What Would Happen if a Big Insurer Failed?

The guaranty funds: Hartley points out that the insurance guaranty system is different than the FDIC system partly because insurers are regulated by the states, rather than the federal government, and because few insurance companies have failed in recent decades.

Banks, for example, must mention that they are insured by the FDIC in their ads. They apply the same insurance limits to all types of insured deposits.

In contrast, state laws based on the Life and Health Insurance Guaranty Association Model Act forbid insurers from mentioning guaranty funds when they are selling insurance. Insurance regulators want life and annuity buyers and their advisors to watch insurers carefully for signs of any problems, not depend on the funds to protect them against failures.

The guaranty fund rules differ from state to state, some state regulator efforts to help struggling insurers are confidential, and guaranty fund exposure limits vary by product type.

In a typical state, Hartley writes, the exposure limit might be $250,000 for the present value of individual annuity benefits, $300,000 for life insurance benefits and just $100,000 for life insurance net cash surrender value.

Protection haircuts: In extreme cases, a guaranty fund can also get court approval to reduce the guaranty fund protection below the usual payout cap, Hartley says.

“It is unclear what weight the guaranty association would assign to policyholders of the insolvent insurer versus profitability of the remaining intact insurers (whose representatives would make up most of the guaranty association’s board members) when assessing what action would be in ‘the public interest,’” Hartley adds. “However, it is important to note that because of reputational and regulatory concerns, there are strong incentives not to impose haircuts on coverage from the guaranty associations.”

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