They Say, Hearsay
I read that the property insurance bill Gov. Rick Scottsigned has something in it that will make my homeowners' premium goup by 15 percent a year because of rising reinsurance costs. Whatthe heck is this reinsurance, and why am I paying for it?

We Say
Remaining fully informed about legislative changes to propertyinsurance—and their impact—is a little like trying to follow thestoryline in one of those too-cleverly written spy thrillers thatkeep you on edge. Keeping up with the twists and turns of annuallegislative manipulation of property insurance law is hard enoughfor those of us in the business.

Our policyholders are even more confused, and not only feel onthe edge of a cliff, but maybe over it. Help them back away bybringing context to inquiries over how the change in SB 408 relatedto reinsurance works. 

First off, we need to correct the misrepresentation thatpremiums are going to rise by 15 percent a year now that insurerscan pass along reinsurance costs to customers. Insurers previouslywere allowed to do this (at 10 percent), so it is nothing new. WhatSB 408 does is raise the pass-along ceiling from 10 percent to 15percent. More than a few people figured (incorrectly) that rateswould double in 5 years due to this change because they wereunaware that a pass-along already existed. Raising the ceiling by 5percent is a relatively small change. It also is worth noting thatif reinsurance rates do not rise, then there is no change atall.

Policyholders also should know that insurers are prohibited frompassing along any costs without approval from state regulators. In2009, a law allowed expedited rate filing reviews for reinsurancecosts, meaning that the Florida Office of Insurance Regulation(OIR) must approve or disapprove a reinsurance-related rateincrease within 45 days, rather than the 90 days it has to look ata regular rate increase. The faster reviewenables insurers to account for fluctuating reinsurance prices, andthis has an upside to insurance consumers: If an insurance companycan more quickly recoup the costs of doing business, then it can domore business. The existence of reinsurance allows insurers towrite more risk, therefore bringing competition to the market.

Buying reinsurance is not optional in Florida. All insurers arerequired to purchase a mandatory layer of reinsurance from thestate-sponsored Florida Hurricane Catastrophe Fund (Cat Fund).Because it funds a good portion of the coverage it provides byselling bonds after a major storm occurs, there is always thespecter of falling short of what is needed.

So, insurers who have limited financial flexibility with theirown on-hand funds seek sources of protection with privatereinsurers in addition to the Cat Fund. This enables them to payclaims that may come with a major hurricane, continue to servicepolicyholders after storm claims are paid, and earn a decent gradefrom rating companies.

(By the way, the state's Citizens Property Insurance Corp. isbuying private reinsurance this year for the first time since2006.)

Taking on the extreme risk of writing wind insurance in thenation's most hurricane-prone state is made possible throughreinsurance. Smaller, Florida-only companies rely most heavily uponit. Without access to the worldwide resources of reinsurers, onlyvery large national companies could write any business in Florida,and most of them have curtailed their exposure here. The truth is,reinsurance is often the cheapest and best form of capital for manyof Florida's insurance companies.

It is hard for policyholders to believe that the money Floridainsurers have on hand is not enough to pay for actual claims,especially following a natural disaster. Yet it is painfully true.It is challenging to figure out how the cost of reinsurance affectsan individual insurer's rates because while regulators review allreinsurance contracts, reinsurance is not considered a statutoryasset until reinsurance losses are incurred. That helps explain whythere is a big disconnect when one looks at the annual reportdeveloped by the OIR. It shows premiums collected and claims paidout, but does not reflect the value of reinsurance. Without it,however, many Florida insurance companies would not be able to payclaims after even a relatively small hurricane.

A well-planned reinsurance program preserves policyholdersurplus to pay for ordinary, everyday claims. Reinsurance pays forthe extraordinary claims, such as the $11.3 billion (in 2009dollars) in losses from Hurricane Wilma in 2005.