Government and insurers need to work together to effectively shield consumers from unanticipated changes in price while limiting interference in private markets, which delays long-term recovery. As the previous administration exits office and a new political wave of elected officials starts to work, the Florida business and insurance community will be focused on the 2011 legislative session. During 2010, critical legislative changes were just one pen stroke from being enacted, but were ultimately vetoed by then Governor Charlie Crist. Thus, the property insurance legislation so desperately needed to help stabilize the market was defeated.
Florida’s experiences over the past six years provide a window into the
impact of natural disasters when combined with fluctuating capital market
conditions. What should government and insurers do?
By Bob Betz, Judith Durdan, Lloyd Stofko and Brian O’Neill
The Changing Winds in Florida
Property Insurance Implications
A Little History
In 2004 and 2005, Florida was hit by multiple storms that were devastating and significantly changed the way modelers view the frequency and severity of storms. The development of a near-term view of hurricane risk, along with increased scrutiny by rating agencies, dramatically altered the amount of capital reinsurers needed to support the transfer of risk for the world’s most highly exposed wind zone. The cost to reinsure Florida exposure soared and was passed to consumers through rate increases. The marketplace melted down as capital market needs and consumer pricing came head to head. Consumers naturally reacted negatively to rate increases, and politicians responded with rushed legislation conceived during a special session in January 2007. HB1A, legislation that implemented sweeping changes to Florida’s insurance industry, was signed into law within the first three weeks of a new administration with many new legislators, as Florida’s term limits forced out many experienced lawmakers.
One unintended consequence was the establishment of legislative language that allowed the insurance system to be manipulated by some public adjusters. After a majority of the 2004 and 2005 storm losses were adjusted, many claim personnel were without work. With a failing economy and a liberal legal system, public adjusters became very creative regarding claims. Five years later, Florida continues to have new claims from 2005’s Hurricane Wilma. While public officials were questioning insurance companies for rate increases due to these claims, they created a mindset with some insureds that insurance abuse was acceptable. There are lessons to be learned here:
• Beware the impact of term limits and inexperienced lawmakers on insurance legislation, whether state or federal.
• Once there is intrusion of inappropriate legislation on contract language, it is difficult to correct without making it worse, and the judicial system can compound the problems with case law. • Beware the impact of a significant number of
unemployed claim adjusters.
The legislative process is one of the greatest risks that companies face in Florida. Changes in statute can radically alter companies’ business plans, and negatively affect the availability and affordability of the reinsurance that is critical to the survival of most carriers. Without proper management of the reinsurance portion of the insurance equation, carriers cannot retain exposure for Florida property. What affects the availability and affordability of reinsurance for Florida?
Florida Hurricane Catastrophe Fund
In 1993, following the devastation of Hurricane Andrew, an experienced group of insurance executives and legislators created the Florida Hurricane Catastrophe Fund (FHCF) to help stabilize Florida’s property insurance market, and insulate consumers from the enormous effect of rising reinsurer and capital market costs.The premise was to provide catastrophe reinsurance for private insurance companies writing personal and commercial residential property insurance through a state facility. FHCF coverage is mandatory, with several purchase options. The coverage is limited by statute to cash on hand and debt raised post-event. The cost is approximately 70% to 80% less than open market reinsurance for the same coverage. The plan’s architects were looking for a minimal solution that would have the least effect on private insurance transactions while stabilizing the market and maintaining affordability for carriers and their policyholders. They recognized that this facility would rely on cash, debt — and, ultimately, all of Florida’s insureds — to pay the bill.
But the 2004 and 2005 storms caused reinsurance costs to rise, and carriers again raised their rates. Consequently, HB1A expanded coverage of the FHCF, increasing its exposure from $16 billion to $30 billion. It introduced the Temporary Increase in Coverage Limits (TICL) layer, which provided companies with the option to purchase additional $1 billion tranches of coverage above the original FHCF layer, up to $12 billion. TICL pricing was approximately 10% to 15% of corresponding private market reinsurance rates.
This additional coverage was not mandatory. However, in an effort to reduce property insurance rates, companies could not forgo TICL, then buy private reinsurance and pass that cost along to policyholders. Rather, companies had to purchase the optional coverage and pass along the “savings” to their insureds.
