15

Let's say there is a fire insurance company X with most of its clients from Region Y. Say that this was Company X's intent, with the knowledge that the following scenario might happen.

A wildfire starts in Region Y, and Company X suddenly owes a lot of money to property owners in Region Y because their houses got burned down by the wildfire. If Company X doesn't have enough money to pay all its clients, what can it be charged with? Are there any geographic limitations on insurance companies to prevent this from happening?

mathlander
  • 439
  • 4
  • 21
  • 18
    Running out of money isn't a crime so the company won't be charged with anything (other than entering bankruptcy) unless there was some sort of malfeasance not specified in the question. Practically, insurance company X would have insured itself in the reinsurance market to mitigate its risks. – Justin Cave Mar 20 '24 at 03:28
  • 1
    What if the company did something like calling itself "San Francisco Fire Insurance" to increase the chances of this happening, thereby decreasing the expected amount of money it loses? – mathlander Mar 20 '24 at 03:33
  • 3
    Sorry, not sure how the company's name increases or decreases the chance of claims exceeding reserves. I'm assuming you meant "thereby increasing the expected amount of money it loses". If your fictional insurance company only writes policies on properties in San Francisco, the state insurance commission would demand that it offload a large fraction of the risk in the reinsurance market or would shut it down. That doesn't guarantee that the company doesn't go bankrupt if the Big One hits San Francisco. But it does ensure that some level of operational prudence. – Justin Cave Mar 20 '24 at 03:38
  • But this doesn't seem like a legal question. – Justin Cave Mar 20 '24 at 03:38
  • 2
    Not directly an answer to your question, but many insurance policies have "force majeure" and "act of God" clauses, explicitly exempting large-scale events (e.g. flood loss and nuclear war) from claims. The concept is that if a disaster is so widespread that it risks bankrupting insurance companies, government disaster relief would take over instead. – R.M. Mar 20 '24 at 14:30
  • 4
    The company would have to be licensed by the state which includes region Y to do business to do business in region Y. If not, the company is in big trouble. If so, then the company has complied with the laws of the state for region Y and those laws would apply in spending the companies reserves, other assets, and possible bankruptcy. In many states the state would take over their business, as Florida has done with several insurance companies due to storm losses. – David Smith Mar 20 '24 at 18:52
  • 2
    @JustinCave: The company's name in mathlander's case is relevant because it's encouraging buyers to all be insured over something that could be a single event. Thus the outcomes of the company are pretty binary: the event doesn't happen and everything is profit, or the event does happen...and then you just declare bankruptcy and start a new company. – Cliff AB Mar 21 '24 at 04:31
  • 1
    I still can't see why a company's name is relevant in that case. A company can simply refuse to write any policies that are contrary to their goals. They can also advertise on what they do. For example Farmer's Insurance covers a bunch of non-farm cars and homes, and they cover almost no farms. – user71659 Mar 22 '24 at 01:25
  • 2
    @user71659 I think there's a little overfocus on company name. It was merely an example of a way in which a company may position itself to take on highly correlated risk. With highly correlated risk, if it the risk does not come to fruition, everyone involved in the company can walk away with a whole lot of profit. And if the the correlated risk does occur, well everyone involved is shielded from significant loss by the company going bankrupt. You could argue that Silicon Valley Bank is exactly an example of selecting a company name that encourages highly correlated risk. – Cliff AB Mar 22 '24 at 02:15
  • 1
    ...the correlation of risk with Silicon Valley Bank is that while interest rates are low, startups do great, but when interest rates are higher, people don't have as much money to throw at moonshots. – Cliff AB Mar 22 '24 at 02:18

1 Answers1

36

It goes bankrupt

It happens constantly; 10 per year is the typical number of insurance company bankruptcies in the USA, but it did hit 50 per year in the 1990s.

Typically, these bankruptcies are due to the normal rough and tumble of business—bad luck, bad judgment, bad risk pricing, and bad timing. People don’t go to jail for poor business decisions. Charges might be laid if there was fraud or other malfeasance, but it's easy enough to go broke in any industry, especially so in a highly competitive one like insurance.

Each state, plus Puerto Rico and Washington DC, requires insurers to contribute to a bail-out fund in the case of an insurer going broke, but payouts to customers are capped and will often not be what was payable under the policy.

Also, insurance companies typically take out insurance themselves for major claims - this is called reinsurance. Reinsurance should ideally make sure the insurer cannot go bankrupt from unexpected claims.

sleske
  • 8,095
  • 4
  • 26
  • 56
Dale M
  • 208,266
  • 17
  • 237
  • 460
  • Comments have been moved to chat; please do not continue the discussion here. Before posting a comment below this one, please review the purposes of comments. Comments that do not request clarification or suggest improvements usually belong as an answer, on [meta], or in [chat]. Comments continuing discussion may be removed. – Dale M Mar 21 '24 at 20:32