Cat Fund a threat to home insurance

Florida needs to shore up the fund so it can cover its hurricane liabilities.

By Paige St. John
Sarasota Herald-Tribune

Ocala Star-Tribune--February 9, 2009 

Months before hurricane season, Florida faces an unprecedented threat to its fragile home insurance market, again risking price spikes and policy shortages.

The threat comes from the state’s primary tool to prevent such a mishap: the Florida Hurricane Catastrophe Fund.

In an effort to stop rate increases, Gov. Charlie Crist and lawmakers two years ago doubled the size of the fund to sell $29 billion in storm protection to Florida insurers, at prices far below the private market.

Insurers, in turn, were to pass the savings on to homeowners.

But since last fall, Cat Fund advisers have warned that Florida cannot borrow enough money to make good on its promise to pay hurricane claims.

The shortfall is an estimated $18 billion.

Now, two key financial rating agencies, A.M. Best and Demotech, say the state must shore up the fund or they will be forced to downgrade the financial ratings of dozens of insurance companies that rely on state coverage.

If that happens, millions of policies could immediately be deemed worthless, triggering banks to invalidate mortgages that require qualified insurance coverage.

Scott Jenkins, senior vice president for the Florida Bankers Association, calls the resulting scenario “a nightmare.”

State leaders are scrambling to find a solution.

But in the current global recession, almost every path leads to further rate hikes in a state already swooning from record foreclosures and unemployment rates veering toward 10 percent.

“We’ve got to go where we can and find what we can, because we have a pretty serious problem,” said Cat Fund Executive Director Jack Nicholson.

The gap in the Cat Fund appeared during hurricane season last year.

Lawmakers in 2007 sought to thwart post-Katrina insurance rate increases by doubling the fund to add $12 billion of hurricane risk.

Florida did not have the cash to pay such losses; lawmakers presumed the state could borrow the money if there was a hurricane.

That borrowing ability evaporated last year with the global credit crisis.

Fund underwriters estimate Florida could raise at most $10.6 billion – more than $18 billion short of the fund’s full liability.

Next week, Cat Fund director Nicholson intends to recommend a combination of possible solutions, including seeking financial backing for the fund or reducing the amount of coverage Florida provides.

Nicholson proposes that the governor approve soliciting Wall Street investors to guarantee a loan that might never be needed, a promise that would cost hundreds of millions of dollars.

To straddle part of the gap last year, the Cat Fund paid billionaire Warren Buffet $224 million for the option to borrow $4 billion if needed.

This year, with financial conditions even worse, Buffett has said no.

Twice since December, Nicholson has approached Ajit Jain, reinsurance manager for Buffett’s Berkshire Hathaway.

“Their capacity is hurt,” Nicholson said. Even if Buffett would recommit, Nicholson said, the price would be higher and the terms “above our resources.”

Cat Fund advisers warn that even if a similar guarantee is found elsewhere, it is bound to cost even more.

Hence, Nicholson also wants to ask the U.S. Treasury for a federal guarantee on Florida’s hurricane debts or an outright promise to give the state a loan.

Fund advisers acknowledge the quest comes “at a time when many voices are competing for federal money.”

Finally, the Cat Fund director believes Florida needs to consider selling less hurricane coverage.

That prospect would force Florida insurers to buy protection elsewhere at much higher rates or reduce their exposure by dropping policies.

The potential hit to consumers is large: insurers get their top layer of hurricane coverage from the Cat Fund at two cents per dollar of protection.

Private reinsurers charge an estimated 25 cents per dollar.

Reducing the Cat Fund by $5 billion would cost insurers – and therefore Florida homeowners – an estimated $1 billion more.

Scaling back the Cat Fund also carries political cost.

Approval would be required not only by the Florida Legislature, but also by Crist, who has made lowering home insurance rates a tenet of his administration.

State Farm’s withdrawal from Florida complicates any effort to shrink the Cat Fund.

Hurricane coverage for its policies – one out of five homes insured by the private market – came through State Farm’s parent corporation.

Companies picking up State Farm’s jettisoned business would be buying reinsurance for those new policies at the same time they would be attempting to replace a portion of the Cat Fund.

The notoriously volatile reinsurance market likely would answer that increase in demand by raising prices.

There is also the risk that private reinsurers could not fill the demand for capital, pushing Florida insurers onto even thinner ice.

Nevertheless, a smaller Cat Fund has strong political supporters, among them Senate budget chief J.D. Alexander.

He plans to use his committee next week to vet the Cat Fund’s shortfall.

“My problem is, if you can’t write the check you shouldn’t write the insurance,” said Alexander, R-Winter Haven.

“It’s legitimate for Florida to take on some of the insurance risk, but we have taken on so much it sinks the boat.”

Rating agencies have made clear they will not wait for a hurricane to expose the Cat Fund’s shortcomings.

A.M. Best gave credence to its threat last fall, when it put the ratings of seven major Florida insurers under review, including Allstate Floridian.

The watch was lifted only after hurricane season was over.

Demotech, which examines more than 60 Florida insurance companies that comprise the majority of the market, said it would withdraw its ratings entirely if the Cat Fund shortage is not addressed by May 15, the end of the legislative session and two weeks before the start of the 2009 hurricane season.

The mortgages on most homes require that property be insured by a rated insurer.

Loans backed by Fannie Mae and Freddie Mac must have an A.M. Best rating.

Without the ratings, most home mortgages would go into default, forcing a scramble for coverage in a pinched market.

“From first glance, this would be a concern for us,” said Jenkins, the Florida Bankers Association senior vice president. “It could be a headache and a nightmare.”

Demotech President Joseph Petrelli – engaged in his own flurry of meetings with Florida politicians, regulators and insurers – said he believes Florida officials will find a way to prevent dozens of insurance companies from losing their ratings.

“We know that May is around the corner in terms of hurricane season, but .?.?. I think the state of Florida is doing as much as it can,” Petrelli said.

Meanwhile, he said, many private insurers are arranging a third layer of protection, backup plans to the backup fund.

These range from lines of credit at banks to bridge loans from other reinsurers.

All come with a cost, Petrelli said, and are accompanied by the question of whether there will be rate hikes to pass that cost to consumers.