Sinkholes: Have the Rates Finally Touched the Bottom?

The Florida Hurricane Catastrophe Fund in 2006 had to issue $1.35 billion in post-event bonds to cover the cost of reimbursing carriers for 2005 losses. At the same time the fund also transacted a deal to secure $2.8 billion for any future losses. And as with Citizens, all of the Cat fund's monies are backed by policyholder assessments.

Due to the magnitude of financial losses and the immediate impact on consumers, the state has established the Property and Casualty Insurance Reform Committee, which has drafted some 50 odd recommendations designed to create a blueprint for a major reform bill addressing the state's moniker of being "Hurricane Alley." Expected to be up for matter of debate during a soon-to-be-called special session, the committee is looking for ways to financially provide more reinsurance to carriers through the Cat Fund, and placing limits on agents' commissions of Citizens' policies. The committee is also looking for ways to encourage policyholders to take a greater role in protecting their property through mitigation measures by promoting Governor Jeb Bush's so-called "Culture of Preparedness."

But even as the legislature moves forward to debate the reform committee's recommendations, the sinkhole situation has been notably absent, and for once, not due to neglect. Instead, lawmakers in the 2006 session moved to resolve the issue and the early evidence shows the reforms are working. Tucked away in the bill was a regulatory scheme designed to as closely as possible objectively handle sinkhole claims. And as a result, Insurance Commissioner Kevin McCarty has issued a "presumed factor of savings," which could save consumers up to 14.4 percent of the sinkhole provision of their policy, which overall could save policyholders in sinkhole-prone areas a four percent reduction in their overall premiums.

"This is a win-win solution," said McCarty. "Not only do revisions in the law reduce court costs, but the legislature mandates this savings be passed to the policyholders."

Sinkhole Alley

The 14.4 percent potential savings on the sinkhole provision of consumers' policies comes from an analysis of the law changes conducted by the actuarial firm Deloitte. The study focuses primarily on Pasco, Hernando, Pinellas, and Hillsborough counties, which the report dubs "Sinkhole Alley." The reason these counties have the highest number of claims is that the geographic conditions are ripe for developing sinkholes. The land surface and the supporting sand and clay layers are thin, leaving the limestone base close to the surface. Due to the composition of the soil, if the water table drops or water erodes the limestone layer, which can quickly form, the scenario can possibly result in the total destruction of a home within days. Geologists have a good idea where sinkholes are likely to form, but it's much more difficult to accurately predict where sinkholes will occur.

The extent of the sinkhole problem is well documented, especially when it comes to Citizens and State Farm, which have been the largest private insurers affected by sinkhole claims. For example, Citizens in 2002 reported having just nine claims at a cost of $300,000, a figure that jumped to 632 claims at a cost of $86.2 million in 2005. As of July 2006, Citizens had received 413 claims from the so-called Sinkhole Alley counties, as opposed to the 19 other claims located around Florida. The study estimated that by the end of 2006, Citizens will have incurred around 740 claims at a cost of around $125 million.

As Citizens' sinkhole costs mounted, so did the insurer's rates. The residual market filed a rate change for the sinkhole portion of policies in several of the Sinkhole Alley counties. The rates included a 55.7 percent increase for Pasco county's coastline and a 73.5 percent increase for the remainder of the county. It should be pointed out that any increase in the sinkhole portion of a policy has a small impact on a policyholder's total premiums. The insurer also included in the filing a new underwriting rule to prevent policyholders from collecting monies from a sinkhole claim and then selling the property without fixing the problem, which has become a major issue with carriers. The new rule declared any property as uninsurable unless the policyholder could document that the repairs had indeed been completed.

Citizens has not been the only insurer affected by the growing prevalence of sinkhole claims. State Farm has similarly shown a sharp upturn in the number of sinkhole claims. The insurer reportedly had only six claims in 1994, a figure that jumped to 400 claims as of 2002. In 2005, the insurer had paid out some $52 million in sinkhole claims.

Quid Pro Quo

Senator Mike Fasano (R-New Port Richey) and Representative John Legg (R-New Port Richey) were the driving force behind the new sinkhole provisions and were insistent that insurers would reciprocate with lower rates in exchange for the law changes. "We don't want to be sitting here two years down the road with insurers still evaluating the impact of the law," said Legg. That is why the bill required the actuarial study and mandated that insurers file new rates to reflect the estimated savings from the provisions.

The bill also includes a provision where policyholders can choose deductibles of one percent, two percent, five percent, and ten percent, which would be applicable to sinkhole damages. Through premium credits, the deductibles allow policyholders some control over their premiums. Even with the passage of the bill, however, it may be some time before insurers are motivated to start writing policies in Pasco and Hernando counties.

By far, the largest factor of the estimated 14.4 percent savings came in the form of changes in the litigation process. Accounting for 9.6 percent of the potential savings, the bill included a process that employs an alternative dispute system, which is designed to steer claims away from the formal legal process.

The plan calls for the use of "neutral evaluators," to evaluate claims. Lawmakers appropriated $300,000 so that the Office of Insurance Regulation could create a panel of evaluators–who may be a professional engineer or geologist–that must complete a course on the process and are deemed to be fair and impartial. Under the process, if an insurer or policyholder elects to use an evaluator, the process is mandatory but non-binding. The two parties must agree on the evaluator or the OIR will designate one after 10 days. The insurer is required to pay the cost of the evaluator and the conference must be held within 45-days of being formally requested.

The hope is that the neutral evaluation process will create the conditions for resolving a claim without relying on a civil suit. However, since the evaluator's findings are non-binding, either the policyholder or insurer may file suit in court if they disagree with the evaluator's findings. Significantly though, the evaluator's report is admissible in the court's proceedings. The report is required to include whether the damage to a home was or was not caused by a sinkhole, and the estimated cost of stabilizing the land and repairing any damage to the home.

Per usual, the bill caused a predictable battle between the industry and attorneys. In Pasco and Hernando counties, attorneys have created a cottage industry that focuses heavily on sinkhole claims. In fact, on U.S. 19, which runs through the area, attorney billboards have sprung up advertising for sinkhole claims. Other attorneys are using more traditional means, with some lawyers relying on online marketing campaigns. Predictably, attorneys blasted the bill, saying it represented another major victory for the industry that will come at the expense of homeowners.

Some lawmakers, including Legg and Fasano, wanted to eliminate all insurer-paid attorney fees, a boilerplate proposition in any major insurance reform bill. Instead, the bill limits insurer-paid fees up to $2,500 in exchange for participating in the neutral evaluation process if the evaluator finds the repair costs will exceed the amount an insurer has offered a policyholder to settle a claim. Attorneys can also collect fees in civil cases where a judge rules a policyholder should receive a greater award than offered by an insurer.