Residual Markets
In a normal competitive market, insurers are free to select from among people applying for insurance those drivers, property owners and commercial opera- tions they wish to insure. They do this by evaluating the risks involved through a process called underwriting.
Applicants who are considered “high risk” may have difficulty obtaining insurance through the regular “voluntary” market channels. (The term “high risk” applies to individuals or individual businesses with a poor loss record due to inadequate safety measures; certain kinds of businesses or professions where the nature of the work is hazardous or where the risk of lawsuits is high; and specific locations where the risk of theft, vandalism or severe storm damage is substantial.) To make basic coverage more readily available to everyone who wants or needs insurance, special insurance plans have been set up by state regulators working with the insurance industry.
The business that insurers do not voluntarily assume is called the residual market. Residual markets may also be called “shared,” because the profits and losses of each type of residual market are shared by all insurers in the state sell- ing that type of insurance, or involuntary, because insurers do not choose to underwrite the business, in contrast to the regular voluntary market.
Residual market programs are rarely self-sufficient. Where the rates charged to high-risk policyholders are too low to support the program’s operation, insur- ers are generally assessed to make up the difference. These additional costs are typically passed on to all insurance consumers. However, in a few states, insur- ers are not able to recoup their residual market losses and political pressure pre- vents rates from rising to the level they should be actuarially.
The number of drivers and properties insured in the residual market fluctu- ates as lawmakers and regulators change laws or address availability, rate ade- quacy and other factors that influence underwriting decisions.
The Automobile Residual Market
The first of the residual market mechanisms for automobile coverage was estab- lished in New Hampshire in 1938. As states began to pass laws requiring drivers to furnish proof of insurance, having auto liability insurance became a prereq- uisite for driving a car. Today, all 50 states and the District of Columbia use one of four systems to guarantee that auto insurance is available to those who need it. All four systems are commonly known as assigned risk plans, although the term technically applies only to the first type of plan, where each insurer
is required to assume its share of residual market policyholders or “risks.” (The term “risk” is used in the insurance industry to denote the policyholder or prop- erty insured as well as the chance of loss.) Commercial auto insurance is also available through the residual market.
Automobile Insurance Plans: The assigned risk plan, the most common type, currently found in 42 states and the District of Columbia, generally is administered through an office created or supported by the state and governed by a board representing insurance companies licensed in the state. Massachu- setts began a three-year process of changing over to an assigned risk plan, begin- ning in April 2008. It formerly had a reinsurance pooling facility.
When agents or company representatives are unable to obtain auto insur- ance for an applicant in the voluntary market, they submit the application to the assigned risk plan office. These applications are distributed randomly by the automobile insurance plan to all insurance companies that offer automobile liability coverage in the state in proportion to the amount of their voluntary business. Thus, if on a given day the plan receives 100 applications from agents around the state, a company with 10 percent of that state’s regular private pas- senger automobile insurance business will be assigned 10 of those applicants and will be responsible for all associated losses.
Assigned risk policies usually are more restricted in the coverage they can provide and have lower limits than voluntary market policies. In addition, pre- miums for assigned risk policies usually are significantly higher, although not always sufficiently high enough to cover the increased costs of insuring high- risk drivers.
Joint Underwriting Associations (JUAs): Automobile JUAs, found in four states, Florida, Hawaii, Michigan and Missouri, are state-mandated pooling mechanisms through which all companies doing business in the state share the premiums of business outside the voluntary market as well as the profits
or losses and expenses incurred. To simplify the policyholder distribution pro- cess, insurance agents and company representatives are generally assigned one of several servicing carriers (companies that have agreed for a fee to issue and service JUA policies). They submit applications to that company, which then issues the JUA policy. In Michigan, however, agents submit applications directly to the JUA office, which then distributes them to the servicing carriers. Cover- ages offered by JUAs generally are the same as those offered in the voluntary market but the limits may be lower. Although rates may be higher than in the voluntary market, they may not be sufficient for the JUA to be self-sustaining. State statutes setting up the JUA generally permit it to recoup losses by surcharg ing policyholders or deducting losses from state premium taxes. (JUAs may be set up for other lines of insurance, including homeowners insurance. JUAs for commercial insurance coverage, such as medical malpractice and liquor liability, may operate somewhat differently in some states, see below.)
