Florida takeout insurers remain untested, warns A.M. Best

The new generation of Florida property insurers have benefited from access to risk through Florida Citizens depopulation program and increasingly more attractive reinsurance pricing and terms, but they remain largely untested, warns A.M. Best.

The takeout or depop insurers in Florida are heavy users of reinsurance capacity, including insurance-linked securities (ILS) and collateralized reinsurance products. As a result A.M. Best’s new report should be of interest to investors and managers in the ILS space, for whom intelligence on counterparties is important.

Florida’s property insurance market has experienced a significant shift in market share since state-run property insurer Citizens Property Insurance Corp. began to depopulate and move policyholders into the private market. The result of the shift has been the emergence of newly formed, in-state writers, who have taken an increasing share of the market.

A.M. Best says in its latest report, titled “Florida Property Insurers Remain Untested: Will 2015 Be the Year?”, that while these companies have experienced significant growth, driven by Citizens’ depopulation program, the end result is “significant risk as proper risk management, risk analytics and overall infrastructure to manage the growth are in some cases untested.”

The takeout trend in Florida really began as the state settled into what has been termed a hurricane drought, with no major storms making landfall in some years. It also coincided with many established, larger property insurance underwriters, downsizing their activities in Florida, as pre-drought hurricane losses, rising reinsurance costs sink hole losses and market conditions drove many to pull back.

It’s resulted in a complete change in the Florida insurance landscape, with many of the previous top-10 writers being replaced by start-up insurers, which A.M. Best notes are “less experienced.”

When major hurricanes next make landfall in Florida, as they certainly will it is simply a matter of time, these start-up and takeout insurers will be tested. Here, it’s not the reinsurance arrangements or financial resources that concern A.M. Best, rather it’s the ability of recently formed companies to deal with complex and debilitating loss scenarios.

“While the financial resources to respond to all their affected policyholders financial loss is considered measurable, the operational resources to handle the volume of claims in an efficient and timely fashion will be equally tested,” A.M. Best explained.

The issue the rating agency is highlighting is that before the Florida hurricane drought insurers had been tested, and following the 2004 and 2005 seasons, when insurers were perhaps tested as strongly as ever before, many began to pay closer attention to their concentrations of Florida catastrophe risks.

So as previous leaders in the Florida property insurance market have contracted, we have seen new start-ups growing rapidly but without any meaningful test to their risk management, claims paying ability and reinsurance arrangements.

“It is not a matter of “if” but “when” the next major hurricane will hit the state and losses could be much larger due to the extensive property development and increased building costs,” A.M. Best warns.

The Citizens takeout program came into effect in late 2013, coinciding with the eighth year of no major hurricanes and also with the rapid decline in Florida property catastrophe reinsurance pricing and the rise of catastrophe bonds and insurance-linked securities (ILS).

That enabled start-ups to generate risks very easily, while operating a heavily reinsured strategy and taking advantage of lower-cost ILS and collateralized reinsurance capacity. This made the Florida market attractive to start-ups, at a time when other more established Florida players continued to contract.

A.M. Best explains; “The opportunity for immediate growth via a take-out afforded companies the opportunity to capitalize on extremely favorable reinsurance market conditions. However, there is significant risk in these strategies as proper risk management, risk analytics and overall infrastructure to effectively manage the growth are in some cases untested.”

However, despite the fact that the new breed of Florida property insurer is largely untested by major hurricane losses, it should be remembered that the majority have experienced management teams and place a significant amount of effort into understanding exposures, risks and how best to hedge them with reinsurance and ILS.

A.M. Best explains that these companies largely perform extensive exposure modeling, in order to understand the exposures with the most profitable risk characteristics. Reinsurance costs matter to these insurers, as they different risks assumed have differing reinsurance costs associated with them. As a result catastrophe modeling and analytics are vital to these insurers, as they seek to maintain a portfolio that allows them to recognise risk premium from the business underwritten, while shaving peak exposures off their portfolios using reinsurance, cat bonds and other ILS products.

“Of particular interest will be the position of new companies after single or multiple catastrophe events, that are actively writing business either though the take-out process or voluntarily and relying on the catastrophe loss estimates based on their exposure data. This group and the other carriers will eventually be tested when the major hurricane(s) make landfall in Florida,” the rating agency continues.

Importantly for investors in insurance-linked securities (ILS), catastrophe bonds and collateralized reinsurance contracts where Florida start-ups are counterparties, A.M Best notes that after the next hurricane, “the operational resources to handle the volume of claims in an efficient and timely fashion will be equally tested.”

With the rise of the indemnity trigger within catastrophe bonds and other ILS products this is particularly key for ILS investors and ILS fund managers. The ability of counterparties to respond to, manage and settle a large number of claims efficiently could have a bearing on the speed of any payouts made.

Hence it’s perhaps becoming important to have independent claims experts to assist with performing due diligence on some counterparties in order to get as much visibility of claims processes as possible before entering into indemnity contracts with them.

The Florida insurance market is a fascinating one and also profitable, hence the emergence of takeout companies and new start-ups. The vast majority of these are run extremely well, by very experienced management teams, but the fact remains that in the last ten years these companies have not been tested and it will be interesting to see how they cope when hurricane’s once again hit Florida’s shores.