Bankrupting Florida

If a catastrophic Katrina-like hurricane sweeps through the state of Florida, it may leave behind more than wrecked houses, damaged shops, and ruined roads: There's a real chance that Governor Charlie Crist's recent insurance reforms could bankrupt the state.

“Our insurance situation is like one of those kitchen timers you wind up,” says J. Robert McClure, president of Florida's James Madison Institute. “In a while, it's going to ring, and Florida will be in quite a mess.” The state has basically offered lower property insurance rates to residents, by assuming enormous financial risks itself. If a truly major storm happens, the legislature has authorized the sale of nearly $30 billion in bonds to cover its exposure. Any way you slice it, that's almost three times as large as the $11 billion California issue that stands as history's largest municipal debt sale. That's where the risk of bankruptcy comes in: If it can't raise enough money through the sale of bonds to pay for hurricane damages, the state won't be able to pay the claims it's on the hook for. “Will the state be able to sell the bonds?” asks Florida State University economist Randall Holcombe. “I wouldn't say 'no,' but I wouldn't say 'yes' either. I just don't know.”

Even the state Board of Administration, which oversees the Florida Hurricane Catastrophe Fund (the Cat Fund) that would issue most of the bonds, wouldn't promise that it can find buyers. In answers to written questions–which spokesman Mike McCauley wouldn't attribute to any particular individual–the board dismisses the question as “speculative” and offers a dodge: “There's no way to account for all contingencies and twists the economy might take that could impact large debt financing. What is more important is for insurers to study [the Cat Fund] and develop their own confidence based on the information that we provide for them.” The board's response also notes that it has over $5 billion in current liquidity, the great bulk of which is from bonds already issued.

Even proponents of the legislation agree that it's a scary situation. Representative Ron Reagan, an insurance agent who reluctantly supported the plan, admits it's unstable. “Everything we did is great so long as the wind doesn't blow,” he says. “There's no doubt about it, the state has taken on an enormous financial risk,” says state representative Julio Robaina, who also voted for the reforms and counts himself as one of their most ardent proponents. But, he adds: “We had to do it. There is no end to the insurance companies' greed.”

Indeed, tremendous pressure for change existed because insurance rates more than doubled for many coastal homeowners in the wake of Hurricane Katrina, and a good investment climate coupled with higher premiums gave insurers record profits. Populist outrage erupted. During his campaign, Crist called for insurance reforms and convened a special legislative session to pass them right after taking office in January.

Thanks to strong-arm tactics–the only two legislators to vote against the proposal found themselves removed from key chairmanships–the outcome was never really in doubt. The governor is a Republican, and Republicans control both houses of the legislature by almost two-to-one. Crist's plan passed overwhelmingly. Although the legislation contained dozens of new provisions and regulations, its crux lies in two related market interventions. One lets the quasi-governmental Florida Citizens Property Insurance Corporation compete with private insurers for most business, and the other vastly expands the Catastrophe Fund's sale of subsidized backup reinsurance coverage for Florida insurers, who are required to obtain reinsurance from the Cat Fund. (Reinsurers insure insurance companies.)

In theory, the plan's first element provides affordable insurance from the state when the private market can't. The second, mandatory, subsidized, reinsurance through the Cat Fund in theory reduces costs for private insurers–and was supposed to prompt them to cut their rates. Yet many private insurers have gone ahead and bought private reinsurance, too. Cecil Pearce, the American Insurance Association's Southeast Regional Vice President, explains why: “With the expansion of the Cat Fund in the 2007 special session . . . it's now going to cover up to $28 billion. And that's a scary number.” Insurers, in short, don't have confidence that the Cat Fund will be able to sell enough bonds after a major storm to cover their claims.

While some insurers have cut rates in the wake of the reform, others have proposed raising them or offered premium cuts much smaller than the 24 percent state actuaries predicted in January. Amidst accusations that the insurance industry has been “greedy, unfair, and has mistreated our fellow Floridians,” insurance commissioner Kevin McCarty (who declined interview requests for this article) has made it clear that he will not approve the proposed rate increases.

Whatever problems the insurance companies may have with state regulators, the state of Florida faces an even worse situation. To pay back bonds issued by the Cat Fund and Citizens, Florida would place mandatory “special assessment” taxes on nearly all property and casualty insurance policies in the state including those owned by people totally uninvolved with Citizens or the Cat Fund. But even this could prove unworkable, because paying off nearly $30 billion in bonds with auto and homeowner premium taxes would almost certainly require an ongoing assessment larger than the state's $1,200 average auto insurance premium.

