ISSUE – INSURANCE CARRIER INSOLVENCY

What happens when an insurance carrier defaults on its obligations under the Longshore and Harbor Workers’ Compensation Act due to insolvency?

I’ll discuss several insolvency scenarios in four separate entries.  Part One will cover default by an insurance carrier, Part Two will cover defaults by both the insolvent insurance carrier and by the insured employer due to bankruptcy, Part Three will cover uninsured employer bankruptcy, and Part Four will cover the bankruptcy of an authorized self-insured employer.  Here is Part One.  The other Parts will appear intermittently in the future.

PART ONE – INSURANCE CARRIER INSOLVENCY

First, what are the consequences to the insured employer if its insurance carrier becomes insolvent?

Section 935 of the Longshore Act (33 U.S.C. 935) provides that discharge of an obligation by an insurance carrier discharges the employer’s liability.  If the insurance carrier defaults, thus failing to discharge this obligation, then the primary obligation remains with/returns to the insured employer.

PARENTHETICAL NOTE:  In the reverse situation, that is, the insured employer becomes bankrupt, section 936(a) provides that, “Every policy or contract of insurance issued under authority of this Act shall contain…(2) a provision that insolvency or bankruptcy of the employer and/or discharge therein shall not relieve the carrier from payment of compensation for disability or death sustained by an employee during the life of such policy or contract.”  This provision refers to first dollar insurance policies issued by insurance carriers authorized by the U.S. Department of Labor to write coverage under the Longshore Act as required by section 932.  It does not apply to reinsurance or excess insurance contracts.

So, Mr. Employer, if your insurance carrier becomes insolvent and defaults then you must immediately assume responsibility for all benefits due and payable (and all interest and penalty provisions of the Act apply).

Here is a generic sequence of events when an insurance carrier becomes insolvent:

1. The State insurance regulator in the state of domicile goes to state court to have the carrier declared insolvent;
2. The State insurance department assumes administration of the carrier;
3. All new and renewal business is suspended and existing policies are cancelled;
4. The State insurance regulator examines the carrier’s finances to determine if it can be rehabilitated or must be placed in liquidation, while open claims go into runoff;
5. Each employer insured with the insolvent carrier receives a letter from the U.S. Department of Labor (DOL) advising that the employer must immediately obtain coverage to secure its obligations under the Act, and that if the carrier stops paying benefits then the employer must immediately assume responsibility for its claims;
6. The DOL will determine whether it is holding any collateral from the insolvent carrier, and in which states the insolvent carrier wrote Longshore business, and what the position of each state’s guarantee fund is likely to be.

Here is what the insured employer must do if its insurance carrier becomes insolvent:

1. get new insurance coverage immediately,
2. find out what protection is available from the guarantee fund in each state where the employer has operations (this can be problematic for Longshore cases, and was the subject of a previous blog posting on August 5, 2010),
3. obtain claim files from the carrier or its TPA, or from the DOL’s District Office,
4. Prepare to pay all open cases in the event that the state places the carrier into liquidation, at which time payments by the state will cease.  There will be a delay while the state administrator ships files to state guarantee funds for possible payment.  In the meantime, penalties and interest will accrue on late payments.

Note that the Special Fund administered by DOL is not yet involved.  The Special Fund under section 918(b) provides the injured employee with a possible source of payments if there is a default by an employer, not a default by an insurance carrier.

And especially Note that in the event of an insurance carrier insolvency and default it is likely that the DOL will take the position that any collateral it holds will be reserved for those cases that cannot be paid because both the carrier and the insured employer are insolvent.  In other words, solvent insured employers will be required to pay their own cases.  In states like California and West Virginia, where the state guarantee funds do not pay benefits in Longshore cases, and in states like Louisiana and New Jersey, whose guarantee funds pay only under restricted conditions, the insured employers are exposed to possible significant liability for their Longshore Act obligations.  For a more complete discussion of the various states please refer back to the August 5, 2010 discussion.

