Imagine this scenario–Mega Store has its primary insurance coverage with Super Insurance Company, which was recently declared insolvent and ordered liquidated by a court; Super Insurance was domiciled in Mega Store's home state (a small southern state). Super Insurance Company also insured a number of other large retailers and corporations around the country in addition to writing some personal lines. Super ran into financial difficulties due to the severe underpricing of their various lines of business along with excessive losses with a bit of corporate fraud thrown in on top, thus rendering them statutorily insolvent and unable to pay their claims. The various state guaranty associations (GAs) are triggered by the liquidation order to fulfill their statutory obligations.
Mega Store is worth billions of dollars. Their primary insurance policy limits and outstanding claims amounts alone would exhaust the entire yearly guaranty assessment capacity of the other than auto assessment account for that guaranty association even with the application of the per claim statutory limitations.
With Mega Store's claims at the time of insolvency exceeding the yearly assessment capacity of the guaranty association in their home state, the guaranty fund would not be able to meet all of its obligations in the other than auto account to the policyholders in that state. This results in the GA having to prorate claims to all covered claims had that small southern state not adopted the Net Worth Exclusion in their guaranty association act. Additionally, several other states affected by the Super Insurance Company insolvency would also be in the same boat with the large number of high net worth insured claims versus the claims of the company's smaller insureds and personal lines insureds causing GA capacity issues without the adoption of the net worth exclusion.
Guaranty Association statutes have evolved over the years to recognize situations that can cause capacity and other coverage issues. Therefore, one of the optional provisions of the NAIC Property & Casualty Insurance Guaranty Association (GA) Model Act of 2009 (the latest model act) and some prior versions is the aforementioned Net Worth Exclusion. The Net Worth Exclusion language can be found under Section 13.
The Net Worth Exclusion states that the guaranty association does not have to pay any first-party claims for high net-worth insureds. The NAIC Model Act defines high net worth insureds as any insured whose net worth exceeds $50 million on December 31 of the year prior to the year in which the insurer becomes an insolvent insurer. The act also provides some alternative definitions. This exclusion means that guaranty fund coverage may not be available in states that have adopted the exclusion under either the most recent GA Model Act or previous versions to policyholder or claimants who have a "high net worth" that is over the amount adopted in the GA statute. The net worth exclusion serves to reflect a public policy position that the guaranty fund system is focused on assisting the average citizen policyholder which is the GAs longtime mission.
The Reliance Group of Insurance Companies insolvency back in 2001 is a prime real-world example of where the net worth exclusions adopted by some states assisted the smaller policyholders and claimants. By having the exclusion in place, they were covered by requiring the high-net-worth insureds to cover their own claims that would have otherwise been covered only up to the statutory limitation of coverage which in most states is $300,000 per claim. This frees up the statutorily limited assessment and funding capacity that otherwise may have been exhausted by the claims of the high net worth individuals and corporations who are in a better position to absorb the losses due to the insolvency.
Not every state has adopted the net worth exclusion language. These exclusions depending upon the residency of the insured (or principal place of business for business entities) only come into play when there is an actual insurance company insolvency. In order to determine net worth, insureds and claimants will be asked to provide evidence of their net worth prior to benefits being provided by the guaranty association. States using the net worth exclusion will request financial information from the insured and/or claimant under the privacy parameters set with the state insurance department to guard that information.
Under the most commonly adopted provision, the insured and/or claimant must show their net worth as of December 31st in the year preceding the insolvency date of the insurer. This would include their aggregate net worth including that of any subsidiaries and affiliates on a consolidated basis. If an insured or claimant refuses or does not provide the financial information showing their net worth, the model act and a number of the enacted statutes allow the GA to treat the insured/claimant as having high net worth until they prove otherwise.
The two most common net worth exclusion amounts used by GAs are $25 million or $50 million in net worth. Some states apply the net worth exclusions only to 1st party claims and others to both 1st and 3rd party claims and on subrogation claims. Those states without the net worth exclusion may have a further exclusion wherein they will not cover a claim that has been excluded by another GA under their net worth exclusion. Therefore, when working with an insolvent insurer carrier, it is recommended that an insured find out if the exclusion is applicable to them.
