PERSPECTIVES ARTICLES THE PERFECT STORM: HURRICANES, INSURANCE, AND REGULATION. Martin F. Grace Robert W. Klein ABSTRACT

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1 C Risk Management and Insurance Review, 2009, Vol. 12, No. 1, PERSPECTIVES ARTICLES THE PERFECT STORM: HURRICANES, INSURANCE, AND REGULATION Martin F. Grace Robert W. Klein ABSTRACT The intense hurricane seasons of 2004 and 2005 caused considerable instability in property insurance markets in coastal states with the greatest problems occurring in Florida and the Southeast. Insurers have substantially raised rates and decreased their exposures. While no severe hurricanes struck the United States in 2006 and 2007, market pressures remain strong given the high risk still facing coastal states. These developments generate considerable concern and controversy among various stakeholder groups. Government responses have varied. In Florida, political pressures prompted a wave of legislation and regulations to expand government underwriting and subsidization of hurricane risk and constrain insurers rates and market adjustments. Other states actions seem more moderate. In this context, it is important to understand how property insurance markets have been changing and governments have been responding to increased catastrophe risk. This article examines important market developments and evaluates associated government policies. We comment on how regulation is affecting the equilibration of insurance markets and offer opinions on policies that are helpful and harmful. INTRODUCTION The risk and cost of natural disasters and their effects on insurance markets and associated government policies are elements of an interesting and important story about the interplay of economics and politics. 1 It is a story that may contain some familiar as well as peculiar elements to students of political economy. In our opinion, the high degree of uncertainty associated with disaster risk challenges insurers and its opaque Martin F. Grace, James S. Kemper Professor, Department of Risk Management, Georgia State University, P.O. Box 4035, Atlanta, GA ; phone: ; fax: ; e- mail: mgrace@gsu.edu. Robert W. Klein, Associate Professor and Director of the Center for RMI Research, Georgia State University, P.O. Box 4036, Atlanta, GA ; phone: ; fax: ; rwklein@gsu.edu. This article was subject to double-blind peer review. 1 Hurricane risk can be defined in different ways. A simple definition of hurricane risk is the expected average annual loss from hurricanes. A broader definition would include various dimensions of the estimated probability distribution for hurricane losses, e.g., its mean, variance, and long right-hand tail. One could also include parameter uncertainty in the definition of hurricane risk. 81

2 82 RISK MANAGEMENT AND INSURANCE REVIEW nature enables politicians to shift risk more easily and obtain greater subsidies for those exposed to disasters. 2 Also, we believe that the notion that natural disasters are acts of God and beyond the control of their victims can affect the regulatory and political climate facing insurers. Such a story is now unfolding with the increased threat of hurricanes striking the United States and the response of insurance markets and government officials to this threat. The intense hurricane seasons of 2004 and 2005 caused substantial instability in property insurance markets in coastal states with the greatest pressure occurring in Florida and the Southeast. 3 Other coastal states exposed to hurricanes also have experienced some market pressures and changes. 4 The increased risk of hurricanes striking the United States prompted significant changes in these same markets beginning in the early 1990s but the particularly intense hurricane activity during has led to another round of market adjustments. 5 Both the loss shocks of the storm seasons as well as insurers belief that hurricane risk has increased have been major drivers of the recent market adjustments. The fact that a severe hurricane did not struck the United States in 2006 and 2007 was a welcome relief allowing insurers and reinsurers to replenish some of their lost capital but the risk of more hurricanes remains high and is still driving conditions in property insurance markets. Unfortunately, the reprieve of major storm activity in the United States was not permanent, as the 2008 storm season produced several hurricanes that struck the United States. Recent developments have generated considerable concern and controversy among various groups of stakeholders. In the face of increased risk and uncertainty, insurers have sought to adjust their rates and exposures in order to ensure their economic viability in the short and long term. Reinsurers also made substantial adjustments; their prices increased as new capital flowed in to replace recent losses and respond to the increased demand for catastrophe reinsurance (Guy Carpenter, 2008). Presently, it appears that affected property insurance and reinsurance markets have probably undergone most of the adjustments necessary but the situation is fluid. There are indications that some insurers believe their rates are still inadequate in Florida due to regulatory constraints. 6 2 Moss (2002) studies the political economy of the government s assumption of risk with insights pertinent to disaster risk. Meier (1988) and Klein (1995) consider alternative theories of regulatory behavior in terms of their application to the insurance industry. The themes in this literature are reflected in our examination of the political and regulatory climate for property insurance in hurricane-prone states. 3 We support this observation in our discussion of market conditions in Florida in contrast with other Southern coastal states. As we will show, Florida has been subject to the greatest rate increases and market restructuring among coastal states. Grace and Klein (2007b) and Klein (2008) further document market pressures in Florida. 4 For a discussion of states other than Florida, see Higher Insurance Costs Hit U.S. Coastal Living. International Herald Tribune, September The article states that coverage has tripled in some cases on Cape Cod...and have risen as much as 50 percent on Long Island. 5 Lecomte and Gahagan (1998) and Grace et al. (2003) examine insurance market conditions in Florida following Hurricane Andrew. 6 In July 2008, State Farm filed for an overall rate increase of 47.1 percent for homeowners insurance in Florida. A spokesperson for the Florida Insurance Council was quoted in a newspaper article as stating, It won t be surprising if additional companies make rate filings...the vast