Florida’s government fully involved itself in the private market by expanding reinsurance capacity and coverage. It is noteworthy that this expansion of capacity and coverage relies on cash and future debt for ultimate payment. In the event of a loss, the insurance consumer would repay the debt through future assessments over as many as 30 years, while the government was “holding down rates” to policyholders. Ultimately, this potential debt dependence would prove to be a fi nancial disaster. As the credit markets disintegrated in 2008, it became clear that the FHCF would not be able to meet its obligations if an event occurred, given its cash reserves and estimated bonding capacity. Recognizing the potential implications of this burden on the taxpayers of Florida, the 2009 legislature embarked on a six-year strategy to reduce TICL, increase premiums charged and stabilize the potential assessment burden.
Although companies pay premiums to the FHCF each year, if a loss causes a depletion of cash reserves, the FHCF relies completely on bonding funded by assessments to nearly all insurance lines. While these assessments have been manageable to date, the potential inability of the FHCF to pay losses in a credit crunch has changed the current political winds within Florida.
Citizens Property Insurance Corporation
After Hurricane Andrew, legislators and the industry worked together to establish the Florida Residential Property and Casualty Joint Underwriting Association (FRPCJUA), which would write risks abandoned by the market due to insolvencies and carrier withdrawal. The Florida Windstorm Underwriting Association (FWUA) was originally created in 1970 to provide windstorm coverage to those coastal areas not able to obtain open market coverage — primarily in Monroe County. However, by the mid-1990s, it was expanded to include 29 of the 35 coastal counties. The objective was to limit these residual market entities. However, over time, they were affected by political pressure, so that coverage was increased while rates were never allowed to rise appropriately. In 2002, the Florida legislature combined the two existing property residual markets into a single entity, creating Citizens Property Insurance Corporation. Citizens’ mandate was to provide property insurance coverage only to those applicants who could not otherwise obtain coverage in the private market. This included a requirement that Citizens’ rates not be competitive with rates charged by the admitted market.That all changed following the 2004 and 2005 storm seasons. HB1A legislation was imposed by newly elected legislators and a regulatory body pressured by a populist governor. These changes included: • Rolling back and freezing Citizens’ rates for four
years
• Removing language that required Citizens’ rates to be noncompetitive (now the primary competition to carriers)
• Requiring that Citizens’ recommended rate at the end of the rate freeze be “actuarially sound,” without defining the term
• Allowing Citizens’ policyholders to remain with Citizens even if a private insurance company offered coverage
• Expanding Citizens to include multiperil commercial nonresidential property insurance Because Citizens is a quasi-governmental entity relying on the FHCF, policyholders consider it an A-rated company backed by the full faith and credit of Florida. Instead of being the “insurer of last resort,” Citizens is now the largest carrier in the state, with nearly 1.3 million policies, 22% of the personal lines market and 62% of the commercial habitational market.
How does Citizens affect the availability and affordability of reinsurance? It relies on the FHCF and its own cash and debt structure with pre-event notes and post-event bonding to pay for catastrophic events. Citizens dramatically increases the potential size of FHCF assessments and creates its own assessments in the event of a significant loss. This means that Citizens will be competing in the same bond market as the FHCF.
Although Citizens has explored purchasing private reinsurance, it has not done so because the
legislatively imposed rate freeze makes it impossible for it to absorb the cost. This places Citizens in an unfair competitive rate position because admitted carriers need to purchase reinsurance to control their exposure to loss.
Absent any changes to reduce the size of Citizens, it will continue to grow even though it is intended to be the insurer of last resort. When a major storm makes landfall in Florida, Citizens relies on a complex assessment mechanism to pay for losses when cash on hand is depleted. The tiers of potentially onerous assessments of its three separate operating accounts, along with FHCF assessments, must all be absorbed by insurance consumers.
This assessment issue brings to light a real problem that many will not face until after a major storm, when the real cost to consumers will become clear. Florida’s new leaders have the advantage of hindsight, including experiencing the collapse of the capital markets, to help them recognize the issues inherent in a debt-ridden structure. In 2011, positive legislation and the desire of incoming Governor Scott to reduce the debt of the FHCF and the size of Citizens could move exposure back into the private market. The new administration and legislature will need to recognize the capital markets’ volatility, the pressure on consumers and the need to balance paying now versus paying later in order to get Florida’s house in order. The state’s previous actions have set in motion case law that affects insurance contracts, resulting in the need for additional legislation to correct some judicial decisions.
Lloyd Stofko Specializes in the Florida property insurance market. Towers Watson, New York Brian O’Neill Specializes in the Florida property insurance market. Towers Watson, New York
The Marketplace
Florida continues to provide significant opportunity for growth (Figure 1). Population growth has been the engine of Florida’s economy for many years, and even with slow economic recovery, the wave of baby-boomer retirees will provide insurers with an expanding market.
