A state-based insurance safety net

The best choice for consumers is the tried and true property/casualty guaranty fund system administered by the states

From almost the moment Gramm-Leach-Bliley was signed into law in late 1999, discussion turned to the question of state or federal regulation for insurers. Debate continues with participants anxiously assessing the impact of this year’s election results on their interests.

Interestingly, the component of the regulatory system that could mean the most to consumers and taxpayers has gone mostly unnoticed; that is, what would happen to the current state-based property/casualty guaranty fund system if insurers can choose federal oversight? It’s a provocative question made more so because the state system works, a fact that has not gone unnoticed.

Speaking this past summer, Deputy Assistant Secretary of the U.S. Treasury for Financial Institutions David G. Nason said, “While there are passionate views on virtually all aspects of the [insurance] modernization debate, the viability and merit of the state guaranty system is rarely, if ever, called into question.”

The American Insurance Association (AIA), whose membership includes many of the companies supporting an optional federal charter, has previously favored leaving the state-based guaranty fund system intact and requiring all national insurers to join state guaranty funds in the states in which they do business.

The two major OFC bills introduced in Congress during 2006 also would make use of the current state-based guaranty association system for both state and federally chartered insurers.

State property/casualty funds were created by statute some 35 years ago. Since their inception, they have consistently carried out their mission to promptly pay outstanding claims of insolvent insurance companies so that policyholders are not left unprotected. To date, state guaranty funds have handled hundreds of insolvencies and paid more than $21 billion to affected consumers. The system works exactly the way state legislators intended and can continue to handle all property/casualty insurer insolvencies, regardless of charter.

Beyond the question of effectiveness, issues of cost-benefit are unavoidable. A national guaranty fund for federally chartered insurers would duplicate effort, particularly because the state-based system would continue to exist for the companies that would likely remain state chartered. State Guaranty Funds would continue to operate using locally based personnel to receive and process claims, and to make assessments as needed.

A federal guaranty fund mechanism for nationally chartered insurers might look something like the FDIC, which currently employs 5,300 people and has a budget of slightly more than $1 billion. The state guaranty fund system is estimated to cost under a tenth of that amount, with fewer than 500 employees.

Most critically, two systems could actually reduce the overall capacity of the combined safety nets. An analysis undertaken in 2001 showed that assessment capacity of the state funds would have been reduced from $4 billion to $2.3 billion, while the national guaranty fund’s capacity would have been just $1.2 billion (assuming that only the 10 largest property/casualty insurers became national insurers participating in a separate federal guaranty fund mechanism).

While the assessment capacity of the state guaranty fund system has since grown to $6.8 billion, the concentration of insurance premium in the largest insurers continues, and the same division of capacity would still exist. In an era of mega catastrophes and heightened terrorism risk, a bifurcated system that could reduce overall capacity poses a substantial risk to consumers.

Not to be overlooked is that as a national system, the state funds haven’t needed access to anything close to its maximum assessment level; since the early ’90s, the average assessment of all state guaranty funds is less than 20 percent of capacity and has not exceeded 35 percent (Those figures are based on the total of all states’ assessment capacity. Because states make separate assessments based on the premiums written in their state, some states have experienced assessments approaching their annual capacity in recent years). The insolvency of one major national insurer could have a much more dramatic impact on a single national fund with lower assessment capacity.

Wherever you come out on the question of an optional charter for the property/casualty industry, there is no reason to worry about how consumers will fare under a state-based guaranty fund system. With $21 billion and thousands of affected lives later, it’s clear that the guaranty funds are delivering on the low-cost public policy promise state legislators made to insurance policyholders long ago.

Roger H. Schmelzer is president of the National Conference of Insurance Guaranty Funds in Indianapolis. E-mail: rschmelzer@ncigf.org. Phone: 317-464-8199.

Topics Carriers Property Property Casualty Casualty