3 HURRICANES, INSURANCE, AND REGULATION 83 There is considerable anecdotal evidence that many affected property owners are concerned about sharp premium hikes and the diminished availability of coverage. 7 Although the relatively benign storm seasons of were a welcome relief to insurers and others, they also appear to have undermined public acceptance of insurers rate increases as well as strengthened political pressure on government officials to constrain insurers actions and to ease conditions for consumers. 8 This was reflected in a wave of legislative and regulatory actions in Florida in 2007 and 2008 aimed at lowering the cost of insurance to coastal property owners. 9 Some of these changes expanded the state s underwriting and subsidization of catastrophe risk and others sought to place tighter constraints on insurers (Milliman, 2007). Unfortunately, we believe these measures are undermining private markets and the private financing of catastrophe risk. We also note that coastal politicians are making a strong push for the federal government to underwrite a significant portion of hurricane risk. 10 This article examines how insurance markets have changed and government policies have evolved. Our main focus is Florida the center of this perfect storm where market pressures are strongest and regulatory-legislative responses are particularly severe. We also discuss developments in other selected coastal states that offer interesting similarities as well as contrasts to Florida. These other states are Mississippi, Louisiana, South Carolina, and Texas and are the states that appear to face the most significant hurricane risk issues next to Florida. We offer observations on how the interplay of economics and politics influences the management of catastrophe risk. The next section of this article briefly reviews the environmental, economic, and regulatory context for hurricane risk and property insurance and examines the structure and performance of property insurance markets. We then describe and evaluate significant regulatory actions and other government policies. We conclude with a summary of our key observations. majority of companies have continually told us that their rates are inadequate. See More Insurance Rate Hike Requests Predicted, Palm Beach Post, July 17, Florida Farm Bureau, for example, asked for a 28.4 percent rate increase in late July See State Probes Farm Bureau Rate Plan, Daytona News Journal, July 30, Consumer discontent has been reflected in town hall meetings, rallies, legislative hearings, and letters to the editor that are documented in Florida newspapers. See, for example, Rising Rates a Top Priority for Most Voters, Poll Shows, Tampa Tribune, October 26, 2006; Rally Cries for Insurance Relief, St. Petersburg Times, October 8, 2006; and Homeowners Rip Insurance Package, Palm Beach Post, July 25, Daniels et al. (2006) examine public policy issues associated with Hurricane Katrina and its aftermath. Quigley and Rosenthal (2008) address a broader set of issues associated with various disaster threats. 9 The vehicle for the 2007 legislation was Florida House Bill 1-A (2007). The vehicle for the 2008 legislation was Florida Senate Bill 2860 (2008). 10 See, for example, the testimony of Kevin McCarty for the The National Association of Insurance Commissioners before the Subcommittee on Housing and Community Opportunity of the House Committee on Financial Services (March 27, 2008).

4 84 RISK MANAGEMENT AND INSURANCE REVIEW FIGURE 1 U.S. Hurricane Strikes By Decade: All Major -Category 3-6 Number of Hurricanes Source: National Oceanic and Atmospheric Administration. HURRICANE RISK AND INSURANCE MARKETS Nature, Economic Development, and Insurance To understand developments in property insurance markets in coastal states, one must understand the natural and economic environments in which these markets function. 11 The natural environment comprises short- and long-term weather patterns and cycles principally, the frequency and intensity of tropical storms and hurricanes striking different areas (Holland and Webster, 2007). The natural environment interacts with the important aspects of the economic environment the growth and geographic distribution of commercial and residential property development (Pielke et al., 2008). Together, these circumstances heavily influence the property exposed to hurricanes and the demand for and supply of insurance. History and meteorological science document the cyclical nature of weather patterns and storm activity. Hurricane frequency and intensity increased during the period and then fell during the next three decades (see Figure 1). Storm activity intensified again starting in the late 1980s through the present (National Oceanic and Atmospheric Administration, 2006). Within these long-term cycles, short-term factors can affect the number, intensity, and paths of storms in any given year. 11 See Grace and Klein (2007b) for a more detailed discussion of this topic and references supporting the summary observations offered here.

5 HURRICANES, INSURANCE, AND REGULATION 85 During the active storm cycle in , coastal areas were less developed so storms striking these areas caused less property damage. During the next three decades, there was considerable economic growth in these areas but storm activity had lessened and does not appear to have impeded growth. 12 Hence, considerable development occurred when hurricane losses and insurance prices were relatively low. It also appears that insufficient attention was paid to hazard mitigation (e.g., building hurricane-resistant homes), which has further contributed to the catastrophe risk problem. 13 Consequently, the pressure on property insurance markets rose because of economic development in areas subject to greater hurricane risk. While insurers and reinsurers are expected to expand the supply of insurance to meet this greater demand, they increase their vulnerability to catastrophe losses if they increase their concentration of exposures in high-risk areas. This pressure can strain existing risk transfer and diversification mechanisms and reduce the availability of insurance coverage for those seeking it. More storms and extensive economic development have caused economic losses from hurricanes insured and uninsured to escalate dramatically over the last 15 years, as shown in Figure 2. Hurricane Katrina was the most expensive natural disaster to date with insured losses of over $40 billion and total economic losses exceeding $100 billion, but much larger losses could occur if a severe hurricane struck a larger metropolitan area such as Miami. 14 Insurance markets reverberate from these loss shocks but their effects on estimates of the nature of the risk that insurers face, arguably, is the most critical factor that influences market conditions (Froot and O Connell, 1997). Entries, Exits, and Market Concentration We begin our analysis by looking at shifts in the market positions of leading writers of homeowners insurance in Florida in Table 1. In this table, we focus on the voluntary market and do not include the residual market. We can see that there have been dramatic changes in the Florida market since The top two groups in 2006 State Farm and Allstate were also the top two groups in However, their combined market share dropped from 50.9 percent to 29.2 percent. These two insurers have significantly reduced their relative presence in the Florida market (as measured by premiums). It is also interesting to note that while State Farm s market share actually has increased since 2000, Allstate s share declined from 11.2 percent to 7.8 percent. This appears to be consistent with Allstate s stated intention to substantially reduce its concentration of exposures in high-risk areas to a level that it believes is more economically viable. 15 Other mid-tier insurers have remained in the top 20 but some have moved up in the rankings while others have moved down. 12 Information on coastal population trends can be obtained from the National Oceanic and Atmospheric Administration NOAA website at Insurance Information Institute (2008b) also discusses coastal development. 13 The damages caused by Hurricane Andrew demonstrated problems with the enforcement of building codes intended to make homes more resistant to strong winds. See New Building Code Brings Cost and Confusion, St. Petersburg Times, August 19, Following Hurricane Andrew there have been strong efforts to improve the mitigation of the hazards associated with hurricane risk, including but not limited to establishing stronger building codes, as discussed in Wharton et al. (2008). 14 See Storm Scenarios Take Hard Look, St. Petersburg Times, June 8, See, for example, Allstate Won t Renew 106,000 Policies, Miami Herald, January 5, 2007.

