What happens if my insurance firm goes bust?

British homeowners, holidaymakers and drivers were left in limbo last night as they waited to find out how they would be affected by the potential demise of American International Group (AIG), one of the world’s largest insurers.

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Fortunately for investors and policyholders alike, US central bank the Federal Reserve, stepped in overnight with an $85 billion (£48 billion) rescue package to save the insurance giant from bankruptcy.

The Fed is thought to have acted due to fears that the collapse of AIG would have a much more dramatic impact on world stock markets than the failure of investment bank Lehman Brothers.

The company has a trillion dollars in assets and insures bank loans around the world.

Even if the company had gone bust, however, UK consumers with insurance policies underwritten by AIG would have been covered thanks to a scheme set up by City regulator the Financial Services Authority (FSA).

Nobody is claiming that AIG is out of the woods yet, despite the rescue package. But, should the company or any other regulated insurer fail, UK customers can to claim their money back from the Financial Services Compensation Scheme (FSCS).

What is the FSCS?

The FSCS is a pool of money, provided by financial institutions, designed to compensate consumers who lose out due to the collapse of financial services companies.  Most people have heard of it in relation to the protection it providers for savers.  But it also providers cover for customers of UK regulated insurance companies.  For customers hit by the downfall of an insurance company, it refunds the full amount paid in premiums to enable the customer to go out and find cover elsewhere.

Anyone who has a claim that is being dealt with at the time of a companys collapse is also covered by the FSCS.

Should AIG, best known in the UK as the sponsor of Manchester United football club, collapse despite the $85 billion from the Fed, policyholders will still be able to get their money back as a result.

Making a claim through the FSCS takes time, however. So anyone who is affected by the collapse of an insurer may have to take out alternative cover with a rival company in the interim using a comparison site such as Moneysupermarket.com to find the best deal.

What can I claim?

There are some limits to the amount of compensation the FSCS can provide.

Claims relating to insurance intermediaries, for example, can only be dealt with if the policy was set up on or after January 14, 2005.

When it comes to policy providers, claims involving insurance that is compulsory in the UK such as third party motor cover are completely covered.

For other types of insurance, including contents and travel policies, the scheme will refund 100% of the first 2,000 spent, plus 90% of any amount above this.

When can I claim?

It is worth pointing out that any claims against insolvent insurers must initially be directed to the companys insolvency practitioners, as the FSCS will only pay out if there is not enough money in the company’s accounts to cover its liabilities.

In these uncertain times, anyone taking out a new policy with an insurer should also ensure that it is regulated by the FSA as unregulated companies are not covered by the FSCS.

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