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Florida Hurricane Catastrophe Fund

Cat Fund Completes $3.5 Billion Liquidity Arrangement;
Eyes $57 Billion Two-Year Claims-Paying Capacity

The Florida Hurricane Catastrophe Fund completed this week a $3.5 billion floating rate note transaction giving it $8.5 billion in liquidity which, hopefully, it won’t need until at least the 2008 hurricane season.

The arrangement was completed Monday, John Forney, Raymond James & Associates and financial advisor for the Cat Fund, reported to the Cat Fund Advisory Council. Liquidity initiatives were proposed this summer, but then delayed because of the sub-prime mortgage lending crisis in New York and other financial markets.

The $3.5 billion is costing the Cat Fund Libor, plus 78 basis points.

The $8.5 billion liquidity structure also includes $2.8 billion in debt from 2006 and $2.2 in surplus expected to have accumulated by the end of this year.

For the first time, the debt elements in the liquidity program are producing a negative arbitrage, some $15 to $20 million for this year, because of an increase in interest rates, Forney said. “It is not as good as it was, but we still feel like it is the most cost effective program out there,” he commented.

The Advisory Council approved the semi-annual adjustment in capacity and bonding estimates required by Florida statutes. It adopted a Raymond James estimate of “total multi-year claims-paying capacity” of $57.158 billion, down $1.7 billion from the May 2007 projection. This breaks down to a “maximum single-season, statutory claims-paying capacity of $27.8 billion under
current market conditions and $26.4 billion for the subsequent season.

The estimated claims-paying capacity of $57.2 billion comes from a projected year-end balance of  $2 billion and $1.6 billion respectively, and available  bond proceeds of $25.752 billion and $25.208 billion respectively. This would require an ongoing assessment of 4.96 percent for about 30 years and 5.04 percent for the subsequent season bonding.

Forney addressed the ongoing concern of whether the Cat Fund could deliver $28 billion in capacity during the 2007 hurricane season. “The Cat Fund has a reasonable chance to get to $28 billion,” he said. “I would never guarantee it.”
 

Cat Fund World's Largest Hurricane Reinsurer

This section was updated on July 2, 2007.

The Florida Hurricane Catastrophe Fund, known commonly at the Cat Fund or FHCF, is one of Florida's true success stories in the aftermath of Hurricane Andrew. According to Senior FHCF Officer Jack Nicholson, it is the "the largest catastrophe reinsurer in the world" and "the backbone of the Florida residential property insurance industry." Cat Fund reinsurance is provided on $1.8 trillion in residential property (as of December 31, 2006), including $1.5 trillion in single-family homes; $141 billion in condo and apartment master policy coverage; $38 billion on mobile homes; $22 billion for tenant coverage; and $77 billion for condo unit owners coverage.

The Cat Fund does not cover commercial risks, including shopping centers and individual businesses. It is a residential program which does include "commercial-residential," condos and apartments. Commercial business was covered initially, but was excluded after the first year (1994) when legislators determined the private market for business insurance was sound and that the Cat Fund should focus on the troubled residential property insurance market.

The Cat Fund provides residential hurricane reinsurance at rates for its basic coverage that are one-quarter to one-third of rates on the private reinsurance market and sometimes, depending on conditions in the private market, in quantities not available elsewhere. The Legislature priced the optional lower level coverage in the special session package at about private market rates and the optional higher level coverage at about 3 percent of rate on line (3 cents for every dollar of coverage), compared to 15 percent or better of ROL in the private market.

These lower rates are possible due to the Cat Fund's "tax exempt status, low administrative costs and lack of any profit or risk-load factor," the Senate Banking and Insurance Committee noted in its staff summary on the bill (April 20, 2004). "As such, the FHCF acts to lower premiums for residential property insurance as well as to expand reinsurance capacity, which enables a greater amount of insurance to be written in the state than could otherwise be written if the fund did not exist." They also are possible because of the program's ability to sell bonds and assess to retire them, with an assessment base of all property & casualty except workers' compensation and medical malpractice.

The Florida Cat Fund was the first program in the country in which a state provided for tax-exempt accumulation of private cash to pay for major disasters. It has been studied by other states and by the federal government as a possible model for future federal natural disaster insurance programs. As a public-private partnership, the Cat Fund has created a multi-billion-dollar pool of cash to pay part of the cost of rebuilding homes after major hurricanes. Its revenues are exempt from federal taxes, and if it issues bonds to cover claims it cannot pay from cash, the bonds will be treated as tax exempt government bonds.