6 86 RISK MANAGEMENT AND INSURANCE REVIEW FIGURE 2 Insured Losses for U.S. Catastrophes ($Billions): $70 $60 $50 Unadjusted Current Dollars $40 $30 $20 $10 $ Source: Insurance Information Institute. Another significant development has been the entry/expansion of some insurers as other companies have retrenched or withdrawn from the market. Ten of the top 20 groups in 2006 entered the market after This reflects several phenomena. Two important factors were the startup of several new insurers in Florida during the 1990s and entries by other established insurers. Another group of companies has entered the market since 2005, according to the Florida Office of Insurance Regulation (FLOIR), although none of these companies appears in the top 20 writers in The retrenchment or exit of some insurers created opportunities for other insurers to fill the gap. Also, several of the large national groups established Florida subsidiaries that now underwrite all or most of their homeowners business in the state. Entry into the Florida market carries significant risk, especially for insurers with all or most of their exposures concentrated in the state. This was demonstrated by the rapid rise of the third and fourth leading groups in 2005 the Poe and Tower Hill groups. Poe was hit hard by the 2004 and 2005 storm seasons and is currently being liquidated by regulators. 17 The Tower Hill Group was also stressed by the recent storm seasons and 16 As of May 7, 2008 the FLOIR reported that 39 property insurers have entered Florida since January See Insurance: Big Risks, Big Payoffs, Tampa Tribune, May 7, Information on Florida market entrants can be accessed at 20Companies/index.aspx. 17 See Court Approves Liquidation of Poe Companies South Florida Business Journal, June 1, 2006, found at April 20, 2008.

7 HURRICANES, INSURANCE, AND REGULATION 87 TABLE 1 Changes in Leading Insurers Market Share Florida 1992, 2000, % HO Prem Name in Florida R DPW MS R DPW MS R DPW MS R DPW MS State Farm Group 12.2% 1 1,444,281, % 1 1,175,850, % 1 583,296, % 1 653,427, % Allstate Ins Group 9.6% 2 524,702, % 2 495,663, % 3 325,641, % 2 436,329, % Tower Hill Ins 100.0% 3 342,029, % 4 285,914, % Group Universal Prop & 100.0% 4 338,419, % 8 159,161, % 26 25,611, % Cas Ins USAA Group 13.5% 5 316,536, % 6 253,944, % 4 152,088, % 3 95,171, % Nationwide 17.3% 6 297,439, % 5 274,919, % 5 144,675, % 5 88,595, % Corporation Liberty Mutual 14.4% 7 221,726, % 7 172,197, % 10 51,714, % 12 32,534, % Group ARX Holding Corp 82.1% 8 216,582, % ,834, % 25 27,120, % Group Universal Insurance 100.0% 9 186,151, % 18 81,510, % Group American 54.9% ,500, % ,271, % 15 38,442, % 53 3,771, % International Group Chubb & Son Inc 10.7% ,699, % ,290, % 8 68,324, % 6 62,874, % St Johns Ins Co. Inc 100.0% ,404, % 25 64,285, % (continued)

8 88 RISK MANAGEMENT AND INSURANCE REVIEW TABLE 1 (Continued) % HO Prem Name in Florida R DPW MS R DPW MS R DPW MS R DPW MS United Prop & Cas 100.0% ,913, % ,987, % 36 14,473, % Ins Co. Hartford Fire & 13.3% ,457, % ,479, % 7 76,738, % 9 49,288, % Casualty Group St Paul Travelers 58.2% ,197, % 9 124,905, % 6 92,445, % 4 89,664, % Group Gulfstream Prop & 100.0% ,088, % 17 93,418, % Cas Ins Co. 21st Century 100.0% ,574, % 20 77,513, % Holding Group Florida Peninsula 100.0% ,706, % 42 20,290, % Ins Co. GeoVera Holdings 69.2% ,034, % ,695, % Inc. Group First Protective Ins 100.0% 20 89,864, % 32 37,847, % 43 10,928, % Co. Note: R = rank; DPW = direct premiums written; MS = market share. Source: NAIC Financial Database; authors calculations.

