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, known as residual, shared or involuntary markets, have been set up by state regulators working with the insurance industry.
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 regulations to address availability, rate adequacy and other factors that influence underwriting decisions.
- National: In 2011 total exposure to loss in the residual property insurance market (FAIR and Beach and Windstorm Plans) surged to $884.7 billion, which means that if all the policyholders insured by the two plans suffered a total loss, property damage claims would total that amount. At the same time, the number of policies in force in the residual property insurance market rose to 3.3 million in 2011. (By comparison, in 1990 total exposure was $ 54.7 billion and the policy count was under 1 million.) The largest of the property insurance plans, the Florida Citizens Property Insurance Corporation, now has almost 1.3 million policyholders. It is now trying to shed some of those policies by raising prices and reducing coverage.
- States, Alabama: As of December 2012 the Alabama wind pool covered more than 27,000 properties, up from more than 24,000 in December 2011, but the number of new policies added to the pool in December was the lowest in any month in the past year. The pool’s total exposure to loss—insured value of all the properties it insures—is more than $4.5 billion, mostly in coastal areas. However, the Alabama Insurance Underwriting Association is encouraging private insurers to return to the market, particularly to the south of the state, where it is hoped that some residents will find companies that can offer lower rates and broader coverage than the pool.
- Property owners in coastal areas who build their homes to the “Fortified....for safer living” construction standards of the Insurance Institute for Business and Home Safety are eligible for discounts on windstorm coverage from the Beach Plan and other insurers. The size of discounts varies according to where the home is located and the type of building construction. Homes made of reinforced concrete in the seacoast zone may receive a discount of as much as 56 percent. Discounts are also available for existing homes that are retrofitted to make them better able to withstand high winds. The Mississippi wind pool offers a similar discount program. The legislature is considering several bills aimed at shrinking the size of the pool and making coverage in the private marketplace more easily available, among them a proposal to offer insurers financial incentives to assume residual market policies.
- Florida: A number of proposals to reduce the size of the state’s insurer of last resort, Citizens Property Insurance Co., have been put forward, including a plan for a clearing house that would allow private insurers to decide whether they wanted to take on pool policies that were up for renewal and new applications before they were accepted by Citizens. Each policy would automatically be submitted for quotes by private insurers, and policyholders would be required to select an offer if the premium was within 15 percent of the price charged by Citizens. This proposal was first suggested by Citizens itself and is supported by key legislators as a way to overcome difficulties homeowners may face in finding new coverage. Other ideas include raising the rates Citizens may charge to actuarially sound levels, providing incentives to insurance agents to send more business to private companies, and barring new policies on new construction seaward in the Coastal Building Zone.
- In addition, lawmakers would like to reduce the amount of reinsurance coverage the Florida Hurricane Catastrophe Fund provides private insurers, a proposal that would reduce the risk of the fund needing an infusion of public monies in the event of a mega-catastrophe but at the same time push up the annual cost of reinsurance for the state’s property insurers.
- Last year, Florida Governor Rick Scott pushed for significant changes in Citizens designed to educe the number of policies the company issues, but Citizens still insures some 1.3 million property owners.
- Citizens is doing what it can without legislation to reduce the amount of risk it assumes for each policyholder. To accomplish this goal, starting in late 2011, Citizens began to eliminate coverage for items that are not part of the main building on the property, including awnings, screened–in pool enclosures and most patios, except those that are attached to the main building with a common roof. Some private insurers reduced coverage for these secondary structures after they were heavily damaged when Hurricane Wilma hit the state in 2005. Citizens has also imposed a 10 percent deductible on sinkhole claims and lowered the amount of personal liability coverage it offers. And since the start of 2012, the insurer has stopped underwriting policies for coastal (high-risk) properties valued at more than $1 million which is expected to reduce losses. It is also hoping that private insurers will take over blocks of the insurer’s business as soon as depopulation programs are once again in place. In February 2013 Florida-based Weston Insurance Company said it would assume some 31,000 residential and non-residential high risk policies from Citizens that would reduce the pool’s exposure to loss by about $30 billion.
