In a normal competitive market, insurers are free to select from among people
applying for insurance those drivers, property owners and commercial operations 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 selling 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, insurers are generally assessed to make up the difference. These additional costs are
typically passed on to all insurance consumers. However, in a few states, insurers are not able to recoup their residual market losses and political pressure prevents rates from rising to the level they should be actuarially.
The number of drivers and properties insured in the residual market fluctuates as lawmakers and regulators change laws or address availability, rate adequacy and other factors that influence underwriting decisions.
The Automobile Residual Market
The first of the residual market mechanisms for automobile coverage was established in New Hampshire in 1938. As states began to pass laws requiring drivers
to furnish proof of insurance, having auto liability insurance became a prerequisite 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 property 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. Massachusetts began a three-year process of changing over to an assigned risk plan, beginning in April 2008. It formerly had a reinsurance pooling facility.
When agents or company representatives are unable to obtain auto insurance 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 passenger 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, premiums for assigned risk policies usually are significantly higher, although not
always sufficiently high enough to cover the increased costs of insuring highrisk 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 process, 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. Coverages 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 competition” regulations take effect.) An automobile reinsurance facility is an unincorporated, 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 percentage 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 market 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.