In a major hurricane, insurers face huge risk

Jul 24, 2011

The following article was published in the Sarasota Herald-Tribune on July 24, 2011:

In a major hurricane, insurers face huge risk

By Paige St. John

Records kept secret by Florida regulators show more than a dozen property insurers — carriers that cover almost one in three insured homes — risk financial ruin in the wake of a catastrophic hurricane.

The endangered list includes Universal Property and Casualty, a former sports memorabilia vendor poised to surpass State Farm as Florida’s largest property insurer.

In June, the Fort Lauderdale company filed regulatory reports indicating it would fall $220 million short of the money needed to pay claims for a 100-year loss, the standard measurement of a property insurer’s strength.

Reports also show that State Farm’s and Allstate’s Florida carriers would not be able to cover losses caused by such an extreme hurricane and remain in business without bailouts by their national parents.

Nine other carriers filed reports with regulators at the start of the 2011 hurricane season showing they could not weather a 100-year loss. Four would fail under much less disastrous scenarios.

Almost all of the companies disputed the state-required test and said they could survive based on their own methods that predicted substantially smaller hurricane losses.

In State Farm’s case, that meant using a computer program that generated high hurricane loss estimates to set homeowner rates but a completely different program, with lower estimates, to assess the company’s own hurricane risk.

A collapse by any of the companies after a storm would make hurricane victims reliant on the state for money to rebuild their homes, trigger tax increases and push new customers into the state-run Citizens Property Insurance.

“We all wind up paying in the end,” said Terry Butler, who was the state’s acting insurance consumer advocate until this week.

A failure by Universal alone would dump more than half a million policyholders into the taxpayer-supported Citizens. Company officials said they are just as prepared for a hurricane as in the past, but changes to risk models have made their protection appear to be substandard.

The dangers are spelled out within hurricane risk reports property insurers must submit to the Office of Insurance Regulation at the outset of hurricane season. The files contain estimates of carriers’ hurricane losses and details of their ability to pay those claims, usually through the purchase of reinsurance.

The Office of Insurance Regulation refused to make the documents public or discuss general findings from the reports.

However, the Herald-Tribune obtained copies of the filings for more than 80 property insurers and made details available on its website.

The files offer a rare glimpse at how prepared insurers are for major hurricanes or multiple storms.

And they show the extent to which regulators fail to police that risk, such as allowing carriers to add new customers when they cannot guarantee protection for the homes they already insure.

Five carriers reporting their inability to survive a 100-year loss, including Universal, told regulators that they plan to continue adding business.

Up until 2010, those companies would have violated a requirement by the Office of Insurance Regulation that they have the resources to withstand a 100-year loss. Florida Insurance Commissioner Kevin McCarty last year removed the long-standing mandate, arguing that it would lower consumer premiums.

Locke Burt, a former state senator from Ormond Beach who now runs Security First Insurance, warned that Florida’s combination of weak carriers and a lack of minimum standards compounds the damage that would be done by a hurricane.

“The fact of the matter is, there is no regulation, no law, no unwritten rule” setting a minimum at which Floridians can expect to be protected, he said.

Rolling the dice

The broader national insurance industry measures a carrier’s health by a benchmark known as the 100-year loss, essentially a company’s ability to withstand losses it has a 1 percent chance of facing in any given year.

Despite its name, the term does not represent a Storm of the Century. Hurricane Katrina, for instance, was classified as a 35-year hurricane but triggered 100-year losses for many affected insurers that did business in New Orleans.

The risk is cumulative. Over five years, a carrier has a 5 percent chance of paying such losses and in 10 years, a 10 percent chance.

Private rating agencies such as A.M. Best and Standard and Poors use the 100-year loss as a test of strength, and often penalize carriers unable to withstand two such events in a single year.

European regulators regard even that standard as inadequate and are moving to a requirement that insurers be able to withstand the equivalent of a 200-year event.

Despite the U.S. insurance industry’s widespread acceptance and use of the 100-year standard, McCarty last year eliminated it from his agency’s rules.

McCarty said the standard exposed Florida’s weakest carriers to “predatory pricing” by reinsurers selling that mandatory coverage. He also argued that eliminating the mandate would enable insurers to buy coverage for multiple smaller hurricanes, advantageous in a state that averages more than two storms a year.

Even so, state reports showed at least 19 insurers unprepared to handle more than a 50-year second event.

McCarty would not respond to questions about the reports. His staff claimed that the documents are confidential, and that releasing even year-old reports would “impair the safety and financial soundness” of those insurers.

Florida’s biggest risk

The lack of a hurricane standard in the nation’s most hurricane-prone state has facilitated the growth of insurers such as Universal Property and Casualty.

The publicly traded company began operation in 1990 as a distributor of sports memorabilia, hawking window decals and pens capped with tiny football helmets.

In 1997, Universal shifted focus to insure homes and later added pest control and pool cleaning. It remained a small insurer until 2006, when a taxpayer-funded $25 million loan helped launch the company into the field of the state’s biggest carriers.