- To further cut its risk, Citizens will purchase more reinsurance than it did last year. In addition, it has issued a $750 million catastrophe bond to transfer a portion of its hurricane risk to the capital markets, see also report on Reinsurance for other residual market entities that have issued such bonds.
- Louisiana: The state’s residual property insurance market, the Louisiana Citizens Insurance Corp, has successfully transferred all but the most risky policies to the private market. However, the pool has to pay a nearly $105 million judgment in a long court battle over whether it began adjusting claims from 2005 hurricanes Katrina and Rita within the 30-day time limit. The class action involves some 18,500 policyholders. The pool will also be called upon to pay many property claims resulting from Hurricane Isaac, which hit the state on August 28, 2012. Much of the damage occurred in the state’s coastal counties where many of the pool’s policyholders live.
- In 2007 Citizens set out to reduce its policy count to below the 2005 pre-Hurricane Katrina total of 125,000. At one point the pool was the state’s third-largest insurer, with 171,000 policyholders. Premiums for most policyholders are set 10 percent above those charged by private insurers that write at least 2 percent of policies in a given area.
- As a fourth round of policy removals came to an end in 2010, the number of homeowners and commercial policies insured by the pool dropped to about 115,000. In 2011 the insurer shed more policies, leaving it with about 105,000 at the end of the year. Insurance Commissioner Jim Donelon aims to transfer another 20,000 to the private sector and to open the pool to transfers at least once a year. That would leave Citizens with just the policies that no private insurer will cover, returning it to its original role as insurer of last resort.
- Mississippi: Starting in July 2009, the pool has been offering discounts of up 25 percent to policyholders who improve the hurricane resistance of their homes. This is another step toward the state’s goal of encouraging development along the coast. Buildings that are better able to withstand high winds lessen the negative economic impact of being in a hurricane-prone region.
- South Carolina: As a possible solution to the question “was the damage caused by wind or water?” the state has been requiring wind pool policyholders to purchase flood insurance since the beginning of 2008. Without it, they may not receive reimbursement for the full replacement cost of repairing storm damage. About 70 percent of wind pool policyholders already had flood coverage.
- Wind pool officials say the new mandate is designed to avert disputes about the exact cause of damage, a situation that may have held up some claim settlements after Hurricane Katrina. Most of the state is susceptible to flooding, they say. (Connecticut has a similar requirement for its C-Map policyholders.) A structure does not have to be in a federal flood zone to suffer flood damage. Between 30 and 35 percent of flood claims are filed by policyholders living outside designated flood zones, according to the National Flood Insurance Program.
- Texas: Lawmakers, including those who are part of the Coastal Windstorm Task Force, which was formed by the legislature to study the Texas Windstorm Insurance Association (TWIA) and wind insurance issues, are discussing several options to replace TWIA, which, in its current condition, is “unsustainable,” according to the state’s insurance commissioner. TWIA now insures more than half of the market in coastal counties.
- One suggestion is to create an assigned risk pool, see Background. However, an assigned risk pool would require insurers currently doing business in Texas to accept policyholders now insured by TWIA, with the possible result that capital to support these new policies might have to be withdrawn from existing policies. If that happened, those existing policies would not be renewed, disrupting the market for homeowners insurance in other parts of the state. No other state has an assigned risk plan for property insurance.
- Insurers say the underlying problem with TWIA is that funds that should have been accumulating as surplus in the past three relatively storm- free years have been used instead to pay on-going claims from 2008 Hurricane Ike, leaving the TWIA without a viable financial base to pay future claims. Lawmakers should focus on rebuilding the funding structure for TWIA, insurers say, rather than creating an entirely new untested structure.
- A report prepared by Merlinos and Associates recommends that the pool reduce its policy count and raise its rates over a period of several years so that they are more in line with those in the private market, providing a greater incentive to policyholders to move out of the pool and stabilizing its financial condition. The report said that rates would need to rise by an average of 44 percent to ensure the pool’s fiscal health.