The National Conference of Insurance Guaranty Funds makes a chart available providing details on net worth provisions by state; a copy may be accessed here.
Additionally, Workers Compensation Claims in most states are paid in full either by the state property & casualty guaranty fund or by a separate Workers Compensation guaranty fund. There are a few exceptions that set workers compensation claims at GA limitations. Further exceptions are North Dakota, Ohio and Washington who still operate under monopolistic Workers Compensation funds. Claimants affected by Workers Compensation insurance company insolvency are not subject to the Net Worth Exclusion.
Personal injury protection claims, no-fault claims or third-party claims for ongoing medical treatment are not affected by the net worth exclusion in those states that adopt the third-party net worth exclusion. In addition, in circumstances where a high net-worth insured has itself become financially unable to pay their claims, the model act sets forth the parameters in which the net worth exclusion would not apply to the third-party claims of such an insured.
The following is an example of how net worth provisions would affect a high-net-worth individual by comparing what would happen in a net-worth state as opposed to a non-net-worth state on a first-party homeowner's claim. A Quarterback of an NFL team resides in a state, which has a $50 million net worth provision on both 1st and 3rd party claims under their GA statute. The multi-million dollar home of the "star" quarterback (one of the NFL's highest paid) is totally destroyed in a tornado. His insurance company, Backup QB Insurance Company is declared insolvent by a court due to excessive losses as a result of multiple natural disasters shortly after the quarterback's tornado loss, which was one of the multiple natural disasters contributing to the insurer's insolvency. The GA receives the claim file (which had already been adjusted prior to insolvency but unpaid) and sends out the Net Worth Affidavit to the quarterback who reports his net worth as being $150 million. Because his net worth exceeds $50 million, the quarterback will not have a claim that is payable by the GA up to their $300,000 per claim statutory limitation. However, he would still have a policyholder level claim against the liquidation estate of the insolvent insurer, and would receive his pro-rata share of any estate distributions should there be any assets available in the liquidation estate.
Had the net worth provision not been applicable if he resided in and the property was located in a state without a net worth provision, his claim for the tornado loss would have been paid up to that state's $300,000 statutory limitation on coverage. The amount that exceeded the GA limitation would remain an over-limits claim against the liquidation estate, and he would share pro-rata in any policyholder class estate distributions.
Now assume that the same quarterback in a net worth exclusion state has a third-party liability claim against him for a slip and fall at his residence and is sued by the injured party. The net worth provisions would still be applicable. However, the GA could or would (depends on the state) provide a defense under the policy, and pay either up to their statutory limitation of coverage or policy limits, whichever is lesser, and the GA would bill the quarterback for cost of the defense and any loss payment made by the GA. Any amount awarded to the claimant that would have been covered under the quarterback's insurance policy with the insolvent insurer would remain a claim against the liquidation estate as described previously.
However, if the settlement exceeds the insolvent insurer's policy limit or includes punitive or other damages not covered by the underlying insurance policy or the applicable guaranty fund statute, those would be the responsibility of the quarterback. For the sake of simplicity we are not addressing exhaustion of all other applicable insurance coverages found in GA statutes for third party claims.
Claims against a corporate entity would work in a similar manner. However, the GA would look at the corporation's principal place of business and where the property or loss occurred in determining which GA would respond to the loss, and which GA statutory provisions would apply. In addition to seeking the Net Worth Affidavit, the GA would also seek Articles of Incorporation and other necessary documentation in order to make that determination.
This is just a brief general summarization of the Net Worth Exclusions. When faced with an insurance company insolvency, insureds, agents and attorneys should refer to the specific state guaranty association statute to determine if this particular exclusion would be applicable. Additional information regarding guaranty associations can be found at The National Conference of Insurance Guaranty Funds ( www.ncigf.org ) which is the coordinating body for the various state guaranty funds.