Good article. We were always told, when I was in the business, you couldn't mention these failsafes or sell using them. But this will make some of you feel better. It'll be a mess, but you'll be ok as policyholders: Insuring the insurers States' back-up plans protect life, auto, homeowner policyholders By Andrea Coombes, MarketWatch Last update: 5:06 p.m. EDT Sept. 15, 2008Comments: 4SAN FRANCISCO (MarketWatch) -- If you've got a life-insurance, auto or homeowners policy through AIG, you might be worriedly watching the insurance giant's financial fate -- but some back-up plans exist to keep most policyholders safe. It's unclear at this point how AIG (AIG:American International Group, Inc AIG 4.76, -7.38, -60.8%) will ultimately fare, but the good news for consumers is that each state has a guaranty association in place to protect policyholders in the event of an insurer's failure. For its part, AIG says its insurance subsidiaries, all of which are wholly-owned, are "well capitalized and they meet or exceed local regulatory capital requirements," said Joe Norton, an AIG spokesman. "These companies continue to operate in the normal course of business to meet our obligations to policyholders." See full story. But even if AIG -- or any other insurer -- faced insolvency, state guaranty associations exist to protect consumers. Life insurance For life-insurance policies, every state, plus the District of Columbia and Puerto Rico, runs a guaranty association that requires insurance companies to essentially cover for their competitors. That is, firms have to pay a fee -- the amount is based on their market share in any given state -- to help ensure any failed institutions' customers are protected. If they don't pay the fee, they risk losing their license in that state. Life insurance policyholders are protected for at least $100,000 in cash surrender or withdrawal value on their policy and at least $300,000 in death benefits, said Peter Gallanis, president of the National Organization of Life and Health Insurance Guaranty Associations in Herndon, Va. "If you've got $100,000 or less in cash surrender value on your contract, there is a very good chance that your policy will be transferred and you'll never miss a beat," Gallanis said. Some states provide higher protection, he said. For instance, New York, Connecticut and the District of Columbia protect life insurance policyholders up to $500,000, he said. "We work with the receiver of the failed company to engineer bulk transfers of the insurance blocks of business to healthy companies, to new insurers, and typically the new insurer will provide all of the protection that would have been provided under the old policy," he said. Insurers "are induced to take over these blocks of business by the transfer of some or all of the assets that were left in the failed company, together with a payment from the guarantee associations to make up the asset liability shortfall," Gallanis said, noting that given how insurance companies are regulated, even after a company fails there are usually assets left. Policyholders with a life insurance policy worth more than the limit may find they'll be on the hook for more out-of-pocket costs, Gallanis said. "Typically the policyholder will either be given a choice of either having the policy level reduced to the level guaranteed by the guaranty association or else picking up the cost of receiving policy protection in an amount over and above what the guaranty association provides," he said. "Now, usually that cost is not going to be that dramatic, because the way life insurance companies are regulated," Gallanis said. That is, a failed life insurance company often still has significant assets, he said. Homeowners, auto policies There are similar guaranty associations at work protecting consumers who have homeowner or auto-insurance policies. If you have a claim filed with a company that then fails, the guaranty association takes over. "If they have a claim and the insurance company is insolvent, the guaranty fund just accepts that claim the way an insurance company would, and they would adjust the claim and they would do everything an insurance company would do," said Roger Schmelzer, chief executive of National Conference of Insurance Guaranty Funds Inc. in Indianapolis. "The guaranty fund steps into the shoes of the insurance company from a claims-paying perspective," he said. Most states' guaranty associations cover homeowners and auto policy claims up to $300,000, he said, though the maximum can range from $100,000 to $1 million. Guaranty members -- that is, state guaranty associations that cover property and casualty insurers -- "say they can hardly remember ever a claim that was not within the $300,000, which is the cap in most places," Schmelzer said. Still, the claims-paying process might be delayed, industry experts said. If you're simply holding a policy, with no claims in process, and the company fails, then it's time to shop around, he said. "There would be a date at which you'd no longer be covered by that company," Schmelzer said. "You'd go buy another policy someplace else ... the protection there is the marketplace. You've got plenty of choices." If an insurance company fails and you have prepaid a substantial amount of premium, then that premium, too, is usually recoverable through the guaranty association, said Barb Cox, the group's vice president of legal and regulatory affairs. In an email interview, she offered one possible scenario: "For example, I paid a six-month premium for car insurance. My company is liquidated and found insolvent two months into that policy period. In most states, guaranty funds cover 'unearned premium' claims for covered claimants," Cox said. "These claims are often subject to statutory limits that may be different from the limit on loss claims," she said. "Often a state will have an unearned premium claim limit of $10,000 or $25,000, while their loss claim limit is typically $300,000." Andrea Coombes is an assistant personal finance editor for MarketWatch, based in San Francisco.