Florida is a laboratory experiment in financing catastrophic risk. This lab has some of the highest insured property value in the U.S. (second only to New York) and more storms blowing through than any other place on Earth.
The experiment has been ongoing in the property insurance market since Hurricane Andrew in 1992. Managing the state's insured residential property exposure (in excess of $2 trillion) may never be easy, but steps are needed to prevent a natural disaster from becoming a financial one.
Florida policymakers are tasked with making financial preparations for the likelihood of catastrophic storms. To help them, the Legislature tasked the Florida Catastrophic Storm Risk Management Center, housed within the College of Business at Florida State University, to prepare an analysis of Florida's property insurance market and offer recommendations on how to best correct and stabilize the market.
Three major themes are apparent: The role of residual markets, the need for capital to support Florida's exposure to hurricanes and the importance of risk reduction through property mitigation.
Many people do not realize Florida is the only state that requires property insurance companies to use simulation-based modeling of hurricanes to predict future loss costs. This puts Florida ahead of its U.S. peers in seeking a forward-looking view of risk, especially since insurance must be arranged in advance of storms and their costs. In recent years, however, Florida, in an attempt to encourage homeowners to reduce their storm risk through mitigation, experimented with price discounts that departed from a true reflection of anticipated loss costs. Most homeowners did not mitigate but property insurance companies' rates were suppressed. Unfortunately, that was likely a primary factor in pushing national, well-capitalized insurers out.
The private property insurance market is now dominated by smaller Florida-based insurers, many of whom have limited capital and limited business diversification. This has resulted in Florida having the lowest level of capitalization, as measured by policyholder surplus, of any catastrophe-prone state other than Texas. With relatively low capital levels and high concentration of risk in one state, Florida-based companies purchase a lot of reinsurance to pay claims and ensure their solvency after a catastrophe. The problem is that much of the reinsurance they buy is from a state-run entity – the Florida Hurricane Catastrophe Fund (FHCF) – which can potentially run out of money.
Legislative and regulatory intervention enabled both Citizens Property Insurance Corp. and the FHCF to expand, departing from the state's forward-thinking practices about risk financing and pricing since these state insurance mechanisms get funds to pay claims after a big storm hits. Through a system of assessments, they shift costs from current to future policyholders. This is an imbalance that makes property insurance a challenge for all Floridians.
Citizens now insures more than 1.4 million policyholders, a 42 percent increase since December 2009. And during two of the last three years, the FHCF likely could not have successfully issued bonds sufficient to pay its full potential liabilities. These are significant points since Florida has authorized Citizens and the FHCF to charge post-loss assessments if they do not have sufficient funds to pay liabilities. And, they are not the only entities that can assess after storms. Add in the Florida Insurance Guaranty Association, which pays the claims of insolvent insurers.
Consumers want transparency in property risk financing and to know what subsidies will cost them when state-run funds fall short. To achieve transparency, we recommend first addressing the appropriate mix of pre-loss insurance premiums and post-loss assessments. Strategies to attract financial capital to Florida's property insurance market and return the FHCF to its original role as a market stabilizer are also imperative for ensuring sufficient capital. Speeding the glide path for Citizens' rates is another recommendation to protect all policyholders from assessments. Absent a faster path to risk-based rates, it will take Citizens five more years to reach actuarially-fair rates, and we can't count on more storm-free years.
These changes must be introduced with caution so as to not disrupt the marketplace, accompanied by efforts to promote risk reduction through property hardening, known as loss mitigation. Without loss mitigation, other market changes have only limited effectiveness. Improving homeowners' knowledge of the benefits of mitigation and making mitigation more affordable are keys to reducing property insurance prices while maintaining fairness. What is most fair is helping Floridians see the true cost of risk and deal with those costs in the present day, not letting the debt pile up for the next generation.