Insurance Company Insolvencies: A Primer for Corporate Policy Holders

Unfortunately, even the most careful risk manager cannot completely avoid insolvent insurance companies. Delayed manifestation claims, such as those involving injury from asbestos exposure, drugs, and environmental pollutants, may implicate policies purchased decades ago, when the insurance company at issue may have had a robust financial outlook. Thus, it is important to know how to protect your company's interests in the event of insurance company insolvency.

It is important to note at the outset that there are two separate and equally important sources of recovery in most insurance company insolvencies. First, distributions are made from the assets of the insolvent insurance company, on a pro rata basis, in much the same way that distributions are made in a bankruptcy case. This usually results in an eventual recovery of a small percentage of a policyholder's actual losses under its policy.

Second, distributions are made by nonprofit organizations in existence in all 50 states known as state insurance guaranty associations ('state associations'). The amount of such distributions varies from state to state and rarely exceeds a few hundred thousand dollars per claim.

Recovery from either of these sources of payment may take years. Moreover, no corporate policyholder should expect to recover the full amount of its loss from the insolvent insurance company or state association. However, there are steps that corporate policyholders can, and in most cases should, take to maximize the likelihood of some recovery with respect to the insolvent insurance company in question. These steps include:

• Preservation of rights through notification of the relevant liquidators, state associations and any supplementary or ancillary proceedings that may exist.
• Ongoing correspondence and cooperation with liquidators and state associations concerning claim updates and liability conclusions.
• Negotiation of settlements with liquidators and state associations.
• Drop down of coverage of solvent excess insurers.

Rehabilitation versus Liquidation

Insurance companies are exempt from federal bankruptcy laws. Instead, state law governs such insolvencies. Ordinarily, a state, through its insurance department, will consult with a troubled insurance company for several months in an attempt to keep it out of delinquency proceedings. If the company's position does not improve, the insurance department will petition the state court to institute a delinquency proceeding in the form of a rehabilitation initially, and then, if necessary, a liquidation under applicable state laws.

An attempt at rehabilitation often is made prior to liquidation, although in practice, rehabilitation is often a prelude to an eventual liquidation. Policyholders stand a much better chance of maintaining coverage and receiving substantial recovery for claims in a successful rehabilitation.

Direct Recovery From An Insolvent Insurance Company

If it becomes necessary to liquidate an insurance company, the court in the state where the insurance company is domiciled enters an order of liquidation, and a liquidator, typically the state insurance commissioner of the domiciliary jurisdiction, is appointed to oversee the liquidation. The insurer is suspended from writing new policies and all existing policies are cancelled as of 30 days after the order of liquidation. All litigation against the company is enjoined. The liquidator marshals assets, evaluates claims and distributes assets in payment of such claims.

In theory, all creditors of an insolvent insurance company, including policyholders, are given notice of the liquidation, and are provided with proof of claim forms. These forms must be returned to the liquidator prior to a court-imposed filing deadline (the 'Bar Date') in order to share in a distribution of assets of the estate. Usually, the Bar Date is one year after the date of the order of liquidation.

In New York, the failure to receive a proof of claim form from the liquidator constitutes grounds for extending the Bar Date to allow the creditor to file a timely proof of claim. However, in most other states the failure to receive a proof of claim form is immaterial. Notice of the insolvency is deemed sufficient to put a creditor on notice of the need to file a proof of claim. In these states, creditors who file late proofs of claim will not be paid until all timely filed proofs of claim are paid in full.

A policyholder should complete and file a separate proof of claim form for each insurance policy issued by the insolvent company. The proof of claim should reference every claim pending against the policy, whether liquidated or contingent.

In addition, in many states policyholders are permitted to file their claims for 'policyholder protection,' ie, for all future or contingent claims that may arise against the policyholder for which it would be entitled to coverage under the terms of the policy, up to the limits of the policy had the policy still been in effect. Policyholders should always file a proof of claim for policyholder protection even if no liquidated claims exist at the time of the filing.

As in bankruptcy cases, the available assets of an insolvent insurance company are distributed to claimants according to a priority established by statute. Under the Insurers' Super-vision, Rehabilitation and Liquidation Model Act (1977) (the 'Liquidation Model Act'), policyholder claims usually receive third priority status, ie, they are paid only after administrative and wage claims have been paid in full.

Prior to payment of policyholder claims, the liquidator reviews all such claims to determine whether they should be 'allowed' in the liquidation proceeding. During the allowance process, claims are evaluated to determine their validity. The liquidator may assert any defenses available to the insolvent insurer, including policy exclusions and noncompliance with policy requirements. In order to facilitate the allowance of a claim, the policyholder should provide the liquidator with copies of all relevant documents pertaining to the claim, including documents which evidence that it has been paid by the policyholder.