Wholesale Cat Fund Activation Occurs After $6 Billion Hurricane Event

Wholesale activation of the Cat Fund in 2007 would take place after damages from a hurricane exceeded about $6 billion. The $6 billion retention or industry deductible would be for each of the two largest storms in a multi-event season. Wholesale activation for storms after that would come after $2 billion in losses, the so-called "drop-down retention." The term "wholesale activation" is significant because each company has an individual retention, its proportionate share of the industry aggregate of $6 billion and $2 billion. A carrier taking unusually heavy losses from a storm could qualify for Cat Fund reimbursement, while the industry overall might not. This was common during the 2004 and 2005 hurricane seasons. Insurers were authorized in the January special session package to  buy down their retention in three increments - their share of $5 billion, their share of $4 billion and their share of $3 billion, but no carrier exercised this option.

After it absorbs the first $6 billion in losses (or $2 billion after three or more storms), the homeowner's insurance industry would be eligible for reimbursement from the fund for additional losses up to $28 billion. This maximum capacity was expanded from $16.5 billion to $28 billion during the January special session. Carriers were granted the option to purchase additional coverage in their proportionare share of $1 billion increments up to $12 billion in additional capacity. As noted above, the industry did purchase almost all of this new upper level Cat Fund coverage. Like the deductible, the maximum coverage is company-specific. Citizens Property Insurance Company is eligible for its proportionate share of $28 billion, as are other companies. Depending on its losses and risk concentration, an individual insurer could use up all of its Cat Fund coverage, while coverage might still be available for other carriers. This occurred during the 2004 hurricane season.

The options to purchase additional lower level and higher level coverage will be in place for the 2007, 2008 and 2009 hurricane seasons with the Legislature deciding - presumably during the 2010 regular session - whether to reenact the Cat Fund expansion.

The State Board of Administration - Governor Charlie Crist, Chief Financial Officer Alex Sink and Attorney General Bill McCollum - were authorized by the special session package to allow an additional $4 billion in upper level coverage to a total of $32 billion. Cat Fund staff and the Cat Fund Advisory Council recommended against this additional $4 billion, concerned the Cat Fund revenue stream would not be adequate to retire the bonds necessary to reach $32 billion in total capacity.

Citizens Largest Beneficiary of Cat Fund

The largest beneficiary of the Cat Fund is Citizens Property Insurance Corporation. Citizens has about a third of the hurricane exposure in southeast Florida and about 25 percent statewide. Other large Cat Fund beneficiaries are State Farm, Allstate, USAA and Nationwide. 

Insurers have Coverage Options

The FHCF is a reinsurance program - insurance for insurance companies, in other words. Every residential insurance company is required to participate and pay a premium based on its hurricane exposure. Companies can select one of three coverage levels - 45 percent of losses after their retention, 75 percent or 90 percent.

The 2002 Legislature authorized the Cat Fund to cover carrier's losses for additional living expenses (ALE), subject to restrictions. ALE reimburses policyholders for residence is uninhabitable because of dollars in ALE after Hurricane Andrew. ALE is an integral part of the loss reimbursement to consumers, and its exclusion from FHCF coverage would have created significant problems in loss reporting and claims administration. The Florida Insurance Council and other groups lobbied for several years to have ALE included in losses reimbursable from the Cat Fund.

Premiums paid by carriers into the Fund are reflected in the rates paid by policyholders as are other reinsurance expenses. The FHCF premium may be included in rates or recouped as a surcharge. Companies must demonstrate to the Office of Insurance Regulation that there is no overlap between the FHCF premium included in their rate filing and their so-called "cat load," covering either private reinsurance or the insurers retained losses from catastrophes."

Governor, CFO, Attorney General Administer Cat Fund

Florida's Cat Fund is administered by the State Board of Administration, the agency which invests the state's pension funds. The Trustees of the SBA are Governor Crist, CFO Sink and Attorney General McCollum. Major policy decisions are reviewed for the SBA by the Florida Hurricane Catastrophe Fund Advisory Council. Advisory Council members include John Auer, St. Petersburg, American Strategic Insurance Corp. president, who represents the Florida Insurance Council.