October 8, 2002 1

The Challenges of Dealing With Natural Catastrophes:Florida

Larry D. Johnson, FCASAVP, Allstate Insurance

October 8, 2002 2

Roll Credits!Dr. Jack Nicholson, Senior FHCF Officer, Florida State Board of AdministrationRade Musulin, ACAS, Vice President, Florida Farm Bureau Insurance CompaniesApologies: no handouts, but file will be posted on CAS website Disclaimer: Opinions are the author’s. No Farm Bureau Actuaries or SBA Staff were knowingly harmed in the making of this presentation

October 8, 2002 3

Southeast Florida Population Growth

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

2000199019801970196019501940

Miami- Dade

Broward

Palm Beach

During the 1990’s SE Florida population grew by 1 million (25%)

October 8, 2002 4

The Challenge of Growing ExposureIn 1992 Hurricane Andrew inflicted $16.7 billion insured loss, $12 billion residentialPopulation has grown by 25% and per-unit insured values have grown 4% per year, both with no signs of abatingAnother Andrew at Homestead would now inflict $27 insured loss, $21 billion residentialAnother Andrew north of Homestead would cost $40 to $80 billionAre we keeping up or are we falling behind in this race?

October 8, 2002 5

Approaches to Dealing With Catastrophe Risk

Spread over timeSpread over broader populationsReduce or mitigate

October 8, 2002 6

Spread Over Time

Private Government

Adequate Rates (risk adjusted?)

Use of Models, Risk-Based Class Plans

FL Commission on Hurricane Modeling

Debt Financing Debt financing, cost reflected in rates

FHCF, JUA, FWUA, Citizens w/assessments

Tax Treatment Tax-Deferred Proposals

Tax-Deferred Proposals (?)

October 8, 2002 7

Spread Over Broader PopulationsPrivate Government

Reinsurance, CAT Bonds, Swaps, etc.

Used Extensively FHCF, Natural CAT & Terrorism “Reins.” Proposals

Debt financing through broad assessments

Collect assessments FHCF

Market Restructuring

Partial/Total withdrawals, new entrants, coverage changes

JUA, FWUA, Citizens, Guarantee Funds

Tax Treatment N/A FHCF, Citizens Tax-Exempt Status

Disaster Relief N/A Federal & state funded; spread over tax base

October 8, 2002 8

Reduce or Mitigate LossPrivate Government

Building Codes Advocate Enact, Regulate and Inspect

Land Use Codes Advocate? ???

Incentives for enforcing codes

BCEGS BCEGS

Incentives for mitigation

Credits, Discounts

§627.0629 Mandates for Credits, Discounts

October 8, 2002 9

Spread Over Time – Adequate Rates FL Commission on Hurricane Loss Projection Modeling

Established 1995; 11 statutorily defined voting members representing government, consumers and insurance industry, including experts in actuarial, insurance, finance, meteorology, engineering, statistical and computer sciences. Model audits done by Professional Team consisting of experts in same fieldsStandards: General (7), Meteorological (9), Engineering (7), Actuarial (17), Computer (8), Statistical (5), 53 total1st models accepted 1996; in 2002 AIR, ARA, RMS, & EQECAT acceptedStandards added or enhanced this year: Actuarial, for modeling building mitigation features. Statistical, for modeling uncertainty and sensitivity analysis

October 8, 2002 10

Spread Over Time – Adequate Rates FWUA (now Citizens) risk based class plan

Implemented July 1, 2000, with 93% rate increase spread over 2000, 2001 & 2002Base class is frame, unbraced gable, pre-1972 building codes, not mitigatedPrimary class factors: construction, secondary water resistance, sheathing attachment, shuttering, hurricane straps, roof type, gable bracingSecondary class factors: roof covering, absence of garage-car ports-porches-2nd story-sliding glass doors, single vs. double garage doors, bracing of garage doorsHurricane premium discounts of up to 85%

October 8, 2002 11

Reduce or Mitigate LossesStatewide Building Codes

Effective 6-1-2002, statewide code replaces local codesDefines 3 zones: High Velocity Hurricane Zone (>140mph), Wind-Born Debris Zone (>120mph), all other areasSpecifies enhancements appropriate to zone for roof strength & covering, roof to wall strength, foundation attachment, opening protection

