The Florida insurance market continues to attract controversy as ongoing attempts to suppress rates are met with economic realities – and fears of an overly active hurricane season

As the 2010 hurricane season gets under way and many predict stormy seas in the North Atlantic and Gulf of Mexico, practitioners within the Florida insurance market will have their eyes firmly glued to the Weather Channel. Florida beaches are already seeing their first glimpses of the massive oil slick emanating from the Deepwater Horizon rig – an environmental disaster likely to be compounded by this summer’s stormy seas.

While the past four years have been notable for their lack of hurricanes along the Florida coastline, several insurers have gone insolvent in recent months. That this should happen after a year devoid of major losses does not bode well for 2010, and hints at some of the failing dynamics at work in the market.

For the reinsurance market, the 1 June ‘Florida book’ renewals saw a marginal decline in rates of 10%-15%, reflecting the return of capacity to the sunshine state. Prices did not reduce by as much as some had predicted, which is thought to be a result of continuing uncertainty in the market. Mid-year renewals are often down to the wire, but the stand off during this year’s negotiations left very few firm orders in advance of 1 June.

According to Aon Benfield’s renewals update: “The Florida residential insurance market is one of the few areas … that reinsurers believe became more rather than less risky in 2009 and the first half of 2010.”

Elephant in the room

The Florida market is the most dysfunctional property insurance market in the USA, according to Insurance Information Institute president Robert Hartwig. In a recent presentation entitled ‘Elephants in the room: big problems in Florida’s insurance markets that nobody wants to discuss’, he warned that artificial rate suppression and a hostile regulatory environment was undoing the viability of the private insurance market, leaving Florida consumers on the hook for multibillion-dollar events.

With a $2.459 trillion exposure in 2007, Florida has remained the most hurricane-exposed state in the USA. This exposure had grown by $522bn (27%) from $1.937 trillion in 2004, according to risk modelling specialist AIR Worldwide.

Despite the drop in house prices since the collapse of the US subprime market, these exposures remain high. The lure of the Florida coastline to millions of Americans continues to inflate the population (presently 18.55 million, according to the US census), with year-on-year insured values increasing in the state as a result. The value of insured residential coastal exposure is $1.24 trillion – far more than any other state – while commercial structures account for $1.22 trillion.

As the 2010 elections get under way for a new Florida governor, there is no doubt that the cost of insurance in the state will feature strongly on the agenda. When present incumbent Charlie Crist was elected in 2006, he pledged to lower homeowner rates in the state. His tenure has seen a raft of legislation intended to lower the cost of cover along with the expansion of the state’s residual market, including state-owned insurer Citizens and reinsurance backstop the Florida Hurricane Catastrophe Fund (FHCF). (See box, ‘(Re)insurers of last resort’.)

Turning to the private market

The Florida Office of Insurance Regulation (OIR) continues to cite the high cost of reinsurance as a significant issue in the market. It recently relaxed its stance on how much reinsurance it requires insurers to purchase, having previously mandated that carriers buy up to the 100-year return period.

This has resulted in a net decrease in reinsurance capacity purchased at mid-year, according to Aon Benfield. It estimates demand for private market cover fell by around 5% at mid-year, compared with the 1 June renewals in 2009.

The reduction is all the more notable given that there is ample capacity available. A benign catastrophe year in 2009 and recovering financial markets boosted earnings for many reinsurers, although these have since been eroded by catastrophes in the first quarter, including the Chilean earthquake and European Winter Storm Xynthia. There is also the growing exposure to the Deepwater Horizon oil slick.

Another dynamic that should have boosted demand for private market protection was the reduction of the FHCF’s temporary increase in coverage limits (TICL). From $10bn a year ago (down from $12bn in 2008), TICL was reduced to $8bn for 2010, with a take-up of just $2.72bn expected. As the price differential between TICL and the private market shrinks, many cedants were expected to buy at least some of their reinsurance protection from private sources.

