A Florida Insurance Council
White Paper

Summary

Legislation passed in the January 2007 special session of the Florida Legislature, greatly expanded the state’s liability for hurricane losses—from $16 billion to $28 billion.  That legislation also allowed for further expansion of the government run insurer, Citizens Property Insurance Corporation, making it the largest property insurer in Florida, the largest property residual market entity in the world, and based on the size of its Personal Lines Account alone, the tenth-largest property insurer of any kind, in the United States.

While the two government entities are separate bodies that operate completely independent of one another, they are, nonetheless highly dependent upon the fortunes or misfortunes of the other. The solvency of Citizens is dependent upon the Cat Fund’s ability to borrow enough money to meet its financial obligations.  Citizens’ solvency, at least for the 2008 hurricane season, is largely dependent upon the Cat Fund’s good fortune of not being forced to attempt to raise the limits of its legislatively-mandated financial obligations.

Therein is the problem.  Under today’s economy, financial experts have delivered some sobering news to policymakers about the prospect of borrowing money, especially at the $28 billion level authorized by the special session legislation.  Financial advisers to both the Cat Fund and Citizens Property Insurance Corporation say they could not guarantee that the Cat Fund could sell that level of bonds “or even come close to it.”

If the Cat Fund cannot sell bonds to meets its financial obligations, the claims-paying ability of Citizens Property Insurance Corporation would be placed in serious jeopardy.  The timely paying of claims from private companies would be jeopardized as well.  Private companies were mandated by the special session legislation to purchase reinsurance from the Cat Fund, making them also dependent upon the fund’s ability to borrow money.

If the Cat Fund cannot deliver, Florida policyholders—policyholders in Citizens as well as those insured by private companies—could suffer through huge delays in having their claims paid.  Some, particularly those insured with Citizens, could see their claims go unpaid altogether.

This paper examines all aspects of Florida’s battle with financing hurricanes, and offers critical perspective.  The paper traces back the steps state policymakers have made since the pivotal year of 1992 when Hurricane Andrew devastated Florida, nearly collapsing the insurance market upon which the state’s economy is hugely dependent.  Without a vital insurance industry, businesses could not start up or expand.  Houses, hospitals and schools could not be built.  Jobs would disappear. 

That’s why sound solutions for providing stability to the property insurance market are essential.  The decisions policymakers must decide today will have ramifications far into our state’s future.


Background

To fully understand the financial crisis now confronting the Florida Hurricane Catastrophe Fund, and the potential impact that crisis presents to the roughly 1.3 million Citizens Property Insurance Corporation policyholders, and arguably, to virtually every property owner in the state of Florida, we must trace back the origins of both government entities.

Citizens Property Insurance Corporation was created by the Florida Legislature in 2002 by combining two earlier government creations, the Florida Residential Property and Casualty Joint Underwriting Association (FRPCJUA) and the Florida Windstorm Underwriting Association (FWUA).  The latter of those entities, the Florida Windstorm Underwriting Association was created in 1970 for the purpose of covering wind risk in the Florida Keys.  In the years since, it was expanded to most of Florida's 35 coastal counties to provide Florida residents adequate wind coverage, when it was unavailable in the insurance market place.

The Florida Residential Property and Casualty Joint Underwriting Association, commonly known as the JUA, was created in a special session of the Florida Legislature in December 1992, just months after Hurricane Andrew ripped through south Florida causing $15.5 billion in insured losses. (About $23 billion in 2008 dollars)   The enormity of Hurricane Andrew and its all-time high financial losses left 11 small property insurance companies insolvent and most of the larger companies doing business in the state were forced to stop writing new policies and, in addition, reduce the number of writings they did have.  Andrew made it quite apparent that companies were over-exposed to hurricane risk.

The third entity created to deal with financing hurricanes, The Florida Hurricane Catastrophe Fund, commonly know as the "Cat Fund," was created by the Legislature in 1993 to further bolster the Florida Windstorm Underwriting Association, the Florida Residential Property and Casualty Joint Underwriting Association, and private insurance companies, and help them cover their losses from a major hurricane.

Under these creations, private insurers, as well as the Florida Windstorm Underwriting Association and the Florida Residential Property and Casualty Joint Underwriting Association, paid an annual premium to the fund which then built up over time. When a major storm hit, private insurers, as well as the Florida Windstorm Underwriting Association and the Florida Residential Property and Casualty Joint Underwriting Association, drew money from the Florida Hurricane Catastrophe Fund based on pre-determined formulas. The insurers recouped the annual premiums they paid to the Florida Hurricane Catastrophe Fund from their policy holders through rate filings.

Hurricane Financing Plans put to the test

In creating the Florida Hurricane Catastrophe Fund, the Legislature acknowledged that providing a stable and ongoing source of reimbursement to insurers for a portion of their catastrophic hurricane losses would create additional insurance capacity sufficient to ameliorate the current dangers to the state's economy and to the public health, safety and welfare.
 
