Companies are increasingly being hit by a second disaster after a fire or other catastrophic loss: the discovery that the insurance company that wrote their policies is insolvent.
There have been almost 100 insurance company insolvencies in the past five years -- about the same number as the previous 15 years.
While the companies that turn out to be unable to pay claims have been relatively small players in the industry, some have been estimated to have a negative net worth of more than $1 billion.
"All is not lost upon discovery that an insurance carrier has become insolvent," said David M. Hoffmeister, a lawyer for SYNTEX (USA) Inc. But, he said, "corporations and other policyholders, who are most affected by the failures, tend to be unaware of their rights and obligations in liquidation proceedings."
He has tried to correct that situation by publishing a primer on what corporate executives should do when their insurer is declared insolvent. The article appears in the latest issue of the Docket, the quarterly publication of the American Corporate Counsel Association.
The first step is to try to collect from the assets of the insurance company itself. That can be a long process -- it is not unusual for it to take 10 years to convert the holdings to cash -- and is usually a fruitless one.
Nonetheless, it pays a company to file a claim quickly, because most state laws give late filings a much lower priority than those filed on time.
"Administrative expenses and wage payments will often exhaust the insurer's assets," Hoffmeister said. But if they do not, promptly filed claims stand next in line to get some reimbursement.
It's much more likely, however, that companies can collect from special guaranty funds that have been set up in every state but New York.
These are protective pools designed to make sure that an insurer's insolvency will not cause a loss to a policyholder.
But there are a lot of strings attached. Only certain policies are included; the guaranty fund does not reach reinsurance or fidelity, credit or title coverage. The reimbursement is available only to residents of the state where the claim is made. Companies operating in a lot of states will usually be considered a resident only of the one where the "principal place of business" is located.
And there's a limit on the payout for each loss. The model statute drawn up by the National Association of Insurance Commissioners for the guaranty plans suggests that the cap be put at $300,000, but in practice states have chosen numbers ranging from $100,000 to $500,000. A lot of business losses are many times that large.
There's one more place for a company to turn. "The corporate policyholder may have a right to recover from an insurance broker or agent who procured an insurance policy from a carrier who subsequently was placed in receivership," Hoffmeister said.
From a legal standpoint, "subsequently" is the key word in that sentence. If the broker picked a company that was actually insolvent when the policy was written, that would be considered such a reckless business decision that the broker would be held liable for any loss. Under traditional legal approaches, that's as far as the obligation went.
Three years ago, however, the Texas Supreme Court extended a broker's legal duty, setting up a yardstick to measure professionalism that allows the selection of a company that was solvent at the time the policy was written to be considered reckless.
The ruling came in a case brought by the owner of a bowling alley who had his coverage with Proprietors Insurance Co., a firm that was placed into receivership shortly after the bowling alley burned down.
After the claimant's lawyer showed the jurors that most of the companies in the field had a much higher fiscal safety rating than Proprietors, they decided the agent had taken an unreasonable risk and awarded the bowling alley owner $752,000.
The state high court disagreed, and said that the agent had no liability. Nonetheless, the justices said, there are circumstances under which they would have upheld such an award.
The key question: Were there facts a diligent agent could have discovered that would have alerted him that the risk was becoming unreasonable?
The ruling opens the way for companies to argue that, even if the insurer was solvent when a policy was written, the broker should have kept monitoring the situation and recommended a switch of carrier when insolvency loomed.
No other state has adopted this standard, but Hoffmeister suggests that a company lawyer might profitably urge local courts to do so.