated 

state action are (1) the regulation of insurance holding 

company systems, (2) the need for uniformity in state 

liquidation procedures, (3) the need to coordinate the 

administration of state guaranty fund programs, and (4) 

the need to impose market discipline on those programs 

through prefunding and coverage limitations. 

Both the states and the federal government have 

proposed solutions to the current regulatory problems. 

NAIC has recently established a program to accredit state 

insurance departments that have adopted certain model 

solvency-related laws and to establish through this program a nationwide system of regulation. To date, 13 states 

have become accredited. The recent actions of NAIC to 

strengthen state insurance regulation and the responsiveness of many state legislatures are impressive. Yet, the 

accreditation program may not be sufficient to resolve the 

serious problems in the areas in which coordinated state 

action is essential-holding company regulation, liquidation procedures, and guaranty fund laws. 

Although several proposals for a federal system of 

regulation exist, none of them appears likely to become 

law in the near future. Estimates of the cost of the recent 

S&L crisis range from over $200 billion to $500 billion, 

without counting interest. These figures and the recent 

rash of bank failures are sober reminders that federal 

regulation is not a panacea for the problems in the regulation of financial industries. In fact, many of the more 

serious problems that GAO has identified in connection 

with state regulation apply also to federal regulation. In 

particular, GAO has criticized the failure of federal bank 

regulators to comply with existing statutes and regula- tions. Moreover, the states and NAIC have extensive 

experience in regulating insurance. Many of the current 

federal proposals recognize that experience by either pro- viding for retention of state regulation (with the addition 

of federal mandates and oversight) or adopting NAIC’s 

accreditation standards. 

In their current form, neither the bill introduced by 

Senator Metzenbaum nor the bill introduced by Representative Dingell provides for a real federal-state partnership. The Metzenbaum bill would transform state regulators into administrators of a federal program. The Dingell 

bill would appear to allow states to continue to regulate 

some aspects of insurance, but the broad preemptionpower granted the federal agency and private industry entities 

may signal the end of state regulation. 

A promising proposal for strengthening administration of state liquidation and guaranty fund procedures is 

the interstate compact. Through a compact administered 

by a commission with limited rulemaking authority delegated to it by state legislatures, states could centralize the 

liquidation of insolvent insurers and guaranty funds. In 

order to ensure its success, such a compact should provide 

for accountability through an independent audit of the 

commission’s activities and contain incentives to encourage participation. A legislature-based compact would be 

in a position to work with and exploit the wealth of experience possessed by NAIC. 

The use of a compact would have another important 

benefit. During the 1970s and 19% the prior bright lines 

89 
separating insurance from banking and from securities activities began to blur. The distinctions among these financial 

industries will almost certainly continue to blur in the foreseeable future. A realistic assessment of state-federal relations would compel the conclusion that federal regulators 

faced with regulating the interstate and international aspects of the financial industries will preempt state regulation 

of insurance rather than attempt to deal with 51 different 

insurance regulators and regulatory systems. But if states 

can put in place a structure for coordinated regulation of 

some of the interstate aspects of insurance, they will have 

the ability to enter into a regulatory partnership with the 

federal government, rather than becoming mere administrative divisions of the central government. 

The history of state regulation of insurance demonstrates that states have strengthened and coordinated 

their regulatory procedures when forced to do so during 

periods of congressional activity, such as federal investigations and threats of preemption. The other side of the coin 

is, of course, the tendency for states to relax their efforts 

at coordination when the congressional spotlight shines 

elsewhere. Given this history, it may be time to authorize 

a federal agency to conduct research and issue studies of 

the property-casualty and life insurance industries to ensure continual federal scrutiny of state regulatory efforts. 

Some examples of studies that could increase the effectiveness of state insurance regulation include: the size and 

effect of reinsurance offsets on state tax revenues and insurer solvency, a state-by-state examination of the percentage 

of policyholders that reside in the state of domicile of their 

insurers, the effect of guaranty fund assessments on state tax 

revenues, the effect of the federal priority statute on the 

capacity of state guaranty funds, analyses of workplace and 

product safety, and analyses of highway safety issues. In 

conducting insurance studies, a federal agency could review 

trends that are wider than single states. 

Notes 

A complete list of the bills is set forth in U.S. v. South-Eastern 

Underwriters Ass’n, 322 US. 533, 592, n. 15. 

Stewart Economics, Inc., Insurance Insolvency Giiaraiitees 

(Chapel Hill, North Carolina, 1990). 

A company is classified as “professional” if the majority of its 

business is reinsurance. 

Few states actually regulate insurance rates today, but most 

states have laws granting them the power to do so. The history 

of state insurance regulation shows that states have alternately 

favored/disfavored rate setting as a regulatory tool. 

Thomas Heath and Albert B. Crenshaw, “Insurance Firms 

Pick Up Tab for Regulators’ Events, Waliington Post, Decem- ber 14, 1992. 

Phone interview with Allene, member, Texas Insurance 

Board, December 15, 1992. ’ U.S. Advisory Commission on Intergovernmental Relations, 

Cliaiigiiig Public Attitudes on Goveninierits and Tares 1992 

(Washington, DC, 1992). The question posed was: “Should the 

federal government regulate companies that sell life, fire, 

property, casualty, and automobile insurance throughout the 

country, or should each state government regulate the companies that sell these types of insurance in its state?” 

90 
Appendix A 

State Requirements: 

Minimum Capital and Surplus 

Required of Insurers 

National Association of Insurance Commissioners 

September 17,1992 1 0 NAlC 1992 

91 
92 
ALABAMA $8 27-3-7 to 27-3-9 

CaDital su€Lh 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

Life 

Disability 

Life and Disability 

New Domestic Stock Life Insurers 

Property 

Casualty 

Marine 

Surety 

Title 

Multiple Lines 

800,000 

500,000 

800,000 

1,000,000 

300,000 

400,000 

300,000 

350,000 

200,000 

500,000 

150% / 100% 

150% / 100% 

150% / 100% 

1,000,000 

150% / 100% 

150% / 100% 

150% / 100% 

150% / 100% 

150% / 100% 

150% / 100% 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

Life 

Disability 

Life and Disability 

Property 

Casualty, excluding vehicle 

Marine and Transportation 

Surety 

Title 

Vehicle 

Any three or more of numbers 2,4-7, and 9 

Legal Expenses 

Mortgage Guarantee 

1,000,000 

1,000,000 

1,250,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

500,000 

1,000,000 

3,000,000 

1,000,000 

1,000,000 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

Life+ 

Disability 

Life and Disability+ 

Property 

Casualty 

Marine and Transportation 

Surety 

Title*+ 

Vehicle 

Multiple Lines (any two or more numbers 4 

through 7 

300,000 

300,000 

400,000 

600,000 

600,000 

600,000 

1,000,000 

500,000 

600,000 

1,000,000 

1,000,000 

1,000,000 

1,250,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

500,000 

1,000,000 

3,000,000 

1,000,000 

1,000,000 

750,000 

750,000 

1,000,000 

750,000 

750,000 

750,000 

750,000 

250,000 

750,000 

2,250,000 

750,000 

750,000 

150,000 

150,000 

200,000 

300,000 

300,000 

300,000 

500,000 

250,000 

300,000 

500,000 

* Does not apply to mutual insurers 

Director may require additional capital based on type, volume and nature of business conducted. 

+ Does not apply to reciprocal insurers 

Copyright NAIC 1992 

93 
ARKANSAS $0 23-63-205,23-63-207 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

Life 

Disability 

Life and Disability 

Property 

Casualty 

Surety 

Marine 

Title 

Title and Abstractor's Professional Liability 

Property, Casualty & Marine 

Multiple Lines 

500,000 

500,000 

500,000 

250,000 

500,000 

500,000 

250,000 

100,000 

1 25,000 

750,000 sum of the minimum 

as set forth 

500,000 

500,000 

500,000 

250,000 

500,000 

500,000 

250,000 

100,000 

125,000 

750,000 sum of the minimum 

as set forth 

1. Life 2,250,000 100% of capital 

2. Life and Disability 2,500,000 100% of capital 

3. Title 250,000 100% of capital 

4. Fire 350,000 100% of capital 

5. Marine 350,000 100% of capital 

6. Surety 350,000 100% of capital 

7. Disability 250,000 100% of capital 

8. Plate Glass 100,000 100% of capital 

9. Liability ) ( for any or all 100% of capital 

10. Workers' Compensation ) ( of these 

11. Common Carrier Liability) ( 300,000 

12. Life and any of above 3 lines 2,550,000 100% of capital 

for any or 

all of them 

13. Boiler and Machinery 100,000 100% of capital 

14. Burglary 100,000 100% of capital 

15. Credit 100,000 100% of capital 

16. Sprinkler 100,000 100% of capital 

17. Team and Vehicle 100,000 100% of capital 

18. Automobile 200,000 100% of capital 

19. Aircraft 100,000 100% of capital 

20. Miscellaneous 100,000 100% of capital 

21. Mortgage 250,000 100% of capital 

22. Mortgage Guaranty 1,000,000 100% of capital 

plus $200,000 

Insurers transacting multiple lines shall have $2,600,000 or the aggregate as set forth above, whichever is lower. 

Incorporated insurers not transacting life lines, fire, marine or surety shall have excess capital of $300,000 over the 

aggregate amount set forth above. 

For admission, no incorporated insurer shall have less than $l,O00,000 nor more than $2,600,000 capital. 

Copyright NAIC 1992 

94 
COLQBBM 0 10-3-201 

Certificate of Authority issued 

prior to 5/6/63: (but see below) 

1. Life 

2. Fire 

3. 

4. 

5. 

6. 

7. Multiple Line 

Fire (territory limited to Colorado) 

Casualty (including fidelity and surety) 

Casualty (excluding fidelity and surety) 

Casualty (including fidelity and surety and 

territory limited to Colorado) 

Certificate of Authority issued 

On or After 5/6/Q: (but see below) 

1. Life 

2. Fire 

3. 

4. 

5. 

6. 

7. Multiple Line 

8. Title 

9. 

Fire (territory limited to Colorado) 

Casualty (including fidelity and surety) 

Casualty (excluding fidelity and surety) 

Casualty (excluding fidelity and surety and 

territory limited to Colorado) 

Title (territory limited to Colorado) 

Certificate of Authority issued 

On or After 7/1/79: (but see below) 

1. Life 

2. Fire 

3. 

4. 

5. 

6. 

7. Multiple Line 

8. Title 

9. 

Fire (territory limited to Colorado) 

Casualty (including fidelity and surety) 

Casualty (excluding fidelity and surety) 

Casualty (excluding fidelity and surety and 

territory limited to Colorado) 

Title (territory limited to Colorado) 

CaDital 

100,000 

200,000 

50,000 

250,000 

100,000 

50,000 

400,000 

CaDital 

200,000 

200,000 

100,000 

250,000 

200,000 

100,000 

400,000 

200,000 

100,000 

CaDltal 

400,000 

400,000 

200,000 

500,000 

400,000 

200,000 

1,250,000 

400,000 

200,000 

Certificate of Authority Issued 

QImAhmm: 

Companies licensed prior to July 1, 1991 shall have until 

12/3 1/92 to increase their total capital and surplus to the 

amounts marked with asterisks. 

