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Florida Wakes Up To a New Insurance Reality

Rule Changes Shifted More of the Burden To Homeowners; Paying 2% Deductible Twice

By CHRISTOPHER OSTER, CARRICK MOLLENKAMP, and CHAD TERHUNE, The Wall Street Journal

(Sept. 7, 2004 ) - As Floridians begin picking up the pieces from the second devastating hurricane in less than a month, many are also discovering the full effects of a decade of maneuvering by insurance companies and state officials that has dramatically reduced the obligations of private insurers to pay for the impact of catastrophic storms.

Charley and Frances are two of the biggest hurricanes to hit the U.S. since Andrew slammed into southeastern Florida in 1992, wreaking $15.5 billion in insured damage and wiping out every cent of profit insurance companies had ever generated on property policies in the state. The losses forced 11 insurers out of business and triggered a wholesale revamping of Florida's insurance market in a desperate attempt to prevent other carriers from fleeing the state.

Big players such as Allstate Corp. agreed not to abandon a combined 1.2 million policyholders in Florida only after state officials began cooperating in a legislative and regulatory effort to shift from insurance companies to consumers the burden for paying hundreds of millions of future storm-related losses. As a result, hundreds of thousands of Florida homeowners -- including many who have paid for what they believed was "full" property insurance -- now find themselves holding the bag for a much bigger portion of the estimated $10 billion to $15 billion in insured damage from Frances and Charley than they would have a decade ago.

Florida regulators and legislators allowed private insurance companies to add hefty new deductibles to homeowners' policies and to raise premium rates in some cases by as much as fourfold. Thousands of property owners now hold policies with small local companies, whose financial stability is severely strained by the back-to-back storms of the past month and concerns that others may soon follow. Already, another major hurricane, Ivan, is gathering force in the Atlantic and could threaten Florida by the end of the week.

Big insurance companies say the changes in deductibles and the decision to set up separate units in Florida were necessary to preserve the availability of adequate insurance across the state -- for situations just like the past month's storms. "This is all happening without any market turmoil," says Robert Hartwig, chief economist for the Insurance Information Institute, a trade group.

After dumping more than 13 inches of rain along Florida's central east coast on Sunday and knocking out power to about six million people, Frances entered the Gulf of Mexico. It then made a second landfall Monday near Apalachicola, a major oyster-harvesting area in the Florida panhandle. The storm has been blamed for at least four deaths. Even after being downgraded to a tropical storm, Frances roared into Alabama and Georgia still packing fierce winds and sheets of rain.

Gasoline retailers and Florida state officials were scrambling Monday to replenish fuel supplies at depleted service stations, as about 2.5 million residents who evacuated from the storm zone began heading back home. Frances also threw another wild card into the unpredictable political equation in Florida -- a critical battleground in the November presidential election. The well-organized relief effort after Hurricane Charley, directed by Gov. Jeb Bush, appeared to blunt the risk of political fallout from that storm for President Bush. But tempers were growing strained in the wake of Frances as relief agencies struggled to get essential supplies, electricity and emergency services into hard-hit areas, and victims of Charley took a second round of torrential rains.

When Hurricane Andrew slammed into Florida in 1992, private insurance companies, primarily Allstate and State Farm Mutual Automobile Insurance Co., picked up the lion's share of the damage tab. The companies were sent reeling by the scale of the devastation, and in the aftermath, there was little debate that changes had to be made in the state insurance system.

It will take weeks or months to tabulate the precise losses from Frances and Charley, and how much of that insurers will absorb. But consumer advocates say the increased liabilities shouldered by homeowners during the two recent storms raise the question of whether the changes have been too generous to the insurers.

Already, it is clear that the steps taken by big insurance companies are successfully shielding them from responsibility for huge losses that in the past would have fallen directly to them. State Farm and Allstate paid a combined $6.2 billion in claims after Andrew 12 years ago. After Charley, which ripped through Central Florida on Aug. 13, causing considerably less damage than Andrew overall, State Farm and Allstate -- still Florida's two largest private insurers -- estimated their combined losses at just $625 million, after collections from the state catastrophe fund and private reinsurers. A State Farm spokesman said some of its Florida unit's reinsurance was provided by State Farm itself, but he declined to say how much.

Big Shift

What has happened in Florida is partly the result of a big shift in the way U.S. insurance companies have operated over the past decade. The industry has adopted increasingly sophisticated underwriting tools to avoid insuring higher-risk homes and has taken steps to lay more of the burden to pay claims on policyholders themselves. California residents who face the threat of storms or wildfires, for example, must choose between sometimes bare-bones coverage offered by insurance pools organized by the state and high-cost policies from niche insurers such as Lloyd's of London. But the shift of responsibility for property losses in Florida -- in terms of the number of policyholders pushed into state-backed insurance funds and the hefty increases in premiums and deductibles -- far exceeds what has happened in most other states.

