For the past 13 years, Florida property insurers have beencomforted knowing that no matter how many severe hurricanes hit thestate, they always had a backstop of reinsurance through theFlorida Hurricane Catastrophe Fund. Often known as the “crownjewel” of the post Hurricane Andrew reforms, according to mostexperts the Cat Fund has been responsible for sustaining a privatemarket that otherwise may have fled the state, especially after thehurricane seasons of 2004 and 2005 that cost the industry over $33billion dollars. But never before has the market and the stateleaned so heavily on the fund's ability to prop up the market inthe event of a major hurricane. All of which, leaves open thequestion of how much financial pressure can the Cat Fund take.

When Governor Charlie Crist was elected on the platform oflowering homeowners' rates, the Cat Fund became a major player inaccomplishing that goal. Showing confidence in the Cat fund,lawmakers changed state law to have the fund pick up more risk,lessening the exposure of private insurance companies in an effortto lower the premiums homeowners pay for their wind damagecoverage. The trade-off is that the catastrophe fund will be on thehook to pay more in claims from a large storm.

To get the Cat Fund in a better financial position to react to amajor storm, Crist and state officials in charge of the Cat Fundsought to borrow about $7 billion from the capital markets so thestate would have a total of about $12 billion available almostimmediately after a storm. “The idea is to make sure that we havethe money there,” Crist said after a cabinet meeting approved theidea in late July. “If we have a big storm, we've got the money topay to make sure our people are covered.”

Turbulence in the Capital Markets

But a not-so-funny thing happened as the Cat Fund prepared toseek additional financing by selling bonds: It found the creditmarkets had grown much tighter than expected–largely because of thefallout from the sub-prime mortgage lending fiasco.

As a result, the state Board of Administration fund managersthat oversee the Cat Fund decided to delay indefinitely issuing anybonds. The unexpected delay, which occurred at the peak of theAtlantic hurricane season, has sent shivers throughout the Floridainsurance industry. The concern is not so much can the Cat Fundraise the money now, but whether it will be able to raise billionsmore after a catastrophic storm.

“There is a concern about how quickly the Cat Fund can raise themoney it needs,” said Sam Miller, spokesman for the FloridaInsurance Council. “Would the Cat Fund run into the same problemafter a major hurricane? There always was a concern among someinsurers about whether the Cat Fund would have enough money, nowthere is a lot more concern.”

Before the legislative changes enacted in January, the Cat Fundwas only on the hook for $16 billion in claims. Now, that figure isa whopping $28 billion. Currently, the fund has $3.8 billion cashon hand now and, barring a hurricane, will have $5.2 billion by theend of the year. Private insurance firms purchase backup insurancefrom the state's catastrophe fund. The fund begins to pay damageclaims when total property losses exceed $6 billion.

A Question of Liquidity

William Stander, assistant vice president and regional managerfor the Property Casualty Insurers Association of America, also hasconcerns about the Cat Fund's future viability. “Would the capitalmarkets be able to absorb a huge offering of $20 billion or morefollowing a storm,” he said. “There is definitely a question ofliquidity and it is unclear if the Cat Fund would be in aprecarious position.”

The main issue, Stander said, is that after a big storm it won'tjust be the Cat Fund going to the capital markets for money.Citizens Property Insurance Co., the state's largest insurer andinsurer of last resort, would also likely be looking to borrowbillions as well. This raises the question of whether the bondmarket would be able to handle both. The single largest bondoffering ever made by a tax exempt organization was $10 billion byan Illinois public works project, Stander noted.

Under laws passed by the state legislature, insurers have to payclaims within 90 days. So the insurers won't have months to delayseeking funding in the case of a natural disaster. If the Cat Fundcan't meet its obligations, the State of Florida or Floridaconsumers will have to step in. That would mean either a specialassessment on homeowners or a big bump in sales taxes.

Boosting Reserves: an Option?

The state catastrophe fund has always had the ability to issuebonds and assess policyholders after a major hurricane. But, theFlorida Cabinet decided that the catastrophe fund needed more inthe bank before a hurricane so it would be ready to respondquicker. Financial advisors to the Cat Fund last January said theydidn't expect the fund to have any problem boosting its reserves,which many expected to be done through a series of bond offerings.But that was before the $1.2 trillion sub-prime home loan marketfell into a deep freeze this summer as delinquencies by borrowerscontinue to rise and credit rating agencies downgrade thesecurities.

A lending slowdown in a housing market that is already seeinglower average home prices across the U.S. is threatening to spillover into broader credit markets and slow economic growth evenfurther. Officials from the Florida Cat Fund had little to sayafter postponing its bond offering, and they refused to talk aboutits prospects of having enough money or liquidity should a majorstorm hit. “We normally don't provide any type of commentary orattempt to speculate on future events,” said Cat Fund spokesmanMike McCauley. As far as when it will go to the bond market again:“The State will continue to evaluate market conditions and accessthe market as conditions normalize,” he said.

Citizens Changes the Equation

In the short term at least, Florida homeowners will likelybenefit by the state's decision to delay selling bonds in the tightcredit market. That's because, by waiting, Florida could find abetter rate on the bonds later, state fund managers and analystsagree. To average Floridians, the decision means that potentialassessments, fees collected by the catastrophe fund that show up oninsurance policies, would be pricier if bonds were issued now thanif the state were to wait.

Meanwhile, insurers, citing the catastrophe fund's low cashreserves, are purchasing a special kind of reinsurance that wouldgive them access to quick cash to pay claims if hurricanes strike,in case the catastrophe fund is slow to pay. Some are also seekingto charge policyholders for that cost, which has irked some stateinsurance officials.

The PCIA, whose 1,000-plus members write more than $194 billionin premiums, supported expansion of the Florida catastrophe fund.That was before the “dramatic expansion” of Citizens, which isusing “artificially suppressed” rates. If a 1-in-25-year storm hitsFlorida, Citizens would suffer a $3.7 billion deficit and the CatFund would suffer a $22.3 billion deficit, according to a report byMilliman Inc., which was commissioned by the PCI.

To pay for claims, those entities would likely have to seek outthe bond market to raise up to $26 billion for a 1-in-25-year stormand up to $69 billion for a 1-in-250-year event, Milliman said.That would take time to arrange, and might negatively impact thestate's credit rating, it said.

Florida Insurance Commissioner Kevin McCarty is very aware ofthe potential problems. “Certainly you can conjure a scenario wherea number of storms can bankrupt the Cat Fund and Citizens insurancecompany,” McCarty said. Yet, given the state's critical situation,“I think Florida has done the prudent and responsible thing,” hesaid.

McCarty has criticized Florida insurers for spending the savingsfrom the legislative reforms buying reinsurance instead of passingon the savings to policyholders. But insurers say they are onlybeing prudent.

“Consumers have not seen savings anywhere near those promised bythe governor because the 'reforms' enacted during the SpecialSession ignored the economic reality that hurricanes present to allFloridians,” Stander said. “The fact is, Florida has more coastalproperty–nearly $2 trillion worth–exposed to more frequent andsevere storms than anywhere in the world.”

To follow the history of the Florida Cat Fund's annual bondingcapacity and end of year balance go towww.sbafla.com/fhcf/pdf/bonding-estimates/be.pdf.