Last year, I wrote after Hurricane Ian that the FHCF may collapse due to the size of the loss. While the Fund has not gone bust yet, it is perilously close.
What follows is an update on the FHCF’s financial condition, its ability to handle further losses, and a projection of its future cash flows. The story is not pretty.
Punchline: The FHCF needs multiple loss free years to survive. If you are an insurer paying premium in, you should ask yourself how you feel about providing bailout funds for cover that may not exist.
FHCF 2023 Claims Paying Capacity
By statute, the FHCF is supposed to be able to pay $17B in claims. Newsflash: they can’t!
They only have $3.7B of surplus, down from $12.7B last year (and actually that’s $3.7B projected at YE23). They also have $3.5B of bonds they previously issued which gives them $7.2B of “capacity” (though no way to pay back the bonds!).
This leaves them $9.8B short! They assume they can raise $8.6B in new debt after a loss. Much more on that later, but even if so, they are still $1.2B short. In other words, they can’t pay $17B in coverage and may pay much less than that if bond markets don’t cooperate.
How do insurance companies buying FHCF cover feel about that? They appear to be nonplussed. They continued to pay normal premiums to the FHCF ($1.5B statewide) without any rebate for the potential shortfall.
What happens if FHCF can only raise another $3.5B of debt? A full loss would leave insurers getting < 2/3 of what they expected. That may be the difference between them remaining solvent or not!
Has any insurer disclosed what their “surprise retention” could be if there is a large hurricane and the FHCF can’t fully pay? Has Demotech incorporated this risk into their ratings?
Nobody seems to want to discuss it. The approach across the market seems to be willful ignorance.
So what type of loss would it take to cause a crisis? Good question. Thankfully, the FHCF has provided us some answers.
To wipe out the $3.7B of surplus (so $12.8B loss including industry retention) takes a $13.3B personal lines loss which is around a $20B industry loss. In this case, the FHCF only has bond funding available and would likely be declared insolvent (more details later).
Another Irma would also wipe out the $3.5B of existing bonds as well. A repeat of Ian would leave the fund needing to raise $2.8B to pay claims with nothing left to continue on next year, so it would need to raise $20B to be a going concern.
To say the situation is precarious is an understatement.
The No Storm Solution
But what if there are no hurricanes? Wouldn’t the FHCF rebuild its surplus? Yes, but slowly.
Premium is $1.5B/yr. The fund has historically operated at >$10B of surplus so you would need five loss free years to get there (after accounting for operating costs and interest). You would also have to refinance the $3.5B of debt.
Could Florida go five years without a loss? Certainly, but this is now necessary. Otherwise, they are reliant on the debt market.
I should also mention all this math presumes the $10B estimate for Ian holds. Given most FL storms develop adversely, this is not an insignificant risk.
Bonds To The Rescue?
One of the grave mistakes the FHCF makes is they assume if they have losses greater than their current $7.2B of funds that they can bridge the difference by raising debt.
This makes two huge assumptions:
1. That bond markets will be receptive to a borrower with no surplus.
2. That any bonds issued never have to be paid back (i.e. they can always be refinanced).
This is more optimistic than assuming there won’t be any hurricanes for the next five years!
When they did the $3.5B offering in 2020, they had $11B of surplus. That makes it a lot easier to borrow because the risk of attachment was much lower.
When you only have $3.7B of surplus (and have upcoming maturities on the $3.5B outstanding debt), the odds of the bonds experiencing losses are much higher. Thus, the coupons should be much higher and the rating lower. This makes it harder to borrow as much.
Yet, the FHCF has indicated no change in their potential borrowing capacity since last year (it’s actually up slightly from $8.0 to $8.6B!). They also suggest they can still borrow at the same rate (5%) even with increased risk and increased rates across the economy.
Unless they have kidnapped bond buyers and forced them to buy bonds in return for their freedom, this seems nigh impossible.
The “process” they use to make these fundraising estimates is they ask five large banks what they think they can raise and take the average.
You can imagine JP Morgan isn’t putting their top bankers on this project. They seem to take the same estimates as the year before and roll them forward with small changes. Not a lot of critical thought here and thus the accuracy of the estimates is likely very low.
What will be the bank’s excuse when they’re wrong? “We couldn’t foresee the change in market conditions.”
