Insurance in the red: guaranty funds, already under pressure, now have to cope with the Reliance fiasco

Risk & Insurance, May, 2003 by Lori Widmer

The predicted shakeout has arrived. Insurers' weakened debt and financial strength ratings are just one indication of a market in flux. The question facing risk managers is how the uncertainty will affect their future claims.

For those who weren't completely in the dark over the past two years, the emerging solvency issues for insurers comes as little surprise. Debt and financial strength ratings are plunging on even some of the strongest of carriers. Lowly C ratings plague smaller, less visible companies, while even large insurers find their financial strength under mounting scrutiny by A.M. Best, Standard & Poors and Weiss Ratings.

While some experts in the industry look upon insurer insolvency as an inevitable, cyclical process, others see the shakeout as a strengthening of the overall marketplace. "While I won't say it's a good thing that insurers are going into liquidation," says one source, "I will say that the industry will strengthen as the weaker players fall away."

According to the National Association of Insurance Commissioners (NAIC), there were 26 companies in 2002 that were in rehabilitation, receivership, liquidation or supervision. A.M. Best data show that the number of insolvencies is holding steady at about 30 each year for the past two years.

One analyst says the market is still stronger than it was more than a decade ago. A. M. Best's Rick Decker, a senior financial analyst, says there are fewer insolvencies now than in the mid-1980s.

The size of the payouts are growing, however. The National Conference of Insurance Guaranty Funds reports that insolvencies assessed by guaranty funds have jumped to $389.7 million in 2000 from $231.4 million in 1997, an increase of 68 percent.

And those numbers don't include the Reliance Insurance Co. fiasco. Many experts predict the fall of Reliance will be the costliest insolvency in history. Estimates say the final tab may be upward of $2 billion.

An Industry in Crisis

While the rate of insolvencies is steady--0.74 percent as opposed to 1.62 percent on the heels of Hurricane Andrew, the situation is critical. "There are major concerns on the insolvency side," says Francine Semaya, senior partner and chair of the insurance corporate and regulatory group at Cozen O'Connor in New York. "There are concerns now with commercial insureds. What do they do? How do they handle the insolvency?"

More importantly, how can a risk manager get payment on claims if his or her company is in liquidation? Under the current system of liquidation, or rehabilitation, states' guaranty funds would cover claims up to a statutory maximum. "The average runs between $300,000 and $500,000," says Semaya. "It's very state-specific. There are certain things some states do not cover, such as net-worth exclusions, and there has to be a declared insolvency, not just a rehabilitation. And every state has its own rehabilitation and liquidation laws."

Yet a report by the Alliance of American Insurers warns that the state guaranty fund system is facing serious difficulties because of larger payouts, the biggest being Reliance. "The guaranty funds estimate that roughly $6.5 billion in claims will flow through the guaranty fund system before the Reliance insolvency is over," states the report. The final tally is dependent on the accuracy of Reliance's reserves and how much of Reliance's reinsurance is collected. "Whatever the final number," continues the report, "the Reliance insolvency will be bigger than what the guaranty funds have ever been asked to cover."

Compounding the problem are more insolvencies with similar liabilities. According to the report, insurers such as Credit General of Beachwood, Ohio; HIH America Compensation & Liability Insurance Co. of Australia and California's Superior National are filling the guaranty fund pool with a wave of claims exposures. Add to that Legion Insurance Co.'s $2.5 billion in claims and the news couldn't be worse for the guaranty funds. In North Carolina, the state's guaranty fund is reporting that Reliance's collapse could cost the state's insurance companies between $40 and $50 million.

Even more troubling are the downgrades of major carriers--Long Grove, Ill.-based Kemper Insurance Cos.; Hartford, Conn.-based Hartford Financial Services Group; Chattanooga, Tenn-based UnumProvident; and Munich-based Allianz AG. The failure of any of these companies could spell disaster for the guaranty fund system.

"The loss costs have gone up, which have caused companies to get stressed," says Decker. "If you look at the distribution of the number of solvencies in 2000-2001, it was around 70 percent. It's still around the same percentage due to reserves."

Decker says that thanks to the sheer size of insurers, fewer insolvencies hit the market after Sept. 11. "Hurricane Andrew hit a lot of middle-class neighborhoods where a lot of smaller, less well capitalized insurers were operating. I think that's why you saw more insolvencies out ofAndrew than out of Sept. 11. That event hit the AIGs, the Hartfords and Liberty Mutuals, companies which have very formidable capital positions."