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Florida’s Property Insurance By Fiat

Should state government subsidize property insurance costs for homes most likely to sustain damage from a natural disaster? Florida Gov. Charlie Crist thinks so.

Since Hurricane Wilma blew through Florida in October 2005, property insurance costs have more than doubled for most homeowners. Such rate increases, coupled with higher property taxes, have made homeownership more difficult to achieve or maintain in Florida. Hearing the pleas of his constituents during his campaign for governor last year, Crist vowed to fix the state’s insurance crisis if he were elected.

Crist convened a special legislative session on insurance shortly after taking office in January. The session resulted in the passage of House Bill 1A, which made numerous changes to the Florida Insurance Code. The most significant allows insurers to purchase reinsurance from the Florida Hurricane Catastrophe Fund (CAT Fund) at a significant discount from prices charged by private reinsurance companies in the open market, so that the savings may be passed on to policyholders.

Reinsurance is essentially insurance for insurance companies. Insurers purchase reinsurance for several reasons, one of which is to spread their risk so that they may meet claims following a catastrophic event. Reinsurance is the largest contributor to the dramatic increases in homeowners’ insurance rates, although significant appreciation in property values and a substantial rise in the cost of building materials and labor to rebuild after a hurricane have contributed.

According to a study by the Florida State Board of Administration in September 2006, the price of Florida hurricane risk reinsurance in the private sector increased 50 percent to 70 percent at the beginning of 2006, and another 50 percent to 100 percent on July 1, 2006. Last year, 52 of 167 property insurance carriers in Florida requested rate increases in excess of 25 percent, primarily because of sizable increases in their reinsurance costs and higher expectations of future hurricane losses. For example, in 2006, the Office of Insurance Regulation approved State Farm and Nationwide’s requests for rate increases of 52 percent and 71 percent, respectively, for policies renewing this year.

Fund Created To Reimburse Insurers

After Hurricane Andrew devastated much of Homestead, Fla., in 1992, the state Legislature established the Florida Hurricane Catastrophe Fund to reimburse insurers for a portion of their catastrophic hurricane losses. The fund functions as a state-administered reinsurance program, creating additional insurance capacity. Participation is mandatory for property insurers writing residential policies that provide wind or hurricane coverage on structures.

The CAT Fund has three resources for meeting insurer reimbursement claims: accumulated premiums charged participating insurers, investment income and the issuance of post-event bonds secured by emergency assessments on Florida property and casualty insurers. In the end, all Florida homeowners must pick up the tab if the fund is unable to cover all reinsurance claims, because the private insurers pass on those assessments to their policyholders.

As of October 2006, the fund had set a maximum singleseason claims-paying capacity of $15 billion for the initial and subsequent seasons. However, the fund has an estimated balance of only about $1.2 billion for 2007. The other $13.8 billion would be raised by issuing debt. The majority of the payouts to insurers for 2004 and 2005 losses, which total about $3.95 billion and $4.5 billion, respectively, have also been covered by bond proceeds.

The fund issued about $1.35 billion in post-event revenue bonds in June 2006 to cover payments for losses during the 2005 hurricane season. The following month, the fund issued $2.8 billion in pre-event debt to enable it to pay claims resulting from future hurricanes. Standard & Poor’s, a credit rating agency, originally assigned a AA rating for both issues. The AA rating is the agency’s third highest and implies that the fund is financially secure and unlikely to default on the debt. After the new legislation was passed, Standard & Poor’s downgraded the debt to AA-, its fourthhighest rating, because of the fund’s additional risk and liability exposure, which could increase its need to issue more bonds.

By expanding the fund to increase the state’s reinsurance capacity, regulators calculated that insurers would pass along an average savings of 24 percent to policyholders. However, rate cuts proposed to the Office of Insurance Regulation have been much smaller. For example, State Farm and Nationwide’s average reinsurance savings are only 7 percent and 4.5 percent, respectively. In fact, some insurers that originally planned to reduce rates by as much as 35 percent are now stating that discounts will be lower than current rates by a few percentage points or rates will actually increase by as much as 32 percent.

Crist is not pleased, and has been publicly criticizing property insurers as greedy. In a speech at the Florida Association of Realtors’annual convention in late August, Crist said, “I’m a pro-business guy, but I’m pro-good business.... I believe in profits, but I do not believe in profiteering on the backs of my people.”

Why Aren’t Insurers Passing Along The Savings?

Private insurers may not be passing along some of the savings because they have to answer to more than just Florida’s government. Rating agencies, such as Standard & Poor’s, Moody’s and A.M Best, have made it clear to insurers that if they maintain large exposure to Florida, their ratings will decline unless they substantially increase their capital reserves. Insurers need to maintain strong credit ratings to attract new capital and to keep borrowing costs low.

Insurers and reinsurers are reassessing their risk tolerance after the losses they incurred during 2004 and 2005, and based on predictions of increased hurricane activity for the next decade. Some insurers have implemented new underwriting restrictions to account for changes in their risk tolerance. This has also resulted in insurers and reinsurers substantially increasing their rates. Other insurers are either dropping policies or leaving the state.

