Reining In the Cat Fund

Half the market's average proposed rate decreases equaled roughly 11 percent. Another 17.6 percent of the market averaged 21.9 percent in reductions. However, 32.5 percent of the market proposed average increases of 12.8 percent. These numbers became a target of lawmakers and regulators with the flashpoint being Allstate, which requested rate increases of nearly 40 percent for some of its Florida companies. The has led to an ongoing legal battle, with McCarty suspending the insurer's companies from writing new business. It also led the Senate to create the Select Committee on Property Insurance Accountability.

After spending three meetings and more than 20 hours grilling company executives, computer modeling experts, and reinsurance brokers under oath, the committee concluded its work without finding any smoking gun. Instead, the committee's work has led to more questions. Committee Co-Chair Jeff Atwater (R-North Palm Beach) said at the conclusion of the committee's hearings that he would discuss with Senate President Ken Pruitt (R-Port St. Lucie) the possibility of hiring outside counsel to gather and review all the documents the committee requested. He and other committee members also remained unsure whether they would be ready to present any legislative recommendations this year.

"Timewise, it would be difficult," said Co-Chair Steve Geller (D-Hallandale Beach). "Whether or not we make legislative recommendations is a discussion we will have to have."

But the committee's work did result in one serious outcome. For the first time in recent memory, lawmakers finally received a comprehensive education about how the industry works, starting from reinsurance to the effectiveness of last year's property bill. And it also accomplished the goal of highlighting the interrelationship between homeowners' premiums and the impact of assessment. For years, the legislature has been driving down homeowners' premiums by shifting the cost to future assessments, a legislative version of pay now or pay later. As a result of the committee's hearings, lawmakers now understand just exactly how much of a gamble they have been taking and the enormous cost it represents to consumers.

Sink's Proposal

Sink's proposal has its genesis in the legislature's decision last year to dramatically increase the capacity of the Cat Fund from $16 billion to $28 billion. Although it immediately helped many companies restructure their financial pictures, lawmakers presented policyholders with the risk of substantial assessments, or, as the CFO's office refers to it, a "tax." As Mike Carlson, Sink's director of legislative affairs told the Senate Banking and Insurance Committee, "The CFO is concerned about rates and supported HB 1A, but there are other parts of insurance costs. The assessment risk is a back-end cost, or tax if you will."

What Sink is proposing is that the legislature reduce the so-called Temporary Increase in Coverage Limits (TICL) program from its current level of $12 billion to $9 billion. Secondly, the proposal would only offer reimbursements of 70 percent of an insurer's share of the TICL pie instead of offering coverage limits of 45 percent, 75 percent, and 90 percent of an insurer's losses. With the TICL addition limits, the Cat Fund would cover a one-in-65-year hurricane.

Carlson referred to Sink's plan as a "modest proposal," and in certain ways it is. But it also goes to the heart of what the legislature did with the Cat Fund last year. Until last year's law, the Cat Fund's total reimbursement to insurers was limited to $16 billion for a single storm season, but by adding the TICL program, that figure was inflated to $28 billion dollars. The program also offered the coverage for a premium of 2.2 percent of an insurer's portion of the $12 million, a pittance compared to the 10 to 20 percent charged by the private market at that time. At that rate, insurers grabbed up $11.5 billion of the TICL coverage for a mere total premium of $242 million.

What does that mean to the Cat Fund and the state's homeowners? A lot. John Forney with Raymond James, the Cat Fund's financial advisor, spelled out the financial realities faced by the fund. The Cat Fund currently only has around $2 billion in cash and $6.3 million in pre-event notes, which it is currently making payments on. That means for the fund to meet its ceiling of a potential $28 billion liability, it would have to go to the capital markets and convince investors to pour $25 billion in 30-year bonds to ensure the Cat Fund could fully reimburse carriers.

The first question is whether the capital markets would have the appetite for that much debt, especially following the economic disruption a major storm or series of storms could cause. That is why Forney and the Cat Fund are supporting Sink's proposal. "We need to reduce a bond of that size, especially in a turbulent market after a storm that big impacts an economy the size of the state of Florida," he said. "This is a modest step in the right direction."

Forney also advised the committee that "There are periods where the market is closed regardless of price and it is not a matter of the interest rate." Then there is the question of how much debt the capital markets would bear. The single largest tax-exempt long-term debt issuance was for $6 billion. Forney said he didn't believe the Cat Fund could raise the $25 billion at once and that it would probably take several bond issues over a 12 to 18-month period. If the Cat Fund would have to fully fund a potential $56 billion liability for the 2008 and 2009 storm seasons, it would have to assess its maximum assessment rate of 10 percent annually for 30 years.

