Independent insurance agents in the Midwest are locked in a legal battle with insurance regulators over the constitutionality of some state's insolvency laws.

At issue are laws requiring agents to pay unearned premiums to liquidators handling an insurance company insolvency. The liquidators treat the unearned premiums just like any other collectible asset of a bankrupt company. With the number of insurer insolvencies at an alarming high, agents are concerned over the cost of this growing liability.Unearned premiums represent premiums not yet earned by an insurance company because no insurance has yet been provided.

For example, assume a policyholder purchases an insurance policy on Jan. 1, 1986, for coverage through Jan. 1, 1987. The full premium for the entire year's coverage is payable on Jan. 1, 1986, but the agent decides instead to let the policyholder pay the premium in quarterly installments rather than up front.

After the first two installments are paid, assume that the insurance company writing the policy goes bankrupt. Knowing this, the policyholder declines to pay the final two installments, the unearned premium.

Only a fool would pay money to an insurance company for coverage you are not going to get, said Diane Nash, general counsel to the Independent Insurance Agents of America, the agents trade group.

Nevertheless, the laws of many states require their insurance agents to do just that, Ms. Nash said. Agents are required to pay the unearned premium, even though the insurer is no longer in business to provide coverage. In our mind this is unconstitutional because it takes private property - agent's money - without just compensation.

Agents will have an opportunity to argue that in court beginning this May. The case involves the Iowa National Mutual Insurance Co., Des Moines, which

went belly-up in the fall of 1985, and approximately 40 independent insurance agencies in Missouri, North Carolina, Wisconsin and other states.

After Iowa National was declared insolvent, the Iowa insurance commissioner was appointed liquidator to clean up the mess. The fallout from the insurer's collapse included more than $31 million in lawsuits and claims - for both earned and unearned premiums - against 250 insurance agents across 15 states.

One of these is Springfield, Mo.-based Proctor-Jarvis-Chappell & Associates. The liquidator sued the agency for, among other monies, $67,000 in unearned premiums. Proctor-Jarvis refused to comply with the commissioner's request on the grounds that the money was for insurance that would never be provided since Iowa National was now bankrupt.

William Hager, Iowa's insurance commissioner and the liquidator in the insolvency, filed suit late last year against Proctor-Jarvis in the U.S. District Court for the Southern District of Iowa to collect the unearned premiums. Mr. Hager cited Section 507C.33 of Iowa's insurance code, which states that an agent is obligated to pay an unpaid premium for the full policy term due the insurer at the time of the declaration of insolvency, whether (the premium is) earned or unearned.

Proctor-Jarvis, and approximately 40 other agencies that were also being sued by the liquidator, then filed a countersuit in Missouri.

This is the first time this issue will be tested in a federal court and could well set a precedent in other states which carry similar insolvency laws on the books, said Les Bushmann, executive vice president of the Independent Insurance Agents of Missouri.

James Wirken, a partner in the Kansas City, Mo., law firm of Spradley, Wirken, Riesmeyer & King, the attorneys for Proctor-Jarvis, claims Iowa's law is unconstitutional because it's in contravention of the Fifth and Fourteenth Amendments of the United States Constitution.

Mr. Wirken explained that Iowa Code 507C.33, by requiring agents to pay the liquidator unpaid, unearned premiums, violates the prohibition against taking private property for private use. The private property in this case is money, which is protected by both the federal and state constitutions, he said.

There can be no doubt that a taking has occured in this case since the agents are required to pay the liquidator unearned premiums of the insured out of their own pockets. This money is then used to pay the claims of private individuals, including creditors, injured parties and employees of the insurance company, said Mr. Wirken.

Mr. Hager disagreed.

Under the framework of laws in Iowa, all laws are presumed to be constitutional. This was a duly passed provision based on a carefully crafted model law drafted by the National Association of Insurance Commissioners (a trade group representing the industry's state regulators), Mr. Hager said.

In my judgment, it's constitutional, he added.

Moore Lifter, general consultant to the Delaware Insurance Department and a member of the NAIC task force that drafted the model act on insurer insolvencies, said the task force is reviewing the law and will take the agent group's position into consideration.

Nevertheless, Mr. Lifter said that an agent who allows a policyholder to pay in installments, rather than the entire premium up front, is taking the risk for someone who hasn't paid for his or her insurance, he said.

Many agents who take this business risk premium-finance it. In other words, the agent takes perhaps 25 percent of the policy premium up front and then has a premium-finance company finance the rest of the premium. If the insured doesn't come through with the premium, the finance company cancels the policy and pays off what's owed.

Agents who don't do this are financing insureds themselves, Mr. Lifter said.

Mr. Hager added that agents can recoup the unearned premiums paid to liquidators by filing a claim against their state's guaranty fund, a fund financially supported by insurers to pay claims in the event of an insurer's collapse.

But agents say they only receive a fraction of the amount paid in unearned premiums from the guaranty fund, and only after many years have elapsed. Often such claims are overturned by the fund, they charge.

With insurance company insolvencies becoming more frequent, we feel it is urgent to settle this matter, said IIAA's Mr. Bushman. Right now, agents are stuck between a rock and a hard place.