Rating agency Demotech has encouraged insurers to purchase more cover from the private market, explaining that companies buying from TICL will only be able to maintain an A financial strength rating (FSR) if they can demonstrate exceptional solvency.

Migrating to the survivors

Despite this confluence of factors that should have boosted demand for reinsurance, less cover was bought than a year ago. Lockton North America executive director John Daum thinks this is a result of the regulator’s changed stance on reinsurance purchasing and reinsurers pulling away from troubled accounts.

Fearful that many residential insurers may not survive even a hurricane-free season, Aon Benfield notes that capacity has been withdrawn from Florida, benefiting cedants outside the market.

In recent months, the OIR has shut down or suspended six insurers, approved the sale of two others and ordered many more to enhance their solvency levels. Daum has categorised cedants into three groups: “the almost dead, the walking dead and the survivors”.

“There are an awful lot that are walking dead and with one little puff of wind will be out of business, so it’s a very precarious situation in general in Florida,” he says. “Reinsurers are looking at some of the companies and saying they’re almost impossible to reinsure because of their financial difficulties.”

Insolvencies include Magnolia Insurance of Coconut Grove, Northern Capital Insurance and its affiliate Landmark One, which were all established in the past two years by taking customers from state-owned insurer Citizens. All three were forced into liquidation in April, leaving up to 300,000 homeowners without cover as the hurricane season began.

Insurers’ ability to increase premiums has not been improved by windstorm mitigation credits (reductions on residential premiums based on the strength of a home to withstand wind damage). While they are intended to promote stronger construction practices, the system has failed in practice. “The mitigation credits that the state has mandated really drove down the price they had to charge their insureds. Now that’s starting to catch up because the state is allowing across-the-board 14% rate increases,” Daum explains.

In the firing line

According to AM Best’s 2010 US Catastrophe Review, four consecutive years without a hurricane have not improved the average rating of the top 10 homeowner underwriters in Florida. Their composite rating fell from an average FSR equivalent of A and A+ to an average of A- in 2009. The market share of the top 10 has also steadily fallen (to 38.3% in 2009, compared with 51.9% in 2002), while state-owned Citizens has assumed a greater role in the state’s homeowner market.

Despite these four hurricane-free years, many insurers have been unable to build up a surplus because of the tough pricing environment. “What has occurred over the past couple of years is somewhat depressed pricing due to regulatory constraints in the marketplace,” Attanasio says. “That, combined with the increased wind mitigation credits companies are forced to provide to policyholders, has resulted in the pressures insurers face today.”

Should Florida face a sizable loss this summer or aggregate losses, as was the case in 2004 when the state was hit by Hurricanes Charley, Frances, Ivan and Jeanne in quick succession, Citizens and the FHCF will be pushed to the limit. While AM Best remains concerned about the ability to fund all obligations associated with the FHCF, it recognises it has an improved cash position in 2010 (at roughly $9bn) and more favourable credit market conditions. But it notes that a gap exists between its current cash position and the amount of capacity issued to the market ($17bn).

“There’s still a significant amount of uncertainty if an extreme large event were to occur,” AM Best assistant vice-president, property/casualty ratings, Jeff Mango, says. “Those waters are largely untested as far as issuing bonds to the magnitude they may have to issue, so that is why we approach it with a sense of scepticism.”

The FHCF is also able to levy emergency assessments, but as its assessment base is shrinking, it could result in higher assessments in percentage terms. The cat fund has $9.5bn in pre-event loss reimbursement capacity but $20bn in potential obligation for the 2010 season, according to Aon Benfield. “Any deficit will require an issuance of post-event debt and policyholder surcharges over multiple years,” it warns.

As the hurricane season gets under way, forecasters are warning this is likely to be a very active year. On 2 June, experts at Colorado State University increased their forecast, saying they now expect at least 10 hurricanes (average is 5.9) and 18 named storms (average is 9.6), while the probability of US major hurricane landfall and Caribbean major hurricane activity is well above its long-period average.

Should Florida prove to be in the firing line this summer, the state could be in deficit for years to come. GR