1. Life 

2. Fire 

3. Casualty 

4. Multiple Line 

5. Title 

*780,000 

*780,000 

*900,000 

*2,000,000 

*630,000 

sww 

50,000 

100,000 

25,000 

125,000 

50,000 

25,000 

350,000 

s.urh 

100,000 

100,000 

50,000 

125,000 

100,000 

50,000 

350,000 

100,000 

50,000 

sww 

200,000 

200,000 

100,000 

250,000 

200,000 

100,000 

750,000 

200,000 

100,000 

Colorado continued on next page 

Copyright NAIC 1992 

95 
COLORADO (cont.) 

Wital and Sumlus 

Certificate of Authority Issued 

-: 

1. Life 

2. Fire 

3. Casualty 

4. Multiple Line 

5. Title 

Certificate of Authority Issued 

-: 

1. Life 

2. Fire 

3. Casualty 

4. Multiple Line 

5. Title 

Certificate of Authority Issued 

-: 

1. Life 

2. Fire 

3. Casualty 

4. Multiple Line 

5. Title Insurance 

960,000 

960,000 

1,050,000 

2,000,000 

690,000 

1,140,000 

1,140,000 

1,200,000 

2,000,000 

690,000 

1,320,000 

1,320,000 

1,350,OOO 

2,000,000 

720,000 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

I\. 

Life 

Mortgage Guaranty 

Health 

Marine 

Fidelity and Surety 

Title 

Worker's Compensation 

Liability 

Property 

Life & Health 

A\\ Lncs-Max. R.equ;\red. 

CaDrtal 

1,000,000 

2,000,000 

500,000 

500,000 

500,000 

500,000 

500,000 

500,000 

500,000 

1,000,000 

1,oOo~m 

Mutual 

surplus surplus 

2,000,000 

2,000,000 

500,000 

250,000 

500,000 

500,000 

500,000 

500,000 

250,000 

2,o 00,o 00 

2,000,000 

3,000,000 

4,000,000 

1,000,000 

750,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

750,000 

3,000,000 

4,ooo,ooo 

Copyright NAIC 1992 

96 
DELAWAREtit. 18 Q 511 

1. Life 

2. Health 

3. Life and Health 

4. Property 

6. Marine & Transportation 

7. Surety 

8. Title 

9. Multiple 

5. casualty 

300,000 

300,000 

350,000 

300,000 

400,000 

350,000 

300,000 

250,000 

500,000 

150,000 

150,000 

200,000 

150,000 

200,000 

175,000 

150,000 

125,000 

250,000 

Life Companies 

Capital Stock Company 1,000,000 50% of capital stock 

Mutual Company N/A 1,5OO,OOO 

Capital Stock Company 300,000 300,000 

Domestic Mutual Company N/A 300,000 

Foreign and Alien Mutual Company NIA 400,000 

Fire and Casualty Companies 

................................................................................................................................................... 

FLORIDA QQ 624.407.624.408, 628.161 

To receive authority: capital and surplus of $2,500,000 

To maintain certificate of authority: 

Insurers licensed prior to 1989 must maintain at least: 

Until Dec. 31, 1992 $1,300,000 

Thereafter 1,500,000 

or alternative calculation based on liabilities. 

Maintenance 

Level Sum 

1. Health 300,000 200,000 

2. Property 200,000 150,000 

3. Casualty 300,000 200,000 

4. Any Combination 1,2,3 400,000 250,000 

5. Life 2,500,000 1,500,000 

Mutuals 

GEORGIA $0 33-3-6and33-3-7 

1. For companies newly admitted 1/1/91 and 

thereafter and for all companies on 7/1/92 

and thereafter: 1,500,000 1,500,000 or 50% cap. 

Until July 1, 1992 for companies admitted 

prior to 1/1/91: 1,5OO,OOO 400,000 or 50% cap. 

2. 

Commissioner may, at his discretion, grant a company 2 extra years to meet these requirements. ................................................................................................................................................... 

Copyright NAIC 1992 

97 
HAWAII $0 431~3-205 to 431:3-207 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

surphls 

Additional 

Capital (Stock) amount required of - or Unimpaired all insurers after 

m 

Life 600,000 50% capital 

Disability 450,000 50% capital 

Property 750,000 50% capital 

Marine and Transportation 1,000,000 50% capital 

Vehicle 1,000,000 50% capital 

General Casualty 1,500,OOO 50% capital 

Surety 1,000,000 50% capital 

Title 400,000 50% capital 

Combination of Classes: Amount equal to the sum required of each individual class of 

insurance, total not exceed $2.5 million. 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

Life 

Disability 

Life and Disability 

Property 

General Casualty 

Marine and Transportation 

Vehicle 

Surety 

Title 

Multiple Lines (all but life and title) 

Any 2 of Property, Marine & Transportation, 

General Casualty, Vehicle, Surety, Disability 

400,000 

400,000 

506,000 

400,000 

500,000 

450,000 

400,000 

500,000 

100,000 

650,000 

550,000 

400,000 

400,000 

500,000 

400,000 

500,000 

450,000 

400,000 

500,000 

100,000 

650,000 

550,000 

CLASS 1 : Life. Accident and 

a. Life 

b. Accident and Health 

C. Legal Expense 

CLASS 2: Casualtv. Fidelitv and Surety 

a. Accident and Health 

b. Vehicle 

C. Liability 

d. Workers' Compensation 

e. Burglary and Forgery 

f. Glass 

g. Fidelity and Surety 

h. Miscellaneous 

1. Other Casualty Risks 

j. Contingent Losses 

k. Livestock and Domestic Animals 

1. Legal Expense 

Illinois continued on next page 

CJ .ASS 3: Fire and Mhe. etc. 

a. Fire 

b. Elements 

C. War, Riot and Explosion 

d. Marine and Transportation 

e. Vehicle 

f. 

g. 

h. Contingent Losses 

i. Legal Expense 

Property Damage, Sprinkler Leakage and Crop 

Other Fire and Marine Risks 

Copyright NAIC 1992 

98 
ILLINOIS (cont.) 

StockInsurers 

1. Class la, b and/or c 

2. Class 2a, b, c, d, g, g, i, andor j 

3. Class 2e, f, i, 1 andor Class 3 

(any, all of or combination of) 

4. Class 2 - any and all clauses except e, f, k, 

1 

and Class 3 - any and all clauses 

5. Class 2 - fork only** 

- 

1. 

2. 

3. 

Class la, b and/or c 

Class 2a, b, c, d, g, h, i, anda 

Class 2e, f, k, 1 andor Class S 

i 

(any, all of or combination of) 

Class 2 - any and all clauses except e, f, k, 

1 

and Class 3 - any and all clauses 

Class 2 - for k only 

4. 

5. 

CaDltal 

1,000,000 1,000,000 

1 ,000.Ooo 1,000,000 

400,000 600,000 

1,000,000 1,000,000 

100,000 150,000 

1,500,OOO 

700,000 

1,5OO,OOO 

150,000 

*In addition to minimum original capital. 

** Provided company shall not expose itself to any loss on any one risk in an amount exceeding $5,000. 

2,000,000 

2,000,000 

1,000,000 

2,000,000 

250,000 

Surplus to be 

Maintained* 

199 1-1995 

500,000 

500,000 

300,000 

500,000 

50,000 

Surplus to be 

Maintained* 

1991- 1995 

1,500,000 

INDIANA $8 27-1-5-1, 27-1-6-14,27-1-6-15 

SLAsu CkAssA 

a. Life and Annuities a. Fire, Wind, Hail, Loot, Riot 

b. Accident and Health b. Crop 

sLAsu d. Marine and Transportation 

a. Accident, Health and Disability 

b. Employers Liability, Workers' Comp. 

C. Burglary and Theft 

d. Glass 

e. Boiler and Machinery 

f. Motor Vehicle Liability 

g. Water Damage 

h. Liability 

1.. Credit 

j. Title 

k. Fidelity and Surety 

1. Other Casualty 

m. Legal Expense 

C. Water and Fire Extinguisher Damage 

Indiana continued on next page 

Copyright NAIC 1992 

99 
".A (cont.) 

Stock: 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

1. 

2. 

3. 

4. 

5. 

Organized Prior to 3/7/67: 

One or More Kind of Class 1 

Any One Kind of Class 2 except k 

Any 2 Kinds of Class 2 except k 

3 or More Kinds of Class 2 except k 

One or More Kind Class 3 

One or More Kinds under Class 2 and 

Class 3 

One or more Kinds of Class 2 including k 

Organized after 3/6/67 and prior to 

7/1/77: 

One or More Kind of Class 1 

Any One Kind of Class 2 except k 

One or More Kind Class 3 

One or More Kinds under Class 2 and 

Class 3 

One or more Kinds of Class 2 including k 

Organized after 6130177: 

Mutual: 

1. 

2. 

3. 

Organized prior to 7/1/77: 

One or More Kinds under Class 2 or 

Class 1 and Class 3, excluding 2k 

One or More Kinds of Class 2 including k 

One or More Kinds under Class 2 and 

Class 3, including 2k 

Organized after 6/30/77: 

In CaDU 

200,000 

200,000 

300,000 

400,000 

400,000 

750,000 

750,000 

400,000 

400,000 

400,000 

750,000 

750,000 

1,000,000 

Minimum 

250,000 

750,000 

1,000,000 

1,000,000 

suQb 

Sumlus 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

1,000,000/250,000# 

2,000,000/1,250,000# 

1. Life 600,000 600,000 

2. Single Line (Property or Casualty) 450,000 300,000 

3. Multiple Line (Property or Casualty) 900,000 600,000 ................................................................................................................................................... 

Copyright NAIC 1992 

100 
mTUCKX 8 304.3-120 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

13. 

14. 

15. 

16. 

17. 

18. 

19. 

20. 

Life 

Health and Accident 

Life, Accident and Health 

Vehicle Physical Damage 

Title 

- licensed prior to 9/1/85 

- licensed on or after 9/1/85 

Industrial Fire 

Workers' Comp. Only (licensed as of 

7/27/66) 

Crop and Livestock Only (licensed as of 

7/27/66) 

Vehicle 

Liability 

Burglary and Forgery 

Workers' Compensation 

Glass 

Fidelity and Surety 

Fire and Extended Coverage 

Steam Boiler and Sprinkler Leakage 

Crop and Livestock 

Marine and Transportation 

Miscellaneous 

All Lines, except Life and Title 

100,000 

100,000 

100,000 

100,000 

50,000 

100,000 

200,000 

100,000 

100,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

1 ,000,000 

Capital and surplus requirements for companies admitted on or after 9/1/89: 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

13. 

Life 

Health and Accident 

Life, Accident and Health 

Vehicle Physical Damage 

Title 

Industrial Fire 

Vehicle 

Liability 

Workers' Compensation 

Burglary and Forgery 

Glass 

Fidelity and Surety 

Fire and Extended Coverage 

sul2lu 

200,000 

200,000 

200,000 

150,000 

25,000 

200,000 

100,000 

50,000 

150,000 

350,000 

350,000 

350,000 

350,000 

350,000 

350,000 

350,000 

350,000 

350,000 

350,000 

350,000 

InCm .. 