9 HURRICANES, INSURANCE, AND REGULATION 89 was downgraded by A.M. Best. 18 Two other Florida insurers Florida Select and Vanguard were seized by regulators due to their insolvency/impairment resulting from the recent hurricanes. This illustrates the drawback of relying heavily on local or regional insurers to fill large gaps left by larger, national insurers. Smaller insurers can bolster their capacity with extensive use of reinsurance but this comes at a cost along with some retention of risk at a primary level that is unavoidable. In 1992, on an aggregate basis, insurers Florida homeowners premiums accounted for 8.1 percent of their total homeowners premiums countrywide. By 2006, this number increased to 19.6 percent. Of course, Florida insurers do not pool their exposures in one bucket. Hence, the mean or median Florida/countrywide premium ratio among Florida homeowners writers may be more telling. In 1992, calculated at the group level, the mean Florida/countrywide premium ratio was 6.6 percent and the median was 18.4 percent. In 2006, the group-level mean ratio had increased to 53.8 percent and the associated median ratio had increased to 66.2 percent. The shift to less geographically diversified insurers also is apparent in looking at the top 20 writers (at a group level). In 1992, only one of the top 20 insurers wrote 100 percent of their homeowners premiums in Florida. 19 In 2006, 9 of the top 20 insurers wrote 100 percent of their homeowners premiums in Florida. The story of the Poe companies is a good example of the go for broke strategy that some insurers employ when they encounter financial difficulty. 20 Poe insured more than 300,000 homes with most concentrated in the high-risk areas of Palm Beach, Broward, and Dade counties. Despite major losses from the 2004 storms and declining capital, Poe added more policies in 2005, gambling that it would not incur more storm losses. Such gambling is encouraged by a regulatory system in which an insurer can shift its losses to the state (i.e., insurance consumers and taxpayers) through insolvency guaranty associations and to other creditors. 21 An insurer s owners reap the potential upside of such gambles and stick the public with the potential downside. 22 The downside scenario became fact when the Poe companies became insolvent after the 2005 storm season generating approximately $988 million in payments (as of year-end 2007) by the Florida Insurance Guaranty Association (FIGA) for 46,162 claims from Poe s policyholders (FIGA, 2007). We were unable to find any evidence that Florida regulators attempted to constrain Poe s actions until The Tower Hill Group writes business in four Southeastern states but most of its business is concentrated in Florida. A.M. Best lowered the ratings for Tower Hill Preferred Insurance Company and Tower Hill Prime Insurance Company from A to B on June 23, A.M. Best s rationale for the downgrade was the companies significant dependence on reinsurance, geographic concentration of risk with exposure to hurricanes, and unfavorable operating performance (see A.M. Best, 2007a). 19 This observation is not evident in Table 1 but is based on our determination of the top 20 insurers in 1992 using the same source of data the National Association of Insurance Commissioners financial database used for all the calculations in Table See Insurance Failures Spawn New Levy on Florida Policies, Palm Beach Post, October 30, This includes federal taxpayers throughout the country (Barrese and Nelson, 1994). 22 Willenborg (2000) discusses this problem associated with guaranty associations.

10 90 RISK MANAGEMENT AND INSURANCE REVIEW TABLE 2 Florida Market Structure With Citizens Property Insurance Corporation CPIC CPIC HHI w/ HHI w/o Year CPIC DPW MS (%) Rank CPIC CPIC ,157, ,280, ,210, ,605, ,903, ,493, ,298,388, Note: The Florida Residential Property & Casualty JUA became the Citizens Property Insurance Corp. (CPIC) in Source: CPIC & NAIC Database, authors calculations. Several national and regional insurers entered or increased their market presence but their market shares were still relatively modest in 2006, i.e., less than 3 percent. This may reflect a more viable strategy of acquiring or maintaining small, digestible shares of a large but risky market by more broadly diversified insurers. The structure of the homeowners insurance market looks somewhat different when the state s residual market mechanism is included the Citizens Property Insurance Corporation (CPIC). Table 2 shows the CPIC s direct premiums written, market share, and market rank for the period We can see from this table that the CPIC s market share increased from 2.2 percent in 2000 to 16.1 percent in Its market rank rose from ninth to second over this same period. The growing market share of the CPIC reflects its increasing importance in the total (voluntary and residual) homeowners insurance market in Florida. When the 2007 financial data become available they may reveal that the CPIC s market share has further increased. The changes in the voluntary market s concentration in Florida and in the other selected costal between 1992 and 2006 are shown in Table 3. The combined market share for the top four groups (CR4) in Florida decreased from 55.3 percent to 39.2 percent. The combined market shares for the top eight insurers (CR8) also declined over this period but to a lesser degree as this measure reflects more insurers who have experienced smaller cuts in their business as well as some insurers who have increased their business. These changes track with the decline of the Herfindahl-Hirschman Index (HHI) from 1,440 in 1992 to 695. Market concentration in Florida, as measured by the HHI, was lower with the inclusion of the CPIC until 2006 (see Table 2). In 2006, the HHI with the CPIC included was 749 compared to 695 without the CPIC. The decline in market concentration and the relative changes for the market leaders versus the mid-tier insurers is consistent with what we would expect to see based on the greater risk and higher cost of retaining large amounts of high-risk exposures (Klein and Kleindorfer, 2003). Less concentration implies that there is a greater dispersion of

11 HURRICANES, INSURANCE, AND REGULATION 91 TABLE 3 Market Concentration in Selected States Homeowners Insurance: 1992 and State CR4 CR8 HHI CR4 CR8 HHI Florida 55.3% 70.9% 1, % 54.5% 695 Louisiana 68.2% 76.7% 1, % 79.4% 1,721 Mississippi 71.7% 83.8% 1, % 84.0% 1,597 South Carolina 61.3% 76.5% 1, % 77.7% 1,159 Texas 69.7% 78.2% 1, % 80.4% 1,423 Note: CR4 = combined market share of top four firms; CR8 = combined market share of top eight firms; and HHI = Herfindahl-Hirschman Index, the sum of the squared market shares of all firms. Source: NAIC Financial Database; authors calculations. exposures among carriers in Florida that could be viewed as a positive development in terms of greater diversification of risk. In markets subject to disaster losses, lower concentration levels may be a necessary condition to allow insurers to maintain their catastrophe exposures at manageable levels. One caveat to the observation about market deconcentration in Florida is the movement of exposures from national carriers to smaller state or regional insurers that are not pooling risk across a diversified base of countrywide exposures. There is a limit to how much these insurers can diversify risk even with extensive use of reinsurance. Singlestate companies within national groups can receive support from their affiliates in the event of large losses, but as we explain below, these national groups cannot engage in sustained cross-subsidies of their Florida insureds. 23 Market structure changes appear to be much less significant in other states. In these other states, the data indicate the emergence of only two to three new insurers (since 2000) that are now among the top 20 writers in these markets (see Grace and Klein, 2007b). The relatively greater stability in these other state markets may reflect several factors. One is that insurers plans to adjust their positions are not fully implemented and revealed by the 2006 data. Another factor may be that insurers see less of a need to reduce their business in these states. Some of these states also appear to be taking a less restrictive approach to regulation than Florida (at least for the present) that may be helping insurers to retain a greater presence in these states. We should also note that the proportion of coastal exposures is considerably lower in these states than in Florida and, hence, coastal risk would be expected to have less of an effect on insurers statewide market shares. 23 Even if the national insurers attempted to impose cross-subsidies from non-florida to Florida consumers, market forces and other states regulators would not allow such subsidies.