- In 2011 management of TWIA was replaced after a series of poor administrative decisions regarding the pool came to light. In June 2011, in a special session of the legislature called by the governor after lawmakers failed to agree on key reforms, the House and Senate agreed on various changes to strengthen the association’s financial well-being, allowing the agency to issue “pre-event” bonds once a year and to improve its administrative and claims paying operations, including measures to prevent lawsuit abuse. However, insurers say, the bond program has proved to be unmarketable.
- National: Nationally, the residual market’s share of total cars insured was less than 1.0 percent in 2010, or 1.9 million, the latest annual data available, see chart below. In most jurisdictions the percentage was well below 1.0 percent. The three states with the most vehicles in shared market plans were North Carolina, Massachusetts and New York.
- North Carolina: The state with the highest percentage in the private passenger residual market in 2010 was North Carolina, at 1.5 million, or 21.6 percent, of the market. In North Carolina a considerable number of drivers are insured in the residual market because the state’s current auto insurance regulatory system does not allow insurers the flexibility to charge a rate that reflects true risk. Those drivers believed to be too risky for the rate allowed are ceded or transferred to the shared market.
- Massachusetts: In Massachusetts about one quarter of all commercial auto insurance premiums ends up in the residual market. However, Massachusetts’ share of the shared market is dropping as a result of managed competition, the auto insurance system established in Massachusetts in 2008, the assigned risk plan has taken over from the earlier residual market program, known as CAR (Commonwealth Automobile Reinsurers). The process began in April 2008. Under the Massachusetts law drivers insured in the residual market must be offered the rate filed for the residual market or the appropriate rate in the voluntary market, whichever is lower, providing an incentive for insurers to offer low-risk former CAR policyholders coverage in the voluntary market, ultimately reducing the residual market’s size. The residual market dropped more than 33 percent in 2008 and almost 6 percent in 2009. To protect drivers who cannot find coverage in the voluntary market from sudden, large premium increases, rates in the assigned risk plan are capped. Where policies are underpriced as a result, losses will be borne by the voluntary market.
- Positive trends in the workers compensation residual market appear to be coming to an end. In the states for which the NCCI collects data, market share held steady at about 5 percent in 2011 but ticked up slightly in the first quarter of 2012, with the largest companies showing the greatest increase. The combined ratio worsened slightly from the previous year, moving to 121 percent from 120 in 2011. This means that insurers paid out about $121 in residual market claims and expenses for every $100 in premium collected in 2011. The NCCI pools generally sustain an operating loss. See also the report on Workers Compensation.
Insurance is a mechanism through which individuals and businesses can transfer risk to another entity: an insurance company. Many different programs have been established to assure that insurance is available to individuals and businesses having difficulty obtaining coverage in the "voluntary market," that is the risk that insurers voluntarily assume. 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.
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 43 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 was the last state to adopt an assigned risk plan. It began a three-year change-over process from a reinsurance facility in April 2008.
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.
Generally, each insurer services the policyholders assigned to it just as it would the policyholders it insures in the voluntary market. However, there are exceptions. For example, five states have set up a service center to carry out all administrative and service functions, except handling claims. In many jurisdictions, companies that prefer not to service the policies of policyholders assigned to them can make arrangements for a fee to have them serviced by others, either by the Plan or by “servicing companies,” insurers that service other companies’ business as well as their own. A few states allow such service arrangements in the commercial auto residual market, especially large commercial accounts such as taxis and corporate-owned fleets.
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 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 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 surcharging 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 and New Hampshire. 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 1.73 million cars in 2009, about 1.0 percent of the total market, 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 2009, 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. 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 2009.
The North Carolina residual auto insurance market is unusual in that the laws governing the North Carolina Reinsurance Facility, the state’s auto insurance residual market pool, have produced a complex system of subsidies that keeps the pool’s population high. Drivers with traffic violation points on their record and inexperienced drivers in the pool do pay higher rates, but some of those in the pool, because of some lesser risk, pay the same as the highest rate charged good drivers. All rates are highly regulated.