100,000 

100,000 

100,000 

100,000 

100,000 

200,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

650,000 

1,900,000 

1,900,000 

1,900.000 

1,150,000 

400,000 

800,000 

1,350,000 

1,350,000 

1,350,000 

1,350,000 

1,350,000 

1,350,000 

1,350,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

500,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

Louisiana continued on next page 

Copyright NAIC 1992 

101 
LOUISIANA (cont.) 

14. Steam Boiler and Sprinkler 

15. Crop and Livestock 

16. Marine and Transportation 

17. Miscellaneous 

18. All Lines, except Life and Title 

650,000 1,350,000 1,000,000 

650,000 1,350,000 1,000,000 

650,000 1,350,000 1,000,000 

650,000 1,350,000 1,000,000 

650,000 1,350,000 1,000,000 

The commissioner may require additional capital and surplus based on type, volume, and nature of business transacted. ................................................................................................................................................... 

MAINE 24-A $8 410,411 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

Life* 

Health 

Life and Health* 

Casualty 

Marine and Transportation 

Property 

Surety 

Title 

Multiple Line 

All lines (life and one or more lines except 

health) 

Legal services (in addition to above) 

Financial Guaranty (monoline) 

Paid-In Capital - (Stock) or Basic 

1,500,000 

1,000,000 

2,500,000 

1,500,000 

1,500,000 

1,000,000 

1,500,000 

500,000 

2,500,000 

5,000,000 

500,000 

2,500,000 

Initial Free 

Sumlus 

1,500,000 

1,000,000 

2,500,000 

1,500,000 

1,500,000 

1,000,000 

1,5OO,OOO 

500,000 

2,500,000 

5,000,000 

47,500,000 

*Does not apply to reciprocal insurers. 

A domestic mutual insurer holding a certificate of authority prior to January 1, 1989 may continue to write a business if it 

maintains the following basic surplus: 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

Life 

Health 

Life and Health 

Casualty 

Marine and Transportation 

Property 

Surety 

Title 

Multiple Line 

1,000,000 

500,000 

1,250,000 

750,000 

1,000,000 

500,000 

1,000,000 

350,000 

2,500,000 

Prior to 7111a: 

1. 

2. Health 

3. 

4. Title 

5. Wet Marine and Transportation 

6. 

Life, including annuities and health 

Property and Marine, excluding #5 

Casualty, excluding #7 and #8 

Maryland continued on next page 

200,000 

100,000 

250,000 

250,000 

250,000 

250,000 

Copyright NAIC 1992 

102 
MARyLAND (cont.) 

7. Vehicle Liability 

8. Workers' Compensation 

9. Surety 

10. 2 or more of these listed lines 

Commencing Business 

1. 

2. Health 

3. 

4. Title 

5. Wet Marine and Transportation 

6. 

7. Vehicle Liability 

8. Workers' Compensation 

9. Surety 

Life, including annuities and health 

Property and Marine, excluding #5 

Casualty, excluding #7 and #8 

10. 2 or more of these listed lines 

Commencing Business 

-: 

1. Life, including annuities 

2. Health 

3. 

4. Title 

5. Wet Marine and Transportation 

6. Casualty, excluding #7 and #8 

7. Vehicle Liability 

8. Workers' Compensation 

9. Surety 

Property and Marine, excluding #5 

10. 2 or more of these listed lines 

CaDltal 

250,000 

250,000 

250,000 

lesser of $500,000 

or sum total 

500,000 

250,000 

250,000 

250,000 

250,000 

250,000 

250,000 

250,000 

250,000 

500.000 

CaDital 

1,500,000 

750,000 

750,000 

750,000 

750,000 

750,000 

750,000 

750,000 

750,000 

1,500,000 

surolus 

#* 

# 

# 

SuIDlUs 

# 

# 

# 

# 

# 

# 

# 

# 

# 

# 

surolus 

# 

# 

# 

# 

# 

# 

# 

# 

# 

# 

On or after 7/1/2001 any insurer which qualified to engage in business before 7/1/91 shall possess and maintain paid-in 

capital in an amount not less than 150% of that required of insurers commencing business on 6/30/91. 

#Minimum Surplus Required: (1) new insurers need minimum surplus of 150% of minimum capital stock; (2) insurer 

which commenced business on or after 7/1/66 shall maintain surplus in an amount not less than 100% of minimum 

capital required; (3) an insurer which commenced business before 7/1/66 shall maintain surplus in an amount not less 

than 50% of minimum capital required. 

1. Fire 

2. Ocean Marine, Inland Navigation 

a. 1 + Ocean marine 

b. 1 - ocean marine 

3. Surety and Fidelity 

4. Boiler and Machinery 

200,000 400,000 600,000 

300,000 600,000 900,000 

400,000 800,000 1,200,000 

300,000 600,000 900,000 

200,000 400,000 600,000 

200,000 400,000 600,000 

Massachusetts continued on next page 

Copyright NAIC 1992 

103 
MASSACHUSETTS (cont.) 

Paid-Sughs in Sumh 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

13. 

15. 

16. 

17. 

19. 

Accident and Health, Liability and 

Property Damage, Automobile Workers' 

Compensation 

- Accident and Health Only 

Glass 

Water Damage and Sprinkler Leakage 

Elevator and Aircraft Property Damage 

Credit Insurance 

Title 

Mortgage 

Burglary, Forgery and Larceny 

Livestock 

Reinsurance 

Life 

Repair and Replacement (when combined 

with one or more of classes 1, 2 and 8) 

Legal Services 

400,000 

100,000 

100,000 

200,000 

200,000 

200,000 

100,000 

200,000 

200,000 

100,000 

500,000 

400,000 

400,000 

100,000 

800,000 

200,000 

200,000 

400,000 

400,000 

200,000 

400,000 

400,000 

200,000 

1,000,000 

800.000 

800,000 

200,000 

1,200,000 

300,000 

300,000 

600,000 

600,000 

300,000 

600,000 

600,000 

300,000 

1,500,000 

1,200,000 

1,200,000 

300,000 

Classes 6 & 16 800,000 800,000 

Classes 1 & 8 200,000 

Classes 1 & 2 except ocean marine 300,000 

Classes 1 & 2 400,000 

Classes 1 & 17 400,000 

Classes 1,2, 8, 17 400,000 

Any 2 or more in Classes 4, 5, 6, 7, 8, 9, 10, 12, 13 - Largest amount plus 1/2 requirement for each additional 

line. Surplus is twice that amount. ................................................................................................................................................... 

MICHIGAN $500.410 

s to ins- 7/1/65. 

CaDltal - 

1. Life 1,000,000 500,000 

2. Life and Disability 1,000,000 500,000 

3. Disability 1,000,000 500,000 

4. Property and Marine 1,000,000 500,000 

5. Automobile 1,ooo,Ooo 500,000 

6. Casualty 1,000,000 500,000 

7. Surety and Fidelity 1,000,000 500,000 

8. Surety and Fidelity, Casualty 1 ,000,Ooo 500,000 

9. Multiple Lines 1,000,000 500,000 

1. $1,500,000 is the minimum amount of capital and surplus required for an initial COA. Dept. has authority to require 

additional surplus. After licensure, $l,O00,OOO must remain unimpaired. 

Copyright NAIC 1992 

104 
- 

1. Fire 

2. Marine and Transportation 

3. Boiler and Machinery 

4. Life 

5a. Accident and Sickness 

Mutual insurers 

5b. Workers' Compensation 

6. Fidelity and Surety 

7. Title 

8. Glass 

9. Burglary, Theft and Forgery 

10. Livestock 

11. Credit 

12. Vehicle 

13. Liability 

14. Elevator 

15. Legal Expense 

16. Multiple Lines 

Mutual Insurers 

CaDital 

350,000 

350,000 

200,000 

1,000,000 

500,000 

500,000 

500,000 

500,000 

200,000 

200,000 

200,000 

350,000 

500,000 

500,000 

200,000 

350,000 

1,000,000 

350,000/175,000 

350,000/175,000 

200,000/100,000 

2,000,000/500,000 

1,000,000/500,000 

1,500,000/1,000,000 

1,000,000/500,000 

500,000/250,000 

500,000/250,000 

200,000/100,000 

200,000/100,000 

200,000/100,000 

700,000/350,000 

1,000,000/500,000 

1,000,000/500,000 

200,000/100,000 

350,000/175,000 

1,000,000/500,000 

2,000,000/1,500,000 

#First amount is initial requirementkecond amount is that to be constantly maintained 

Mutual insurers must meet same surplus requirements except where otherwise specified. 

MISSISSIPPI $83-19-31 

CaDital surolus 

1. 

2. 

3. 

4. 

5. 

5a. 

6. 

7. 

Glass, Fire, Windstorm, Related 

Coverages, Wet Marine or Inland Marine 

Fidelity, Casualty, Surety or Guaranty 

Sprinkler Leakage 

Vehicle, Bicycles, Aircraft and Elevator 

Life or Accident and Health 

Life, Accident and Health 

Industrial Life 

Multiple Lines 

400,000 

400,000 

400,000 

400,000 

400,000 

400,000 

100,000 

600,000 

600,000 

600,000 

600,000 

600,000 

600,000 

600,000 

50,000 

900,000 

Copyright NAIC 1992 

105 
MISSOUBI (cont.) 

PIC insurers licensed prior to 7/11/87, have until December 31, 1992 to meet requirements, in graduated steps: 

CaDital suQ.h 

One line by 12/3 1/9 1 surplus of 700,000 700,000 

More than one line by l2/3 1/9 1 

surplus of 1,100,000 1,100,000 

Mutual Insurers: 

More than one line 2,400,000 

Single line mutuals 1,600,000 

Mutuals licensed prior to 7/1/87 have until 12/31/92 to increase surplus to these amounts in graduated steps: 

One line by 12/3 1/9 1 surplus of 

More than one line by 1U3 1/9 1 

1,400,000 

surplus of 2,200,000 ................................................................................................................................................... 

MONTANA $0 33-2-109,33-3-204 

1. 

2. 

3. 

4. 

5. 

6. 

7a. 

7b. 

8. 

9. 

10. 

Life 

Disability 

Life and Disability 

Credit Life and Disability 

Property 

Marine 

Casualty, except Workers' Compensation 

Casualty with Workers' Compensation 

Surety 

Title 

Multiple Lines 

CaDital 

200,000 

200,000 

300,000 

50,000 

400,000 

400,000 

400,000 

600,000 

500,000 

200,000 

800,000 

surplus 

200,000 

200,000 

300,000 

50,000 

400,000 

400,000 

400,000 

600,000 

500,000 

200,000 

800,000 

Initial Capital 

(Stock) or - ilnuwhs 

Maintained 

s!+xR.h 

Life and Variable Life without Variable 

Annuities and/or Accident and Sickness, or 

any one line P/C 1,000,000 1,000,000 

All Lines including variable annuities 2,000,000 2,000,000 

Copyright NAIC 1992 

106 
NVADA $ 680A.120 

Effective 10-1-91 for a certificate of authority must have: 

Paid-In Capital - (Stock) or Basic 

Life, health, property, casualty, surety, 

marine and transportation, and multiple 

line 500.000 

Title 500,000 

Financial Guarantee 10,000,000 

ree 

1,000,000 

750,000 

40,000,000 

Insurers licensed prior to effective date may continue to meet the requirements below until 1/1/94. 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

Life 

Health 

Life and Health 

Property 

Casualty 

Casualty and Health 

Surety 

Marine and Transportation 

Multiple Line 

Title 

200,000 

200,000 

300,000 

300,000 

300,000 

400,000 

500,000 

300,000 

500,000 

100,000 

500,000 

500,000 

750,000 

750,000 

750,000 

1,000,000 

1,000,000 

750,000 

1,000,000 

250,000 

1. All Stock Insurers 

2. All Mutual Insurers 

3. Multiple Lines 

4. Life Stock Insurers 

5. Title Insurers 

800,000 200,000 1,000,000 

500,000 800,000 

400,000 400,000 

600,000 150,000 750,000 

200,000 100,000 300,000 

a. 

b. 

d. 

e. 

f. 

g. 

h. 