12 92 RISK MANAGEMENT AND INSURANCE REVIEW Table 3 also reveals that the other selected states have experienced less significant changes in market concentration than Florida. The combined market of the top four insurers and the HHI has declined in all of the coastal states shown. However, in all but Florida, the top eight insurers increased their combined share of the market over the same period. The decrease in the CR4 measure suggests that the very largest insurers have decreased the amount of business they are writing but this pattern has not extended to the top eight writers. The decline in the overall market concentration in the other states (as measured by the HHI) reflects a more even distribution of the market beyond the largest insurers. This could be due to the increasing market penetration by smaller insurers and/or the decisions by mid-tier insurers (beyond the top eight) to decrease their business in these states. Insurer Exposure Patterns Another important part of the story is the distribution of insurers shares of exposures (the amount of insurance coverage) in different areas in a state. Table 4 compares the company-level HHI (based on the amount of insured homeowners property) by county in Florida between 1997Q1 and 2006Q4 (coastal counties are shown in bold type). 24 Table 5 compares the exposure-based market shares of the 20 leading insurers in Broward, Dade, Monroe, and Palm Beach counties (combined) between 1997 and 2006 at a group and company level. We see several important developments in these data. The first is a tendency toward decreased concentration in the higher risk counties (along the coasts). The second is that several leading insurers in the state have decreased their shares of exposures in the four southeastern counties that are considered to be among the highest risk counties in the state. We also observe that new insurers have moved in to underwrite a significant proportion of exposures in the four southeastern counties. Another observation is that the start-up insurers that formed in the mid-1990s had been forced to write a large share of portfolios in high-risk areas as they took policies out of the residual market mechanism (see Grace et al., 2006). However, when the 3-year requirement on retaining these policies expired, the majority of these insurers dropped a significant portion of their high-risk exposures, which returned to the residual market or were underwritten by other entrants like the Poe and Tower groups. This action may have been motivated by concerns about the risk associated with retaining a substantial concentration of high-risk policies in coastal areas. Prices The price of home insurance is a primary area of interest and concern. Figure 3 shows trends in the average homeowners insurance premium in five coastal states from the first quarter of 2002 to the first quarter of We calculated the average premium (total premiums divided by insured house-years) for each quarter in the series. We can see from this figure that Florida has experienced the greatest increase in its average 24 We were able to obtain data on insurers exposures by county by year/quarter for Florida from the FLOIR. Exposure in these data refers to the amount of coverage, which is based on the limits on the policies that insurers write. For residential policies, this includes the coverage limits for the dwelling, other structures, contents, and loss of use.

13 HURRICANES, INSURANCE, AND REGULATION 93 TABLE 4 Florida Homeowners Exposure Company Level HHIs by County in 1997Q1 and 2006Q4 Counties Ranked in Descending Order of HHI Rank County HHI Rank County HHI Rank County HHI Rank County HHI 1 Taylor 2, Hernando 1,439 1 Taylor 3, Pinellas 1,159 2 Hendry 2, Lake 1,419 2 Desoto 2, Dade 1,151 3 Dade 2, Flagler 1,409 3 Monroe 2, Okaloosa 1,149 4 Broward 2, Pasco 1,370 4 Hendry 2, Gilchrist 1,125 5 Brevard 2, Bradford 1,346 5 Glades 2, Lake 1,106 6 Desoto 2, St. Johns 1,341 6 Hardee 2, Washington 1,093 7 Volusia 2, Alachua 1,340 7 Baker 2, Pasco 1,087 8 Osceola 2, Sarasota 1,327 8 Jefferson 2, Alachua 1,022 9 Polk 1, Leon 1,319 9 Putnam 1, Hamilton 1, Okeechobee 1, Putnam 1, Okeechobee 1, Orange 1, Glades 1, Jefferson 1, Bradford 1, Santa Rosa 1, Palm Beach 1, Calhoun 1, Volusia 1, Osceola Monroe 1, Bay 1, Hernando 1, Citrus Dixie 1, Hamilton 1, Columbia 1, Lee Charlotte 1, Union 1, Duval 1, Sarasota Escambia 1, Nassau 1, Jackson 1, Marion Highlands 1, Madison 1, Lafayette 1, Levy Pinellas 1, Levy 1, Polk 1, Gadsden Seminole 1, Washington 1, Dixie 1, Walton St. Lucie 1, Jackson 1, St. Johns 1, Franklin 857 (continued)

14 94 RISK MANAGEMENT AND INSURANCE REVIEW TABLE 4 (Continued) Rank County HHI Rank County HHI Rank County HHI Rank County HHI 21 Hardee 1, Suwannee 1, Clay 1, Indian River Santa Rosa 1, Manatee 1, Calhoun 1, Flagler Columbia 1, Walton 1, Sumter 1, Holmes Lee 1, Marion 1, Broward 1, Gulf Okaloosa 1, Holmes 1, Madison 1, Nassau Duval 1, Sumter 1, Suwannee 1, Hillsborough Orange 1, Martin Leon 1, Collier Clay 1, Liberty Highlands 1, St. Lucie Baker 1, Gilchrist Union 1, Manatee Citrus 1, Gulf Escambia 1, Bay Lafayette 1, Franklin Brevard 1, Martin Indian River 1, Gadsden Liberty 1, Palm Beach Collier 1, Wakulla Seminole 1, Wakulla Hillsborough 1,493 Statewide 1, Charlotte 1,174 Statewide 892 Source: Data from FLOIR; authors calculations.