Voluntary market rates in North Carolina are kept low. As a result, auto insurers send business that is not expected to be profitable to the pool and the pool loses money each year. This shortfall is offset by surcharges incorporated into premiums, spreading the loss across all drivers. Supporters of the system say the subsidy system makes it easier for more people to buy insurance—North Carolina is among the states with the lowest percentage of uninsured drivers. Critics say that good drivers should not have to pay more so that others can get a good deal.
Other states have seen their residual market fluctuate, depending on conditions in the voluntary market such as the regulatory environment and rate adequacy. For example, in 1987, close to 1.8 million drivers were insured in the New Jersey shared market, compared with about 97,300 in 1993. But gradually, this number crept up again as insurers began to withdraw from the state because of the overly harsh regulatory system. Market reforms passed in New Jersey in recent years have brought more auto insurance companies into the market, increasing competition and reducing the need for drivers to seek coverage in the residual market. A 2004 study of residual markets by the Property Casualty Insurers Association of America found that in states where competition is the primary regulator of price, the residual market tends to be small.
The Property Residual Market
Pools: FAIR Plans and Beach and Windstorm Plans:: A property insurance 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 activities handled by the pool varies. Some pool operations are limited to redistributing 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), business 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, generally urban or coastal areas, and businesses that with a poor safety record or other high risk characteristics. Among the best-known primary pooling arrangements are property insurance plans, which insure owners of properties vulnerable to severe storm damage.
History of Property Pools: The first urban area plan, a forerunner of FAIR Plans, see below, went into effect in 1960 in Boston. Following a spate of fires in some inner-city neighborhoods, insurers began to withdraw from these communities, making it difficult for some Boston residents to obtain fire insurance. The Massachusetts legislature drafted a bill that called for a state-operated assigned risk plan for fire insurance. Insurers were against the proposal, pointing out that an assigned risk plan for auto liability insurance has a very different goal from the proposed property insurance plan. Assigned risk plans in auto insurance were established to protect third parties from having no financial recourse if they were struck by a car driven by a driver who had been refused coverage in the voluntary market. A fire insurance assigned risk plan would enable the owner of a property which had been rejected for coverage to buy insurance to protect his own assets.
The industry set out to find a better way to make coverage available, pledging that no property would be denied insurance unless it was inspected and found uninsurable. Where property was deemed in too poor a condition to insure, owners were told what to do to bring it up to insurable standards. A special fire hazard inspection office was established and charged with carrying out the program, which became known as the Boston Plan. Fire losses in these neighborhoods subsequently declined and insurance became more readily available. The success of the Boston Plan led to similar programs in other cities and by 1967 there were 10 urban plans.
In 1967 riots broke out in many cities across the nation. As property insurers withdrew from inner-city neighborhoods, citing huge losses, insurance departments and insurance industry leaders were called upon to expand existing urban plans and create new ones which eventually led to the establishment of FAIR Plans.
Beach and Windstorm Plans had a different genesis. Just as Hurricane Katrina drew attention in 2005 to the weaknesses of the federal government’s flood insurance program and to the private insurance industry’s exposure to loss along the coastline of the Gulf and Atlantic states in what appears to be a new period of increased hurricane activity, so hurricanes Camille (1969) and Celia (1970) drew attention to the industry’s exposure 40 years ago. This led to pooling arrangements in coastal sections of seven southern states. Four of these states provide coverage for wind and hail damage only, hence the term Beach and Windstorm Plans.
FAIR Plans: As of November 2011, 32 states and the District of Columbia had property insurance plans known as FAIR, an acronym for Fair Access to Insurance 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 instituted 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 operation, they are mandatory, see below for a list of jurisdictions.
Originally, most plans provided protection only for "perils” outlined in the federal statute: fire, extended coverage (which includes windstorm and hail damage) and vandalism and malicious mischief. Coverage for fire is available as a “stand-alone” policy. Almost half the Plans now offer some form of homeowners insurance policy—homeowners insurance always includes liability coverage. In New Jersey insurers can now use "wraparound" policies to turn FAIR Plan policies, which provide limited coverage, into typical homeowners policies. Some FAIR Plans also offer commercial package policies and some miscellaneous optional coverages such as crime, earthquake and sprinkler leakage. But while broader coverage responds to homeowners needs in one respect, it also pushes up the cost of coverage.
