Breaking Up is Hard to Do

Commissioner McCarty’s Florida Property Insurance Proposal

The Florida Senate Banking and Insurance Committee meeting on January 16th, 2013, started off with a simple pronouncement from CFO Jeff Atwater to the members of the committee that “standing still cannot be the solution.”  To those on the outside of the Florida residential property insurance market, it would appear that lawmakers have been anything but “still” over the past few years.  Passage of Senate Bill 408 and changes to rates and coverage options at Citizens Property Insurance Corporation would leave a casual observer to think that the property market has been in flux as of late.  However, the results of these actions show that they have been simply nibbling at the edges.  Citizens continues to grow at a rate of 8,000 new policies a week and, despite recent interest in depopulation, only about 60% of the policies approved for depopulation were actually removed.  Searching for a more holistic approach to fixing the market, the Committee requested Insurance Commissioner McCarty present a principle-based reform plan for Florida’s property insurance market.

The Committee charged Commissioner McCarty with providing solutions that, among other things, returned to a free market approach, enhanced Florida’s attractiveness as a place for insurers to do business, and reduced the overall exposure of Citizens.  The Commissioner’s presentation clearly reveals, from an insurance fundamentals perspective, a market that is distressed.  Since 1992, national insurers have decreased their Homeowners insurance market share from 96% to 31%.  To fill the holes left in the market (which was growing in total throughout this time period), Citizens grew to account for 20% of the market while the Florida domestic insurance market grew to account for 49% of the market.  This domestic market has produced a net income loss from 2008 to 2011, when no major catastrophes struck the state.

Part of this loss, and resulting rate increases for the domestic market, is due to the effects of the cost of reinsurance.  The Commissioner estimated that 91% of the Florida domestic carriers were reinsured to a 1-in-100 year event.  This reinsurance protects the domestic carriers from the most severe catastrophic events, but also makes sure that liquidity can be provided at the time of an event, meaning losses can be paid on a timely basis.  As a comparison, Citizens was estimated to have to begin assessments within its Coastal account after only a 1-in-34 year event.  The nature of the Citizens entity as it currently stands foregoes providing funding for events prior to their occurrence (which is the standard to which private carriers are held) for long-term financing of these losses over time by the taxpayers.  As a result of not having to provide reinsurance or capital before a catastrophic event, Citizens has cost advantages over the private market.

When these cost advantages are coupled with the statutory capping of the Citizens rates in their move to “actuarially sound” levels, the ability to remove policies from Citizens decreases tremendously.  Please note that “actuarially sound,” as used above, is company specific.  An actuarially sound rate for Citizens would provide for all of its costs, not the reasonable costs to which a private carrier would be subject. 

For the same product, the “actuarially sound” rate for most private carriers would be higher than the “actuarially sound” rate for Citizens.  Citizens’ CEO Barry Gilway, in his own presentation to the Committee, presented the following information on the relative percentage of his Company’s policies that were currently at “actuarially sound” rate levels:

HO-3 and Coastal HW-2 Policies
2012 132,900 17%

In the many years that Merlinos & Associates has been providing actuarial consulting services to already established and start-up property insurance companies in Florida, we have observed this pricing disparity addressed in several ways in the market.  After the storms of the 2004 and 2005, private carriers who agreed to accept policies from Citizens were required to charge rates equal to or below Citizens for a period of time.  This requirement allowed for effective and efficient depopulation.  However, the cost differences noted above, exacerbated by the effects of House Bill 1A in 2007, left many carriers in a financial hole and led to several large insolvencies.  As regulators have become more concerned with the adequacy of the rates for policies being taken from Citizens, the financial condition of private carriers has begun to improve at the expense of the efficiency of the depopulation process.  As the “actuarially sound” rates of the private carriers and Citizens have invariably begun to separate, private carriers have found it increasingly difficult to match the premiums that Citizens charges and prevent Citizens policyholders from opting out of the depopulation or simply returning to Citizens when it presents a cheaper option at renewal.

Recognizing the incompatibilities discussed above, the Commissioner correctly described the current role of Citizens as an alternative market, not a residual market, which is attempting to serve two masters: provide a market to those who cannot find coverage AND provide affordable rates.  A residual market entity would provide coverage to insureds who cannot find insurance at any price from the private market.  In the Citizens alternative market, the short term economic hardship of high rates is suppressed for the benefit of individuals in exchange for long-term structural deficits for all taxpayers. The main issue with this approach is that the faucet cannot be turned off.  As rates are held below truly “actuarially sound” levels (as required by the private market), Citizens continues to grow and the structural deficits become larger and larger.

The Commissioner’s presentation outlined a plan of reforms that seek to achieve four desired outcomes:

  • Restructure alternative markets so they become residual markets.
  • Maximize the risk-bearing capacity of the private market.
  • Promote consumer choice, responsibility, and market power.
  • Enhance meaningful risk mitigation programs.

The first outcome is paramount to the creation of a competitive market place, and reaching this outcome requires recognition that the Citizens mechanism is failing in its current form.  With this in focus, the Commissioner calls for the deconstruction of Citizens into component parts:

The Beach Plan

  • Would consist of what is currently the Citizens’ Coastal Account.
  • Would focus on providing only wind insurance, so as to maximize the ability to respond to a catastrophic even and allow technical experts to pursue cost savings advantages for this peril.

The Residual Risk Plan

  • Would include the remainder of Citizens’ policies.
  • Would be subject to a market-pricing rate standard.
  • Would implement a policy Clearinghouse (as described by Citizens CEO Barry Gilway) to better facilitate shopping by insureds prior to their receiving coverage.

The Sinkhole Facility

  • Would essentially eliminate sinkhole as a covered peril within the standard insurance market.
  • Would provide a separate program to aid those whose properties have been damaged by such an event

These proposals are bold in scope and reflect a clear understanding of many of the underlying problems with the current Florida property market.  The return to rate adequacy for Citizens would allow for more effective depopulation efforts, remove pressures currently on private carriers to compete with subsidized Citizens rates, and attract new capital to the markets.  These proposals also allow for a more gradual movement towards rate adequacy for coastal exposures and areas affected by sinkhole losses by carving out those risks from the Citizens book of business.  As such, it would seem the Commissioner’s proposals are well-reasoned and meet many of the actuarial issues facing the market. However, as the Commissioner himself recognized, these principles-based solutions are not the same thing as the politically tractable solutions.

These reforms are substantial and would require several years to establish these mechanisms and transition to a post-Citizens market.  Additionally, these reforms would require some insureds to pay substantially higher premiums than they currently receive.  In the interim, as these mechanisms are established and individuals learn of their premium levels, elections will occur that could change the political landscape once again.  Is there political will to see that these long-term decisions are carried to fruition?  It would seem that these changes should be coupled with near-term corrections to the Citizens rate capping statutes to better facilitate transition of policies to a market-based rate standard.  Additionally, increasing the Citizens rate cap above the current 10% level would allow increased efficiency in the depopulation of Citizens and reduce the likelihood of assessments for the upcoming storm seasons.  Finally, allowing additional rate increases within Citizens would provide benefits to the market that could not be undone by the shifting of political winds.  In the current political climate, focus should be given to making these long-term decisions while simultaneously providing short term assistance to an ailing market.  After all, breaking up is hard to do.

Ryan Purdy, FCAS, MAAA, is a principal and consulting actuary at Merlinos & Associates.