SB 408: A Modest Proposal

The recent signing of Florida Senate Bill 408 by Governor Rick Scott may be seen by some in the insurance industry as a weak consolation prize for the transformative legislation for which some were hoping. With the failure to provide any substantive reforms to Citizens Property Insurance Corporation or its relationship to the private market, the Florida Legislature has concluded that the short term future of the Florida residential property market will look very similar to the recent past. Hope still exists for legislative action as part of a special session, but broad sweeping changes will require a fight that pits district against district in a battle of “who pays.”  If there is one thing the actuarial exam process taught me it is: hope for the best, prepare for the worst.

So can the measured approach to correcting the market set forth in SB 408 really be effective? The answer is yes. The single most beneficial revision set forth in SB 408 is the removal of the requirement that claims for structural damage be paid at full replacement cost. The law now requires that actual cash value of the damages be rendered with the remainder to be paid once the insured contracts for repairs. This practice is standard in the other 49 states for good reason. It’s all about incentives.

Since the start of the recession in the 4th quarter of 2007, countrywide non-catastrophe homeowners pure premiums for the industry have increased nearly 20%*. During the same period, Florida non-catastrophe homeowners pure premiums have increased by 58%*. One would expect claims costs to rise in an economic downturn as individuals become less likely to self insure small losses and more apt to sue others for damages. Was the economic downturn in Florida that much more devastating to affect such a large discrepancy in the pure premium growth? Not likely. Other states that had significant downturns in their housing markets did not suffer similar fates. The pure premiums for California rose a modest 8.6%*, while those for Nevada decreased by 2.1%*.

The ability of the insured to receive full replacement cost coverage without contracting to make repairs, along with an increased number of financially strained insureds, creates a natural economic incentive and avenue for some individuals to take advantage of the system. The insurers have cited many instances where these incentives have been abused in the recent past. The Florida Office of Insurance Regulation’s “Report on Review of the 2010 Sinkhole Data Call” states that “For about 20% of the total claims reported, the repair option was initiated.” Were you to remove these sinkhole claims from the experience the OIR reviewed, you would see a much more consistent level of sinkhole claims made from 2006 through 2010, not the extreme increase in frequency the OIR reported. Is this an instance in which the economic incentives are being acted upon? If so, would this be a fair use of the insurance system?

Insureds that have always intended to use insurance proceeds to repair their properties or those that have total losses will not be in a materially different economic position under the new law. Their losses will be paid in full according to the contract. The only parties affected by this law change are those that wish to not repair the damage to their homes after a loss.

Why would someone choose not to repair their home after a partial loss? Are you comfortable with only half a roof? Do the charred cabinets and smoke damage have a nice aesthetic?! For most, the idea of letting your largest investment and asset sit in disrepair is unthinkable. If most people repair their homes after a loss, then very few people should truly be affected by the law change. The effect of the law change should be limited to the removal of an economic incentive to game the insurance system. The result will be decreased fraud, fewer litigated and reopened claims, and a slowing of the rapid growth in pure premiums that have plagued the State over the last few years.

With the non-catastrophe pure premium growth slowed or even reversed, the Florida domestic carriers, weather permitting, will have an opportunity to show their business models can succeed in this challenging market. With their success, the market will be able once again attract capital and parties interested in assuming risks from Citizens. As the housing and mortgage crises showed, misalignment of incentives can quickly compile into a disaster. However, the correction of this misalignment can be achieved quite simply. All it takes is a modest proposal.

* Based on ISO FastTrack information through 4th quarter 2010. Measures increase between 4 quarter rolling average pure premium at 12/31/2007 and that at 12/31/2010.

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