What if your insurance company goes bankrupt?

The "bankruptcy" of an insurance company is referred to as "insolvency". It is roughly defined as the financial inability to pay claims as they accrue.

As a condition of becoming authorized (licensed) to transact insurance business in the company's state of domicile, it is required to pay a portion of its income into the insurance guaranty association of the state. This is essentially a state-administered pool of funds which is used to pay claims (although not always in full) when an insurer becomes insolvent.

Important to note is that only authorized (licensed) insurers are required to participate in and pay into guaranty associations, and therefore, only when you have a policy issued by an authorized insurer, do you have the chance to participate in the guaranty fund if the need arises. It is therefore important that you ensure that you are ensured by a licensed insured and not by a phony one. Illegal insurers crop up periodically, especially during periods of hard insurance markets, which tend to be cyclical.

That said, there is an alternative market of insurance which is quite legitimate, but which is not covered by guaranty associations. This is the surplus lines market. It caters to often unusual risks that are not able to be insured in the more customary market. Most states have Surplus Lines Offices which offer some level of regulation to this market, but it is far less than for the authorized market.

When a licensed insurer becomes insolvent, a Receiver is appointed in the domicile state to administer its and to run the company. Ancillary receiverships may be established in other states where the insurer did business. Assets are marshalled, a date is set for policy coverage to end, and decisions are made as to whether the company is susceptible to rehabilitation or whether it must be liquidated. Claims are handled in as orderly a fashion as possible, with priorities assigned to claims of various types laid out by statute. Time limits are set by which claims must be filed with the Receiver, and if they are not they are barred.