In theory, rates for FAIR Plan coverage were to be set at break-even level. In practice, in most states, there is a subsidy so that rates are lower than they would be in the voluntary market for the same level of risk. FAIR Plans, like many other residual market programs, historically have lost money over the long term, although in a specific year they may be profitable. To cover losses, FAIR Plan members are assessed according to their share of the voluntary property market. Losses are then passed on to policyholders in the plan in the form of higher rates and in some states to policyholders in the voluntary market as well. Some states prohibit the consideration of residual market results when setting rates in the voluntary market. A number of states allow insurers to recoup losses through rate surcharges, which are itemized on a policyholder’s premium bill.
Owners of properties failing to meet basic levels of safety, typically older houses and commercial establishments, may be required to make improvements as a condition for obtaining insurance. Such improvements may include upgrading the electrical wiring, heating and plumbing and ensuring that the roof is sound, for example. Where deficiencies are not remedied, FAIR Plan administrators may deny insurance as long as hazards are unrelated to the neighborhood location or to hazardous environmental conditions beyond the applicant's control, such as being located adjacent to a fireworks factory.
In all states except California, residents in any part of the state can apply for insurance through the FAIR Plan as long as they meet Plan criteria. In California, applicants for fire coverage must live in areas specifically designated by the insurance commissioner. These include not only urban communities and some entire counties but also certain areas that are prone to wildfires.
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 located in a designated area to be eligible for insurance under the Plans.
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.
To encourage insurers to offer coverage on a voluntary basis to properties in Beach and Windstorm Plan areas, these Plans allow for a company to "buy out" of the Plan by providing insurance in the pool area equal to its share of the voluntary market. In Texas, however, buyouts are limited to 80 percent of a company's share in the Windstorm Plan market, so that some of the potential burden of insuring the least desirable risks is spread over all companies offering property insurance in the state.
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 insurance 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. In the states whose Beach Plans offer fire coverage, a policyholder may purchase a basic fire policy from the Plan, or in some states a homeowners policy that offers more comprehensive protection, including liability coverages. Where there is flood damage and the policyholder is insured through the federal government's National Flood Insurance Program, the policyholder's homeowners insurance broker or agent generally coordinates the claim settlement process.
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, see also Catastrophes report.
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: The first state to decide that one entity should run its residual property insurance market was Florida. In 2002 the state’s two residual market organizations, the JUA and the Florida Windstorm Underwriting Association, merged to become the Citizens' Property Insurance Corporation (CPIC). The JUA was established by the Florida legislature in 1992, following Hurricane Andrew, to provide homeowners insurance to those unable to find coverage in the voluntary market. The Florida Windstorm Underwriting Association (FWUA) was formed in 1970. (Homeowners continued to purchase fire, theft and other homeowners coverages from a regular insurance company.) Over its more than 30 years of operation, the windstorm pool grew in geographical size as well as in the number of property owners it insured. Windstorm coverage is now available from the CPIC for part or all of 29 of Florida's 35 coastal counties.
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.
The enabling legislation required that Citizens reduce its probable maximum loss, the greatest loss it is expected to sustain, by 25 percent by February 2007 and by 50 percent in 2012. For a while rates were frozen so Citizens continued to grow. However, effective in 2010, rates may be increased by up to 10 percent a year until they are actuarially sound and the state succeeds in gradually reducing the size of the residual market through arrangements with private insurance companies, mostly small Florida-based companies, to assume batches of Citizens policyholders.
In an effort to reduce its potential exposure to loss, Citizens offers policyholders financial incentives to invest in hurricane-resistant home improvements. Premium discounts range from 3 percent for roof gable and garage door bracing to as much as 18 percent for improvements that reduce the likelihood of materials such as glass shattering when hit with flying debris.
At one time, rates for wind risk were based on factors associated with fire and other hazards, as if the coverage were part of a regular homeowners policy. To rate wind risk more accurately, the Florida windstorm pool reclassified each home based on risk of wind damage, applying premium credits for features that decreased the likelihood of damage, such as shutters, and surcharges for those that increased it. For example, two-story structures are more vulnerable to damage than one-story dwellings. Citizens’ rates are based on the revised classification.
