Claims Adjudication in the Personal Automobile Insurance Residual Market

Article excerpt

INTRODUCTION

This study analyzes the differences between the two major forms of automobile residual market facility used in the United States: assigned risk plans (ARPs) and joint underwriting associations (JUAs). Its purpose is to determine if the form of the residual market facility affects claims payments. Due to differences in incentives, the authors predict that JUAs result in higher claims payments on the part of insurers, and the results are consistent with the prediction. Although the empirical analysis is restricted to automobile insurance, the study's hypothesis that joint underwriting associations result in higher loss payments than assigned risk plans is applicable to other lines of insurance. A variety of government programs exist that provide insurance to high-risk consumers, including property, liability, and health coverages.

For a mandatory insurance coverage such as automobile insurance, the consumer rated "uninsurable" by traditional underwriting standards is at a serious disadvantage without some form of governmental intervention. Many states require that drivers purchase automobile liability insurance. In these states if a driver is unable to obtain insurance in the private market, the residual market mechanism provides the necessary coverage. Without a residual market the individual would either have to forgo driving, which may interfere with the ability to maintain employment and thus earn an income, or operate the vehicle in violation of the law.

Similarly, businesses in all but two states, Texas and South Carolina, are required to purchase workers' compensation coverage for their employees. As with automobile insurance, the states have residual market facilities for making the required coverage available. Workers compensation assigned risk pools, which exist in 28 states, are presently the high-risk workers compensation insurance facility of choice in states that do not have a monopolistic state fund (Huebner, Black and Webb, 1996). In two jurisdictions, Florida and Wisconsin, the residual market facility is a joint underwriting association (Robinson and Rudd, 1995).(1)

Even when coverages are not required by law, society may deem them essential, and thus the government creates some means for these coverages to be made available to those who feel they need them. Typically these mechanisms have many traits similar to residual market facilities. Examples of insurance coverages provided by these quasi-governmental programs include health insurance for high risks, property insurance through beach plans, and property insurance through FAIR plans.(2)

While this empirical analysis is limited to private passenger automobile insurance residual market facilities, the theoretical argument presented in Section 3 is not insurance coverage specific. In Section 4 the authors report their empirical methodology and findings. Section 5 summarizes the study and contains suggestions for future research. Section 2 provides background information on the operation of residual market facilities. The research contributes to the public policy literature by analyzing the cost differences between the two types of residual market facilities.

OPERATING CHARACTERISTICS OF RESIDUAL MARKET FACILITIES

Government high-risk insurance plans vary in terms of structure and operation. In automobile insurance, most states have an assigned risk plan (ARP), while a few have joint underwriting associations (JUAs). ARPs and JUAs are similar in their purpose: to provide state-mandated automobile insurance coverages to high-risk drivers. They are also similar in that by design they are expected to create underwriting losses (AIPSO, 1997). They are, however, fundamentally different in their structure and operation.

In the case of an ARP, high-risk drivers are "assigned" to insurers, typically by some measure of the insurer's voluntary automobile coverage market share. …