Property insurance: Still living in fear of the really big one

By Tom Zucco, Times Staff Writer
Published March 2, 2008


If you knew what that word meant three or four years ago, congratulations. You're an insurance agent.

The rest of us came to know what the term means because of that crash course in insure-speak forced on us by the property insurance crisis.

Here are two more terms you'll probably be hearing more about - a national catastrophe fund and the global catastrophe bond market.

But first, let's go back to reinsurance, which is the backup coverage insurance companies buy to protect themselves from big losses. It's insurance for insurance companies.

And it's a key element in the Florida insurance puzzle. Already there are signs that the Legislature will make changes to the insurance reforms passed in 2007. Reinsurance was a key factor then, and it figures to be again.

After insurance companies complained in 2005 and 2006 that it was the high cost of reinsurance that was driving up rates, Florida did something no other state has even considered. It expanded its pool of cheaper backup coverage - the Florida Hurricane Catastrophe CAT Fund - by $12-billion.

Florida put a total of $28-billion worth of state-backed reinsurance on the line, thinking that insurance companies would buy the cheaper state coverage and pass along the savings to homeowners in the form of lower rates.

Some did (American Strategic, State Farm), some didn't (Allstate, USAA, Hartford), and some we're still not sure about (Nationwide). The most telling statistic is this: only 20 percent of Floridians have seen their premiums go down.

Gov. Charlie Crist, Insurance Commissioner Kevin McCarty and the Legislature are trying to figure out why that happened, mostly at the expense of the biggest offender: Allstate.

But relatively speaking, that's a small battle.

Which brings us back to reinsurance.

Florida CFO Alex Sink has recommended shrinking the CAT Fund by about $3-billion. Sink argues that by offering all that extra cheaper state reinsurance, the state put too much at risk. Plus the cost of private reinsurance dropped about 15 percent last year, and should keep falling this year.

The key question is who can take on those billions of dollars of added risk that have to be accounted for. The total exposure to risk for Citizens Property Insurance alone is about half a trillion dollars.

The state of Florida needs to unload some of its massive risk. But who would want it? Citizens and the private market can do the insuring. But who will take on the reinsurance, and do it at a reasonable price?

This is where a national catastrophe fund and the global catastrophe bond market come in.

Proponents of a national catastrophe fund say it would be like a super Florida CAT Fund. Policyholders from all states would pay into it, creating a giant reinsurance fund that would provide a stable backstop for insurance companies.

Pricing? That's an unknown for now, but in theory, it would be lower than private reinsurance.

The other option is for states or companies to try another form of a loan - selling catastrophe bonds on the global financial market to lessen the need for reinsurance.

There is also a combination of the two that some experts find intriguing.

McCarty, who has traveled to Washington several times to lobby for the creation of a national cat fund, said that unlike national flood program administered by FEMA, a national cat fund would offer layers of federal and state reinsurance to insurance companies.

And not just for hurricane or earthquake coverage. McCarty favors an all-perils policy that would include the true moneymaking lines like fire and theft.

He also thinks selling cat bonds should be included in order to take some of the financial risk off government. "We should go beyond reinsurance and look at the capital markets," said McCarty, adding that passage of national cat fund, "is going to be a challenge."

Okay, so is selling cat bonds on the global market a good way to unload all that risk? The state tried to sell about $5-billion in bonds last summer and was only partially successful.

John Seo, who sells cat bonds for a living, says the appetite in the global market is there.

Co-founder of Westport, Conn.-based Fermat Capital Management, which manages more than $2-billion in catastrophe bond investments, Seo argues that cat bonds can be an effective way to move significant risk out of the insurance market and into the financial markets, primarily because the financial markets have far more capital. They can absorb the huge risks that are doubling about every 10 years.

"The global capital market is from $30-$50-trillion," Seo said in a recent interview. "These are folks who deal in blocks of trillions, mainly non-U.S. national pension funds. The capacity is there."

On the downside is the issue of liquidity in the event of a megadisaster. In other words, how quickly could insurance companies get their hands on the money they need to pay claims? Reinsurers are built to pay off quickly; not so the bond market.

Here's another argument against sending the risk offshore: "When no storms hit, investors make tremendous profits," said Chris Neal, a spokesman for State Farm Florida. And years of relative quiet far outnumber active years.

"But one of the nice things about cat bonds," Neal added, "is that they really help even out the peaks and valleys."

Whether its through cat bonds or a national reinsurance program, stronger building codes or more meaningful mitigation efforts, the bigger aim is finding a way to shrink those massive risk numbers. To lower the amount of money we need to insure ourselves.

"We need to reduce our exposure to catastrophic risk," McCarty said. "That has to be our goal."

Tom Zucco can be reached at zucco@sptimes.comor (727) 893-8247.

The options

As it is now

Florida's Hurricane Catastrophe Fund was expanded to $28-billion, with the promise that homeowner premiums would decline as a result. But only 20 percent of Floridians have seen that happen. What's worse, if one or several storms exhaust the CAT Fund money, anyone in Florida who owns a home, car or business would pay assessments on top of their insurance premium.

Two optionsCreate a national catastrophe fund that everyone in the United States would contribute to. It would cover everything from floods and earthquakes to hurricanes and tornadoes. The reserves created after just one year would be enough to cover most disasters. But there is slim hope Congress will create such a fund.

A second option is selling bonds on the global catastrophe bond market. But there are drawbacks there as well, including the price of the bonds, a cost that would be passed to policyholders.