Insurance Commissioner Kevin McCarty delivered a major speech before an Aon Benfield gathering in Miami on January 28. We are reporting it now because it addresses some topics not covered or not in as much detail as in major addresses he delivered earlier in January. These are remarks which were prepared for the commissioner and are a formal OIR paper, but he does often diverge from his prepared text.

The commissioner listed the following as “my ‘top five’ biggest issues confronting the property markets in Florida.
    Firstly --- as Florida’s economy recovers and our appetite for insurance increases, we must be concerned about developing new ways to invite additional capital to our state; the status quo, specifically maintaining the current level of insurer investment, will not suffice. We need additional capacity.

    Secondly --- from a solvency standpoint, we must continue to be cognizant of a national phenomena: large insurers leaving our state. If this trend continues (and I believe it will), we will continue to need to rely on more homegrown domestic insurers to fill the gap, and must adjust our solvency regulation (and surplus requirements) accordingly. We also must rely on international reinsurance markets or develop access to alternative methods of risk-sharing – potentially tapping into other financial markets.

    Thirdly --- we must re-evaluate the role of Citizens Property Insurance Corporation. At over 1.2 million policies and 1,000 employees it is the largest property insurer in our state. Due to price freezes a few years ago, Citizens policies are priced anti-competitively relative to private insurers, which is leading to market distortions.

    Fourthly --- we must address cost-drivers in our system. These include 1) The current replacement cost methodology, 2) A reported increase in fraud, 3) Premium reductions from mitigation discounts; and 4) An increase in reported sinkhole claims. As a result, several large insurers have sought (and been granted) rate increases from 6% to 28.8% during the last year. Unfortunately, more rate increases may be on the way.

    Fifthly --- we must address the issue of sinkholes. I realize I have mentioned sinkholes in the cost-driver section, but sinkholes deserve their own category. With nearly $2 billion in damage over the past five years, sinkholes have become our “silent catastrophe.” In fact, we may even have to confront a pivotal underlying question: given the fact that sinkholes are unpredictable geological events – are sinkholes really an insurable risk? If they are not – this could lead to a multitude of other challenges as both banks and consumers need to have some protections from this risk.”

His complete prepared remarks are available below:
Aon Benfield’s Catastrophe Summit
Friday, January 28, 2011
Miami, Florida
Opening Remarks by
Florida Insurance Commissioner Kevin McCarty

Good afternoon. It is a pleasure to participate in Aon Benfield’s Catastrophe Summit in Miami. I would like to start by thanking Kevin Campion for inviting me to this outstanding event.

Today, I would like to provide a brief overview of the Florida residential property markets, and then give a preview of property insurance issues that may be on the Legislature’s agenda this year. To begin, I was asked to discuss what I considered to be the “top five biggest issues” confronting our Office. Interestingly, in most years --- my top five priorities would all pertain to property insurance issues as this continues to be an enduring challenge that we must confront. Ironically, not this year. This year I would include the implementation of federal health insurance, and the cost-drivers affecting the auto insurance industry as some of my most significant concerns. I say this as a subtle reminder to this audience that Office regulators must handle a variety of insurance issues on a daily basis – even issues that do not involve property insurance.

However, for the benefit of this audience – I will mention my “top five” biggest issues confronting the property markets in Florida, which will form the outline of my speech this morning.

  1. Firstly --- as Florida’s economy recovers and our appetite for insurance increases, we must be concerned about developing new ways to invite additional capital to our state; the status quo, specifically maintaining the current level of insurer investment, will not suffice. We need additional capacity.
  2. Secondly --- from a solvency standpoint, we must continue to be cognizant of a national phenomena: large insurers leaving our state. If this trend continues (and I believe it will), we will continue to need to rely on more homegrown domestic insurers to fill the gap, and must adjust our solvency regulation (and surplus requirements) accordingly. We also must rely on international reinsurance markets or develop access to alternative methods of risk-sharing – potentially tapping into other financial markets.
  3. Thirdly – we must re-evaluate the role of Citizens Property Insurance Corporation. At over 1.2 million policies and 1,000 employees it is the largest property insurer in our state. Due to price freezes a few years ago, Citizens policies are priced anti-competitively relative to private insurers, which is leading to market distortions.
  4. Fourthly --- we must address cost-drivers in our system. These include 1) The current replacement cost methodology, 2) A reported increase in fraud, 3) Premium reductions from mitigation discounts; and 4) An increase in reported sinkhole claims. As a result, several large insurers have sought (and been granted) rate increases from 6% to 28.8% during the last year. Unfortunately, more rate increases may be on the way.
  5. Fifthly – we must address the issue of sinkholes. I realize I have mentioned sinkholes in the cost-driver section, but sinkholes deserve their own category. With nearly $2 billion in damage over the past five years, sinkholes have become our “silent catastrophe.” In fact, we may even have to confront a pivotal underlying question: given the fact that sinkholes are unpredictable geological events – are sinkholes really an insurable risk? If they are not – this could lead to a multitude of other challenges as both banks and consumers need to have some protections from this risk.

