Depth of Field – Feature – June 2008
WHAT? ME WORRY? FLORIDA’S HURRICANE INSURANCE REFORMS MEAN EVERY FLORIDA INSURANCE CONSUMER MAY BE BURIED UNDER SURCHARGES PILED ATOP SURCHARGES–ALL TO CREATE CHEAP RATES TODAY. SOME SEE A FEDERAL BAILOUT IN THE OFFING.
In Tallahassee, it’s nail-biting time for Jack Nicholson. June marks the start of hurricane season. Nicholson is the director of the Florida Hurricane Catastrophe Fund, and he is looking at the skies these days, wondering if the state will once again dodge the bullet and escape without a major hurricane.
For the past two years, the state has defied prognosticators who are convinced it’s just a matter of time before a monster forms out in the Atlantic and smashes into the Florida coast. Not only was there no “Big One,” there weren’t any hurricanes at all to cause trouble for Floridians in 2006 and 2007.
The big winners, in addition to the homeowners and businesses that avoided devastation, were the Florida legislature and Gov. Charlie Crist. Their solution to high rates and capacity issues following Hurricane Katrina and seven other hurricanes in 2004 and 2005 was to put the state four-square into the insurance and reinsurance business, devising a plan to give people insurance while keeping rates artificially low.
But when one replaces an insurance system based on private capital and premiums based on risk with one that relies on borrowing after the event and sets premiums based on politics, it’s just a matter of time before someone has to pay the piper. The first person on the line will likely be Nicholson, whose agency was way out on a ledge during the 2007 season, with $27.83 billion in reinsurance exposure, and expects to be on the hook for nearly $30 billion this season.
Of that total, some $11 billion is reinsurance coverage for Florida’s state-run Citizens Property Insurance Corp. Although Citizens is described as the state’s insurer of last resort, under the state’s political approach to insurance, it essentially has become the insurer of first resort. All a Florida resident needs to do to get insurance from Citizens is show a private insurer’s quote that is 15% higher than Citizens would charge. That’s not hard, since Citizens has had its rates rolled back and frozen by legislative fiat for the last few years. It is the largest insurer in the state, writing 1.3 million policies with $485 billion insured value at the end of 2007.
As Florida State Rep. Dennis Ross, R-Lakeland, one of only two legislators to vote against the so-called reforms of 2007, says, the state isn’t really in the insurance and reinsurance business at all; it’s in the debt-issuing business. And therein lies the Florida shell game.
People buy insurance from Citizens or from a number of thinly capitalized new companies that have come in, many with state help, to replace more established insurers that have pulled back or pulled out because they can’t compete with Citizens’ rates and other regulatory requirements. The rates paid by Citizens policyholders are low now, but here’s what happens if and when a decent-sized hurricane hits:
The Florida Cat Fund will need to issue enough bonds to pay the tab for Citizens and the private companies that have bought reinsurance from the state at artificially low prices. At least Nicholson hopes he can issue enough bonds to pay those obligations, but that’s another part of this story.
Citizens then will take that Cat Fund reinsurance payment and probably have to issue bonds of its own to cover whatever shortfall exists so it can pay the insurance obligations it has taken on—again, assuming it can find takers for those bonds.
And the tab for those bonds will be paid in the form of assessments on every person and business in Florida with a property or auto policy, even people who don’t live in Florida but have a Florida policy on a second home or car or business. Everyone—repeat, everyone—even those who placed their p-c policies with a company other than Citizens, will pay. Those assessments could last up to 30 years.
Whoa, Nellie!
Thirty years? Even for people who didn’t insure with Citizens? And here’s the final move of the shell. If there is another hurricane this season or the following year or years, that whole cycle would start again, with assessments on top of assessments.
Suddenly, the short-term gain of those unrealistic insurance premiums doesn’t seem quite as attractive.
Can lawmakers really believe that Florida residents will tolerate assessments of this sort—an estimated $600 annually per policy for 30 years in the event of a Category 3 or stronger storm—and not rise up in revolt?
Ross thinks his legislative colleagues believe they will never be held accountable because the federal government will step in to head off the assessment disaster.
“I think that politically, my colleagues look at it and think that the Feds will come in because that’s what they did in Katrina. And I think politically, the Feds will come in. But what have we done? We haven‘t taken a responsible approach to insuring this risk in the most responsible way and that is with private capital,” says Ross.