Ancillary Proceedings

When the assets of an insolvent insurance company are located in more than one state, several statutes provide for the orderly transfer of the insurance company's assets between states. See Uniform Insurers Liquidation Act (1939), which has been adopted by 30 states, and the Liquidation Model Act (1977), which has been adopted by 10 states. A 'domiciliary' proceeding will be conducted in the insurance company's home state. One or more 'ancillary' proceedings will be conducted in any other states where the insolvent insurer holds significant assets. The ancillary receiver will collect the assets located in his or her state, and pay the claims of residents of that state. Residents of a state in which an ancillary proceeding has been established may file their claims with either the ancillary receiver or the domiciliary receiver. Upon payment of all residents' allowed claims, the ancillary receiver will transfer any remaining assets to the domiciliary receiver for ultimate distribution.

Recovery from State Insurance Guaranty Associations

State associations provide a second source of recovery for policyholders. State associations have been created by statute in each of the 50 states to provide limited protection to policyholders and claimants who are residents of the state.

All of the state association statutes, with the exception of New York's, are based on a Model Act adopted by the National Association of Insurance Commissioners (the 'Model Act'). Despite this common genesis, many significant differences exist among the 50 state associations. Accordingly, the following discussion is based primarily on the Model Act. Questions regarding a particular state association can be answered only by reference to the applicable state statute.

The key element of all state association statutes is the obligation to pay 'covered claims.' The Model Act defines a covered claim as 'an unpaid claim, including one for unearned premiums, which arises out of and is within the coverage of a policy issued by an insolvent insurance company.' In addition, the statute provides that either the policyholder or the claimant must be a resident of the state at the time of the insured event, or the property giving rise to the claim must be permanently located there. Under the Model Act, the association in the state where the policyholder resides has primary responsibility for claims against the policy at issue. Only if such claims are rejected by that association, or the policyholder is not a resident of any state, will coverage be provided by the state association in the state where the third-party claimant resides, or where the property is permanently located. Multiple recoveries from more than one state association are not permitted.

A necessary requirement for recovery from most state associations is the timely filing of a proof of claim. It is often not sufficient to file a proof of claim with the liquidator of the insolvent insurance company. In many instances, a copy of the proof of claim must be filed with the appropriate guaranty funds as well. Most state associations have instituted deadlines for filing proofs of claim. Usually, the association's deadline will be the same as the insolvent insurer's Bar Date, but some associations have adopted longer or shorter deadlines.

Generally, claims filed with the state associations after the deadline will not be accepted. See Satellite Bowl. Inc. v. Michigan Property & Casualty Guar. Ass'n, 165 Mich. App. 768, 419 N.W.2d 460 (Mich. Ct. App.), appeal denied, 430 Mich. 888 (1988); Jason v. Superintendent of Ins., 67 A.D. 2d 850, 413 N.Y.S.2d 17 (1st Dep't 1979), aff'd, 49 N.Y.2d 716, 402 N.E.2d 143, 425 N.Y.S.2d 804 91980). But see Middleton v. Imperial Ins. Co., 34 Cal. 3d 134, 666 P.2d 1, 193 Cal. Rptr. 144 (Cal. 1983), where a policyholder was permitted to file a late claim because the California Insurance Commissioner had failed to send timely notice of the insolvency to the policyholder.

Numerous courts have held that state associations have the same rights and obligations as the insolvent insurance company within the parameters of the statutes that created them. The state association 'steps into the shoes' of the insolvent insurer with respect to all covered claims. See Biggs v. California Ins. Guar. Ass'n, 126 Cal. App.3d 641, 179 Cal. Rptr. 16 (Cal. Ct. App. 2d Dist. 1981). In other words, the state association assumes all of the duties of the insolvent carrier, including the duty to indemnify and defend the policyholder. Martino v. Florida Ins. Guar. Ass'n, 383 So.2d 942 (Fla. Dist. Ct. App. 1980). As a corollary, state associations have all of the same contractual defenses to coverage as the insolvent insurance company and the liquidators. All notice provisions and cooperation clauses, for example, are still effective despite the insolvency. Moreover, many state associations have taken the position that they may act independently from the liquidator of the insolvent insurance company in denying claims, eg, denying coverage for a claim already accepted by the insolvent insurance company.