Now that I have given you an overview of my biggest five most important issues – I will discuss the problems in greater details, as well as talk about potential solutions being considered by the Florida Legislature during the upcoming session.

In many ways, Florida has been the victim of its own success. Our warm weather, positive business climate, and beachfront property, have led to explosive growth over the last several decades. In 1980, there were 9.7 million people living in Florida, which has nearly doubled to over 18 million today. While our population doubled in 30 years, we have tripled our structure exposure in only half that time. From 1995 to 2009, Florida’s insured structure exposure increased from $747 billion to $2.3 trillion today. In fact, Florida has more insured structure exposure than all but a handful of countries around the world.

This exponential growth creates an underlying problem for insurance in our state. Over the past 15 years, this translates to an increased demand of roughly 8.5% percent annually. To put this into perspective – every single year our state must overcome the challenge of finding millions of dollars of additional insurance capacity simply to meet the growth in new homes, new business, and new people moving to our state. Certainly, this trend has dampened in recent years due to the economy – but as our economy rebounds – so will our appetite for insurance.

Against this background of success, are several challenges. Large insurers are reducing their risk in Florida and nationally. This phenomena did not begin during the 2004-2005 hurricane seasons – it has been occurring for the past two decades. In the early 1990s, prior to Hurricane Andrew, State Farm and AllState wrote nearly 50% of the Florida homeowner’s markets followed by other large insurers like Nationwide, USAA and Liberty Mutual. However, following this event large insurers have slowly began limiting their exposure in our state.

This is not a Florida phenomenon. National insurers are reducing their exposure in all coastal states from Maine to Texas. In fact, I recently read news reports that in Louisiana, State Farm was dropping wind and hail coverage for small commercial properties on the coast and increasing rates by 19 percent. In Mississippi, USAA Group will no longer offer wind or hail coverage in three coastal counties: Hancock County, Harrison County, and Jackson County.

Both of these insurers are significant players in the Florida market as well – and you can imagine – have far greater concerns about coastal exposure in Florida than in Louisiana or Mississippi.

The reason national insurers are minimizing their exposure in Florida is simple: catastrophic risk – or what I like to call “the risk of ruin.” According to the RMS RiskLink hurricane model the 1-in-100 year storm scenario would create a Probable Maximum Loss for residential property in Florida of $54.6 billion – the next highest state for the 1-in-100 year storm scenario is Texas at $13.4 billion. In fact, according to this model – Florida has more hurricane risk than all the other states combined. Basically, if you are a national insurer and intend to make a strategic decision to reduce your risk – you must start in Florida.

Against this backdrop of underlying challenges are what I call more transitory challenges – challenges that have arisen suddenly, and demanded action by state policymakers. The first is the unprecedented 2004-2005 storms series, which put in motion a series of events that continues to affect our marketplace. Large insurers announced they were accelerating their reduction in exposure; to offset this development, the Legislature instituted the Insurance Capital Incentive Build-Up Program to encourage investment in our state through the creation of homegrown domesticated companies. These smaller domestic companies are required to begin with at least $5 million in capital according to Florida statutes. Given our experience over the last few years – this may not be sufficient.

By 2006, we were forced to address another transitory event -- a dramatic escalation in reinsurance costs. Incorporating these reinsurance costs into their rates – companies were compelled to file massive rate increase requests – some as high as 100%. Floridians demanded action and the Governor and Legislature responded by expanding the Florida Cat Fund to provide additional capacity. Generally, this strategy has worked as reinsurance rates have declined roughly 20% from their highs in 2007.

Another concern that arose was the role of Citizens in the marketplace. Due to affordability concerns, in 2007 the Florida Legislature froze Citizens’ rates, and these rates remained frozen for three years. In 2009, the Legislature lifted the rate freeze, and allowed Citizens’ rates to be on a glide path of no more than a 10% rate increase every year. However, there are still concerns that Citizens rates are anti-competitive relative to the private sector.

Finally, we have seen the emergence of cost-drivers that I have already mentioned. I do want to focus on one particular cost-driver: sinkhole claims. When we think of sinkholes, we tend to imagine a house being swallowed into the earth. In actuality, these cataclysmic events are referred to as “catastrophic ground cover collapse” in Florida Statutes. In practical terms, sinkhole claims are often the result of cracks in the sidewalk, small shifts in the foundation, or cracks in the walls. The costs associated with these claims can be quite significant as insurance companies must investigate the claims, perform expensive testing of the area, and often settle the claim to avoid litigation. In 2009, Citizens Property Insurance Corporation incurred over $84 million in sinkhole losses plus adjustment expenses, yet obtained only $19.6 million in earned premium.

To understand this phenomenon, the Office conducted a sinkhole data call in 2010 that asked for five years worth of data and subsequently issued a report on November 9, 2010. Our principal objective was to gain specific information about sinkhole claims, to analyze trends, and to understand the magnitude of the problem. In short, the 211 private companies surveyed reported they had paid $1.4 billion for sinkhole expenses to during the 2006-2010 scope period. However, this is an understatement as more than one-third of the 24,671 claims were still open. The estimated total cost for sinkholes during this period is expected to be nearly $2.2 billion.