So far, the dice roll is working because, in addition to the fact that there have been no hurricanes, very few Floridians are aware they’re on the hook. A recent survey by the Property and Casualty Insurers Association of America found that 71% of Floridians do not know the legislative changes allow Citizens and the Cat Fund to assess virtually all insurance policyholders in the state if there is a financial shortfall.
“It is deeply concerning that the vast majority of Floridians are completely unaware of the reason they face this potential assessment,” said Rep. Don Brown, R-DeFuniak Springs, in a recent letter to Florida House Speaker Marco Rubio. Brown is the other lawmaker who voted no on the insurance package.
“This suggests,” says Ross, “that Floridians are also unaware of the reason why these ‘hurricane taxes’ exist. One major storm and the taxpayers of the state will be hit with assessment.”
In fact, policyholders are already paying three assessments from Citizens, the Cat Fund and the Florida Insurance Guaranty Association.
The Guaranty Association, which covers insurer insolvencies, has been levying assessments equal to 2% of annual premium on Florida homeowners policies for the past two and a half years to cover claims resulting from the liquidation of Poe Financial Services in May 2006 (for a policyholder with a $1,000 annual premium, that amounts to $20).
Citizens also assessed Florida homeowners policyholders amounts ranging from 2.07% to 6.84% of premium to make up deficits from the 2004–05 hurricane season.
The only Citizens assessment currently in place is a 1.4% of premium charge that began in December 2006 and will continue through 2016. And the Cat Fund is levying an annual assessment of around $60 a year for five more years to cover bonds issued in the aftermath of the 2005 season. Any further assessments stemming from the current hurricane season would be add-ons to those pre-existing charges.
The risk of the hurricane package enacted by the legislature in 2007 has not escaped the attention of the rating agencies. A.M. Best weighed in last year and suggested insurers might wish to secure private market reinsurance as a backstop in case the Cat Fund could not make its promised payments. Fitch Ratings recently issued a special report calling the Florida homeowners insurance market “unstable” and said the situation is “not likely to be resolved in the near term.”
“Fitch’s main concern from a ratings perspective is that if a major storm(s) were to hit Florida this year, the fragile market could effectively collapse, especially if such an event intensifies the withdrawal of private capacity,” the report says.
The longer the situation goes on, Fitch said, the greater the possibility of a negative ratings impact for insurance companies with material presence in the Florida homeowners market.
Crist, who is not up for re-election for two more years and who won the gubernatorial race on his vow to fix the insurance situation, blew off the Fitch assessment.
“I don’t know what Fitch is,” Crist told reporters. “What I can tell you is that from a consumer point of view, it’s better than it was for Florida even a year ago. So no disrespect to Fitch, but what I care about more is Johnny and Susie Floridian than Fitch.”
Meanwhile, the thin reed on which the state’s insurance and reinsurance solution is hanging—the ability to issue bonds after an event to get the cash to pay for the losses—is anything but a certainty.
The largest-ever sale of this type to date was around $11 billion by a California municipality, and Florida could be seeking much more than that. Plus, it is one thing to try to issue bonds pre-event and quite another to go after funding following a major natural disaster. Then there is the huge problem of upheaval in financial markets due to the ongoing mortgage crisis.
“You’re talking about trying to access the markets for an unprecedented amount of money in what we all agree would be uncertain, stressed conditions in the economy,” John Forney, a financial advisor who works with both Citizens and the Cat Fund, testified at a legislative hearing on the insurance assessment situation. “It is difficult to overestimate the difficulty of this challenge.”
Nevertheless, Sharon Binnum, chief financial officer for Citizens, takes a “don’t worry be happy” approach to the whole situation, noting that Citizens enjoys strong credit because it has such unlimited and open-ended assessment ability.
“The assessment authority is one of the greatest components of the strong credit that Citizens enjoys,” Binnum says. “Also, the expansion of the Florida Hurricane Catastrophe Fund has given us more very affordable reinsurance. And in addition to assessment ability, our assessment base was recently enhanced.
“If a one-in-a-hundred hits Citizens, we could enjoy about $11 billion of Cat Fund coverage. Even if a smaller hurricane would hit, we would have reinsurance claims through the catastrophe fund,” Binnum says.
The Cat Fund has had some problems issuing bonds, but “we have not,” Binnum said. “The market has changed dramatically and it has tightened, but we have been able, with our strong credit, to draw investors.”
