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Pay Me Later

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  • | 2:28 p.m. July 31, 2009
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Florida's risky property insurance system relies on a patchwork of undercapitalized public and private insurance, suppressed rates, policy assessments, an unlikely national catastrophe plan, and the next weather report. It could add up to one big bankruptcy for all of us.

A 1-in-100 year hurricane event is comparable to a category four hurricane making landfall in Tampa Bay or Miami.

Such a single storm is estimated by the state to cause $65.6 billion in residential losses, including $4.5 billion in policyholder deductibles. Businesses would incur about $30 billion in insured losses. Total losses could approach $200 billion.

But most experts admit that the state's patchwork of public and private insurance, plus its reinsurance, would come well short of covering it. And that exposes Floridians to enormous costs, including more than $30 billion in debt service because the money would have to be borrowed due to unrealistically low premiums mandated by the state.

This is the “pay me later” method that has immediate political benefits of keeping rates low, but ultimately costs more. To handle catastrophic losses following the devastating 2004 and 2005 hurricanes, the state set up Citizens Property Insurance Corporation — intended to be the residential property insurer of last resort. In short, order it became the largest.

In 1993, the Legislature created the Florida Hurricane Catastrophe Fund (Cat fund), a state-run mandatory reinsurer to help insurance firms. The purpose was to provide a stable and ongoing source of reimbursement to insurers for a portion of hurricane losses in order to provide additional insurance capacity in the state.

Still, property insurance experts question whether the state's patchwork of public and private insurance companies and reinsurance will be enough to cover it. Even Florida's Office of the Insurance Consumer Advocate says on its Web site: “ ... Florida remains vulnerable to catastrophic financial loss in the event of major storm damage.”

'Worst Idea of the Year'
Other state officials seem to question it too, with their hands out for federal aid.

But, the U.S. Treasury says it doesn't have the authority to issue a line of credit backing up the Cat fund. And, a national catastrophe fund, in the guise of the “Homeowners' Defense Act,” sponsored by U.S. Rep. Ron Klein, D-Boca Raton, is another scheme going nowhere fast despite the lobbying of Gov. Charlie Crist and state Insurance Commissioner Kevin McCarty.

In fact, the bill's been called the “Worst Idea of the Year,” the title of a July 7 story by property insurance expert Eli Lehrer, a senior fellow with the Competitive Enterprise Institute. He writes, “reinsurance focused on the U.S. narrows the risk pool and thus, will cost more than international reinsurance.”

Lehrer also notes that those who point to the national flood insurance program as a model should consider that it operates under laws requiring “'adequate premiums'” on most properties,” but is still $19 billion in the hole “and has no practical way of paying it off.”

Some argue that such a storm could put the state on a path to bankruptcy. Here's an indication from a Florida Department of Financial Services March 2009 economic study:

The interest payment on Citizens and Cat fund catastrophe debt is $480 million per year. The annual interest on the projected $22.5 billion in debt necessary in the event of a 1-in-100 year storm would be about $1.8 billion per year.

So the total annual interest on the existing debt for a 1-in-100 year storm is estimated to be $2.3 billion per year. The total estimated interest cost over the life of the borrowing adds up to about $30.6 billion.

More recent figures cut the current combined deficit of Citizens and the Cat fund to $21.6 billion. And unofficial figures being tossed around by Cat fund staff suggest it's dropped further, yet to a still problematic $11 billion.

According to Cat fund Chief Operating Officer Jack Nicholson, nearly half the drop is due to best guesses by state financial advisors about thawing credit markets. But most of the rest ($4.4 billion) is because most property insurers decided it was less risky to buy reinsurance in the private market than purchase it from the state.

Their reason: the private companies know they have little chance of collecting from the Cat fund. Those who gambled on it, says one expert, must be betting on small odds of a federal bailout.

In short, things aren't as bad as they were, but things haven't improved enough to change the picture.

Assessment calculator
Hurricane Charley was no pretty picture — a category four hurricane that made a mega-mess of Charlotte and parts of Lee and DeSoto counties in 2004 with winds of 150 miles per hour. But if Charley had hit the Tampa-St. Pete area, the costs would have been many times higher and the impact on Floridians' insurance would have been many times higher.

These charges can now be estimated with the ICA's new assessment calculator. See sidebar.

First, understand that the Cat fund is financed by charging participating insurers and investment earnings.

Those costs to insurers then get passed on to policyholders, but instead of paying the full rates up front as premiums — “pay me now” — the balance of the true costs are shifted to the back end through assessments — the “pay me later” strategy.

In May, Cat fund staff prepared a presentation titled, “Estimated Loss Reimbursement Capacity.” According to the report, the estimated loss reimbursement capacity comes from the fund's three senior managing underwriters who projected borrowing capacity under current market conditions.