Insurers in Florida also have shielded themselves from losses through the use of private reinsurance sold by companies including Berkshire Hathaway Inc., large European insurers and Bermuda-based companies including XL Capital and Ace Ltd. Homeowners insurers didn't heavily rely on such reinsurance prior to Andrew and the coverage was hard to come by in the years following that storm. Even so, the state-sponsored relief mechanisms shouldered nearly $3 billion of Charley's $7.4 billion in insured damage.

After Andrew in 1992, state officials agreed to set up a backstop fund called the Florida Hurricane Catastrophe Fund guaranteed by the government that will pick up the bulk of the insurance companies' tabs from Charley, Frances and other massive storms.

Claims from Charley are expected to consume about $2 billion of the $6 billion in cash held by the hurricane catastrophe fund, which has about an additional $9 billion of noncash assets. Frances will take another so-far-unknown bite. Once the fund's cash is gone, it can sell bonds to raise more and impose an assessment, or surcharge, of up to 2.27% on each policy written in the state.

In 2002, Florida lawmakers combined another insurer of last resort, the Florida Windstorm Underwriters Association, with the other big state-organized insurer, the Joint Underwriting Association, to form the Citizens Property Insurance Corp. Now, about 800,000 coastal homes that private insurers refuse to fully cover are currently insured by Citizens Property. Its capital base, already rocked by Charley, could be depleted by Frances.

Citizens Property Insurance expects to pay about $950 million for 37,000 claims related to Charley -- nearly two-thirds of the $1.5 billion surplus it reported at the end of June. It also could levy a surcharge on homeowners' policies if it runs out of money.

Many of the largest insurers in Florida also have established separate corporate entities to operate in the state. Rather than distributing the cost of Florida losses across all policyholders of the insurance company, as is traditional in the insurance business, the new Florida units pay losses only from the assets of the single-state units. If massive storms wipe out those funds, the Florida companies can dissolve without affecting the parent company's operations elsewhere in the U.S.

For homeowners, the biggest change came through dramatically higher premiums and new deductibles that require policyholders to absorb thousand of dollars in costs from wind damage.

A total of 2.5 million Florida homeowners have policies with windstorm deductibles of 2% of their home's policy value. A further 177,000 homeowners have 5% deductibles, meaning a homeowner with a policy value of $300,000 would pay $15,000 to repair hurricane damage before the insurer would pay any part of the claim.

Many homeowners hit by Hurricane Charley three weeks ago were already smarting from having to pay higher deductibles for storm damage. They're livid that they may be forced to pay a second deductible for Frances-related damage when their homes have yet to be repaired. The damage has been exacerbated in some areas by flooding, which isn't covered by most private insurance under a decades-long practice.

Charley did about $15,000 of damage to Don Boyle's roof in Orlando, Fla. Then Frances shredded the blue tarps covering his two-story house Sunday and caused eight new leaks in his kitchen, garage and elsewhere. He got up on his roof during Frances and tried to put the tarp back down, but the winds were too strong.

He called his insurer, USAA, to ask whether he risked getting charged a second 2% deductible -- about $4,000 on damage from the second storm. The company told him a claims adjuster would make that decision after he surveyed the new damage. "Now Ivan is lurking out there," said Mr. Boyle, a 32-year-old engineer at Lockheed Martin. "Paying a $4,000 deductible again wouldn't be my first choice."

Mac Jones, a 53-year-old mailman living in Belle Isle, south of Orlando, has a 5% deductible totaling $6,200 on his house. He was incensed at the prospect of having to pay double that if Frances inflicts more damage. "This is legalized price-gouging. They are ripping me off," Mr. Jones said as the rains and wind of Frances rolled through his neighborhood over the weekend.

He said he realized his deductible had increased only after calling State Farm to report that a massive laurel oak tree in his front yard had fallen on his house during Charley.

Some local insurance agents in Florida said homeowners shouldn't be surprised by the level of their hurricane deductibles, given that numerous notices were sent to policyholders after a separate windstorm deductible was introduced in Florida in 1996.

The decision on charging policyholders one or two deductibles could be open to interpretation. Damage in the same area of the house could be deemed a continuation by an insurer, agents say, but a tree falling on a separate part of the house could be treated as a new claim from Frances. In 1996 insurers were allowed by the state to charge double deductibles for separate storms under a "named storms" provision. Charley and Frances are the first major hurricanes under the windstorm deductible.

Florida officials say the state's onerous deductibles are simply part of the price residents had to pay to keep private insurers in the state. Insurance generally is regulated on a state level, typically by powerful commissioners who have the authority to block rate increases proposed by companies and to set voluminous rules under which insurers operate. But after Andrew hit, many insurance companies said they would abandon Florida unless the state made radical changes in its regulations and rate structures.

