Oct. 8 (Bloomberg) -- Penn Treaty Network American Insurance Co., facing the biggest insurer failure in at least five years, may need more than $1 billion in additional funds to pay claims, a state regulator said.

Penn Treaty “is far more insolvent than originally believed,” Pennsylvania Insurance Commissioner Joel Ario’s office said in an Oct. 2 request for liquidation. Penn Treaty American Corp., the Allentown, Pennsylvania-based parent of the insurer, included the document in a regulatory filing yesterday.

Sellers of long-term care coverage, including Penn Treaty, suffered after underestimating expenses, while the broader life insurance industry has reported losses on declines in stocks and bonds. Penn Treaty, with about 120,000 customers, was hurt by investment losses in the recession and “seriously under- reserved” for claims in previous years, the regulator said.

“It’s potentially a big deficit mostly that will come from guarantee funds,” Rosanne Placey, a spokeswoman for Ario’s office, said in an interview.

Claims are paid over time as the company’s customers need medical care. Policyholders pay Penn Treaty about $249 million in annual premium for coverage, and the regulator ruled out using rate increases to bridge the potential $1.3 billion gap between assets and future claims. That deficit will be left to state guaranty funds, which are funded by solvent insurers.

A woman who answered the phone at Penn Treaty today referred inquiries to the regulator.

Long-Term Costs

Conseco Inc., whose streak of quarterly losses was snapped at eight this year, announced plans in August 2008 to transfer a long-term care business to an independent trust to cap costs. The policies have come back to haunt insurers that underestimated the number of claims, the cost of care and the life expectancies of customers.

Life insurers in the U.S. reported net losses of $52 billion last year, compared with profit of $29 billion in 2007, according to the National Association of Insurance Commissioners. The annual results “were the worst in memory” and indicate that regulatory takeovers and liquidations will rise “materially” this year and next, ratings firm A.M. Best said in May.

“There are still insolvencies going on,” said Carl Austin, an analyst with A.M. Best, in an interview today. “Will there be more? I think, sure. Because investments are still an issue, and raising capital isn’t easy.”

Raising Capital

MetLife Inc., the biggest U.S. life insurer, lost $1.9 billion in the first half, while No. 2 Prudential Financial Inc. posted a $1.1 billion deficit in 2008. Private investors withheld new funds from the industry late last year, pushing at least 12 insurers to seek U.S. bailouts.

Hartford Financial Services Group Inc., the Connecticut- based insurer, accepted $3.4 billion in government funds in June. Philadelphia-based Lincoln National Corp. took $950 million. New York-based MetLife and Prudential, of Newark, New Jersey, shunned U.S. aid and raised money from investors as markets improved this year.

Penn Treaty is among at least eight carriers in the U.S. facing forced rehabilitation or liquidation by regulators this year, according to data collected by the National Organization of Life & Health Insurance Guaranty Associations. That compares with four in 2008. California’s regulator seized Golden State Mutual Life Insurance Co. on Sept. 30 after the company was unprofitable for five straight years.

Shenandoah Life Insurance Co. was brought under the control of the Virginia watchdog, which announced plans to sell the company’s group business to Assurant Inc. Shenandoah was seized after losing about $50 million on investments in mortgage- finance firms Fannie Mae and Freddie Mac.

No Buyers

Ario, who seized Penn Treaty in January, didn’t find an insurer to purchase or assume any of its policies. According to Nolhga, Penn Treaty has about $1 billion in assets. Cash from premiums will be sufficient to pay claims for several years, Placey of the Pennsylvania regulator said.

“There’s enough money to pay claims going forward and get the guaranty associations ready for the transition,” Placey said.

Guaranty funds are used to pay claims when regulated insurers are unable to meet obligations. Penn Treaty policies will remain active for customers who continue to pay premiums. A state court will weigh Ario’s request to liquidate the company, his office said in statement last week.

Penn Treaty gained 1 cent to 17 cents in over-the-counter trading at 3:30 p.m. in New York. The company dropped 43 percent in the two weeks ended yesterday.

Long-term care policies provide coverage to help pay for home-health aides or residence in a nursing home or assisted- living facility. Penn Treaty policyholders with questions may call 1-800-362-0700 and dial extension 3270.

To contact the reporter on this story: Andrew Frye in New York at afrye@bloomberg.net

Last Updated: October 8, 2009 16:20 EDT