Coastal Property Residual Markets:Challenges and Potential Solutions

Prepared by David C. Marlett, PhD, CPCU Appalachian State University

The Brantley Risk and Insurance Center www.insurance.appstate.edu

Prepared for 2008 Out of the Storm Hilton Head, SC

Estimated Insured Value of Coastal Exposure (2007, $ Billions)

$895.1

$224.4

$191.9

$158.8

$132.8

$92.5

$85.6

$51.8

$14.9

$2,458.6

$0 $500 $1,000 $1,500 $2,000 $2,500 $3,000

Florida

Texas

Louisiana

S. Carolina

Virginia

North Carolina

Alabama

Georgia

Mississippi

Maryland

Source: AIR Worldwide athttp://www.air-worldwide.com/_public/images/pdf/AIR2008_Coastline_at_Risk.pdf?src=email

Over the last three years (2005-2007), the insured value of

properties in coastal areas grew at a 7.3%/year compound rate. If this growth rate persists, the insured

value will double by 2017.

In Some States, Coastal Exposure is aHigh Percent of the State’s Insured Value

35%

28%

26%

17%

13%

12%

11%

9%

5%

79%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Florida

Louisiana

S. Carolina

Texas

U.S.

Mississippi

Alabama

Virginia

North Carolina

Georgia

Source: Insurance Information Institute and AIR Worldwide June 11, 2008 release, athttp://www.air-worldwide.com/_public/images/pdf/AIR2008_Coastline_at_Risk.pdf?src=email

“Insured value” is an estimate of the cost to replace structures

and their contents, including additional living expenses and business interruption coverage,

for all residential and commercial property in a state

that is or can be insured.

Insurability

Standard market E&S market Residual market

Market of last resort Beach plan Wind pool Citizens FAIR

Why Have Residual Markets

Economic Development

Lenders, Construction, Real Estate Agents, Developers

“market of last resort”

Major Issues

Subsidization and Risk Seeking Behavior Measuring the Risk Catastrophe Loss Financing Arrangements Political Pressures and Rate Suppression Transparency Leadership and Board Composition Accountability Role of Excess and Surplus Lines Insurers

Residual Market Mechanisms

FAIR Plan Urban Protection and Reinsurance Act of 1968 Roughly half the states still have a FAIR Plan

Beach Plans / Wind Pools Alabama, Florida, Louisiana, Mississippi, North

Carolina, South Carolina, and Texas. Virginia coastal property owners are insured through a FAIR plan.

State Wind or Beach Pools

Source: Daniel Sutter University of Texas – Pan American Presentation at ALEC, 7/30/08 State Current Name Year Established Policies in Force Total Liability

Alabama Alabama Insurance Underwriting Association

1970 9,699(6/08)

$1.682 Billion

Florida Citizens Property Insurance Corporation

1970 1,216,960(5/31/08)

$441.9 Billion

Louisiana Louisiana Citizens 1968 129,203(3/07)

$21.13 Billion

Mississippi Mississippi Underwriting Association

1987 39,340(11/07)

$5.709 Billion

North Carolina NC Insurance Underwriting Association

1969 163,527(3/31/08)

$67.80 Billion

South Carolina SC Wind and Hail Underwriting Association

1970 42,663(4/30/08)

$16.80 Billion

Texas Texas Windstorm Insurance Association

1971 216,008(12/31/07)

$58.64 Billion

Residual Market Penetration

Residual Market –

(% Homeowners Premiums)

Source: PCI, based on data from NAIC, PIPSO and NCIUA

21.3%

14.1%

9.7%

6.8% 6.4%

1.4%

4.6%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

Florida Massachusetts North Carolina

All States Louisiana Rhode

Island Remaining

States

Residual Market Penetration

Statewide Market Penetration doesn’t tell whole story because the it is the coastal property presents the greatest exposure due to location and value

The Coastal Insurance Market in North Carolina

North Carolina as a case study

Raise issues to encourage discussion

NCRB Rating Territories

Homeowners Insurance DWP and Market Share in North Carolina (2007)