This is equivalent to a hurricane striking Florida in the last five years – without the benefit of reinsurance reimbursements. As importantly, these numbers continue to grow exponentially – the amount of claims doubled from 2006 to 2009. Interestingly less than one percent of these claims are for catastrophic ground collapse – the remaining claims are for the more proverbial “crack in the sidewalk.” There are several alternative explanations for the cause of an increase in sinkhole claims.

One insurer, HomeWise Preferred Insurance Company, demonstrated that claimants who had representation, typically through a public adjuster, received higher pay-outs, and were more likely to take the insurance money and not repair their home. It is possible that the current increase in sinkhole claims is less to do with geological events, and more to do with incentives in our system.

Therefore, heading into the 2011 Legislative session we have several underlying problems that include Citizens’ rates, cost-drivers including sinkholes, and the fact that large insurers are continuing to reduce their exposure in Florida requirement our state to rely increasingly on smaller home-grown companies, and the global reinsurance markets.

How will these underlying issues affect the Legislative agenda for insurance in 2011? Well, we have already begun preliminary meetings with legislative staff and the industry, and here are a few things that I expect to see during the upcoming legislative session.

First, I expect to see legislation that addresses the role of Citizens Property Insurance Corporation. Let me be perfectly clear about this issue: until systematic and fundamental changes are made to the role and function of Citizens Property Insurance Corporation – Florida’s property insurance marketplace will never function properly as a competitive marketplace. Florida’s policymakers need to make overhauling Citizens’ role a priority in order for other insurance reforms to work.

Citizens Property Insurance Corporation originally began as the “insurer of last resort” and had policies priced accordingly. Over time, the mission of this entity has evolved, and now has become an affordable option relative to the private sector. In fact, Citizens’ rate inadequacy has negatively impacted the market by encouraging consumers to buy coverage from Citizens due to artificially low prices; consequently, other companies must lower their prices to compete with Citizens.

To illustrate this point, earlier this year one of Florida’s larger insurers, St. John’s Insurance Company had an actuarial rate indication of 43.4%, yet they asked for a 0.1% rate increase –

(essentially zero) to compete with Citizens. In many recent rate filings, the Office has forced insurance companies to accept higher rate increases than what they requested. Florida policymakers need to keep this in mind as they consider rate deregulation. Put simply, rate freedom may not matter if private insurers’ policies continue to be underpriced by Citizens.

Apart from Citizens, Chariman Richter has filed SB 408, which is similar to SB 2044 that was vetoed by the Governor during the last session. One of the most important (and perhaps overlooked) elements of last year’s property bill was the requirement to increase minimum surplus for new companies to $15 million, and to phase in this requirement for existing companies. By increasing this threshold we can better protect consumers, and better protect other companies operating in Florida by reducing the need for assessments. Increasing the statutory surplus increases the “financial cushion” to allow a start-up company to succeed, or if a company fails – to give the receiver more surplus to pay consumers.

Another element of the property insurance bill will be to address costs, specifically, sinkhole costs. At this juncture, there are a number of possible solutions, including forming a sinkhole facility to pay sinkhole claims, limiting company liabilities by making the offering of sinkhole coverage optional, or changing the replacement cost methodology to better ensure that sinkhole claims payments are used to fix the problem; not pocketed by the consumer. All of these suggestions have one unifying theme – to change the incentives in the system to discourage frivolous claims.

SB 408 also modifies the calculation of mitigation credits, improves, and corrects problems related to “replacement cost” methodologies. SB 408 goes a long way toward addressing many of the cost drivers we have identified as impacting the market. While I am sure that this bill will continue to evolve during the session, I am hopeful that the Legislature will act decisively to address the problems facing the industry.

Although I have been asked to focus on residential property insurance for this speech -- I do want to mention that there is a commercial insurance de-regulation bill, SB 178, being circulated by Senator Oerlich. Although I did support similar legislation last year that attempted to deregulate insurance products for large corporations – this legislation, in its current form, goes farther by potentially affecting small businesses; this has me concerned. During these difficult economic times, it is problematic to support legislation that may increase costs to small businesses – therefore I am reserving judgment on this bill at this time to monitor how it develops during the legislative process.

In conclusion, our state’s property markets will continue to face unique challenges simply based on our geographic location, and the fact that we have nearly half of our country’s catastrophic wind risk. Although addressing non-catastrophe cost-drivers is an essential part of the solution, we cannot ignore the “elephant in the room”: Citizens Property Insurance Corporation. With over 1.2 million policies and 1,000 employees -- it is the largest property insurer in our state, and one of the largest insurers of property insurance in the country.

Florida’s policymakers need to consider making dramatic changes to this organization to make Citizens smaller with products that are less attractive from a price or coverage perspective. A “less attractive” and “less competitive” Citizens will better allow private insurers to compete for Florida policyholders, and ultimately, could lead to additional private sector investment in our state.