States under cover

Natural catastrophes — and the affordability and availability of property insurance in disaster-prone areas — have been on center stage in coastal states from the Northeast to the Gulf Coast. This fall, the nation’s capital took up the issue again with the introduction of federal legislation — the Homeowners’ Defense Act of 2007, a bill introduced by Reps. Ron Klein, D-Fla., and Tim Mahoney, D-Fla. — intended to address the growing problem of natural disasters.

“It’s a front and center issue,” says Eric Goldberg, associate general counsel of American Insurance Association (AIA).

While some in the industry would prefer a national solution to catastrophe risk, states are not standing by waiting for help from Washington, D.C. New York, Florida, Texas, Lousiana, South Carolina and others are addressing natural disaster risk head on with incentives, discounts, special funds and other methods — some of which are supported by the insurance industry and others not.

Even so, Don Griffin, vice president of personal lines, Property Casualty Insurers Association of America (PCI), says insurers are encouraged by some states’ willingness to address natural catastrophe issues.

Below are a few of the recent efforts by states.

Rainy Day Fund

In October, New York Insurance Superintendent Eric Dinallo proposed a new regulation that would require insurance companies providing homeowners, business and other property insurance in the state to create a catastrophe reserve fund to help pay claims caused by hurricanes and other natural disasters.

Dinallo’s plan would require insurers to set aside a portion of premium for a catastrophe fund. Eventually the reserves could be exempt from taxes, although not initially.

Under current accounting and tax rules, insurance companies are discouraged from setting up a reserve to fund losses from events that have not yet occurred, such as those from future hurricanes. Companies can deduct from this year’s revenues money reserved for claims resulting from events that occur this year. That reduces the current year’s taxes. Statutory accounting considers those reserves an operating expense. But if a company does not know when the event will occur, then money placed in reserve is not considered an expense in the current year and is subject to federal and state taxes.

Dinallo said he thinks a private solution for catastrophe coverage is better than a public fund and insurers tend to agree. But they also have trouble with Dinallo’s state approach.

“We appreciate the idea,” says PCI’s Griffin, “but it’s not a new idea.”

Griffin says PCI is pushing for catastrophe reserves, but instead prefers federal — not state — tax-deferred catastrophe reserves. “Companies would be allowed to set those up free of federal income tax as well as set it up for all the states they do business with. … What New York is seemingly doing is setting up a segregated surplus on a mandatory basis,” he said. “The idea of fed legislation that we would support would be on a voluntary basis.”

“We are pleased that Superintendent Dinallo is looking for private market solutions and not creating new government mechanisms to try to address natural catastrophe risk,” said AIA’s Goldberg. But AIA insurers are also concerned about setting up catastrophe reserve funds on a state by state basis.

“If there’s to be a development of a catastrophe reserve fund, we’d prefer it be done on a national basis because that’s how insurers think about their exposure to natural catastrophe risk,” Goldberg explained. “They do not think about (catastrophe risk) in the New York, New Jersey, California market and so forth. We do think that any kind of proposal like that ought to be done nationally if at all.”

PCI’s Griffin agrees, noting that while the idea is interesting and certainly worth talking about, a one state mandatory, segregated surplus is not the solution. “We believe that the federal solution in that particular instance is probably better.”

S.C. makes waves

South Carolina took big steps this year to ease the insurance cost and availability crunch facing coastal property owners in the state by passing the Omnibus Coastal Property Insurance Relief Act of 2007, which provides for discounts and tax breaks to consumers and insurers. The approach has received attention frrom other coastal states trying to decide what to do.

The South Carolina program includes tax incentives and insurance discounts to residents who make their homes more hurricane resistant. It allows homeowners to put money in hurricane savings accounts to offset large deductibles or self-insure. It also requires that insurers give a 90-day cancellation notice during hurricane season.

Insurers could also receive tax credits by writing full-coverage policies along the coast.

PCI’s Griffin said while the insurer tax credits are not a large amount, “it still provides a little bit of incentive for companies to voluntarily write there.”

“This is the first legislation in a long time that is very pro-consumer and it should set the South Carolina market in a good position for 10 or 15 years to come,” said Scott Richardson, the state’s insurance director, when the legislation was passed in June. “It’s also important on a national basis as South Carolina is the first to codify market philosophy – not to mention the response we’re getting from other states asking us how we did it.”

