Public Policy and the State of Florida’s
Handling of Catastrophic Risk
By
Donald D.Brown
Former State Representative
Former Insurance Committee Chair
Introduction – A Change in Public Policy
Public policy in the State of Florida regarding the handling of catastrophic risk,
predominately wind from hurricanes, has changed rapidly over the course of the last five
years. As homeowners insurance rates became a political issue during the 2007 elections,
the solution offered by most politicians was to expand the Florida Hurricane Catastrophe
Fund (FHCF) in order to “replace” private reinsurance with “lower cost” state provided
reinsurance. It was thought that by expanding the roll of the FHCF homeowners
insurance rates would drop about 24% statewide and “solve” the crisis. Other provisions
were enacted into law to lower the rates for Citizens Property Insurance Corporation
(Citizens) and allow it to compete with the admitted insurance market rather than serve
the role of an insurer of last resort.
This abrupt shift in public policy has changed the nature of both the FHCF and Citizens.
Their original role of stabilizing and maintaining the market has changed to one of being
mechanisms to lower insurance rates and to replace the private market with government
insurance programs.
In an effort to provide an easy and quick “fix” many ratemaking and risk management
fundamentals important at the time when both the FHCF and Citizens were created have
been ignored. In doing so, the state has assumed a tremendous amount of risk, which
now has the potential to bankrupt the state. The potential exists that losses in the
billions may not be funded due to the current crisis in the financial markets.
The state of Florida has highly leveraged the homeowners insurance markets and has
shifted loss payments from the private sector to the citizens of the state. Lower insurance
rates have been accomplished at the cost of transferring tremendous risk to the citizens of
Florida.
In many or most cases, the citizens of the state have been unaware of how the rate
reductions have been achieved. To make matters worse, the expected rate reductions
have not resulted in the promised savings to policyholders.
The 2004 and 2005 hurricane seasons resulted in assessments from the FHCF, Citizens,
and the Florida Insurance Guarantee Fund (FIGA). These assessments are being spread to
a broader base of policyholders as a result of the cross subsidization of homeowner
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insurance rates. Those being assessed are not happy. The state is relying heavily on
uncertain financial markets in order to finance losses with future debt rather than building
capital and/or transferring risk to insurers and reinsurers.
The state is one storm away from a major economic and financial crisis. If this happens,
there is the expectation that the federal government will come to the rescue. Even if the
federal government steps in to pay claims (which is by no means a certainty), it is
doubtful that there will be a viable market the day after. Emergency assessments used to
fund future capacity may not be viable if Florida citizens balk at increasing their exposure
to additional losses (increasing assessments to fund future capacity).
Also, there is no guarantee that the level of bonding needed to fund future losses will be
available when needed. Subsequent season capacity may not be available and certainly
not enough will be available to avoid major problems.
If the federal government bails out the state, the federal government may insist that the
state rely on the private market rather than agreeing to bail out the state a second time
with U.S. taxpayer dollars. The way things are currently structured, the day after a
federal bailout will be when Florida’s problems become unmanageable. Anyone relying
on a federal solution is stopping short of thinking the situation through and is only
focusing on the immediate short term.
The Florida Hurricane Catastrophe Fund Created to Stabilize the Market and Add
Insurance Capacity
Sixteen years have passed since Hurricane Andrew made landfall. Following Hurricane
Andrew, world reinsurance capacity contracted, the private sector insurers were unable to
maintain sufficient capacity to enable Florida residents to obtain property insurance.
State action was needed to maintain a viable and orderly insurance market.
The Florida Hurricane Catastrophe Fund was created to “…provide a stable and ongoing
source of reimbursement to insurers for a portion of their catastrophic hurricane losses...”
The idea was to “create additional insurance capacity sufficient to ameliorate the current
dangers to the state’s economy and to the public health, safety, and welfare.”
The statute that created the FHCF says that “it is therefore the intent of the Legislature
that this program be structured as a state trust fund under the direction and control of the
State Board of Administration and operate exclusively for the purpose of protecting and
advancing the state’s interest in maintaining insurance capacity in this state.”
The major benefit of the FHCF was originally intended to stabilize the market, to provide
a level of coverage that is reliable and dependable, to provide additional reinsurance to
supplement the private reinsurance market (not to replace private reinsurance), and to
help maintain a viable and orderly marketplace. The FHCF was meant to be operated
exclusively and solely to maintain insurance capacity in the state.
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A New Public Policy – Lower Residential Property Insurance Rates
Beginning in 2006, reinsurance prices spiked following Hurricanes Katrina, Rita, and
Wilma. This caused homeowners rates in Florida to increase significantly. In January
2007, the Legislature met in special session in order to address the crisis. Most
politicians ran for office based on a promise to reduce homeowners insurance rates. The
expansion of the FHCF was seen as the solution to the “insurance crisis” since the high
cost of private reinsurance was recognized as the primary cause of the problem.
Thus, the FHCF’s capacity was expanded by provisions that allowed for optional
coverage both above the FHCF’s existing capacity and below its insurance industry
retention.
The coverage above the FHCF known as TICL (Temporary Increase in Coverage Limit)
potentially expanded coverage by $12 billion. The TICL coverage was priced using the
same methodology as the pricing for the FHCF’s mandatory coverage. As such, the
pricing was far below market rates for private reinsurance.
Another $4 billion on top of the $12 billion TICL layer was provided at the option of the
State Board of Administration (SBA) under the same pricing terms.
The coverage below the FHCF’s existing industry retention (about $6 billion at the time)
allowed for insurers to cut their retentions in half as well as provide such coverage for
two events. This was known as TEACO (Temporary Emergency Additional Coverage
Option) coverage. The potential increase in capacity below the FHCF was $6 billion.
The pricing was very aggressive at 85% rate-on-line or 85 cents for each dollar of
coverage for each insurer’s share of a $3 billion retention, 80% rate-on-line for $4 billion,
and 75% rate-on-line for $5 billion.
Additionally, coverage was provide to limited apportionment companies of up to $10
million with a trigger of 30% of their surplus at a cost of 50% of the coverage chosen –
50% rate-on-line. The sum total of all potential coverages would total $38 billion.
However, the SBA did not offer the top $4 billion and no insurers purchased the TEACO
coverage. This reduced the overall capacity to $28 billion.
Summary
The public policy designed to lower homeowners insurance rates has actually resulted in
the creation of a “catastrophic financial risk” to the state. Risk has been shifted from the
private insurance industry to the policyholders of the state. The funding of the FHCF
capacity is heavily reliant on the financial markets. Currently, the financial markets are
in a liquidity crisis, and it is uncertain whether the FHCF could issue the needed amount
of revenue bonds to fully fund its $28 billion of capacity.
There is the potential that the FHCF could fall $10-$18 billion (or more) short of the
capacity needed to fund its full capacity. With backup by the Federal government, the
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state might be able to survive a “bad” year, but it is certain that the FHCF could not
continue to provide sufficient capacity to keep rates low. Insurers will likely be forced to
turn to the private reinsurance markets and consumer prices and the availability for
residential property insurance will be adversely impacted.
Without regard to whether or not the federal government steps in to bail Florida out, the
insurance market will be decimated the day after a large event.
For the benefit of all Floridians an alternative to the current “solution” must be found.
We all have a financial stake in the outcome.
Donald D. Brown, POB 866, DeFuniak Springs, FL 32435 – (850) 865-9280
don@donanddiane.com
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