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A crushing commitment?

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Major insurance industry players are wary of Florida's unprecedented solution to protecting the state's $1.9 trillion in coastal risks from hurricane losses.

Many reinsurers and reinsurance intermediaries were left empty-handed when Florida Gov. Charlie Crist signed legislation early this year to provide broad reinsurance protection through the Florida Hurricane Catastrophe Fund. Some reinsurers adjusted by writing around the state program or writing coverage in other states, but rates often have been flat or reduced, industry experts say.

Insurers of homeowners' risks were the primary beneficiaries of the cheap reinsurance they could buy from the fund, although each insurer is required to calculate its savings and pass them on to homeowners.

The new state law also significantly expanded Citizens Property Insurance Corp., which is pressuring insurers to charge lower rates due to its increased competitiveness.

Policyholders benefit from lower rates in the short-run, but the lack of risk-based pricing raises long-term questions, many observers say. Some also question the subsidization of high-risk coastal homeowners by lower-risk inland residents.

Post-event funding

Both programs rely on post-event funding to pay losses if the cat fund or Citizens experiences deficits, either through the state's use of its bonding authority or direct assessments on policyholders across most property/casualty lines, which raises another subsidization issue.

"It's a pray-now, pay-later approach," said Bradley Kading, president and chief executive of the Washington-based Assn. of Bermuda Insurers and Reinsurers. "Florida has created a ring fence around its dangerous borders and decided to keep much of the hurricane risk within its own boundaries, thus forcing taxpayers to pay more than they otherwise would pay" with its post-event funding plan.

"They socialized the reinsurance product for the insurance companies and the insureds," said James P. Bryce, president and chief executive officer of IPC Re Ltd. in Pembroke, Bermuda. "Pricing is unrealistic for sustainability over time," he said.

"It's a political solution, but I don't think it's the right solution," said Steve Bolland, president of Gill &Roeser Inc., a New York-based reinsurance intermediary.

A few in the industry supported some of Florida's actions or recognized them as part of a growing trend.

The Property Casualty Insurers Assn. of America, whose 1,000-plus members write more than $194 billion in premiums, supported expansion of the Florida catastrophe fund.

"We think it is a reasonable and responsible way to further spread catastrophe risk and mitigate the cost of cat reinsurance, which is a major contributor to the rising cost and limited availability of primary coverage," said Joseph Annotti, senior vp-public affairs for the Des Plaines, Ill.-based PCI.

PCI is concerned, however, about the "dramatic expansion" of Citizens, which is using "artificially suppressed" rates, Mr. Annotti said.

"For many companies, expansion of the FHCF is helping them to stabilize the cost of the products and continue to write and renew business in Florida," Mr. Annotti said.

Florida's expansion of Citizens as its market of last resort is part of an exploding growth trend, according to a report released last month by the New York-based Insurance Information Institute.

"While state-run insurers of last resort fulfill a key role by ensuring that policyholders can obtain insurance coverage, many have morphed from their traditional role as urban property insurers into major providers of insurance in high-risk coastal areas," said Robert P. Hartwig, the III's president and chief economist.

According to the III report, more than a dozen states' total loss exposure surged to more than $600 billion in 2006, compared with $54.7 billion in 1990. In Florida alone, Citizens' total exposure to loss increased 164% to $434.3 billion this year from $154.6 billion in 2002, when Citizens was created.

The exposure to loss is substantial.

If a 1-in-25-year storm hits Florida, Citizens would suffer a $3.7 billion deficit and the FHCF would suffer a $22.3 billion deficit, according to a report by Milliman Inc., which was commissioned by the PCI.

To pay for claims, those entities would likely have to seek out the bond market to raise up to $26 billion for a 1-in-25-year storm and up to $69 billion for a 1-in-250-year event, Milliman said. That would take time to arrange--especially since $10 billion is the largest U.S. public bond offering to date--and might negatively impact the state's credit rating, it said.

Florida Insurance Commissioner Kevin McCarty is very aware of the potential problems.

"Certainly you can conjure a scenario where a number of storms can bankrupt the cat fund and Citizens insurance company," Mr. McCarty said. Yet, given the state's critical situation, "I think Florida has done the prudent and responsible thing," said Mr. McCarty, who has lived in Florida for decades.

Most reinsurers didn't agree and "reinsurers were quite vocal in their opposition," when the plan was being developed, Mr. McCarty said. "They said it was essentially using the taxpayers to subsidize the private market," he said. Reinsurers also argued that it was not a good signal to send to capital markets that recapitalized after the 2004 and 2005 hurricanes.

To solve the state's reinsurance capacity problems, reinsurers advised letting the market reach "equilibrium," Mr. McCarty said. "The problem for Floridians was that reaching that 'equilibrium' was prohibitively expensive and not sustainable," he said. "Floridians had to choose between the basic essentials of life sustenance and paying their homeowners' premium."

Worst fears not realized

In addition, large numbers of commercial policyholders were among those relaying horror stories at public hearings, including one business that faced a 603% premium increase, from $128,000 to $900,000, Mr. McCarty said.

Initially, estimates said the state-run programs could remove up to $2 billion of reinsurance revenue from the marketplace and that reinsurers would leave the state.

But "the worst fears were not realized," said David Cash, chief underwriting officer of Endurance Specialty Holdings Ltd. in Pembroke, Bermuda. "The impact on the industry was not as significant as people in the industry originally feared."

Private markets still have "an important role to play" to provide additional cat cover to the market, Mr. Annotti said.

Even so, the global reinsurance market "cannot compete with politically driven rates," said Frank Nutter, president of the Washington-based Reinsurance Assn. of America. For example, Mr. Bolland said a number of reinsurers have reduced their earnings projections for this year in anticipation of losing some Florida business.

