A Game of Risk for Small Insurers

May 28, 2008

Small, Florida-based insurers are snagging market share — but are they the solution to reinvigorating the state’s home insurance market?

By Mike Vogel
Florida Trend–June 1, 2008

Domestic bliss:
‘Domestic’ insurers — Florida-based companies that generally only do business here — now have more than a third of the state’s home insurance market. Combined profits at John Auer’s companies, American Strategic and ASI Assurance, topped $40 million in 2007. [Photo: Mark Wemple]

American Strategic Insurance, a young Florida home insurance company, did more than just survive the 2004 and 2005 hurricane seasons that sank other insurers and kicked the crutches from under Florida’s crippled property insurance market. The St. Petersburg-based insurer lost only $1.5 million in the first storm year and turned a $3.2-million profit in the second.

Meanwhile, as overexposed State Farm and Allstate shed Florida policies, American Strategic was growing — to 257,000 policies. As hurricane season opens, the 11-year-old group says it’s fortified for trouble, structured financially to withstand a cataclysmic 1-in-250 year storm. By contrast, Florida’s largest insurer, state-subsidized Citizens Property, as of April had the underpinnings to withstand only a much smaller storm: Anything larger than a 1-in-68 year event means Citizens will need to levy charges on the policyholders of all Florida insurance companies.

American Strategic is in a growing class of companies known as domestic insurers. Formed under Florida law and founded in the main by Florida entrepreneurs, most domestics are less than a decade old and generally only do business here — a state-specific orientation almost unique to Florida. The cadre of domestics has grown rapidly and now holds 34% of the Florida market. One, Fort Lauderdale-based Universal Property & Casualty, has become Florida’s fourth-largest insurer, with more market share in Florida than Nationwide and USAA.

The advent of the domestics looks to be an unqualified success for a state struggling to make homeowners insurance affordable and available. Certainly, both state officials and industry executives are heralding the domestics’ growth. Domestics are “filling a very important void right now,” says David Sampson, president and CEO of Property Casualty Insurers Association of America. Says Florida Insurance Commissioner Kevin McCarty, “The growth of the Florida domestic market is critical to the rebuilding and revitalization of our marketplace.”

Critical, but as American Strategic CEO John Auer indicates, they are far from a cure-all.

Auer, a veteran insurance industry executive, saw opportunity in 1997 when he and his management team assembled $6 million in seed capital to found American Strategic. (Auer and his management team control 52% of the group; the rest is owned by one of the largest reinsurers in the world, Bermuda-based XL Re Ltd.)

Auer wanted to be a “premier operator” known for disciplined underwriting. Many insurers say that, of course, but others in the industry hold American Strategic’s success as worthy of emulation. Direct premiums at American Strategic and its smaller sibling ASI Assurance more than tripled in the last five years, reaching $357 million in 2007. Their combined profit in 2007 hit $40 million.

Some domestics got their start taking policies from Citizens or its predecessors. Auer, worried about assuming unknown risks, chose organic growth.

To control risk, American Strategic and other domestics rely on computer models of thousands of potential storm paths. The company evaluates prospective customers based on the age of their homes (and thus what building codes the builders followed), past losses, proximity to water and other data.

‘Mixed Blessing’:
Jeff Grady, president of the Florida Association of Insurance Agents, says many agents worry that some domestics lack the claims-handling foot soldiers needed in a crisis. Grady has another concern: Domestics are more highly leveraged,
he says. [Photo: Ray Stanyard]

The modeling produces a limit on how many homes American Strategic will write in a particular area — diluting risk and keeping reinsurance costs low. In addition, because it’s a new company, American Strategic can also be more selective. “We have way more than our fair share of newer homes,” Auer says.

Multistate firms like State Farm and Allstate also are trying to accomplish that selective risk-taking, of course. But having built their books of business when seizing market share was the name of the game, the multistates must do it in reverse, by shedding policies.

Holding down reinsurance costs is particularly critical for American Strategic. Most domestic insurers keep a bigger share of the risk they underwrite — meaning they suffer bigger losses after storms and rack up bigger profits when the wind doesn’t blow. By contrast, American Strategic achieves the stability of a traditional multiperil company — fire, theft, etc. — by turning over most of its hurricane risk to reinsurers.

