A residual market is an insurance mechanism that serves as a coverage source of last resort for businesses and individuals who have been rejected by voluntary market insurers due to their high-risk profiles or other underwriting concerns.
The residual market, also known as the assigned risk market, shared market, involuntary market or non-voluntary market, is a critical component of the American insurance system designed to ensure universal access to legally required or essential insurance coverage.
This marketplace operates separately from the standard voluntary insurance market where carriers can freely choose which risks to insure based on their underwriting criteria. In contrast, the residual market functions as a safety net for those deemed “uninsurable” by conventional standards.
The existence of residual markets stems from a fundamental societal need: ensuring that high-risk entities can access essential insurance coverage while balancing the commercial realities of insurance companies.
State laws often mandate specific types of insurance, such as workers’ compensation for employers or auto liability for drivers, yet some businesses or individuals present risk profiles that make them unattractive to standard insurers. Without residual markets, these entities would be unable to legally operate or would face devastating financial exposure.
While residual markets are primarily state-based, there are also federal residual market programs like the National Flood Insurance Program (NFIP) for flood insurance.
Residual Market Mechanisms
Residual market mechanisms in the United States are not one-size-fits-all; they vary significantly depending on the type of insurance and the state in which they operate.
States have implemented a variety of structures tailored to specific lines of insurance, such as auto, property, and workers’ compensation. Each of these mechanisms plays a role in maintaining balance of essential coverage whilst distributing the financial burden of high-risk policies across all participating insurers.
The most common structures include Joint Underwriting Associations (JUAs), FAIR (Fair Access to Insurance Requirements) Plans, assigned risk pools, and reinsurance facilities.
Joint Underwriting Associations (JUAs) are a common mechanism for managing high-risk policies. In this model, all insurers in a particular line of business within a state are required to participate in the JUA.
The association pools resources from these insurers to provide coverage to high-risk policyholders. JUAs are often used for lines of insurance like medical malpractice or commercial auto liability.
Policies issued through JUAs are typically underwritten and serviced by one or more designated carriers on behalf of the association, with losses and profits shared proportionally among all participating insurers.
FAIR Plans (Fair Access to Insurance Requirements) are another type of residual market mechanism, primarily focused on property insurance. These plans were established in response to urban unrest and natural disasters in the 1960s when many insurers began withdrawing from high-risk areas.
FAIR Plans provide basic property insurance to homeowners and businesses that cannot obtain coverage through the voluntary market due to location risks or other factors.
While FAIR Plans ensure access to coverage, they often come with higher premiums and limited policy options compared to standard market offerings.
Assigned risk pools are commonly used for auto and workers’ compensation insurance. In this system, high-risk policyholders who cannot find coverage in the voluntary market are assigned to insurers operating in the state. Assignments are typically made based on each insurer’s market share in that line of business.
For example, if an insurer writes 15% of the state’s voluntary auto policies, it will be assigned approximately 15% of the residual market auto policies. This ensures that no single insurer bears an undue burden of covering high-risk policyholders.
Reinsurance facilities operate differently from other residual market mechanisms. Instead of assigning individual policies to insurers, reinsurance facilities allow insurers to issue policies directly but then cede some or all of the risk to a centralized reinsurance pool.
This structure is often used for auto insurance in states like North Carolina and South Carolina. Insurers retain responsibility for servicing the policies but share the financial risk with other insurers through the reinsurance facility.
Operationally, residual markets are carefully structured by state regulators to distribute these high-risk policies among all insurers licensed in that state. Insurance companies must participate in these markets as a condition of doing business in the state.
The mechanism typically assigns policies to carriers based on their market share in the voluntary market for that line of business.
This distribution system is often called the ‘quota share’ approach, where each insurer must accept a proportional share of residual market policies
For example, if an insurer writes 10% of a state’s voluntary auto insurance, they would be assigned approximately 10% of the residual market auto policies. This system ensures the burden of insuring high-risk entities is shared proportionally across the industry.
For business owners, the residual market provides a fallback option if a business is denied coverage in the standard market due to industry classification, claims history, or location risks.
Policies obtained through residual markets often come with higher premiums than comparable voluntary market policies, directly impacting a business’s operational costs.