Nicholson, however, is not so sanguine. Last summer, he tried to issue around $7 billion in pre-event bonds to invest and provide some liquidity for the Cat Fund in the event of a significant hurricane and was only able to sell $3.5 billion of them, and those came with a higher interest rate than he had anticipated.
With that $3.5 billion and other cash and bond resources, Nicholson says the Cat Fund has around $8 billion or $9 billion in resources heading into the 2008 hurricane season. That could cover “a very large storm for the first 12 weeks or so” since claims routinely pay out over a long time frame. But after a few months, things could get dicey.
“The problem is that after a period of time, if the markets freeze up, we would have a liquidity crisis, and that may last a short time or may last a long time,” he says. “We would just keep knocking at the door until we were able to finance all of our needs, but certainly we are at the mercy of the markets to some extent. The problem would come into play if something happened and the markets froze up, and we didn’t have the ability to issue long-term bonds.”
For smaller storms, there would be more time to get the bonds sold. With the non-Katrina hurricanes of 2004 and 2005, it took almost a year to pay out the first $3 billion, he says.
“It’s just the mega event that would push everything to the limit that would be the big problem,” Nicholson says. “Companies ought to consider what our capabilities are as we move into the hurricane season and address those needs given the capability.”
Is he saying he would be more comfortable if insurers would cover their bets with private reinsurance?
“Yeah,” Nicholson replies. “Nobody is going to be real excited about reinsurance that doesn’t pay. It would question your ongoing ability as a state entity to offer reinsurance. I’m going to do everything in my capacity to get the debt sold, but the big negative is just the unknown risk. How big will the loss be? What if it is a $100 billion storm? What if there is some lock up in the markets for a $10 billion shortfall? If I were an insurance company, I might want to sue the cat fund or sue the state.”
So with hurricane season just starting and running through November, does he sleep at night?
“I try to but not real well,” Nicholson says. “I didn’t vote for this stuff. I just tell them what the effects are.”
New, thinly capitalized, unrated insurers flood Florida market while heavy hitters pull back.
A number of new, startup insurers have moved into Florida, many with state government incentives, to fill gaps left by the major personal lines carriers that have pulled back or stopped writing property business altogether, but there is no proof those insurers are financially stable.
Florida Gov. Charlie Crist and Insurance Commissioner Kevin McCarty hail the arrival of these new companies as giving Florida consumers more options and taking pressure off Citizens. The startup companies receive low-interest loans from the state if they are willing to use a percentage of their capital to assume policies that were issued by Citizens Property Insurance Corp.
The Florida Senate this spring approved a bill adding $250 million to the program.
“Through its funding for the Capital Build-Up Incentive Program, the bill will help continue to encourage growth in Florida’s insurance market, which already has seen more than 20 new companies and $3.4 billion in capital added to the Florida market since January 2006.” McCarty says.
The Florida Legislature approved an additional year’s freeze in Citizens rates, through Jan. 1, 2010, before adjourning in May. The lawmakers rejected a provision that would have limited the amount of increase in Citizens rates to 10% a year after the freeze expires and said actuarially sound rates must be charged.
“This is akin to someone who has been addicted to drugs and now must go through a methadone program. You can’t go cold turkey,” says Rep. Dennis Ross, R-Lakeland, a critic of the current state insurance and reinsurance programs.
In addition, the bill made some changes in the regulatory process, including more transparency in Office of Insurance Regulation proceedings and an expedited hearing process for rate changes, that Ross hopes will encourage more national insurance companies to return to the state.
The bill, which Gov. Charlie Crist was expected to sign, also limits to 45% of annual premium the amount Citizens could assess its policyholders to cover any future deficit and reduces from 10% to 6% the amount other policyholders in the state could be assessed.
Meanwhile, for the first time in history, Citizens will purchase $100 million of reinsurance from the private market to cover a shortfall if the state’s cat fund has trouble selling bonds after a major storm.
Insurance industry observers are concerned about the financial vulnerability of these companies. In the event of insolvencies caused by either a major hurricane or other financial problems, the Florida Insurance Guaranty Association would have to cover their losses.
“The state is going to be the umbrella, the safety net, because these firms are so thinly capitalized, either through Citizens or the Insurance Guaranty Fund,” says Florida Rep. Dennis Ross, a Lakeland Republican and strong critic of the state’s increasing role in the insurance and reinsurance business. “Politically, it plays that you are bringing new capital into the market, but show me their financial ratings, show me their balance sheets. None of them are rated.”