South Carolina also expanded the territory for the South Carolina Wind and Hail Underwriting Association (wind pool) slightly to provide a little relief for those properties that were right up against the territory line.

Other changes to the wind pool resulted in a “two-tiered” rating plan to ensure that the rates charged for coverage reflected the risk of the property. In addition, the plan of operation was changed to increase minimum deductibles to better reflect the realities of the market. Underwriting standards were also revised.

Louisiana incentives

In an effort to reduce the number of policies written through the Louisiana Citizens Property Insurance Co., the market of last resort, Insurance Commissioner Jim Donelon launched a state program that offers incentives to insurers willing to do business in Southern Louisiana.

Under the initial phase of the $100 million incentive program, qualified insurers may apply for grants of $2 million to $10 million. The insurers must commit the same amount in new capital and use that money and the matching grant to write new property coverage.

The program requires that 50 percent of the net written premium shall be received from property owners in the 37 parishes affected by hurricanes Katrina and Rita, and 25 percent of the new written premium must be from property insured by the Louisiana Citizens Property Insurance Corp. At least half of that 25 percent must be from properties located in those parishes affected by hurricanes Katrina and Rita.

The incentive program is modeled after a Florida program, according to PCI’s Griffin.

“The idea is to get some new companies, or small start up companies, going and writing business in the coastal areas but to give them a little bit of financial backing in case something happens right away,” Griffin said. “So far it’s helped in Florida to bring a little market growth there and some additional companies into the game,” he added. “But this is just a $100 million and that isn’t a lot.”

Nevertheless, it’s little things that have been done by some states that have made a difference and it may be enough to make even bigger changes, Griffin said.

“These are good steps to encourage small companies to go in and get started and hopefully give them financial footing, but it’s not the entire solution, there (in Louisiana) or in Florida either,” he added.

Thinking similar to Louisiana’s to incentivize more insurers to come and write business in the Gulf Coast area, can help, says AIA’s Goldberg.

“Whether the matching program is going to attract the kinds of insurers that Louisiana wants to see there in the long run remains to be seen,” Goldberg says. “But really in a broader sense it’s positive in terms of private market solutions rather than new government mechanisms.”

Wind pool in Texas

Legislation to revamp the funding structure of the Texas Windstorm Insurance Association (TWIA), the wind market of last resort serving the Texas coastline, came within inches of passing this year. The legislation would have allowed for the issuance of pre-event and post-event bonds to boost TWIA’s funding. It has been estimated that if a Category 3 storm were to hit the Galveston-Houston area, TWIA could see losses in the $3 billion to $5 billion range, an amount it is not prepared to respond to under its current funding structure.

TWIA estimates the potential windstorm loss at about $3.3 billion, but they only have about $1.3 billion available. “So if they had a 100-year storm down there they would be in trouble,” says PCI’s Griffin.

Should a major storm strike, property/casualty insurance companies that operate in the state would be hit with unlimited assessments to cover the remaining losses. Those insurers could then recover the amount of those assessments through premium tax credits, which could in effect remove about $5 billion from the state’s operating budget over the course of several years.

“The right way to handle a deficit in a residual market like TWIA is to assess insurers for their proportion of the deficit, and then allow insurers to recoup those deficits via a surcharge directly to policyholders,” AIA’s Goldberg explained. “That’s not what’s done today.” Today, “insurers are assessed based on their percentage of the market, then they have to recoup those assessments through the rate process and that’s a problem because of the way accounting rules are set up.”

When insurers get assessed they have to carry that assessment on the negative side of their balance sheet, Goldberg continued. “But if there’s a law that says you can recoup those deficits directly through a policyholder surcharge, then you can offset the assessment in the same year.” That provides more capacity to write new business, he said. “That’s what the Texas legislature tried to do last year, and it failed in the 11th hour. … hopefully they’ll do it right in ’09.”

“The change that Texas was looking at certainly would be helpful,” Griffin said. “What we see in some of these coastal windstorm programs is a growth that is getting quite large.”

TWIA’s current liability is more than $46 billion and some expect that number to grow to $60 billion by the end of the year.

Despite Texas Insurance Commissioner Mike Geeslin’s approval of $1 billion of reinsurance for TWIA this year, the reinsurance is not sufficient to fund even a 50-year storm without resorting to insurer assessments at a level that would qualify for premium tax credits, the industry says.

