Last year, AIG, the largest insurance company in the country, made headlines when it asked Congress for a multi-billion dollar loan to stave off bankruptcy. The extent of AIG’s financial woes may have been a surprise, but the adverse effect of the economic downturn on insurance companies is not.
One of the primary ways insurance companies make a profit is investing policyholders’ premiums in securities. As a result, many insurance companies have been severely affected by the current economic downturn. A.M. Best, an insurer rating agency, reported the U.S. property/casualty insurance industry’s net income after taxes fell a whopping 85 percent in the first nine months of 2008.
In this economic climate, it is more important than ever for construction companies to ensure they are buying insurance from companies in good financial health. It may be tempting to buy the least expensive coverage available, but that approach can create problems if the insurance company ends up going bankrupt.
What Happens If an Insurance Company Becomes Insolvent?
When insurance companies become insolvent, the best-case scenario for policyholders is that their policies are sold to another company. However, in many cases, policyholders are left to pursue their claims in liquidation proceedings.
Insurer liquidations are governed by state insurance insolvency law rather than federal bankruptcy law. The state regulator overseeing the liquidation sets a deadline by which all policyholders must submit claims, which is usually six months to a year after the insurance company is placed in liquidation.
For policyholders with valid claims, two basic sources of payment exist: state guaranty funds and the insurer’s estate. State guaranty funds operate somewhat like the Federal Deposit Insurance Corporation. If the insurance company becomes insolvent, the guaranty fund pays covered claims up to a certain amount. The limits vary from state to state. In California, for example, payments are generally limited to $500,000. It is important to note that payments on surety bonds are not covered by some state guaranty funds.
With the insurer’s estate, policyholders usually are given top priority in the distribution of estate assets. However, because sufficient funds don’t always exist, policyholders are paid on a prorated basis. Unfortunately, insolvency proceedings can last many years—20 years is not uncommon—so payments often are delayed for a long time.
One of the biggest problems for policyholders faced with an insurer insolvency is the possibility of future claims. Because all policyholder claims must be filed by the set deadline, claims that arise after the deadline usually are not covered. In such cases, policyholders are left to pursue other insurance policies that might provide coverage, or foot the bill themselves.
Given the complexity and length of time involved in winding one’s way through insolvency proceedings, and the limits on recoveries, purchasing coverage from insurance companies on rocky financial
footing is something to avoid. Fortunately, tools are available to help companies make wise purchasing decisions.
Research Insurance Companies A number of agencies rate the financial health of insurance companies, often free of charge. A.M. Best ranks insurers based on their financial strength, credit ratings and debt ratings. The financial strength rating evaluates the insurer’s ability to meet its obligations to policyholders, and the ratings range from an A++ for “superior” to D for “poor.” According to A.M. Best, insurers with ratings between A++ and B+ are considered “secure,” while companies falling below that level are considered “vulnerable.”
Other top rating agencies include Fitch, Standard & Poor’s, Weiss Research and Moody’s Investors Services. Construction companies also may want to research the financial strength of the sureties issuing construction bonds. Because most of these sureties are insurance companies, their financial strength can be investigated using the same agencies.
In addition, the U.S. Department of the Treasury maintains a list of surety companies that meet criteria necessary to issue surety bonds required by the federal government. This list (Treasury Circular 570) is available at
www.fms.treas.gov/c570/index.html.
Include Insurer Approval Provisions in Contracts
Contractors that rely on subcontractors or others to purchase policies should ensure they have authority to approve or disapprove a subcontractor’s choice of insurance carrier.
Some standard contracts already include such provisions. For example, one standard long-form contract stipulates the subcontractor must procure policies from insurers “acceptable to” the contractor. Contractors should ensure such provisions are included in all final contracts and take advantage of this control mechanism.
Alternatively, a contractor may prefer to include a specific financial rating requirement in the contract. For example, a contractor could stipulate the insurance must be procured from an insurance company with a minimum A.M. Best rating.
By taking these precautionary steps, most companies can avoid placing coverage with financially unstable insurers. But if the unexpected occurs and a policyholder believes a likelihood of future claims exists, it is advisable to consult an attorney experienced in insurer insolvencies to help protect the company’s insurance asset.
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Friday, September 3, 2010