October 8, 2002 12

Reduce or Mitigate Losses§627.0629 Mandated Discounts and Credits

On 6-1-2002, rate filings must include discounts or credits for major features in new codeIn addition to major features, must provide rating for roof shape, construction, reinforced doors & garages, gable end bracingBy 2-28-2003, all insurers must file for discounts and creditsDepartments of Insurance and Community Affairs sponsored public domain study performed by ARADOI recognizes “…study results as a basis for deriving actuarially reasonable differential…”; may rely on other studies “…as long as filings include comparable documentation…”Must specify how construction features will be verified Cannot offset hypothetical premium loss, but can temper discounts by 50%

October 8, 2002 13

Spread Over Time – Debt FinancingFlorida Hurricane Catastrophe Fund

Created 1993, began operation 1994Controlled by State Board of Administration; Governor, Treasurer & Comptroller are TrusteesTrustees advised by 9 member Advisory CouncilDay-to-day operations managed by Senior FHCF Officer and SBA staffAll active personal and commercial residential property insurers must purchase coverage, including JUA, FWUA, Citizens Coverage options 90%, 75%, 40% above retention; 2002 average 88%Projected 2002 premiums $468 million; effective “rate-on-line” 4.255%

October 8, 2002 14

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

Initial Season

Subsequent Season

Historical FHCF Capacity

October 8, 2002 15

$3.837 B Industry Aggregate Retention

$6.104 B Bonding Capacity (Includes Loss Adjustment Expense)

45 year return

time Emergency Assessment Base of $768 million

2.21%

$16.326 B Overall Industry Loss

$4.896 B Projected 2002 Year-end Cash Balance

$11 Billion Capacity

(only $425 million needed)

$1.489 B In

du

stry

Co

-Paym

ents

Not Drawn to scale.

FHCF Initial Season Capacity – 2002

October 8, 2002 16

Spread Over Time – Debt Financing Florida Hurricane Catastrophe Fund

1995 – tax exempt status for the fund; up to 4% assessment on all P&C premium

1996 – public benefits corporation created to be able to issue tax-exempt debt; obtained credit ratings: A1/A+ (S&P, Moody’s, and Fitch) 1998 – began using more than 1 model for ratemaking; use all commission-approved models, 4 for statewide rates, 3 for territories1999 – creation of subsequent season capacity; additional 2% assessment2002 – Addition of additional living expense (ALE), collateral protection insurance, and rapid cash buildup factor

October 8, 2002 17

Projected Growth FHCF Capacity & Assessments*(Current FHCF Statute with $11 billion limit, 4% initial year, 6% aggregate)

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

2002 2003 2004 2005 2006 2007 2008 2009

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Initial Capacity Subsequent Capacity Future Capacity

Initial Assessment Subsequent Assessment Current Assessment

* Based on various actuarial assumptions. Subject to interest rate volatility. Assumes no losses. These numbers are for illustration purposes and should not be relied on since the underlying assumptions are subject to change.

Millions

October 8, 2002 18

“Balanced Growth” FHCF Capacity & Assessments*(Proposed FHCF Legislation 5% initial year, 8% aggregate, $11 billion limit adjusted for exposure growth starting 2003)

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

2002 2003 2004 2005 2006 2007 2008 2009

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Initial Capacity Subsequent Capacity Future Capacity

Initial Assessment Subsequent Assessment Current Assessment

* Based on various actuarial assumptions. Subject to interest rate volatility. Assumes no losses. These numbers are for illustration purposes and should not be relied on since the underlying assumptions are subject to change.