Many Floridians simply couldn't pay premiums that high and would likely find ways to evade it or stop driving. Even tapping general fund revenues to reassure bond buyers might not do the trick, because Florida faces constitutional limitations on property taxes and the imposition of an income tax.

Unstable as it sounds, the current system could survive several mid-sized hurricanes without a serious crisis. But if a Katrina-class storm comes, the state has little choice but to pray that it can raise enough money selling bonds.

Making things better won't be easy. State Representative Dennis Ross, one of only two legislators who voted against the governor's plan, describes the fundamental problem with the system. “There's no investment capital and no way for it to get in,” he says. “It's only debt. . . . We've cut out the private sector.” In the wake of Crist's insurance reforms, in fact, major companies including Allstate, USAA, Nationwide, Liberty Mutual, Travelers, and The Hartford have cut back on issuing policies in the state. State Farm has filed papers that appear to give it room for a wholesale pullout. And, if that happens, other pullouts are sure to follow.

Cutting back the Cat Fund, as both Crist and State Chief Financial Officer Alex Sink have suggested, probably won't extricate Florida from its current mess either. With Citizens still writing new policies, in fact, an immediate Cat Fund rollback might actually increase the state's direct liabilities, because several upstart Florida-only insurers will likely fold before they issue any policies. Meanwhile, big out-of-state carriers (although hardly enamored with the current Cat Fund) would probably cut back operations even further. In both cases, Citizens would then step in and write more policies at below-market rates.

This is a problem because Citizens, which Florida taxpayers have already bailed out twice, has next-to-no chance of remaining solvent in the wake of a big storm without the backing of the Cat Fund or an enormous bond issue. In fact, purely private companies find the Florida market tough sledding in the best of times: In all but four years since 1992's Hurricane Andrew kicked off the modern wave of big storms, the private insurance industry has lost money writing homeowners' insurance policies in Florida.

Because it cannot spread risk and issue policies for events like Montana car crashes and California wildfires that are unlikely to correlate with hurricanes, Citizens has a big disadvantage relative to major private insurers. In addition, Citizens–already banned from raising premiums until 2009–will have a hard time convincing politicians to raise premiums enough to keep its fiscal ship afloat. Thus, Citizens could easily come to pose a major liability and, like the Cat Fund, would have to rely on special assessment taxes to cover bonds that it would issue to pay claims.

A better system seems elusive. While a variety of proposals have appeared (Ross favors a plan that would have the state cover wind damage and leave everything else to the private sector), it's unlikely that Florida can find a political solution to the crisis. An immediate wholesale undoing of all the January mischief, even if coupled with the most market-friendly reforms imaginable, would send premiums soaring in the short term and might force some people out of their homes. In any case, it's almost inconceivable that the legislature would ever approve it. Whatever happens, the state will need some effort to smooth a gradual transition to a better, private system that avoids enormous fiscal risks.

There's no copacetic model, but four proposals offer hope. First, hurricane-prone South Carolina has passed its own set of coastal insurance reforms. While far from perfect–they contain some open ended subsidies for consumers and industry–they go well beyond Florida's reforms in encouraging people to purchase private insurance and expand the private market. Second, Florida congressman Tom Feeney has proposed creating federal “disaster savings accounts” (a version of which South Carolina has already established), that would help people self-insure against minor emergencies. Although they would do little to deal with major hurricanes, such accounts could help some people raise their deductibles and thus cut their premiums. Third, bipartisan legislation sponsored by Rep. Melissa Bean, an Illinois Democrat, and California Republican Ed Royce in the House, and Democrat Tim Johnson and Republican John Sununu in the Senate, would let insurance companies do what banks have done since the Civil War and organize themselves under federal rather than state law. At least at the margins, this would send some companies trickling back into Florida. Finally, several insurance industry proposals–most prominently one put forward by Travelers–offer strictly limited new types of government-regulated insurance and reinsurance plans that, although still subject to political manipulation, do not pose the same fiscal risks as Florida's current plan.

For all the problems with the current Florida situation, the basics of it–Citizens and the Cat Fund–were in place before Crist first made his proposal. It took years to get Florida into the mess, and it will take years to get the state out of it. In the end, there's no easy solution. Under any circumstances, some Floridians will have to pay higher insurance premiums, move, or see their taxes go up. But the current situation is deeply unstable: If it goes unattended to, a major storm could send Florida into bankruptcy court.