Coastal Property Residual Markets: Challenges and Potential Solutions Prepared by David C. Marlett, PhD, CPCU Appalachian State University The Brantley Risk and Insurance Center Prepared for 2008 Out of the Storm Hilton Head, SC

Estimated Insured Value of Coastal Exposure (2007, $ Billions) Source: AIR Worldwide at Over the last three years ( ), 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 a High Percent of the State’s Insured Value Source: Insurance Information Institute and AIR Worldwide June 11, 2008 release, at “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 StateCurrent NameYear EstablishedPolicies in ForceTotal Liability AlabamaAlabama Insurance Underwriting Association 19709,699 (6/08) $1.682 Billion FloridaCitizens Property Insurance Corporation 19701,216,960 (5/31/08) $441.9 Billion LouisianaLouisiana Citizens ,203 (3/07) $21.13 Billion MississippiMississippi Underwriting Association ,340 (11/07) $5.709 Billion North CarolinaNC Insurance Underwriting Association ,527 (3/31/08) $67.80 Billion South CarolinaSC Wind and Hail Underwriting Association ,663 (4/30/08) $16.80 Billion TexasTexas Windstorm Insurance Association ,008 (12/31/07) $58.64 Billion

Residual Market Penetration

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$314,171,12219% North Carolina Farm Bureau$213,326,08413% Nationwide Mutual Fire Ins Co$172,200,10810% Allstate Ins Co$96,455,8986% Nationwide Mutual Ins Co$85,288,9505% Allstate Indemnity Co$70,297,5494% Erie$63,021,0604% USAA$54,218,3943% Unitrin Auto & Home Ins Co$42,211,0193% Auto Owners Ins Co$32,945,8852% Liberty Mutual Fire Ins Co$30,618,7822% Phoenix Ins Co$29,086,0022% USAA Casualty Ins Co$25,451,9052% Peerless Ins Co$24,544,8251% Standard Fire Ins Co$23,315,4781% Farmers Insurance$21,621,7871%

Homeowners Insurance Loss Experience in North Carolina YearLoss Ratio % % % % % % % % % % % % average70 % Source: NC Department of Insurance

ROE for Homeowners Insurance in North Carolina, 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, * * Excludes expenses, taxes, commissions and dividends. Source: NAIC; Insurance Information Institute Hugo Emily Fran Bonnie 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 Changes source: NC Department of Insurance Filed Date Overall Filed/Proposed Rate Change Effective Date COI Ordered Rate Change RB Implemented Rate Change 18-Jun %01-Oct % 03-Dec %01-Jun % 22-Mar %15-Aug % 25-Feb % 01-Aug % 29-Dec % 01-May %

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: 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