Some State-Run Property Insurance Plans in Precarious Financial Situation

As the 2009 Atlantic hurricane season enters its peak period, the finances of a number of residual market property plans in hurricane-exposed states are on shaky ground. The credit crunch and prolonged economic downturn have exacerbated the already vulnerable financial condition of certain plans, making it more difficult for states to borrow funds, according a revised report by the Insurance Information Institute (I.I.I.).

The I.I.I.'s white paper, titled "Residual Market Property Plans: From Markets of Last Resort to Markets of First Choice," says state-run insurers are putting themselves at increased risk through greater dependence on bond markets even as credit markets struggle to recover from the current financial crisis.

"Disruptions to credit markets will likely make it more difficult and more expensive for some of these plans to issue debt to pay for hurricane losses," wrote I.I.I. President and Economist Robert Hartwig and Claire Wilkinson, the I.I.I.'s vice president - Global Issues, co-authors of the paper.

"Ill-advised legislative steps over the course of several years have also expanded the exposure base of a number of plans such as Florida, yet at the same time curbed the rates they can charge," the authors wrote. "Such moves put state finances under threat and leave taxpayers and policyholders facing the potential for increased assessments in the years to come."

The report noted that legislation passed in several key states this year has started to address some of the problems facing certain plans. In addition, over the last two years, there has been a noticeable reduction in the number of policies and exposures in some parts of the residual property market due largely to the real estate bust and the addition of newly established insurance companies whose financial strength has yet to be tested by a major catastrophe.

The study acknowledged that over the last four decades, state-run property insurers have experienced explosive growth both in terms of the number of policies issued and the exposure value covered. Further, in the 19-year period from 1990 to 2008 - a period characterized by major catastrophes such as Hurricanes Andrew and Katrina - that growth has accelerated, the report said.

"Total policies in force (both habitational and commercial) in the nation's FAIR, Beach and Windstorm Plans combined nearly tripled from 931,550 in 1990 to 2.6 million in 2008. Total exposure to loss in the plans surged from $54.7 billion in 1990 to $696.4 billion in 2008 - an increase of 1,173 percent."

While a number of factors have contributed to the overall growth of the plans in the course of the last 20 years, the I.I.I. found that in some states, such plans have shifted away from their original purpose as predominantly urban property insurers. As a result, many have evolved from their traditional role as markets of last resort into much larger insurance providers, in some cases even becoming the largest property insurer in the state.

In Florida, for example, Florida Citizens, a plan that accounts for the vast majority (69 percent) of the total FAIR Plans exposure to loss, saw its exposure more than double from $210.6 billion in 2005 to $485.1 billion in 2007, reflecting rising coastal property values and higher building and reconstruction costs. Florida Citizens' exposure to loss declined somewhat to $421.9 billion in 2008 and by June 30, 2009, to around $400 billion.

While residual market property plans fulfill a crucial role by ensuring that policyholders can obtain insurance coverage, their exponential growth in the course of the last two decades has key implications for insurers and insurance buyers going forward, the report said. "In particular, there are a number of public policy considerations that will need to be addressed as insurers, regulators and legislators seek a long-term solution to managing and funding catastrophic risk in the future."

The study noted that when, due to political and/or regulatory constraints, insurers are unable to charge a premium commensurate with the risk they assume in coastal areas, this distorts the true cost of insurance coverage.

"Rate and underwriting restrictions on property insurers can result in a situation where high-risk property owners actually pay lower premiums, while low-risk property owners pay artificially higher premiums. This leads to unfair cross-subsidization among risk classes and discourages mitigation," Hartwig and Wilkinson wrote.

"Ultimately, policyholders in both coastal and non-coastal areas pay the price of inadequate premiums in the form of additional payments, such as assessments and taxes following federal/state bailouts, which are passed on to them. Even policyholders of unrelated risks, such as auto and liability, have to pay assessments."