C. 

1. 

j. 

k. 

1. 

m. 

n. 

Fire and Casualty 

Marine and Transportation 

Life and Health 

Liability 

Workers' Compensation 

Boiler and Machinery 

Fidelity and Surety 

Title 

Credit 

Burglary and Theft 

Glass 

Water Damage and Sprinkler Leakage 

Livestock 

Smoke and Smudge 

200,000 100,000 

200,000 100,000 

800,000 1,700,000 600,000 

400,000 600,000 300,000 

300,000 

250,000 50% capital 375,000 

500,000 250,000 

200,000 100,000 

New Jersey continued on next page 

Copyright NAIC 1992 

107 
NEW JERSEY (cont.) 

0. 

P. 

q. 

r. 

All Lines but Life and Health 

Life and Annuity 

Life, Health, Annuity 

Health 

stmmmm2 Mutuals 

CaDital swzlui As!% 

Net Cash 

2,000,000 1,000,000 

1,000,000 2,100,000 

1,5OO,OOO 2,850,000 

500,000 750,000 

Stock Insurers: minimum capital $200,000 with additional $lOO,OOO for each additional line; minimum surplus 50% of 

capital. 

Mutual Insurers: minimum $50,000 net cash assets required for each line authorized to transact. ................................................................................................................................................... 

NEW 8 59A-5-16 

1. 

2. 

3. 

4. 

5. 

6. 

1. 

2. 

3. 

4. 

5. 

Life andlor Health 600,000 400,000 

General Casualty and/or Surety 500,000 500,000 

Property and/or Marine and Transportation 500,000 500,000 

Vehicle 500,000 500,000 

Title 500,000 500,000 

Multiple Lines, except life and/or health 

and title, per each additional line transacted 100,000 100,000 

Aggregate Requirements Related to Premium Volume (earned or received): 

$5 to $10 $10 to $25 Over $25 

Million Million Mllllon 

Life and/or Health 700,000 800,000 900,000 

General Casualty andlor Surety 800,000 900,000 1,000,000 

Property andlor Marine and Transportation 800,000 900,000 1,000,000 

Vehicle 800,000 900,000 1,000,000 

Title 800,000 900,000 1,000,000 

NW YO= $8 11 13,4103,4202,4208,4107 

Group A: 

1. 

2. 

3a. 

3b. 

5. 

6. 

*7. 

*8. 

*9. 

*lo. 

*11. 

12. 

*13. 

*14. 

Life 

Annuities (initial surplus) 

Accident and Sickness 

Disability 

Miscellaneous Propertya 

Water Damagea*c 

Burglary and Theft 

Glass 

Boiler and Machinery 

Elevator 

Animal 

Collisionb*cJ 

Personal Injury Liability 

Property Damage Liability 

Domestic Stock 

CaDital 

2,000,000 

150,000 

100,000 

100,000 

100,000 

300,000 

100,000 

100,000 

100,000 

100,000 

100,000 

500,000 

100,000 

Companies 

s.u&s 

4,000,000 

100,000 

50,000 

50,000 

50,000 

150,000 

50,000 

50,000 

50,000 

50,000 

50,000 

250,000 

50,000 

New York continued on next page 

Copyright NAIC 1992 

108 
WW YOU (cont.) 

Domestic Stock Companies 

CaDital suQl!Js 

*15. 

*16. 

*17. 

18. 

19. 

21. 

22. 

23. 

24. 

500,000 250,000 

900,000 450,000 

400,000 200,000 

Workers' CompensatiodEmployer 

Liability 

Fidelity and Surety 

Credit 

Title 

Motor Vehicle and Aircraft Physical 

DamagecVd 

Marine Protection and Indemnityd 

Residual Value 2,000,000 1,000,000 

Mortgage Guaranty 

Credit Unemployment 400,000 200,000 

* Basic Additional Amount Required to 

Write Any One or More of These Lines 100,000 50,000 

Group B: 

4. FireC 

20. Marine and Inland Marined 500,000 500,000 

500,000 500,000 

Multiple Lines: Domestic Stock Property/Casualty Insurers 

If licensed to write one or more of the lines in Group A and having minimum capital of $1,000,000 may be licensed to 

write any other kind of insurance in Group A upon having an initial surplus equal to the aggregate of capital and surplus 

specified and shall maintain a surplus of the greater of $1,000,000 or aggregate capital specified. 

If licensed to write any kind of insurance in Group A, must have minimum capital of $1,000,000 and an initial surplus 

equal to the aggregate of capital and surplus specified before being additionally authorized to transact any insurance of 

Group B. Insurer shall maintain a surplus of the greater of $1,000,000 or aggregate capital specified. 

Insurers reinsuring lines of business and transacting business outside the U.S. for which they are not licensed to write 

directly, must maintain a minimum surplus to policyholders of $35,000,000 and a deposit of $3,000,000 (included in 

surplus of policyholders). 

a if licensed to write fire (4), additional capital and surplus is not required 

if licensed to write fire (4) or marine and inland marine (20), additional capital and surplus is not required 

if licensed to write fire (4). no additional capital and surplus is required to write miscellaneous property (3, water 

damage (6), collision (12), motor vehicle and aircraft physical damage (1 9) or inland marine only (20) 

if licensed to write marine and inland marine (20), no additional capital and surplus is required to write collision (12), 

motor vehicle and aircraft physical damage (19) or marine protection and indemnity (21) 

New Yotk cotinued on next page 

Copyright NAIC 1992 

109 
NEW YO= (cont.) 

3zaEmm 

Fire 

Burglary 

Glass 

Boiler 

Elevator 

Animal 

Liab. - P.1 

Workers' Comp. 

FidelityBurety 

Credit 

Marine 

Marine P.&I. 

4 [also 5,6, 

12~9 and 20 

inlandla.ble 

7 

8 

9 

10 

11 

13 [also 6,12 

and 14]c*e 

15f 

16 

17 

20 [also 12.19 

and 21]b,d9e 

21b 

300,000 

300,000 

150,000 

300,000 

150,000 

150,000 

500,000 

500,000 

1,500,000 

750,000 

1,000,000 

500,000 

Minimum 

Surplus to be 

200,000 

200,000 

100,000 

200,000 

100,000 

100,000 

400,000 

400,000 

1,000,000 

500,000 

500,000 

500,000 

If licensed to write any kind of insurance specified in TABLE TWO, a mutual propertykasualty company may write any 

one or more of the kinds of insurance specified in TABLE THFU3E - Group A and Group B. 

If licensed to write any kind of insurance specified in TABLE THREE - Group A, it may write any one or more of the 

kinds of insurance specified in TABLE THREE - Group C. 

Burglary 

Glass 

Boiler 

Elevator 

Animal 

Liab. - P.I. 

Workers' Comp . FidelityKurety 

Credit 

Fire 

Marine 

Accident & Health 

Accident & Health 

Water Damage 

Collision 

Liab. P.D. 

Residual Value 

New York continued on next page 

Copyright NAIC 1992 

ihuL4 

7 

8 

9 

10 

11 

13c3e 

15 

16 

17 

4 [also 5.6.12.19 

and 20 inland] 

20 [also 12,19 

and 21]b9d9e 

30) 

3(ii) 

fja,c.g 

p,c,h 

14c*e 

22 

GE!uE 

100,000 

50,000 

100,000 

50,000 

50,000 

300,000 

300,000 

900,000 

300,000 

300,000 

1,000,000 

100,OOO 

100,000 

50,000 

50,000 

50,000 

3,000,000 

Minimum 

Surplus to be 

100,000 

50,000 

100,000 

50,000 

50,000 

300,000 

300,000 

900,000 

300,000 

200,000 

500,000 

100,000 

100,000 

50,000 

50,000 

50,000 

2,000,000 

110 
NEW YO= (cont.) 

A mutual property/casualty insurance company may be licensed to write any one kind of insurance as specified in 

TABLE TWO [except as provided for in b], subject to the following: 

a. 

b. 

C. 

d. 

e. 

f. 

g. 

h. 

If licensed to write paragraph 4, no additional surplus required for 5,6,12,19 and 20 (inland marine). 

If organized to write paragraphs 4, 20 or 21, the initial and minimum surplus required for paragraphs 7, 8, 9, 10, 

11, 13, 15, 16, or 17 to be taken from TABLE TWO for the line with the highest initial surplus. 

If licensed to write paragraph 13, no additional surplus required for paragraphs, 6, 12 and 14. 

If licensed to write paragraph 20, no additional surplus required for paragraphs, 12, 19 and 21. 

If licensed to write paragraphs 13, 14 and 19, must maintain a surplus of $600,000. 

If licensed to write paragraph 15, no additional surplus required for paragraph 3(i) if licensed for the purpose of 

Article 9 of the workers' compensation law. 

If licensed to write paragraph 4 or 13, no additional surplus required. 

If licensed to write paragraphs 4, 13 or 20, no additional surplus required. ................................................................................................................................................... 

NORTH Cm $8 58-7-75.58-7-15 

In Cg&l ihKQ.b 

1. Life 600,000 900,000/150,000# 

2. Accident and Health (cancellable) 400,000 600,000/100,000 

3. Accident and Health (cancellable and 

noncancelable) 600,000 900,000/150,000 

4. One or more of the following lines: Fire, 

Misc. Property, Water Damage, Burglary 

and Theft, Animal, Collision, Motor 

Vehicle and Aircraft, Marine, Marine 

Protection and Indemnity or Miscellaneous 

One or more of the following lines: 

Accident and Health, Water Damage, 

Burglary and Theft, Glass Boiler and 

Machinery, Elevator, Animal, Collision, 

Personal Injury Liability, Property Damage 

Liability, Workers' Compensation and 

Employers Liability, Fidelity and Surety, 

Credit, Title, Motor Vehicle and Aircraft, 

Marine, Marine Protection and Indemnity 

or Miscellaneous. 1,000,000 1,50O,OO0/25O,OOO 

StockInsurers: 

5. 