Although the Florida Hurricane Catastrophe Fund is offering below-market reinsurance, insurers and their stockholders are not convinced that the fund will be able to meet its obligation. Jeff Grady, president of the Florida Association of Insurance Agents, was quoted as saying, “At some point investors start to doubt the viability of being repaid in a state that is having to issue large amounts of debt with the possibility of more of the same.”

State-Backed Insurer Allowed To Compete

In addition to offering discounted reinsurance to private insurers, House Bill 1A allows Citizens Property Insurance Corp., the state-backed insurance provider, to compete with private insurers. This is a large departure from serving only as a safety net for the uninsurable.

State legislators created Citizens Property Insurance in 2002 as the insurer of last resort for homeowners unable to obtain coverage from private insurers. Many Citizens policyholders have property in coastal areas. Private companies are unwilling to insure such property because it typically takes the brunt of the damage from hurricaneforce winds.

House Bill 1A repeals a requirement that Citizens charge higher rates than private insurers. Further, it allows the insurer to sell more than just windstorm coverage. The new legislation also repeals an average 21 percent rate increase that took effect in January for Citizens customers, and another average increase of 56 percent that was supposed to take effect in March. In addition, a homeowner is now eligible for coverage with Citizens even if she is offered coverage from a private insurer, as long as the quoted premium is more than 15 percent higher than that of Citizens for comparable coverage. As a result, Citizens has become the cheapest insurance option for homeowners in many cases.

Citizens became the largest property insurance company in Florida last year. As of Aug. 31, 2007, it had more than 1.3 million policies in force. However, as Citizens continues to grow, so does the potential financial burden for all Florida homeowners, not just Citizens policyholders.

Citizens has needed to be bailed out twice in its first five years. Unlike private insurers, if Citizens runs a deficit in any year, Florida law allows it to levy a regular assessment of up to 10 percent of the deficit on all homeowners in the state. After the 2004 hurricane season, the state-backed insurer ran a deficit of $516 million, which resulted in all Florida homeowners paying $68 toward the shortfall for every $1,000 of insurance premium paid.

Citizens is allowed to levy an additional emergency assessment if the regular assessment is insufficient. After the 2005 hurricane season, Citizens was running a deficit of more than $1.76 billion. The state Legislature appropriated $715 million toward the shortfall, the regular assessment covered $163 million and the remaining $888 million was covered by an emergency assessment. The Legislature decided to amortize and collect the emergency assessment over 10 years to avoid assessing a premium surcharge of 8 percent on all property insurance policyholders in one year. If Florida homeowners look closely at their property insurance bills issued after July 1, 2007, they will notice a separate line item titled “Citizens 2005 Emergency Assessment.”

Florida Farm Bureau Insurance, a private carrier, sent a letter to its policyholders regarding House Bill 1A and the growth of Citizens. The letter says that 70 percent of Citizens’ exposure comes from five coastal counties, and that policyholders in the state’s other 62 counties are materially subsidizing homeowners in those counties. According to the letter, Citizens policyholders in Orange County, an inland county in central Florida, account for only 0.7 percent of total Citizens exposure. If Orange County had paid only its “fair share” to subsidize its Citizens policyholders, residents would have paid about $5 million in assessments. Instead, they will have paid about $37 million by the time the assessment period expires.

What Can Homeowners Do?

Despite the government’s efforts, Florida homeowners have not seen a significant decline in their insurance premiums this year. Although those efforts were well intentioned, the government should not be in the business of offering discounted reinsurance to private insurers or below-market insurance to homeowners in high-risk areas, because all Florida homeowners pay when the government’s resources fall short. Those who wish to live along Florida’s beautiful coasts or in other high-risk areas must pay their fair share.

Homeowners should shop around for less expensive property insurance. However, when comparing rates, they should inquire about credit ratings, which are an indication of insurers’ financial strength and claims-paying ability. If switching carriers, they should wait until the new policy is in place before canceling their current insurance, so as not to be without coverage. Homeowners can also increase their deductibles to reduce their insurance premiums. Further, they can take steps to mitigate hurricane losses by reinforcing doors, windows and roofs, which can result in significant savings.

Otherwise, homeowners can only hope that the 2007 hurricane season is as uneventful as last year’s. Whether Florida is hit by major hurricanes this season will have the biggest impact on insurance bills in 2008, not the government’s attempts to reduce rates. Two consecutive years without hurricanes would be the best relief for homeowners’ dwellings and wallets.

Executive Vice President and Chief Operating Officer Shomari D. Hearn, based in our Fort Lauderdale, Florida headquarters, is among the authors of Looking Ahead: Life, Family, Wealth and Business After 55. He contribued Chapter 2, “Relationships With Adult Children”; Chapter 9, "Life Insurance"; and Chapter 17, "Retiring Abroad." He also contributed a chapter to the firm’s book for young professionals, The High Achiever’s Guide To Wealth.
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