Hurricane fund crisis could put homeowners at risk

Herald Tribune--October 5, 2008

By Paige St. John

SARASOTA –

When Florida lawmakers expanded the state’s hurricane fund in 2007 to force lower premiums, they tied the ability to deliver billions in insurance coverage to something as volatile as tropical storms: Wall Street.

To pay for storm damage, the hurricane fund would need to sell as much as $17 billion in bonds. For the past year, as inflated mortgages undermined the nation’s credit markets, that would have been difficult.

Now, for reasons reiterated daily in headlines, a large sale is near impossible.

The municipal market is "frozen," Florida’s bonding chief, Ben Watkins, told Gov. Charlie Crist at a Cabinet meeting last week. "It is closed."

If Florida is unable to borrow after a major storm, nearly every insurance company operating in the state will come up short. Scores of insurers could find themselves unable to pay claims.

Homeowners would be left with late checks at best; at worst, with no money, insolvent insurers, and a clogged guarantee fund that itself must sell bonds to pay claims.

Florida’s gambit to reduce insurance rates could bankrupt the state, paralyze its economy and leave tens of thousands homeless without money to rebuild.

No other state is as dependent on the markets to generate capital to pay for disaster relief. Other states that subsidize insurance do it on a much smaller scale. And most of those programs rely less on borrowed Wall Street capital.

The Texas wind pool does not have the authority to sell bonds, Mississippi buys private reinsurance, and Louisiana can bond but also taxes its insurers.

But Florida has uniquely staked its ability to pay for a major storm on the nation’s now-tattered financial institutions.

Aware of just such a danger, state officials have a uniform answer: a multibillion-dollar federal bailout.

"Who is relying on the Cat Fund? Everybody is relying on the Cat Fund," said Jack Nicholson, the man who oversees the state’s hurricane fund. "And we’re relying on the financial markets that are gone."

The gamble

Florida’s Hurricane Catastrophe Fund is a post-Andrew invention that, year by year, has taken an increasing load of the state’s hurricane risk off insurers.

Florida requires private insurers to purchase a certain amount of their own insurance from the state. The aim was to keep property insurance available in growth-dependent Florida.

More recently, the Cat Fund became a tool to make insurance cheaper, by subsidizing a large chunk of hurricane risk.

Thanks to two catastrophe-free years and nearly $5 billion in loans, the fund has $8.1 billion, enough to cover its pre-2007 bets: a small hurricane, or to buy time to finance a modest storm.

"Don’t play down the capacity of the Cat Fund right now, which is substantial," said Gen. Bob Milligan, a seasoned Florida political veteran who heads the State Board of Administration.

"Most of this money is not required on Day One after the storm. It’s several months, even years down the pike … and so who knows what the market conditions will be a year from now?"

But the plan to cut home insurance premiums extended the Cat Fund to cover storms much worse — up to the likes of Hurricane Andrew.

The expansion put Florida on the hook to cover as much as $29 billion in insured losses. If a major storm hit today, Florida would have to borrow $17 billion of that through bonds.

In the post-boom glow of early 2007, lawmakers dismissed the notion the Cat Fund would have trouble financing so much debt.

And they ignored early warnings. In August 2007, the Cat Fund attempted to sell $7 billion in pre-storm bonds, but a month later came back with only $3.5 billion.

In May 2008, as insurers arranged their 2008 coverage, the Cat Fund published a notice declaring the ability to sell $25 billion in bonds this season and another $22 billion the year after.

But privately, public records show, fund managers doubted they could raise even half that much.

Losses from soured mortgage investments were drying up the flow of capital. Fund managers’ own estimate was for $10 billion in bonds three to nine months following a hurricane.

A month later, notes show, the managers were "less confident" they could raise even that much.

To plug a portion of the hole, the fund arranged a $4 billion loan from Warren Buffett, money that would not become accessible until after Florida was already deep in bonding uncertainty.

In early September, the municipal bond market seized. Even moderate sales, like $424 million in construction bonds for Wake County, N.C., were put on hold.

The Cat Fund’s own primary underwriters, who would buy state bonds at a discount to resell, are caught. Lehman Brothers is in bankruptcy and Goldman Sachs was forced to sell a major stake.

"As time clicked on, I had a sense that $10 billion was eroding fast," Nicholson said. "The question is: How much can we do?"

Required by law to state new bonding estimates this month, Cat Fund advisers plan to meet Oct. 14 in an attempt to answer that question.

The answer likely will be "not enough," one advisory board member believes.

"We’re selling smoke and mirrors," said John Auer, president of American Strategic Insurance and a member of the advisory board that counsels Nicholson and the Cat Fund.

Too ugly to fail

A Cat Fund that cannot borrow is, under Florida law, a Cat Fund that does not have to pay claims.

If Florida is unable to raise enough cash, it can default on its contracts, leaving insurers to their own devices.

That jeopardizes the checks for storm victims to rebuild and communities to recover.

"Let’s hope we don’t have a storm," said Alex Sink, the state’s chief financial officer.

Failing that, she said, hope for a multibillion-dollar federal bailout.

"We have to recognize that if we have a big enough storm, just like the guys in Wall Street this week, we’ll be up there in Washington, hat in hand," she said.

Even if Washington paid for what the Cat Fund cannot, Floridians might not have cause to celebrate.

Auer asked: Who would step in the after the disaster to provide coverage for the next hurricane season?

As a practical matter, argues Deputy Insurance Commissioner Belinda Miller, it is not a question of if the Cat Fund will pay, but how long it takes for a federal bailout to start the cash flowing.

Officials’ conclusion that the fund is too important to be allowed to fail is echoed by the Office of Insurance Regulation. Despite the Cat Fund’s eroding ability to pay claims in a major storm, OIR continues to give insurers full credit for the coverage they buy — a decision that complicates the potential for disaster.

It allows insurers to have less cash of their own, increases their reliance on the Cat Fund, and thereby increases the fallout should the fund fail.

Nor are financial rating organizations questioning the value of the coverage insurers have bought from the Cat Fund.

In 2007, ratings agency A.M. Best, an authority on the financial strength of insurance companies, warned that the fund was subject to Wall Street risks, a view it repeated in May. Even though that risk has increased, Best has not revisited the credit ratings of the Florida insurers who rely on Cat Fund coverage.

And Demotech, the Ohio firm that rates the financial strength of Florida’s small, one-state insurers, continues to treat Cat Fund coverage as good as cash.

"If it was the private sector, no way," said CEO Joe Petrelli, "but given it is a state fund, we feel they will pay."

Because of its own financial problems, Florida is unlikely to be able to bail out the fund without federal help.

In September, lawmakers raided half of Florida’s $1.2 billion rainy day Budget Stabilization Fund to pay state bills. Nor is there room to borrow. The monthly payments on Florida’s existing $22 billion in debts are close to the legal cap.

In the interim, Miller said, small insurers could seek cash advances from private reinsurers who compete with the Cat Fund, and legacy companies like State Farm and Allstate could seek emergency loans from their national parents.

That does not resolve the question for the Cat Fund’s biggest client, state-run Citizens Property Insurance.

Citizens has reserves, reinsurance and loans of its own to cover hurricane losses up to about $9 billion.

"That’s not too shabby," said CFO Sharon Binnun.

But after that, Binnun said, Citizens relies on the Cat Fund to give hurricane protection to 1.3 million policyholders.

That, and selling bonds.