Fearful that a giant storm or a series of hurricanes couldcripple the Florida Hurricane Catastrophe Fund (Cat Fund) this yearand lead to huge assessments, the trustees of the fund in July madean extraordinary decision to pay $224 million now to secure aguarantee from Berkshire Hathaway that the Nebraska-basedconglomerate would buy $4 billion in bonds in the event that theamount of storm losses reach $25 billion.

Governor Charlie Crist, Attorney General Bill McCollum, andChief Financial Officer Alex Sink all voted in favor of thetransaction, but it only came after a round of criticism from bothMcCollum and Sink that the state was in a bind due to the potentialexposure of the Cat Fund, which was expanded in 2007 right afterCrist came into office. The two elected officials implored Crist toset aside time in the coming months to consider alternatives thatcould reduce the potential claims paid by the Cat Fund, which wouldlikely trigger large assessments.

“I don't like being in a panic,” said Sink, who faulted theFlorida legislature for failing to approve her proposal that calledfor reducing the amount of risk that the Cat Fund now faces by atleast $3 billion. During the 2008 hurricane season, the Cat Fundhas maximum obligations that exceed $29 billion.

Crist said he was not “panicked” but “concerned,” and that iswhy he and his office asked the State Board of Administration (SBA)back in March to start researching what could be done to ensurethat the Cat Fund has enough money to fulfill its responsibilitiesto insurers that purchase coverage from the state-createdreinsurance program. (The SBA oversees the Cat Fund.)

Credit Crunch Raises Fears

John Forney of Raymond James & Associates led a team offinancial advisors who concluded that while the Cat Fund enteredthe 2008 hurricane season with its largest set of cash resourcesthan ever before, it still wasn't enough. The Cat Fund has roughly$8.1 billion available through a combination of cash reserves andpreviously purchased bonds.

While a senior underwriting team continues to believe that theCat Fund could raise $10 billion in the bond markets in the eventof large losses, Forney said the financial team became concernedthat the ongoing crisis with financial markets could make itdifficult to quickly go out in the private market and raise neededcash in the event of a storm that brought huge losses. He said“access to private markets could be a perilous process.”

In analyzing what could be done, Forney said the financial teamconcentrated primarily on finding some type of backup to cover CatFund losses between $25 billion and $29 billion, or storms aspowerful as Hurricane Andrew or Hurricane Katrina. After looking atvarious options, including purchasing private reinsurance, orbuying bond insurance, Forney said the approach that was the mostpractical was to purchase a tax-exempt bond “put option,” which iswhere the Cat Fund pays an upfront fee in exchange for a guaranteethat any bonds it issues will be purchased.

Under the terms negotiated with Berkshire Hathaway, the statewould sell the bonds to the conglomerate if losses reached the $25billion threshold. The bonds would last 30 years and pay aninterest rate of 6.5 percent, leading to an annual debt service of$382 million, which would require an additional one percentassessment to support. Initially Berkshire Hathaway was onlywilling to buy the bonds in the event of one storm that triggered ahuge storm, but after negotiations agreed to also buy the bonds ifthe aggregate losses from multiple storms also reached the $25billion threshold.

McCollum called the put option a “very bad deal” and said therewas only a three or four percent chance that the state wouldactually need to borrow the additional $4 billion. But he also saidit was the only responsible action that the state could take at thecurrent time given the needs of the Cat Fund. Sink, likewise,criticized the deal, saying that Berkshire Hathaway was the onlyfinancial entity that was willing to negotiate with the state rightnow.

“We are being held hostage by one product,” said Sink, who notedthat Berkshire Hathaway CEO Warren Buffet “did not become amulti-billionaire by not doing good deals for himself.

“We've got both hands tied behind our back,” she added.

Focusing on 2009

While the 2008 hurricane season has just started, Sink andMcCollum said state officials need to start in the next few monthsto figure out how to change the exposure of the Cat Fund in timefor the 2009 season. They also asked the SBA to continue to look atissuing additional pre-event bonds that could lower the amount ofadditional financing the Cat Fund would need after a storm hitsFlorida.

“I am concerned where we are with this entire insurancesituation,” said McCollum, who said if a storm hits he wasconcerned that interior residents of Florida would wind up payingmore to subsidize people who live on the coast. “The situation weare in today for the people of Florida is not good.”

One possible solution in the year to come: having the state goout to the private market and purchase reinsurance. Craig Bissellof Aon Re told state officials that reinsurers could offer a seriesof financial options that could add as much as $3 billion inadditional capacity for a total cost of between $225 million to$300 million.

No Rate Hikes Needed for Now

Initially, SBA staff had recommended that the board trusteesapprove a change in the 2008 Cat Fund premium formula in order topay for the $224 million that would go to Berkshire Hathaway. Thiswould have triggered a 17 percent hike in the premium charged toinsurers, who would then be able to ask for increases from theOffice of Insurance Regulation in order to recoup the cost. Onestate analysis calculated that this would have resulted in a 2.5percent increase to policyholders.

But Crist, who supported the purchase of the additional supportfrom Berkshire Hathaway, voted against a change in the premiumformula, saying that he would not support anything that wouldresult in a rate hike for insurance customers. Both Sink andMcCollum did vote in favor of the premium change, but Crist's staffcontended that state law required a unanimous vote.

McCollum's office was initially asked to come up with a legalreview of whether a unanimous vote was needed. But then SBA InterimDirector Bob Milligan did a turnaround, issuing a statement thatsaid the money needed to purchase the put option would come out ofthe Cat Fund reserves. That means that the Cat Fund, which wasprojected to have $3.62 billion in cash by the end of the year,will only have $3.59 billion on hand to pay claims.