Putting Florida’s rate filing and reinsurance controversy in context

Currently underway in Florida is a controversy over the amount of private reinsurance homeowners insurers should purchase in addition to the now expanded $28 billion in reinsurance available from the Florida Hurricane Catastrophe Fund. There seems to be a core issue emerging. Other than the coverage insurers purchase to help pay their Cat Fund deductible and the 10 percent co-pay once they meet their deductible for Cat Fund coverage to kick in, is purchase of any private market reinsurance appropriate?

With approval of the Office of Insurance Regulation, most residential insurers have always purchased reinsurance in excess of maximum payments they will receive from the Cat Fund. However, these purchases are now being questioned by Commissioner Kevin McCarty of the Office of Insurance Regulation as inappropriate and preventing reductions in premiums that were made possible by the Cat Fund expansion in the January special session.

OIR denied a Florida Farm Bureau Insurance Co. filing recently and is now reviewing other insurer filings where rates would either go up or the reduction being passed on to policyholders is dramatically less than the presumed factor, 24 percent average rollback, developed by the OIR early this year.

McCarty issued an editorial to Florida newspapers criticizing Farm Bureau and other companies that have not proposed significant rollbacks in their premiums. “While the companies did, in fact, receive savings from the Florida Legislature’s initiatives, the companies did not plan to pass this savings to the consumer as the Legislature intended,” McCarty wrote. “Instead the savings would be used to purchase additional reinsurance, even purchasing reinsurance from their own subsidiaries, and to shore-up their financial surplus. Regrettably, Florida Farm Bureau’s filing appears to be indicative of filings from the rest of the industry.”

This presents an incomplete, inaccurate picture and implies, incorrectly, that insurance companies are using savings from the Cat Fund expansion to bolster their bottom line.

Recent media stories have reported on the rate filings … and the fact that many filings to date are for rate increases or only slight reductions. The reality of these filings and the reasons behind them are necessarily at odds with promises of rate reductions made at the time of the special session by policymakers, not by insurers. Most insurers made no specific promises as to the extent of expected savings that could result from the expansion of the Florida Hurricane Catastrophe Fund, and the resulting cheaper reinsurance that was made available. In fact, insurers repeatedly sounded a note of caution about the real world impact of the law on policyholder premiums, so as not to raise unrealistic expectations.

Insurers must maintain the requisite financial strength to pay claims, and that necessarily means collecting sufficient premiums to be ready for the worst case scenario. That mandate does not go away even if Florida decides to provide additional and/or cheaper reinsurance. Insurance companies that fail to maintain adequate reserves have no hope of fulfilling their contractual responsibility to policyholders … when a hurricane or other disaster strikes. Private market insurers — unlike Citizens Property Insurance Corp. — cannot turn to the taxpayers for a bailout when premiums are not sufficient to pay claims. Private market insurers must have real dollars on hand to pay claims. They cannot rely on the scheme that props up Citizens, wherein the state provides additional “liquidity” to boost Citizens’ claims-paying capacity.

No one living in Florida can question the need for insurers to have funds sufficient to meet the worst case scenario. In 2004-2005, when the worst case scenario became a reality, a financially strong insurance industry paid $36 billion in claims from eight storms that hit the state. Those storms wiped out multiple years of modest profits in Florida. During the period from 1992-2006, home insurers in Florida paid an estimated $10.4 billion more in claims than they received in premiums.

This $10.4 billion loss remains even after including an estimated $3 billion in profits for 2006. That one profitable year does not complete the recovery from 2004-05. In Florida, modest profits in most years are outweighed by enormous losses in others. The capital requirements of insurance rating agencies, reinsurance rates, the 2004-2005 claims experience, insurers’ lawfully allowed profit factor, and predictions of more frequent and severe storms in the coming years all play a role in determining the rates that companies need to charge in Florida.

In the January 2007 special session, some insurers supported the expansion of the Cat Fund, a change that had the potential to lower the overall cost of reinsurance. The Cat Fund plays an integral role in the state’s residential property protection system especially for bigger storms (insurers are responsible for the first $6 billion in claims). But insurers cannot rely solely on the Cat Fund to ensure that claims following a major hurricane are paid. Depending on the insurer, reinsurance is purchased from multiple sources: the parent company, which may be cheaper than the private market; the private reinsurance market, which allows large multi-state insurers to purchase comprehensive coverage at attractive rates; and the Cat Fund, in which all residential insurers are required to participate.

Insurers take a conservative financial approach — to be ready for the worst case scenario — and have spread the risk beyond the Cat Fund. This is not only good business, but is in many cases required by the insurance rating agencies. The fact is that rates reflect more than just the cost of state-sponsored reinsurance, and private market insurers must take into account a myriad of factors. For private market insurers rates must match the risk, and the hurricane risk in Florida cannot be repealed by anything the Legislature does or public officials say. Insurers will continue to do the right thing by their policyholders. That means being absolutely sure of their ability to pay hurricane claims and still being in business after they have done so.

Sam Miller is executive vice president of the Florida Insurance Council, the state’s largest insurance company trade association with 250 members. This is from a backgrounder prepared in conjunction with the American Insurance Association, National Association of Mutual Insurance Companies and the Property/Casualty Insurers of America.