The most recent NAIC guaranty association model act was adopted by the NAIC in 1985 and amended several times thereafter. Individual state laws often differ in important respects from the model. The model act creates a nonprofit legal entity called the (state) Life and Health Insurance Guaranty Association. All insurers, as a condition of their being licensed to transact any type of insurance covered by the act in the state, must be members of the guaranty association, An assessment mechanism is specified for general administrative costs and for costs associated with settling the claims resulting from insolvent or impaired insurers.The guaranty association is generally under the immediate supervision of the insurance commissioner. The act primarily covers policy owners who are residents of the state where the member insurer is determined to be insolvent or impaired. Beneficiaries are covered regardless of their residence.
Several coverage limits apply. A maximum of $300,000 will be paid in life insurance death benefits, but not more than $100,000 in net cash surrender values. Coverage is limited to $100,000 for annuity cash values and payments, including tax-qualified annuities and structured settlement annuities. Health insurance maximum payments are $500,000 for medical expense insurance coverage, $300,000 for disability income coverage, and $100,000 for all other health coverage’s. These limits apply on an individual insured and not on a per-policy basis. Advertising the guaranty association and its statutory obligations is prohibited. However, the model act does provide for a disclosure to the purchasers of policies that coverage may be available from the guaranty association. Not all states have enacted this disclosure provision.
The Assessment Process
Two kinds of assessments are possible under the Guaranty Association Model Act. Class A, the first type of assessment, is made for the administrative, legal, and examination costs associated with reviewing the financial condition of member insurers and other expenses. Class B, the second kind of assessment, is made to cover the costs associated with insolvent or impaired insurers. The latter assessment is undertaken after an insolvency or impairment. Class B assessments are made of member insurers in the proportion that their state premium writings bear to the total writings for the relevant line of insurance. In total, for each calendar year, all assessments cannot exceed 2 percent of the member insurer’s average premiums received in the state on covered business during the three years proceeding the year of impairment or insolvency. The assessment of any member can be abated or deferred if payment would be harmful to the member insurer in fulfilling its contractual obligations. Many states permit a tax offset for any assessments paid by a member insurer. This offset can be applied against the insurer’s premium tax, franchise tax, or income tax liability to the state. The credit equals 20 percent per year of any assessment paid, for a maximum of five years. The effect of tax offsets is to shift most of the financial burden for insolvencies from insurers and their policy owners and stockholders to the state’s taxpayers. Additionally, payments to the guaranty association are deductible for federal income tax purposes.
An Evaluation of Guaranty Associations
Guaranty associations and funds are rationalized in insurance because of consumer information problems. However, they diminish market discipline to some degree. If buyers know that they will be made whole if they purchase insurance from a solvent insurer, they have less incentive to investigate and monitor solvency. This assertion is more relevant for informed buyers than for less informed individuals. Also, if no distinction for insurer financial solidity is made in the guaranty fund assessment mechanism, the opportunity for moral hazard by firms is enhanced, thus further weakening market discipline. The guaranty association structure has weaknesses. Coverage is not uniform among states. Each state’s association also can act independently from the other associations, although the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA) helps to achieve uniformity of the guaranty association process across the country. Another problem is the potential for a very large insolvency or series of insolvencies that might overwhelm the assessment ability of each state’s guaranty association to provide immediate indemnification.