Main Point Number One: Under the Longshore Act, when an insurance carrier becomes insolvent and defaults, the insured employer must immediately meet its primary obligation to assume responsibility for and to pay its own claims.

Main Point Number Two:  In many states maritime employers cannot rely on protection from state guarantee funds.  As noted, this blog’s August 5, 2010 entry contained detailed information with regard to the expected responses of each state guarantee fund in the event of an insurance carrier’s default in Longshore cases.

Next:  What if both the insurance carrier is insolvent and the insured employer is bankrupt?

Issues – State Guarantee Funds

The U.S. Department of Labor (DOL) administers the Longshore and Harbor Workers’ Compensation Act, and its extensions, the Defense Base Act, the Outer Continental Shelf Lands Act, and the Nonappropriated Fund Instrumentalities Act.

Section 935 of the Longshore Act provides that payment of benefits by an insurance carrier on behalf of an insured employer discharges that employer’s obligation to pay those benefits.  If the insurance carrier fails to pay then the employer must immediately assume its primary obligation to pay all benefits due and payable, subject to the penalty and interest provisions of the Act.

The DOL implemented a security requirement in 1990 applicable to authorized insurance carriers rated lower than “A” by the A.M. Best Company, in order to protect injured workers from the consequences of default in the payment of benefits due to insolvency, and to protect the Special Fund administered under section 944 of the Act.  This was in response to the carrier insolvencies during the 1980s and the subsequent failure by many state guarantee funds to protect Longshore employers and employees.

Due to the inability of Best ratings (or any other rating system) to predict insurance carriers’ financial viability for the long term of the typical workers’ compensation long tail obligation, and the continuing failure by many state guarantee funds to protect maritime employers, DOL published new regulations during 2005 aimed at requiring security from insurance carriers without regard to Best ratings, but rather aimed specifically at business written in those states where the state guarantee funds do not fully protect Longshore benefits.

State insurance laws creating and governing guarantee funds come with a wide variety of restrictions and conditions.  Some states’ funds simply do not pay federal Longshore benefits.  These states are:  Arizona, California, Illinois, Iowa, Kentucky, Missouri, New Mexico, North Dakota, Ohio, Oklahoma, South Dakota, Tennessee, West Virginia, and Wyoming.  Longshore Act business written in these states must be fully secured with DOL.

In addition, provisions in many other states restrict Longshore protection.  A partial list of the restrictions on state payments includes time limits for filing, claims definitions that do not recognize occupational disease exposures, non-payment of deductible portions of an employer’s exposure, maximum limits on benefits, restrictions based on the financial size of the insured employer, restrictions based on financial viability of the insured employer, residency requirements, and rates that are lower than federal Longshore rates.

The following states have demonstrated that their guarantee funds do not provide full protection for Longshore benefits:  Alabama, Arkansas, Delaware, Indiana, Louisiana, Maine, New Jersey, New York, Oregon, Pennsylvania, Utah, and Wisconsin.  Longshore business written in these states must be partially secured with DOL.

States’ funds that have paid or are likely to pay Longshore benefits in full include:  Alaska, Colorado, Connecticut, Florida, Georgia, Hawaii, Idaho, Kansas, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Montana, Nebraska, Nevada,  New Hampshire, North Carolina, Rhode Island, South Carolina, Texas, Vermont, Virginia, and Washington.  Security is not required for Longshore business written in these states.

In those states where guarantee funds have paid full Longshore benefits in the past, it is not a sure thing for the future.  State laws and their interpretation have proven to be very changeable.

The lesson:  If you are a maritime employer you cannot rely on state guarantee funds to protect you if your insurance carrier fails to pay.

Note:  If AEU places your longshore coverage you don’t have to be concerned with the unpredictable response of state guarantee funds.  Your claim obligations are fully secured in a dedicated trust fund regulated by the U.S. Department of Labor and invested only in U.S. Treasury securities.