Reinsurance Facilities: Reinsurance facilities exist in North Carolina, New Hampshire and Massachusetts. (In Massachusetts, beginning in April 2008, the reinsurance facility which is known as Commonwealth Automobile Insurers, or CAR, began disbanding over a three-year period as the new ”managed competi- tion” regulations take effect.) An automobile reinsurance facility is an unincor- porated, nonprofit entity, through which auto insurers provide coverage and service claims. After issuing a policy, an insurer decides whether to handle the policy as part of its regular “voluntary business” or transfer it to the reinsurance facility or pool. An insurer is permitted to transfer or “cede” to the pool a per- centage of its policies. Premiums for this portion of business are sent to the pool and companies bill the pool for claims payments and expenses. Profits or losses are shared by all auto insurers licensed in the state.
State Fund: One state, Maryland, has a residual market mechanism for auto insurance which is administered by the state. It was created in 1973. Private insurers do not participate directly in the Maryland Automobile Insurance Fund (MAIF) but are required by law to subsidize any losses from the operation, with the cost being charged back against their own policyholders. In years that the fund has a loss, all Maryland insured drivers, including MAIF drivers, help offset the deficit through an assessment mechanism.
Size of the Auto Insurance Market: Together, residual market programs insured about 1.97 million cars in 2007, about 1.06 percent of the total mar- ket and a 9.0 percent drop from 2006, according to the Automobile Insurance Plans Service Office, which tracks such data. In 1990 the residual market served
6.3 percent of the total market. In 2007, in a major change from much of the 1990s, only one state, North Carolina, had more than a million cars insured through the residual market. At 1.5 million, the pool insured more than 21.6 percent of the state’s total insured vehicles. In South Carolina, which enacted sweeping reforms in 1998, the residual market dropped from 38 percent of all insured cars in 1996 to close to zero in 2007.
The Property Residual Market
Pools: FAIR Plans, Beach and Windstorm Plans, Assigned Risk and Others: A pool is an organization of insurers or reinsurers through which particular types of insurance coverage are provided. The pool acts as a single insuring entity, as opposed to some JUAs and assigned risk plans where the policyholder deals
directly with an individual insurance company. Premiums, losses and expenses are shared among pool members in agreed-upon amounts. The range of activi- ties handled by the pool varies. Some pool operations are limited to redistrib- uting premiums and losses, while others have broader functions similar to an insurance company. Some pools use specific insurers as servicing carriers.
In pools composed of primary companies (as opposed to reinsurers), busi- ness is placed directly with the pool by the agent. (In a reinsurance pool, a member company underwrites the risk, issues the policy and reinsures the business in the pool, see below.) Pools may be mandated by state legislation or established on a voluntary basis.
Pools assure that insurance is available to property owners in high-risk, gen- erally urban or coastal areas, and businesses with a poor safety record or other high risk characteristics. Among the best-known primary pooling arrangements are property insurance plans, such as Beach and Windstorm Plans, which insure owners of properties vulnerable to severe storm damage.
FAIR Plans: Thirty-two states and the District of Columbia currently have property insurance plans known as FAIR, an acronym for Fair Access to Insur- ance Requirements Plans. The concept of FAIR Plans was established following passage by Congress of the Housing and Urban Development Act of 1968, a measure designed to address the conditions that led to the 1967 urban riots. This legislation made federal riot reinsurance available to those states that insti- tuted such property insurance pools. One of the plans, Arkansas’ Rural Risk Plan, was created in 1988 to provide a market for property insurance in rural areas where fire protection is poor or nonexistent. Mississippi’s Rural Plan, which offered fire, extended coverage and vandalism, see below, was expanded to cover the entire state in 2003. (The state’s windstorm pool offers wind and hail coverage in coastal counties to the Plan’s policyholders.) Georgia’s FAIR Plan also provides windstorm and hail coverage in coastal counties as do Plans in Massachusetts and New York. In most states where FAIR Plans are in opera- tion, they are mandatory.
Beach and Windstorm Insurance Plans: Counterparts to the FAIR Plans are Beach and Windstorm Insurance Plans, operated by property insurers in states along the Atlantic and Gulf Coasts to assure that insurance is available for both residences and commercial properties against damage from hurricanes and other windstorms. Established between 1969 and 1971, Beach and Windstorm Plans
operate in a manner similar to FAIR Plans, except that properties must be locat- ed in a designated area to be eligible for insurance under the Plans.
There are currently five Beach and Windstorm Plans: Alabama, Mississippi, South Carolina, North Carolina and Texas. In 2001 there were seven pools, but Florida’s windstorm pool merged with the joint underwriting association in 2002 to create a new type of residual market entity, see below. In a similar move in 2003, Louisiana merged its FAIR Plan with its coastal pool. The Plans
are mandatory in all of these states with the exception of Alabama. (In addition, hail and windstorm coverage for homes in coastal counties is available through some FAIR Plans, see above and the WindMap in New Jersey.) Windstorm Plans in Mississippi, South Carolina and Texas offer only wind and hail coverage.
