Bankruptcies may strain insurance fund State's protection fund is flawed, some critics claim.


The woman calling the state Insurance Division was worried about her life insurance annuity. Her insurance company had shown no sign of financial troubles, but the daily barrage of bad news about troubled insurers had troubled her.

What happens if my company has trouble, she asked.

Don't worry, said Charles Siegel, an associate insurance commissioner. The policy, he said, will be protected by the state's Life and Health Insurance Guaranty Corp., the private fund set up to protect insurance policies in Maryland.

"She seemed greatly relieved," Siegel recalled.

The relief is well-founded -- probably -- experts say.

But, with several major insurers now in bankruptcy, some critics say Maryland's insurance protection fund -- and similar funds in other states -- are inadequate to cover a major collapse in the insurance industry.

"We think the system is seriously flawed," said Marty Leary, research director with the Southern Finance Project, a non-profit North Carolina group that has studied guaranty funds across the country. "And ultimately they will not be able to stand the test of a big insolvency like Executive Life."

"Certainly we're better off with them than without them," said John A. Donaho, the Maryland insurance commissioner. "The guaranty funds have been extraordinarily helpful. Fortunately, we've never had to really put them to a substantial test."

The two biggest bankruptcies in the history of American insurance -- involving subsidiaries of First Executive Corp. and First Capital Holdings, both of which invested heavily in junk bonds -- have caused a debate in Washington and around the country about the safety of the nation's insurance system.

In Maryland, the focus is on the life and health insurance fund, which the General Assembly established in 1971. The legislature later created a second fund to protect property and casualty insurance policies.

Although created by the legislature, the guaranty funds are private entities, financed and controlled by the insurance industry. Unlike the Federal Deposit Insurance Corp., which is designed to protect bank accounts and is backed by the U.S. government, the guaranty funds are not backed by the state treasury.

If, for example, a life insurance operation that does business in Maryland fails, the guaranty fund can collect an assessment on all Maryland companies that sell life or health insurance or annuities.

Altogether, the fund can collect as much as 2 percent of the industry's total premiums to cover the policies of a failed insurer. The fund can collect the 2 percent assessment every year until all the failed company's policies are honored.

The fund pays out claims on policies held by companies that have failed, or, in the case of a failed life insurer, repays the customer the amount invested in a long-term policy. The fund would protect both term and whole-life insurance policies as well as annuities purchased by individuals.

Since 1971, the two guaranty funds have paid nearly $60 million in claims submitted by people insured by failed companies, according to Joseph R. Petr, the funds' chief administrator.

Neither fund has ever had to assess the full 2 percent premium. In 1989, for instance, the property and casualty fund collected just over one-tenth of 1 percent of the premiums in the automobile insurance industry. State Farm, the largest auto insurer in Maryland, paid the largest assessment, $278,132.

Petr, a lawyer who worked in the insurance business for several years, said Maryland policy-holders are in "pretty good shape," thanks to the guaranty funds.

But Petr pointed out that in the event of a major insolvency the defunct company's policy-holders would have to wait "a period of time," perhaps years, to recoup the money they spent on insurance policies.

The "worst-case scenario," said Petr, would be the collapse of a major company.

But Petr said the industry would not let a major company fail because of the reverberations the collapse would send through the industry. Other insurance companies would probably band together to rescue the company, much as they saved GEICO 20 years ago, he said.

The issue of the guaranty fund's stability is not an academic question for 2,072 Executive Life of California policy-holders in Maryland. Their policies have a total value of almost $720 million.

Three other companies in bankruptcy -- Executive Life of New York, First Capital Life Insurance Co. and Fidelity Bankers Life Insurance Co. -- have more than 3,500 Maryland policy-holders with policies worth a total of more than $550 million, according to Donaho, who has ordered all three to stop writing policies here.

All told, the four companies have more than $1.2 billion in policies in Maryland. By contrast, the state life insurance guaranty fund could assess a total of $47.7 million last year to cover losses. (The amount the fund could collect this year is not yet calculated, Petr said.)

While the fund's resources sound rather paltry, nobody expects that state guaranty funds would cover more than a small percentage of any failed insurer's policies, no matter what might happen to struggling companies. The insurance industry could band together to save the companies, or pieces of the company could be sold. In any case, the failing insurance companies have enough assets to cover most of their obligations.

Perhaps the state's largest investor in any of the failing companies is the Maryland Teachers and State Employees Supplemental Retirement plans, which have invested $12.7 million of their members' pension funds in guaranteed insurance contracts with Executive Life.

Maryland law does not say whether the state guaranty fund must cover guaranteed insurance contracts, a relatively new product offered by insurance companies. But Petr, the director of the fund, said the fund will not cover any losses on those instruments.

Arthur N. Caple Jr., executive director of the retirement plans, said retirees probably would see a reduced interest rate on their earnings should Executive Life be declared insolvent.

Maryland's guaranty funds are the only ones in the country with no limit on the size of the claim they will cover. This could mean a larger hit on the funds than in other states.

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