In addition, all state association statutes have placed a dollar limitation on the amount they will pay on covered claims. This statutory 'cap' varies from $50,000 to over $1 million per covered claim, although most states apply a cap of $300,000. At least one court has held that the phrase 'covered claim' applies to every claim made under a policy up to the limits of the policy. See Connecticut Ins. Guar. Ass'n v. Raymark Core., 215 Conn. 224, 575 A.2d (Conn. 1990). However, despite the Raymark court's ruling, many state associations continue to insist that where multiple claims are made under a policy, the statutory cap should be applied per policy and not per claim.

Numerous state associations have imposed 'net worth' limitations designed to prevent large insured businesses and wealthy individual policyholders from recovering under the statutes. In Borman's v. Michigan Prop. & Cas. Guar. Ass'n, 925 F.2d 160 (6th Cir. 1991), the 6th Circuit Court of Appeals held that Michigan's net worth limitation was a constitutional method of limiting coverage under the statute. Although the Borman's court has ruled this way, there still seems to be a reasonable basis to challenge restrictions of this type.

The effect, if not the purpose, of recent efforts of many state association administrators appears directed toward limiting coverage for the corporate policyholder through restrictive legislation and administrative interpretation of statutory language. In the future, it will likely become increasingly difficult for corporations to recover from state associations absent litigation. A failure of state associations to improve efforts to cooperate and to protect a corporate claimant in the event of its insurer's insolvency may also result in the insolvency of the corporate policyholder.

Contingent and Unliquidated Claims

One of the most challenging issues facing liquidators and state associations today is the treatment of contingent and unliquidated claims. Generally, such claims arise in two contexts: (a) claims which have been refused coverage prior to insolvency and which are in litigation on the date of insolvency, and (b) claims for incurred but not reported losses, such as undiagnosed asbestos claims and long-tail products liability claims. In order to expedite the completion of the insolvency proceeding, liquidators have imposed contingent claim bar dates. Any claim that has not become fixed and liquidated by this date will be automatically disallowed. However, many insolvent insurance companies need to 'prove up' these contingent claims in order to recover reinsurance proceeds for these claims. These companies may choose to allow contingent claims. Unfortunately for policyholders, the reinsurance collected on behalf of these allowed claims has been held to be a general asset of the insolvent insurance company's estate to be distributed pro rata to all creditors, and not an asset of the individual policyholder whose claim has been paid by the reinsurer.

Similarly, many state associations are grappling for the first time with multiple contingent and long-tail claims that are so large as to potentially threaten the viability of the associations. Under most state statutes, the association is obligated to pay covered claims 'existing prior to the determination of insolvency' or arising within 30 days thereafter. See Section 8(1)(a) of the Model Act. Despite this broad language, which arguably includes contingent and unliquidated claims, see In re Johns-Manville Corn., 57 B.R. 680 (Bankr. S.D.N.Y. 1986), most state associations will contest contingent or unliquidated claims.

Gaining Influence by Forming Policyholders' Committees

It is vital for policyholders to maintain an active role in insolvency proceedings. One way to do this is through the formation of a policyholder committee. Liquidators and receivers will try to keep all interested parties as far away from the proceedings as possible, in both actual proximity and knowledge. Accordingly, it is the well-informed policyholders who will have a better chance of determining that their rights are being adequately protected in the proceedings. It is important to investigate who else is affected by the insolvency. Attempt to band together and exchange information because policyholders as a group are naturally more active and assertive and therefore better equipped to exert a powerful influence on the course of a liquidation proceeding.

One way to ascertain who else is affected by an insolvency is to contact the appointed liquidator of the company and ask for a list of corporate policyholders or creditors. Insurance brokers or agents may also be contacted and informed of a desire to pinpoint other interested policyholders to form a committee. Brokers and/or agents may have the ability to aid in the formation of these groups that can in turn aid in maximizing recovery.

Insurance company liquidations usually operate relatively free from the influence of policyholders. Reinsurers, on the other hand, are frequently able to influence the course of liquidation proceedings, since recoverable reinsurance is often the largest single asset of an insolvent insurer. Since the goal of the liquidator and its reinsurers is to reduce the number and the size of the claims against the estate, it is especially important for all policyholders to maintain a strong voice in the insolvency proceedings. One option is for the policyholder group to seek official status from the court overseeing the liquidation. Policyholders were appointed to an Official Creditors Committee in the rehabilitation of the Mutual Fire, Marine and Inland Insurance Company. In the liquidation of Integrity Insurance Company, policyholders were permitted to participate through an informal committee.

In addition to participation in the liquidation proceedings, policyholders should form committees for the purpose of negotiating with the state associations. In this way, they may be persuaded to pool their resources to pay policyholders' claims in a uniform manner, rather than waste their resources finding evermore creative methods of denying claims.