California quakes

When it comes to natural disaster risks, California has them all – floods, fires, tsunamis and earthquakes. Hurricanes can also be an exposure although very rare. The greatest and most damaging natural catastrophe the Golden State faces is earthquake exposures, although wildfires played a significant role in 2007 catastrophe losses.

This year, the California legislature passed a bill that designates $1.3 billion from participating insurers (PI) to fund the California Earthquake Authority (CEA), the largest privately funded and publicly managed catastrophe pool in the nation. That $1.3 billion contribution is being made with no compensation to the PIs and brings the total financial support by the PIs to more than $3 billion. It will replace a $2.2 billion current PI commitment that’s scheduled to expire on Dec. 1, 2008.

The CEA was formed in 1996, following an insurance availability crisis triggered by the 1994, 6.7-magnitude Northridge earthquake that struck California’s San Fernando Valley.

Insurers writing homeowners insurance in California must offer earthquake coverage, either on their own paper or through participation in the CEA.

PCI’s Griffin said that when the CEA was originally structured it included a set provision for a $2.2 billion layer that was the insurance industry’s first level of assessments. “The idea originally was that the CEA would have enough funds over time … and wouldn’t need that industry assessment layer.”

But that hasn’t happened because not as many people buy earthquake coverage as anticipated. In addition, pricing has been stable because the market hasn’t seen a major earthquake in some time, he noted.

“The concern was that this layer was going away and they needed that additional capacity,” Griffin said. In the end, the insurance industry struck a deal with the legislature to still provide a layer of assessment but at a different level. “It’s not the $2.2 billion; it’s a $1.3 billion layer at the top end,” Griffin said.

“Theoretically we should have let the layer go away,” Griffin noted. “Some didn’t want it to go away at all; the industry wanted it to go away entirely. In the end we were able to reach a compromise.”

Catastrophic wildfires wreaked havoc on Southern California in late October. Insurers expect to pay as much as $1.6 billion to thousands of policyholders affected by the wildfires. Yet, the financial toll of this recent disaster is well within the range of what insurers anticipated and should not drive up rates, said Dr. Robert Hartwig, president of the Insurance Information Institute.

“Certainly they are catastrophe risk,” says Griffin. But he noted, “having paid upwards of $62.5 billion in 2005 from hurricanes Katrina, Rita and Wilma, a $2 billion to $3 billion event is not something that’s going to have a severe financial impact on the industry.”

While the wildfire losses thus far have been manageable, property owners and the state’s insurance industry can’t afford to ignore wildfires. “Everybody is always focused on the hurricanes threat, but certainly wildfires, sometimes hail storms, tornadoes, earthquakes, all those things enter (into the discussion),” according to Griffin. Even severe flooding, while not covered by the private insurance market, still impacts the industry, he said.

Florida’s different than the rest

Florida kept the industry and legislators busy this year after a special legislative session in January resulted in the expansion of the Florida Hurricane Catastrophe Fund. The idea was to provide insurers with less expensive reinsurance from the state in hopes that insurers would pass those savings onto insureds.

Among other things the legislation, House Bill 1A, also allowed the state’s property market of last resort, Citizens Property Insurance Corp., to compete with private insurers and blocked insurers from raising rates without state approval.

Florida is taking a different approach in how it has addressed catastrophe risk, notably hurricanes, than any other state, says AIA’s Goldberg.

“The state is essentially having the state be the homeowners insurer and instead of pre-funding risk, which private market insurers do, Florida is doing the opposite by post-funding risk,” Goldberg said. “They are keeping premiums artificially low on the front end and when there is a loss the money essentially isn’t going to be there to pay for those losses.”

Should the state get hit with another catastrophic hurricane, it would be forced to assess all policyholders by floating bonds backed up by the state’s taxpayers, which would be repaid over a long period of time with interest, Goldberg said.

“That’s exactly the opposite of how the private market works today and it’s not an approach we think is a sound one.”

PCI’s Griffin added that those “artificially low rates” in Citizen’s have also lead to a significant expansion in the program. Citizens has grown “more than we like to see,” he said.

While no other state has the kind coastal exposure or hurricane risk that Florida does, the state’s approach has very misguided, in Goldberg’s view. “The better approach is to give private insurers the tools… to manage the risk of natural catastrophe, and to have those risks spread throughout the global reinsurance markets.”