Key Takeaways
- State guaranty funds protect policyholders if an insurer defaults or becomes insolvent.
- These funds operate in all 50 states, Washington D.C., Puerto Rico, and the U.S. Virgin Islands.
- Only licensed insurers must comply with state guaranty laws and fund mandates.
- Insurance companies pay 1-2% of their net sales to fund these guaranty programs.
- Some states require self-insured employers to join a guaranty fund for workers’ compensation.
What Is a State Guaranty Fund?
A state guaranty fund protects policyholders if a licensed insurance company in that state becomes insolvent. Insurers are required to participate, often through separate funds by insurance type, and the system was developed in response to past insurance failures.
Understanding the Mechanics of State Guaranty Funds
State guaranty funds exist in all 50 states, Puerto Rico, the U.S. Virgin Islands, and Washington D.C. Most states maintain separate funds for property/casualty insurance and life/health insurance. These state guaranty funds act as a form of insurance for insurance and are funded by insurance companies that sell insurance in a given state. The amount of funding an insurance company is required to pay is a percentage, ranging from 1% to 2 % of the net amount of insurance it sells within any particular state.
To deal with insolvency, many states have passed a guaranty law based on a model act drafted by the National Association of Insurance Commissioners (NAIC). Some states have enacted the model act verbatim, but most have passed a modified version. As part of these laws, insurers must participate in a state’s guaranty fund if they are licensed to do business in that state. An insurer licensed in all 50 states must participate in a fund in each of those states.
Only licensed insurers must comply with state guaranty laws. Unlicensed insurers (such as reinsurers) are not. Thus, if a business is insured by a non-admitted insurer that is declared insolvent, there is no mechanism for recovering unpaid claims from your state guaranty fund.
Some states require employers to self-insure their workers’ compensation obligations to participate in a guaranty fund for self-insured employers. The fund pays benefits to workers if their employers are unable to pay due to bankruptcy or insolvency.
Important Considerations for State Guaranty Funds
State guaranty funds were created by federal statute in 1969, and are non-profit systems operating in all 50 states, Washington, D.C., Puerto Rico, and the Virgin Islands. Prior to this mandate, some states did seek to independently create guarantees to respond to insurer insolvencies.
Initially, states maintained a single fund to cover one line of business, such as workers’ compensation or personal auto insurance, and insurance companies themselves were relatively small. Many wrote one line of business in a single state. If an insurer went bankrupt, a limited number of policyholders and one state fund were affected.
In 1990, a more comprehensive organization, the National Conference of Insurance Guaranty Funds (NCIGF) was created to coordinate and streamline state guaranty funds.
Today, many states maintain several guaranty funds. For instance, a state might operate separate funds for auto insurance, workers’ compensation, and other lines. In addition, insurance companies are more complex than they were 40 or 50 years ago. Most offer a variety of coverages in multiple states, some in virtually all states, which means an insolvency today may affect numerous policyholders across the country and involve guaranty funds in multiple states.
The Bottom Line
State guaranty funds protect policyholders when a licensed insurer becomes insolvent and are required by state law for participating companies.
Insurers usually contribute about 1% to 2% of their in-state policy volume, while coverage does not extend to unlicensed carriers. Today, these funds span multiple insurance lines and operate across states to reflect the scale of modern insurance markets.