Solvency regulation helps minimize economic failures

Health insurance is one of the most regulated industries in the world. Within its comprehensive regulatory scheme, there are several laws that are designed to assure the solvency of health insurance companies and HMOs. These laws limit and restrict the types of investments that these companies may own, dictate the level of capitalization they must maintain, and establish other solvency measures.

MINIMUM CAPITALIZATION

Most states also have adopted an alternative method for determining a company's minimum capitalization: risk-based capital (RBC). Originally created by the NAIC, the RBC regulation establishes a formula which is used to calculate the minimum capitalization for each company. Most states now require that each company doing business in their state maintain the greater of the statutory capital or the amount determined by the RBC formula. Some insurers and HMOs are able to reduce their RBC requirements by ceding or transferring a portion of the risk associated with their business to other insurers or by capitating their providers.

In addition, states require companies to deposit certain funds with the state, which are available in the event of insolvency. The companies are able to reflect the restricted funds on their balance sheets, but the funds are not available for use in operations. Deposit requirements may vary widely from state to state, with some states requiring HMOs to maintain deposits equal to their annualized out-of-network healthcare expenses.

State regulations also establish various financial ratios and other indicators as early warnings for companies that are in hazardous financial conditions. The premium-to-surplus ratio is perhaps the most relied-upon financial ratio by regulators.

Similar to the FDIC in banking, each state has a "guaranty fund" that provides a safety net for the insureds of a failed insurance company. When an insurance company becomes insolvent and is placed into receivership, a state guaranty fund pays the claims of insureds that are not payable from the assets of the insolvent company. Not all states have established guaranty funds for HMOs.

This column is written for informational purposes only and should not be construed as legal advice.

Barry Senterfitt is a partner in the insurance industry practice of Akin Gump Strauss Hauer & Feld LLP in the firm's Austin, Texas, office.