The Magazine

Bankrupting Florida

A disastrous hurricane could trigger a disastrous insurance debacle.

Aug 20, 2007, Vol. 12, No. 46 • By ELI LEHRER
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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.