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(From the WCLE Website)

When the Insurer Goes Under
By Stephan A. Mills

Category: Insurance Law

Whatever the nature or merits of your claim -- whether you are representing a personal injury plaintiff or a workers compensation claimant, pursuing a professional liability claim, or trying to collect in a complex construction defects action -- you could face a grave challenge from something completely outside your control: One or more of the liability insurers you expected to answer for the anticipated judgment could become insolvent. Insurer insolvencies are not uncommon; an A.M. Best report cited 38 insolvencies in 2002 in the United States, up from 30 in both 2000 and 2001.

Plaintiffs and their attorneys too often respond to the bad news by walking away from their claims -- unless, by fortuity, there is other solvent insurance. Defendants are no less vulnerable to the potentially devastating effects of insurer insolvencies. Many suffer the unpleasant surprise of finding that one or more of their insurers are unable to pay anticipated or actual judgments.

Holders of first-party policies-such as homeowners insurance, fire insurance, and other types of coverage for property or casualty loss-are just as susceptible to the deleterious effects of insurer insolvencies. Similar to third-party claimants, these policyholders frequently fail to take into account that there are viable, state-mandated avenues of recourse available to parties aggrieved by insurer insolvencies. Many practitioners are only vaguely aware that such recourse exists. And those who know of it, but fail to master the unfamiliar, often arcane, legal rules that govern, can quickly run afoul of those rules.

When an insurer becomes insolvent, claims can be made to a state insurance commissioner or equivalent governmental official, as well as to the state insurance guarantee association (IGA). The following is an overview of the differing roles played by IGAs and insurance commissioners during an insurer's liquidation-and of relevant procedures in California.

Getting Started
For states such as California that are governed by the Uniform Liquidation Act (Cal. Ins. Code § 1064.1-.12), the insurance commissioner for the state in which an insolvent carrier is domiciled-that is, incorporated or organized in the case of nonforeign insurers-determines whether it is necessary to initiate a civil action to liquidate the carrier. (Cal. Ins. Code § 1064.1(d).) If so, the commissioner obtains an order appointing himself or herself as receiver and becomes vested with the right to possess and take title to all of the insurer's property. (Cal. Ins. Code § 1064.2.) In California, the commissioner is deemed to be a trustee for the benefit of all creditors and others interested in the insurer's estate (Cal. Ins. Code § 1057) and, as a fiduciary, must effect a pro rata distribution on all allowed claims. (Commercial Nat'l Bank v. Superior Court, 14 Cal. App. 4th 393 (1993).)

Commissioners can also bring ancillary liquidation actions in nondomiciliary states in which the insurer has significant assets. A resident of the state in which the ancillary receivership proceeding is taking place can file claims with the commissioner acting as the ancillary receiver or with the domiciliary receiver. And controverted claims-that is, those rejected by the commissioner-can be proved in either the ancillary or domiciliary proceeding. (Cal. Ins. Code § 1064.4(b).) The most common reasons that a commissioner rejects claims are that they have allegedly not been presented in accordance with procedural rules or that they fall outside the coverage of the insolvent policy.

IGA Forms and Functions
An IGA is not a state agency, nor does the commissioner direct its activities. It is a statutorily created, unincorporated association of private insurers offering particular types of property and casualty policies. (Cal. Ins. Code § 1063-1063.16.) IGAs, which act as reinsurance pools, pay and spread insolvency losses by assessing surcharges on the premiums of all workers compensation, automobile, and other lines of property and casualty insurance issued within a state. Certain states also have separate insurance guaranty associations for lines of insurance, such as life insurance, but this article addresses IGAs with respect to property and casualty policies.

According to section 1063.2-and section 12(2) of the Model Act adopted by the National Association of Insurance Commissioners, which is the basis of many state IGA laws-a person with a claim that may be recovered under more than one IGA must generally first make a claim to the IGA of the state in which the insured resides. No double recovery is permitted.