With relatively few and minimal hurricanes in the twelve years following Hurricane Andrew, this plan, arguably, was never truly tested, however, that real test came in 2004 when the unthinkable happened.  The state was hit with not one, but four major hurricanes leaving Citizens Property Insurance Corporation bankrupt. Citizens assessed every non-Citizens policyholder in Florida 6.8 percent to make up for its $516 million shortfall.  The Cat Fund had accumulated about $6.1 billion in cash from its creation in 1993 to the start of the 2004 hurricane season. 

The more than $25 billion industry-wide losses in 2004 triggered about $2.6 billion in Cat Fund reimbursement to companies, leaving the fund far less capitalized for the following hurricane season that delivered four more major storms causing another $10 billion in losses.  This second season of four back-to-back storms in back-to-back seasons was unprecedented.  This time, the Cat Fund was drained prompting the fund to levy assessments on all property casualty property holders for the first time, and Citizens, still reeling from the previous season, was bankrupt again. 

The Florida Legislature stepped in again.  This time it pumped $715 million of taxpayer dollars into Citizens to retire a portion of its deficit, but even that large sum of taxpayer dollars was too little.  Citizens again assessed every homeowner in the state an additional 2.07 percent regular assessment and a 1.4 emergency assessment to make up for the remainder of the deficit.

Reality Check:  Rates Inadequate for the risk

The financial crisis that occurred as a result of the two back-to-back hurricane seasons of 2004-2005 prompted the Legislature to once again try to provide stability to the Florida’s insurance market. 

What had become abundantly clear is that premiums charged by companies in Florida were woefully inadequate for the risk they assumed.  It was especially true with Citizens Property Insurance Corporation.  Private companies had already ceded coastal-region policies to Citizens as government regulators were reluctant to allow private insurers to charge adequate rates for the risk. 

In the wake of the ’04 and ’05 seasons, private companies retreated even farther from the market allowing Citizens to grow ever larger and with it, assume higher and higher dollar amounts of risk.

In the legislative session following the 2005 hurricane season, Florida lawmakers finally acknowledged the inadequacies of premium, particularly with Citizens.  During the 2006 session of the Florida Legislature, lawmakers passed Senate bill CS/CS/SB 1980 that was to provide Citizens with actuarially adequate rates for the first time in its brief history.  The bill required the government-run insurer to meet the 70-year and 100-year probable maximum loss standards in its pricing imposed on private insurers.

Rate adequacy required by the legislation would have increased Citizens rates by 75 percent statewide by mid-March of 2007.  The public reaction to the sharp rate increase spilled into the 2006 election cycle, particularly it became a centerpiece to gubernatorial race as then candidate Charlie Crist used public outcry to his advantage and demonized the insurance industry.  His campaign promise was to reduce premiums at any cost.  Insurance rate relief also played a large role in key legislative races, particularly in the Keys, Dade, Broward and Palm Beach counties where most of the Citizens policyholders reside.

Immediately upon being sworn into office in January 2007, Governor Charlie Crist called lawmakers into special session and charged them with the task of finding a way to reduce homeowners’ insurance premiums.

Legislators found themselves under intense political pressure—pressure from coastal county dwellers and their elected representatives as well as the newly-installed governor—to reduce rates, while the insurance industry and some legislators who represented inland residents warned that the idea gaining steam, and the idea that ultimately was passed, meant that rates were being artificially lowered.  They warned that risk was being ignored and furthermore, that the plan would created a huge subsidization of rates for the roughly 1.3 million coastal dwellers.  That subsidy would be paid by the more than 4 million inland dwellers.  Despite the warnings, the Legislature passed the plan.
 
The plan repealed the legislation passed only a few months earlier that would have provided Citizens with adequate rates.  In return, the plan restructured Citizens’ financial backbone by providing it the ability to impose tax increases on all property insurance policies, all automobile insurance policies, and many business insurance policies even though the insurance benefits it provides are limited to residential insurance. Citizens also can appeal to the Legislature for taxpayer subsidies. The precedent was established in the 2006 regular session when $715 million in sales tax revenues was appropriated to help retire Citizens’ deficit from the 2005 hurricane season.

The assessments can be unlimited, and can mean dramatic cost increases for homeowners, commercial business owners and automobile insurance policies over many years.

One major provision in the special session hurricane insurance package allows Citizens to aggressively compete with private insurers for business they are writing today in the High Risk Account.  That includes coverage for fire and other perils. The competition does not stop there. Homeowners currently in Citizens have the option to reject a “takeout” offer from private insurers if staying with Citizens would be cheaper for them. Applicants seeking coverage can qualify for Citizens even if they have an offer for private market coverage if the private insurer premium is 15 percent or greater of the Citizens premium.  The expanded intrusion of government into the insurance business is unwarranted.  The private industry is better equipped at servicing consumers through established practices and claims adjusting.  Citizens has proven its inability to efficiently handle its claims and has been plagued with customer service problems.