15 HURRICANES, INSURANCE, AND REGULATION 95 TABLE 5 Leading Insurance Groups and Companies in Broward, Dade, Monroe, and Palm Beach Counties: 1997Q1 and 2006Q4 1997Q1 2006Q4 Rank Group Mkt. Share a Company Mkt. Share a 1 State Farm Group 38.5% Citizens Property Ins. 27.3% Corp. 2 Florida Residential 24.0% State Farm Group 20.7% Property JUA 3 Allstate Insurance Group 6.5% Liberty Mutual Group 5.7% 4 Liberty Mutual Group 4.4% United Property & 4.5% Casualty Ins. Co. 5 Nationwide Group 4.1% Tower Hill Group 3.9% 6 Chubb Group of Ins. 3.1% Universal Property & 3.6% Co. s Casualty Ins. Co. 7 St. Paul Travelers Group 2.8% USAA Group 3.5% 8 USAA Group 2.8% Gulfstream Property & 2.9% Casualty Ins. Co. 9 Hartford Insurance 2.0% Federated National Ins. 2.6% Group Co. 10 MetLife Auto & Home 1.3% Coral Ins. Co. 2.2% Group 11 St. Paul Guardian Ins. 1.1% Allstate Insurance Group 2.0% Co. 12 Berkshire Hathaway 1.1% Vanguard Fire & 1.6% Insurance Group Casualty Co. 13 Bankers Insurance 1.0% HDI U.S. Group 1.6% Group 14 American International 0.7% Universal Ins.Co. of 1.5% Group Inc. North America 15 Southern Farm Bureau 0.7% American International 1.1% Group Group 16 Horace Mann Insurance 0.5% Chubb Group of 1.0% Group Insurance Companies 17 HDI U.S. Group 0.4% MetLife Auto & Home 1.0% Group 18 Atlantic Mutual Companies 0.4% Southern Oak Ins. Co. 1.0% (continued)

16 96 RISK MANAGEMENT AND INSURANCE REVIEW TABLE 5 (Continued) 1997Q1 2006Q4 Rank Group Mkt. Share a Company Mkt. Share a 19 Amica Mutual Group 0.4% St. Johns Ins. Co. 1.0% 20 Safeco Insurance 0.4% Travelers Insurance 1.0% Companies Group Top twenty 96.2% Top twenty 89.6% 1997Q1 2006Q4 Rank Company Mkt. Share a Company Mkt. Share a 1 State Farm Fire & 38.5% Citizens Property Ins. 27.3% Casualty Corp. 2 Florida Residential 24.0% State Farm Florida Ins. 20.7% Property JUA Co. 3 Nationwide Mutal Fire 4.1% United Property & 4.5% Ins. Co. Casualty Ins. Co. 4 Allstate Ins. Co. 4.1% Liberty Mutual Fire 4.2% Ins.Co. 5 Allstate Floridian Ins. 2.3% Universal Property & 3.6% Co. Casualty Ins. Co. 6 Liberty Mutual Fire 2.3% Gulfstream Property & 2.9% Ins.Co. Casualty Ins. Co. 7 Federal Ins. Co. 2.2% Federated National Ins. 2.6% Co. 8 LM Property & Casualty 2.1% Coral Ins. Co. 2.2% Ins. Co. 9 Hartford Ins. Co. of MW 1.6% United Services 2.0% Automobile Assoc. 10 USAA Casualty Ins. Co. 1.5% Allstate Floridian Ins. 1.8% Co. 11 United Services 1.2% Vanguard Fire & 1.6% Automobile Assoc. Casualty Co. 12 Metropolitan P & C Ins 1.2% Tower Hill Preferred Ins. 1.6% Co Co. 13 St. Paul Guardian Ins. 1.1% USAA Casualty Ins. Co. 1.6% Co. 14 First Community Ins. Co. 1.0% Universal Ins. Co. of North America 1.5% (continued)

17 HURRICANES, INSURANCE, AND REGULATION 97 TABLE 5 (Continued) 1997Q1 2006Q4 Rank Group Mkt. Share a Company Mkt. Share a 15 Standard Fire Ins. Co. 0.9% First Liberty Ins. Corp. 1.5% 16 GEICO 0.8% Clarendon Select Ins. Co. 1.2% 17 Great Northern Ins. Co. 0.7% American Home 1.1% Assurance Co. 18 AIG Centennial Ins. Co. 0.6% Tower Hill Prime Ins. Co. 1.0% 19 Automobile Ins Co. of 0.6% Tower Hill Select Ins. 1.0% Hartford, CT 20 Phoenix Ins. Co. 0.5% Southern Oak Ins. Co. 1.0% Top twenty 91.4% Top twenty 84.9% a Market share is based on the amount of exposures. b The FL Residential P&C JUA became the Citizens Property Ins. Corp. in Source: Data from FLOIR; authors calculations. premium from $723 to $1,464 among the six states. Louisiana experienced the second greatest increase in its average premium from $785 to $1,271. An important caveat to the indications of these average premium trends is that they reflect the weighted distribution of the premium increases on all policies in the underlying data. An alternative approach to measuring substate differences and changes in prices is to calculate an average rate per $1,000 of coverage. This approach is less affected by differences in the amount of insurance but still confounds other coverage terms with rates. 25 We employed this approach using county-level data available for Florida and our calculations for the years 1997 and 2006 are reflected in Table 6. The results are quite revealing as the county with the highest rate in 2006 was Monroe with a rate of $34.46; the county with the lowest rate was Clay with a rate of $2.49. Monroe also experienced the greatest relative increase 81.6 percent from its rate of $18.98 in This reflects the high level of risk in Monroe County, which includes the Florida Keys. Another way to compare home insurance prices is to look at the premiums insurers would charge for a hypothetical home policy in different areas within a state. Table 7 shows descriptive statistics for current premium comparisons for Florida. These premium comparisons are posted by the FLOIR on its website and apply 25 Various additional factors would be expected to affect the amount of insurance coverage, including changes in the replacement cost of homes. Some of the increase in the average premium is likely due to increases in replacement costs and the corresponding effect on policy limits.

