ShareThisspecial report:coastal insurance
Predictions and Payouts
Scenarios and Solutions
Footing the Bill for Florida Storms Remains Biggest Concern
By Tom Wetzel
The political storm in Florida over how to pay for future hurricane losses may not be as violent as the real thing. But if the Sunshine State gets slapped with another Category 5 storm or a series of smaller storms in the same year, the current battle between insurers, state legislators and regulators, the business community, and consumers may seem like a minor skirmish. On three points, however, there is little disagreement: there will be more storms; there are no quick, easy, and painless solutions to paying for them; and there are no guarantees that any of the “solutions” will work as planned.
There also is no shortage of predictions on the thousands of possible tracks storms could take and how much damage they could cause.
|
Background on Potential Hurricane Loss Scenarios in Florida AIR Worldwide Corporation On August 24, 1992, Hurricane Andrew tore across the southern tip of Florida, becoming the costliest natural disaster in United States history – at the time. Andrew hit Homestead, a small town just south of Miami, with insured losses totaling $15.5 billion. Many industry experts agreed that had Andrew hit Miami, losses could have been four times higher. Since Hurricane Andrew, the insured value of properties on the United States coasts has more than doubled. So if Hurricane Andrew were to hit Homestead today, the insured losses would be more than $30 billion, and if it were to hit Miami, insured losses would be more than $120 billion. Many other scenarios are possible. Two such scenarios are:
|
According to Boston-based risk modeler AIR Worldwide Corp., a Category 5 hurricane impacting the Tampa/St. Petersburg area and tracking across the state could result in an insured loss of more than $70 billion. A Category 5 hurricane making a direct hit on Miami and turning north toward Orlando could cause insured losses of more than $130 billion.
California-based Risk Management Solutions agrees that Tampa is especially vulnerable. In its analysis, RMS points out that Tampa is low-lying, the waters of Tampa Bay are shallow, and the shape of the bay can cause funneling, which enhances storm surge. RMS projects that a Category 4 hurricane approaching from the southwest could drive a surge of water into the shallow waters of the bay and inundate downtown Tampa. RMS adds that the four counties that make up the Tampa Bay area comprise 14 percent of the total Florida exposure.
The state funded its own projections conducted by Dr. Shahid Hamid, professor of finance at Florida International University, and certified this year by the Florida Commission on Hurricane Loss.
According to Hamid, the worst-case scenarios would be a Category 5 storm hitting Miami and skirting north along the coast and a Category 5 storm striking Tampa. The former could generate as much as $100 billion in insured residential losses. Commercial and public building losses could add as much as $250 billion more. Likewise, the latter could produce as much as $50 billion in insured residential losses and $125 billion more in commercial and public building losses.
One might surmise that these dire predictions would have everyone in Florida on edge.
Is everyone on edge?
“Not necessarily so,” says Rocky Scott, public information officer for Citizens Property Insurance Corporation, the not-for-profit insurer created by Florida. “I think people are more aware of the dangers of hurricanes, and many do understand the need to take steps to make their homes more storm resistant. At the same time, people also tend to wait until the last minute to take those steps.”
Liz Reynolds, NAMIC’s state affairs manager for the Southeast United States and Florida resident and taxpayer, agrees that Floridians understand on one level that the state’s tremendous growth has increased everyone’s exposure and that exposure has to cost more. But she also says that Florida Gov. Charlie Crist and Insurance Commissioner Kevin McCarty have been “very antagonistic toward the insurance industry, and that inflammatory rhetoric has undermined the ability for all parties to come together amicably and work together to find workable and realistic solutions.”
“The governor ran on a pledge to lower rates and force insurers to behave as he wants them to,” she says. “Many Floridians accept what they have been told about insurers – that insurers are ‘greedy’ and ‘profiteers’ that are gouging the public. One cannot help but be sympathetic to the plight of Floridians who are caught in a squeeze – the state’s extended development boom, catapulting property values, the prospect of more devastating storms, and the increased exposure costs for insurers and policyholders.”
Citizens’ Scott notes, too, that for “a lot of folks, their monthly insurance premium is more than their mortgage payment.”
So how did the state end up in such a difficult place, and where will it all end?
