Client News

The 2012 Florida Legislature has some big items on its agenda. Before it adjourns in March, it will have to close a huge budget gap, draw new legislative and congressional districts, and resolve tough battles over education funding.

Yet even as these issues dominate headlines, the state’s dysfunctional property insurance system — particularly the enormous liabilities it places on Florida’s taxpayers — ought to be near the top of the Legislature’s agenda.

Indeed, unless lawmakers act quickly to change things, one major hurricane or a series of smaller storms could leave the state utterly unable to pay any of its bills. This huge risk to the state’s finances stems largely from something called the Florida Hurricane Catastrophe Fund.

The Cat Fund, as it’s popularly known, is a government agency. When insurance companies purchase insurance of their own, it’s known as reinsurance. Florida law requires all companies that sell homeowners insurance in the state to buy reinsurance coverage from the Cat Fund.

Florida’s Cat Fund charges less for this coverage than private reinsurers that do the same thing, and, in theory, property insurers are supposed to pass the savings along to consumers. Despite this, Floridians still pay some of the nation’s highest property insurance rates.

Even worse, the Cat Fund doesn’t have enough money to honor the promises it has made. Right now, it has a little over $4 billion in hard assets to pay liabilities that could approach $30 billion following a particularly bad storm season.

As a result, everyone who has looked at the fiscal situation — even the Cat Fund’s own Chief Operating Officer — has called for significant reforms that would drastically reduce the Cat Fund’s liabilities.

The Cat Fund’s predicament should come as no surprise; it can’t possibly maintain sound fiscal footing while charging insurers less than private reinsurers charge for the same product.

Some background on reinsurance explains why. A private reinsurance company that operates worldwide can spread its risks. Not only could it insure against hurricanes in Florida, but it might also cover flooding in Europe, earthquakes in Asia, and industrial accidents in Brazil.

Because these events will almost never happen at the same time, the company can survive and earn a profit from one type of coverage even while paying out huge claims on another. Thus, a more diversified private reinsurer can almost always charge less than a less diversified one and make the same (or greater) profits.

However, with its mandate to operate only in Florida, the state’s Cat Fund turns the spread-the-risk principle of insurance upside down. It can’t diversify at all and, even after six nearly storm-free years, it still hasn’t even come close to accumulating enough assets to cover a really awful storm season.

Thus, following a bad storm season, the Cat Fund would have two choices, neither of which is good: It could either default on its obligations, leaving devastated Floridians with no funds to rebuild their homes or, more likely, it could impose massive new special taxes called assessments on almost everyone in the state. These taxes could easily total as much as $1,500 per household, and under current law the Cat Fund could start charging them without any specific legislative approval.

Particularly in these tough economic times, there’s no way that Florida could afford either the taxes or the costs of sheltering thousands of suddenly homeless residents. The state would likely have to petition Washington for a bailout — unlikely in the current fiscal climate — or seek some sort of bankruptcy-like restructuring of its finances overall.

Although immediately eliminating the Cat Fund isn’t practical, the Legislature needs to work to begin significantly shrinking its obligations sooner rather than later.

For three straight years, major reforms of the Cat Fund simply haven’t made it into law, and, because storms haven’t hit, the state has still survived. Unfortunately, the state’s good luck can’t be expected to last forever. Florida can’t afford any further delays.

Eli Lehrer is an Adjunct Scholar of The James Madison Institute, a non-partisan policy center based in Tallahassee, and Vice President of Washington, D.C., operations for The Heartland Institute.