Your column on the Citizens Property Insurance Corp.’s recent activities is timely and certainly should be explained to the Florida purchasers of Homeowners Insurance but, unfortunately, it also shows your lack of understanding how property and casualty (P&C) insurance companies conduct their business, indeed, must do so. Insurance is the most complicated and misunderstood of financial products and its providers are too frequently unfairly bashed for their conduct. I have no connection to Citizens and am not even insured by them but, their actions as the state’s home owner’s primary insurance carrier should be lauded rather than criticized as they attempt to do the best they can for their customers and the State of Florida under very difficult conditions.
In as limited a way as I can, this is a very short primer on insurance. Did you ever consider that insurance, especially the property and liability market, is a product which its seller does not know the cost of at the time of sale? Actuaries do the best they can, but as insurance underwriters always complain, “They are looking out of the rear window telling us how to steer the car.”
So, I’m going to insure your house for $ 100,000, how much premium should I charge? Well, says the actuary, if it’s already burning, charge $ 103,000 (we’ve got a little bit of overhead) but if not go and insure ten more and then charge each $ 1,000 in premium because history shows one of them is going to be damaged by fire over the next ten years.
What that overly simplified example attempts to show is that, in order to remain solvent, the insurance company must (1) avoid known or very potential losses, (2) spread its risk and (3) build up a surplus for future losses. Citizen’s is trying to do that under very difficult circumstances. Number one is self-evident and would ordinarily permit a company to carefully select its customers but that option is not totally available for Citizens because they are the only involuntary source for Homeowners insurance in our state. The rest of the available market is being filled by small, poorly funded, newbies. If they fail; who cares? The State will take them over with their Insurance Guarantee Corporation that is funded by the assessing of all other insurance companies. As for the second, although these newbies help somewhat to spread risk, it is insufficient without the help of the old time, big players – State Farm, All State, etc. (the result of the Florida Insurance Dept. allowing them to run away from the state after Katrina). However, buying reinsurance from other companies – foreign or domestic - does spread the risk as best as possible. All insurance companies buy reinsurance to protect themselves from catastrophes. For them it’s like any other “cost of doing business” and it is absolutely not “going down the drain”. This is how the severe exposure of a nuclear power plant is insured by our domestic carriers spreading its risk to companies all over the world.
The third requirement is the most difficult. Traditionally, a P&C company makes only a moderate “profit”. Three percent in a year is considered successful. The bulk of the income that exceeds their losses goes into their reserves for existing losses, also losses incurred but not yet paid and losses not yet incurred! The financial status of an insurance company and its performance is carefully evaluated by its state insurance department and by all fifty of them if they do business in all states; and by A.M Best & Co., the only totally reliable rating company in the country. The latter has labeled the Citizens as “Non-Rated” which, in the eyes of the insurance industry, is a very poor rating for a company to have. Yes, Citizens has 7 billion in surplus and the ability to assess its customers but let’s remember, as you pointed out, although our state has been fortunate for some time, four storms in 2004 totaled 40 billion in damages and in 2005 we suffered three including Wilma which was 20.6 billion alone (FSU 2009). Also, although not here but not too far away, a monster like Katrina cost 60 billion in insured losses (A.P. 9/9/05). I would not think the risk is falling when we always face the possibility of another Katrina.