State Farm Fire $314,171,122 19%

North Carolina Farm Bureau $213,326,084 13%

Nationwide Mutual Fire Ins Co $172,200,108 10%

Allstate Ins Co $96,455,898 6%

Nationwide Mutual Ins Co $85,288,950 5%

Allstate Indemnity Co $70,297,549 4%

Erie $63,021,060 4%

USAA $54,218,394 3%

Unitrin Auto & Home Ins Co $42,211,019 3%

Auto Owners Ins Co $32,945,885 2%

Liberty Mutual Fire Ins Co $30,618,782 2%

Phoenix Ins Co $29,086,002 2%

USAA Casualty Ins Co $25,451,905 2%

Peerless Ins Co $24,544,825 1%

Standard Fire Ins Co $23,315,478 1%

Farmers Insurance $21,621,787 1%

Homeowners Insurance Loss Experiencein North Carolina

Year Loss Ratio

1996 206 %

1997 56 %

1998 76 %

1999 91 %

2000 62 %

2001 50 %

2002 61 %

2003 67 %

2004 44 %

2005 39 %

2006 42 %

2007 45 %

average 70 %

Source: NC Department of Insurance

ROE for Homeowners Insurancein North Carolina, 1997 - 2006

11.4%

24.0% 24.9%

17.0%

29.0%

2.8%7.3%7.0%

-4.9%

-16.2%-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: NAIC and the Insurance Information Institute

Average HO ROE in NC from 1997 through 2006 was 10.2% -- well below the

Fortune 500 All-Industry average.

NC Homeowners Insurance:Loss Ratio, 1986-2005*

58.4

62.2 73

.616

8.9

73.9

54.0

59.6

57.6

206.

155

.6 75.7 90

.9

61.9

49.9 60

.667

.144

.139

.257.2 70

.9

25

50

75

100

125

150

175

200

225

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 5

Los

s R

atio

(%

) .

*Excludes expenses, taxes, commissions and dividends.Source: NAIC; Insurance Information Institute

Hugo

Emily FranBonnie Floyd

Isabel

North Carolina Rate Bureau

Statute – § 58‑36‑1  North Carolina Rate Bureau

Essential lines (residential property, personal auto and workers compensation)

The Governing Committee is composed of 12 representatives of member companies and two non-voting members appointed by the Governor

Annual Filing with DOI for Homeowners is not required

History of Homeowners Insurance Rate Changessource: NC Department of Insurance

Filed Date

Overall Filed/Proposed

Rate ChangeEffective

DateCOI Ordered Rate

ChangeRB Implemented

Rate Change

18-Jun-1993 13.5% 01-Oct-1994 2.0% 2.0%

03-Dec-1998 15.6% 01-Jun-1999 4.3% 4.3%

22-Mar-2002 20.0% 15-Aug-2002 5.0% 5.0%

 25-Feb-2005 12.1%   01-Aug-2005 2.2%   2.2%  

29-Dec-2006  21.9%  01-May-2007   5.4% 

North Carolina’s Residual Markets

NCJUA North Carolina Joint Underwriting Association “FAIR Plan”

NCIUA North Carolina Insurance Underwriting Association “Beach Plan” (Beach and Coastal)

The North Carolina Beach Plan

The Beach Plan was created in 1969 to cover only those barrier islands adjacent to the Atlantic Ocean.

In 1998, the Beach Plan was expanded by the NC General Assembly to include the eighteen (18) coastal counties (called the Coastal Area) for Windstorm and Hail Insurance Only coverage.

The plan was authorized to begin offering Homeowners Insurance Policies for principle residences effective July 1, 2003 for all 18 coastal counties.

Operation of Beach and Fair Plans

14 member Board of Directors 7 representatives from the insurance industry 4 licensed agents 3 members of the general public

The 2006 budget for the operation of the Beach plan provides estimated annual expenses of $8.4 million dollars. FAIR plan 2006 budget estimate is $5.6 million.

