Home Insurance Industry Is Fraught With Risks
coverage in Florida
NYT REGIONAL MEDIA GROUP
Last Modified: Saturday, February 27, 2010 at 11:58 p.m.
Millions of Floridians now bet their homes on property insurers that teeter on the edge of financial failure, a Herald-Tribune investigation has found.
These companies look nothing like the Allstates and State Farms that insure the rest of America – legacy carriers that command bankrolls the size of small nations.
Instead, because State Farm and Allstate are fleeing Florida, a growing number of homeowners get their insurance from tiny, untested companies that have a few million dollars in the bank but insure billions worth of property they could never hope to rebuild on their own.
more failures to come
No one knows what will happen when the next big storm strikes Florida shores. But the indications are not promising.
Over the past year, without having to weather a single hurricane, Florida led the nation with a half-dozen property insurance failures. For the first time, state regulators openly warn that more failures will come, even if a storm does not.
The Herald-Tribune spent more than a year examining Florida’s property insurers, tracing the ownership of more than 70 companies through shell corporations and reviewing the financial filings of each. It found:
One in three privately insured Florida homeowners relies on insurers that exhibit one or more signs of financial risk.
More than 100,000 homeowners relied on companies barely capable of paying for house fires, let alone hurricanes. These insurers’ reserves come so close to the state’s $4 million minimum requirement that they operate with only a few hundred thousand dollars of their own to pay claims.
During the 2009 hurricane season, at least 38,000 Florida homes were insured by companies state regulators knew would fail. Homeowners were not told until after hurricane season, when one company was shut down and the other had to sell.
Lawmakers and regulators have ignored warnings and encouraged private companies to stretch their limited cash further. They have pushed companies to insure more and more homes without increasing the money set aside to pay claims, a practice that put state residents farther out on a limb.
Larger dangers loom. Despite rising property values, one in three Florida carriers has decreased the cash set aside for storms.
The Florida-only carriers that provide the majority of hurricane coverage in this state now stretch their limited cash nearly twice as far as they did before 2004.
They do it by buying a form of backstop insurance, called reinsurance, that is supposed to kick in and prevent insurers from failing when major catastrophes strike.
But insurers still must have their own money to pay what amounts to a deductible. And after every storm they need cash to operate and pay claims until they can collect on backstop policies.
Experts point out that even companies with the best reinsurance policies can fail if they experience cash-flow problems.
‘florida ponzi scheme’
In simplest terms, the average Floridian with a $350,000 house is insured by a company with less than $750 in hand to pay for that home. By contrast, the average carrier had $1,300 in 2003. Allstate and other well-funded insurers had nearly $4,000 banked for the same risk.
“It is the Florida Ponzi Scheme,” said Miami agent Phil Lyons, secretary of the Independent Insurance Agents of South Florida.
Regulators, insurance executives and industry lobbyists argue that the system, perhaps flawed, is all that Florida has to fill the yawning hole left by the mass exodus of national insurers.
“What were the options?” asked Sam Miller, vice president of the Florida Insurance Council, the industry’s largest trade group in the state. “I don’t think any other plan would have worked.”
Yet among insurance insiders there is unease and growing alarm.
“There should be bells and whistles going off everywhere,” said Jeff Grady, president of the Florida Association of Insurance Agents.
“On the surface it may appear things are OK, but below the surface, things are really troubling.”
Beginning with Hurricane Andrew in 1992 and accelerating after Katrina in 2005, Florida’s property insurance market changed dramatically.
State Farm and Allstate, combined protectors of one-third of Florida homeowners before 2004, led a wave of withdrawals, followed by Nationwide, USAA, Hartford and Travelers.
In their place arose what insurance expert Robert Klein, director of the Center for Risk Management and Insurance Research at Georgia State University, calls the “Florida-zation of cat risk.”
These are the insurance companies that only do business in Florida, taking an all-or-nothing gamble on the state’s weather.
In 1992, these concentrated risk-takers insured just 6 percent of Florida. Today, including the Florida-only subsidiaries of national insurers, they cover 71 percent.
Insurance, historically, has been an industry built on huge reserves. Firms amass a foundation of capital, then risk that money by promising to repay homeowners in the event of losses.
Profits, historically, came from the interest earned on the money that sits waiting to be paid out.
All that has changed. In Florida, insurers are now risk-brokers, players with relatively little money and a lot of leverage. In place of huge cash reserves, they have reinsurance – essentially insurance policies for insurance companies – that pays off in a major disaster. Those policies are so costly that most companies have little money left to build reserves.
Reinsurance enables fast growth. Instead of building up a company slowly by amassing enough surplus to write more policies, new insurers can pledge a portion of future premiums and instantly take on thousands more customers and billions more dollars in hurricane risk.
The formula has helped springboard start-up insurers into multibillion-dollar enterprises in months. But it has crashed others just as quickly, putting thousands of Florida homeowners at risk.
Even in 2000, before the explosion of single-state carriers in Florida, A.M. Best, the nation’s oldest financial rating company, issued a report warning that the state was growing companies without the financial depth to survive a single hurricane, let alone the state’s average of 2.5 a year.
