What Is a State Guaranty Fund?
A state guaranty fund is administered by a U.S. state to protect policyholders in the event that an insurance company defaults on benefit payments or becomes insolvent. The fund only protects beneficiaries of insurance companies that are licensed to sell insurance products in that state.
State Guaranty Fund Explained
State guaranty funds exist in all 50 states, Puerto Rico, 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.
The Evolution of State Guaranty Funds
Some states enacted guaranty funds in the 1940s, but most emerged in the 1960s and 1970s, when insurer insolvencies began to rise. 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.
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.