800,000 1,200,000/200,000 

#First amount is initial requirementhecond amount is that to be constantly maintained 

Constantly 

Maintained 

suuius 

Mutual: 

1. Limited Assessable: 

Fire, Misc. Property, Water Damage, 

Burglary and Theft, Glass, Boiler and 

Machinery, Animal, Collision, Motor 

Vehicle and Aircraft, Marine, Marine 

Protection and Indemnity andor 

Miscellaneous lines 300,000 300,000 

North Carolina continued on next page 

Copyright NAIC 1992 

111 
NORTH CA- (cont.) 

2. Assessable: 

A. Fire, Misc. Property and/or Water 

Damage 

B. Burglary and Theft, Glass, Animal, 

Collision, Motor Vehicle and Aircraft, 

Marine, Marine Protection and Indemnity 

and/or Miscellaneous lines 

C. Multiple Lines 

twice the net retained liability under 

the largest policy of insurance; never 

less than $60,000 

60,000 constantly maintained 

400,000 constantly maintained 

800,000 constantly maintained 

3. Nonassessable: 

A. Fire, Misc. Property, Water Damage, 

Burglary and Theft, Glass, Boiler and 

Machinery, Animal, Collision, Motor 

Vehicle and Aircraft, Marine, Marine 

Protection and Indemnity and/or 

Miscellaneous lines 

B. Accident and Health, Water Damage, 

Burglary and Theft, Glass, Boiler and 

Machinery, Elevator, Animal, Collision, 

Personal Injury Liability, Property Damage 

Liability, Workers' Compensation and 

Employers Liability, Fidelity and Surety, 

Credit, Title, Motor Vehicle and Aircraft, 

Marine, Marine Protection and Indemnity, 

and/or Miscellaneous 1,O00,000 constantly maintained 

C. Multiple Lines (A and B above) 1,800,000 constantly maintained 

D. Life 200,000/100,000# 

E. Accidental Death and Personal Injury 200,000/100,000# 

F. Life, Accidental Death and Personal 400,000/200,000# 

Injury 

G. Disability 500,000/300,000# 

H. Multiple Lines 1,O00,000 constantly maintained 

Copyright NAIC 1992 

112 
OHIO 00 3907.05,3909.02, 3925.12, 3929.011 

Stock insurers other than life or title: 

For a new or renewal certificate of authority issued after 8/8/91, domestic and foreign insurers writing the lines in each 

list must have: 

Total 

Maintained 

Capital and At Least At Least 

sudus CaDltal suuzb 

1. List A 2,500,000 1,000,000 1,000,000 

2. List B 5,000,000 2,000,000 2,000,000 

3. List C 10.000,000 4,500,000 4,500.000 

4. Assumes reinsurance and writes from List 

A or B 10,000,000 4,500,000 4,500,000 

Mutual insurers other than life or title: 

For a new or renewal certificate of authority issued after 8/8/91, insurers writing any of the lines listed in each list shall 

have: 

Total 

Maintained 

su-EP.b 

1. ListA 2,500,000 

2. List B 5,000,000 

3. List C 10,000,000 

4. 

A or B 10,000,000 

Assumes reinsurance and writes from List 

A 

fire, allied lines, farmowners multiple peril, homeowners multiple peril, ocean marine, inland marine, earthquake, group 

accident and health, credit accident and health, auto liability, auto physical damage, aircraft, glass, burglary and theft, 

boiler and machinery, and credit. 

B 

commercial multiple peril, financial guaranty, medical malpractice, workers compensation, other liability, fidelity, 

surety, any other risk other than life insurance. 

C 

reinsurance only. 

Title insurers 

$120,000 capital and $180,000 surplus. 

Life insurers: 

Stock: 

$2,500,000 capital and surplus with at least $l,OOO,OOO each in capital and surplus. 

Mutual: 

$l,00O,OOo surplus. 

Copyright NAK 1992 

113 
OKLAHOMA tit. 36 $4 610 to 612.2 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

13. 

Life and/or Accident and Health 

Property 

Marine 

Casualty 

Vehicle 

Surety 

Alien-Surety 

Title 

All Insurance Except Life, Surety and Title 

All Insurance Except Life and Title 

Workers’ Compensation 

Guaranteed Renewable A&H 

Additional Lines, per line 

Capital and 

3urnlUs 

500,000 

500,000 

500,000 

500,000 

500,000 

500,000 

500,000 

500,000 

500,000 

500,000 

5,000,000 

2,000,000 

(if licensed 

after 10/1/84); 

l,O00,000, if 

licensed before 

that date 

100,000 

Additional 

Expendable 

surolus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

50% of min. surplus 

1. All insurers not defined below: 1,000,000 

Additional when first authorized for any 

Certificate of Authority: 500,000 

2. Workers’ Compensation 3,000,000 

3. Mortgage 4,000,000 

4. Home Protection 10% aggregate 

premiums, not 

less than 

40,000 nor more 

than 1,OOO,OOO 

5. Title 500,000 

6. Health Care Service Contractors 250,000 min. 

500,000 min. ................................................................................................................................................... 

EE;”SYLVANU $3 40-5-106,40-37-101,40-59-102,40-61-105 

(a) Class of Business 

(1) Life, Variable Life, Variable Annuities 1,000,000 50% of capital 1,500,000 

(2) Life, Variable Life, Variable Annuities, 

Total (a) Authority 2,100,000 1,050,000 3,150,000 

Health and Disability 1.100.000 50% of caiul 1.650.000 

Pennsylvania continued on next page 

Copyright NAIC 1992 

114 
mYLVAU (cont.) 

CaDital - TQbl 

(b) Class of Business 

(1) Fire, Allied Lines 100,000 50,000 150,000 

(2) Inland Marine, Auto Physical Damage 100,000 50,000 150,000 

Total (b) Authority 400,000 200,000 600,000 

(3) Ocean Marine 200.000 100.000 300.000 

Minimum capital and surplus for any one (c) authority is at least $750,000 and $375,000, respectively. For any two or 

surplus must equal or exceed 50% of the minimum required capital. 

more classes of insurance, the capital must equal the greater of $750.0OQ or the of total reauired fo r each c lass; 

(c) Class of Business 

(1) Fidelity & Surety 

(2) Accident and Health 

(3) Glass 

(4) Other Liability including: 

professional liability, 

medical malpractice, etc. 

(5) Boiler & Machinery 

(6) Burglary & Theft 

(7) Credit 

(8) Water Damage 

(9) Elevator 

(10) Livestock 

(1 1) Auto Liability 

(12) Mine 

(1 3) Personal Property Floater 

(14) Workers' Compensation 

Total (c) Authority 

200,000 

50,000 

50,000 

50,000 

50,000 

50,000 

100,000 

50,000 

50,000 

50,000 

500,000 

50,000 

50,000 

750.000 

1,950,000 

100,000 

25,000 

25.000 

25,000 

25,000 

25,000 

50,000 

25,000 

25,000 

25,000 

250,000 

25,000 

25,000 

375.ooo 

975,000 

300,000 

75,000 

75,000 

75,000 

75,000 

75,000 

150,000 

75,000 

75,000 

75,000 

750,000 

75,000 

75,000 

1.125.ooo 

2,925,000 

Total (a), (b) & (c) Authority 4,450,000 2,225,000 6,675,000 

Mutual insurers issuing non-assessable policies must possess surplus equal to the capital required for stock insurers. 

11. Title Cow 

Must possess capital of at least $250,000 and surplus of at least $125,000. 

111. 

Life and Annuities 

Accident and Health 

Total 

1,000,000 500,000 1,500,000 

1,100,000 550,000 1,650,000 

100.000 50.000 150.000 

Mutual life insurers must have a guarantee capital, before commencing business, of not less than $500,000, and shall 

maintain unimpaired a policyholders surplus of $250,000 out of guarantee capital, surplus, or any combination thereof. 

Mutual life insurers authorized to issue variable annuity contracts, in addition to life and annuity contracts, must have a 

policyholders surplus of not less than $1,500,000. 

No additional amounts are required by stock life insurers for variable life and variable annuity authority; however, 

separate authorization must be sought for variable authority as contained in PA Code, Title 31, Chapters 82 and 85. 

Pennsylvania continued on next page 

Copyright NAIC 1992 

115 
PENNSYL VANU (cont.) 

NOTE; The above capital and surplus amounts are statutory minimums. The Insurance Commissioner has the discretion 

to require additional amounts. Because Section 503 of the Insurance Department Act requires insurers to maintain the 

minimum required capital and surplus unimpaired at all times, the Insurance Commissioner will require newlyincorporated insurers to demonstrate possession of surplus over the statutory minimum amount. The exact amount of 

additional surplus will be dependent upon the financial forecasts included in the insurer’s business plan. 

-TO RICQ 26 $5 309,310,312 

................................................................................................................................................... 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

11. 

12. 

Life* 

Disability* 

Life and Disability* 

Property 

Agricultural Only 

Marine and Transport 

Casualty 

Vehicle Only 

Surety and Fidelity 

Title* 

Mortgage Loans* 

All Lines but Life and Mortgage Loans 

500,000 

300,000 

800,000 

500,000 

must qualify for 

property 

500,000 

600,000 

500,000 

750,000 

500,000 

1,000,000 

1,000,000 

50% of capital 

50% of capital 

50% of capital 

50% of capital 

must qualify for 

Property 

50% of capital 

50% of capital 

50% of capital 

50% of capital 

50% of capital 

50% of capital 

50% of capital 

1. Domestic Insurers 

2. Foreign Insurers 

3. Monoline Companies 

1,000,000 2,000,000 3,000,000 

1,000,000 2,000,000 3,000,000 

2,000,000 capital and surplus ................................................................................................................................................... 

SOUTH CUOLINA $0 38-9-10, 38-9-20, 38-6-30 

Maintained 

nitial Surp lUS bd.!i!s 

1. Life 600,000 600,000 25% initial amount 

2. Accident and Health 600,000 600,000 25% initial amount 

3. Life, Accident and Health 1,200,000 1,200,000 25% initial amount 

4. Property 1,200,000 1,200,000 25% initial amount 

5. Casualty 1,200,000 1,200,000 25% initial amount 

6. Surety 1,200,000 1,200,000 25% initial amount 

7. Marine 1,200,000 1,200,000 25% initial amount 

8. Title 600,000 600,000 25% initial amount 

9. Multiple Lines 1,500,000 1,500,000 25% initial amount 

*. CaDital 

Stock: 

The Commissioner may require additional initial capital and surplus based on the type or nature of business transacted. 

Insurers licensed prior to 7/1/91 which do not meet the minimum requirements shown, must maintain at least the capital 

shown on 1990 annual statement and surplus in an amount of at least 25% of that amount. 

South Carolina continued on next page 

Copyright NAIC 1992 

116 
SOUTH CAROLINA (cont.) 

Mutual: 

1. Life 1,200,000 

2. Accident and Health 1,200,000 

3. Life, Accident and Health 2,400,000 

4. Property 2,400,000 

5. Casualty 2,400,000 

6. Surety 2,400,000 

7. Marine 2,400,000 

8. Title 1,200,000 

9. Multiple Lines 3,000,000 

Mutual insurers maintained surplus must be equal to the sum of capital and maintained surplus of a licensed stock 

insurer. 

The Commissioner may require additional initial surplus based on the type or nature of business transacted. 

Insurers licensed prior to 7/1/91 which do not meet the minimum requirements shown, must maintain at least the capital 

shown on 1990 annual statement and surplus in an amount of at least 25% of that amount. ................................................................................................................................................... 

SOUTHD- 00 58-6-23,58-6-25 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

Life 

Domes tic 

Foreign 

Health 

Domestic 

Foreign 

Life and Health 

Domes tic 

Foreign 

Property 

Casualty with Workers' Compensation 

without Workers' Compensation 

Marine and Transportation 

Surety 

Title 

Multiple Lines 

CaDital 

200,000 

300,000 

200,000 

300,000 

400,000 

400,000 

200,000 

300,000 

200,000 

200,000 

200,000 

200,000 

400,000 

3lJlIiu 

300,000 

350,000 

300,000 

350,000 

400,000 

425,000 

300,000 

350,000 

300,000 

300,000 

300,000 

300,000 

400,000 

1. All Insurers 1,000,000 1,000,000 

2. Reinsurance Only - Credit Life andor 

Accident and Health 150,000 50% of capital 

................................................................................................................................................... 

