Nearly two years ago, when Florida lawmakers created asuper-sized backup for private carriers in the state, the idea wassimple: Do what it takes to cut property insurance rates.

Those who criticized the idea of expanding the Florida HurricaneCatastrophe Fund, the state-run alternative to private reinsurance,were fearful that if a big storm came it would mean hugeassessments on insurance bills in order to pay off the claims.

What no one expected back in January 2007, however, was amonumental meltdown in the American financial system and a seizingup in the credit markets. The result? There is now no way the CatFund comes up with anywhere near the amount of money it would needto take care of a storm similar to Hurricane Katrina.

Exactly how short? The Florida Hurricane Catastrophe FundAdvisory Council in October adopted new bonding estimates for therest of the year that concluded the fund, which is responsible forup to $28 billion in losses, could be short anywhere from $10billion to $15 billion if a major hurricane hits the state betweennow and the end of the hurricane season.

The Council, which is required twice a year to calculate bondingestimates for the Cat Fund, approved the estimates after hearing asobering report prepared for them by a team of financial advisors.The team of advisors concluded that the turmoil in the financialmarkets have made it virtually impossible to borrow the amount ofmoney that the Cat Fund is currently obligated to cover.

The final estimate shows that the Cat Fund could probably onlyborrow from $1.5 billion to $3 billion in the next six to 12months, giving it a total capacity between $11.7 billion and $13.2billion. But in the event that money were needed sooner, thesituation is even bleaker, with one financial advisor publiclystating that the Cat Fund could maybe borrow as little as $250million if the money were needed in the next three months.

Outgoing State Rep. Don Brown (R-DeFuniak Springs), an insuranceagent and one of just two House members to vote against theexpansion of the Cat Fund, listened to the presentation and had oneword for it: “Scary.”

“What we are basically saying is we can't pay under currentconditions,” said Brown, who attended the meeting where the bondingestimates were approved. “That's not good.”

Cat Fund Has Money on Hand

However, Jack Nicholson, chief operating officer of the CatFund, continues to emphasize that the Cat Fund is not broke andcould in fact probably pay off claims for several months if theunthinkable were to happen. He points out that the fund already hasin excess of $10 billion available to pay claims. Nicholson notesthat the Cat Fund had nowhere near that amount of money on handwhen Florida was hit with eight storms in 2004 and 2005 and thefund had to pay out $9 billion.

Nicholson also said that the fund would probably not need alarge infusion of cash right away, because it could take months tofile and pay off claims to those private insurers who havepurchased reinsurance with the Cat Fund.

“We are in a very strong position,” said Nicholson. “We are inthe strongest position we have probably ever been in.”

The reason the Cat Fund borrowing estimates are so important isbecause it was always envisioned that the fund would have to issuesome bonds in order to pay off its debts if Florida were hit with abig storm. The fund then pays the bonds back with premiums fromprivate insurance companies and assessments it can tack on existinglines of insurance issued in the state.

John Forney, the lead financial advisor for the Cat Fund,asserted that the fund model is still a viable one. Forney, whoworks for Raymond James & Associates, maintains that thebonding shortfall should not be viewed as an “indictment of thesystem,” but rather as recognition that the financial crisis haswreaked havoc on the credit markets.

Forney also said the ongoing situation showed that it was a wisedecision earlier this summer for the state to pay $224 million toBerkshire Hathaway for a “put option,” where the company guaranteedit would purchase $4 billion in bonds in the event losses cross the$16 billion threshold.

Forney said there “is something to be said” for pointing outwhat he called the “strong attributes” of the fund. He said thefund still maintains an AA bond rating and remains attractive tosome investors because of its ability to impose assessments oninsurance policies, which he said was “akin to a sales tax.”

Forney also suggested that private insurance carriers shouldlook to building up their own “liquidity” as well so they can payout some claims before turning to the Cat Fund. And he added thatthe situation could quickly change in the next few months andcredit markets could ease.

“Nobody's crystal ball is clear right now,” said Forney.

Backup for Fund Urged

But while Forney urged people to not focus on the “gloom anddoom part of the presentation,” those representing some ofFlorida's largest private insurers are less upbeat about thesituation.

Mark Delegal, an attorney and Tallahassee lobbyist for StateFarm Florida, publicly asked that the state purchase additionalprivate reinsurance to cover any potential losses. Delegal notedHurricane Wilma hit the state in late October 2005 and it wasplausible for another late season storm to surface this year.Delegal said he talked to reinsurers who said that there was $10billion of coverage available.

“We would encourage you to shore up the Cat Fund as much aspossible,” said Delegal. “We would like to hope and pray therewould not be a hurricane between now and the end of the year, butit could happen.”

But Nicholson countered that such a move may not help. He saidit was much better to keep the cash the fund has on hand in case ofa storm rather than use some of it to purchase additionalreinsurance to cover potential losses.

Another point brought up by some private insurancerepresentatives: How can the state force insurance carriers to“pass on the savings” of the Cat Fund's cheaper reinsurance if itcan't provide a guarantee that it has the money to pay offclaims?

Nicholson said that's a legal issue left up to the Office ofInsurance Regulation and state lawmakers who mandated that privatecarriers utilize the fund. But there is some fear it could affectrates, especially if there is a push for them to acquire additionalreinsurance. A.M. Best issued a statement in mid-October where itsaid it was “concerned with the contingent capital nature” of thefund.

One member of the advisory council, however, maintained that thefederal government would step forward and provide assistance if thestate were hit with a storm of such size that it would wipe out theexisting Cat Fund assets.

“I don't want to depend on the federal government to be thebackstop, but we are na?ve if we walk out of here saying the CatFund won't pay its claims,” said John Auer of American StrategicInsurance Company.

Additional Wall Street Fallout

The problems of the financial crisis haven't just hit the CatFund's borrowing ability. They have also hit the fund itself. Theactual cash balance of the fund has suffered losses due to theunprecedented downturn in the market. An October presentation tothe advisory council stated that there had been $216 million inrealized investment losses and a $139 million loss in potentiallosses using mark-to-market investment guidelines.

Right now the current fund balance is $2.31 billion, with anexpected ending-year balance of $2.78 billion. Richard Smith, aportfolio manager with the State Board of Administration, said thatwhile overall investments continue to perform well, it was the“worst 11 months” in the history of the fund.