Millions

October 8, 2002 19

Spread Over Broader Populations – Market Restructure

In 1992 about 50% of Southeast Florida Personal Property Insurance written by “top two” companiesNow “top two” companies write less than 20%A significant number of insurers withdrewOther companies non-renewed policies 1993 Moratorium Law, extended annually, limited annual non-renewals

October 8, 2002 20

Spread Over Broader Populations – Market Restructure

Expansion of FWUA territoriesExplosion of JUA to over 900,000 policiesJUA, FWUA “take out” programsNew insurers enter, focused on writing property insuranceJUA, FWUA policies decline; JUA to 60,000Moratorium law expires in 2000More insurers withdrawJUA, FWUA begin to grow again; JUA to over 120,000

October 8, 2002 21

Citizens Property Insurance CorporationSenate Bill 1418

Effective 8-1-2002, Florida Property JUA and Florida Windpool (FWUA) were merged into CitizensTax-exempt state insurer (court ruling on JUA)State Treasurer appoints the Citizens Board, the CEO, senior managers, and Technical Advisory GroupAll contractual obligations of JUA and FWUA transferred to Citizens3 accounts: Personal & Commercial from JUA, and “High Risk” from FWUA The JUA and FWUA law on funding deficits through assessments applies to Citizens, but base expanded to include Surplus Lines premiums

October 8, 2002 22

JUA received $230 refund onPrior Fed Income Tax in September

October 8, 2002 23

October 8, 2002 24

Citizens Property Insurance CorporationJUA rating law applies to Citizens: rates must be “actuarially sound” and no lower than the highest of top 20 by county “High Risk” wind rates capped at 110% of final FWUA rates until 7-1-03Citizens initially to sell same policies as JUA and FWUABoard will develop plan to sell “Quota Share” policies, for FWUA areasUnder “Quota Share”, Citizens insures 50% or 90% of wind peril with private insurer insuring 50% or 10%. Participation is voluntary for insurers (but see 2007, 2012 rules).Consumers subject to “Takeout” or “Keep Out” have the right to continue with current agent, if agent is licensed under approved risk apportionment plan

October 8, 2002 25

Citizens Property Insurance CorporationBoard may determine that market is healthy in a FWUA “High Risk” area and remove wind-only policyIf by 2-1-2007 the 100-year Citizens PML is not 25% lower (~$2.6B) than JUA-FWUA PML @11-1-2000, the Board shall reduce “High Risk” area eligible for wind-only policy to produce 25% reductionIf by 2-1-2012 the 100-year Citizens PML is not 50% lower (~$4B) than JUA-FWUA PML @11-1-2000, the Board shall reduce “High Risk” area to only property 1,000 feet inland from Intracoastal Waterway

October 8, 2002 26

Citizens Property Insurance Corporation

40% of arbitrated FWUA rates eliminated (as “unnecessary” with tax-exempt status)The “High Risk” area squeeze in 2007 and 2012: where will these risks go?

The JUA is 100% larger @March 2002 than at November 2000, and FWUA is 3% larger@March 2002, total projected 100-year PML is $5 billion for FWUA and $1.8 billion for JUAExisting private capacity may not keep pace with growth in Southeast Florida, especially with these rules

October 8, 2002 27

Florida Cabinet ReorganizationState Treasurer and Comptroller positions replaced by Chief Financial OfficerCFO responsible for treasury, accounting, auditing, risk management, administration, legal services, etcCFO also responsible for insurer rehabilitation, insurance fraud, ins. agent licensing, ins. consumer advocate, workers compensationCreates Financial Services Commission, consisting of the Governor and CabinetThe Commission oversees the Office of Insurance Regulation and Office of Financial Institutions and Securities Regulation

October 8, 2002 28

Florida Cabinet ReorganizationSBA Trustees – Governor, CFO, Attorney GeneralThe Office of Insurance Regulation: regulation of insurance companies; licensing, rates, forms, solvency, claims, adjusters, market conduct, etcOffice of Financial Institutions and Securities Regulation: banks, credit unions, finance companies, and the securities industry.The Directors are appointed by the Commission; both Governor and CFO must concurImpact on insurance regulation unknown, but Insurance Director no longer elected

October 8, 2002 29

Is Capacity Keeping up With Exposure?Growth in Southeast Florida 6% per yearFlorida Hurricane Catastrophe Fund: $11B+$9.6B coverage, plus low costPrivate reinsurance increased, but current pricing may not be economic at today’s primary rates Stronger Building Codes and incentivesMassive restructure of market brings in more capitalBut… companies still non-renewing, withdrawingJUA-FWUA-Citizens exposure is growing againModeling estimates assume no mold exposureSafe to say capacity not keeping up