The effect of the failure of a large U.S. life, health or annuity issuer on state life and health guaranty funds is not clear, according to Daniel Hartley, a senior economist at the Federal Reserve Bank of Chicago.
A state guaranty fund usually imposes assessments on surviving member insurers to cover the cost of an insurer failure, rather than building large reserves.
"The failure of a large life insurer could leave some states in the position of having to levy assessments on the remaining insurers for many years," Hartley writes in a recent Fed paper on how state insurance guaranty funds protect policyholders.
Insurers usually pay life and annuity benefits long after the products are purchased, and issuers pay annuity benefits over many years. That long time horizon could limit how quickly a guaranty fund would need to come up with large amounts of cash to make good on guaranty obligations, Hartley says.
He notes that guaranty funds can cope with gaps in cash flow by issuing state revenue bonds.
But the life and health guaranty fund system is run by the states and is less transparent than the FDIC insurance system for banks, and the fact that insurance company failures have been less common than bank failures means that observers have less information about how a big failure might work, he warns.
"The few examples of insurer failures raise important questions regarding the combination of legal uncertainty and timing, as well as the equitable treatment of similarly situated policyholders," Hartley concludes.
What it means: Hartley's paper could now be what federal regulators have in mind when they're thinking about the possibilities of life and annuity issuers failing.
