Premium Deficiency Reserve Presents Interesting Possibility
Citizens Property Insurance Corporation hosted a depopulation summit last week in Tampa. The event has been widely discussed in the media and other forums. These summaries typically provide a broad overview of the discussion, often concentrating on the public policy considerations that go along with decisions about the extent to which property insurance prices should be subsidized. However, reducing the size of Citizens is a complex issue and requires the balancing of many factors. Some of these considerations involve detailed issues that don’t make their way into more generalized reports. I’ll try to touch on a few of these over the next several days.
One idea mentioned at the summit seemed new, at least to me and at least as far as its potential application to Citizens goes. Mark Brannon of the actuarial firm Merlinos suggested evaluating the possibility of establishing a “premium deficiency reserve” at Citizens. This would be an amount reflecting the difference between policies’ actuarially sound rates and the rates Citizens is charging. One benefit of establishing such as reserve would be that it would highlight the rate deficiency that affects some, but not all, Citizens policies due to the legislatively mandated glidepath. This would help reduce any false sense of security that goes with accumulating funds in Citizens during non-catastrophe years knowing that premiums won’t be sufficient to meet catastrophe costs in the long run.
Another potential benefit is that the reserve could be used to incentivize depopulation. In sum, an insurer removing a policy from Citizens would receive the amount of the premium deficiency reserve associated with that policy. This would help make the policies economically viable for assumption, perhaps causing an insurer to look at those policies more favorably. In addition, we often hear the phrase “cherry picking” when it comes to Citizens depopulation. As was point out at the summit, “cherry picking” should be considered a good thing in the residual market context– the state should want as many policies as possible in the private market, leaving only true residual market policies in Citizens. A premium deficiency reserve helps balance the evaluation of risks across Citizens. Policies that are the most premium deficient will have the biggest reserves and therefore have the most incentive built-in. Policies with less of a deficiency on the other hand are closer to rate adequacy and therefore more attactive on their own merits with less consideration of the reserve benefit. The reserve ends up somewhat leveling the economic merits of Citizens’ various policies because insurers could evaluate the combined effect of Citizens current rate level plus the reserve account.
Obviously many questions would arise relating to the amount of the deficiency and its per-policy allocation, how that amount could be transferred to insurers, and how insurers would be required to treat that amount over the life-cycle of the policy. However, the idea presents a new and unique consideration that merits further evaluation in the debate about Citizens’ role.