Figure 2 illustrates the drop in premiums since the
passage of 2007’s HB1A. This has set the stage for a number of insolvencies and abandonment of the market by some carriers, despite the lack of storm activity over the last five years. This is a function of rate reductions mandated by the Office of Insurance Regulation (OIR) for wind mitigation efforts and increased coverage within the FHCF forcing artificially lower rates for both the FHCF and Citizens.
Rates are beginning their climb back to 2007 levels
(Figure 3), and major rate increases have been
approved by the OIR since mid-2010, which should improve carriers’ earnings throughout 2011. Florida’s OIR, legislature and new cabinet recognize the inherent weakness in the current structure and its heavy reliance on debt. The question is whether they can correct the problems before the next hurricane event.
Figure 1. Florida population, 2000 – 2035 (predicted), in millions
10 12 14 16 18 20 22 24 26 2035 2030 2020 2010 2009 2008 2000 15.982 15.982 18.807 18.807 Decline in population is small and temporary. Decline in population is small and temporary. 18.750 18.750 18.77318.773 21.247 21.247 22.574 22.574 23.821 23.821 State population growth is expected to resume in 2010. State population growth is expected to resume in 2010.
Population will hit 20 million by 2016 and will increase by 2.5 million
between 2010 and 2020. Population will hit 20 million by 2016 and will increase by 2.5 million
between 2010 and 2020.
Despite the recent crash in real estate markets and higher unemployment, Florida will add millions of new residents in the years ahead, putting more strain on the state’s fragile insurance markets.
Source: University of Florida, Bureau of Economic and Business Research; U.S. Census Bureau; Insurance Information Institute
Figure 2. Average homeowner’s insurance premium in Florida, 2007:Q2 – 2009:Q4, in billions
$1,600 $1,700 $1,800 $1,900 $2,000 $1,915 $1,915 $1,641 $1,641 $1,630 $1,630 $1,634 $1,634 $1,655 $1,655 $1,647 $1,647 $1,666 $1,666 $1,710 $1,710 $1,770 $1,770 $1,857 $1,857 $1,914 $1,914
The average homeowners insurance premium as of 12/31/09 is down $274, or 14%, since 3/31/07. The average homeowners insurance premium as of 12/31/09 is down $274, or 14%, since 3/31/07. The state has required rates to be reduced, even though
they were not adequate to begin with.
Discounts don’t make actuarial sense unless the discount is applied to an actuarially sound rate.
Both factors have led most private insurers to reduce their presence in the state.
The state has required rates to be reduced, even though they were not adequate to begin with.
Discounts don’t make actuarial sense unless the discount is applied to an actuarially sound rate.
Both factors have led most private insurers to reduce their presence in the state.
Where Will the Wind Take Us?
Other catastrophe-prone jurisdictions have had the advantage of observing Florida and should recognize the pitfalls of overreacting. Given the attitude of the new legislature and cabinet, the winds of change are shifting to a decidedly more conservative fiscal view. An aggressive plan to deregulate business and a platform pushing tort reform bode well for the industry. Florida needs an overhaul of its regulatory entities to improve responsiveness to market conditions, and to deliver a message of stability that will allow insurers and reinsurers to effectively use their capital and encourage investment in Florida’s insurance market.
The industry is organizing to support reforms and pricing processes to establish a more appropriate balance between pre- and post-event financing in a stable environment, and needs to effectively educate the newly elected officials on these issues.
The major lesson to be learned in the long run is that neither the state nor its politicians can ignore the need for a balance between paying now and paying later. The state’s economic engine cannot run without insurance, reinsurance and capital market support.
For comments or questions, call or e-mail Bob Betz at +1 212 309 3856, [email protected]; Judith Durdan at +1 727 945 1397, [email protected]; Lloyd Stofko at +1 212 309 3530, [email protected]; or Brian O’Neill at +1 212 309 3707, [email protected].
Figure 3. Personal residential multiperil rate history (2003 to present) Average change rate dollars
$0 $50 $100 $150 $200 $250 $300 By peril (2011) Actuarial (2010) WMC (2008) FHC presumed factor (2007) Rate rollback (2007) Actuarial (2007) Top 20 (2006) Top 20 (2005) Top 20 (2004) Top 20 (2003)
DP-3 MHO-3 HO-3 HO-6 HO-4