That strategy dampens profits — but minimizes the potential for devastating losses. American Strategic’s worst year, 2004, is a good example. That year, it took in $134 million in direct premiums, turning over $80.5 million — 60% of the total — to reinsurers. But after Charley, Frances, Ivan and Jeanne, American Strategic was on the hook for only $25 million of the $218 million in losses customers claimed; reinsurers ate the rest. In 2006, when no storms hit, the reinsurers enjoyed the feast portion of their feast-or-famine business, clearing $189 million in premiums ceded from American Strategic.

The company differs from its peers in other respects. It employs 150. Most domestics have much smaller staffs and outsource claims handling and support work. The in-house staffing, Auer says, is why American Strategic posted the lowest complaint ratio among the top 20 residential insurers in Florida in 2004.

Not everything has gone according to plan. In 2006, the state offered $250 million in low-cost matching loans, known as the insurance capital buildup incentive program, to help domestics grow. Auer’s team founded — and American Strategic became a minority owner in — a new company, American Capital, that became one of 13 companies that got state loans and promised to collectively write nearly 2 million policies. American Capital’s target market was condo associations, but the company has fallen substantially short of growth projections because of increased competition, most notably from Citizens.

One question domestics face is their staying power. Jeff Grady, president of the Florida Association of Insurance Agents, calls domestics a “mixed blessing.” They sell through independent agents, which is to his members’ benefit. But agents worry these virtual companies lack the claims-handling foot soldiers that companies need in a crisis. They generally don’t have the financial backing that multistate insurers have and are more highly leveraged, Grady says. Florida’s largest insurance failure, Poe Financial, was made up of Florida domestics. A.M. Best and other brand-name services don’t even rate most Florida domestics because of their youth or Florida-only concentration.

Buffett’s Backing:
Famed investor Warren Buffett thinks Citizens’ Insurance securities are a good bet. In a recent Fortune magazine article, Buffett said he’d just bought one of the state insurer’s auction-rate securities that carried a 11.33% interest rate. He’s not worried about Citizens paying up:
If the company incurs losses from a storm, it will pass those losses onto Floridians in the form of higher premiums.
Instead, domestics are rated by an agency called Demotech, which gives some domestics only the third-highest rating on a scale of six. “Certainly they’re not as strong as your typical national insurance companies,” says Brian Schneider, a Fitch Ratings analyst who in a March report worried that Florida’s unstable market could collapse after a major storm. McCarty, the insurance commissioner, says the domestics exceed the requirements of Florida law.

With an A-minus rating from A.M. Best, American Strategic doesn’t present the solvency risk its brethren do. (A.M. Best rates State Farm and Allstate both as B-plus.) Because of reinsurance, less than 10% of American Strategic’s $200-million surplus is exposed to catastrophic loss — compared to up to 60% to 80% at some domestics.

Despite his own success, Auer says domestics can provide only part of a solution for Florida. His companies don’t insure mobile homes and won’t write policies that include wind coverage in the Keys and most of the windpool area (coastal Florida) outside of Pensacola, Daytona and Sarasota.

Remember also the emphasis that domestics place on spreading risk geographically. As part of a strategy to have high market share in low population areas and vice versa, American Strategic has a 28% market share in inland Lake County, but less than 1% in south Florida.

Florida-specific insurers can take only so many homes from high-risk southeast Florida and the Tampa Bay area before running out of offsetting low-risk inland homes. To offset huge markets such as southeast Florida, an insurer needs to write polices in other states, even other nations, Auer says.

And recall Auer’s reinsurance strategy. Florida domestics need to stay small to avoid the concentration of risk that makes reinsurance unaffordable. Because of the intricacies of the reinsurance market, the closer a company gets to needing $1 billion in reinsurance, the harder it is to find. Auer says that after 2005 it was difficult to locate $600 million in private reinsurance at a price American Strategic could pass on to customers in an affordable premium. To meet its current needs, it contracts with 43 reinsurers.

Reinsurance and Florida’s “very unstable situation” have prompted American Strategic to expand into Texas and other states. “Enough’s enough” in Florida, says Auer, 54. “We’re not really trying to grow in Florida anymore. You can’t solve the problem with a bunch of real small companies in my opinion. A good indicator things are better is when the big-name companies we’ve all heard of are willing to write here — and that’s going to take high rates.”

Homeowners Insurance Premiums

The state website, shopandcomparerates.com, lists insurers writing policies Florida, along with premiums. A sample of rates in various counties was compiled in May. Some insurers may have stopped offering coverage in some counties. Average approved rates are based on a 5-year-old, concrete block home, with a current replacement value of $150,000, a $500 non-hurricane deductible, a 2% hurricane deductible, no claims and no wind mitigation discounts.