BRUSSELS—The European Commission has proposed requiring all European Union member states to establish insurance guaranty funds to protect policyholders should an insurer become insolvent.

The commission published a white paper last week that sets out a framework for the arrangements that would be prefunded by insurers in amounts according to a risk-based formula. A consultation period on the proposed directive runs until Nov. 30.

As proposed, the backstops would cover individual claimants and small businesses. The commission confirmed, though, that it has not ruled out expanding the pool of eligible claimants to large commercial insurance buyers.

“If the consultation reveals that there is support for broadening the scope of claimants, that has not been fully excluded,” said a commission official who asked not to be named.

Of the 30 countries in the European Union and European Economic Area, 12 have one or more insurance guaranty funds, the commission said in its proposal. Those countries are Bulgaria, Denmark, France, Germany, Ireland, Latvia, Malta, Norway, Portugal, Romania, Spain and the United Kingdom.

Of those countries, Bulgaria, Germany and Portugal have only life insurance guaranty funds in place.

The commission argues the arrangements should be implemented in all member states, saying 56% of all nonlife insurance policies and 26% of life policies are not protected by such funds.

While supportive of efforts to protect policyholders, the Brussels-based Comité Europeen des Assurances, the European federation of insurers and reinsurers, said portions of the proposal are worrisome.

Acknowledging that it is “still very early in the process,” William Vidonja, head of the single-market and social affairs department, said the CEA is concerned that the commission is treating insurers too much like banks in calling for backstop arrangements.

“The biggest concern that we have is related to the funding of insurance guaranty schemes that is proposed by the commission,” said Mr. Vidonja. The commission proposal would prefund such arrangements—rather than funding them by assessments after an insolvency occurs—in the same way guarantees for banks are funded, he said.

“The business models of banking and insurance are very different,” said Mr. Vidonja, “and the needs of their consumers are different. We think the solutions in terms of consumer protection schemes should be different.”

While a prefunded system might make sense for banking clients who might need their funds immediately if an insolvency occurs, that is not necessarily the case for insurance policyholders, he said.

Mr. Vidonja said that if the commission issues a directive on insurance guarantees, the CEA believes regulators in the member states should decide the funding method.

The commission official said the European Commission is aware of insurers' concerns, but also said prefunding is the only way to ensure that an insurer that becomes insolvent will contribute to making its policyholders whole.

If the commission proposal is broadened to include large companies as eligible claimants under a guaranty scheme, the funding issue is likely to be the most important for risk managers, said Paul Hopkin, technical director of the Assn. of Insurance & Risk Managers in London.

“If a fund is set up, who pays for it? If it's a levy on insurance, risk managers will take different views on whether the guarantee is worth the levy,” Mr. Hopkin said.

He noted that while the proposal focuses on protecting consumers and small businesses, Airmic will monitor the evolution of the proposal and how it could affect large companies.

Victor Rod, insurance commissioner of Luxembourg, an E.U. member that does not have an insurance guaranty fund in place, says forcing regulators to establish the arrangements does not appear to be necessary or workable.

“At the moment, I think it's a bad idea,” Mr. Rod said. “But that is my personal feeling.”

It would be “very, very difficult to harmonize” guaranty funds across Europe and “even more so to convince those without them to go ahead,” Mr. Rod said. “There's probably not much need for guaranty funds in the insurance industry.”

In Luxembourg, “there's no reason for one because we have one of the best legal frameworks that can exist” to protect policyholders, along with comprehensive supervision, Mr. Rod said. In the event of an insolvency, policyholders in Luxembourg would have priority in recovering funds over other creditors, he said.