Just months after that hurricane, more than a dozen insurers threatened to dump policyholders, potentially leaving more than one million homeowners without coverage. In April 1993, Allstate alone proposed dropping 300,000 policyholders.

The following month, then-Florida Insurance Commissioner Tom Gallagher issued a moratorium preventing insurers from refusing to renew policyholders. Almost simultaneously, he urged Florida's governor and legislature to form the insurer-funded hurricane catastrophe fund that would help shield insurers from future hurricane losses. The fund was formed later in 1993, and insurers began paying premiums into it. The costs were passed along to policyholders in the form of higher premiums.

Just weeks after Andrew hit, the state also created the Florida Residential Property and Casualty Joint Underwriting Association, an insurer of last resort for thousands of property owners that private companies were no longer willing to cover. By early 1994, it had 300,000 customers, despite offering only limited coverage on property and some contents of homes.

Even with the state and the new association taking up a significant portion of hurricane risks, insurers in Florida also asked for huge increases in premiums. In October 1993, the state approved increases for State Farm and Allstate of 24% and 30%, respectively. Still, private insurers remained lukewarm about doing business in the state. The Joint Underwriting Association had more than doubled to 760,000 policyholders by mid-1995.

To induce insurance companies to compete for more of those homeowners, Mr. Gallagher's successor as insurance commissioner, Bill Nelson, now a U.S. senator from Florida, proposed offering private insurers $100 for every policyholder they took out of the JUA. Insurance regulators also promised some insurers they wouldn't have to pay assessments that other carriers would if a hurricane drained the underwriting association's assets. In response, a handful of small insurers, including Florida Select and Sunshine State, were formed with the specific purpose of taking policies out of the state JUA pool.

Dropping 90,000 Policyholders

Big insurers continued dumping policies. After the state-imposed moratorium against dropping insurance policies, the Florida legislature passed a law that said insurers could refuse to renew no more than 10% of their policyholders in any one year. Allstate took advantage of that provision and refused to renew 90,000 policyholders between 1994 and mid-1996.

In July 1996, Allstate said it would stop sending nonrenewal notices to policyholders, sparing another 37,000 homeowners who already had been told they would be dropped after Sept. 16 of that year. But the company agreed to do so only after the state approved its fifth rate increase since Andrew, a 22% jump. More importantly, Florida officials gave Allstate the green light to form the Allstate Floridian Insurance Group, a subsidiary that would issue policies only in Florida and potentially shield the parent company from any losses in the state that exceeded the unit's financial resources.

Allstate had been pushing to form the Florida-only company since shortly after Andrew, but Mr. Gallagher had turned down the request. "I didn't think it was a good idea," Mr. Gallagher says, adding that he didn't want the big insurer to set up a thinly capitalized subsidiary without being obligated to back it up in the event of another hurricane.

But after Mr. Nelson took office, he approved Allstate's request. Allstate capitalized the company with $450 million, and it currently has total assets of more than $1 billion. It's not clear how much of Allstate's $425 million in Charley losses will be taken out of that capital, as the Floridian company doesn't include Allstate's auto business, or non-Florida losses from the recent hurricanes. But rating agency A.M. Best last week placed the company on watch for a possible downgrade of its rating for financial strength.

Until last month, the company had been a money-maker for Allstate. Over the past three calendar years, Allstate Corp. has taken about $300 million in profits out of the Florida subsidiary, according to A.M. Best.

Michael Trevino, a spokesman for Allstate, said forming the separate "well capitalized" unit in Florida was a sensible business decision. He said that if a storm strained Allstate Floridian's capital, the decision of whether Allstate Corp. would pump money into the firm would be difficult, given the damage such a decision might have on Allstate's reputation nationwide and potentially costing the company auto-insurance business in Florida.

Insurers in the mid-1990s also began adding "windstorm deductibles" to their policies. Typically homeowners-policy deductibles are expressed in dollar terms -- $500 is common. But in Florida and other coastal locations, insurers required 2% and higher deductibles to shift the cost of claims to policyholders. In 1996, the legislature approved deductibles as high as 5%.

Insurers also have been able to dramatically raise their premiums through an unusual three-person private arbitration panel set up by the Florida legislature in 1996 to settle price-increase disputes between insurance firms and the state insurance regulator. Previously, the state insurance commissioner held most of the power in approving rate increases. The panel is composed of one person nominated by the insurer, one person chosen by the insurance commissioner and a third person chosen by the two others.

Mr. Nelson decried the use of the panel as "an arbitration system that allows companies to go around the people's elected commissioner." In the summer of 1997, Mr. Nelson shot down a request by State Farm Fire & Casualty Co. to raise rates by about 20%. State Farm appealed to the panel, and in its first hearing, in Miami, the panel voted 2-1 to approve State Farm's request. It was the first of several defeats the panel handed Mr. Nelson.

 

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