Guaranty funds only part of security.

(Editor's Note: The following letter is in response to A.M. Best's 2006 Annual Hurricane Study, highlights of which appeared in the July 2006 issue of Best's Review.)

With the first post-Katrina hurricane season upon us, all eyes are nervously focused on the property/casualty industry's response to the mega-storm everyone hopes never happens. One concern is can the state-based guaranty funds rise to the challenge should weather claims spark new insolvencies? The system of property/casualty guaranty funds was created by state legislatures with one purpose in mind--to pay the outstanding claims of insurance policyholders if their insurer becomes insolvent. It was designed to provide a limited safety net for personal insurance consumers who could suffer Financial ruin if their auto or homeowner claims were not paid. But the funds are only one part of a comprehensive public policy framework that impacts the security of insurance consumers.

Critical to the overall picture is the solvency monitoring responsibilities of insurance regulators intended to spot problems before it's too late. Additionally, underwriting restrictions, rate adequacy, loss mitigation and land use regulations are public sector responses that affect an insurer's ability to meet contractual obligations to its customers. We have even seen the federal government acknowledge that some losses are too large for private industry to withstand alone and have provided a temporary backstop in the event of terrorism losses.

The record of the funds speaks for itself; since inception of the system more than 30 years ago, guaranty association managers have administered more than $17 billion in claims payments--claims that would otherwise be unmet--related to 200 different insolvencies.

For example, insolvencies triggered by Hurricane Andrew in the early 1990s resulted in nearly 25,000 unpaid claims totaling $500 million. That was more than the total amount of assessments for all lines of business levied by the Florida Insurance Guaranty Association over the previous decade. After paying out the capacity it had on hand, FIGA worked with the Florida Legislature to borrow money through a tax-free municipal bond issue that brought in $472 million.

Stories of flexibility and resourcefulness throughout the system abound. Still, the environment in which guaranty associations operate is in need of fine-tuning.

Despite the original intent of the system to step in to pay "everyday" insured losses, increased competition on the commercial side of the property/casualty industry has given rise to some large commercial insolvencies that consume a larger and larger share of guaranty association capacity.

Such was the case in California when a flurry of insolvencies involving workers' compensation insurers, including the state's second-largest writer of workers' comp, Fremont Indemnity, hit the California Insurance Guarantee Association beginning in 2000.

Faced with potential liabilities of more than $4 billion, CIGA moved quickly to develop solutions to the crisis. Ultimately CIGA was given the authority to issue tax exempt bonds over a two-year period to raise up to $1.5 billion to continue to pay the claims of injured workers.

A similar initiative was undertaken in Alaska where Fremont wrote more than a quarter of the market in workers' compensation insurance and left behind claims greatly exceeding the state fund's $4.2 million assessment capacity. Emergency legislation was enacted to allow the state guaranty association to borrow money from the Alaska Development Corp. and to temporarily increase the assessment level. After $19 million in paid claims, the financial solutions developed have put the Alaska Insurance Guaranty Association back on solid footing.

While guaranty funds adapt to the shifting marketplace and make changes to pay claims even more efficiently to those who need it most, lawmakers and insurance regulators should consider thoughtful and sensible steps to make fulfillment of that mission more attainable. The paramount concern of everyone in the insolvency community should be to maintain and enhance the integrity of the statutorily authorized state-based guaranty fund safety net.

Laws should be modernized to reduce coverage for high net worth, sophisticated commercial insureds and to pay out insolvent estate assets more quickly. Significant public policy progress has been made, but much remains to be done to maximize the good work of the guaranty fund associations on behalf of policyholders.

That work is paying off in more ways than one. Lawmakers in California are now very aware of the crucial role guaranty funds play and are willing to act on ideas put forth by CIGA. Its retiring executive director, Larry Mulryan, justifiably beams with pride when he says that every outstanding workers' comp claim in his state has been covered. But he's quick to add that there is no time for complacency.

He's right. After all, the next mega-catastrophe that turns life upside down for tens of thousands of Americans could be right around the corner. It's never too early to make a good safety net even better.

Roger H. Schmelzer, President

The National Conference Of Insurance Guaranty Funds