The Citizens backstop: a precarious plan unlikely to save the Florida market

“Our assessment shows Citizens are charging rates about 80 percent below market, so they’re selling insurance at a loss. That puts them in a very precarious position if we were to see storm activity on the level of what Louisiana has seen in the last two hurricane seasons, with seven named storms striking the state.

“It would be devastating and clearly would be a trigger to market collapse in Florida.”

This was the view of Mark Friedlander (pictured, top right), an expert on the Florida insurance market and director of corporate communications at the Insurance Information Institute (Triple-I), as he spoke during an Intelligent Insurer panel debate titled “Is Florida’s re/insurance market finally nearing collapse?”.

His fellow panellists included Tim Mardon (pictured top left), global head of property reinsurance, SiriusPoint; Gerry Glombicki (pictured bottom right), senior director in the insurance team, Fitch ratings agency; Brad Adderley (pictured centre), partner, Appleby; and Sarah Morgan (pictured bottom left), vice president property reinsurance, Ariel Re.

The issue of a market collapse in Florida has haunted re/insurers for decades, but this year’s combination of extreme weather-related loss costs and rapidly increasing litigation, plus soaring inflation, has brought things to a head.

In a bid to prevent market collapse and protect the state’s homeowners, Florida’s Office of Insurance Regulation (OIR) unveiled what commissioner David Altmaier called an “unprecedented solution”. The aim was to circumvent what the OIR called “disruptive financial rating downgrades from rating agency Demotech”.

Under the plan, Florida will be able to backstop, or provide protection against the failure of, property insurers who have been downgraded by offering reinsurance via the state’s own insurer of last resort, Citizens.

OIR made its announcement as the industry faces the possibility of across-the-board ratings downgrades from Demotech. Widespread downgrades could put the policyholders of primary carriers in conflict with mortgage requirements from the US government-sponsored mortgage securitisation enterprises Fannie Mae and Freddie Mac. If this happened, homeowners would be forced, en masse, into Citizen’s primary coverage. But the US agencies allow exceptions for primary carriers with full reinsurance cover, hence the solution from OIR.

However, the panellists were not convinced this was the best answer to salvage the Florida market in the longer term.

Morgan highlighted the uncertainty around how the Citizens backstop would work, and particularly what would happen in the event of a major storm. She said that this uncertainty was problematic for investors, many of whom are already spooked by heavy losses in the past few years.

Two steps forward, one step back

Morgan said that “legal reform” is needed to protect the market. “There was a little of this at the special legislative session, held in May 2022 to address the state’s property insurance crisis, but it wasn’t much because they’re still trying to appease the policyholders,” she explained.

The new programme introduced by the special session set aside more money to help insurers obtain reinsurance, in turn enabling them to meet the requirements on federally-backed mortgages. But, Morgan said, in response to that programme, insurers had had to take rate decreases: “It’s two steps forward, and one step back.”

OIR introduced the Citizens backstop to support this new programme.

“The backstop with Citizens is definitely a great first step and gives us as a reinsurer a little more comfort on the companies that we insure, that they won’t go under, become insolvent and not be able to pay claims.

“They’ll be there next year to pay premiums and whatnot, but that is really a short-term solution. For the long-term problem, some kind of legal reform needs to be done at the legislative level,” she said.

Triple-I has examined OIR’s plan to establish Citizens as a backstop. Friedlander commented: “It’s not really reinsurance, they’re now calling it a ‘market stabilisation programme’.”

Citizens will pay claims for failed insurers above the threshold of what’s called the Florida Insurance Guaranty Association, he explained, which is established to pay claims for insolvent insurers. There is a cap of $500,000 on claims, so Citizens would be responsible for all claims above that.

“The flag we’ve raised is that we don’t feel that this is a fiscally sound approach because Citizens did not collect premium for those potential claims that they’ve paid. They’ve already stretched their risk with a billion policies across the state, selling well below market premium.

“And now they’re being asked to be a backstop for potentially failed insurers during hurricane season. While that is legally allowed by the state regulations, it’s very concerning to us from a fiscal perspective.”

We’ve got companies losing their ratings just because of the ongoing claims costs—even without a major hurricane.” Tim Mardon, SiriusPoint

Kicking the can down the road

The amount of capital available to Citizens was another problem, highlighted by Mardon. “The issue with Citizens is that it has only a certain amount of capital. If it runs through that it’s basically a post loss assessment model, so you’re kicking the can down the road.

“The long-term solution has to be tackling the litigation issues and premium adequacy. Unless you get that you’re not going to have any entirely stable market. People have been saying this for a long time in Florida,” he said.

Mardon added that while a number of hurricanes have hit Florida over the years, a truly catastrophic hurricane has not affected a highly populated area.

“You have to finance that over time but, I hate to say it, one day it’s going to happen. What’s happening now is, we’ve got companies losing their ratings just because of the ongoing claims costs—even without a major hurricane.”

Friedlander added that in 1992 after category 5 Hurricane Andrew struck south Florida, seven Florida domestic insurers and one foreign insurer from another state failed, so eight in total.

By August this year, four Florida-domiciled insurers had already failed and two Florida insurers had their ratings withdrawn, potentially indicating two more insolvencies.

“This would be on a record-setting pace and we’re very concerned. Even though many of the smaller regional insurers did get their A ratings confirmed, 27 companies remain on a watch list from the Florida regulator in a report put out in early July.

“That means the regulator has concerns about 27 companies operating in the state in terms of their financial stability. We don’t think it would take much to push many of these companies off the ledge and face potential receivership and liquidation. We’re very concerned as the peak of the hurricane season is approaching.”

Questions have been raised about the standard of Demotech’s decision-making around potential rating downgrades. Glombicki could not, of course, speak for Demotech, but he did say that Fitch has stated publicly that it would rate some of the standalone Florida homeowners policies below investment grade, so that would be double B or lower.

“Insurance companies have to have capital to support their business and to be able to withstand the volatility, including catastrophes, that can happen in their state. They have to earn an adequate return for the risks to grow their surplus year on year, and have that surplus be able to withstand shocks to it,” he added.

“Insurers need to be able to demonstrate that they understand and price their risks to a long-term profit.”

Glombicki agreed with his fellow panellists that a longer-term solution is required, and that it would have to include conditions where insurers can earn an adequate rate of return on the capital they put in. This would attract investors to the market. But if insurers cannot do that in the long term, investors will pull out capacity.

“When you’re left with capacity having to come out, the government has to step in or you’ll get exorbitant prices because the capacity isn’t there to compete against it. It’s a complex problem but it stems from and centres on the loss costs and trying to get a handle on that,” he said.

Legal reform is clearly needed, particularly to protect the market for the longer term. So why hasn’t this already resulted in substantial legislative change?

“I guess legislators are unwilling to pass laws that are insurer-friendly, or have been unwilling so far, due to the heavy lobbying of the legal industry,” Morgan said.

“This year is also when people are going to the polls and you want to appease your base to make sure nobody is upset with you. Right now they’ve opted to make homeowner-friendly reforms rather than anything that needs to be done, up to this point.”