FAIR Talk About Residual Markets

The start of hurricane season made me think about a topic that many of us don’t often think about in P&C insurance: residual markets. The 21^st century insurance marketplace in the US is nominally a free market, but we all know that it isn’t perfectly so. This market has requirements that take away some of the choice and freedom.

Our current system creates gaps that must be filled. In a truly free market, people can choose whether or not they bought a product like insurance. However, there are limits to our freedom in the insurance marketplace. Most states require that drivers purchase insurance so that they can drive. The federal government currently requires that many employers provide health insurance. If an employer isn’t required to provide health insurance, people still have to buy health insurance. Most employers are required to buy workers’ compensation insurance by laws. It’s not a completely free market.

There are market forces that naturally create insurance requirements. Anytime a person has a loan for an asset, the loaning institution wants that asset to be protected. Whenever a person buys a house, the mortgage company wants to know that there is enough insurance in place to protect their investment if something were to happen to it. This isn’t an infringement on the freedom of the market. It’s an application of freedom in the market.

The fact that these requirements exist create another fact that limits the exercise of a free market. Some risks are not insurable by the standard market. Insurance companies don’t want to write policies on every risk that’s out there. There are risks that are simply uninsurable for a number of reasons. Yet that doesn’t relieve a person of the requirement to insure it.

You might say that this is why the excess and surplus (E&S) market exists. By the way, the E&S market is much more of a free market than the standard market. Because the E&S market is less regulated, they are willing to take on risks that other markets don’t want, but it will cost. E&S carriers have the liberty to price themselves out of risks that they don’t want to deal with.

This still leaves a gap because there are still risks that might be eligible in E&S, but the pricing can become prohibitive. Even worse, there are risks that even the E&S market doesn’t want. What do consumers do then? This is where the residual market steps in. What is a residual market?

According to International Risk Management Institute (IRMI), a residual market is defined as:

Insurance market systems for various lines of coverage (most often workers compensation, personal automobile liability, and property insurance). They serve as a coverage source of last resort for firms and individuals who have been rejected by voluntary market insurers. Residual markets require insurers writing specific coverage lines in a given state to assume the profits or losses accruing from insuring that state’s residual risks in proportion to their share of the total voluntary market premiums written in that state. LINK

In many states, this refers to an assigned risk pool in the personal auto market or a FAIR plan in the homeowners’ market. There are some states whose residual markets are a little different, but we’re going to ignore those for today.

There are drivers who are generally unacceptable for the standard market. These are the drivers that the assigned risk pool was created to serve. You know which drivers make up this population. They have either had too many accidents, or they have had their licenses suspended or revoked for some time. Many of these drivers will be required to have a SR-22, certificate of financial responsibility.

A FAIR plan is a high-risk homeowners’ insurance program. FAIR stands for Fair Access to Insurance Requirements. It was established to provide homeowners’ insurance for homes that can’t qualify in the standard market. Not every state calls it a FAIR plan, but the idea is similar state-to-state.

Every home that has a mortgage is required to have insurance. Sometimes that insurance is hard to get. Why would a home be hard to insured? It may be due to the location. You may not have realized this, but this country has areas that are impacted by different types of natural disaster risks. The Atlantic and Gulf coasts spend half the year at risk of a tropical cyclone making land fall somewhere, which can dump several inches of rain and brings with it winds in excess of 50 mph.

Another reason a home may need a FAIR plan could be other risk factors, including older mobile homes. Many newer mobile homes (or manufactured homes) are built much stronger than they used to be. The rules and laws that govern how they are to be installed have changed over the years, so a mobile home may not be properly tied to the ground. You did realize that mobile homes are not secured to a foundation like other homes are, didn’t you? Search mobile home tie downs for more information.

Recognizing a risk that is going to be placed with a residual market is part of properly serving customers. Sure, you could simply sell them those insurance policies, but you and your customer would be better served by helping them to understand their particular insurance policies and helping them to move out of the residual market, if that’s possible. Keep in mind that these plans often limit coverage in ways that standard market carriers do not. Liability limits will be lower than is available in the standard market and underwriting guidelines may be very tight.

Residual markets are a necessary part of the insurance world when you have regulations or requirements that some customers will struggle meeting. Being educated about your local residual markets (and other E&S options) is a way to make sure that you’re serving your customers.

Topics Excess Surplus