What You Need to Know if Your Insurance Company is in Financial Distress

March 13, 2009

King & Spalding - The decline in the financial markets has impacted the country’s insurance underwriters. As some of these insurance companies face liquidity challenges or even potential insolvency, it is imperative that senior management and board members evaluate the viability of the carriers that participate in their insurance programs. Below are some practical considerations for officers and directors as well as a summary of relevant insurance company regulation.

  • Practical Considerations

    • Monitor your insurance programs and review the financial viability of your insurers. If a carrier is at risk of being downgraded, consider the types and levels of insurance coverage maintained, retentions and exclusions, potential gaps in coverage, the cost of coverage, alternative risk transfer solutions, and the comparison of your program with others in your industry.

    • Ask your insurance brokers to periodically evaluate ratings data and other financial information (including media reports, press releases, public filings and analyst reports) concerning the company’s insurers to thoroughly evaluate their creditworthiness.

    • If one or more of your insurers are at serious risk of insolvency, consider obtaining a secondary policy to protect the company and its officers and directors if necessary.

    • If a policy is up for renewal, consider a provision allowing for the right to terminate and a pro rata premium refund if the rating of the insurer drops below a fixed benchmark.

  • Summary of Relevant Insurance Company Regulation

    • Applicability

      • The financial health of an insurance company is regulated by the insurance department of its state of domicile. Generally, an insurance company is required to notify its state insurance department if it is impaired, meaning that its assets are less than the required minimum.

      • State insurance laws may provide for increasing levels of supervision and regulation dependent upon the financial decline of an insurer.

      • Insurance companies may not be debtors under the federal bankruptcy laws, although noninsurer affiliates of an insurance company may be debtors under the federal bankruptcy laws.

    • Insolvency Process

      • Because they cannot file for protection under the federal bankruptcy code, insurers are placed in receivership (sometimes referred to as conservation). The insurer receivership process is customarily a lengthy and inefficient process. During this process policyholder benefits may be delayed or deferred for substantial periods of time.

      • Once an insurance company is in receivership, the state insurance department must decide whether rehabilitation or liquidation is more appropriate. With either rehabilitation or liquidation, a state insurance department retains broad discretion over an insurer and is focused on protecting the insurer’s policyholders.

      • Unlike bankruptcy, receivership proceedings are typically not transparent.

      • If a state insurance department determines that an insurer should be liquidated, distributions are subject to priorities similar to those that exist under the federal bankruptcy laws. However, the major distinction between an insurer liquidation and a bankruptcy proceeding is that policyholders always have a priority over general creditors in an insurer liquidation.

      • If an insurer’s assets are not sufficient to satisfy its policyholders’ claims, state guarantee associations or funds will, in many instances, ensure payment of all, or a portion, of such policyholders’ claims.

    • Guarantee Associations

      • Guarantee associations or funds have been established in every state to protect holders of life, health, annuity, property or casualty insurance policies, to varying degrees, if an insurer becomes insolvent. Guarantee associations will provide coverage for an insolvent insurer’s policyholders, subject to certain limitations, either by taking on the policies directly or by transferring the policies to another insurer that is financially stable.

      • The amount of coverage by guarantee associations with respect to various types of insurance products varies among states, but coverage amounts are generally relatively modest and are not likely to provide significant benefits for large commercial policies, including D&O insurance policies.

    • Insurance Holding Company Statutes

      • Insurers within an insurance holding company system (such as AIG) are regulated by a state’s insurance holding company statute, which regulates inter-company transactions. Under these statutes, the state insurance departments have the authority and duty to review transactions between an insurance company and its non-insurer affiliates. While an insurance company’s assets should not be inappropriately transferred to its non-insurer affiliates to the detriment of its policyholders and creditors of an insurer’s affiliate should not obtain rights to the insurer’s assets, there are such occurrences.

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