Drop Down of Excess General Liability Coverage

'Drop down' occurs when excess insurance policies fill the gap in coverage left by an insolvent underlying insurance company. Under very limited circumstances, a policyholder may obtain drop down recovery from its excess insurers, thereby entirely avoiding the complex and often frustrating process of attempting to recover from insurance liquidations and state associations. This is purely a result of state law interpretations of the language of the contract.

Most courts have ruled that an excess insurer does not have to drop down when the primary insurance company is insolvent. These courts frequently reason that the premium charged for an excess insurance policy does not take into account the risk of being forced to drop down. See Ambassador Associates v. Corcoran, 143 Misc. 2d 706, 541 N.Y.S. 2d 715 (N.Y. Sup. Ct. 1989).

The Supreme Court of Louisiana's decision in Kelly v. Weil, 563 So.2d 221 (1990), provides a useful overview of the three main types of clauses that address an excess insurance company's responsibility to drop down in the event of a primary insurance company's insolvency. They are as follows:

1. Some insurance policies provide for coverage in excess of 'collectible' or 'recoverable' primary insurance. Courts construing such polices may require the excess insurance company to drop down to indemnify the insured for any amount not actually recovered. See, eg, Reserve Ins. Co. v. Pisciotta, 30 Cal.3d 800, 180 Cal. Rptr. 628, 640 P.2d 764 (1982).
2. Other insurance policies describe the excess coverage as the excess of the limits of the policies that are 'covered' in the schedules attached to the policy. Courts typically do not require the excess insurance company to drop down based on such language. This conclusion follows from the plain meaning of the insurance policy that defines its limits by reference to the stated limit in the underlying policy. The collectibility or recoverability of the underlying insurance is irrelevant for the purpose of the excess carrier's liability. See, e.g., Mission Nat'l. Ins. Co. v Duke Transportation Co., Inc., 792 F.2d 550 (5th Cir. 1986).
3. In the third category of cases, the policyholder's liability or retained limit is defined as the greater of the 'applicable limits of the scheduled underlying insurance ' plus the applicable limits of any other insurance collectible by the insured.' This language, or variations of it, has received very inconsistent treatment by the courts. The court concluded, as have the majority of courts, that the excess insurance company had no duty to drop down because the proper interpretation of the policy language does not require the underlying insurance to be collectible. See, e.g., Transco Explor. Co. v. Pacific Employers Ins. Co., 869 F.2d 862 (5th Cir. 1989). However, other courts have concluded that this clause is ambiguous, and thus, should be construed in favor of the policyholder, See, e.g., Geerdes v. St. Paul Fire & Marine Ins. Co., 128 Mich. App. 730, 341 N.W.2d 195 (1983).

Based upon the foregoing, it is essential to review both the language of the insurance policy and the jurisdiction in question to determine whether a particular policy may be interpreted to require the excess insurance company to drop down.

Conclusion

The most important concept corporate policyholders should retain from the foregoing is that there are definite steps which can be taken in an effort to maximize recovery in insurance company insolvency proceedings. Although the obstacles faced by policyholders may appear insurmountable, actively involved policyholders stand a better chance of recovery in liquidation proceedings. While it is true that most liquidation and receivership proceedings appear large and unwieldy, policyholders need not succumb to the somewhat passive role that has historically been expected of them.

The single most important asset a policyholder can possess that will aid in maximizing recovery in insolvency proceedings is his amount of knowledge and willingness to remain active in all phases of the proceedings.

John N. Ellison is the Managing Partner of the Philadelphia office of Anderson Kill & Olick, P.C. and concentrates in insurance coverage matters. Joshua Gold is with the firm's New York office. His practice includes insurance coverage counseling and litigation.

The past several years have seen some major property-casualty insurance companies on the ropes and worse, far worse. Home Indemnity Company and Legion Insurance Company, two notable insolvency casualties, have left their policyholders without the full protection paid for and required. Sadly, they pale in comparison to the train wreck that is Reliance Insurance Company. The demise of Reliance has had repercussions for insurance buyers and others all over. Once a fixture in the directors' and officers' ('D&O') liability insurance marketplace, among other insurance markets, Reliance is now well underway in the liquidation process, after a brief and unsuccessful attempt at 'rehabilitation.' The Reliance debacle has left policyholders scrambling to protect themselves while state insurance departments wrangle with one another in an attempt to snap up a share of the inadequate pool of assets left behind in the collapse of Reliance.

