INSURANCE TOPICS

Residual Markets

THE TOPIC

JUNE 2009

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 address availability, rate adequacy and other factors that influence underwriting decisions.

RECENT DEVELOPMENTS

Property Insurance

• Alabama: In April 2008 legislation was passed 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 state is considering setting up a captive insurance company to insure coastal residents. In this case the captive would be run by local governments for the benefit of coastal property owners to revitalize the residential construction industry in coastal communities. Captives are often formed as a way to stabilize rates. As of May 2009 the Alabama pool covered some 12,000 properties, up from about 7,800 in June 2007, with 493 policyholders added to the rolls in May alone. The exposure to loss—insured value of all properties—is about $2.0 billion.
• Property owners in coastal areas who build their homes to the “Fortified....for safer living” construction standards of the 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.
• Connecticut: To increase the options available to homeowners living within 2,600 feet of the coast, the cut-off point in some insurers’ underwriting guidelines, the state’s insurance department has asked the FAIR Plan to set up a Coastal Market Assistance Plan (C-MAP). A C-MAP is a temporary program designed to encourage participating insurers to issue homeowners insurance policies beyond the scope of their underwriting guidelines on a voluntary basis. The C-MAP is administered by the FAIR Plan.
• Currently in the voluntary market, when an applicant for insurance lives close to the coast, an insurer may require some type of storm protection to reduce the likelihood of damage, such as hurricane shutters or precut plywood ready to install in window openings or hurricane impact resistant glass. Coverage through C-MAP does not require such loss mitigation measures; however, the owner must meet other requirements, including the purchase of flood insurance.
• Florida: In May Governor Crist signed legislation that would allow the Citizens Property Insurance Corporation, the state-run insurer, to raise rates by up to 10 percent a year for as many as five years until rates are actuarially sound, ending the rate freeze that had put Citizens financial health in jeopardy. Earlier the House had passed a bill that would have allowed an individual’s rates to increase by as much as 20 percent. The increase in rates, recommended by a task force in January, will help return Citizens to its former role as the state’s insurer of last resort. Currently, Citizens is the state’s largest homeowners insurer, with more than 1 million policies.
• The bill will also begin phasing out part of the coverage available from the Florida Hurricane Catastrophe Fund that provides reduced cost reinsurance to insurance companies. This will increase the cost of reinsurance for the state’s property insurance companies in that they will have to purchase additional reinsurance coverage in the private market. To compensate for the higher reinsurance costs, insurers would be allowed to increase rates up to 10 percent statewide and 12 percent for an individual with out going through the usual regulatory approval process.
• All auto and homeowners policyholders in the state must pay an annual surcharge on their premiums of 1.4 percent until 2017 to cover Citizens’ shortfall in 2005, when it had insufficient funds to pay hurricane damage claims. Citizens has $17.5 billion in claims paying capacity, but some of this is dependent on the state’s Hurricane Fund which, in the event of a major hurricane, might not be able to pay all claims because of its inability to raise funds as a result of the crisis in the credit markets. To pay claims after a major storm, Citizens might have to impose additional surcharges. Assessments would be highest for Citizens policyholders, up to 45 percent of their annual premiums. Policyholders with private insurers could also be charged. They would pay up to 18 percent.
• Early in 2008, 10 “take-out” companies were approved and four additional companies were approved a few months later. Together, these insurers removed some 360,000 policies in 2008. The depopulation process is on-going. Insurers must retain policies removed from Citizens for three years. Citizens no longer pays a bonus to insurers as an incentive to assume its policies. As of December 2008, Citizens total policy count was down 17 percent from year-end 2007 but the average exposure to loss per $1,000 of premium has increased about 30 percent from last year because of increases in building costs.
• Georgia: The state’s insurance department is considering setting up a separate state-run wind pool that would exist under the umbrella of the Georgia Underwriting Association to make insurance more available in the state’s coastal counties. Currently, such coverage is available from the Underwriting Association, which offers residual market coverage for properties anywhere in the state.
