It looks like someone’s realized that you can’t just wish away the cost of cat cover. Seen in an Orlando Sentinel blog:
The Cat Fund could face an $11 billion gap between the cash it has on hand and can raise($18 billion), and what it could have to pay following a major disaster this year ($29 billion). And the only options are for Florida itself to buy re-insurance on the open market, or try to set up tax-exempt bonding agreements in advance that a buyer couldn’t refuse to honor after the storm.
Nicholson says the only way to completely cover all the risk Florida has assumed is to buy reinsurance. But since the state is offering this coverage to private companies at a steal to lower rates, Florida would have to pay out the gazoo if it then turns around and buys the same coverage private carriers would otherwise purchase.
In other words, ensuring the state could pay the entire $12 billion in added risk Crist and Florida lawmakers took on in 2006 could cost taxpayers $1.7 billion this year. All Florida will charge in premium to private carriers for the extra state risk is $250 million.
Now, while I will admit that the insurance and reinsurance markets aren’t always as efficient or logical as we would sometimes like to believe, that doesn’t alleviate the fact that the cost of insuring catastrophe risk really is expensive. Not only do you have to fund the expected loss, but you also have to acknowledge the need to maintain a large pool of assets on hand to pay claims in the event of disaster.
The folks who provide that cash, generally would like to see expected income for the use of that cash commensurate with the risk they face. Unless we suddenly become a communist or wholly altruistic society, that is a cold, hard fact of life.
I’m sure that Florida insurance buyers are “happy” to see this news from the Orlando Sentinel:
Floridians will pay an extra $1 on top of every $100 of insurance premium for an additional two years under a plan approved Tuesday by Gov. Charlie Crist and the Cabinet to pay off claims still lingering from the 2005 hurricane season.
Crist and the Cabinet agreed to authorize the sale of as much as $625 million in bonds this summer, mostly to cover costs stemming from Hurricane Wilma, which had been initially expected to do little damage to Florida but ultimately rang up $11 billion in rebuilding costs. Wilma has become one of the state’s costliest storms on record.
Jack Nicholson, manager of the state’s Catastrophic Fund, said there are still 7,819 claims outstanding from Wilma and the state currently has only $187 million to cover these costs.
Let’s see….it’s the Florida model for state underwriting of cat risk that we’re supposed to be emulating through a federal cat reinsurance program, right?
There’s a reason that insurers accumulate such large warchests of capital — so that when disaster strikes, the claims can be paid and the insurer can continue to operate.
If sufficient capital isn’t on hand after disaster…well, it’s going to come from somewhere.
However, this mention of Wilma reminds me that it was an odd storm. It did far more damage in south Florida than it “should” have. In particular, I remember the claims files on several of the new, mostly-glass towers on/near the beach, where it almost seemed like either the materials didn’t perform as well as advertised, or someone failed to consider the wind-tunnel effect created by the construction of so many towers.
Also, I remember the claimants being significantly more aggressive than claimants in the 2004 storms, or Katrina and Rita….
An article in the Wall Street Journal over the weekend reminds us of the rumblings about the federalization of catastrophe insurance possibly playing a role in this year’s election cycle:
The proposal — backed by giant insurers Allstate Corp. and State Farm Mutual Automobile Insurance Co., as well as Florida lawmakers — focuses on "reinsurance," the policies bought by insurers themselves to protect against catastrophic losses. The proposal envisions a taxpayer-financed reinsurance program covering all 50 states, which would essentially backstop the giant insurers in case of disaster.
The program could save homeowners roughly $500 apiece in annual premiums in Florida, according to an advocacy group backed by Allstate and State Farm, the largest writers of property insurance in the U.S.
But environmentalists and other critics — including the American Insurance Association, a major trade group — say lower premiums would more likely spur irresponsible coastal development, already a big factor in insurance costs. The program could also shift costs to taxpayers in states with fewer natural-disaster risks.
"This bill makes it a little bit too easy for the state to go to the federal government for a bailout," said Eric Goldberg, associate general counsel at the American Insurance Association, an insurers’ trade group.
The legislation passed the House with bipartisan support, 258-155, late last year, despite a presidential veto threat. Although a Senate vote is unlikely this year, proponents are trying to make it a litmus-test issue in the presidential race. The two Democratic contenders, Sen. Hillary Clinton of New York and Sen. Barack Obama of Illinois, in their recent visits to Florida — a key swing state — have both voiced support for the plan.[...]
The proposal envisions the creation of funds like Florida’s in all 50 states. These reinsurance funds would collect premiums from companies like Allstate, who would benefit because they would be paying less than in the private reinsurance market. That savings would get passed on to homeowners. Then, if a state got hit with a particularly severe disaster, whether hurricane, earthquake, tornadoes or other crisis, federal loans and state-backed reinsurance could step in to cover big losses.
In order to draw congressional support from states with somewhat less disaster risk, the federal program is designed to kick in for events that don’t necessarily approach the catastrophic level of, say, a Hurricane Katrina. In tiny Delaware, for example, federal payouts could begin after yearly losses of less than $300 million. Katrina-related losses in Louisiana, by comparison, topped $20 billion.
On general principle, I’m not a fan of the government stepping in to provide a service that is already mostly-adequately addressed in the open market.
However, I also have to admit that yes, a chunk of reinsurance cost is a hefty profit/risk load, required to attract the capital necessary to support the business. If cover were provided with the feds underwriting the risk, then in theory, the profit motive should be eliminated, and arguably less capital would be required to maintain solvency…assuming that the federal government can continue to be thought of as infinitely solvent.
Aside from my small-ell libertarian objection to federalization of cat cover, I also have a couple of practical concerns of the idea:
First, our government seems allergic to fiscal responsibility — it likes to spend money without adequate thought being given to exactly how or when the revenue will be raised. A catastrophe program like this should accumulate assumed premiums into a reserve fund which can be tapped to pay when disaster strikes, if the program is to be financially viable over the long term.
I don’t think I’m being too cynical to think that an accumulation of a large warchest of cash will be too tempting for bureaucrats to resist repurposing, as part of accounting magic to hide the national addiction to credit, much as is being done with the Social Security trust fund (and as was done with the Medicare trust fund, before it was depleted).
Such manipulations of the national financial records will eventually net themselves out, but I am extremely uncomfortable with providing the feds another means by which they can deceive the public about our debt problems.
Second, I have reservations about any federal bureaucracy attempting to operate as efficiently as a private business. I’m not sure that the personal insurance behemoths of Allstate and State Farm would be doing themselves any favors by relying on federal reinsurance to eventually pay out, rather than private reinsurers.
And finally…even though a federally-supported entity might be able to avoid some of the price drag created by a need to provide investors profit, there is still the reality that the underlying loss costs are very high in certain parts of the country. Do we actually think that a federal agency will have the chutzpah to demand adequate cessions in support of (say) Florida wind exposure, when the head of the executive branch of the government (and therefore the federal reinsurance entity) has to appeal to Florida voters every four years?
With Obama supporting the idea, and Florida still considered a swing state (albeit not as much of one as it would be with Hillary at the head of the Democratic ticket)… I could actually see this mattering somewhat as an issue this summer and fall.
