Insurance Guaranty Funds

Publication Date: November 2003

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Business

Type:

Abstract:

Some constituencies are urging Congress to allow insurers to become federally regulated, like banks. Other constituencies are urging Congress to instead ratify its 1947 delegation of insurance regulation to the states. Both houses of the 108th Congress have held hearings on these and related issues of insurance regulation. Legislation has been introduced in the 108th Congress (S. 1373) to require all interstate insurers to be federally regulated, establish a pre-funded national insurance guaranty association, and require all interstate insurers to pay into the fund.

How to protect insurance policyholders in the event of their insurer's insolvency is among the thorniest issues in insurance regulation, whether federal or state-based. The current system of protection for insurance policyholders is called "insurance guaranty funds." This interdependent system is a cooperative effort among regulators and insurers in the states where the insolvent insurer operated. It is administered state-by-state and funded by assessments on insurers. Though it has developed relatively recently, the system has provided some protection for policyholders of both large and small insolvent insurers.

If Congress were to consider regulating insurers federally, it would confront the issues of whether and how to provide that policyholder protection. Should Congress wish to protect insurance policyholders in an insolvency, it might choose to establish or expand a federal program like the Federal Deposit Insurance Corporation, the Pension Benefit Guaranty Corporation, or the National Credit Union Share Insurance Fund. Another option would be to require federally regulated insurers to participate in the state-based guaranty fund system.

Establishing federal protection for policyholders of insolvent federally regulated insurers would have costs and benefits. Direct costs would include, at the least, the costs of establishing and administering the system. Costs could also include funding of catastrophic shortfalls, as happened in the savings and loan crisis in the 1980s. Indirect costs could include inefficiencies that might result from dampening market discipline. The measure of benefit to policyholders would depend on the scope of protection offered. The potential benefit to the U.S. economy would require further analysis.

Requiring federally regulated insurers to participate in state guaranty funds would have costs and benefits as well. The costs would include the economic inefficiencies created by externalizing the costs of ineffective solvency regulation. The benefits would be simplicity and a consolidated assessment base.

This paper describes generally how state-based insurance guaranty funds operate currently. It also compares the extant insurance system with protections offered bank depositors, potential and current pensioners, and credit union participants. It will be updated if major events warrant.