Unless you’re buying a home outright, you’ll probably acquire a mortgage to cover its cost. And the mortgage company, in turn, will likely require that you purchase a homeowners insurance policy.
But qualifying for a mortgage on a home doesn’t necessarily ensure you will do so for the homeowners insurance the lender requires—and that’s wise to get, regardless of the requirements. For example, your insurance approval could falter on the basis of your claims history, a factor that likely wouldn't come up during a mortgage evaluation. Or mortgage lenders might be more comfortable than insurers with the risk associated with a property in an area prone to wildfires.
Those differing criteria can leave homeowners in a bind. Fortunately, those trapped in this limbo can turn to what’s known as a residual homeowners insurance market. This option is sometimes unpredictable, and premiums may be higher and less easily negotiated than with regular homeowners insurance. But this insurance is well worth consideration as a last resort for those who face challenges in finding regular insurance for their home.
What is residual insurance?
Residual insurance is typically a state-run option designed for businesses or individuals that may not qualify for traditional insurance policies. According to the American Insurance Association, the residuals market has the following key attributes:
- It creates a system where insurance companies share in both the deficits and surpluses of the residual market
- It strictly limits the scope of coverage in some states
- It allows for higher risk-based rates
For insurance companies, participation in the residuals market is mandatory, as the system is designed to equitably spread the risks and rewards of the insurance market across the board.
Benefits of residual homeowners insurance
The residuals market helps ensure everyone can obtain adequate homeowners insurance coverage. And in many states, the number of policies written in the residuals market has been rising. In Georgia, for example, the number of residuals market policies for all types rose from 16,596 to 21,297 in 2016. The total value for all policies jumped nearly $10 million in that time.
This growth coincides with a recovery in the housing market. New home sales have nearly doubled in the U.S. since 2013, marking a significant financial recovery. However, rapid growth in the home sales market has made the residuals market all the more important, given the homeowners insurance policy requirements typically present when individuals acquire a mortgage.
Downsides to residual homeowners insurance
Obviously, if the residuals insurance market was optimal, more consumers would be using it. But the market is designed for those who are a considered a higher risk to insure, and so comes with commensurately high premiums and deductibles compared with what’s typical the voluntary homeowners insurance market.
Both the minimum and maximum coverage you can get with a residuals policy may also be lower than with a regular policy. Minimum and maximum coverage amounts are determined on a state-by-state basis. To again use Georgia as an example, the minimum coverage is set at $25,000, which is far below the industry average of around $100,000 in the private market, and the maximum is $2,000,000, including the house and all possessions. Although most individuals may not need more than $2 million in coverage, Georgians who do require a higher amount will be unable to find proper coverage for the value of their home and possessions.
Additionally, as more individuals utilize homeowners insurance, across both the regular and residual markets, the risk rises for insurance companies. Major natural disasters, such those in 2017 with hurricanes in Texas and wildfires in California, can force insurers to pay out more than they received in insurance payments. To mitigate this risk, insurers may raise rates across the board, including the already-higher premiums for residual homeowners insurance.
Finally, receiving coverage under the state insurance program does not guarantee that it will always be an option. As the risks associated with the insurance market can go up, it’s not uncommon for state insurers to drop policies to reduce financial risk. In central Florida, for example, the state insurer dropped over 50,000 policies between 2012 and 2015, leaving many homeowners without coverage.
Quite often, anyone can purchase insurance from the residuals market, even if they don’t need to so. Yet there’s little reason to do so; residual homeowners insurance is typically a worthy option only for those who are forced to live with its higher cost and other disadvantages.