The situation created by insolvencies may yet get worse for policyholders. There is already grave concern over the prospects for at least one very large U.S.-based insurance group, coupled with the specter of additional insolvencies affecting European property-casualty insurance companies. Presently, extreme concern exists over the viability of many of Europe's largest insurance companies. A recent article in the insurance trade press quoted an analyst suggesting that many European insurance companies were already 'technically insolvent,' with the specter of asbestos liabilities looming ever more onerous.

The above scenarios are at least a partial illustration that insolvencies occurring today differ markedly from those of the past. First, the insolvencies of the past occurred primarily among small and marginal insurance companies, most of which wrote personal lines or automobile coverage. Today, many of the insurance companies facing insolvency are those that have written huge amounts of general liability insurance and workers' compensation coverage. Second, the insolvent insurance companies of the past were local or regional companies, whereas today, many of the troubled insurance companies are licensed to write insurance in all 50 states. The implication of these differences is that insolvencies now take a much greater toll on businesses in general, as more and more companies find that one or more of their insurers is unable to pay their claims.

Unfortunately, even the most careful risk manager cannot completely avoid insolvent insurance companies. Delayed manifestation claims, such as those involving injury from asbestos exposure, drugs, and environmental pollutants, may implicate policies purchased decades ago, when the insurance company at issue may have had a robust financial outlook. Thus, it is important to know how to protect your company's interests in the event of insurance company insolvency.

It is important to note at the outset that there are two separate and equally important sources of recovery in most insurance company insolvencies. First, distributions are made from the assets of the insolvent insurance company, on a pro rata basis, in much the same way that distributions are made in a bankruptcy case. This usually results in an eventual recovery of a small percentage of a policyholder's actual losses under its policy.

Second, distributions are made by nonprofit organizations in existence in all 50 states known as state insurance guaranty associations ('state associations'). The amount of such distributions varies from state to state and rarely exceeds a few hundred thousand dollars per claim.

Recovery from either of these sources of payment may take years. Moreover, no corporate policyholder should expect to recover the full amount of its loss from the insolvent insurance company or state association. However, there are steps that corporate policyholders can, and in most cases should, take to maximize the likelihood of some recovery with respect to the insolvent insurance company in question. These steps include:

• Preservation of rights through notification of the relevant liquidators, state associations and any supplementary or ancillary proceedings that may exist.
• Ongoing correspondence and cooperation with liquidators and state associations concerning claim updates and liability conclusions.
• Negotiation of settlements with liquidators and state associations.
• Drop down of coverage of solvent excess insurers.

Rehabilitation versus Liquidation

Insurance companies are exempt from federal bankruptcy laws. Instead, state law governs such insolvencies. Ordinarily, a state, through its insurance department, will consult with a troubled insurance company for several months in an attempt to keep it out of delinquency proceedings. If the company's position does not improve, the insurance department will petition the state court to institute a delinquency proceeding in the form of a rehabilitation initially, and then, if necessary, a liquidation under applicable state laws.

An attempt at rehabilitation often is made prior to liquidation, although in practice, rehabilitation is often a prelude to an eventual liquidation. Policyholders stand a much better chance of maintaining coverage and receiving substantial recovery for claims in a successful rehabilitation.

Direct Recovery From An Insolvent Insurance Company

If it becomes necessary to liquidate an insurance company, the court in the state where the insurance company is domiciled enters an order of liquidation, and a liquidator, typically the state insurance commissioner of the domiciliary jurisdiction, is appointed to oversee the liquidation. The insurer is suspended from writing new policies and all existing policies are cancelled as of 30 days after the order of liquidation. All litigation against the company is enjoined. The liquidator marshals assets, evaluates claims and distributes assets in payment of such claims.

In theory, all creditors of an insolvent insurance company, including policyholders, are given notice of the liquidation, and are provided with proof of claim forms. These forms must be returned to the liquidator prior to a court-imposed filing deadline (the 'Bar Date') in order to share in a distribution of assets of the estate. Usually, the Bar Date is one year after the date of the order of liquidation.

In New York, the failure to receive a proof of claim form from the liquidator constitutes grounds for extending the Bar Date to allow the creditor to file a timely proof of claim. However, in most other states the failure to receive a proof of claim form is immaterial. Notice of the insolvency is deemed sufficient to put a creditor on notice of the need to file a proof of claim. In these states, creditors who file late proofs of claim will not be paid until all timely filed proofs of claim are paid in full.

A policyholder should complete and file a separate proof of claim form for each insurance policy issued by the insolvent company. The proof of claim should reference every claim pending against the policy, whether liquidated or contingent.

