Florida Looks to Restructure Its Hurricane Fund; Federal Option Proposed

Florida lawmakers are poised to consider restructuring the state-run property reinsurance facility by possibly lowering its mandatory annual capacity by billions due to concerns that one major storm could exhaust its resources and leave insurers without further coverage.

The Florida Hurricane Catastrophe Fund is statutorily responsible for providing property insurers up to $17.5 billion in coverage for a single storm season and another $11 billion for losses from a second storm.

Cat Fund Executive Director Jack Nicholson said the Cat Fund currently has $8.5 billion in cash and an estimated bonding capacity of $7 billion for a total of $15.5 billion. However, that still leaves it short by $1.5 billion to meet its first storm obligations and potentially on the hook for another $11 billion.

Nicholson said that is why he would like lawmakers to consider restructuring the fund so that its financial stability improves and it can help bring more stability to the state’s insurance market.

“We want to maintain capacity for the long term and not exhaust it in one year,” said Nicholson.

Nicholson said one major question is whether the Cat Fund, if it has to issue bonds to reimburse insurers for losses, could do so quickly enough before the insurers went insolvent.

Citing concerns of the uncertainty in the bond markets that are still recovering from the recession and the turmoil surrounding the federal budget issues, Nicholson said the more the Cat Fund depends on the markets, the less stable it becomes.

“We could end up out on a limb depending on the financial markets,” said Nicholson. “There are just no clear signals what things are going to be like in six months or two years.”

Nicholson said one option the fund is exploring is issuing pre-event bonds to beef-up its cash on hand to pay claims.

Florida Insurance Counsel Sam Miller said it is incumbent on lawmakers to examine possible changes in the Cat Fund.

“If the Cat Fund is supposed to be able to pay $17 billion, then it should be able to deliver that,” said Miller.

There are some political complications to any Cat Fund reform. Some of the legislative solutions surrounding the fund called for its $17 billion obligation be reduced by as much $5 billion to $12 billion. Doing that would require the industry to increase its financial retention rate and depend less on the Cat Fund as a source of reinsurance. In so doing, however, it would inevitably increase insurers’ rates since they would have to make up the difference in coverage with more expensive private reinsurance.

One option to mitigate those rate increases would be to carve out any rate changes so that they are not included when calculating agents’ commissions. There is a precedent for such a move. There is a catastrophe risk load factor placed on every Citizens Property Insurance Corp. policy that is not included in agents’ commissions.

“We shouldn’t pass increases on to insurance agents,” said Miller. “Instead the focus should be on rates.”

Agents do not like that precedent. Florida Association of Insurance Agents President Jeff Grady said that such a move would penalize agents that are already taking a financial hit due to the increase in mitigation credits that reduce policyholders’ premiums.

Grady said that in Miami, the commission listed by Citizens for a personal lines policy is 10 percent. However, due to all the premium carve-outs and mitigation credits, the effective rate is more like 5.5 percent.

“Agents are losing hand over fist,” Grady said. “And this is just a matter of the last guy standing in line getting stuck with the bill.”

While Florida explores ways to bolster the Cat Fund, one member of Florida’s congressional delegation has proposed legislation that would create a federal backstop funding source in the event the Cat Fund and other state-sponsored reinsurance facilities cannot meet their obligations.

Republican Rep. Dennis Ross has filed the Homeowners Insurance Protection Act that would cover funding shortfalls for state catastrophe funds like the Cat Fund in the event of a one-in-200 year disaster.

The bill also contemplates allowing other state-sponsored property insurance programs such as the Louisiana Citizens Property Insurance Corp. and the California Earthquake Authority to purchase reinsurance from the federal fund.

‘When a once-in-a-lifetime disaster strikes, whole communities are lost and people want to rebuild and they want to rebuild quickly,” said Ross in a statement. “The Homeowners Insurance Protection Act will provide a safety net to insurers and markets, allowing them to provide affordable insurance to homeowners and allow Americans to rebuild.”

The proposed legislation is not without its critics.

R Street Senior Fellow R.J. Lehmann said the legislation would serve as a disincentive for states like Florida to address their own insurance markets and instead rely on underfunded residual market entities like Citizens. He said that a federal backstop would encourage developers to construct even more property along state’s coastline, increasing catastrophic exposure.

“A new federal reinsurance program would exacerbate all these programs,” said Lehman.