Florida's programs have "softened pricing in the cat market," Mr. Bolland said. While Florida's reinsurance pricing has been flat, Midwestern pricing has softened, he said.

Mr. Bryce said some pricing on non-cat risks was flat or rose only by single digits at a time when the cost of capital had increased "post-KRW"--Hurricanes Katrina, Rita and Wilma.

Some interest continues in alternative risk-financing vehicles.

For example, RenaisssanceRe Holdings Ltd. announced last month that it created about $375 million in new reinsurance capacity for the Florida homeowners' market by establishing Starbound Reinsurance II Ltd., a Bermuda-based reinsurer.

In addition, there is now about $10 billion in cat bonds, about one-third of which relate to Florida risks, one-third to California risks and one-third to other risks, Mr. Cash said.

The capital markets will be there "when the price is right and the terms attractive," Mr. Bryce said.

Last resort now first choice

Meanwhile, many insurance industry spokesmen are very concerned about the intended and unintended effects of expanding of Citizens, Mr. Annotti said. "Instead of fulfilling its original mission of being the insurer of last resort, the Legislature's action is making Citizens the insurer of first choice," he said.

Consumers will pay less than they would have without the reforms, but there already has been a dramatic expansion of Citizens. When the next storm hits, it will "undoubtedly" result in Citizens' policyholders experiencing delays in settling claims. Also, suppressing prices for the highest-risk areas will lead to continued development of those areas, further expanding Citizens, he said.

State Farm Florida Insurance Co. initially was "vehemently opposed to the legislation because of the public policy implications," said its Florida spokesman, who subsequently acknowledged that the law was "fairly helpful."

State Farm Florida in Winter Haven, which has about 1 million policies in force in the state, was able to buy $1 billion in reinsurance for its program at a price that was "remarkably similar" to what it had paid its parent company for similar coverage. As a result, it removed about $1 billion in liabilities from its parent, the State Farm Mutual Automobile Insurance Co. of Bloomington, Ill.

State Farm, though, has found Citizens to be a serious competitor for homeowners' premium dollars. Due to that competition, State Farm's policyholder count dropped by 11,000 in the first half of 2007, for the first time since 1998 when it began writing coverage in the state, he said.

Allstate Floridian Insurance Co. is also losing policyholders, but it is doing so voluntarily. The subsidiary of Northbrook, Ill.-based Allstate Corp. is in the process of paring its book of homeowners' business to 350,000 to 400,000 policies, or roughly half of what it had in force in 2005, through a series of arrangements whereby other insurers assume its customers, said the insurer's St. Petersburg, Fla.-based spokesman.

greatest risks subsidized

In the future, Mr. Cash predicted that more homeowners' coverage will be written by specialist companies, although the state is trying to discourage that.

Insurers had mixed views about the public policy issue of subsidization of high-risk coastal property by low-risk property, sources said.

"The biggest beneficiaries of the legislation will be homeowners living in southern coastal counties with estimated premium reductions for the average homeowner reaching $1,096 in Dade County and $1,587 in Monroe County," according to the Milliman report. Homeowners in non-coastal or northern counties will see only modest premium reductions. For example, premiums will drop an average of $47 in Orange County, $36 in Duval County and $28 in Leon County, the report said.

"I would think that this would be a huge issue among Floridians, possibly fanning the flames of class warfare," said Robert Detlefsen, vp-public policy for the Indianapolis-based National Assn. of Mutual Insurance Cos.

If major storms occur this season or next, and Citizens imposes assessments on all private insurers to recoup its losses, those would be passed on to most property/casualty policyholders, he said. "We'll have a situation in which someone renting a trailer in a mobile home park will pay more for car insurance in order to subsidize the insurance costs of million-dollar homes on the coasts," Mr. Detlefsen said.

The Legislature's sensitivity to that issue is demonstrated by a ban beginning next summer on Citizen's writing residences valued at $1 million or more as well as property owned as second homes.

In addition, Allstate's spokesman questioned the issue of geographic subsidies. The lesson his company learned from 2004 and 2005, when inland Orlando was struck by three hurricanes, is that "all of Florida is a high-risk entity," he said.

The state's goal, as Mr. McCarty said, is "not to divide Florida, but unite Florida behind a plan that we believe will help us stabilize the marketplace; encourage economic growth and development; and hopefully have a national federal plan as a backstop to ensure the long-term viability of Florida, the Gulf of Mexico and any catastrophe-prone area."

Coastal concerns

Florida has adopted the nation's toughest building codes and established mitigation programs, including one that requires retrofitting homes with storm shutters. "We've stepped up to the plate and we think this is the standard by which other states prepare for natural disasters," said Mr. McCarty, who also supports a federal catastrophe backstop plan.

Many critics in the insurance industry, however, emphasize that Florida is not doing enough to prevent development along high-risk coastlines, which will ultimately increase Florida's exposure and make the problem worse.

The U.S. Census Bureau predicts that Florida will add 11 million residents by 2030.

"Risk-based insurance pricing would inhibit this lemming-like march to the sea, but it would also inconvenience the state's realtors, mortgage lenders, homebuilders, hospitality industry and other powerful interests," Mr. Detlefsen said. "Florida's irresponsible insurance reforms have been attributed to 'populism,' but these special interests no doubt played a role as well."

If Florida's solution to dealing with its hurricane threat has "a silver lining," it's that "more people see insurance as a necessity," the Allstate spokesman said.

But in an ironic twist, "insurance policyholders have been forced to be the reinsurers for the very homeowners' insurers they vilified," Mr. Nutter said.