In addition, in many states policyholders are permitted to file their claims for 'policyholder protection,' ie, for all future or contingent claims that may arise against the policyholder for which it would be entitled to coverage under the terms of the policy, up to the limits of the policy had the policy still been in effect. Policyholders should always file a proof of claim for policyholder protection even if no liquidated claims exist at the time of the filing.

As in bankruptcy cases, the available assets of an insolvent insurance company are distributed to claimants according to a priority established by statute. Under the Insurers' Super-vision, Rehabilitation and Liquidation Model Act (1977) (the 'Liquidation Model Act'), policyholder claims usually receive third priority status, ie, they are paid only after administrative and wage claims have been paid in full.

Prior to payment of policyholder claims, the liquidator reviews all such claims to determine whether they should be 'allowed' in the liquidation proceeding. During the allowance process, claims are evaluated to determine their validity. The liquidator may assert any defenses available to the insolvent insurer, including policy exclusions and noncompliance with policy requirements. In order to facilitate the allowance of a claim, the policyholder should provide the liquidator with copies of all relevant documents pertaining to the claim, including documents which evidence that it has been paid by the policyholder.

Ancillary Proceedings

When the assets of an insolvent insurance company are located in more than one state, several statutes provide for the orderly transfer of the insurance company's assets between states. See Uniform Insurers Liquidation Act (1939), which has been adopted by 30 states, and the Liquidation Model Act (1977), which has been adopted by 10 states. A 'domiciliary' proceeding will be conducted in the insurance company's home state. One or more 'ancillary' proceedings will be conducted in any other states where the insolvent insurer holds significant assets. The ancillary receiver will collect the assets located in his or her state, and pay the claims of residents of that state. Residents of a state in which an ancillary proceeding has been established may file their claims with either the ancillary receiver or the domiciliary receiver. Upon payment of all residents' allowed claims, the ancillary receiver will transfer any remaining assets to the domiciliary receiver for ultimate distribution.

Recovery from State Insurance Guaranty Associations

State associations provide a second source of recovery for policyholders. State associations have been created by statute in each of the 50 states to provide limited protection to policyholders and claimants who are residents of the state.

All of the state association statutes, with the exception of New York's, are based on a Model Act adopted by the National Association of Insurance Commissioners (the 'Model Act'). Despite this common genesis, many significant differences exist among the 50 state associations. Accordingly, the following discussion is based primarily on the Model Act. Questions regarding a particular state association can be answered only by reference to the applicable state statute.

The key element of all state association statutes is the obligation to pay 'covered claims.' The Model Act defines a covered claim as 'an unpaid claim, including one for unearned premiums, which arises out of and is within the coverage of a policy issued by an insolvent insurance company.' In addition, the statute provides that either the policyholder or the claimant must be a resident of the state at the time of the insured event, or the property giving rise to the claim must be permanently located there. Under the Model Act, the association in the state where the policyholder resides has primary responsibility for claims against the policy at issue. Only if such claims are rejected by that association, or the policyholder is not a resident of any state, will coverage be provided by the state association in the state where the third-party claimant resides, or where the property is permanently located. Multiple recoveries from more than one state association are not permitted.

A necessary requirement for recovery from most state associations is the timely filing of a proof of claim. It is often not sufficient to file a proof of claim with the liquidator of the insolvent insurance company. In many instances, a copy of the proof of claim must be filed with the appropriate guaranty funds as well. Most state associations have instituted deadlines for filing proofs of claim. Usually, the association's deadline will be the same as the insolvent insurer's Bar Date, but some associations have adopted longer or shorter deadlines.

Generally, claims filed with the state associations after the deadline will not be accepted. See Satellite Bowl. Inc. v. Michigan Property & Casualty Guar. Ass'n, 165 Mich. App. 768, 419 N.W.2d 460 (Mich. Ct. App.), appeal denied , 430 Mich. 888 (1988); Jason v. Superintendent of Ins., 67 A.D. 2d 850, 413 N.Y.S.2d 17 (1st Dep't 1979), aff'd, 49 N.Y.2d 716, 402 N.E.2d 143, 425 N.Y.S.2d 804 91980). But see Middleton v. Imperial Ins. Co., 34 Cal. 3d 134, 666 P.2d 1, 193 Cal. Rptr. 144 (Cal. 1983), where a policyholder was permitted to file a late claim because the California Insurance Commissioner had failed to send timely notice of the insolvency to the policyholder.