In Louisiana, following Florida’s model, the FAIR Plan and the Coastal Plan became the Louisiana Citizens Property Insurance Corporation in 2004. The enabling legislation required the new plan’s rates to be actuarially sound and to be 10 percent higher than average rates charged in the voluntary market to ensure that it is truly a market of last resort. (In 2007, however, legislation was passed that allowed the surcharge to be dropped in some coastal areas where there was little competition and the pool had 50 percent or more of the market.) The enabling legislation also set up a system allowing funds to be set aside tax free for catastrophes and allowed insurers to recoup losses incurred by the Plan from all property insurance policyholders in the state. Lack of a recoupment process is one reason why so many insurers had withdrawn from the state, leaving it with only 20 companies competing for homeowners insurance business before the law was revamped. Other measures passed in 2007, including financial incentives, were designed to shrink the size of the pool by encouraging more insurers to enter the marketplace and to take over pool policies, see report on Catastrophes. These measures have been successful in returning the pool to its pre-Hurricane Katrina size.
Other Efforts to Make Property Plans Financially Viable: A number of other states have made changes to their property pools to make them more financially self-sustaining, and, in the process, to improve the private market for property insurance.
In April 2008 legislation was passed in Alabama that allows the state’s Beach Plan, the Alabama Insurance Underwriting Association, to come under state law, enabling it to raise funds through the sale of bonds and to carry funds over from one year to the next. The association has taken advantage of its new authority to raise funds through the private sector. Under an agreement with a major reinsurer, it will receive a fast injection of cash when a defined event, such as a hurricane with winds that reach a certain threshold, occurs. This kind of contract is known as parametric insurance and is based on an advance assessment of the likely amount of damage in a given area under specific circumstances after a disaster, rather than the actual losses incurred, which take longer to assess, see background section of the report on Catastrophes: Insurance Issues.
In North Carolina, legislation enacted in August 2009 capped insurers’ financial responsibility for property insurance Plan claims at $1 billion, providing them with greater certainty as to what their ultimate financial obligation to the Plan would be if a major hurricane hit the state. To reduce the Plan’s potential losses, the maximum coverage available to rebuild the structure was cut from $1.5 million to $750,000 and coverage for the home’s contents was scaled back from 70 percent of the home’s value to 40 percent. All policyholders in the state’s coastal counties receive discounts for measures that improve their homes’ resistance to storm damage.
In 2009, Texas lawmakers approved a measure in 2009 to reform the way the state’s windstorm pool, the Texas Windstorm Insurance Association (TWIA), is funded. The legislation made available up to $2.5 billion for catastrophic losses, relieving insurers of paying for all losses when the pool’s coffers run dry, and putting the pool on a more actuarially sound footing. There is a 10 percent cap on TWIA rate increases during a 12-month period when there is no hurricane. But in the event that the state is hit by a hurricane that causes significant losses, TWIA policyholders and most other policyholders in the state must share the cost of paying for claims with insurers through a system of insurance policy surcharges and insurer assessments. There is no provision for funding losses above $2.5 billion.
The TWIA covers 14 coastal counties and part of Harris County. Increasing development, together with a reduction by some insurers of the number of coastal policies they will issue, is pushing up the pool’s policy count and its exposure to loss. As a result, the state, through TWIA, has become the insurer of a large portion of the Gulf Coast region.
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. Florida’s residential JUA became part of its Citizens Property Insurance Corporation in 2002. Florida also has a workers compensation JUA, which was established in 1993. 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. However, in the 1990s, the market for medical malpractice insurance softened, as in other commercial sectors, and several JUAs were dissolved. Some states have provided extra protection in the form of a state-subsidized layer of “excess” medical malpractice coverage in addition to the JUA or separately, either to reduce the cost of additional coverage or to make it more readily available. In a number of states rising costs in the early 2000s forced several insurers to leave the medical malpractice marketplace, which in turn diminished the amount of medical malpractice coverage available. Some of the excess programs set up by states were short-term solutions to the most recent crisis and have sunset clauses. These require the entity to cease operations unless conditions warrant its continued existence.
