Michael Adams explains the changes in the Florida market for windstorm insurance.

The state of Florida is embarking on the most ambitious reorganisation of its residual homeowners' property insurance market market since the current structure was put in place following hurricane Andrew in 1992. The new entity, Citizens Property Insurance Corp (Citizens) merges the two existing residual markets and will be exempt from state and US federal taxes. As a result, the state will assume primary control of the residual market and will have a greater capacity to handle claims from a large catastrophic loss.

For two years, Florida Insurance Commissioner Tom Gallagher has pushed the state legislature to approve his plan merging the Florida Residential Property and Casualty Joint Underwriting Association (JUA) and the Florida Windstorm Underwriting Association (FWUA). These two residual homeowners markets are largely the legacy of the state's efforts to rebuild the market following the $11bn residual loss caused by Andrew.

As of May 2002, together they equated to roughly 514,690 policies in force, representing $118bn in liabilities, and a probable maximum loss (PML) for a one-in-100-year storm of $6bn. The JUA writes all-perils policies and issued nearly one million policies in the mid-1990s before depopulation programs successfully reduced its size to below 100,000 members. Currently, the association has 123,690 policies located in southeast Florida in Dade-Miami, Broward and Palm Beach counties.

Private companies formed the FWUA in the 1970s as a small market to insure properties in the Florida Keys, a string of islands extending from the southern tip of Florida to 90 miles north of Cuba. After Andrew, however, the association's territory was expanded to include the coastline portion in 29 of the state's 36 coastline counties. The FWUA limits its coverage to windstorm and hailstorm damage. It has some 391,000 policies in force with 65% of those policies located in Dade-Miami, Broward and Palm Beach counties.

A political battle
Gallagher's argument for creating Citizens rested primarily on two points. First, he decried the FWUA's `industry-dominated' board, where private carriers appointed 12 out of 15 members. His position is that the industry's influence worked against the consumer's interest, a position that found wide support after the FWUA was permitted to make a 96% rate increase in 1999. Although the rise was scheduled for implementation over five years, it created a political firestorm with south Florida lawmakers that worked to bolster Gallagher's arguments.

His main contention, however, was that the industry's involvement in the FWUA would preclude it from achieving tax-exempt status, which could have far reaching effects on the residual market's ability to pay claims. For example, the New York-based financial firm JP Morgan estimated that, depending on interest rates, the ability to issue tax-exempt bonds could result in $1bn savings on a $2.5bn bond issuance over 20 years.

The benefit of tax-exempt status has long been known in Florida, where the state set up a tax-free fund to serve as a reinsurer for hurricane losses. The Florida Hurricane Catastrophe (CAT) Fund was created in 1994 to augment the private reinsurance market.

Owing to light catastrophic losses and its tax-exempt status, the fund has accumulated some $4.3bn in cash. It also has a $15.7bn bonding capacity, although the fund is currently restricted to bonding just $6.1bn as part of an $11bn one-year cap in payouts. The CAT Fund coverage recently expanded its coverage to include additional living expenses on a percentage basis.

Despite Gallagher's arguments, however, his plan languished in the Florida Legislature, where powerful lawmakers supported by the insurance industry had little appetite for the complex proposal. That changed, however, when US Northern District of Florida chief judge Roger Vinson ruled that the JUA constituted an "integral part of the state" and, therefore, should be tax exempt.

Tax exempt
The JUA was created in the immediate aftermath of hurricane Andrew and its make-up reflects a greater amount of involvement by the state. The insurance commissioner appoints eight of the 13 members of the board that governs the association. The state Department of Insurance (DOI) also was instrumental in helping the association obtain catastrophe funding in the private market. The JUA currently has $400m in bonds that were issued in 1997, after retiring $150m as of 1 July 2002. The association also has a $730m bank line of credit.