The company expanded rapidly by targeting agents instead of consumers. Rather than running ads, Universal adopted underwriting rules that allowed it to insure homes other carriers rejected and gave agents $25 debit cards for each new policy sent its way.

By March 30, records show, Universal insured more than 582,000 homes, apartments and condos in Florida. It lagged State Farm by just 8,000 policies.

Based on its own growth projections, Universal should now be the state’s largest private insurer.

Universal in June reported that the hurricane coverage it bought from the state of Florida and private reinsurers covers up to the first $1.8 billion in claims, an 80-year loss.

The company’s current catastrophe risk model — run according to state standards — shows that Universal has $110 million in capital surplus to pay additional losses, but would be out of money well before a 90-year event.

Universal’s reports show the company falls $220 million short of the bill for a 100-year storm. Chief operating officer Sean Downes said that deficit is misleading because of changes in the new risk models.

“Although models change over time, they are useful in allowing us to evaluate the strength of our reinsurance program from year to year,” Downes said. “Our 2011 program continues to reflect our philosophy of protecting against both a single large event and possible multiple events.”

The company provided regulators with an optional view of risk that suggested it could pay 100-year losses if costs normally associated with hurricanes were left out, an argument the company also made to its public stockholders last year.

It is unclear what action, if any, state regulators took to address Universal’s June report.

Regulators did not notify the state agency that gave Universal its $25 million expansion loan. The state requires the company to maintain resources to pay for a 100-year loss. Anything less puts the government loan in default.

Florida Catastrophe Fund manager Jack Nicholson, who runs the lending program, verified the requirement but said it is up to the Office of Insurance Regulation to inform him of any violation.

Two months into hurricane season, McCarty’s agency has yet to do so, he said.

McCarty would not answer questions about the Universal loan. His office denied requests for records showing whether Universal met state loan requirements in 2010, saying to do so could imperil the company.

The art of shrinking storms

Insurance executives whose hurricane risks exceeded their resources almost universally had the same cure: Change how those storms are calculated.

In addition to providing risk estimates according to state guidelines, they submitted alternative calculations that produced lower losses that they could pay with their available capital and resources. In each case, they told the Herald-Tribune they favored their own methodology.

The difference shows the variety of hurricane loss estimates produced by an array of computer models available to insurers.

Though the state required carriers to calculate their hurricane risk with the same software they use to set homeowners’ rates, some companies switched to programs that generated lower losses.

Both Butler and Robert Klein, director of the Center for Risk Management and Insurance at Georgia State University, called the practice “model shopping” and said it allows the insurer a double standard unfair to consumers.

Florida regulators also required carriers to include calculations for the price increases in building materials and labor that typically occur after large storms. Several did not. In some models, the reports show, that decision shaved off up to 25 percent of their expected losses.

And some companies calculated their hurricane risk with older software no longer in widespread use, gaining a potential reduction in hurricane risk of 50 to 70 percent. Other Florida insurers told regulators those software programs are no longer credible.

State Farm Florida used just such an optional report to rebut its own primary filing showing it lacks the capacity to remain in business after a 100-year loss.

“The report I believe you are referring to asks different questions and makes different assumptions,” spokesman Chris Neal said. “State Farm Florida Insurance Company is adequately prepared for not only a 1-in-100-year storm, but a 1-in-250-year storm.”

Neal’s claim is not based on the software regulators required — the one it used to raise customer rates — but on a different program that cut the risk in half.

Neal would not say why the company used different models.

The state-required program calculates State Farm Florida’s disaster protection ends at an 85-year event. It estimates that a 100-year loss would leave the Florida carrier with so little capital, it would trigger a mandatory shutdown by state regulators.

United Property and Casualty’s case is similar.

The midsize company, based in St. Petersburg, told its public stockholders it could withstand a 100-year hurricane. Its confidential risk report showed it reinsured only to a 70-year loss, and $86 million short of paying a 100-year event.

The discrepancy stems from what United omitted from its stockholder report — “demand surge,” the industry’s term for post-storm inflation caused by shortages in building supplies and labor.

Though demand surge is well-documented, United CFO Joe Peiso said such inflation “is not a factor” because United saw no such costs in past storms and expects none in future ones.

“Whatever legislative or society pressures keep construction costs at bay — the same sort of pressures will be in place,” he said.

HomeWise and St. Johns Insurance said they could meet or come close to meeting the 100-year test if they did not have to include demand surge.

HomeWise president Dale Hammond said his company bought the same amount of reinsurance as the year before and reduced the number of homes it insures. His company’s hurricane risk increased because the new computer models “distorted” the numbers, he said.

People’s Trust said it did not need to factor it in because it has stocked a warehouse with building materials and employs its own contractors.

While reports for half of Florida’s property insurers have them prepared for only a 100-year storm or less, almost as many were armed against 250-year losses or higher.

Klein, the Georgia State expert, said that suggests two different business models at play: carriers equipped to stay in business for the long run, and those willing to “turn the keys over with the expectation they can walk away, having made money in the good years.”

He said that should give consumers pause.

“They should be concerned the state allows carriers to operate with such low margin of safety,” Klein said. “Who pays for that?”

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