Copyright NAIC 1992 

117 
TEXAS Arts. 2.02, 3.02, 3.22, 15.04, 21.43,21.44 

cas!ml s!KPJu 

1. Companies Other Than Life, Accident or 

Health 1,000,000 1,000,000 

2. Life and/or Accident and/or Health 700,000 700,000 

3. Foreign Mutual - Cyclone, Tornado, Hail 

and Storm Insurance 2,000,000 

By 12/31/92, company's capital must be increased by at least 10% of the difference between the minimum capital level 

required for a newly incorporated company and the company's capital on December 31, 1991. 

By 12/31/93, company's capital must be increased by at least 20% of the difference between the minimum capital level 

required by a newly incorporated company and the company's capital on December 3 1, 1991. 

By 12/31/94, increase by at least 30%. 

By 12/31/95, increase by at least 40%. 

By 12/31/96, increase by at least 50%. 

By 12/31/97, increase by at least 60%. 

By 12/31/98, increase by at least 70%. 

By 12/31/99, increase by at least 80%. 

By 12/31/2000, increase by at least 90%. 

By 12/31/2001, same as for new company. 

The board may adopt rules, regulations and guidelines requiring.any company incorporated under this article and any 

admitted alien or foreign insurer to maintain capital and surplus levels in excess of the statutory levels required by this 

article based upon nature, type and volume of risks, company's portfolio, and company's reserves. ................................................................................................................................................... 

UTM $0 31A-5-211,31A-17-302,31A-6-204,31A-7-201,31A-9-209,31A-14-205 

Capital (Stock) 

or Surplus Compulsory 

fMuuau - 

1. 

*2. 

*3. 

*4. 

*5 * 

*6. 

*7. 

*8. 

9. 

10. 

11. 

12. 

Life, Annuity, Disability or and 

combination 

Property 

Surety 

Bail Bonds Only 

Marine and Transportation 

Vehicle Liability 

Liability 

Workers' Compensation 

Title 

Professional Liability, excluding Medical 

Malpractice 

Professional Liability, including Medical 

Malpractice 

Multiple Lines, except life, annuity or title 

400,000 (See note #) 

200,000 

300,000 

100,000 

200,000 

400,000 

600,000 

300,000 

200,000 

700,000 

1,000,000 

2,000,000 

*Subject to an aggregate of $l,000,OOO capital for more than one of these lines. 

Assessable Mutuals: shall not issue life or annuities; need not have a permanent surplus if policyholder assessment 

liability is unlimited; compulsory surplus is equal to that required of an insurer in compliance with the code. 

Utah continued on next page 

Copyright NAIC 1992 

118 
UTAH (cont.) 

## Compulsory Surplus: the greater of 

a. 75% minimum capital; or 

b. net total of $SO per $1,OOO life insurance amount at risk, plus 10% disability premiums earned, plus 

3 1/2% annuity reserves, plus 15% net workers' compensation and other liability premiums earned, plus 

20% medical malpractice premiums earned, plus 10% net premiums earned on lines of insurance not set 

forth, plus 5% admitted value of common stocks and real estate, plus 2% admitted value of all other 

invested assets (some exclusions apply), less any mandatory security valuation reserve being 

maintained, and less minimum required capital (or permanent surplus) required. 

Stock Insurers: 

Commence 

All Insurers Seeking to 

Business After 7/1/91 

Prior to 7/1/91 

2,000,000 3,000,000 

250,000 150,000 

Ehcsudu 

Mutual Insurers: 

Commencing Business After 

7/1/91 2,000,000 3,000,000 

Prior to 7/1/91 250,000 150,000 

rementa: 

1. Life 

2. Disability 

3. Life and Disability 

4. Property 

5. Marine and Transportation 

6. Vehicle Only 

7. General Casualty 

8. Surety 

9. Bail Bonds Only 

10. All Lines but Life and Title 

CaDital 

100,000 

100,000 

125,000 

200,000 

250,000 

200,000 

300,000 

100,000 

25,000 

450,000 

Sumlus 

50,000 

25,000 

75,000 

50,000 

150,000 

100,000 

150,OOO 

400,000 

25,000 

250,000 

Virgin Islands continued on next page 

Copyright NAIC 1992 

119 
YIBGIN ISLANDS (cont.) 

CaDital 

Additional Capital Requirements: 

A. Authorized for Disability: 

Property 

Vehicle 

General Casualty 

Marine and Transportation 

Surety 

Bail Bond 

Fidelity 

Disability 

Vehicle 

General Casualty 

Marine and Transportation 

Surety 

Bail Bond 

Fidelity 

Disability 

Property 

General Casualty 

Marine and Transportation 

Surety 

Bail Bond 

Fidelity 

D. Authorized for General Casualty: 

Disability 

Property 

Vehicle 

Marine and Transportation 

Surety 

Bail Bond 

Fidelity 

Disability 

Property 

Vehicle 

General Casualty 

Surety 

Bail Bond 

Fidelity 

Disability 

Property 

Vehicle 

General Casualty 

Marine and Transportation 

Bail Bond 

Fidelity 

B. Authorized for Property: 

C. Authorized for Vehicle: 

E. Authorized for Marine and Transportation: 

F. Authorized for Surety: 

Virgin Islands continued on next page 

150,000 

150,000 

200,000 

250,000 

250,000 

50,000 

50,000 

50,000 

100,000 

150,000 

100,000 

150,000 

50,000 

50,000 

50,000 

100,000 

100,000 

100,000 

150,000 

50,000 

50,000 

none 

50,000 

none 

50,000 

50,000 

25,000 

none 

50,000 

50,000 

50,000 

100,000 

100,000 

25,000 

50,000 

50,000 

50,000 

50,000 

50,000 

50,000 

none 

none 

Copyright NAIC 1992 

120 
VIRGIN ISLANDS (cont.) 

G. Authorized for Bail Bond: 

Disability 

Property 

Vehicle 

General Casualty 

Marine and Transportation 

Surety 

Fidelity 

CaDital 

100,000 

200,000 

200,000 

275,000 

225,000 

250,000 

50,000 

CaDital surlzlu 

New Ins-: 

1. All Stock Insurers 1,000,000 3,000,000 

2. Assessable Mutual Insurers 1,600,000 

4. Nonassessable Mutual Insurers Authorized 

3. Nonassessable Mutual Insurers 2,000,000 

After 6/30/9 1 4,000,000 

Paid-In (Stock) Capital 

or Basic Surplus Additional 

(Mutual) sul2lus 

Before 7/1/91: 

1. Life 

2. Disability 

3. Life and Disability 

4. Property 

5. Marine and Transportation 

6. General Casualty 

7. Vehicle 

8. Surety 

9. Any Two of the Following: Property, 

Marine and Transportation, General 

Casualty, Vehicle, Surety, or Disability 

10. Multiple Lines (all but Life and Title) 

1,000,000 

1,000,000 

1,200,000 

1,000,000 

1,000,000 

1,200,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,200,000 

1,000,000 

1,000,000 

1,200,000 

1,000,000 

1,000,000 

1,5OO,OOO 1,500,OOO 

1,500,000 1,500,000 

Washington continued on next page 

Copyright NAIC 1992 

121 
WASHINGTON (cont.) 

On or After 7/1/91: 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

Life 

Disability 

Life and Disability 

Property 

Marine and Transportation 

General Casualty 

Vehicle 

Surety 

Any Two of the Following: Property, 

Marine and Transportation, General 

Casualty, Vehicle, Surety, or Disability 

Multiple Lines (all but Life and Title) 

Paid-In (Stock) Capital 

or Basic Surplus Additional 

fMU& SuIDlUs 

2,000,000 

2,000,000 

2,400,000 

2,000,000 

2,000,000 

2,400,000 

2,000,000 

2,000,000 

3,000,000 

3,000,000 

2,000,000 

2,000,000 

2,400,000 

2,000,000 

2,000,000 

2,400,000 

2,000,000 

2,000,000 

3,000,000 

3,000,000 ................................................................................................................................................... 

WEST VIRGINIA $0 33-3-5a, 33-3-5b, 33-24-10 

Minimum Capital 

(stock insurer) 

or Surplus 

lor to 3/10/9Q: 

1. Life 750,000 2,000,000 

2. Accident and Sickness 750,000 2,000,000 

3. Life, Accident and Sickness 1,000,000 2,000,000 

4. Fire and Marine 250,000 2,000,000 

5. Casualty 250,000 2,000,000 

6. Surety 600,000 2,000,000 

Fire and Marine and/or Casualty 450,000 2.000,000 

8. Fire and Marine and Casualty 500,000 2,000,000 

and Marine, and/or Casualty 750,000 2,000,000 

7. Accident and Sickness with: 

9. Surety with Accident and Sickness, Fire 

Insurers authorized under prior law have until 1/1/93 to meet requirements below. 

................................................................................................................................................... horized On or After 3/10/9Q: 1,000,000 1,000,000 2,000,000 

CaDital surolus - 

WISCONSIN 0 611.19 

Minimum Capital 

(stock insurer) 

or Surplus 

1. 

2. 

All Stock and Nonassessable Mutual 

Insurers 

Assessable Mutuals: 

Initial Minimum 

Assessment Unlimited 

Assessment Limited 

2,000,000 50% of minimum 

100,000 

none 

reduced to 

reasonable 

amount 

Copyright NAIC 1992 

122 
WYOMING $0 26-3-108 to 26-3-1 10,26-24-109 

1. Life 

2. Disability 

3. Life and Disability 

4. Property 

5. 

6. 

7. Marine and Transportation 

8. 

9. Title 

Casualty without Surety or W.C. 

Casualty with Surety and W.C. 

Multiple Line (property and any 

additional kind) 

Reciprocals - and Foreign 

Domestic 

Mutuals Mutuals 

CaDital slJ.rdu- suI731us 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

1,000,000 

2,000,000 

500,000 

500,000 

500,000 

1,000,000 

1,000,000 

1,000,000 

1,500,000 

1,000,000 

2,000,000 

250,000 

1,500,000 150,000 

1,500,000 150,000 

2,000,000 

2,000,000 200,000 

2,000,000 200,000 

2,500,000 250,000 

2,000,000 

4,000,000 

The commissioner may require additional capital and surplus based on types, volume, and nature of insurance business 

transacted. 

................................................................................................................................................... 

Every attempt has been made to provide correct and complete information. The reader should consult the statutes of the specific states to ascertain all applicable requirements. 

NAIC 

9/17/92 

w:\charts\company\capsurp2 

Copyright NAIC 1992 

123 
124 
Appendix B 

Financial Regulation Standards 

and Accreditation Program 

National Association of Insurance Commissioners 

June 19,1992 

0 NAlC 1992 

125 
INTRODUCTION 

A system of effective solvency regulation has certain 

basic components. It requires that regulators have adequate statutory and administrative authority to regulate 

an insurer’s corporate and financial affairs. It requires 

that regulators have the necessary resources to cam out 

that authority. Finally, it requires that insurance departments have in place organizational and personnel practices designed for effective regulation. 

To guide state legislatures and state insurance departments in the development of effective solvency regulation, the NAIC began, in 1988, the process which led to 

the adoption of the NAIC Financial Regulation Standards 

in June 1989. These standards, discussed in greater detail 

below, establish minimum requirements for an effective 

regulatory system in each state. 