JUA executive director James `Jay' Newman said the association had been pursuing the ruling since 1999, based on several legal opinions that found the association was an extension of state government. As a result of Chief Judge Vinson's ruling and subsequent decision by the US Internal Revenue Service (IRS) not to appeal, the JUA is scheduled to receive a tax refund of $172m plus interest. The money will double the association's current surplus. Additionally, the ruling will ease the potential size of assessment levied against all Florida policyholders to pay off debt.

"When the big storm comes, the JUA can issue tax-exempt debt," said Newman. "That means there is now the choice of smaller assessments or paying off debt faster."

As a result of the court ruling, Gallagher was able to obtain an IRS private letter ruling, stating that if Citizens were implemented, it would be exempt from federal taxes. Armed with the IRS ruling, Gallagher had the political firepower necessary to force state lawmakers to act. "This ruling is a good starting point for implementing reforms of our state residual markets," said powerful chair of the House council on competitive commerce committee, JD Alexander, who had previously blocked all of Gallagher's plans.

Gallagher was enthusiastic over his victory, which will give him wide-ranging control over the new entity. As approved by lawmakers, from the time Citizens is activated on 1 August 2002, it will be governed by a seven-member board that will serve at the pleasure of the insurance commissioner. Gallagher attributed his victory in large part to the IRS private letter ruling, which could translate into savings of $80m this year. "We were confident we would get the letter, but it is better to have had it in hand," he said.

The industry has been more faint in its praise of the plan. Although there was always general support for the concept of a tax-exempt entity, there was little enthusiasm for massive residual market reform. The prevailing opinion was that the current market mechanisms had worked well and had the advantage of being known in the capital markets. Citizens presents a myriad of details that must be addressed and could take years to resolve. Still, the industry had little choice but to accept the plan based on the political dynamics.

"The insurance commissioner worked hard for the tax-exempt status and that's good for all Floridians," said Florida Farm Bureau vice-president Rade Musulin, who is a nationally-recognised expert on hurricane losses.

Gallagher pressed for his Citizens to become operational in time to secure the tax-exempt status for this year's hurricane season, which extends from June through November. Noted hurricane forecaster Dr. William Gray of Colorado State University, has forecasted that there will be 12 named Atlantic-basin storms this season, which is two more than average. He also is predicting a greater probability of landfall along the US coast.

Accelerated timetable
The accelerated timetable, however, will likely not see the full implementation of Citizens, which could take several years. Citizens will issue all perils policies for residential and commercial residential risks except in the current FWUA areas. In those areas, Citizens will offer wind-only policies to residential, commercial residential and non-commercial residential risks.

The wind-only policies will be handled through a separate account that allows private companies to enter into quota-share agreements with Citizens. Under the agreements, private companies may offer hurricane coverage to policyholders while retaining only 10% or 50% of the losses. The quota-share arrangement is design to shift some of the hurricane loss burden back to private companies, thus reducing Citizen's PML and the potential assessment burden on state policyholders.

Lawmakers mandated that if the residual market's $6bn PML is not reduced by

25% as of 1 February 2007, the wind-only eligibility areas should be reduced. Further reductions could take place as of 2012, if a 50% reduction from current PML is not achieved. It should be noted that this mandate reflects only legislative intent; it does not have an enforcement provision, such as an assigned risk plan, in the event the PML reductions are not met. Additionally, at Gallagher's urging, lawmakers rewrote the residual market depopulation laws so that consumers have the option of staying in Citizens and not accepting an offer from a private company. The prior law made FWUA and JUA policyholders ineligible for coverage upon receiving an offer of private coverage.

The current financial structures of the FWUA and JUA will remain in place, but by next year it is expected that Citizens will have to enter into other financial agreements that will reflect much higher exposure limits. Operationally, there are many decisions to be made since the FWUA and JUA offices are located in separate cities and have duplicate services as well as vendor contracts to be considered.

By Michael Adams

Michael Adams is a Tallahassee,

Florida-based insurance journalist.

Email: onworkcomp@aol.com