WHAT HAPPENS IF AN INSURANCE COMPANY FAILS?

When banks fail, the Federal Deposit Insurance Corp. protects depositors. But what happens if an insurance company fails?

With a $170 billion federal bailout keeping insurance giant American International Group afloat and several other insurance companies reporting big quarterly losses, millions of policyholders have reason to wonder.

"Insurance companies and life insurers in particular are feeling stress," said Donald Light, a senior insurance analyst in the San Francisco office of Celent, a Boston-based financial-consulting firm.

This stress comes from the downturn in the stock market and real-estate market, in which insurance companies invest their assets.

"But most are just fine," Light said.

And for those that are not and eventually will fail, there is protection for the consumer.

A national system of private associations -- including two in Ohio -- function much like the FDIC on behalf of insurance customers and guarantee policy payouts when companies go under.

The money for those payouts -- more than $40 billion nationally in guarantees for the policies of failed companies -- comes from the insurance companies.

For example, Ohio policyholders received a total of $6.2 million from the state guaranty association when London Pacific Life had problems in 2005.

Regulation regimen

Who regulates the insurers? Not the federal government.

Instead, it is up to individual states. In Ohio, it is the job of the Ohio Department of Insurance, which is connected to other states through the National Association of Insurance Commissioners.

Any insurance company that does business in Ohio must be registered with the department and meet certain requirements such as total reserves, assets and where they can invest these assets.

"People buy insurance policies because of the promise they will be paid if a loss occurs, and we make sure they can deliver," said Mary Jo Hudson, director of the Insurance Department.

Her office, she said, reviews, analyzes and internally rates the 1,700 companies that sell insurance in Ohio, with an extra emphasis on the 260 based in the state.

"We would not let a company write policies if they were not meeting our requirements and in good financial shape," Hudson said. "The insurance market in Ohio is very safe and very sound."

Two worlds of insurance

In the insurance world, there are two lines of business.

The first is property and casualty and includes homeowners and business insurance as well as automobile coverage.

The second sector includes life and health insurance and annuity coverage.

Each line of insurance is guaranteed by a different state association.

The Ohio Insurance Guaranty Association oversees property and casualty; the Ohio Life & Health Insurance Guaranty Association handles life and health insurance and annuities.

Insurance companies that sell policies in Ohio are required to be members of one or both associations, depending on the types of insurance they sell.

"The life and health association was formed in 1989, and we had our first assessment (of members to pay into its reserve fund) in 1990," said Frank Gartland, president of both associations. "Over the years, we've assessed our members about $120 million to pay for insolvencies."

The property and casualty association was formed in 1970 and has assessed members about $112 million, he said.

"We participate and contribute to every guaranty fund in every state we do business in, all 45," said Nationwide spokeswoman Nancy Smeltzer. "We are required to be members as a condition to do business."

There are also national organizations that coordinate the state organizations: the National Organization of Life & Health Insurance Guaranty Association and the National Conference of Insurance Guaranty Funds for property and casualty.

Limits to guarantees

Like the FDIC, these groups cap payouts in the event of company insolvencies.

For property and casualty benefits and life insurance death benefits, the cap is $300,000.

For life insurance cash surrenders, health insurance and annuity claims, the cap is $100,000. But that isn't necessarily all the policyholder might receive.

"You have to keep in mind that when an insurance company becomes insolvent, they still have assets and can usually pay 85 (cents) or 90 cents on the dollar, for example, on the life and health side," Gartland said. "So we work with the liquidator, and if the company pays 90 cents on the dollar, we pay the other 10 cents."

For example, the Ohio Life & Health Insurance Guaranty Association has a $300,000 maximum for a life insurance death benefit.

In the case of a $400,000 policy, the first $300,000 is guaranteed. Then, if the bankrupt company has enough assets to pay 85 cents on the dollar, the policy holder would receive another $85,000 for a total of $385,000.

When an insurance company that writes policies in Ohio fails, no matter where it is based, all the companies that sell similar lines of insurance in the state chip in to pay off policy claims in the Buckeye State.

"We can assess life and health companies up to 2 percent of the average they've written in policies for that line of coverage," Gartland said.

This 2 percent equals about $400 million for life and health insurance and annuities.

"And if that's not enough, we can assess another $400 million the following year," Gartland said.

Property and casualty companies can be assessed 1.5 percent, which adds up to about $175 million a year.

While the London Pacific failure was the only one that required an assessment, it was not the only insurance company to go into bankruptcy.

"(We) have been able to fund them out of assets received from older insolvencies as their liquidators have been releasing funds to us," Gartland said.

On the life, health and annuity side, $21.3 billion has been guaranteed since 1983 on more than 100 insolvencies, according to the National Organization of Life & Health Insurance Guaranty Association.

Of this total, insurance companies were assessed $5.2 billion by state associations -- and the rest came from the assets of the failed companies.

On the property and casualty side, $23 billion has been guaranteed on about 550 insolvencies since 1976, according to the National Conference of Insurance Guaranty Funds.

Of this total, insurance companies were assessed about $11 billion and the remainder came from assets of the failed companies.

How do you collect?

When a property and casualty insurance company is found to have insufficient funds to pay claims, the court orders it into liquidation and the state Insurance Department assumes the role of liquidator.

Policyholders receive a notice stating their coverage will be terminated in 30 days and that they need to find new insurance by this date.

Any pending claims or claims made within this 30-day window are covered by the Ohio Insurance Guaranty Association.

"We handle claims like the insurance company would," Gartland said.

If you have paid for premiums beyond the 30 day-day termination period, the association also covers the refund up to $10,000.

Life and health insurance and annuity guarantees are more complicated.

"The process is similar (to property and casualty), but the policies are not canceled," Gartland said. "If you have life insurance, you can't just cancel it and get another. Or with annuities, you don't want to be forced out and have to pay taxes."

The Ohio Life & Health Insurance Guaranty Association provides direct coverage of these existing policies or arranges for a financially sound insurance company to take over the policy.

"In most cases, it's the latter," Gartland said.