Numerous courts have held that state associations have the same rights and obligations as the insolvent insurance company within the parameters of the statutes that created them. The state association 'steps into the shoes' of the insolvent insurer with respect to all covered claims. See Biggs v. California Ins. Guar. Ass'n, 126 Cal. App.3d 641, 179 Cal. Rptr. 16 (Cal. Ct. App. 2d Dist. 1981). In other words, the state association assumes all of the duties of the insolvent carrier, including the duty to indemnify and defend the policyholder. Martino v. Florida Ins. Guar. Ass'n, 383 So.2d 942 (Fla. Dist. Ct. App. 1980). As a corollary, state associations have all of the same contractual defenses to coverage as the insolvent insurance company and the liquidators. All notice provisions and cooperation clauses, for example, are still effective despite the insolvency. Moreover, many state associations have taken the position that they may act independently from the liquidator of the insolvent insurance company in denying claims, eg, denying coverage for a claim already accepted by the insolvent insurance company.

In addition, all state association statutes have placed a dollar limitation on the amount they will pay on covered claims. This statutory 'cap' varies from $50,000 to over $1 million per covered claim, although most states apply a cap of $300,000. At least one court has held that the phrase 'covered claim' applies to every claim made under a policy up to the limits of the policy. See Connecticut Ins. Guar. Ass'n v. Raymark Core., 215 Conn. 224, 575 A.2d (Conn. 1990). However, despite the Raymark court's ruling, many state associations continue to insist that where multiple claims are made under a policy, the statutory cap should be applied per policy and not per claim.

Numerous state associations have imposed 'net worth' limitations designed to prevent large insured businesses and wealthy individual policyholders from recovering under the statutes. In Borman's v. Michigan Prop. & Cas. Guar. Ass'n , 925 F.2d 160 (6th Cir. 1991), the 6th Circuit Court of Appeals held that Michigan's net worth limitation was a constitutional method of limiting coverage under the statute. Although the Borman's court has ruled this way, there still seems to be a reasonable basis to challenge restrictions of this type.

The effect, if not the purpose, of recent efforts of many state association administrators appears directed toward limiting coverage for the corporate policyholder through restrictive legislation and administrative interpretation of statutory language. In the future, it will likely become increasingly difficult for corporations to recover from state associations absent litigation. A failure of state associations to improve efforts to cooperate and to protect a corporate claimant in the event of its insurer's insolvency may also result in the insolvency of the corporate policyholder.

Contingent and Unliquidated Claims

One of the most challenging issues facing liquidators and state associations today is the treatment of contingent and unliquidated claims. Generally, such claims arise in two contexts: (a) claims which have been refused coverage prior to insolvency and which are in litigation on the date of insolvency, and (b) claims for incurred but not reported losses, such as undiagnosed asbestos claims and long-tail products liability claims. In order to expedite the completion of the insolvency proceeding, liquidators have imposed contingent claim bar dates. Any claim that has not become fixed and liquidated by this date will be automatically disallowed. However, many insolvent insurance companies need to 'prove up' these contingent claims in order to recover reinsurance proceeds for these claims. These companies may choose to allow contingent claims. Unfortunately for policyholders, the reinsurance collected on behalf of these allowed claims has been held to be a general asset of the insolvent insurance company's estate to be distributed pro rata to all creditors, and not an asset of the individual policyholder whose claim has been paid by the reinsurer.

Similarly, many state associations are grappling for the first time with multiple contingent and long-tail claims that are so large as to potentially threaten the viability of the associations. Under most state statutes, the association is obligated to pay covered claims 'existing prior to the determination of insolvency' or arising within 30 days thereafter. See Section 8(1)(a) of the Model Act. Despite this broad language, which arguably includes contingent and unliquidated claims, see In re Johns-Manville Corn., 57 B.R. 680 (Bankr. S.D.N.Y. 1986), most state associations will contest contingent or unliquidated claims.

Gaining Influence by Forming Policyholders' Committees

It is vital for policyholders to maintain an active role in insolvency proceedings. One way to do this is through the formation of a policyholder committee. Liquidators and receivers will try to keep all interested parties as far away from the proceedings as possible, in both actual proximity and knowledge. Accordingly, it is the well-informed policyholders who will have a better chance of determining that their rights are being adequately protected in the proceedings. It is important to investigate who else is affected by the insolvency. Attempt to band together and exchange information because policyholders as a group are naturally more active and assertive and therefore better equipped to exert a powerful influence on the course of a liquidation proceeding.

One way to ascertain who else is affected by an insolvency is to contact the appointed liquidator of the company and ask for a list of corporate policyholders or creditors. Insurance brokers or agents may also be contacted and informed of a desire to pinpoint other interested policyholders to form a committee. Brokers and/or agents may have the ability to aid in the formation of these groups that can in turn aid in maximizing recovery.