The Bond Math
So how much debt can they raise? It’s hard to say precisely, but let’s go through some of the math to figure out what might make sense.
First, as noted, FHCF collects $1.5B in premium annually. They also have the ability to charge assessments. However, that is politically unpalatable and they didn’t even add any assessments for this year.
The assessable base is >$70B and they can in theory go as high as 6% but that would never fly in Tallahassee. I assume a 1% assessment is more realistic which would add $700M/yr.
Thus, in total, inflows would be $2.2B. What about outflows?
First, there are claims. Let’s be optimistic and assume no new losses for the moment.
Next, there is interest. This will depend on how much money is raised. FHCF estimates they can raise at 5%, though I suspect it will be far higher. We’ll return to this.
Finally, there are debt maturities. Bondholders eventually expect to be paid back. This is where the big problem lies.
Scenario #1: $10B @ 5.3%, no losses
Let’s assume they raise $10B at (generously) 5.3% for 7 years. How does the claims paying ability change if there are no losses?
We start with $7.2B of surplus + the old bonds. Adding the $10B takes it to $17.2B. Add on the next seven years of premium and there is $27.7B gross. This sounds fantastic!
|Bond raise||+ $10B|
|2030 Total||= $27.7B|
But we have to subtract things too. Interest would go to $600M/yr. That takes off $4.2B. And, of course, debt comes due. $13.5B of total debt would need to be paid leaving the FHCF with $10B of surplus and no debt.
|Interest paid||– $4.2B|
|2030 Surplus||= $10.0B|
This is a good outcome, but it is reliant on no losses for seven years! And even then, they still would have to raise additional debt to get from $10B to $17B.
Scenario 2: $5B @ 10.5%, $20B storm
However, let’s change a few assumptions. One, there is a $20B hurricane this year which wipes out the $3.7B in surplus. Two, the bond raise is at a more realistic 10.5% given the greater risk and, three, they are only able to place $5B.
In this case, I assume the 1% assessment, so there are $15.4B of inflows over the next seven years.
However, there is no surplus left, just debt – the $5B new and the existing $3.5B. This creates a few problems.
First, the fund has only half its mandated capacity for ’24 so insurers can’t get fully paid. How would they feel about paying full premium for half the coverage? Not so good, I’d imagine.
Next, even if the following six years have no storms, they still don’t get all the way back to $17B before the debt has to be paid off. If there is no way to get back to $17B, why should insurers keep paying premium?
|Ending Capacity||= $8.5B||$10.1B||$10.5B||$12.1B||$12.7B||$14.3B||$15.9B||$11.2B|
What other rosy assumptions could you make? You can argue for higher assessments. You can assume they can raise more debt in future years, but, remember, you’re also assuming no future storms!
The math just doesn’t work.
Scenario #3: $40B storm (Hurricane Ian repeat), debt markets shut
I’m not even going to do this one! You can figure it out by now. That would be a $10B loss to the fund leaving it with -$6.3B of surplus and no way to pay of the $3.5B of current debt. It would be impossible to raise debt in that scenario.
They’d have to turn the lights out immediately and insurers would get paid pennies on the $ for their claims.
What’s the lesson from these scenarios? The only way insurers might get paid if there’s a storm this year is if it’s a small one. There is no protection for larger events! So why are insurers still buying the coverage?
Willing Ponzi Participants
The FHCF has become a Ponzi scheme. Its only way to survive is to take premium in from insurers and pay nothing out!
Ironically, the insurers willingly engage in the deception because if they don’t pretend the FHCF will pay them, then they can’t afford reinsurance and they will have to shut their doors.
Everyone is bluffing each other! And they are all holding losing hands. Those who will pay the price are ordinary Floridians who don’t get fully paid on their claims because they end up in the state guaranty fund after the next hurricane.
Insurers are supposed to have enough capital to pay their potential claims before they take on (or renew) business. Any insurer in the state of Florida who is dependent on the solvency of the FHCF to remain solvent themselves isn’t honoring that promise.
If the only way for the insurer to win is if the wind doesn’t blow, then it’s heads the insurer wins, tails the policyholder loses. That isn’t how insurance is supposed to work.
So it’s nice that the state passed some reforms that might reduce future severity after a storm, but you know what they didn’t address? The elephant in the room…
Local insurers won’t have the reinsurance proceeds to pay claims after a loss which means this hurricane season is Florida Roulette.