Coverage obtained through residual markets may have more limitations and less flexibility than policies obtained in the voluntary market, potentially creating coverage gaps that require careful management.
Examples of Residual Market Coverage
Example 1: A Construction Company’s Workers’ Compensation Challenge
Hillcrest Construction, a small residential construction company with 15 employees, experienced three significant workplace injuries within a two-year period. After their workers’ compensation policy expired, their insurance agent approached several carriers but received rejections due to the company’s poor loss history.
With workers’ compensation coverage legally required for operating in their state, Hillcrest’s agent submitted an application to the state’s workers’ compensation assigned risk pool.
Through the residual market, Hillcrest obtained the legally required coverage, albeit at a premium approximately 25% higher than their previous policy. The assigned risk policy came with mandatory risk control services, which helped the company identify and address workplace safety deficiencies.
By implementing the recommended safety measures and maintaining an injury-free workplace for two years, Hillcrest eventually qualified for coverage in the voluntary market again, resulting in significant premium savings and more flexible coverage options.
Example 2: A Retail Store in a High-Risk Area
Main Street Boutique, a clothing retailer, opened a new location in an urban neighborhood with historically high crime rates.
Despite having excellent financial records and no previous claims, the business owner found that standard market insurers were unwilling to provide property insurance due to the store’s location.
Commercial property insurance was essential not only for protecting the business’s physical assets but also required by the building’s mortgage lender.
The business owner turned to the state’s FAIR Plan, a residual market mechanism for property insurance.
Through the FAIR Plan, the boutique secured the necessary coverage, meeting their lender’s requirements and protecting their inventory and equipment.
While the premium was higher than comparable voluntary market rates, the coverage enabled them to operate in an underserved neighborhood where they found a profitable niche market.
After three years of operation with no claims and documented security improvements, the business eventually qualified for standard market coverage at more competitive rates.
Benefits and Drawbacks of the Residual Market
The residual market offers several important benefits to businesses.
Primarily, it guarantees availability of legally required or essential insurance coverage regardless of risk profile, enabling businesses to operate lawfully even when standard market insurers consider them uninsurable.
For new businesses in high-risk industries or locations, the residual market may be the only pathway to securing necessary coverage during their early years.
Many residual market programs include risk management services that help businesses identify and address safety concerns, potentially making them more attractive to voluntary market insurers in the future.
The most obvious disadvantage of the residual market is its cost. Premiums in the residual market are typically higher, sometimes substantially, than comparable voluntary market policies for the same coverage.
Coverage options also tend to be more limited, with fewer endorsements and less flexibility in policy customization. For businesses operating in multiple states, navigating different residual market systems adds administrative complexity.
Some residual markets operate at a loss, with costs ultimately passed on to all policyholders in the voluntary market through various assessment mechanisms.
Pool Assessments
Some residual market programs may be subject to assessments if the pool experiences financial deficits, creating potential additional financial liabilities beyond the premium.
Residual market pools provide insurance coverage for high-risk individuals or businesses that struggle to obtain policies in the voluntary market. State regulators address financial deficits from these pools by imposing proportional assessments on insurers, which are then passed on to policyholders through higher premiums.
Did You Know?
The first residual market mechanism in the United States was established in New Hampshire in 1938 for automobile coverage, coinciding with the introduction of laws requiring drivers to furnish proof of insurance.
Today, disparities between states’ residual market volumes can be significant. North Carolina has the highest percentage of private passenger auto policies in the residual market at 24%, while Massachusetts channels approximately one-quarter of all commercial auto insurance premiums through its residual market. Residual market participation rates can change over time.
These variations largely reflect differences in state regulatory approaches rather than underlying risk profiles of businesses or individuals.
Sources and further reading:
Residual Markets – Insurance Information Institute
Residual Market – IRMI
Residual Market Involuntary Business Term Glossary – CSIMarket
Workers Compensation Residual Market – IRMI
FAIR Talk About Residual Markets – Insurance Journal
What is the Residual Market? – Insuranceopedia
Residual Market Insurance – EINSURANCE.com
Assigned Risk – Liberty Mutual Business Insurance
Residual Market – WCRIBMA
About CAR – Our Role – Commonwealth Automobile Reinsurers
Residual Market Expiration List – NCCI