Insurance company liquidations usually operate relatively free from the influence of policyholders. Reinsurers, on the other hand, are frequently able to influence the course of liquidation proceedings, since recoverable reinsurance is often the largest single asset of an insolvent insurer. Since the goal of the liquidator and its reinsurers is to reduce the number and the size of the claims against the estate, it is especially important for all policyholders to maintain a strong voice in the insolvency proceedings. One option is for the policyholder group to seek official status from the court overseeing the liquidation. Policyholders were appointed to an Official Creditors Committee in the rehabilitation of the Mutual Fire, Marine and Inland Insurance Company. In the liquidation of Integrity Insurance Company, policyholders were permitted to participate through an informal committee.

In addition to participation in the liquidation proceedings, policyholders should form committees for the purpose of negotiating with the state associations. In this way, they may be persuaded to pool their resources to pay policyholders' claims in a uniform manner, rather than waste their resources finding evermore creative methods of denying claims.

Drop Down of Excess General Liability Coverage

'Drop down' occurs when excess insurance policies fill the gap in coverage left by an insolvent underlying insurance company. Under very limited circumstances, a policyholder may obtain drop down recovery from its excess insurers, thereby entirely avoiding the complex and often frustrating process of attempting to recover from insurance liquidations and state associations. This is purely a result of state law interpretations of the language of the contract.

Most courts have ruled that an excess insurer does not have to drop down when the primary insurance company is insolvent. These courts frequently reason that the premium charged for an excess insurance policy does not take into account the risk of being forced to drop down. See Ambassador Associates v. Corcoran, 143 Misc. 2d 706, 541 N.Y.S. 2d 715 (N.Y. Sup. Ct. 1989).

The Supreme Court of Louisiana's decision in Kelly v. Weil, 563 So.2d 221 (1990), provides a useful overview of the three main types of clauses that address an excess insurance company's responsibility to drop down in the event of a primary insurance company's insolvency. They are as follows:

1. Some insurance policies provide for coverage in excess of 'collectible' or 'recoverable' primary insurance. Courts construing such polices may require the excess insurance company to drop down to indemnify the insured for any amount not actually recovered. See, eg, Reserve Ins. Co. v. Pisciotta , 30 Cal.3d 800, 180 Cal. Rptr. 628, 640 P.2d 764 (1982).
2. Other insurance policies describe the excess coverage as the excess of the limits of the policies that are 'covered' in the schedules attached to the policy. Courts typically do not require the excess insurance company to drop down based on such language. This conclusion follows from the plain meaning of the insurance policy that defines its limits by reference to the stated limit in the underlying policy. The collectibility or recoverability of the underlying insurance is irrelevant for the purpose of the excess carrier's liability. See, e.g., Mission Nat'l. Ins. Co. v Duke Transportation Co., Inc., 792 F.2d 550 (5th Cir. 1986).
3. In the third category of cases, the policyholder's liability or retained limit is defined as the greater of the 'applicable limits of the scheduled underlying insurance ' plus the applicable limits of any other insurance collectible by the insured.' This language, or variations of it, has received very inconsistent treatment by the courts. The court concluded, as have the majority of courts, that the excess insurance company had no duty to drop down because the proper interpretation of the policy language does not require the underlying insurance to be collectible. See, e.g., Transco Explor. Co. v. Pacific Employers Ins. Co., 869 F.2d 862 (5th Cir. 1989). However, other courts have concluded that this clause is ambiguous, and thus, should be construed in favor of the policyholder, See, e.g., Geerdes v. St. Paul Fire & Marine Ins. Co., 128 Mich. App. 730, 341 N.W.2d 195 (1983).

Based upon the foregoing, it is essential to review both the language of the insurance policy and the jurisdiction in question to determine whether a particular policy may be interpreted to require the excess insurance company to drop down.

Conclusion

The most important concept corporate policyholders should retain from the foregoing is that there are definite steps which can be taken in an effort to maximize recovery in insurance company insolvency proceedings. Although the obstacles faced by policyholders may appear insurmountable, actively involved policyholders stand a better chance of recovery in liquidation proceedings. While it is true that most liquidation and receivership proceedings appear large and unwieldy, policyholders need not succumb to the somewhat passive role that has historically been expected of them.

The single most important asset a policyholder can possess that will aid in maximizing recovery in insolvency proceedings is his amount of knowledge and willingness to remain active in all phases of the proceedings.

John N. Ellison is the Managing Partner of the Philadelphia office of Anderson Kill & Olick, P.C. and concentrates in insurance coverage matters. Joshua Gold is with the firm's New York office. His practice includes insurance coverage counseling and litigation.