Last Updated 1/7/19
One of the primary objectives of insurance regulators is to identify, as early as possible, insurance companies that are showing signs of becoming financially troubled so corrective action can be taken to protect policyholders, claimants, and creditors from financial loss.
A troubled insurance company is generally defined as a company that either is in or is moving toward a financial position that subjects its policyholders, claimants and other creditors to greater-than-normal financial risk, including the possibility the company may not maintain compliance with the applicable statutory capital and/or surplus requirements.
The opportunity and ability to save a troubled insurance company from insolvency and liquidation, and thereby minimize any loss to policyholders and creditors, generally diminishes the longer a troubled company continues to operate in an adverse financial condition. Therefore, special procedures should be designed and implemented by insurance regulators to identify potential troubled companies in an early stage.
State insurance departments routinely perform a variety of functions to monitor the financial condition of insurance companies. Such monitoring activities would ordinarily include the collection and analysis of annual and quarterly financial information, desk audits of financial information, SEC filings and other holding company filings, the collection and review of information in connection with the licensing or admission of companies, and review of RBC (Risk-Based Capital) reports. At times, the gathering and analysis of financial information, by itself, may not be sufficient to identify a troubled company situation and analysis of the operational aspects of the company (e.g., market conduct) should also be considered.
Operational and financial conditions need to be considered together with other corroborative information to reach a conclusion as to whether an insurance company is troubled. The additional information to corroborate these findings might be obtained through communications with other insurance departments or through requests for additional information from the company.
The NAIC Financial Analysis Working Group (FAWG), offers a layer of peer review for each regulator's solvency monitoring efforts, thus ensuring that experienced state regulator colleagues improve and enhance state regulator judgments regarding a company's financial condition. FAWG ensures state insurance financial regulators share information and ideas in their work to identify and monitor potentially troubled insurers. With its regular meetings FAWG provides the efficient means of facilitating and increasing communication between the state of domicile of the troubled company and other interested state regulators.
When state regulators identify a troubled company, they must decide on the most appropriate courses of action. Regulators should be prepared to act quickly, if necessary, to stabilize a troubled situation and to prevent further deterioration. Preliminary actions may include instituting controls over operations or transactions, including access to and use of the company's assets. Most state insurance departments have adopted the NAIC's Risk-Based Capital for Insurers Model Act which requires specific action on the part of the company, the department, or both, when a company's RBC ratio falls below specified levels.
Among corrective actions that may be undertaken by regulators are: taking control of the company's assets (monitor the sale or purchase of assets), changing the company's management, changing the company's operations, raising new capital, entering into reinsurance transactions, changing the mix of the company's asset portfolio, merging with a financially sound insurance company, and selling certain assets.
At some point, the insurance department may determine that the company situation cannot be corrected or the corrective plan cannot be completed successfully. In those circumstances, state regulators may determine the appropriate course of action is to place the troubled company in receivership.
Among the typical causes of insurer insolvency are: undercapitalization; uncollectible or inflated assets; insufficient loss reserves for risks assumed; agents who misappropriated or improperly handled money belonging to the insurer; problems involving reinsurance, e.g., insolvency, disputes, collectability, etc.; unprofitable lines of business/inappropriate underwriting or claims management; risky investments; fraudulent transactions; failure to monitor agents; and mismanagement by directors and/or officers.
Insurer insolvencies are governed by state law, rather than federal bankruptcy law. State statutes typically provide for the appointment of the insurance commissioner as receiver of an insurer. Although insolvency is governed by the law of the state in which the insurer is domesticated, the laws of the various states in which an insurer conducted business may also be implicated. Consequently, during the takeover and administration of an insolvent insurer, it is important for the receiver to consider the laws of those states.
Three distinct forms—conservation, rehabilitation, and liquidation—can be distinguished in the receivership proceedings. Most states have enacted statutes that govern the conservation, rehabilitation and liquidation of insurance companies and are patterned after three models acts (the Uniform Insurers Liquidation Act, the Insurers Rehabilitation and Liquidation Model Act, and the Insurer Receivership Model Act) that have been adopted by the NAIC
- Conservation allows the receiver a period of time in which to analyze the company and its financial condition and determine whether the policyholders and creditors will be best served by liquidation, rehabilitation or returning the company to private management. A troubled company does not move systematically from one form of receivership to another, but rather, the regulator may choose to petition for the form of receivership appropriate to the circumstances at any given time.
- If rehabilitation is warranted, state regulators must allege and prove a specific statutory ground in order to proceed. In rehabilitation, a plan is devised to correct the difficulties that led to the insurer being placed in receivership and return it to the marketplace. The receiver is charged with implementing the restrictions, limitations and requirements set forth in the order of rehabilitation. The order may prohibit the insurer from writing new business or may severely limit the amount and type of new business written. Similarly, the order might impose significant restrictions or prohibit the renewal of business when the renewal is at the option of the insurer. The order may also suspend claims payments and halt the transfer of cash or loan values on life insurance contracts. The order will possibly provide that reinsurance agreements may not be canceled and that the insurer may not obtain any new reinsurance without the approval of the receiver. The receiver will be empowered under the order to seize the insurer's physical and liquid assets immediately and perform an inventory of these assets. In addition, the order will likely suspend the payment of any dividends to shareholders, affiliates and subsidiaries. The receiver may restrict new investments and may, in fact, liquidate certain investments. If previously discussed by the regulator and agreed to by the insurer's parent or shareholders, the order may require infusion of capital into the insurer.
- The regulator must determine whether a rehabilitation of the company is likely to be successful, or if its problems are so severe that would significantly increase the risk of loss to policyholders. If the latter is true, the appropriate course of action is to liquidate the insurer. Once a petition for liquidation is filed, the company will have an opportunity to defend itself, which can result in a trial or an evidentiary hearing. After the order for liquidation is issued, the receiver is charged with the duty to secure, marshal and distribute the assets of the estate. The power to perform these duties is provided by the order of liquidation and the state receivership statute. Courts have held the order of liquidation effectively cancels outstanding policies and fixes the date for ascertaining debts and claims against the insolvent insurer. However, the insolvency of a life insurer presents a unique situation. The NAIC Model Acts provide for the continuation of life, health and annuity policies.
The receiver organizes the assets of the insurer, determines the liabilities of the insurer to policyholders and other creditors, and distributes the assets in satisfaction of such claims in accordance with a priority-of-distribution scheme prescribed by state law. Most state insurance departments maintain a list of companies in receivership/liquidation on their website.
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