The analogy of insurers to banks is useful—insurers and banks are both financial intermediaries performing similar important functions in the U.S. economy. The federal insurance funds of the Federal Deposit Insurance Corporation (FDIC), the Pension Benefit Guaranty Corporation (PBGC), and the National Credit Union Share Insurance Fund (NCUSIF) provide similar protections. How Insurance Guaranty Funds Work

Provision for policyholders of insolvent insurers began slowly in the late 1930s. Cooperation among the states where the insolvent insurer operated is essential. There are other differences among the protection systems, too, including whether the protection fund exists before the insolvency, whether the contributors to the fund pay based on the risk each presents to the system's solvency, and whether those contributors can recoup the costs of their payments to the system. Whether to change the current system of policyholder protection would be a significant policy issue in any legislation to authorize or require federal regulation of insurers. In the 110 th Congress, Senators John Sununu and Tim Johnson introduced the Senate version of the National Insurance Act of 2007 ( S. 40 ), and Representatives Melissa Bean and Ed Royce introduced a House version ( H.R. 3200 ). Both bills would require all federally licensed insurers to participate in state guaranty funds, with the possibility of a federal guaranty fund if the state guaranty funds do not treat national insurers in the same manner as state insurers. 3766 ) to allow insurers to elect federal licensing and regulation. It also would have required federally regulated insurers to participate in a state-based system of policyholder protection operating generally as it does now. Some of the policy issues that Congress might confront should it consider federal chartering for insurers are as follows:
Should federal legislation create a federally based protection system for federally chartered insurers, or instead require them to participate in the state-based guaranty fund system? Requiring federally regulated insurers to participate in a state-based protection system would entail significant, though unquantifiable, indirect costs to policyholders, insurers, and taxpayers. This is because incentives would be misaligned: that is, the costs of insolvencies would fall on the states, not on the federal regulator, and the states, though bearing the financial burden, would have no control over the effectiveness of federal regulation for solvency. These conflicting objectives could create the potential for significant economic inefficiencies. The principal issues would be deciding what types of policyholders would be protected in the event of an insurer's insolvency and what the limits on their recovery should be. Also, if Congress wished to protect only policyholders of federally regulated insurers, then constituents might have different levels of protection depending on whether their insurers were state-regulated or federally regulated. Should Congress decide to offer federal protection, technical issues could include how to fund the protection, its scope, the location of the administering agency in the executive branch, and how to enforce market discipline fairly.
Some constituencies are urging Congress to allow insurers to become federally regulated, like banks. Other constituencies are urging Congress to instead ratify its 1945 delegation of insurance regulation to the states. In the past few years, various pieces of legislation have been introduced to implement some form of federal charter for insurance companies. The latest such legislation is the National Insurance Act of 2007 (S. 40 and H.R. 3200).
How to protect insurance policyholders in the event of their insurer's insolvency is among the thorniest issues in insurance regulation, whether federal or state-based. The current system of protection for insurance policyholders is called "insurance guaranty funds." This interdependent system is a cooperative effort among regulators and insurers in the states where the insolvent insurer operated. It is administered state-by-state and funded by assessments on insurers. Though it has developed relatively recently, the system has provided some protection for policyholders of both large and small insolvent insurers.
If Congress were to consider regulating insurers federally, it would confront the issues of whether and how to provide that policyholder protection. Should Congress wish to protect insurance policyholders in an insolvency, it might choose to establish or expand a federal program like the Federal Deposit Insurance Corporation, the Pension Benefit Guaranty Corporation, or the National Credit Union Share Insurance Fund. Another option would be to require federally regulated insurers to participate in the state-based guaranty fund system.
Establishing federal protection for policyholders of insolvent federally regulated insurers would have costs and benefits. Direct costs would include, at the least, the costs of establishing and administering the system. Costs could also include funding of catastrophic shortfalls, as happened in the savings and loan crisis in the 1980s. Indirect costs could include inefficiencies that might result from dampening market discipline. The measure of benefit to policyholders would depend on the scope of protection offered. The potential benefit to the U.S. economy would require further analysis.
Requiring federally regulated insurers to participate in state guaranty funds would have costs and benefits as well. The costs would include the economic inefficiencies created by externalizing the costs of ineffective solvency regulation. The benefits would be simplicity and a consolidated assessment base.
This report describes generally how state-based insurance guaranty funds operate currently. It also compares the extant insurance system to protections offered bank depositors, potential and current pensioners, and credit union participants. It was originally prepared by [author name scrubbed], Insurance Consultant, Government and Finance Division, and will be updated as warranted by legislative events.