Reprinted with permission from Financial Week, February 2, 2009

What if a large insurance holding company goes under? What happens to the insurance you bought from one of its insurance subsidiaries?

Take the case of American International Group, currently owned by the U.S. government. Under the applicable federal and state statutes, AIG's subsidiaries would not be subject to the holding company's bankruptcy or the jurisdiction of the federal bankruptcy court. In addition, there are additional state regulatory protections for the policyholders of the insurance subsidiaries separating the assets of those subsidiaries from AIG, the parent. As a result, a federal bankruptcy filing by AIG would not have a direct effect on the assets of the insurance subsidiaries or its policyholders.

Insurance companies are specifically excluded from the Bankruptcy Code. Instead, insurance companies are regulated by state laws that are designed to protect the interests of policyholders. Only the relevant insurance commissioners have the authority to place the insurance subsidiaries into receivership proceedings, which cannot be pre-empted by the federal bankruptcy law.

Consequently, since insurance companies are exempt from the reach of federal bankruptcy, the reach of a debtor-in-possession or a federal receiver can not extend to the assets of an insurance subsidiary.

What if, as the corporate parent, an AIG attempts to draw upon the subsidiaries' assets in order to satisfy AIG's creditors? This is barred under applicable insurance laws and regulations.

Every state has enacted insurance holding company statutes, based upon the Model Act adopted by the National Association of Insurance Commissioners (NAIC). These acts regulate inter-company transactions involving an insurance company within a holding company structure. These statutes ensure that the assets of insurance companies are held separate from its parent.

Every transaction between an insurance subsidiary and its holding company must be disclosed and approved by the relevant insurance commissioner. Each transaction must: be fair and reasonable; and not adversely effect the insurer's policyholders. Moreover, the Insurance Commissioner has the power to avoid any transaction which he "determines may adversely affect the interests of the insurer's policyholders."

Accordingly, the relevant insurance commissioner has the power and responsibility to review and approve any transaction between the parent company and the insurance subsidiary. With the current public concern regarding AIG's financial strength, for instance, it appears obvious that any transaction whereby AIG seeks to draw on a subsidiaries' assets that could potentially harm policyholders would not be approved by the Commissioner.

A recent example of the interplay of these rules concerns Conseco—which was a holding company and had insurance company subsidiaries. In late 2002, Conseco filed for Chapter 11 bankruptcy protection. None of Conseco's insurance company subsidiaries were brought into the bankruptcy, nor were their assets drawn upon to satisfy Conseco's creditors.

Worst case: suppose the federal bankruptcy trustee of an insurance holding company attempts to make a grab for an insurance subsidiary's assets. While we know of no legal basis or prior history of such an attempt, the response would be simple: the relevant Commissioner would place the subsidiary into Receivership to prevent such transactions.

In the case of AIG, the carrier's insurance businesses are its most valuable assets and if there is any change it would be more likely that they will be sold to raise capital (although this probably does not include core P/C businesses). These sales would be closely monitored by the NAIC and the state insurance regulators. It should also be noted that insurance companies are bought and sold all the time. A sale of an insurance company does not change the coverage or policy terms, other than the name and address of the new entity.

There is no guarantee, however, that an insurance subsidiary will not face economic difficulties resulting from the adverse publicity of a parent company's failure.

R. Mark Keenan is a senior shareholder in the New York office of Anderson Kill & Olick, P.C. and chair of the firm's Insurance Financial Institutions Group. Greg Hansen is a senior associate in Anderson Kill's New York office. Michael Chung is an associate in the New York office.

Anderson Kill represents policyholders only in insurance coverage disputes, with no ties to insurance companies, no conflicts of interest, and no compromises in it's devotion to policyholder interests alone.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations