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The guaranty fund system may have served policyholders once upon a time. But that was long, long ago in a galaxy far, far away. Today the guaranty fund system is broken and it needs a serious fix--now.

Policyholders of Pennsylvania-based Reliance Insurance Co., which went into liquidation in 2001, and Legion Insurance Co. and Villanova Insurance Co., which went into liquidation in 2003, know that better than anyone else.

In the case of the California-based workers' comp insurer Mission Insurance Co., policyholders had to wait 21 years--21 years--for insolvency proceedings to resolve themselves.

It's an even wager that by the time the last of the claims stemming from a complex insolvency get paid, dozens of policyholders will probably be dead; so much for representing the interests of policyholders. Who can afford to wait that long?

When insolvency lawyers and receivers finally slam the last nail into the coffin of a drawn-out insolvency, it's not unusual for the cost of the entire mortuary exercise to have ballooned into the tens of millions of dollars; so much for representing the interests of taxpayers. Who can afford these kinds of cost overruns?

Beginning in January 2006, according to the National Conference of Insurance Guaranty Funds, property-casualty guaranty funds have been taking a long and hard look at themselves. At least the industry recognizes there's a problem. Let's just hope the funds wrap up their business faster than it takes to settle the average insolvency proceedings.

Yet, perhaps we ought not be surprised by the waste and inefficiency among our national guaranty funds. The way the guaranty fund system was patched together over the past four decades should leave us wondering what kind of administrative morass we're dealing with.

Guaranty funds spin around an axis of unaccountability. Receiverships, which control tens of millions of dollars, are often managed by insolvency practitioners with few professional qualifications. The lack of oversight leaves the funds to operate in the blackness of night, inviting abuse and mismanagement.

The framework for dealing with insurance insolvencies is decades old, and attempts to improve the guaranty fund system have been executed piecemeal. As usual with the state-based insurance system, there's no central data repository of statistical and financial details on insolvencies in the past.

It's not unusual to foist onto receiverships the responsibility to manage the insolvency of large multinational insurance corporations with offices in dozens of countries.

Complex liability lines dominate the nature of insolvencies instead of simpler property lines, and the insolvencies we see today involve complex reinsurance arrangements as well. Managing these bankrupt behemoths is neither for the faint of heart, nor the marginally qualified.

It's no accident that the management of guaranty funds has, at best, a checkered record of success.

The guaranty fund system is in desperate need of attention and reform, whether that means shoring up the state-based system already in place, or whether it requires an alternative. Time to scrap the Band-Aid approach.

Here's a contrast for you: In Australia, following the 2001 collapse of HIH Insurance Group, the first distributions to policyholders occurred five years later, in 2006, thanks to an arrangement proposed by the liquidator. Similar processes are also allowed in the United Kingdom, Bermuda and Singapore.

But not in the United States. We seem content with a system that's inefficient, expensive, slow and unfair. We fail at failures ... and with that we seem perfectly content.

The time has come to end this charade. Either we repair our system, or give it the boot.

CYRIL TUOHY is managing editor of Risk & Insurance®.

To get the other side of the issue, read the "Point" by Roger H. Schmelzer.

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September 1, 2007

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