Before Hurricane Andrew in 1992, the insurance climate in Florida was healthy according to many observers: insurers competed for business, premium levels were acceptable, and consumers appeared satisfied. After Andrew, insurers recognized their vulnerability to another “big one” and began reassessing their exposure. The state also took action, creating the Florida Hurricane Catastrophe Fund and a wind Joint Underwriting Association, and also tightened up building codes across the state, except for an exemption in the Panhandle.
More dramatic changes, however, took place after the back-to-back-to-back 2004 storms of Charley, Ivan, Frances, and Jeanne; and Hurricanes Katrina and Wilma in 2005.
This year, Florida instituted a number of reforms that pleased consumers and angered many insurers. First, the state elected to take on more of the risk should the state be hit by a major storm. Premium levels for Citizens Property Insurance Corporation were frozen until the end of 2008. All Florida homeowners are now able to obtain property insurance from Citizens, as long as the premium for the private policy is 15 percent or more than the comparable Citizens policy. Citizens can now offer traditional homeowners coverage to its high-risk policyholders as well as wind-only policies, and the company now administers the commercial property insurance pool created to offer wind and hail coverage to small businesses that cannot obtain coverage in the standard market.
The state also created a program to allow insurers to purchase more reinsurance from the state-run FHCF, with the proviso that they pass on any savings to their policyholders.
In addition, the Panhandle building code exemption was repealed.
“Reform implies something was made better,” says Robert Hartwig, president of the Insurance Information Institute.
“In 2004, Citizens reported a deficit of $516 million. In 2005, the company reported a deficit of $1.8 billion. So even before the changes were made this year, the company was underfunded and undercapitalized. In the new plan, they rolled back rates and froze them, making it more difficult for private companies to operate. In mid-2007, Citizens had a $600 billion exposure.
“While there are debates about what role the government should play in insurance, it should not be encouraging developers and exposing taxpayers unnecessarily,” Hartwig says. “Some companies are at peace with the changes while others oppose them, but no one disagrees with the concept that premiums must reflect risk. In Florida, we do not have actuarial-based pricing; we have political-based pricing. Actuaries have been banished and locked up in a closet.”
A different lens
“To understand these changes, one must look at Florida through a different lens,” says Citizens’ Scott. “Florida is a growth-based economy and is always looking to grease the rails of development. Many politicians are not concerned as much about rates being actuarially sound as they are with keeping construction jobs in the state and keeping taxes low.”
Two Florida politicians opposed the changes made this year by the state, state Rep. Dennis Ross, R-Lakeland, and state Rep. Don Brown, R-DeFuniak Springs.
In an article in the Summer 2007 issue of the Journal of the James Madison Institute, Brown wrote, “we learned that government actions that ignore or distort market forces – in particular, actions that subsidize insurance costs – create powerful incentives for unwise or uncontrolled growth. It is time to consider whether true market pricing of insurance – a system in which consumers pay the real, unsubsidized cost of living along our vulnerable coast – may be the best way of protecting the coast.”
In an illustration, Brown theorized on what would happen if the owners (including businesses) of large, gas-guzzling SUVs complained to the government that the high price of gasoline was making their vehicles unaffordable. “So the government decides to provide affordable gasoline to SUV owners and it decides to tax owners of … hybrid vehicles to support the SUV subsidy.”
In the same issue, Ross argues for a plan based on insurance that is “backed by private capital, not taxpayer debt; the risk of living in high-risk areas should be borne by people who live there; and building codes must be strictly enforced and investment made in the aggressive retrofitting of existing structures.”
A study by Milliman, an actuarial consulting firm, examined the impact of the new legislation. Significant findings included the fact that while all homeowners will pay less for property insurance, the major beneficiaries will be homeowners in southern coastal counties. Motorists and small-business owners will see no direct benefit but could face higher policyholder assessments in the event of an average-to-large hurricane.
Milliman also reports that by reducing premiums in high-risk areas, the legislation encourages additional development in those areas, which adds to the financial burden from future storms. The report states that if Florida is hit by major storms in consecutive years, charges may exceed 20 percent of the underlying premium and continue for more than seven to eight years.