In order to provide guidance to the states regarding 

the minimum standards and an incentive to put them in 

place, the NAIC adopted in June 1990 a formal certification program. Under this plan, each state’s insurance department will be reviewed by an independent review team 

whose job it is to assess that department’s compliance with 

the NAIC Financial Regulation Standards. Departments 

meeting the NAIC Standards will be publicly acknowledged, 

while departments not in compliance will be given guidance 

by the NAIC to bring the department into compliance. 

Furthermore, beginning in Janualy 1994, accredited states 

will not accept reports of zone examinations from unamedited states except under limited circumstances, providing 

further impetus for states to adopt the minimum standards. 

It is likely that states will pass similar provisions to act as 

incentives for state insurance departments to become accredited. For example, a state may decide not to license a 

company domiciled in a non-accredited state. 

To help states assess their compliance with the standards, the NAIC has performed a review of each state’s 

laws and regulations addressing insurer insolvency, in order to alert states to differences between the NAIC models that are a part of the Financial Regulation Standards 

and each state’s statutes and regulations. 

Thirteen states-Colorado, Florida, Illinois, Iowa, 

Kansas, Minnesota, New York, North Carolina, North 

Dakota, Ohio, South Carolina, Virginia, and Wisconsinhave undergone the formal certification process and have 

been accredited as being in compliance with the Financial 

Regulation Standards. Additional states will be reviewed 

in the second half of 1992. 

HOW THE ACCREDITATION PROGRAM WORKS 

The NAIC accreditation program establishes minimum requirements under which a state insurance department may seek initial accreditation. Additionally, the Program establishes guidelines for states already accredited 

to maintain that accreditation over time. 

2. 

3. 

4. 

5. 

6. 

7. 

8. 

9. 

10. 

17 

Initial Accreditation Review 

1. State requests an accreditation review by contacting 

the Support and Services Office (SSO) of the NAIC. 

NAICISSO confirms with the state that the Financial 

Regulation Standards Self-Evaluation Guide on file 

at the SSO is current and complete or requests the 

state to submit an updated Self- Evaluation Guide. 

NAICISSO notifies the Financial Regulation Standards and Accreditation Committee (FRSAC) that 

the state has requested an accreditation review and 

provides FRSAC with a list of qualified Review Team 

candidates, comprised of experts in insurance regulation with no present ties to either the industry or an 

insurance department. 

FRSAC selects the Review Team and the Review 

Team Leader from the qualified list. The Review 

Team consists of three to six individuals, depending 

on the size of the state. At least one of the Review 

Ram members is required to be a disinterested former executive level regulator. 

NAICISSO notifies the state of the Review Team selected by the FRSAC. 

NAICISSO notifies the Review Team members.The 

Review Team members are paid by the NAIC/SSO at 

a set hourly rate for the time plus reasonable actual 

expenses incurred. 

NAIC/SSO works with the state to schedule the site 

visit and notifies the Review Team of the timing. Generally, a site visit takes three to five days, depending 

on the sue of the state. 

NAICISSO sends copies of the state’s completed Fi- nancial Regulation Standards Self-Evaluation Guide 

plus any applicable supporting documentation and 

the NAIC/SSO staff’s synopsis of the Self-Evaluation 

Guide and detailed review of the Laws and Regulations section including any concerns and potential 

problems to each Review Team member to enable the 

Review Team to plan and prepare for the site visit. 

NAIC/SSO notifies the state of the data, other information, and interview needs of the Review Team for 

their on-site review. 

Review Team performs the on-site review following a 

general outline of procedures to be performed to al- low for uniformity among the site visits at the differ- ent states. In addition, an NAIC/SSO representative 

is an observer on each site visit to help ensure uniformity and consistency in each on-site review. Before 

the on-site review, there is an initial meeting of the 

team members to discuss comments and concerns 

from review of the Financial Standards Self-Evaluation Guide and supporting documentation and the 

NAIC staff’s synopsis of the Self- Evaluation Guide. 

The on-site review consists of the following: 

a. Interviews with department personnel. 

b. Review of laws and regulations. 

c. Review of prior examination reports and supporting work papers and analytical reviews. 

126 
12. 

d. Inspection of regulatory files for selected companies. 

e. Review of organizational and personnel policies. 

f. Walk-through of the department to gain an understanding of document and communication flows. 

g. Meeting of the team members to discuss com- ments and findings from the review. 

h. Closing conference with the state to discuss findAs a result of the site visit, a report is prepared by the 

Review Team and submitted to the FRSAC by the 

Team Leader. The report summarizes the scope of 

the procedures performed during the site visit, documents the findings on an exception basis, highlights 

major recommendations as a result of the review, and 

concludes with an opinion of the Review Team as to 

whether the Team believes that the state should be 

accredited by the FRSAC. 

ings. 

13. FRSAC meets to discuss the Review Team’s report. 

FRSAC also has copies of the state’s Financial Regulation Standards Self-Evaluation Guide and supporting documentation available. In addition, the Review 

Team and/or the Team Leader is present at the meeting as needed. The NAIUSSO representative who 

served as an observer on the on-site review also attends the meeting. 

14. As a result of this meeting, the FRSAC makes a decision whether or not the state should be accredited. Except in unusual circumstances, the recommendations of 

the review team will be adopted by the FRSAC. 

15. FRSAC informs the state of its decision. If the decision is favorable, the state receives an accreditation 

award at the next scheduled NAIC national meeting, 

and a press release acknowledging the accreditation 

will be issued. If the decision is unfavorable, the state 

has three options: withdraw the request for accreditation; ask FRSAC to hold its decision in abeyance 

pending legislative or other corrective action to bring 

the state into compliance with the standards; or ask 

the FRSAC to reconsider the decision. 

16. If the state requests reconsideration, FRSAC meets 

to hear the state’s appeal. As a result of this meeting, 

FRSAC makes a final decision regarding whether to 

accredit the state and inform the state of the decision. 

Interim Annual Reviews 

1. Annually, on the first four anniversaries of the state’s 

accreditation, the state shall submit updated Financial Regulation Standards Self-Evaluation Guides 

along with a report which summarizes the changes 

from the prior year to the NAIC/SSO. 

2. The state’s report in the first interim year after accreditation shall also respond to all recommendations 

made in the Review Team’s report which was prepared during the accreditation process. 

NMC/SSO will review the documentation submitted 

by the state and summarize for presentation to 

FRSAC. 

After hearing the report from the NAIC/SSO, 

FRSAC will determine whether the state still complies with the financial regulation standards. (FRSAC 

can request that a representative of the state be present to answer questions, if desired.) 

If FRSAC finds the state to be in non-compliance 

with the financial regulation standards, the specific 

reasons would be documented in a letter to the state 

and the accreditation would be revoked. 

On the fifth anniversary of the state’s accreditation, 

the state would be subject to a full accreditation review following the steps outlined for an initial accreditation review above. 

3. 

4. 

5. 

6. 

A CLOSER LOOK 

AT THE MINIMUM STANDARDS 

The financial regulation standards have been divided 

into three major categories: laws and regulations; regulatory practices and procedures; and organizational and 

personnel practices. 

Laws and Regulations 

1. Examination Authority 

The department should have authority to examine companies whenever it is deemed necessary. Such authority 

should include complete access to the company’s books 

and records and, if necessary, the records of any affiliated 

company, agent, and/or managing general agent. Such authority should extend not only to inspect books and records but also to examine officers, employees, and agents 

of the company under oath when deemed necessary with 

respect to transactions directly or indirectly related to the 

company under examination. 

18. If FRSAC concludes that the state should not be accredited, the specific reasons are documented in a report to the state. 

3. 

The department should require that all companies reportNAIC Accounting Practices and Procedures 

127 
ing to the department file the appropriate NAIC annual 

statement blank which should be prepared in accordance 

with the NAIC’s instructions handbook and follow those 

accounting procedures and practices prescribed by the 

NAIC’s Accounting Practices and Procedures Manual. 

4. Corrective Action 

State law should contain the NAIC’s Model Regulation to 

Define Standards and Commissioner’s Authority for Companies Deemed to be in a Hazardous Condition or a substantially similar provision which authorizes the department 

to order a company to take necessary corrective action or 

cease and desist certain practices which, if not corrected, 

could place the company in a hazardous financial condition. 

5. Valuation of Investments 

The department should require that securities owned by 

insurance companies be valued in accordance with those 

standards promulgated by the NAIC’s Valuation of Securities Office. Other invested assets should be required to 

be valued in accordance with the procedures promulgated 

by the NAIC’s Financial Condition (EX4) Subcommittee. 

6. Holding Company Systems 

State law should contain the NAIC Model Holding Company Systems Act or an Act substantially similar, and the 

department should have adopted the NAIC’s model regulation relating to this law. 

7. Risk Limitation 

State law should prescribe the maximum net amount of 

risk to be retained by a property and liability company for 

an individual risk based on the company’s capital and surplus which should be no larger than 10 % of the company’s 

capital and surplus. 

8. Investment Regulations 

State statute should require a diversified investment portfolio for all domestic insurers both as to type and issue and 

include a requirement for liquidity. 

9. Admitted Assets 

State statute should describe those assets which may be 

admitted, authorized, or allowed as assets in the statutory 

financial statement of insurers. 

10. Liabilities and Reserves 

State statute should prescribe minimum standards for the 

establishment of liabilities and reserves resulting from insurance contracts issued by an insurer; including, life reserves, active life reserves, and unearned premium reserves and liabilities for claims and losses unpaid and 

incurred but not reported claims. 

11. Reinsurance Ceded 

State law should contain the NAIC Model Law on Credit 

for Reinsurance and the Model Regulation for Life Reinsurance Agreements or substantially similar laws. 

12. CPA Audits 

State Statute or regulation should contain a requirement for annual audits of domestic insurance companies by independent certified public accountants, such as 

contained in the NAIC’s Model Requiring Annual Audited Financial Reports. 

13. Actuarial Opinion 

State statute or regulation should contain a requirement 

for an opinion on life and health policy and claim reserves 

and property and liability loss and loss adjustment expense reserves by a qualified actuary or specialist on an 

annual basis for all domestic insurance companies. 

14. Receivership 

State law should set forth a receivership scheme for the 

administration, by the insurance commissioner, of insurance companies found to be insolvent as set forth in the 

NAIC’s Model Law on Supervision, Conservation, Rehabilitation, and Liquidation. 

15. Guaranty Funds 

State law should provide for a statutory mechanism, such 

as that contained in the NAIC’s model acts on the subject, 

to ensure the payment of policyholders’ obligations subject to appropriate restrictions and limitations when a 

company is deemed insolvent. 

16. Other 

i) State Statute should contain a provision similar to the 

NAIC Model Act requiring domestic insurance companies to participate in the NAIC Insurance Regulatory Information System (IRIS). 

ii) State law should contain a provision similar to the 

NAIC’s Model Risk Retention Act for the regulation 

of risk retention groups and purchasing groups. 

iii) State statute should contain the NAIC’s Model Law 

for Business Transacted with Producer Controlled 

PropertyKasualty Insurer Act or a similar provision. 

This Model was amended in June 1991 and will not be 

required for accreditation until June 1993. 

17. Recent Additions to the Standards 

In December 1990, the NAIC added to the original list of 

Financial Regulation Standards three additional standards: 

i) Managing General Agents 

State law should contain the NAIC Managing General 

Agents Act or an Act substantially similar. 

ii) Reinsurance Intermediaries 

State law should contain the NAIC Reinsurance Intermediaries Act or an Act substantially similar. 

iii) Examinations 

State law should contain the NAIC Model Law on 

Examination or an Act substantially similar. 