In some states, medical malpractice JUAs operate in a fashion similar to JUAs for automobile insurance, through servicing insurers. In others, such as South Carolina, the medical malpractice JUA serves as an insurance company, collecting premiums, issuing policies in its own name and adjusting losses. Depending on the state, if the medical malpractice JUA runs into financial difficulties, the shortfall is picked up by the state’s insurance companies, its medical care providers or some form of financing that ultimately is paid for by taxpayers. When the insurance industry is assessed, assessments are spread over as broad a base as possible, sometimes the entire liability insurance market. Each company contributes in proportion to its share of the liability market, which may include personal and commercial automobile liability, general and professional liability and, in some states, workers compensation as well.
In many states, the insurance commissioner has been given standby authority to set up a JUA whenever marketplace conditions for any type of insurance require such a move. When it became obvious that insurance was becoming more difficult to obtain in parts of Florida, following the disastrous hurricane seasons of 2004 and 2005, the state set up a statewide commercial JUA to provide commercial property insurance.
Market Assistance Plans (MAPs): A MAP is a temporary, voluntary clearinghouse 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 rotating basis. In the mid-1980s, MAPs were set up for liability insurance. At that time, some businesses like ski resorts and bars, as well as municipalities, were having trouble finding liability insurance because of the increase in lawsuits filed against them. When the liability insurance market eventually adjusted and liability insurance became readily available once again, most liability insurance MAPs were dismantled.
Increasingly, MAPs are being created to deal with property insurance problems. In New Jersey, for example, where insurers are concerned about potential storm losses, the insurance department established a MAP in the 1990s, known as WindMAP. Insurers representing 70 percent of the state's homeowners insurance market participate. Some 20,000 residents in 92 ZIP codes are eligible to apply to the plan for coverage.
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 in Texas, and medical malpractice MAPs were created in states such as Washington, when the medical community had difficulty finding malpractice insurance.
Workers Compensation Assigned Risk Plans and Pools: The mechanism used to handle the residual market varies from state to state. In the four remaining states with a monopolistic state workers compensation fund (West Virginia 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 reinsurance pooling arrangement.
In most states, between 80 and 90 percent of residual market plan business is assigned to the pool. In a few states the pool is the only option. The pool hires servicing companies, generally insurers, which receive a fee to issue policies and settle claims. All insurers doing business in the state that elect to participate in the pool rather than direct assignment share in the profits and losses in accordance with their share of the state's workers compensation market. In some states, the assigned risk plan is administered by the National Council on Compensation Insurance, which also administers the largest of the pooling arrangements, the National Workers Compensation Pool (NWCP). The term "national" is a misnomer. The NWCP shares some administrative functions across state lines but operates a separate pool in each of the states for which it is responsible.
There are also other mechanisms for dealing with the residual market. Florida, for example, established a JUA to serve the workers compensation residual market. Unlike assigned risk plans where insurers subsidize the plan, JUAs are supported by assessments on self-insured employers and employer groups as well as traditional insurers. Minnesota is an exception to the competitive fund rule. The state has a competitive fund but also has an assigned risk plan. The competitive fund is assessed, based on its market share, like any other workers compensation insurer doing business in the state. Several other states have residual market programs in which the state fund shares in the financial results.
Before a firm can be offered workers compensation coverage through the assigned risk plan, in most states the applicant must have been rejected in the voluntary market by two insurers. The firm's application for coverage is sent directly to the plan's administrator, which either assigns the business to one of the direct assignment insurers or insures it in the pool.
Second Injury Funds: Second injury funds were created to encourage businesses 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. (See below.)
Second injury funds have played an important societal role. Before the protection afforded by the American Disabilities Act such workers might have had difficulty finding jobs because if they were injured in the workplace, the employer would have been liable for compensation for the total disability, not just the work-related injury. Where second injury funds still exist, in most states, if a person already handicapped in some way suffers an injury, the current employer's insurance company pays only the benefits associated with that workplace injury. The second injury fund pays the difference between the workplace injury benefits and those that the worker would receive for the total disablement—the initial handicap combined with the subsequent injury on the job. The funds operate on a pay-as-you-go basis instead of establishing reserves for liabilities anticipated as a result of claims that have been transferred to them.