• Louisiana: Vowing not to follow Florida’s lead, lawmakers passed legislation in 2007 designed to make the state more attractive to insurers while at the same time helping property owners deal with increased property insurance costs. Among other things, the legislation allowed Louisiana Citizens Property Insurance Corporation to solicit bids from private insurers to take over its policies. In addition, the state provided financial incentives to new insurers who enter the homeowners insurance marketplace on the condition that 25 percent or more of their new business consists of policies taken over from Citizens. The insurance department announced in April 2008 that five companies had been awarded $29 million in grants under the incentive program.
• The goal of the program was to reduce the size of the residual market pool and focus attention on the insurance opportunities in the state. The pool had become the state’s third-largest homeowners insurer. At the end of 2008, the Citizens policy count was 130,000, and 40,000 policies had been transferred. A Citizens rate increase is expected to further reduce the pool’s policy count. The program will remain in place, but unused funds will be stripped from the program to be used to help close the budget gap.
• Massachusetts: On the Cape, which is the region in the state most vulnerable to storms, the FAIR Plan is the largest insurer with about 40 percent of the market there, in part because until recently its rates were very low relative to the risk it was assuming. The Massachusetts FAIR Plan is one of only six such plans that offer coverage almost comparable to a homeowners insurance policy.
• The Plan also offers a form of guaranteed replacement cost, a coverage no longer available from most private insurers, which pays up to $1 million to rebuild a home. Most companies now provide extended replacement cost coverage, which usually adds up to 20 percent of the policy limit in the event that reconstruction costs soar after a widespread major disaster.
• A bill that would have allowed the FAIR Plan to substitute the essentially unlimited coverage with coverage closer to that offered in the private market failed to pass at the end of the session. Earlier, the Plan’s request for an average increase of 13.2 percent was rejected by the insurance commissioner. Had it been approved, some residents of the Cape would have faced increases of as much as 25 percent.
• Mississippi: Wind pool premiums for homeowners and businesses dropped in summer of 2008 by an average of 11 percent and now the pool will get an extra $20 million from the state’s budget contingency fund to purchase reinsurance that will help lower rates and stimulate the Gulf Coast economy.
• The legislature last year approved a transfer of $25 million from the state’s tax coffers to the fund, part of an $80 million package passed in 2007 that helped pay for reinsurance, boosted the pool’s reserves for windstorm damage claims payments and allowed it to use state insurance premium tax revenues for four years to reduce policyholder premiums until the market stabilizes. The goal is to allow the pool to function like an insurance company—paying out in bad years and building up funds in good ones.
• Insurers that write new wind and hail insurance policies in coastal areas may now receive credits against the payment of state insurance premium taxes.
• In addition, policyholders statewide can now be surcharged for the cost of selling bonds to raise money in an emergency and for pool deficits, which after Hurricane Katrina, were more than two and a half times some companies’ annual premiums. Prior to passage of the law, insurers were assessed for pool deficits but could not pass on the cost to policyholders directly, as they can in other states.
• The insurance department is working on a plan to create a hurricane damage mitigation program that would improve the hurricane resistance of building stock, both new homes and existing ones, in six coastal counties. The state’s goal is to encourage development along Mississippi’s coast. Buildings that are better able to withstand high winds lessen the negative economic impact of being in a hurricane-prone region.
• However, as insurers pull back from writing coverage along the coast, the pool’s policy count has continued to grow, from about 1,600 in 2006 to more than 42,000 in January 2009. Some 800 new policies are added each month.
• North Carolina: The state’s Beach Plan is seriously underfunded but, as in other states, reform pits coastal county legislators against inland communities because any true reform would raise the amount residents in coastal areas pay for homeowners insurance. Nevertheless, rate changes approved in December 2008 for coverage in the private market and the Beach Plan will take effect May 1 as scheduled, after a Wake County Superior Court judge dismissed a petition to delay the increases. Rates are scheduled to rise about 4 percent statewide. While some inland communities could see decreases, policyholders living in 18 coastal counties whose homes are insured by the Plan could see rates jump by as much as 30 percent. The judge’s decision does not affect the stay of deductible and surcharge increases that the Beach Plan was scheduled to impose on new policies as of Feb 1. In this case the judge ordered the insurance department to revise its procedures, ruling that former Insurance Commissioner Jim Long did not establish a proper process for the changes.
