Property Insurers Tackle Reinsurance Challenges

Each year, primary property insurers writing business in Florida have to address unique reinsurance issues and face the challenge of structuring their programs to accommodate pricing and risk factors in view of the state's catastrophe exposure. This is done in the context of the political and regulatory realities that require a balancing of insurer solvency with market pricing and rating concerns. This year, both primary insurers and reinsurers have experienced additional challenges from another type of catastrophe — the global financial crisis.

Worldwide reinsurance broker Guy Carpenter and Company reports in its 2009 Reinsurance Market Review that, despite last year's costly natural and financial catastrophe losses, record earnings during 2006 and 2007 bolstered the balance sheets of many reinsurers at the start of 2008. In fact, all four major rating agencies maintained stable outlooks for the global reinsurance industry in their September 2008 reports. However, reinsurers have since suffered significant unrealized losses largely due to the capital market and financial catastrophe.

The global economic crisis, normal supply and demand factors, as well as recent catastrophe loss, have all served to increase the cost of Florida property reinsurance.

Increase in Demand

Industry reports indicated that equity losses from last year resulted in insurers purchasing less reinsurance and retaining more risk. In contrast, primary insurers have purchased more reinsurance this year in an effort to protect their balance sheets. As evidence, Guy Carpenter reported a five to ten percent increase in demand.

In view of well-documented capital market issues and the increased demand for reinsurance, there has been some concern about a possible lack of capacity in Florida. Reports of a hardening market have been viewed as a particular challenge, especially in the context of recent Florida legislation. Dramatic changes in the state's laws have been designed to reduce the public's catastrophe exposure over time and ultimately result in a shift of more risk to the private sector.

Recent Legislation

The Florida Hurricane Catastrophe Fund (Cat Fund), which was established in 1993, sells reinsurance to Florida insurers at a lower rate than what is available in the private market. The fund consists of several layers of coverage: A mandatory layer for all Florida residential property insurers, and an optional $10 million “drop-down” layer of coverage that it has offered to select insurers over the past few years.

In an effort to control rising insurance rates, the 2007 Florida Legislature substantially increased the coverage limits of the fund by adding a Temporary Increase in Coverage Limit (TICL) layer that originally allowed insurers to purchase up to $12 billion in additional coverage above the mandatory coverage. Since TICL's inception, most Florida property insurers have taken advantage of this additional reinsurance coverage.

This year's major property insurance bill, House Bill 1495, which was recently signed into law by Gov. Charlie Crist, included significant changes to the Cat Fund. The $12 billion TICL layer will be eliminated in $2 billion increments over a six-year period, commencing in 2009. Additionally, the TICL premium will be increased each contract year.

The bill also allows insurers to make an expedited rate filing to recoup the cost of alternative arrangements to replace or finance the TICL coverage, so long as the impact per policyholder is less than ten percent.

Finally, the bill includes a mechanism to improve the Cat Fund reserves by providing a premium inclusive of a cash build-up factor that will increase over time.

Funding Problems

Although HB 1495 maintains the Cat Fund's ability to offer substantial, subsidized reinsurance coverage to Florida property insurers, many have questioned the fund's ability to pay claims in the event of a significant hurricane or multiple smaller events. At a recent meeting, the fund's advisory council was told that the fund's single-season maximum loss reimbursement theoretical capacity is currently $27.499 billion. Based on pre-event bonds and liquid resources, plus estimated post-event bonding capacity, the council was told that the fund has a loss funding and liquidity problem, at least at the TICL layer.

These possible funding issues have become a focal point for rating agencies, which have raised concerns about insurers' plans to address these issues. While many believe that a post-event remedy would be implemented to address any immediate shortfall, the fact remains that no definitive plan exists, and the fund's liquidity problem remains subject to the credit markets and feasibility of effectuating significant post-event bond financing.

With the onset of the 2009 hurricane season, the Cat Fund recently reported that the probability of storm losses exceeding its resources is approximately 5.5 percent. With the partial reduction of TICL, the uncertainty of the fund's ability to pay claims, the provisions for expedited procedures to recoup costs incurred to replace or finance TICL coverage, and the rating agencies requiring insurers to develop contingencies to address the fund's liquidity issues, insurers have purchased more reinsurance in the private market and have developed other plans to address possible funding shortfalls.

Price Increase

Guy Carpenter reported that, as of the April 1 reinsurance renewals, Florida property and casualty reinsurance rates increased ten to fourteen percent for the lower layers of coverage, and fourteen to sixteen percent for the higher layers of coverage. This was partly due to a decrease in capital caused by the global financial crisis, as well as to the impact of natural catastrophes, such as Hurricanes Gustav and Ike. Losses from these two storms have been projected to total $7 billion and $15 billion, respectively. In this context, Florida property reinsurance pricing has increased by an average fifteen percent for the June 1 renewals. This is in stark contrast to last year's approximate fifteen percent pricing decrease.

Despite pricing increases, Florida property insurers have purchased more private reinsurance for the 2009 hurricane season. Increased demand likely has been the result of a confluence of many factors, such as global credit market and financial issues, recent catastrophe losses, reinsurer balance sheet issues, the reduction in TICL coverage, Cat Fund liquidity concerns, legislative changes permitting the pass-through of certain reinsurance costs, and typical factors such as solvency concerns and appetite for risk. Although the market is tight, there appears to have been sufficient reinsurance capacity to satisfy this year's private market demands.

Buying patterns for this year's Florida reinsurance programs also appear to have changed. Leading industry analyst Dowling and Partners has suggested that U.S. property carriers have migrated to higher quality reinsurers and are relying upon more security than ever before. Because of capacity and pricing issues, especially at the upper limits of their reinsurance programs, primary carriers have had to carefully manage their reinsurance dollars. This may have included making adjustments in reinsurance retentions, third and fourth event covers, and the maximum coverages at the upper ends of the reinsurance programs. In essence, there has been a need to accommodate primary carrier budgetary concerns in view of overall reinsurance pricing increases.

Florida remains the world's peak catastrophe zone. Hurricane forecasters have predicted average activity for the upcoming season, which equates to twelve named storms and two intense hurricanes.

Private market forces have drawn their lines in the sand after Florida's Legislature charted a course to gradually decrease the public's exposure to hurricane risk. With ongoing worldwide economic issues contributing to uncertainty in the Florida market, industry professionals and public officials will observe the unfolding of the 2009 storm season with great interest to see whose bets have been properly hedged.

Fred E. Karlinsky is a shareholder in the law firm of Colodny, Fass, Talenfeld, Karlinsky, Abate. Richard J. Fidei is a partner in the firm. Susan Verini is an associate. Karlinsky may be reached in the Ft. Lauderdale office at 954-332-1749 or fkarlinsky@cftlaw.com. Fidei may be reached in the Ft. Lauderdale office at 954-332-1758 or rfidei@cftlaw.com. Verini may be reached in the Ft. Lauderdale office at 954-492-4010 or sverini@cftlaw.com. The firm, which also has offices in Tallahassee, specializes 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.