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Analysis: As hurricanes loom, Florida insurance lives on borrowed time

Strong waves crash around coastal houses in Key West, Florida, as Hurricane Ike passes to the south in this September 9, 2008 file photo. RE
Strong waves crash around coastal houses in Key West, Florida, as Hurricane Ike passes to the south in this September 9, 2008 file photo. RE

By David Adams

MIAMI (Reuters) - Mother Nature has been kind to Florida's coastline lately with a record run of seven years without a hurricane making landfall, allowing property insurers time to re-stock their depleted coffers.

As a result, when the new six-month hurricane season gets underway on Saturday, state insurance officials say the industry is ready to withstand a major storm. "We are better positioned today than I have seen in 10 years," Kevin McCarty, who heads the state's Office of Insurance Regulation, told Reuters.

Still, industry experts question whether Florida's state-controlled insurance system is able to cope in the long term.

"It's very fortunate for Florida that is has been able to build up its reserves, but the fact of the matter is that Florida is living on borrowed time," said Robert Hartwig, president of the Insurance Information Institute.

Just this week, Republican Governor Rick Scott signed a new property insurance law designed to reduce the state's exposure to hurricane losses by gradually steering homeowners towards private insurers. The new law also slashes the value of homes that the state-run Citizens Property Insurance can cover, down from $2 million to $700,000.

Because of its size and geographical position, with 1,200 miles of coastline on a peninsula sticking out into the warm waters where the Caribbean meets the Atlantic, Florida is a uniquely risky insurance market. Most of its insured residential and commercial property - 79 per cent - lies in coastal areas vulnerable to both wind damage and flooding.

Coastal property is valued at just under $3 trillion, according to a report due to be released next week by AIR Worldwide, a global leader in catastrophe risk modeling. Florida accounts for almost 30 percent of the nation's entire $10 trillion coastal exposure, AIR found.

Only New York has as much exposure, with $3 trillion in coastal property, and that compares to $239 billion in South Carolina and $107 billion in Georgia.

Florida is peculiar in other ways too. Unlike most other states where private companies dominate the market, Florida's insurance system is tightly controlled by the state, and requires all companies to pay into a state-run Hurricane Catastrophe Fund which acts as a safety net. Louisiana has a similar system for its state property insurer, also called Citizens, and California has its own safety net for earthquakes.

Florida's private insurance industry was ravaged in 1992 by Hurricane Andrew, which caused $26 billion in damages in Miami-Dade county. The state was badly hit again when a series of storms hit south Florida in 2004 and 2005.

Designed as a state-run insurer of last resort, Citizens has been left holding more than 1.3 million policies, making it the state's largest property insurer, with about 21 percent of the entire residential market. Due to the lack of recent storms, Citizens has managed to build up a cash surplus of about $6.6 billion, plus another $1.8 billion in reinsurance.

Citizens has tried to manage its exposure by issuing catastrophe bonds, which allow insurance companies to transfer risk to private investors. Buyers of so-called cat bonds receive enhanced returns in exchange for the risk that their principal could be wiped out in the event of disasters of a certain kind or size.

By the end of this year cat bonds will provide well over $10 billion in coverage to the south-east and Florida, according to John Seo, co-founder at cat bond investor Fermat Capital Management.

Still, critics say the state's consumer-wary politicians have allowed Citizens to charge below-market rates, leaving the insurer under-funded. They note that its total insured exposure has more than doubled since 2005, and it faces a potential $21 billion payout in the event of a once in a 100 years storm.

"With the risk transfer we have really narrowed the gap. We haven't closed the gap but we have narrowed the gap significantly," Sharon Binnun, Citizens' chief financial officer, told Reuters.

VULNERABLE TO A ONE-TWO PUNCH

Property insurance typically does not cover hurricane-related flood damage, which has to be insured separately. Private insurers don't cover many coastal homes in Florida which are insured instead by the federal flood insurance program.

The state's 'Cat Fund', created to back up private insurers after Andrew, has also managed to build a large surplus, amassing almost $12 billion to pay potential claims in the event of a major storm, according to its director, Jack Nicholson.

Although he denied it was under-funded, Nicholson said the fund was vulnerable to volatility in the municipal bond market, which it relies on to meet a $17 billion obligation mandated by the state.

A.M. Best, the main credit ratings agency for the insurance industry, said Friday it recognized the Cat Fund's position had improved of late.

The recent run of weather luck may have saved the state from bankruptcy, said Hartwig of the Insurance Information Institute, noting that if a major storm had hit Florida in the midst of the recession, the state would likely have been turned away by the bond market.

Nicholson worries that unless the Cat Fund increases its cash reserve, one big storm could leave it empty, exposing insurers to the next big storm.

If it has to borrow money to meet claims, the Fund is required to place an "assessment" on almost all insurance policies in the state, from homes to cars, no matter if they live in inland areas not prone to hurricanes. Such assessments are decried by some as a tax that provides "welfare" for wealthy beachfront homeowners. Policy holders are still paying off an assessment from the last hurricane, Wilma in 2005.

The bill signed by Governor Scott on Wednesday aims to steer homeowners away from Citizens and cap the value of homes that can be insured by the state-run company. The legislature rejected a tougher bill that would have accelerated that process by charging new Citizens enrollees much higher premiums.

"Citizens has gotten way too big...There was no way in a significant hurricane that Citizens was going to be able to pay," Scott told emergency officials in Miami on Thursday.

(Additional reporting by Sarah Mortimer in London, Harriet McLeod in South Carolina and Kevin Gray in Miami; Editing by Claudia Parsons)

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