Guaranty funds solid in spite of shadow of insolvency

Schmelzer: The current stability is primarily due to the fact that insurance and solvency regulation have improved over the years. State regulators have created new testing devices where they can determine if a company has enough money to operate, which most do. Since 1976, there have been about 600 insolvencies of property-casualty insurers, which is a pretty good record considering the number of players in the market.

And the industry is well capitalized, too. Even after last year, insurers had more than $1 trillion in reserves to pay claims directly. Solid statutory measurements seem to be in place, so we're not really expecting any significant insolvency activity this year.

Everything is cyclical. In the early '90s and earlier in this decade, insurers were looking for different ways to be competitive. We're now in a more stable period, except for AIG, and their problems weren't on the insurance side.

If you're running a property-casualty company now, you've probably made sure that you have exactly the investment portfolio you want, and that you are underwriting the risks you really want to underwrite. It's a time for fundamentals.

AA&B: What are some of the biggest trends in insolvency protection taking place in NAIC and at the state level?

Schmelzer: I don't see any overarching trend. Typically after a commercial insolvency period, there is movement to try and make sure the guaranty fund system will be able to pay claims for the everyday auto and homeowner policyholder. Everything for the most part is designed to strengthen the system for them.

What we try to do is advise our members on things that will weaken or strengthen the system for average policyholders. We have done quite a bit; it's a time for fundamentals on this end as well.

AA&B: The current guaranty fund system has worked well for 40 years. Have current market conditions put new stressors on the system, and is it in need of an overhaul?

Schmelzer: This is not likely because there have not been many insolvencies as of late. Historically, the biggest insolvency was Reliance Insurance Co. in 2001, a top 25 carrier with a $2.9 billion payout. During that same period, state guaranty funds had a capacity of more than $55 billion, so the Reliance insolvency was more than covered. You must also take into account that we recovered $1.8 billion from the Reliance estate, so there was a net liability of only $1.1 billion.

We don't believe there are stressors in the state guaranty fund system, which was built to accommodate pretty much anything that will come along.

AA&B: Coastal states like Florida are currently on the edge of crisis because of catastrophic exposures, insurer market pullouts and underfunded state-run insurers. What do you believe is the best panacea for these unique situations?

Schmelzer: The best thing for Florida from a public policy standpoint would be to let the markets work. You can't control the pricing the way the legislators want to in Florida and expect companies to stay. As far as the impact on us, our projections are we could withstand quite a bit if we had do. Even if several companies went under, claims would be paid. Based on the information we collect, we don't see anything that indicates the state guaranty fund couldn't handle it. If you were butting up against assessment limits, there would be other things to be done as in other states, such as raising assessment caps, bonding, and borrowing between different accounts to beef up the guaranty fund. There's plenty of capital to cover a catastrophic situation there.

AA&B: Why do you think the federal government has not attempted to play a role in the state guaranty fund system, and do you think this will change in light of current economic conditions?

Schmelzer: Based on the current political situation, I could see the potential for a federal role with respect to systemically significant companies, whatever that might be. Not because the state guaranty funds couldn't handle the insolvency, but because there is a big disconnect in the minds of people in Washington when they think of doing more on a federal level to regulate insurance. With the FDIC as a model, it's difficult for them to see that you wouldn't need a federal guaranty with the current system.

A point that hasn't been developed yet is if there are federal guaranties, what would be guaranteed? Guaranty funds do more than write checks like the FDIC; you've got the entire claims adjustment process that must be undertaken. If indeed you use the FDIC model for insurance on a federal level, how do you address claims adjustment and the other variables of the claims process? I don't know the answer, but it's certainly an interesting period.

AA&B: Looking back at "historical" insolvencies of the 1990s, how does today's marketplace compare?

Schmelzer: One of the primary differences is in the regulation itself, which is now very much oriented to failures of that magnitude. Regulators learned from that; they know what to look for and how involved they need to be in a company's affairs to ensure they are properly capitalized.

I'm not sure that insurers are doing anything differently. We'd like to know and understand this better. We didn't understand much about the large deductible policies and learned about that but so did the regulators; now they're more educated on some of these products. But companies are probably being more careful, too.

AA&B: How should retail agents and brokers advise their clients in the event of a carrier insolvency?

Schmelzer: This is a very fluid time for the insurance industry, and it behooves all of us on the front line to be very aware that we're going through a transitional period in the industry. Agents need to stay up on the ratings of the companies, as that's a pretty good indicator of where things are. I think your readers can be comforted to know that their clients are going to be paid if there's a claim, even if their company fails. The guaranty fund system is healthy, very tested and dedicated to paying claims. People will be paid.

Top 5 largest insolvencies:

Reliance Insurance Co., October 2001: $2.3 billion

Legion Insurance Co., July 2003: $1.3 billion

California Compensation

Insurance Co., Sept. 2000: $1 billion

Fremont Indemnity

Insurance Co., July 2003: $848 million

PHICO Insurance Co., Feb. 2002: $726 million