Initially, second injury funds were limited to cases where the combined injury resulted in permanent and total disability. In addition, to be compensated, an employer had to prove that he or she was aware of the worker's preexisting condition at the time that person was hired. However, many states relaxed these rules. As a result of this broadened eligibility, fund obligations in some states grew dramatically and some accrued substantial unfunded liabilities.
Second injury funds receive money from insurance companies and employers 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.
Other Pooling Arrangements
Nuclear Energy and Other Voluntary Pools: The use of nuclear fission for peaceful purposes brought with it a demand for limits of liability insurance significantly higher than individual companies alone were able to provide. Originally three nuclear energy pools were voluntarily organized in the United States by the insurance industry in response to this demand. Now there is one. American Nuclear Insurers provides liability and property damage coverage for nuclear reactors and fabricators and transporters of reactor fuels. The pool purchases reinsurance from Lloyd's and other insurers not domiciled in the United States. Policies are issued in the name of the pool, showing each member company's participation.
Reinsurance Pools: There are two basic types of reinsurance pools. In the first, an individual member company underwrites the risks and issues the policy to the policyholder. The member then automatically reinsures the risk with the pool in accordance with the pooling agreement. In the second type, the pool functions as a general reinsurer, underwriting reinsurance policies for primary companies regardless of whether they are members of the pool. Examples of reinsurance pools include the Registered Mail Insurance Association, which covers currency, securities and other valuables transported by registered and first-class mail, and shippers of property transported by armored cars; and the Excess Bond Reinsurance Association, which offers fidelity coverage (protection against employee fraud) to commercial banks.
Unsatisfied Judgement Funds: Unsatisfied Judgment Funds exist in three states—Michigan, New York and North Dakota—to compensate victims of auto accidents (with the exception of uninsured vehicle owners) who cannot collect the damages awarded them, generally because the defendant had no insurance or assets with which to pay the judgment.
Unsatisfied Judgment Funds are administered differently, depending on the state. In two states—Michigan and South Dakota—they are administered by the state and in New York by insurers alone. New Jersey began to phase out its fund in 2003. Like residual markets, these funds are partially subsidized or totally paid for through assessments against insurance companies. To be eligible for state funds, accident victims must be residents of the state and have been injured in an accident that occurred within state boundaries. Out-of-state residents usually are eligible if their home state provides a similar program. There are few standard provisions. Each state has its own set of rules which determine deductibles, maximum compensation available, minimum size of losses covered, coverage for property damage and so on.
High Risk Health Insurance Pools: Pools have been set up by states to insure medically high-risk individuals who often have difficulty obtaining health insurance in the voluntary market. Most are similar to JUAs and FAIR Plans in that they assess insurance companies for claim costs in excess of the premiums collected. Most set premiums at a level that is lower than the price these individuals would have to pay if they could obtain health insurance through normal channels.
|State||Habitational policies||Commercial policies||Exposure (2) ($000)||Direct written premiums ($000)|
(1) Does not include the FAIR Plans of Arkansas and Hawaii. Data for Maryland is incomplete.
(2) Exposure is the estimate of the aggregate value of all insurance in force in all FAIR Plans in all lines (except liability, where applicable, and crime) for 12 months ending September through December.
(3) Citizens Property Insurance Corporation, which combined the FAIR and Beach Plans.
(4) The Mississippi and Texas FAIR Plans do not offer a commercial policy.
NA=Data not available.
Source: Property Insurance Plans Service Office (PIPSO).
|State||Voluntary market||Shared market||Total||Shared market as a percent of total|
(1) Less than .001 percent.
(2) Texas data are provided by the Texas Department of Insurance.
NA=Data not available.
Note: Negative numbers represent adjustments or corrections from a prior period.
Source: Automobile Insurance Plans Service Office, Texas Department of Insurance.
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