It accused Florida, paying these new companies to assume policies from the state insurance pool, of handing the riskiest properties to “thinly capitalized, opportunistic insurers.”
Assets and risks
Miami businessmen Alexander Anthony and Albert Fernandez sold their security guard business to launch Northern Capital Insurance Group. They rocketed from $476,000 in revenue in 2006 to more than $95 million by 2008, adding a second carrier, Northern Capital Select, in the process.
Last September, Inc. Magazine heralded the company as “America’s Fastest Growing Private Company.”
The award came with publicity and a congratulatory letter from Gov. Charlie Crist, thanking the carrier for its phenomenal growth.
But the meteoric rise also came at great risk, mostly to customers.
State records show the group has the most concentrated roll of the dice in all of Florida.
Three of every four policies written by the companies were in a 143-mile stretch of the Atlantic coast – Miami to Palm Beach – that presents the single greatest hurricane threat in all of America. For as far back as the records go, a Category One storm has rolled ashore here at least every four years.
The exposure of these two insurers during the 2009 hurricane season was twice that even of Citizens Property Insurance, the state-run company that covers homes deemed too risky by other insurers.
Six other Florida carriers are in the same boat, carrying greater concentrations of risk in Miami than Citizens does.
“It scares me. I fear when the next storm comes. I fear if it lands anywhere near here,” said Dulce Suarez-Resnick, a Miami agent who is past president of the Latin American Association of Insurance Agencies.
While Northern Capital Select had the highest concentration of hurricane risk in Florida, it also had the least amount of money.
Northern Capital Select’s financial statements and reinsurance contracts show that in 2009 it was operating with barely a $300,000 cushion above what it needed to meet state solvency requirements – not even enough to cover a handful of house fires.
The larger Northern Capital had greater assets, but also more risk, leaving it at the start of 2009 just above what state laws required for its exposure.
The problems started when the company was formed. Under the old business model of property insurance, the Northern Capital companies would have needed more than $130 million set aside to meet state requirements for the value of homes they insured in Florida.
They did it with less than $20 million.
The companies bridged the gap by buying huge amounts of reinsurance from overseas investors willing to gamble against a storm. According to third-quarter financial statements, the carriers by September 2009 spent $64 million of the $94 million in premium they collected buying that protection.
Between what the insurers paid for reinsurance and what they paid in other overhead costs, contracts filed with regulators show, there was not enough money left to pay claims.
The constant losses destroyed reserve funds. By last September, Northern Capital Select barely met the state solvency requirement.
But regulators did not warn consumers about the risk.
Instead, the agency in August secretly prepared an order placing the company under administrative supervision.
While Northern Capital basked in the glow of its Inc. Magazine publicity and hit the financial markets hoping to raise $12 million, OIR sought to require the company to buy more reinsurance and stop writing new business in Miami-Dade, Broward and Palm Beach counties.
By October, Northern Capital began retrenching, merging its two insurers into one. In February, the company lost its “A-exceptional” financial rating from Demotech, after the rating agency claimed deadlines to raise additional cash and come up with a new business plan passed unmet.
The company remains in business.
benchmarks and measures
The financial troubles of Florida insurers go far beyond Northern Capital.
Six companies have failed or been forced to sell in the past year. Florida regulators say more are on the verge of collapse, but will not name the companies or say how many are in trouble.
In the absence of public disclosure, the Herald-Tribune turned to measures commonly used by those in the industry, from agents who place your policy to regulators who police the business, to academics and consumer advocates.
A half-dozen experts consulted by the Herald-Tribune cautioned that no single measure told the strength of an insurer. They agreed, however, that there are several important indicators of financial weakness and they provided benchmarks for each. They include: low levels of savings, comparatively high amounts of risk, an over-reliance on reinsurance and a heavy concentration of customers in one geographic area.
The Herald-Tribune found that about 30 companies out of more than 70 reviewed appear fiscally sound. Forty-two failed at least one of the benchmarks.
That means one in three privately insured homes in Florida – some 2 million families – relies upon an at-risk insurer for hurricane protection.
Fourteen of those insurers tripped two or more of the four warning flags. Of the three companies that failed at least three tests, two of them, Edison and Northern Capital Select, were being shut down or sold by January.
The Office of Insurance Regulation readily acknowledges Florida is in the throes of dramatic change.
From Kevin McCarty, insurance commissioner, to the lowest-level regulators, OIR officials expressed optimism for the market as a whole despite trepidation over the stability of individual insurers.
Robin Westcott, solvency director for OIR’s property division, said she and other regulators think most of Florida’s relatively new insurers will survive and a large portion of the market is strong.
These officials argue the failures are a natural byproduct of the state’s need to find new insurers quickly as national carriers dumped hundreds of thousands of customers after 2005.
“I think it’s a success story that we’re able to attract new companies that are writing 615,000 policies,” McCarty said.
[ Paige St. John writes for the Sarasota Herald-Tribune ]