An IGA is required to participate in the liquidation process by paying pre-insolvency claims that are covered by the insolvent insurer's policy and that are not barred by any statutory exclusions. For example, covered claims cannot be brought by assignees or subrogated insurers or involve nonproperty/casualty or surplus-lines carriers. (Cal. Ins. Code §§1063.1(c) (1)-(12) and 1063.2(a).) The primary policy behind the California insurance guarantee association (CIGA) is to ensure that those who have purchased insurance, paid premiums over the years, and counted on coverage to prevent financial calamity are not left high and dry when their insurer goes under. (American Nat'l Ins. Co. v. Low, 84 Cal. App. 4th 914 (2000).) After paying claims, the IGA can make its own claim to the commissioner for reimbursement, from the estate of the insurer in liquidation, of the sums it paid to the claimant.

Recovery Possibilities and Timing
There is no statutory upper limit on how much a claimant may recover from the estate of the insolvent insurer on a claim made to the commissioner. By contrast, CIGA need not pay out more than $500,000, except on claims for workers' compensation benefits, on any one claim. (Cal. Ins. Code § 1063.1(c)(7).) Each state has its own statutory ceiling. However, the commissioner can usually pay only a pro rata share of whatever assets he or she can derive from the estate of the insolvent insurer-meaning that, depending on the severity of the insurer's financial problems, the claimant will not likely receive 100 percent of its claim. Furthermore, it can take many years for the commissioner to complete an estate liquidation, and he or she is under no statutory deadline as to when approved claims must be paid. The commissioner in California may make substantial interim distributions on approved claims, but does so at his or her own discretion.

IGA claims, on the other hand, are not limited to assets that can be salvaged from the insolvent insurer's estate. And payment of IGA insolvency claims is not delayed until the commissioner winds up liquidating the estate's assets or makes partial interim distributions.

Claims to the commissioner do not require the claimant to meet complicated statutory definitions as to which insolvency claims are covered-for example, obligations of an insolvent insurer incurred no later than 30 days after the commissioner is appointed as liquidator are compensable by CIGA. A person need only demonstrate that the insured had coverage under a policy of an insolvent insurer and that, but for the insurer's insolvency, that claim would have been paid under that policy. In contrast, even if an insolvent insurer's policy indisputably provided coverage, an IGA may nevertheless reject a claim on the ground that it is not a covered claim (Cal. Ins. Code § 1063.1(c)(1)-(2)), or on the ground that is one of the ten types of obligations that are not covered. (Cal. Ins. Code § 1063.1(c)(3)-(12).)

Covered Claims
In construing what claims are covered, two cases are preeminent in displaying California courts' reluctance to accept a restrictive view of CIGA's statutory obligations.

The Second District, in CD Investment Co. v. CIGA, (84 Cal. App. 4th 1410 (2000)), rejected CIGA's contention that an insured who recovers at least $500,000-the per-claim liability limit under Insurance Code section 1063.1(c)(7))-has no claim against CIGA for the balance. In other words, the court rejected CIGA's attempts to reduce the statutory limits of its liability by the amount a claimant receives from solvent carriers. It also rejected CIGA's attempt to aggregate several policies into one claim subject to a single $500,000 CIGA limit.

Finally, while CD Investment acknowledged that covered claims are not coextensive with an insurer's obligations under its policies, the decision reaffirmed that CIGA's statutory duties can best be defined by examining the contractual duties imposed on the now insolvent insurer either by law or policy provisions.

In American National, mentioned earlier, CIGA argued unsuccessfully that the claimant, which was an insurance company, could not have a covered claim because the CIGA statutes are intended to protect only individuals. The court also rejected CIGA's attempt to focus the public policy argument on the need to keep the number of covered claims limited to assure its financial stability, holding that the "argument that CIGA's financial stability is preeminent could be used to oppose any recovery under the statute, and taken to the extreme would result in no claims being covered."

