Residual Markets Changing on the Coasts, A Tale of Two States

Published January 28, 2011

Windstorm insurance is a never-ending problem for states along the Atlantic and Gulf Coasts.

In many coastal states, lawmakers have set up state-run windstorm insurers (or “wind pools”) to act as insurers of last resort. They write wind policies when the private market will not.

Unfortunately, in some states over the last decade, these residual markets have grown to eclipse the private market, largely because insurance rates were held below actuarially sound rates. This forced major insurers to withdraw from the market.

Growing in Florida
In recent years the residual markets have been shrinking. This is not true across the board however. In Florida, the state with the greatest level of windstorm risk, its state-run insurer, Citizens Property Insurance Corporation, has continued to grow. Efforts to depopulate the residual market by placing policies into smaller subsidized private companies have seen mixed results.

Robert F. Sanchez, policy director at the James Madison Institute in Tallahassee, Florida, argues many of Florida’s windstorm insurance problems arise from poor political decisions by insurance regulators and former Governor Charlie Crist.

“When Florida’s insurance regulators evidently yielded to political pressure and disallowed reasonable rate adjustments, some major insurers prudently decided to decrease their exposure in Florida,” Sanchez said. “Several initially declined to renew a percentage of their policies, especially in high-risk coastal counties, and announced plans to withdraw from Florida altogether.”

“Unfortunately, the Legislature’s 2007 attempt at reform had the unintended consequence of making the situation worse. Subsequent attempts to rectify those problems were discouraged by Gov. Charlie Crist, an avowed populist who famously celebrated State Farm’s announcement that it planned to withdraw from Florida’s property insurance market. The inaction prolonged a situation in which private insurers’ rates were suppressed, Citizens grew, and Floridians in low-risk inland areas were essentially forced to subsidize lower-than-market rates for property owners in high-risk coastal areas,” Sanchez said.

Shrinking in Louisiana
In stark contrast to the growth of Citizens in Florida is the success Louisiana has had in depopulating its version of Citizens. Since its all-time high of 170,000 policies in the years immediately following Hurricane Katrina in 2005, Louisiana Citizens has successfully shed thousands of policies back to the private market. Louisiana Citizens now has approximately 129,000 policies, and the number continues to shrink, according to Louisiana Insurance Commissioner James Donelon.

Donelon attributes Louisiana’s successes in depopulating Citizens to keeping rates in line with those in the private market. Donelon suggested that one of the problems with Florida Citizens was the decision to force rates down.

“Louisiana copied the law that created Florida Citizens when we launched our state-run insurer,” Donelon said. “We have seen success in bringing down the number of policies in Citizens because we simply stuck with the original model and annually adjusted rates to keep Citizens competitive with the private market.”

He said this keeps the residual market from interfering with the private market, making Louisiana Citizens “a true insurer of last resort.”

Using Sound Rates
Donelon also said using actuarially sound rates has prepared Louisiana Citizens to withstand a financial hit from a storm as strong as Hurricane Gustav, which hit in 2008 and did more than $6.6 billion of damage in the Caribbean Sea, Gulf of Mexico, and United States, including $4 billion of damage in Alabama, Florida, Louisiana, and Mississippi.

Kevin Kane, president of the Louisiana-based Pelican Institute for Public Policy, a public policy think tank, says Citizen’s efforts to shrink its residual market “seems to be bearing fruit and we hope the state will continue to move in this direction. A state-run residual insurer can distort the market and crowd out competition. This harms consumers and taxpayers. It appears that the state is committed to continuing in this direction. Louisiana is facing large deficits and is not in a position to expand state-run programs, insurance or otherwise.”

Back in Florida, Sanchez says the election Republican Rick Scott as governor last November could lead to a change in how Citizens is run.

Changing Politics in Florida
“As for trends, fortunately, now that Governor Crist has left office, there may be a better chance for Florida’s private property insurance market to recover. Both the new governor, Rick Scott, and the legislative leadership are generally supportive of free-market principles. They know that a robust private property insurance market akin to Florida’s robust competition in auto insurance would serve property owners and taxpayers much better in the long run than the overreliance on a state-run insurer,” said Sanchez.

Sanchez added, however, that the political realities of windstorm insurance in Florida would likely force any changes to Florida insurance regulation to be gradual.

“An abrupt soaring of rates could cause a political backlash and a shock to a weak economy,” said Sanchez. “Therefore, we would expect legislation to pass this year or next to rectify some of the problems attributed to the 2007 legislation and allow a phased-in migration back to a robust private property insurance marketplace in which the rates reflect the risk.”

Matthew Glans ([email protected]) is a legislative specialist in financial services for The Heartland Institute.