In a report titled “Weathering the Next Storm: Insurance Industry Perspectives on Florida Law,” Towers Perrin concluded that:
“The legislation accelerates the trend toward risk socialization in the state through the expansion of the Florida Hurricane Catastrophe Fund … continues a trend toward replacing risk-based, pre-event funding with a system supported by post-funding mechanisms.” The report also notes that “the pressure for a federal solution is likely to grow. If the wind does not blow, then policyholders benefit by means of insurance policies priced below their risk-based rate (heads I win). If the wind does blow and the post event-funding mechanism fails, the federal government might step in (tails you lose).”
In testimony in April 2007 before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, NAMIC President & CEO Charles Chamness said that “many states in catastrophe-prone coastal regions impose rating and underwriting restrictions on property insurers that act as price ceilings on coverage…. Rate suppression may seem like a good thing to government and private businesses that thrive on growth and development, but, unfortunately, government rate suppression distorts the public’s perception of risk, thus encouraging the very phenomenon that created the problem in the first place. Federal and state governments must then bear the cost of the economically irrational decisions that result from rate suppression by paying for disaster aid to repair properties that should never have been built in the first place.”
Mortgaged the future
“Our concern,” says NAMIC’s Reynolds, “is that the changes made this year by the Florida Legislature have mortgaged the future. These changes have masked the true cost of the risk. The tremendous expansion of Citizens has created an unlevel playing field. For example, Citizens has a tax-exempt status, which helps it set its rates well below those of private insurers. At the same time, the rates have been frozen until next year, despite the fact that legislation passed in 2006 recognized that rates for Citizens needed to increase.” Contributing to the unlevel playing field is that Citizens can fund deficits and cover a rate freeze through tax/policyholder assessments, while private companies can only fund a deficit by dipping into policyholder surplus.
In October 2007, the FHCF completed a $3.5 billion floating-rate note transaction, giving it $8.5 billion in liquidity. According to a Raymond James estimate, the fund’s total multi-year claims-paying capacity is $57.158 billion, down $1.7 billion from a 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 is based on 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.
Florida’s Chief Financial Officer Alex Sink has proposed to reorganize the administration of the FHCF so that it reports to a board consisting of the governor and the cabinet.
The federal government is also addressing the issue. In November, the House approved legislation allowing coastal states to pool their catastrophe risk and obtain private-market insurance coverage through catastrophe bonds and reinsurance. The “Homeowners Defense Act of 2007” garnered bipartisan support from Florida, Louisiana, California, and other states. The bill also creates the National Homeowners Insurance Stabilization Program, under which the Treasury secretary can extend loans to states impacted by severe natural disasters.
Caught in the middle of the battle is Citizens. Founded as the market of last resort, the company now finds itself, in the words of many observers, “the market of first choice.” Citizens is now the largest insurer in the state with more than 1.4 million policyholders. As of October, the company holds a capacity to pay a total of $14 billion in claims in the event that the state is hit by a major hurricane.
The company projected it would have 1.6 million policyholders by the end of the year and 2 million at the end of 2008. Citizens has $10 billion in cash and investments available to pay claims, $5 billion in bond proceeds, a $2.5 billion surplus projected by the end of 2007, and a line of credit.
The company has expanded its workforce and improved claims efficiency to service the business it has. Records indicate, for example, that in 2004 through 2005, the company had 3,500 open claims. Today it has less than 800.
Everyone agrees that the problems facing Florida and how it faces paying for hurricanes in the future are daunting, however, no solution can completely overcome Mother Nature. As Florida International University’s Hamid concluded, “A Category 5 storm will always cause problems, no matter where it strikes.”
Tom Wetzel is president of Thomas H. Wetzel & Associates, Inc., a full-service marketing communications firm that operates exclusively in the insurance industry. With more than 30 years of insurance communications experience, he has represented many insurers, brokers, and associations. He can be reached at twetzel@wetzelandassociates.com or www.wetzelandassociates.com.
Posted: Monday, January 21, 2008 12:00:00 AM. Modified: Monday, January 21, 2008 3:35:40 PM.
(317) 875-5250 - Indianapolis | (202) 628-1558 - Washington, D.C.
Contact NAMIC | Press | Advertise | Sponsor
= access available only to registered users from NAMIC-member companies