As the 2010 Hurricane Season wanes, another non-weather-related cost driver has been eroding what should have been a positive bottom line for Florida's property insurance industry. An unprecedented rise in the frequency and severity of sinkhole claims — which are often difficult if not impossible for carriers to defend — has significantly affected insurers' bottom lines.

The Florida Senate Committee on Banking and Insurance is in the process of finalizing an interim report on what now amounts to a crisis. Part of the statistical basis for the report will be the cumulative results of an industrywide data call issued by the Office of Insurance Regulation to all Florida residential and commercial property insurers. The Senate's ultimate findings and recommendations will undoubtedly fuel significant debate during the upcoming 2011 Florida legislative session.

No Hurricane Claims, Yet Insurers Are Losing Money

In an alarming trend, many residential property insurers in Florida are losing money despite several hurricane-free years. Most cost drivers that have caused poor financial results for insurers have been well-documented: suppression of rates; full replacement cost statutes mandating payment for damages, even if the insured does not undertake repairs; the ever-growing population of public insurance adjusters anxiously soliciting the next big claim; and the recession and related high unemployment that may be fostering fraudulent or enhanced claims activities. However, the exponential growth in sinkhole claims has emerged as a key culprit in damaging insurers' bottom lines.

In a recent interview, Florida Insurance Commissioner Kevin McCarty specifically characterized the unprecedented and growing number of non-catastrophe losses in Florida as an "explosion." He warned that, if left unchecked, the rise in sinkhole claims could significantly destabilize the state's tenuous insurance market.

Dramatic evidence of the magnitude of Florida's sinkhole problem is manifest through Citizens Property Insurance Corp.'s related claims statistics. In 2009, Citizens collected almost $20 million in sinkhole coverage premiums. Concurrently, it paid out almost $100 million for sinkhole claims.

Other Florida property insurers, while not necessarily experiencing commensurately dramatic premium-to-claim disparities, also have seen an unprecedented growth in the number of sinkhole-related claim payouts. With such a wide and unsustainable chasm between premiums collected and losses paid, the question remains whether sinkhole risk is simply uninsurable.

Sinkhole Problems Aren't New, Just Growing

Nearly 20 years ago, the Florida State University Center for Insurance Research conducted a study that determined sinkhole claims carried a relatively high adjustment expense, partially because determining the actual cause of loss related to earth movement was difficult to ascertain. In its conclusion, the study recommended that Florida establish a facility for the adjustment and payment of sinkhole claims similar to the Illinois Mine Subsidence Fund. While legislative committees have reviewed this study and its recommendations, no legislation has been adopted that would establish a facility specifically to deal with sinkhole claims.

A 2002 follow-up report concluded that, since the prior study, Florida's sinkhole problem had grown in frequency and severity. That study further noted that sinkhole activity appeared to be concentrated in the state's central region.

More recently, an April 2005 report to the Florida Legislature in part dealt with the feasibility of a state-established facility and set forth certain cost/benefit considerations. The report further determined that the frequency and severity of sinkhole losses continued to grow.

Moreover, additional 2003 industry financial statistics reflected that sinkhole losses equaled 3.71 percent of the industry's total annual premiums. This represented a huge increase from 1991, when sinkhole losses equaled .052 percent of premium dollars.

Altogether, this historical perspective documents a continued disproportionate increase in sinkhole losses — an alarming trend. Notably, the 2005 study voiced the geological community's concerns with language in Florida's principal law governing sinkhole coverage. More precisely defining the terms "sinkhole activity" (which geologists feel is difficult to quantify) and "sinkhole loss" was recommended.

The Legislature's 2005 efforts at revising both definitions have not apparently resolved the definitional issues concerning what constitutes sinkhole activity or loss in an insurance-coverage context.

Uninsurable at Any Price?

To deny a sinkhole claim, insurers must establish that the damages claimed were not caused by a sinkhole. This involves the retention of experts who must eliminate sinkholes as the cause of the damages within reasonable professional probability.

For the past 20 years, Florida sinkhole issues have remained a concern and problem to the property insurance industry. Consumer-friendly laws that foster large payouts, significant real estate development in sinkhole-prone areas, and the proliferation of claim-starved public adjusters, coupled with the recession and crippling unemployment, have created a fertile sinkhole claim environment.

Perhaps sinkhole risk may not be insurable by the private market at any price. Like flood and mine subsidence programs in other states, underlying coverage may well warrant the establishment of a public sinkhole fund or risk apportionment plan to subsidize the losses.

Florida's current sinkhole law requires carriers to hire professional engineers and geologists at substantial expense to disprove that the claimed sinkhole activity causes structural cracks and other property damages.

In litigation, an insurer would have to satisfy this burden of proof, which is often impossible as it requires the proving of a negative — that the damage was not caused by sinkhole activity. Thus, insurers are pressured to pay claims rather than incur substantial claims handling expenses or face the risk of losing in court and liability for attorneys' fees.

Florida's loose legal definition of "sinkhole loss," identified by the prior studies as encompassing "structural damage" to a building inclusive of the foundation, is a fundamental problem. This enables policyholders to secure claims payment, given any level of "structural damage" to the covered building, such as some cracks in driveways, sidewalks and along walls.

The 2010 Florida Senate sinkhole report is expected to show the significant driving cost of continued growth in sinkhole claim frequency and severity. Pasco and Hernandez counties have long been considered the centers for Florida's sinkhole activity. However, the recent spate of claims has reached far beyond those borders. The Senate's findings and recommendations — and the ultimate actions of lawmakers during the 2011 session — could dictate whether this issue will be the one that finally sinks Florida's property insurance industry.

Richard J. Fidei is a partner in the law firm of Colodny, Fass, Talenfeld, Karlinsky, Abate. He may be reached in the Ft. Lauderdale office at 954-332-1758 or by e-mail at rfidei@cftlaw.com. The firm also has offices in Tallahassee. The firm practices in insurance, legislative, regulatory and transactional law, commercial and civil litigation, governmental consulting and administrative law. Its litigation practice group handles commercial, civil rights, employment discrimination and child advocacy matters in both trial and appellate levels. More information is available at www.cftlaw.com.

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