Florida's big gamble to fix the state's property insurancemarket is becoming more and more a losing bet.

State lawmakers rolled the dice in 2007 and expanded the size ofthe backup insurance the state provides to insurers as a way tocontrol the prices of private property insurance. Their luck hasheld out for two years as Florida avoided any serioushurricanes.

But the ongoing national credit crisis and recession has donewhat the weather couldn't: Batter the Florida Hurricane CatastropheFund so much that it may be unable to keep insurance rates down anylonger.

Heading into this year's hurricane season, financial advisorsand top officials for the Cat Fund estimate that the fund is awhopping $18.43 billion short of what it is supposed to cover forboth private insurers and for Citizens Property Insurance Corp.,the state-created insurer of last resort. It's not that the CatFund is broke, but right now the most optimistic scenario showsthat the fund has about $10.57 billion in potential resources,which would include an estimated $3 billion in bonding.

The fund, however, is legally obligated to offer up to $29billion in coverage for the coming year, even though right nowthere is no guarantee that the state could borrow the money itneeds for claims if a major storm hits. The ongoing credit crisishas shredded the state's ability to go out and find potentialsources of funding.

The current risk models show that there is a six percent chancethat Florida could get hit with a storm of enough force to wipe outthe fund's current finances. If that happens, it could cause thecollapse of the state's entire economy.

“We're really in a bad situation,” conceded Cat Fund CEO JackNicholson.

Cat Fund Woes Could Rattle Industry

The news that the Cat Fund lacked the financial resources in theevent of a big storm surfaced last fall when the credit crisisfirst gripped Wall Street. However, there were expectations thatthe crisis would ease before private insurers needed to go out andpurchase reinsurance for the 2009 season.

Instead, the problem has grown more acute. That is because ofthe multi-layered way the Cat Fund works. The fund has optionalcoverage it offers to insurance companies, as well as a mandatorycoverage that all carriers must purchase.

The largest optional coverage, called the Temporary Increase inCoverage Limit, is roughly $12 billion worth of risk that statelawmakers authorized in 2007. Companies are under no obligation tobuy it, but many do. (State law says that if private companies turnto private reinsurance to provide this level of coverage theycannot pass on any of the higher costs on to their customers.)

But the bigger problem now is that the fund's shortfall is sosignificant that it also includes part of the roughly $17 billionin mandatory coverage that all carriers must buy in order to dobusiness in Florida. Most carriers who purchase the mandatorycoverage purchase a policy that covers 90 percent of their lossesonce they meet their deductible limits.

The looming shortfall could have tremendous ramificationsthroughout Florida's private insurance market. If the Cat Fundcannot pay off claims, it puts private insurers at risk of beingunable to cover storm damages and potentially going insolvent.

But even without a storm, the Cat Fund troubles could forceinsurers to spend substantially more money in the privatereinsurance market at a time when reinsurance rates are expected toclimb. Rating agencies may be forced to downgrade the financialcondition of private insurers because of the problem.

“Make no mistake about it — there is no more significant entityin the Florida property insurance market than the Florida HurricaneCatastrophe Fund,” said John Forney of Raymond James &Associates, who acts at the Cat Fund's financial advisor.

Demotech Inc., a rating company that has rated the smallerstart-up domestic companies in Florida over the last several years,warned in a November letter that it could begin changing rates byMay 15 unless it got “definitive financial information” that showedthe fund had access to cash it could use.

Crisis May Force Lawmakers to Act

This unraveling of the Cat Fund places additional pressure onlawmakers to act during their annual session that convenes inMarch.

The $12 billion in optional coverage is due to expire in 2010.Some legislative leaders, such as Senate President Jeff Atwater(R-North Palm Beach), have already been pushing forward the idea ofa “stair-stepping” or “glide path” downward of the amount of CatFund coverage this year. Atwater and other legislators favored agradual decline so that there would not be a need to sharplyincrease insurance rates.

But such an approach may be insufficient if the unthinkablehappens and the state is hit with a major storm this year. Plus,some legislators say it is wrong to sell reinsurance to companiesif there is no way the claim can be paid.

“To me, that is being dishonest,” said Rep. Alan Hays, aUmatilla Republican and vice chairman of the House Insurance,Business and Financial Affairs Committee.

However, if lawmakers chose to eliminate a large portion of theCat Fund coverage, it would inevitably lead insurers to seek ratehikes to offset the purchase of more expensive private reinsurance.Nicholson told lawmakers last month that the Cat Fund results inabout a 30 percent premium savings for customers.

In a Jan. 30 memo, Forney said that he sees three options: Lowerthe amount of coverage offered by the fund, have the state purchasefinancial backing in the private market, or look to the governmentfor help.

Last year, the fund spent $224 million to purchase a $4 billionloan guarantee from Berkshire Hathaway, Inc. But the outlook for asimilar type of deal this time is murky; meetings between Nicholsonand the company have not yielded any concrete arrangements.

If the state turns to the private reinsurance market andpurchases up to $5 billion in coverage, then it will be at a heftyprice. According to the fund's financial advisors, such a dealcould cost the fund as much as $1.25 billion, which would alsoforce up insurance premiums.

Forney admits that even doing this won't be enough to cover thesizable shortfall. He has recommended that if the state doespurchase private reinsurance, then it use it to shore up themandatory coverage layer.

Possible Federal Bailout

The other possible solution is to turn to the state or federalgovernment for help.

Back in 2006, Florida did help shore up Citizens, but thecurrent meltdown in the economy has sapped the state's financialresources. Florida lawmakers have already slashed billions in statespending, and they expect to do even more cutting in the next fewmonths.

Insurance Commissioner Kevin McCarty traveled to Washington D.C.in February to lobby Florida's congressional delegation on the ideaof trying to obtain a line of credit that the state could use inthe event there was a problem with the fund.

“We are not oblivious to this situation,” said Deputy InsuranceCommissioner Belinda Miller. “We would like to see a federalbackstop if we could obtain one.”

But it's not clear that such an approach will work. Pastlobbying efforts to convince Congress to create a nationalcatastrophe fund have been blocked by politicians from non-coastalstates concerned that their taxpayers would wind up subsidizingresidents of California, Florida, and Texas.

There is a fourth option, one we have relied on before: Wait andthrow the dice, betting that Florida can stay lucky for yet anotheryear.