• A study by Milliman, an actuarial consulting firm, commissioned by the Property Casualty Insurers of America Association and released in October 2008, confirmed the already precarious financial condition of the state’s Beach Plan, which is growing by about $1 billion a month due to its below cost rates. In December 2008, officials sought to strengthen the Plan by increasing homeowners policy deductibles, raising rates, and allowing the Plan to retain more capital or policyholder surplus. Some lawmakers from coastal areas and industries that rely on attracting more people to the region such as real estate are opposing the changes fearing that they will negatively impact the local economy. A judge has put a stay on some, saying the department of insurance did not follow proper procedures; others are being challenged in court by municipalities; and now coastal legislators are pushing for a two-year delay.
• In January 2009, a Joint Select Study Committee charged by the legislature last summer to make recommendations to restore the state’s Beach Plan to its original role as insurer of last resort made public its recommendations. Among other things, it recommended that the current statute be amended to clarify that the Plan is the market of last resort, that rates and deductibles be no more favorable than those in the voluntary market and that the maximum coverage on a home insured under the Plan be cut in half from $1.5 million to $750,000 to limit the Plan’s liability for hurricane damage.
• The committee also said that the Plan should operate as a tax-exempt entity and that it should create a study commission to look into improvements in building codes and programs to encourage homeowners to upgrade the wind resistance of their homes. The committee rejected a proposal to prohibit the Beach Plan from writing coverage on second homes.
• Among the insurance industry’s recommendations not included in the committee’s report is to make it easier to understand how the state’s property insurance system functions and to modernize the state’s rate regulation system and the way deficits are recouped.
• The North Carolina Beach Plan insures about $72 billion in property but only has about $2.4 billion to pay claims. Once that money is exhausted, the Plan can assess insurance companies that operate in the state. According to Milliman, the Plan’s lack of funds threatens the availability and affordability of property insurance for all policyholders (as evidenced by the withdrawal of one major insurance company that cited the potential for huge assessments, which are very difficult to estimate and plan for).
• The pool could face a $6.2 billion deficit in a season with a large storm, the Milliman study notes. Even a small storm could leave it with $1.4 billion in the red. If a major storm should occur, insurers could be assessed for much more than the amount of premium they collected. Some small insurers could become insolvent even though they may not insure coastal property because assessments are imposed on all property insurers doing business in the state. There is no law mandating actuarially sound rates for the Beach Plan and the insurance commissioner is under political pressure to keep rates down.
• 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 and, as a result of the new law, several thousand additional policyholders are now covered for flood damage.
• 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, see above.) 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: After six years of discussion, legislators have approved a measure that will reform the state’s windstorm pool, the Texas Windstorm Insurance Association (TWIA), the state’s insurer of last resort and only insurer for residents and businesses of the state’s coastal counties. The bill sets up a system to fund the pool for up to $2.5 billion in losses, relieving insurers of funding all losses when the pool’s coffers run dry.
• Texas Governor Rick Perry had designated the reform of TWIA and funding of the Catastrophe Reserve Trust fund as emergency items for this legislative session, threatening legislators with a special session if no bill was forthcoming. TWIA had virtually no funds after paying claims from hurricanes Dolly and Ike, which struck Texas in 2008. It has already assessed its member insurers $530 million. Legislators had to come up with a proposal that would be acceptable to both coastal and inland constituencies. About 25 percent of the state’s population lives along the Gulf Coast, but the area generates about 30 percent of the state’s business activity.
• The bill, HB 4409, puts the pool on a more actuarially sound footing but will not necessarily result in an immediate rate hike for coastal policyholders. 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 will share the cost of paying for claims with insurers through a system of insurance policy surcharges. These surcharges together with insurer assessments will fund the sale of so-called post event bonds after the hurricane strikes. In the meantime, wind pool policyholders will have to purchase flood insurance, eliminating the disputes over whether wind or storm surge caused the damage, and meet current TWIA building code requirements, thus reducing potential damage claims.
• 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. The pool grew from about 69,000 policyholders at the end of 2001 to more than 229,000 by October 2008. Almost half of the TWIA’s residential properties are in Galveston County.