The Cat fund's $34.9 billion assessment base includes all property and casualty lines except worker's comp, medical malpractice, accident and health, and federal flood insurance.

Currently, state policyholders are paying two 1% emergency assessments for about eight years to pay off two tax exempt post-event bonds. Principal and interest payments add up to more than $2 billion.

In the meantime, if the 1-in-100 year storm hits, the new assessments will get tacked on to what policyholders assessments are now — another 6% of premiums for losses in a single year only limited by a 10% maximum total assessment.

The new one would add up to about $2.1 billion a year in assessments according to Nicholson.

The average total premium per household, factoring in business premiums embedded in the costs of products and services purchased by consumers, is $5,265 a year. This, according to “Economic Impact of a 1-in-100 Year Hurricane,” a study issued last March by the state's Department of Financial Services.

The Business Review looked at how this much in premium would translate into assessments by using the state's new online assessment calculator.

A private insurance policyholder would face a total assessment of $2,865, or would be paying $220 a year for 30 years, or $6,600. This assumes financing is available at 6.5% for a 30 year bond. A higher rate is very possible and means bigger assessments. The news is worse for Citizens' policyholders — they pay $7,920, or $264 a year for 30 years.

'The brink of collapse'
The Cat fund will pay losses up to its theoretical loss reimbursement capacity. For a 1-in-100 year or a 1-in-250 year hurricane, the Cat fund would need to borrow somewhere in the range of $15.1 billion to $19.5 billion.

The problem is that their projected borrowing capacity after such a storm is only $8 billion, although it also could be zero, according to Goldman Sachs, one of the state's three senior managing underwriters.

With nearly $8 billion cash and another $8 billion borrowed, the total loss reimbursement capacity is under $16 billion.

And if Goldman Sachs is right, the Cat fund would be left relying on less than $8 billion on hand. Lehrer sees it this way: “The Cat Fund has very little in the way of hard assets and would simply impose enormous taxes on Florida residents were a major storm to hit.”

On top of the Cat fund shortfall is another $3.82 billion estimated deficit from Citizens. If both entities go out in the bond market together, one could crowd out the other if bond investors have a limited appetite. Multiple storms and insurer bankruptcies compound the problem.

Much will depend on the state of the credit markets, and while there's been recent improvement, there may not be much demand for a record $11 billion or more of Florida debt in a narrow window.

Asked if the Cat fund's needs could crowd out Citizens' post-event bonding capacity, Nicholson is quick to respond, “Absolutely. In tight markets like we have now, there's only a limited amount. ... if there's a limited amount of capacity available, there's going to be a problem.”

Lehrer thinks it could get to a point where the only out for Florida is to amend the constitution to increase taxes. “There is still an enormous unfunded liability and no way to fund the shortfall without an amendment to the constitution.”

Many, including 86% of the Legislature, feel that more rate flexibility for the private market is part of the ultimate solution. That was the central theme of House Bill 1171 that legislators passed this spring. But Crist vetoed it with
McCarty's support.

A main reason cited for the veto was McCarty touting $5 billion of new insurance company capital as evidence of a vibrant, growing homeowners insurance market. However, the Business Review found that only 5% of the new capital could be traced to companies actually writing homeowner's or mobile home insurance, and 20% of that came from a state incentive loan program funded by taxpayers.

Lehrer understands the regulatory constraints private insurers are facing, and the financial disaster to follow the natural one. In a paper, he writes, “Florida's private market seems to face the same, deep structural problems as
Citizens and the Catastrophe Fund. All three major components of Florida's property and casualty insurance system, in short, sit on the brink of collapse.”

No less shocking is the candid testimony of OIR Chief Economist Raymond Spudeck. On July 2, he appeared before a congressional subcommittee regarding “The Homeowner's Insurance Crisis: Solutions for Homeowners, Communities and Taxpayers.”

Spudeck told the subcommittee he believes the state's “pay me later” policy advocated by the governor and McCarty, his bosses, is all wrong.

In fact, Spudeck quotes the old television commercial with the auto mechanic saying, “'You can pay me now, or you can pay me later.'” Then he says, “It is almost always more inexpensive to finance disaster recovery before a catastrophe occurs, rather than after the fact. This is precisely the purpose of insurance — to pay prior to the accident, to provide an economic cushion to survive the adverse event.”

Online Insurance Assessment

According to a state Web site: “In Florida, there are three entities that may levy assessments due to residential property insurance claims:

• Florida Hurricane Catastrophe Fund

• Citizens Property Insurance Corporation and

• The Florida Insurance Guaranty Association.

Regular assessments for a single year and emergency assessments for one or more years are made as necessary to pay off the debt. The calculator will provide you with the amounts you may expect to be assessed.”

To use the calculator, go to:


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