18 98 RISK MANAGEMENT AND INSURANCE REVIEW FIGURE 3 Average Homeowners Premium Trends: 2002Q1 2007Q FL LA MS SC TX Q1 02Q2 02Q3 02Q4 03Q1 03Q2 03Q3 03Q4 04Q1 04Q2 04Q3 04Q4 05Q1 05Q2 05Q3 05Q4 06Q1 06Q2 06Q3 06Q4 07Q1 Source: PCIAA/ISO Fast Track Monitoring System; authors calculations. to a hypothetical policy home. 26 Using the data from these comparisons, we computed the maximum, minimum, mean, and median premiums for each county. These figures are intended to provide some indication of the difference in how much a homeowner would pay for insurance depending on his or her location. The great variation in the hypothetical premiums reported by each company for a given location prompts us to focus on measures of central tendency, i.e., mean and median premiums, for each location. We discuss issues raised by this variation below. Table 7 reveals significant price differences among insurers in each county reflected by the difference between the minimum and maximum premium as well as significant differences among counties reflected by the means and medians for each county. The highest median premium $3,658 is in Monroe County and the lowest premium $801 is in Duval County (which includes Jacksonville). In other words, a typical homeowner might expect to pay a premium four times higher in Monroe County than he or she would pay in Duval County, all other things equal. Of course, the actual experience of homeowners could vary somewhat from the indications provided here. 26 The premium comparisons are for a 5-year-old Florida concrete block home with a current replacement value of $150,000, a $500 nonhurricane deductible, a 2 percent hurricane deductible, no claims, and no wind mitigation discounts.

19 HURRICANES, INSURANCE, AND REGULATION 99 TABLE 6 Florida Homeowners Insurance Rates per $1,000 by County County 1997Q1 2006Q4 % Chg. County 1997Q1 2006Q4 % Chg Monroe $18.98 $ % Volusia $2.77 $ % Dade $7.23 $ % Highlands $3.24 $ % Franklin $6.42 $ % Lafayette $4.36 $ % Broward $5.35 $ % Washington $3.81 $ % Gulf $4.90 $ % Madison $4.04 $ % Palm Beach $4.45 $ % Hamilton $4.14 $ % Walton $4.47 $ % Gilchrist $3.89 $ % Martin $3.66 $ % Calhoun $3.80 $ % Indian River $3.80 $ % Citrus $2.98 $ % Pinellas $3.25 $ % Liberty $4.15 $ % Pasco $3.07 $ % Gadsden $3.61 $ % Escambia $3.68 $ % Polk $3.00 $ % Bay $3.64 $ % Suwannee $3.91 $ % St. Lucie $3.95 $ % Jackson $3.64 $ % Collier $3.88 $ % Union $3.78 $ % Charlotte $3.16 $ % Putnam $3.60 $ % Lee $3.34 $ % Bradford $3.41 $ % Dixie $4.70 $ % Nassau $3.38 $ % Hernando $2.84 $ % Jefferson $3.86 $ % Okaloosa $3.90 $ % Flagler $2.76 $ % Sarasota $3.30 $ % Osceola $2.67 $ % Santa Rosa $3.06 $ % Seminole $2.53 $ % Brevard $3.15 $ % Marion $2.98 $ % Glades $3.96 $ % Orange $2.66 $ % Okeechobee $3.54 $ % Columbia $3.35 $ % Hendry $3.42 $ % Baker $3.49 $ % Holmes $3.89 $ % St. Johns $2.71 $ % Wakulla $4.26 $ % Alachua $2.61 $ % Hillsborough $3.44 $ % Sumter $3.36 $ % Manatee $3.37 $ % Duval $2.76 $ % Hardee $3.87 $ % Lake $2.83 $ % Levy $3.93 $ % Leon $2.42 $ % Desoto $3.55 $ % Clay $2.55 $ % Taylor $3.76 $ % Total $3.87 $ % Source: Data from FLOIR; authors calculations.

