What happens when an insurance company cannot pay insurance because of natural circumstances?

Question

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?

Answer 1

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.