Given California’s recent catastrophic fires and the difficulty experienced by its property insurance carriers in recovery of their losses through subrogation, it is important to evaluate facilities that can help the state maintain a healthy and competitive private insurance market. Failure to do so may lead to the creation and expansion of quasi-governmental residual market insurers such as Florida’s Citizens Property Insurance Corporation. Though such an entity would provide for direct underwriting capacity in California should the private market shrink, it would not be the most efficient way of providing funds in response to the fire losses suffered by California property carriers, and it would still leave insureds susceptible to emergency assessments.
In response to California’s looming capacity crisis, the Florida Hurricane Catastrophe Fund may be a better case study. Its ability to provide carriers with relief during catastrophe’s will help California maintain a competitive private market while minimizing exposure of insureds to assessments. A California state fund similar to the FHCF would be able to reimburse carriers for their catastrophic losses at a cheaper price than private reinsurance due to its non-profit status, tax-exempt status (lower cost-of-capital and no federal/state income taxes), lower operating/underwriting costs, and the ability to assess insureds in case of an extreme funding emergency.
Here is a summary of the Florida Hurricane Catastrophe Fund:
- The Florida Hurricane Catastrophe Fund (FHCF) was created by the 1993 legislature in the wake of Hurricane Andrew to protect and advance the state’s residential property insurance capacity by providing a stable and ongoing source of reimbursement (similar to reinsurance) to insurers for a portion of their catastrophic losses.
- It is a non-profit trust fund run by the State Board of Administration (SBA).
- The FHCF helps the Florida residential property market by providing reinsurance that is less expensive than the private market due to the following reasons:
- The FHCF operating cost is less than 1 percent of the annual premium collected, whereas, the operating costs for private reinsurance can range from 10 percent to 15 percent of the premium collected.
- The FHCF does not pay reinsurance brokerage commissions.
- The FHCF has no underwriting costs.
- The FHCF is a tax-exempt entity that does not pay federal income taxes or state taxes.
- The U.S. Internal Revenue Service recognizes the Cat Fund as an instrumentality of the state that serves a major purpose of not only providing resources for the payment of claims to rebuild after a catastrophic hurricane, but also serving to stabilize the economy by managing hurricane risk for the state of Florida under the executive leadership of its top elected officials—the governor, the chief financial officer and the attorney general.
- The FHCF has the ability to issue tax-exempt debt, which results in lower financing costs should it become necessary to finance losses with revenue bonds.
- The FHCF does not include a factor for profit for reinsurance sold by the FHCF.
- The FHCF does not include a risk load for reinsurance sold by the FHCF.
- As of 12/31/18, statutory maximum capacity of $17B is funded primarily through participating insurer paid premiums ($13B cash balance), purchased reinsurance ($1B), issued pre-event bonds ($2.2B), and potential post-event bonds (which would require assessments).
- Mandatory participation
- By all admitted residential property insurers (including Citizens)
- Prevents adverse selection
- Promotes stability and predictability
- Contributes to financial markets evaluation of the FHCF as a credit worthy buyer
- No underwriting
- Coverage provided to each eligible insurer on identical terms
- No variation in rates or coverage (except to reflect the insurer’s elected options)
- Assures that each participant has its fair share of the finite capacity for reimbursement
- Reimbursement Contract
- Reimbursement on a paid basis for residential wind policies.
- Participating insurers select coverage of 45%, 75%, or 90% above their retention (deductible). There is also a copay amount above the retention.
- Reimbursement also includes +5% for loss adjustment expense (LAE).
- An insurer’s maximum reimbursement is the insurer’s proportional share of the FHCF’s statutory maximum obligation ($17 billion), not to exceed the insurer’s proportional share of the actual claims-paying capacity (sum of cash balance, reinsurance recoveries, and debt financing from post-event bonds).
- Participating insurer’s pay “Actuarially Indicated Premiums” which have been unanimously approved by the SBA trustees.
- Are based on an insurer’s exposure.
- Include additional 25% rapid cash build-up factor to build up cash balance and reduce risk of assessments.
- Insurers include cost of FHCF premiums in the premium they charge their insureds.
- When the cash balance of the FHCF is insufficient to cover losses from a hurricane, the law authorizes the FHCF to issue revenue bonds.
- These post-event bonds are funded by emergency assessments on all property and casualty insurance premiums paid by policyholders (other than workers’ compensation, accident and health, federal flood, and medical malpractice), including surplus lines policyholders.
- Essential factor in achieving federal tax-exempt status.
For more information please contact our partner George Feijoo.