Rejected by standard market insurer?

Find out more about your last resort – high risk pools

One of the most common methods of dealing with insurance availability problems, in lines such as general auto insurance, property, workers’ compensation and medical malpractice, has been the use of state-created residual risk pools. These mechanisms, which are complex and vary greatly from state to state by line of insurance, are intended to be an insurer of last resort for those who have been rejected by standard market insurers (these individuals are known as residual risks).

Although the specific operating structure of each pool may differ, they are based on a common concept: that any insurer doing business in that particular line must share in the profits or losses of insuring residual risks.

The size of residual risk pools is considered an indicator of the degree of rate inadequacy in the voluntary market. Because insurance companies generally will choose to accept applicants for whom rates are commensurate with the risk to be assumed, the greater the inadequacy, the greater the likelihood that the applicant will be rejected for coverage. Applicants rejected by the voluntary market may apply to the residual market. Acceptance into a residual risk pool is usually contingent upon proof of inability to obtain coverage in the voluntary market, with some pools requiring evidence of rejection from two or three companies.

If the size of the residual pool is considered a proxy for rate inadequacy, prior approval systems would be more likely to have inadequate rates than competitive systems. This is because in competitive systems rates are generally allowed to rise to adequate levels for most risks while competitive pressures work to guard against excessiveness for those same rates. Studies on auto insurance bear this out.

A 1986 General Accounting Office study, “Auto Insurance Cost and Availability”, found that prior approval states insured nearly twice as many drivers through residual risk pools as competitive states. According to data from the organization which services these pools nationwide, the Automobile Insurance Plans Service Office, each of the five states with the largest automobile insurance residual risk pools in 1986 (Massachusetts, New Jersey, New York, North Carolina and South Carolina) used either state-made or prior approval rate regulatory systems.

In addition, these five states alone accounted for 77 percent of the total number of privately owned vehicles insured in the residual auto insurance market, but only 16 percent of the nation’s registered cars.
Although the state goal of residual risk mechanisms is to provide insurance at rates below cost (inadequate levels) with the losses to be paid by others (usually voluntary market policyholders), the losses in some of these systems have reached exceeding high levels.

This has led many states to consider making such risk pools more self-sufficient by charging higher rates to those who imposed high costs on the system. This trend highlights the fact that inadequate rates are not sustainable in the long run.

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