Impact on the Market

When looking at the proposed reduction of the TICL program from $12 million to $9 million, there are several considerations. Number one, 40 percent of the Cat Fund's liability is earmarked to reimburse Citizens' Property Insurance Corporation. Fortunately, since the last several storm seasons have not impacted the insurer, it has allowed Citizens to build up its resources so that it currently has $10 billion to pay claims, meaning it is less likely to have to gain access to its total Cat Fund reimbursements. And fortunately, the insurer's population has not exploded, which was a fear when the legislature rolled back the insurer's rates last year, making it more competitive with the private market

But Department of Financial Services representative Belinda Miller said Citizens' rates could require an increase due to the reduction in the TICL program, especially when the insurer is required to charge actuarially justified rates next year. She also pointed out that the insurer has tried to purchase more reinsurance in the private market without success.

"Citizens officials are in Bermuda looking to buy reinsurance," she said. "I don't know if they have a deal, but they haven't found one in the last several years."

Anyway they looked at, however, lawmakers kept running into the trade-off between rates and assessments. The Department of Financial Services said that reducing the TICL program by $3 billion could increase homeowners' premiums ranging from between 1.5 percent to 3.2 percent, on average. For some lawmakers, that is a deal breaker since the whole goal has been to reduce homeowners' rates.

Senator Mike Bennett (R-Bradenton) said he would only support the change if the reinsurance market didn't immediately raise rates. "If I don't see a dramatic increase in reinsurance rates, I'll go along with it," he said. "But if not, when we come back we'll kill the deal."

Senate Banking and Insurance Committee Chair Bill Posey (R-Rockledge), however, argued that on whole, the proposal had merit. He said the large insurers didn't benefit from the program when compared to their total exposures, although some small insurers may have to institute rate increases. But given the reduction in private reinsurance, he said it was unlikely the TICL change would destabilize the market. "We don't want the state to take a bigger hit than it can," he said. "We've had a couple of lucky years and we have a bit more operating room."

The DFS has calculated that the reduction in the TICL program by $3 billion could potentially save Floridians from between $111 million and $217 million in annual assessments. On a 30-year bond issuance, this could result in a savings ranging from between $3.3 billion and $6.5 billion.

Senator J.D. Alexander (R-Lake Wales) has come down decidedly on the side of reducing the TICL program. He stated that he didn't believe it would lead to greater rates since insurers are still having to pay for reinsurance to cover the time period until they could collect their reimbursements from the Cat Fund. He noted that reinsurance brokerages such as Bear Stearns offer insurers bridge loans so they have immediate access to cash, which represents an additional cost to insurers. "We can't forget that an insurance company has to pay claims whether the Cat Fund has the money or not," he said.

The Industry Reacts

For its part, the industry is supporting Sink's proposal. Sam Miller, executive vice president of the Florida Insurance Council, said by pulling back the Cat Fund's obligation, it could further stabilize a market that has rebounded since the 2004 and 2005 hurricane seasons. "I think the position of many companies is that the legislature is looking to do the responsible thing," he said. "The companies want to have confidence that the Cat Fund can meet its obligations."

Miller said there is a school of thought that all the factors in the TICL program, plus the major reductions in the reinsurance market, could offset any proposed rate increases. The question remains, however, if regulators would allow insurers to pass any reinsurance rate increases to policyholders, a move that is unlikely. Then there is the question of what the legislature will do after the entire TICL program, which is scheduled to sunset after the 2009 hurricane season. "We think the legislature will pass some form of the program after two years," he said.

Florida Association of Insurance Agents President Jeff Grady said he is concerned whether the proposal will get through the legislature if it is tagged as a homowners' rate increase. Both Geller and Atwater are opposing any change in the TICL if it means higher rates or a contraction in the market. Grady said agents would welcome any reduction in assessments since they are required to explain the Byzantine layers of assessments to their clients. In addition to the Cat Fund and Citizens, homeowners could also face assessments from the Florida Insurance Guaranty Association to fund claims from any insolvent insurer.

"We are on the frontlines and any less government involvement is welcomed," Grady said. "Our great fear is that if there are large assessments for great amounts, there is going to be a real blame game on the part of consumers."

Change in Oversight

One other part of Sink's proposal is a change in the Cat Fund's oversight. Since the fund's creation in 1993, it has been under the board of trustees of the State Board of Administration that consists of the governor, CFO, and attorney general. The board then appoints an executive director to manage the SBA's affairs, which includes the financial oversight of 30 investment funds with $184 billion in state assets.

The proposed bill would create a Division of the Florida Hurricane Catastrophe Fund that would report to the governor and the entire cabinet, including the Commissioner of Agriculture and Consumer Services. The cabinet would appoint an executive director who could execute contracts, sign-off on revenue bonds, and enforce other rules. The director would also work with the Office of Insurance Regulation as required.