States will have two years from the date of adoption by 

the NAIC to comply with these new standards (see 

“Evolving Standards: The Impact of Changes in the Fi128 
nancial Regulation Standards,” page 11, for procedures 

for revising standards). 

examination such as determinations of the NAIC 

IRIS Examiner Team. 

I 

I 

I 

‘ 

~ 

! 

! 

I 

! 

I 

I 

, 

i 

! 

I 

i 

! 

1. 

0 

ii) 

Regulatory Practices and Procedures 

Financial Analysis 

Department should have a sufficient staff of financial 

analysts with the capacity to effectively review the financial statements as well as other information and 

data to discern potential and actual financial problems of domestic insurance companies. 

Department should have an intra-department communication and reporting system that assures that all 

relevant information and data received by the department which may assist in the financial analysis process 

is directed to the financial analysis staff. 

vi) The department’s procedures require that all exami- nation reports which contain material adverse find- ings be promptly presented to the Commissioner or 

his or her designee for determination and implementation of appropriate regulatory action. 

vii) The department’s reports of examination should be 

prepared in accordance with the format adopted by 

the NAIC and should be sent to other states in which 

the company transacts business in a timely fashion. 

3. Other 

The department should generally follow and observe the 

procedures set forth in the NAIC’s Troubled Insurance 

Company Handbook regarding domestic insurance com- oanies identified as troubled, including communication to 

G) The internal financial analysis process should provide ihe insurance departments &I jurisdiEtions in which the 

carrier transacts business. for levels of review and reporting. 

iv) The financial analysis procedure should be priority 

based to ensure that potential problem companies are 

Organizational and Personnel Practices 

reviewed promptly. Such a prioritization scheme 

should utilize the NAIC’s Insurance Regulator Information System and/or a state’s own system. 

2. Financial Examinations 

i) The department should have the resources to examine all domestic companies on a periodic basis 

which is commensurate with the financial strengths 

and position of the insurer. 

ii) The department’s examination staff should consist of 

a variety of specialists with training and/or experience 

in the following areas or otherwise available qualified 

specialists which will permit the department to effectively examine any insurer: computer audit specialist, 

reinsurance specialist, life and health company examiners, property and liability examiners, life and 

health actuarial examiners, property and liability actuarial examiners, and property and liability claims 

examiners. 

1. Professional Development 

The department should have a policy which requires the 

professional development of staff through job-related 

college courses, professional programs, and/or other 

training programs which are funded by the department. 

2. Organization 

All financial regulation and surveillance activities are the 

responsibility of an individual who shall report to the 

Commissioner or his or her designee. 

3. Evaluation of Staff 

The department’s staff and contractual staff involved in 

financial regulation and surveillance should all be periodically evaluated by the department to ensure that job duties and responsibilities are being discharged in a satisfactory manner. 

4. Minimum Educational and Experience Requirements 

The department should establish minimum educational 

and experience requirements for all professional employees and contractual staff positions in the financial surveillance and regulation area which are commensurate 

iii) The department’s procedures for examinations shall 

provide for supervisory review within the department 

Of examination work papers and 

orooriate and comolete and that the examination was 

to 

that the examination procedures and are ap- with the duties and responsibilities of the position. 

‘conhucted in an eificient and timely manner. 5. Pay Structure 

and procedures for examhations should follow those that are set forth in the 

NAIC’s Examiners Handbook. 

iv) ne department’s The department’s pay structure for those positions involved 

with financial surveillance and regulation should be competitively based to attract and retain qualified personnel. 

’c r) In scheduling financial examinations, the department 6* Funding 

should follow those procedures set forth in the 

NAIC’s Examiners Handbook. The schedule should 

provide for the periodic examination of all domestic 

companies on a timely basis. This system should accord priority to companies which are having adverse 

financial trends or otherwise demonstrate a need for 

The department’s funding should be sufficient to allow 

for the financial surveillance and regulation staff’s participation as appropriate in the meetings and training sessions of the NAIC and meetings relating to the review, 

coordination, and the development and implementation 

of action for troubled insurers. 

129 
Evolving Standards: 

The Impact of Changes 

in the Financial Regulation Standards 

As insurance industry practices evolve, so must solvency 

regulation. In recognition of this, the NAIC has anticipated 

that the original Financial Regulation Standards, outlined 

above, would not be static, but would be changed from time 

to time. The Accreditation Program reflects this concept by 

allowing for additional minimum standards. In the event additional standards are established by the NAIC, state insurance departments seeking to acquire or retain ameditation 

will have two years from the date of the NAIC established 

the new standards to implement them. 

In December 1991, the NAIC adopted formal procedures to encourage input from public officials, consumers, 

academics, and industry representatives in the process 

when making changes in the NAIC’s Financial Regulation Standards and Accreditation Program. 

The procedures identify four ways in which the solvency standards may be modified: 

1. The development of new models; 

2. Amendments to existing models already included in 

the standards; 

Addition of more or more specific requirements in 

any part of the standards; or 

Modification of current requirements already generically included in the standards, such as modification 

of the Annual Statement Blank required tobe filed by 

all companies. 

The procedures for the development of a new model 

that the Executive Committee foresees will be considered 

for incorporation into the standards and amendments to 

models already included in the standards are much the 

same. In both cases, the Executive Committee, either 

upon request or of its own initiative, will make note of the 

potential impact on the standards in its charge to the panel 

responsible for the development of the model. The panel 

will then give notice to all insurance regulators, the National 

Conference of State Legislatures (NCSL), National Governors’ Association (NGA), National Conference of Insurance 

Legislators (NCOIL), and others, both of the potential 

change in standards and of meeting times and places. 

Once the new or amended model is received by the 

Executive Committee, it will be referred to the Financial 

3. 

4. 

Regulation Standards and Accreditation Committee 

(FRSAC) for a recommendation on whether the model is 

appropriate for inclusion in the standards. 

Should any member of the NAIC or FRSAC propose 

additional requirements in parts A, B, or C of these standards, initial review of that proposal will be conducted by 

FRSAC, and the procedure for notice to and participation 

by public officials and members of the public shall be the 

same as for other changes in the standards. 

WHAT THE FUTURE HOLDS: 

A STRONG SYSTEM 

OF SOLVENCY REGUMTION 

In its present state, the regulation of the insurance 

industry for solvency stands as a unique example of how a 

national regulatory system can be built with its foundation at 

the state, not federal, level. The strength of that system 

resides in the interdependence of independent state regulators, each responsible to his or her own constituency, yet 

jointly responsible for the financial health of an entire industry. State insurance regulators, not content to rest on 

historic success of the current regime, have devised, in the 

Financial Regulation Standards Accreditation Program, a 

powerful means of achieving the necessary degree of uniformity among states without sacrificing the multi-state 

diversity that has been instrumental to that success. At 

this writing, state legislatures and insurance departments 

across the nation are moving at an unprecedented pace to 

bring their respective solvency regulation into compliance 

with the NAIC’s standards. In fact, in 1991 alone, 42 states 

adopted legislative packages designed to bring their departments of insurance into compliance with the Financial Regulation Standards. Four other states and the District of Columbia considered similar packages. 

This flurry of legislative and administrative activity 

runs counter to the prediction of some critics of the Accreditation Program that the incentives for compliance 

with the standards would prove to be inadequate to motivate legislatures and insurance departments to upgrade 

their solvency regulation approach. As can be seen from 

this activity, the blend of peer pressure among state regulators, political support from multi-state domestic insurers, the sanction imposed by the new Model Law on Examination (see discussion at Page l), and the likelihood of 

the future adoption of even more severe incentives, has 

proven to be a potent force in encouraging legislators and 

regulators to strive to attain the NAIC’s standards. 

130 
Other ACIR Publications 

Federal Statutory Preemption of State and Local Authority: Histo- Inventoa and Issues. A.121. 1992 ... $10.00 

Changing Public Attitudes on Governments and Taxes-1992. S.21. 1992 ........................... $10.00 

Significant Features of Fiscal Federalism. 1992 Edition. Volume I. M.180. 1992 ...................... $20.00 

Volume 11. M.180.11. 1992 ................................................................. $22.50 

Toward a Federal Infrastructure Strategy: Issues and Options. A.120. 1992 ......................... $10.00 

Medicaid: Intergovernmental mends and Options. A.119. 1992 .................................... $10.00 

Local Boundary Commissions: Status and Roles in Forming. Adjusting and Dissolving 

Local Government Boundaries. M.183. 1992 ................................................. $8.00 

Characteristics of Federal Grant-in-Aid Programs to State and Local Governments: 

Grants Funded FY 1991. M.182. 1992 ...................................................... $10.00 

Metropolitan Organization: The Allegheny County Case. M.181. 1992 ................................ $10.00 

State Taxation of Interstate Mail Order Sales. M.179.1992 ....................................... $10.00 

The Changing Public Sector: Shifts in Governmental Spending and Employment. M.178. 1991 ........ $15.00 

Coordinating Water Resources in the Federal System: The Groundwater-Surface Water Connection. 

A.118. 1991 ............................................................................. $15.00 

Interjurisdictional Tax and Policy Competition: Good or Bad for the Federal System? M.177. 1991 .... $10.00 

State-Local Relations Organizations: The ACIR Counterparts. A.117. 1991 ......................... $10.00 

The Structure of State Aid to Elementary and Secondary Education. M.175. 1990 ................... $10.00 

Representative Expenditures: Addressing the Neglected Dimension of Fiscal Capacity, M.174. 1990 ....... $20.00 

Mandates: Cases in State-Local Relations. M.173. 1990 .......................................... $10.00 

State Constitutional Law Cases and Materials. M.159S. 1990 ..................................... $30.00 

Intergovernmental Regulation of Telecommunications. A.115. 1990 ................................ $10.00 

1988 Fiscal Capacity and Effort. M.170. 1990 ................................................... $20.00 

Local Revenue Diversification: 

$8.00 

$8.00 

$5.00 

$5.00 

State Taxation of Banks: Issues and Options. M.168.1989 ........................................ $10.00 

State Regulation of Banks in an Era of Deregulation. A.110. 1988 .................................. $10.00 

State Constitutions in the Federal System: Selected Issues and Opportunities for State Initiatives. 

Residential Community Associations: 

Rural Economies. 93.13. 1990 ............................................................. Local Sales Taxes. SR.12. 1989 ............................................................. Local Income Taxes. SR.lO. 1988 ........................................................... User Charges. SR.6. 1987 ................................................................. 

A.113. 1989 .............................................................................. $15.00 

Private Governments in the Intergovernmental System? A.112. 1989 ........................... $10.00 

Questions and Answers for Public Officials. M.166. 1989 ....................................... $5.00 

and Architectural Barrier Removal. A.111. 1989 ............................................. $10.00 

Disability Rights Mandates: Federal and State Compliance with Employment Protections 

Assisting the Homeless: State and Local Responses in an Era of Limited Resources. M.161. 1988 ..... $10.00 

Devolution of Federal Aid Highway Programs: Cases in State-Local Relations and Issues in State Law. 

Devolving Selected Federal-Aid Highway Programs and Revenue Bases: A Critical Appraisal. 

M.160. 1988 .............................................................................. $5.00 

A.108. 1987 .............................................................................. $10.00 

1 The Organization of Local Public Economies. A.109. 1987 ........................................ $5.00