Recent Decisions Limit Recovery From State Guaranty Funds

Two recent decisions have clarified the applicability and limitations of coverage available from state insurance guaranty funds. Guaranty funds are designed to protect insureds when an insurer becomes insolvent and is unable to pay claims, but the obligations of guaranty funds are limited by statute and the funds are generally designated as insurers of last resort. Recently, the highest courts in Illinois and New Jersey both applied state statutes favorably for guaranty funds, limiting the funds’ liability to claimants. Both cases provide important statutory interpretations and insight into the limitations of guaranty fund recovery.

In Farmers Mut. Fire Ins. Co. of Salem v. N.J. Property-Liability Ins. Guar. Ass’n, 215 N.J. 522 (2013), the Supreme Court of New Jersey determined that the state Guaranty Association was not subject to pro rata allocation for a loss implicating multiple insurers and its obligations did not arise until all other insurance had been exhausted.

In the case, Newark Insurance Company issued a homeowner’s policy for a property that was subsequently insured by Farmers Mutual. After the Farmers Mutual policy took effect, the property was found to have groundwater contamination from leaks from underground fuel storage tanks. The contamination began while Newark insured the property and continued while Farmers Mutual insured the property. Under its policy, Farmers Mutual paid all the remediation costs. However, Newark Insurance became insolvent and the Guaranty Association took over its claims.

New Jersey case law dictates that in continuous-trigger cases where multiple insurers are implicated, the insurers’ liabilities are allocated on a pro rata basis according to the “carrier’s years on the risk and the degree of risk assumed as measured by the coverage provided.” Based on this precedent, Farmers Mutual sought reimbursement from the Guaranty Association for the insolvent insurer’s share of the loss. The Guaranty Association countered that its statutory obligation to pay arises only after all solvent insurance coverage is exhausted.

The New Jersey Supreme Court agreed with the Association and held that the exhaustion provision of the statute trumped the normal method of allocation among multiple insurers. The court noted, “[The Guaranty Association Act] is remedial legislation intended to protect insureds and not insurers… when one of several insurance carriers on the risk is insolvent in a continuous-trigger case, then the limits of the policies issued by solvent insurers in all other years must first be exhausted before the Guaranty Association is obligated to pay statutory benefits.”

The decision is significant in New Jersey as it reiterates the Guaranty Association’s role as a payor of last resort and makes solvent insurers responsible, at least up to their policy limits, for the failed obligations of insolvent insurers sharing the risk. The ruling enforces the limited interest of guaranty funds in protecting insureds and could extend unexpected liability to solvent insurers on shared risks.

In Rogers v. Imeri, 2013 IL 115860, the Illinois Supreme Court was faced with the question of how to calculate the obligations of the state’s guaranty fund in light of insurance payments from other insurers and the state’s dram shop liability statute.

The case arose after a drunk driver struck and killed a teen. The teen’s parents received $106,550 between the driver’s liability insurance and their own underinsured coverage. They then sought recovery under the state’s Dramshop Act from the bar that had served the driver. Illinois’ dram shop liability statute capped damages at $130,338.51. Before the claim could be resolved, the bar’s liability insurer became insolvent and the state Guaranty Fund assumed the bar’s defense and the policy obligations.

Under Illinois’ statute, the Guaranty Fund acts a substitute insurer to pay claims for insolvent insurers but, among other limitations, the Fund’s obligations are reduced by any amounts recovered or recoverable from other available insurance. In this case, both parties agreed that the law required a setoff of $106,550 for other insurance, but they disagreed as to the amount from which the setoff from other insurance should be deducted.

The Guaranty Fund, stepping into the shoes of the bar’s insolvent liability insurer, argued that because the bar owner’s maximum liability was capped by statute at $130,338.51, the setoff should be deducted from that capped amount, which would result in a total liability of $23,788.51. The parents, on the other hand, argued that the setoff should not be deducted from the dramshop liability cap but rather from the total damages in the case, as determined by a jury. By the parents’ calculation, if a jury were to return a verdict of $500,000 in total damages, that amount would be reduced by the $106,550 already recovered from other insurance, and the remaining total of $393,450 would be limited to the statutory maximum of $130,338.51.

The Illinois Supreme Court agreed with the Fund, holding that the reduction for other insurance should be deducted from the dramshop liability cap, not the jury verdict. According to the court, the Fund’s initial obligation is limited to the “covered claim,” defined as those amounts for which the Fund is legally liable. In this case, the liability of the bar owner, assumed by the Guaranty Fund, was limited by the statutory cap. Therefore, the Guaranty Fund statute required the other insurance proceeds to be deducted from the actual amount for which the Fund was legally liable—the statutory maximum—not the amount of total damages determined by a jury. The court reasoned, “[The Guaranty Fund statute] provides a key limitation which ensures that potential claims on the Fund are reduced by the assets of solvent insurers, not assets of the Fund itself… The Fund’s obligation cannot be expanded by a jury’s verdict; it can only be reduced by other insurance.”

The Illinois court tightly framed the Fund’s limited obligations and emphasized its role as an “insurer of last resort.” Similarly, the New Jersey Supreme Court applied its statutory scheme to limit the liability of the state’s Guaranty Association by placing it beyond the standard obligations of pro rata allocation. Both cases highlight the statutory limitations of state insurance guaranty funds and courts’ applications of those statutes tailored to the limited purpose of protecting policyholders and other claimants from insolvencies. Insurers and insureds should be aware of the limits of guaranty funds and courts’ strict approaches to the statutory protections they offer.