Plans in Alabama and North Carolina offer coverage for fire as well. In some states, Plan policyholders must buy flood insurance also.
Property owners who live in areas covered by Beach and Windstorm Plans may be insured for windstorm losses by the Plan or by an individual insur- ance company. If an insurer has accepted all the windstorm risk it is prepared to assume, an applicant for homeowners insurance may purchase a policy that excludes windstorm coverage from the homeowners insurance company and pay a separate premium for windstorm coverage to the Plan.
One disadvantage of Beach and Windstorm Plans, and the National Flood Insurance Program, is that the availability of insurance encourages development of coastal areas where construction otherwise would not be feasible and where tax money must be spent to protect against continuous erosion to preserve the property.
In the past there was a clear delineation between coastal and urban plans with coastal properties insured under Beach and Windstorm Plans, and urban properties under FAIR Plans. Increasingly, the distinctions are blurring. FAIR Plans are acting as an insurer of last resort for residents who live in shoreline communities in states that do not have a Beach and Windstorm Plan, such as New York State. Beach and Windstorm Plans in some states are being merged with FAIR Plans or joint underwriting associations, as in Florida and Louisiana, or are administering new FAIR Plans, as in Texas. As a result, it is difficult to compare the number of properties insured under any Plan with numbers from earlier years. FAIR Plans have almost doubled in size, pushed up in large part by these mergers and the increase in coastal properties in such states as New York and Massachusetts, but also by more stringent underwriting standards on the part of insurers in the voluntary market.
Residual Market Plan Mergers: In 2002 Florida’s two residual market organizations, the JUA and the Florida Windstorm Underwriting Association, merged to become the Citizens’ Property Insurance Corporation (CPIC). The Florida CPIC, known as Citizens, has a tax-exempt status. This feature enables it to finance loss payments in the event of a major disaster by issuing tax-exempt bonds that carry low interest rates, thus reducing financing costs over the years by hundreds of millions of dollars. In Louisiana, following Florida’s model, the FAIR Plan and the Coastal Plan became the Louisiana Citizens Property Insur- ance Corporation in 2004.
Other Residual Market Entities
JUAs for Other Lines of Insurance: JUAs are not limited to automobile insurance. At various times, there have been JUAs for residential insurance and workers compensation. A number of states have medical malpractice JUAs, most of which were set up in the 1970s or 1980s when the line was beset by high losses.
Market Assistance Plans (MAPs): A MAP is a temporary, voluntary clear- inghouse and referral system designed to put people looking for insurance in touch with insurance companies. They are organized when something happens to cause insurance companies to cut back on the amount of insurance they are willing to provide. MAPs are generally administered by agents’ associations, which assign insurance applications to a group of insurers doing business in a state.
These companies have agreed to take their share of applicants on a rotat- ing basis.
MAPs may be organized for a single line of insurance, such as daycare liability or homeowners insurance, or for a broad range of liability coverages. Homeowners insurance MAPs have been formed in several East Coast states, including Connecticut and Texas, and medical malpractice MAPs were created in states such as Washington, when the medical community had difficulty find- ing malpractice insurance.
Workers Compensation Assigned Risk Plans and Pools:
The mechanism used to handle the workers compensation residual market var- ies from state to state. In the four remaining states with a monopolistic state workers compensation fund (North Dakota, Ohio, Washington and Wyoming switched to a competitive market in July 2008), all businesses are insured through that fund. In most states with a competitive state fund (an entity that competes for business with private insurers), the fund accepts all risks rejected by the voluntary market, thus eliminating the need for assigned risk plans. In states without a competitive fund, insurers may be assigned applicants based on their market share and service those employers as they would employers that came to them through the voluntary market, through a system known as direct assignment. They may also participate in the residual market through a reinsur- ance pooling arrangement.
Second Injury Funds: Second injury funds were created to encourage business- es to hire workers who are physically handicapped by congenital defects or the residual effects of an accident or illness but due to other laws that now protect the physically handicapped worker, such as the Americans With Disabilities Act, some states are disbanding their fund.
Second injury funds receive money from insurance companies and employ- ers as well as from legislative appropriations. Insurance company payments may be based on a percentage of total compensation paid, premiums collected or the nature of the specific injury. The second injury funds may be administered by the state Workers Compensation Commission, Industrial Board or Department of Labor.