A Fitch Ratings report noted that many of these new companies “are generally smaller, thinly capitalized, Florida-only insurers that are often unrated or low-rated, not the traditional market participants. Thus the quality of the protection they provide Citizens is somewhat questionable in the event of a major catastrophe that affects their capital, as was the case with the failure of the Poe Financial Group in 2006 following the 2004–2005 storm seasons.”
Fitch noted that the average financial strength of property insurers in Florida “has declined in recent years and is approaching ‘vulnerable’ rating levels (below ‘BBB’ rating category) as larger, financially strong insurers have either stopped writing new policies or are completely exiting the market. This potentially increases assessment risk for private insurers that currently underwrite property business in Florida from the perspective of state guarantee funds.”
Another concern is that these insurers have not been around long enough to have a reputation to protect, heightening the probability that they would cut and run after a major event.
Brian Schneider, a Fitch analyst who researched the Florida report, says “reputational risk” is one reason that companies such as State Farm and Allstate are unwilling to commit to a major presence in the Florida market given the current regulatory and competitive situation.
“It says a lot if they are really willing to walk away from that market,” he says. “They really do feel that they’re just not able to deal with the insurance market there in a profitable way.”
Bad Odds on Florida
Modelers: Big storms and Florida are inevitable.
Hurricane modelers can’t tell you precisely when, where or how big, but they can say there is a very strong chance of a major hurricane striking Florida in the relatively near future.
Thirty-one of Florida’s counties border the coast, and the 36 others are within 100 miles. During a rash of hurricanes in 2004 and 2005, insurers processed hurricane claims from policyholders in every county.
John Rollins, vice president of risk modeler AIR Worldwide Corp., says all parts of Florida are at significant risk and a single event in the 1% probability range could cause $50 billion or more of damage.
“AIR catalogs tens of thousands of simulated hurricane events, and these catalogs, while simulated, are all scientifically possible,” he says. “We don’t simulate a Category 5 hurricane striking Nova Scotia, but it is scientifically possible for a Category 5 hurricane to strike any part of Florida. And further, there is a certain level of frequency that, frankly, should make us somewhat nervous.”
Claire Souch of Risk Management Solutions says although all of Florida is at risk, the southeastern coast is the most likely to experience significant damage since it sticks out into the Caribbean. It is more likely to be hit by storms that form in the Atlantic and pick up speed and intensity as they cross the Caribbean.
Souch, who leads RMS’ global modeling product management team from London, says the worst scenario for the state would be a Category 3 or greater hurricane that barrels into Miami causing anywhere from $50 billion to $100 billion in damages.
“There certainly is a very high possibility of a strike that is worse than Katrina,” she says. “That damage estimate is from the wind effect and doesn’t even take into account the impact of flooding.”
Rollins agrees. That worst case scenario was very nearly realized in 1992 with Hurricane Andrew, which came ashore in the Homestead area, about 30 miles south of Miami, and caused an estimated $15 billion in damage. Although many of his fellow Floridians talk about how unlucky the state was with Andrew, Rollins says in fact, “we were very, very lucky.”
“If Andrew tracked about 30 miles north, the $15 billion in losses could have been four times higher. Even back in 1992 dollars, we could have had a $60 billion loss if it had hit downtown Miami, but we narrowly escaped by pure meteorological luck,” Rollins says.
“Hurricane Andrew also was relatively small, so it isn’t just the category of the storm but also how wide it is” that factors into the damage potential, Souch says.
Another worst-case loss scenario involves a powerful storm coming ashore in the Tampa Bay area and tracking across the state on the I-4 corridor, southwest to northeast, hitting Disney World and the Orlando area, then going back out to sea in the Atlantic Ocean.
“That could easily result in losses of $70 billion, according to AIR’s current catalog of hurricane events and our industry-wide exposure database,” Rollins says.
Another big risk is in Tampa Bay itself. “What happens in a storm surge is the action of the wind on the surface of the sea pushes up a wall of water, and if that wall of water comes into Tampa Bay, there is no place for it to escape to,” Souch explains. “It goes inland and hits the north part of the Bay, and that also is where you have the highest concentration of property, both commercial and residential.”
April 2008