The Florida Cat Fund’s low bar for fiscal ‘health’
The headlines blaring from the Sunshine State today are unambiguous. The state-run Florida Hurricane Catastrophe Fund is “in good shape” Indeed, its latest report card shows it is the “best it’s looked in years.”
Let’s not pop the champagne cork just yet.
It is true that the latest iteration of the twice yearly report from the Cat Fund’s financial advisor, Raymond James & Associates, estimates that the fund will have $19.1 billion of claims-paying capacity for the 2013-2014 reinsurance year. That’s up from $15.5 billion in the last report, in October 2012, and $15.6 billion just before the start of the 2012 storm season.
In part, the improvement can be attributed to Florida’s extraordinarily lucky streak of seven straight years without a land-falling hurricane. With no claims to pay out, the projected fund balance has grown pretty steadily since 2008 and is now $9.8 billion, up from $8.6 billion a year ago.
An even larger contributor to the fund’s improved financial status was its successful placement earlier this year of $2.0 billion of taxable pre‐event notes. With those additional resources, the fund’s estimated claims-paying capacity is now the highest it’s been since it hit $25.5 billion in May 2010, and the report marks the first time since May 2011 that the fund’s claims-paying capacity exceeds its total liabilities.
But declaring that the Cat Fund will probably be able to pay out on the $17.013 billion of reinsurance it has written for every property insurer in the state (including the state-run Citizens Property Insurance Corp., which has about one-fifth of the market) is an extraordinarily low bar for celebration. Indeed, if a major hurricane were to strike the state and the Cat Fund was not able to make good on all its obligations, that would be the apocalypse scenario for Florida.
Remember that this is not just money sitting in the bank. The report projects that, given the $9.77 billion fund balance and the $2.0 billion from the pre-event bonds, the Cat Fund would need to raise roughly $5.243 billion in the capital markets to make good on all of its outstanding obligations in the wake of a sufficiently large hurricane.
A $5.243 billion bond issuance is nothing to sneeze at. Indeed, if it is needed, it would be the third-largest municipal bond offering since the end of the financial crisis in 2009. Only a $6.86 billion taxable offering and a $6.54 billion tax-exempt offering, both from the State of California, have been bigger. In fact, the Cat Fund’s own $2.0 billion issuance earlier this year is itself the 10th largest in that time frame.
The report assumes that, rather than going to market with one big issuance, the Cat Fund might be able to break it up into several smaller issuances over the course of 12 months. While that would provide greater flexibility for the fund, it also could require that some cedants wait to be paid. Moreover, in the past two years, the largest amounts bonded by any single municipal entity were for $4.0 billion and $7.0 billion, both by the New York State Dormitory Authority.
Raymond James estimates that the Cat Fund would be able to raise $7.3 billion in the 12 months after the storm, comprised of $3.3 billion of tax-exempt bonds and $4.0 billion of taxable bonds. The estimate comes from averaging the projections of four banks that act as senior managers for the fund’s bond issuances: Barclays, Citigroup, J.P. Morgan and Goldman Sachs.
It should be noted that, besides the potential conflict of interest in having institutions that will profit from debt issuances also offering advice on a public agency’s financial strength, the managers were not even unanimous in the belief that the Cat Fund could raise the $5.2 billion needed to fund all its obligations. Goldman Sachs projected the fund would only be able to raise between $3.5 and $5.5 billion in the year after a storm, comprised of between $2.5 and 3.5 billion in tax-exempt bonds and between $1.0 and 2.0 billion of taxable bonds.
It’s also worth bearing in mind how that borrowing would be paid down. The Cat Fund finances its bond obligations by levying assessments on all property and casualty insurance policies in the state, except for workers’ compensation and medical malpractice. That means an enormous tax hike at precisely the moment when the state is most likely to have suffered a big loss to its capital base.
It’s actually even worse than that. By statute, the Cat Fund can assess up to $2.17 billion annually for storms that occur in one contract year and up to $3.62 billion for storms occurring over multiple years. Unfortunately, if there were a major storm that required the Cat Fund to levy assessments, it would be almost certainly also require Citizens and the Florida Insurance Guaranty Association (which funds the obligations of insurers that become insolvent) to levy assessments on nearly the exact same base of policies to fund their own shortfalls. This stacking of assessments of billions of dollars in assessments could become so large as to grind the state’s economy to a halt.
And that’s just in year one. The truly scary scenario is what would happen if Florida faced major hurricanes in back-to-back years, as it did in 2004 and 2005. Should the Cat Fund be forced to tap all of its resources for a storm-ravaged year, the report estimates its claims-paying capacity in the subsequent season would drop to $9.93 billion. That would leave it some $7.07 billion short of the money it could need.
With the Legislature once again punting on Cat Fund reform during its recently completed session, and AccuWeather projecting three land-falling U.S. hurricanes for the 2013 season, let’s hope we aren’t forced to test just how “healthy” the fund really is.