Auto Insurance

• National: Nationally, the residual market’s share of total cars insured dropped 7.5 percent between 2005 and 2006 to 1.2 percent. This is well below the 1995 figure of 4 percent. In most jurisdictions the percentage was well below one percent. In the three states with the most vehicles in shared market plans, the number of cars fell by 28.3 percent in New York to 153,241 and 19.5 percent in Massachusetts to 198,644. But in North Carolina, which has a reinsurance facility, see Background section, the number of cars insured in the residual market rose 2.4 percent to 1.58 million, almost a quarter of the total cars insured in the state.
• The residual market can be viewed by share of cars insured or by premiums. In 2006 nationally, more than $1.6 billion of premium was written in the private passenger auto insurance residual market, representing about 1.0 percent of the total private passenger auto insurance premium. (The commercial residual auto insurance market represents about 2 percent of the total commercial auto insurance premium.)
• New York State had less than 1.7 percent of its cars insured in the pool in 2006, a fraction of North Carolina’s 23 percent, but New York ranks third in premiums because auto insurance is generally more expensive in New York than in North Carolina. In 2006 North Carolina topped the list with $692.0 million in private passenger residual market written premium, compared with $254.0 million in New York. Massachusetts, which has since changed its residual market system, was second with $299.3 million.
• New Jersey dropped a take-all-comers provision from its books in January 2009 in compliance with the 2003 auto insurance reforms. The measure had required auto insurers to offer insurance to all but the worst drivers in order to reduce the size of the residual market. At that time more than 143,000 drivers were insured by the state plan, compared with just 23,000 in June 2008, according to the insurance department. If the plan’s share grows to more than 10 percent, the state may reinstate the take-all-comers law.
• North Carolina: state with the highest percentage in the private passenger residual market in 2005, was North Carolina, at 23 percent, followed by Massachusetts, at 6 percent. However, in Massachusetts, about one quarter of all commercial auto insurance premiums ends up in the residual 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: Following the report of a study group appointed by Governor Deval Patrick that found that the state should consider moving toward a more competitive market by using a flex rating system, the new insurance commissioner, Nonnie Burnes, said that the state would adopt an assigned risk plan along with the change to a system of “managed competition.“ See report on rate regulation modernization.
• The assigned risk plan is taking over from the current residual market program, known as CAR (Commonwealth Automobile Reinsurers), over a three-year period starting in April 2008, when auto insurance companies began using the new rates they have filed. CAR now insures both high-risk drivers and drivers who may have a good driving record but live in an area where the state-mandated rates are insufficient to support the risk assumed in providing insurance. Since CAR is a reinsurance facility, policies are issued by a regular insurer and the policies that cover bad “risks” are reinsured through CAR.
• Under 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. Now that managed competition has taken effect, there is an incentive for insurers to offer low-risk CAR policyholders coverage in the voluntary market, ultimately reducing the residual market’s size. 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.
• The initial move to an assigned risk plan was stalled for several years while insurers who opposed the change-over challenged the commissioner’s power to make such a decision in the courts. In August 2006, in a unanimous decision, the Massachusetts Supreme Judicial Court confirmed the commissioner's authority to revamp the state’s residual market for auto insurance.

Workers Compensation

• Positive trends in the workers compensation residual market are continuing. Estimated residual market premiums in 2007 for the pools serviced by the NCCI declined from $1.2 billion in 2006 to an estimated $1 billion in 2007. The residual market's share of the total workers comp market also decreased, falling from 10 percent of the total in 2006 in the states for which the NCCI collects data to an estimated 8 percent in 2007.
• Ten percent fewer employers nationwide were insured in the residual market in the first quarter 2008, compared with the first quarter a year ago, according to NCCI figures. The drop was steepest for large employers who have been moving to the voluntary market, partly as a result of revised NCCI pricing and safety incentive programs. Residual market premiums bottomed out at $300 million in 1999. In the early part of the 1990s it was a considerable burden on the voluntary market, which has to pay for the residual market’s losses, accounting for more than one-quarter of total market premiums in NCCI states.
• While the workers compensation residual market share dropped, the combined ratio, a measure of profitability, rose, moving from 115 in 2006 to an estimated 124 in 2007. This means that insurers paid out about $115 in residual market claims and expenses for every $100 in premium collected in 2007. The combined ratio had been more.

BACKGROUND

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.

1) 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.

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.

2) 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.)

3) 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, will be disbanded 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.

4) State Funds—Maryland established a state-funded residual market mechanism 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.

Together, residual market programs insured about 2.2 million cars in 2006, about 1.2 percent of the total market and a 7.5 percent drop from 2005, 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 2004, 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 1.6 million, the pool insured more than 23 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 (two cars) in 2006.

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.

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 Texas, and medical malpractice MAPs were created in states such as Washington, when the medical community had difficulty finding malpractice insurance.

Pools—FAIR Plans, Beach and Windstorm Plans, Workers Compensation 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 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 2008, 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 this to happen, Citizens had to shrink rather than grow. However, legislation passed in 2007 spurred its growth in order to reduce the cost of insurance and increase its availability for the state’s property owners. In addition, legislation that required its rates to be actuarially sound has been put on hold until year-end 2009. Nevertheless, the state is succeeding in gradually reducing the size of the residual market through financial 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.

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.

Workers Compensation 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.

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. The nuclear energy pools were voluntarily organized by the insurance industry in response to this demand. There are three nuclear energy pools in the United States today that provide liability and property damage coverage for nuclear reactors and fabricators and transporters of reactor fuels. Each pool issues identical policies and reinsures its business with the other two pool members. In addition, the pools purchase 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.

State Funds and Other Pooling Arrangements: 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.

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.