20 100 RISK MANAGEMENT AND INSURANCE REVIEW TABLE 7 Homeowners Premium Comparisons in Florida County Max Min Mean Median County Max Min Mean Median Monroe $13,973 $1,780 $4,531 $3,658 Holmes $1,709 $720 $1,122 $1,079 Dade $7,600 $1,949 $3,609 $3,380 Gilchrist $1,617 $854 $1,181 $1,071 Broward $7,545 $1,731 $3,182 $3,043 Lafayette $1,763 $845 $1,197 $1,071 Hendry $8,391 $1,562 $3,012 $2,805 Gadsden $1,716 $720 $1,109 $1,066 St. Lucie $5,425 $1,365 $2,537 $2,390 Madison $1,743 $757 $1,163 $1,054 Collier $6,279 $1,385 $2,455 $2,320 Desoto $1,626 $735 $1,114 $1,038 Palm Beach $6,279 $1,385 $2,455 $2,320 Wakulla $1,983 $807 $1,140 $1,036 Okeechobee $5,728 $1,212 $2,397 $2,299 Suwannee $1,532 $739 $1,049 $1,030 Osceola $6,342 $1,284 $2,479 $2,236 Jefferson $1,511 $621 $1,014 $1,022 Pasco $4,223 $1,351 $2,005 $1,882 Walton $1,511 $697 $1,007 $1,021 Glades $4,651 $1,220 $1,990 $1,853 Gulf $1,511 $697 $988 $1,019 Sarasota $4,000 $1,075 $1,890 $1,827 Hamilton $1,842 $664 $1,090 $1,019 Hernando $4,201 $1,124 $1,900 $1,818 Bay $1,511 $697 $982 $1,009 Liberty $5,176 $1,224 $2,093 $1,786 Putnam $1,569 $758 $1,069 $1,009 Indian River $4,835 $1,128 $1,931 $1,785 Clay $1,429 $760 $1,004 $999 Santa Rosa $5,176 $1,105 $1,944 $1,757 Dixie $1,340 $684 $982 $980 Escambia $5,176 $1,107 $1,954 $1,748 Polk $1,527 $772 $1,036 $980 Martin $3,873 $1,027 $1,843 $1,714 Taylor $1,667 $649 $1,034 $968 Orange $3,755 $1,030 $1,721 $1,611 Baker $1,529 $684 $975 $967 Washington $5,176 $987 $1,833 $1,602 Levy $1,533 $673 $1,025 $967 Calhoun $5,176 $1,002 $1,871 $1,583 Marion $1,459 $683 $990 $961 (continued)

21 HURRICANES, INSURANCE, AND REGULATION 101 TABLE 7 (Continued) County Max Min Mean Median County Max Min Mean Median Pinellas $2,313 $940 $1,601 $1,535 Columbia $1,234 $709 $958 $958 Brevard $4,671 $1,047 $1,678 $1,532 Seminole $1,638 $661 $995 $956 Okaloosa $5,176 $974 $1,839 $1,505 Lake $1,650 $733 $1,025 $944 Volusia $1,918 $863 $1,391 $1,474 Union $1,529 $724 $982 $923 Hillsborough $1,778 $889 $1,279 $1,304 Nassau $1,191 $693 $920 $918 Charlotte $2,022 $934 $1,352 $1,296 Citrus $1,466 $625 $924 $910 Lee $2,022 $934 $1,358 $1,296 Sumter $1,680 $625 $933 $900 Flagler $2,200 $968 $1,321 $1,290 Alachua $1,364 $586 $877 $888 Leon $3,869 $845 $1,519 $1,276 Bradford $1,370 $556 $880 $858 Highlands $1,723 $921 $1,310 $1,263 St. Johns $1,340 $555 $850 $854 Hardee $1,691 $780 $1,201 $1,156 Franklin $1,293 $627 $846 $833 Manatee $1,626 $764 $1,173 $1,123 Duval $1,293 $555 $837 $801 Jackson $1,535 $720 $1,075 $1,083 Mean $3,078 $918 $1,508 $1,413 Note: The premium comparisons are for a 5-year-old, Florida concrete block home, with a current replacement value of $150,000, a $500 nonhurricane deductible, a 2 percent hurricane deductible, no claims, and no wind mitigation discounts. Source: FLOIR.

22 102 RISK MANAGEMENT AND INSURANCE REVIEW The significant variation in premiums among companies in a given county warrants some discussion. There could be several reasons for the variation. One is that insurers rate structures vary. A second factor could be the possibility that some insurers have rates on file for every location in the state but may not be actively writing business in some locations, especially if their rates are far below what they consider adequate. A third factor could be differences in the coverages offered by insurers as well as differences in their underwriting standards. There could be other reasons for the variation that are less obvious. Grace and Klein (2007b) also examine substate price differences in other selected coastal states. While they find a similar pattern in these states, the relative magnitude of the price increases and the relative differences between coastal and noncoastal rates are substantially lower in these states than in Florida. In sum, all of these price measure comparisons tell a common story. The price of homeowners insurance is: (1) much higher in coastal areas than in noncoastal areas, and (2) the price of insurance has substantially increased, especially in the highest risk areas. Of course, this is no great surprise but our calculations reveal some of the magnitude of the differences and changes in Florida and help to explain why property owners in high-risk areas have voiced their discontent about the rising cost of insurance and have pressured legislators to lower this cost. Availability of Coverage The availability of insurance coverage also is an important performance outcome and an area of attention and concern to property owners, government officials, and other stakeholders. Economists tend to use insurance availability indicators such as the size of the residual market, noting that there are several factors confounded in residual market shares (Klein, 2008). As we show and discuss in our evaluation of regulatory policies, the residual market for property insurance has greatly increased in Florida. It accounts for a significant portion of the homeowners insurance market, most of which are the highest-risk coastal exposures (Insurance Information Institute, 2007, 2008c). 27 Residual markets have also grown in other coastal states, but to a much lesser degree (Insurance Information Institute, 2007, 2008c; Klein, 2008). Although several factors affect the size of a residual market, it appears that the availability of coverage in Florida s voluntary market has tightened considerably. How this situation will evolve in the future will also depend on several factors, including insurers assessment of hurricane risk, changes in capacity, the supply and price of reinsurance, and regulatory actions. However, we note that the Florida experience is similar to the experience of certain other states in lines of business such as auto insurance and workers compensation insurance where strict price regulation has been accompanied by large residual markets (Klein, 1995). If regulators suppress rates below what insurers consider to be an adequate level, the supply of insurance will tend to decrease and more consumers may find it difficult to find coverage in the voluntary market and will turn to the residual market for insurance. For example, constraints on rates in the voluntary 27 Our estimates indicate that it accounted for 16.1 percent of homeowners insurance premiums in the state in 2006; the figure for 2007 could be higher given its continued growth. Figures from the Property Insurance Plans Services Office (PIPSO) indicated that the CPIC accounted for 18 percent of total habitational policies in the state in 2006 (PIPSO, 2007).