When an insurance company is declared insolvent it goes through a process similar to a company in bankruptcy. Creditors, including insured policyholders with claims, can present proof of debt to the trustee. The trustee locates all assets of the liquidated insurance company, establishes a priority of claims, and uses the available funds to pay those claims. If little or no assets exist, the parties that have submitted proof of debt will not receive any funds. For example, when Executive Life Insurance was seized by the California State Insurance Commissioner, people with guaranteed insurance annuity policies saw their payout cut in half.
Policyholders are at risk with a failed insurance company in several ways.
First, they no longer have insurance coverage and are out the premium they paid. Second, should a claim against them be filed, the insurance company is no longer able to hire legal counsel to defend the insured in a lawsuit. Third, should a claim be awarded against the former insured, the insured party will have to pay the award out of their pocket. That places the person, who paid the premium at risk for claims pending and claims yet to be filed. With claims yet to be filed the balloonist may not be aware that there is a potential risk.