The legislation capped Citizens Property Insurance Rates at 2006 levels through the year 2007 however, lawmakers extended that rate freeze through the year 2008 when they met later in regular session.  Lawmakers in regular session also expanded the role of Citizens by allowing it to directly compete with the private industry at rates that clearly were and remain inadequate.  The Legislature also put state taxpayers at risk of major tax hikes by expanding the Cat Fund to the unprecedented level of $28 billion.

Without a storm to reveal the plan’s extreme reliability on after-storm tax hikes it appeared the Legislature’s roll of the dice for 2007 was a wise move, even with Florida’s Chief Financial Officer Alex Sink expressing concern that the Cat Fund may not be able to deliver its legislatively-mandated financial liability.

That concern fell upon deaf ears until the sub-prime mortgage lending crisis began to unfold by late summer and early fall.  The first signs of trouble appeared when the Cat Fund attempted unsuccessfully to make a $7 billion bond sale.  Only after repeated attempts was it able to secure half of that level of bonding. By late fall 2007 financial advisors to both Citizens and the Cat Fund gave warnings about the Cat Fund’s ability to meet its financial obligations.

House of Cards Begins to Unravel

In a series of hearing that began in the weeks leading up to the 2008 Legislative Session, The House and Senate asked Citizens and the Cat Funds’ financial advisers to brief them on the claims-paying vulnerability of either of these government entities.

Advisors described how dependent Citizens is upon the Cat Fund for its claims-paying ability.  If the Cat Fund is unable to raise its financial obligations, the timely payments of claims, if those claims could be paid at all, is in serious question.

Even more troubling are proposals in the 2008 Regular Legislative Session that would make matters worse. For example, a Citizens Property Insurance Corporation actuary told the House Insurance Committee that a proposal in the Florida Senate to freeze Citizens rates yet another year—through the year 2010 is unwise.

The actuary, Paul Erickson, said, “From an actuarial (basis) I would not think that is appropriate.” Erickson’s response came amid a series of questions from Insurance Committee Chairman, Rep. Don Brown, R-DeFuniak Springs regarding Citizens rates currently in place and the level of rates recommended by Erickson in 2006.  Erickson said he recommended a 44 percent rate hike that the Office of Insurance Regulation refused to approve, allowing instead an increase of 25.9 percent to go into effect on January 1, 2007.  Shortly after that increase was put into effect, the Florida Legislature met in special session and canceled that increase and ordered Citizens rates to be rolled back to 2006 levels.
 
Chairman Brown scheduled the six-hour meeting in which he placed Citizens’ officials under oath, to call special attention to the prospect of Citizens and the Florida Hurricane Catastrophe Fund being unable to pay claims should a moderate to severe storm or series of storms strike Florida.

In similar presentations before the Senate Banking and Insurance Committee, Citizens officials and their actuaries said that in a 100-year PML event, Citizens would face claims of $24 billion and the Cat Fund would be expected to generate its total capacity of $28 billion. Citizens alone would qualify for $12 billion of the $28 billion.  Citizens’ Chief Financial Officer, Sharon Binnun said Citizens has $10.5 billion in claims-paying capacity, however about half of that is “borrowed money,” and the ability of Citizens to borrow all of the money it would need to meet its obligations is largely dependent on the Cat Fund being able to sell unprecedented levels of bonds. 

Even more sobering is the level of tax increases that would have to be passed along to Florida residents to pay of the bonds, assuming they could be sold in the first place.

During testimony, financial advisors said that assessments could total more than $10 billion from Citizens alone.  Additional assessments from the Cat Fund and the Florida Insurance Guaranty Association could cause assessments to rise to $35 billion or more.  An economist with the University of Miami testified about the economic impact of these huge assessments.

Dr. David Leston, Associate Professor of Economics said that a $15 billion assessment would cause about 29,000 job losses and a loss of revenues in the amount of $300 million per year.

As the Legislature continues in regular session for 2008, voices from around the state are heeding the warnings the industry raised a year ago.  On April 3, 2008 the Miami Herald wrote that last year’s plan to artificially lower rates is “fiscally reckless.”  The paper said, “Extending the rate freeze on Citizens through 2009 is fiscally unsound.  Citizens is not collecting as much money as it needs to build reserves and stay financially solid.  At some point, Citizens would have to raise rates or impose assessments, and that would be more painful than gradual rate hikes.”

The paper also called the Capital Build-Up Program a good move for Florida.  However, the paper cautioned that paying for the program with Citizens surplus as the House plan would, is a “bad idea (that) would increase the risk of uncovered losses in a massive storm, and state policyholders would have to cover the losses.”

The paper said the Senate’s plan to use non-recurring general revenue dollars to fund the program is “a much better approach.”

The paper also agrees with CFO Sink’s plan to reduced Cat Fund risk.  “This would reduce Florida’s exposure to loss from a one-in-50-year storm.”