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Florida Insurance

This is an unpublished report about Florida Catastrophe insurance -- I think it will stand up well the next year three hurricanes hit the Grapefruit state.

Insurers plan to stay in the shallow end of the risk pool

By Michael Brady 8/26/06

After hurricanes have dealt heavy losses to national insurance companies, many are raising rates and whining about leaving Florida. But in fact, some, like State Farm, are utilizing their subsidiaries and the reinsurance market to build a safety net designed to minimize any losses in Florida regardless of the weather, and keep it a lucrative source of profits.
Florida only insurance companies are finally learning to function as the limited liability subsidiaries they were created to be – suitable fictions that accept blame without responsibility. Historically unable to adequately price risk in Florida due to an unfavorable insurance regulatory environment, companies are using the current climate of fear to put in place practices that guarantee Florida homeowners will continue to pay more money for less coverage.

The plan

State Farm Florida, a company in the Illinois-based State Farm Group of Insurances, and Allstate Floridian, a subsidiary of Illinois-based Allstate (NYSE: ALL), plan to increase rates, outsource risk and drop properties they feel most likely to make claims against them. State Farm received approval from State regulators to increase their rates by a statewide average of 52.7 percent. Allstate Floridian was approved for a 16.8 percent increase.
These rate increases are reviewed and approved by Florida’s Office of Insurance Regulation after public meetings are held for all requests of more than 15 percent. Most of the recent rate increase requests have cited reinsurance costs as the reason for their requested increases, said Bob Lotane, spokesman for the state of Florida’s office of reinsurance.
Because the cost of reinsurance tends to be approved if companies show that it’s being used to pay for the reinsurance, Lotane said, bigger rate increases have been routinely approved this year.
It also appears to be a way insurance companies are using to work around the inadequate pricing structure they feel that the State of Florida’s strong regulatory restrictions that have forced on them in the past.

Saying good-bye to risk

State Farm Florida is outsourcing risk this year by more than doubling its reinsurance with its own national company in Illinois, at the cost of one third of their annual premiums in Florida, according to a information provided in a 543 page rate request filing with the Florida’s office of insurance regulation.
They will spend $662 million purchasing one year of reinsurance, 73 percent of it going to State Farm Mutual of Illinois. This will buy $7.5 billion of reinsurance coverage for the 2006-7, starting in July. Last year, State Farm held $3 billion worth of coverage for which it received slightly more than $ 100 million from its Florida subsidiary. State Farm Florida is spending five times more for reinsurance this year than last—one-third of their $1.5 billion in premiums, to get more than twice as much coverage as last year.
This doubling of outsourced catastrophe risk is indicative of a trend, according to Ansis Vallens, an analyst for Benfield PLC., a London based independent reinsurance and risk advisor.
“Florida’s risk is thought to uncertain, and predictive models are not indicating whether the four storms of 2004 are an aberration or a trend,” Vallens said. “Insurers like State Farm are spooked and buying reinsurance based on storms that happen once in every 250 years instead of the old standard of 1 in a 100.”
Vallens does not feel that State Farm is necessarily spending too much on reinsurance this year and said that due to the fear and uncertainty in the market, it may be “they are erring on the side of caution and trying to insure the survival of their company.”

[Lose some, win some—that’s the point]

State Farm Florida sustained net losses and loss adjustment expenses of $1.3 billion in 2004 and its parent company lost almost $3 billion through its Florida exposure in the reinsurance market, according to the rating company A.M. Best.
Despite that, State Farm Illinois has also done very well in the profit department, they saw net assets go from $17.5 billion to $24 billion in the last three years despite putting $750 million into its Florida subsidiary in 2004 after big losses in 2004, according required filings with the National Association of Insurance Commissioners.
Traditionally, insurance companies have averaged weather risk over decades instead of years. Insurance works by mathematically evaluating risk and setting aside enough money to cover that risk over time, said Adam Shores, spokesman for Allstate Floridian.
But now that risk has been outsourced, the time element that allows for the setting aside of capital for a rainy day to be compromised.
“Instead of the money staying in Florida, building up interest and accumulating over the calm years to pay out in the bad ones, the money’s just [left the state],” Shores said. It’s a little like the difference between term and whole life insurance – term insurance is in the moment and holds no value other than as a specific snapshot in time.
Allstate Floridian has also seen “huge” increases in what they pay for reinsurance this year. But different than State Farm, most of its reinsurance is “outsourced and not with our parent company,” said Shores, but he declined to give numbers, citing `proprietary reasons.’

Reinsurers edging into new models

Reinsurers primarily are using one of three models to evaluate risk this year: RMS, Risk management solutions bases in Stanford, Ca., AIR Worldwide, based in Boston and Eqecat, based in Oakland, Ca., all three have revised models approved this year by the Office of Insurance regulation, and all show significantly higher risk for potentially catastrophic storms to occur over this “cycle of increased hurricane activity,” said Vallens.
“Reinsurance is big business and its money flows towards the best risk,” Vallens said, “and Florida’s seen as a big mess.”

Because of this, reinsurance firms have become much more disciplined and structured on how much risk they are willing to accept in Florida, because of both recent losses and the perception among big reinsurers that Florida’s risk has become too “risky.” Reinsurers are now only accepting new risk with unfavorable rules and conditions, said McDonnell. “What’s left is higher cost products like catastrophe bonds, usually provided by hedge funds, or risk pools, at a very high cost,” McDonnell said. “The cost for any additional reinsurance has become unaffordable for many [insurance] companies, especially those without a national company to fall back on.”


[Florida insurance, the recent history ]

Insurance methodically looks to the long term, it’s a ‘measure twice, cut once’ sort of business that thrives by minimizing chance and managing risk. Much like a casino in Las Vegas, it plays of the role of the house and expects to win every time-- over the long run.
And like Vegas, if you didn’t pay out big occasionally, no one would pay to visit.
The bigger insurance companies in Florida thought they covered their exposure after Hurricane Andrew by: leaving the market, forming “baby” subsidiaries to limit risk and not-renewing problem properties.
Eight storms over the 2004-5 seasons shocked them silly. Risk began to look unmanageable, the math failed and they could no longer see where the long run would lead them.
Florida responded to Andrew by allowing smaller companies to step in-- in fact rewarding them with bonuses for “depopulating” the higher risk policies. These “Florida Only” companies technically met the capital requirements, but in time would prove undercapitalized and without resources to bail them out if the worst happened. Many were crippled by losses after eight hurricanes swept over Florida in 2004-5; some went bankrupt.
Citizens insurance, the last resort provider, picked up failing companies and most of the at risk properties abandoned by private companies, On July 1, it became the largest insurance company in the State.
Funded by charging the highest rates allowed, public debt, the ability to assess private property insurers for losses and a one-time grant from the State of $750 million, Citizens continues to be rated A+ by Fitch ratings service. Fitch notes: “ It’s expected that Citizens will be backed by the taxpayers of Florida for any future losses.”


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