CD Investment and American National may signal an increasing willingness by the courts to carefully examine whether CIGA's interpretations serve both the letter and policy of the CIGA statutes. (See, Black Diamond Asphalt, Inc. v. Superior Court, 109 Cal. App. 4th 166 (2003), in which the court soundly rejected CIGA's contention that considerations of hardship and public policy dictated that venue for all complex actions against it should be Los Angeles County, where CIGA is headquartered.)

A claimant who wants to pursue a claim with the commissioner must intervene in the liquidation action by initiating an order to show cause proceeding within 30 days after the commissioner sends a written notice of rejection. (Cal. Ins. Code § 1032.) This provides the claimant with a speedy and relatively inexpensive remedy. However, the practitioner must be quick and careful-filing a complete and seamless case for coverage within the 30-day period, including declarations and exhibits addressing all issues of coverage. By contrast, if an IGA rejects a claim, the recourse is to file an ordinary action against the IGA separate from the liquidation proceeding. (Kortmeyer v. CIGA, 9 Cal. App. 4th 1285 (1992) ("covered claims" are not to be determined in "show cause" proceedings).) The lawsuit is more cumbersome and expensive than an order to show cause proceeding, but it offers the opportunity for a full trial.

A claimant may not bring a CIGA claim unless he or she has timely filed a proof of claim with CIGA or the commissioner. (Cal. Ins. Code § 1063.1(c)(1)(iii).) The commissioner must give notice of the claims-bar deadline "to its policyholders, creditors, shareholders, and all other persons interested in its assets." (Cal. Ins. Code §§ 1021 and 1063.7.) A plaintiff who receives notice from the commissioner should timely submit a proof of claim and not rely on the defendant to do so. Unless a proof of claim is filed within the time limit established by the liquidation order, the claim will be barred. (Cal. Ins. Code § 1024; the required form and contents for claims are prescribed in Cal. Ins. Code § 1023.)

Policyholders whose claims -- or liabilities, in liability policies -- have not been fixed should file "contingent and undetermined" proofs of claim on each of their policies and regarding any claims against any people or entities insured by the insolvent carrier. (See, Garamendi v. Mission, 15 Cal. App. 4th 1277 (1993) and Cal. Ins. Code § 1025.) Even though proofs of claim arguably need not be filed for policies covering liability to third parties (such as occurrence-type commercial general liability policies), when no claims have been made or even threatened against the policyholder, it is good practice to file such proofs of claim, marking them "contingent and undetermined."

After the initial claims bar deadline, the commissioner may publish and mail notices to policyholders requesting that they amend any contingent and undetermined proofs of claim. It is crucial that the amended claims be stated properly and timely filed. If not, the commissioner might deny the claims outright, regardless of their merits.

Battling Rejection
If a claim is rejected, the commissioner must give written notice to the claimant. The policyholder will have 30 days from the time rejection notice is mailed to file an order to show cause in the liquidation action asking the court to overrule the commissioner's rejection of the claim. (Cal. Ins. Code § 1032.) The deadline should be regarded as jurisdictional, so, unless the commissioner is willing to stipulate to an order to show cause and to a briefing schedule so that the parties can present their arguments and evidence, the claimant must file the application for an order to show cause, including points and authorities and supporting declarations, within that period or risk losing the claim.

The burden on the claimant is increased by the fact that the rejection letter may be the first indication that the commissioner views a claim with disfavor. The notice may not specify any reasons for rejection and may simply recite that the claim is rejected because there is purportedly no coverage under the policies. Upon receiving a rejection letter, the claimant should attempt to get the commissioner to stipulate to the reasons underlying the rejection so that all the parties can properly focus their efforts.

Stephan A. Mills (smills@ zemanekandmills.com), a member of the Los Angeles firm of Zemanek & Mills, practices in the insurance insolvency area. The firm represented the appellant in CD Inv. Co. v. California Ins. Guar., which is discussed in this article.

Article updated: March 2004

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