The Guaranty Fund System: A Vital Safety Net

Suzanne Sahakian

Property/casualty guaranty funds were created by state statutes beginning in the late 1960s to protect the public against financial losses to policyholders and claimants as a result of property and casualty insurance company insolvencies.

Each of the 50 states, plus the District of Columbia, Puerto Rico and the Virgin Islands, has a property/casualty guaranty fund or association comprised of member insurance companies licensed to do business in that state. The guaranty fund system serves as a limited but vital safety net by paying claims of policyholders and claimants that qualify as “covered claims” under the guaranty fund statutes.

When do guaranty funds get involved?

Generally, guaranty funds are triggered by an order of liquidation with a finding of insolvency. The triggering language is usually found in each statute’s definition of an insolvent insurer. Once triggered, the guaranty funds become obligated to handle covered claims of residents in their states and have the same rights as the insolvent insurer would have had if not in receivership, for example, to appear in court and to investigate, defend and settle covered claims.

How are guaranty funds funded?

Guaranty funds assess their member insurance companies based on a percentage of the net direct premiums written in the state in particular covered lines of insurance for the preceding calendar year. The statutes in Illinois, Iowa, Kansas, Minnesota, North Dakota, South Dakota, and Wisconsin cap their maximum annual assessments for each covered line of insurance at 2 percent; Ohio has an assessment cap of 1.5 percent; and Indiana, Michigan, Missouri and Nebraska set maximum annual assessments at 1 percent. In addition to assessments, guaranty funds may receive early access payments from insolvent estates and are entitled to estate distributions for the reimbursement of claims handling expenses and loss payments.

What claims do guaranty funds cover?

Guaranty funds were designed to afford coverage and protection to those persons and entities least able to absorb an unexpected loss due to the insolvency of an insurance company. Therefore, the guaranty fund statutes place restrictions on the claims that the guaranty funds may handle and limit the amounts that guaranty funds may pay on individual claims.

Most guaranty fund statutes contain a bar date, which requires
policyholders and claimants to file a claim with the guaranty fund by a certain date. In Iowa, Michigan, Minnesota, Missouri and Nebraska, a claim must be filed on or before the proof of claim filing deadline set by the receivership court; in Illinois, North Dakota, Ohio, South Dakota and Wisconsin, a claim must be filed by the earlier of the final date set by the court or 18 months from the date of the liquidation order; in Indiana, a claim must be filed within one year from the date of the liquidation order.

A guaranty fund’s obligation on a given claim is no greater than what the insolvent insurer’s obligation would have been. In addition, the guaranty fund statutes contain a claim cap, which defines the maximum obligation of each state guaranty fund on a covered claim. Most states, including Illinois, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota and Wisconsin, have a $300,000 claim cap (with no limits for workers’ compensation claims).

Indiana has a cap of $100,000 per claim and $300,000 per occurrence. Michigan, on the other hand, has a very high claim cap that is never reached, because its cap is based on a formula (1/20 of 1 percent of the previous year’s aggregate premiums written in the state), which amounted to a cap of $7.3 million for insolvencies occurring in 2003.

Many state statutes also contain a “net worth” provision, which either excludes claims of insureds having a net worth in excess of a specified amount or gives the guaranty fund a right of recoupment against an insured having a high net worth for any losses the guaranty fund pays.

For example, Illinois, Minnesota and Missouri exclude first and third-party claims against the insured where the insured has a net worth in excess of $25 million; South Dakota excludes claims against insureds having a net worth in excess of $50 million; North Dakota sets a limit of $10 million for first-party claims and gives the North
Dakota Insurance Guaranty Association the right to seek reimbursement from insureds whose net worth exceeds $25 million for any payments made on their behalf.

Michigan excludes claims of insureds whose net worth is greater than 1/10 of 1 percent of the aggregate premiums written by member insurers in the state in the preceding calendar year (e.g., the net worth limit for insolvencies occurring in 2003 was $14.5 million). The Iowa, Kansas and Nebraska statutes do not contain net worth provisions.

Guaranty funds are considered insurers of last resort. To that end, most guaranty fund statutes contain a provision requiring the claimant to exhaust other solvent coverage first and entitle the guaranty fund to take a credit against a covered claim for any other recoverable insurance. Since their inception, property/casualty guaranty funds have paid out over $9 billion in claims in over 400 insolvencies—providing immediate protection to those who otherwise would have to wait years for a distribution from the insolvent estate.

Suzanne Sahakian is a partner in the law firm of Dykema Gossett. She specializes in insurance company insolvencies and guaranty fund law and is the head of her firm’s insurance practice group. She can be reached at www.dykema.com or ssahakian@dykema.com.

Editor’s note: A version of this story appears in the July 19 print edition of Midwest, which covers Ohio, Michigan, Indiana, Wisconsin, Illinois, Missouri, Minnesota, Iowa, North Dakota, South Dakota, Nebraska and Kansas.

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