(Accounting and Fiscal Affairs Committee, Annual Board Meeting)

Summary of Combined Exposure for NC Beach and FAIR Plan Premium,

Exposure and Loss Potential

Source: http://www.ncjua-nciua.org

2004 2005 2006 2007 2008

Written Premium $99 mil. $130 mil. $180 mil. $196 mil $269 mil.

Total Insured Value $28 bil. $39 bil. $51 bil. $54 bil. $68 bil.

Ave. Annual Loss $110 mil. $146 mil. $230 mil. $235 mil. $270 mil.

100 Year PML $1.8 bil. $2.4 bil. $2.9 bil. $3.3 bil. $3.8 bil.

The North Carolina Beach Plan Catastrophe Loss Financing

Most beach plans include a combination of accumulating a reserve, assessments, and reinsurance

North Carolina is unique in that it has only recently purchased reinsurance and relies primarily on assessments

Dangerous to rely on Assessments (especially a modified form)

Reasons for Buying Reinsurance

Liquidity improves since payment from reinsurer should be faster and more reliable than assessments

Rely less on assessments which should stabilize market due to fewer potential insolvencies from assessments

Can define the cost of risk (reinsurance premium)

Establish relationship with reinsurer and broker which may be valuable during rough times. Gain expertise and trust.

Reasons for Buying Reinsurance

The “reinsurance questionnaire” was sent out to 200 member companies and 113 responded.  The first question asked whether or not the respondents felt that their company had adequate capacity to absorb potential beach plan losses and 89 said yes. 

The President of the Independent Insurance Agents of North Carolina submitted a letter to the General Manager of the Beach Plan expressing a desire for the Beach Plan to consider buying reinsurance

Reasons against Buying Reinsurance

Takes large chunk of retained earnings and will slow ability to grow surplus

Odds are high that it will not be needed

Tax implications (could lose tax exempt status)

Insurers can buy their own reinsurance and manage their assessment exposure

Reasons Against Buying Reinsurance

Less incentive for insurers to try and avoid the assessments by writing voluntarily along the coast.

Lessens overall capacity for standard market regarding NC coastal exposure

It is expensive and the cost can change for many reasons (worldwide market)

Assessments

Initially based upon market share

Ability to reduce obligations through voluntary writings

Are they reliable?

Will they destabilize insurers and market?

Assessments

Can insurers pass the cost along or are they supposed to absorb?

What happens when insurers become insolvent and cannot pay?

What is the role of the Guaranty Fund?

Results in massive subsidy to property owners along coastline

Preliminary Recommendations

1. The Beach Plan should once again truly act as the “market of last resort” and not be the “market of choice”

Allow rate levels to be influenced more by market competition than regulatory authorities.

Streamline the rate approval process Ensure that coverage from the Beach Plan is not

superior to that offered in the standard market. Review the 15% differential develop a figure with a

sound actuarial basis

Preliminary Recommendations

2. Verify that the Beach plan is prepared to meet financial obligations that may result following a catastrophic event.

The Beach Plan should purchase reinsurance that is adequate to pay claims following the 100 year probable maximum loss

Verify the reliability of assessments. The Beach Plan administration should conduct loss simulations to estimate impact of assessments on insurers (particularly smaller ones)

Preliminary Recommendations

3. Decrease the reliance on assessments that would result in non-coastal regions subsidizing the coastal region.

Purchase adequate reinsurance

The disbursement of retained earnings to insurers should also be suspended. The Beach Plan should not disperse funds to insurers until there are funds in place (or reinsurance coverage) that are adequate to pay claims resulting from the probable maximum loss

Preliminary Recommendations

4. Make operation of Beach Plan transparent

Hold meetings in major cities and invite the public Post catastrophe loss financing plans on their

website. This should include specific information on reserve funds, assessments and reinsurance.

Revise board membership to include non-coastal resident

Clarify leadership structure and decision making process