Why Home Insurance in Florida Is a Mess

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1:15Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, we need to do more on insurance. Yeah, absolutely. So we are recording this October 18th. In the last several weeks, we've had two extraordinary storms. The second one, Milton, that aimed directly at Florida near Tampa Bay, was not as bad as people thought even a few hours before landfall, which people thought was just going to be tremendously catastrophic potentially. However, it was obviously still quite damaging. And once again, the question of hurricane risk, storm risk, these certain flood-prone markets, who's going to pay for them, all of these things continues to be a source of, I would say, rising anxiety, regardless of what just happened with these storms.

2:06Yeah, absolutely. And you've seen estimates flying around for how much this is going to cost the insurers, but I think there was one that said as much as$55 billion from those two storms. So big numbers here. And obviously, people who live in those areas have been talking for a long time about how their insurance premiums are already going up a lot. And certain areas of the country are perhaps becoming unaffordable. Or maybe you can't find insurance for a property on the coast of Florida anymore. Or if you do, you have to go to the state insurance body rather than a private entity. And I think just getting really big picture, I find insurance fascinating because it's basically the original finance.

2:49Yes. It's like the pricing of risk is essentially the very essence of finance. So I find the idea of how we're going to be pricing the risk of more and more storms, who's going to bear those costs. Absolutely fascinating. Totally. And we know there are structural issues going on in the market and there are myriad and we will get into all of them. But yes, there is much to discuss on this topic, on this episode, and probably many episodes to come. Okay, so in this particular discussion, we're going to be coming at it from a slightly different angle. We're going to focus on Florida, what's been happening in the structure of that market, and what else could be done.

3:26And yes, I promise, listeners, there will be discussion about Florida roof insurance frauds and all of that, because there are some interesting things happening there as well. So I'm very happy to say we do, in fact, have the perfect guest. We're going to be speaking with Jerry Theodoro. He is the Policy Director of Finance, Insurance, and Trade over at R Street Institute, which describes itself as a free market think tank. He has written a lot about the Florida insurance market. So, Jerry, thank you so much for coming on All Thoughts. Thank you, Tracy. Thank you, Joe. It's a pleasure to be here.

3:59So maybe give us your background just to start, because you've been in the insurance world for a while. Yeah, thanks. I began my career as a commercial underwriter at Chubb & Son, and after a couple of years, moved over to AIG. AIG shipped me over to Europe, and I worked in Paris and Frankfurt in the Middle East for about 10 years as an expatriate. And after coming back to the United States, I joined a company called Conning, worked at Conning for about a dozen years. Conning is an insurance asset manager that has an insurance research arm. I was one of the researchers there, one of the analysts, wrote a lot of books, did a lot of presentations on the insurance industry.

4:38And about three and a half years ago, I joined R Street and using my knowledge of the market and economics and products, connections in the industry for public policy purposes to explain to folks in Washington and state capitals how insurance works and recommended policy solutions for areas that are troubling like the one we're discussing today. You do sound indeed like the perfect guest. You know, let's say 15 years from now, or let's say not 15 years from now, let's say today I were 60. I'm like, all right, I'm ready to retire. I don't want to live in the cold weather anymore. I just want a nice little house in Fort Myers, Florida.

5:17But I kind of want to get insured because it's a big part of my retirement, this asset. What are my options? What am I going to do? Well, first of all, I agree. It's a lovely prospect to have a place in Fort Myers where you can see the ocean front from your window. But when the ocean comes into your bedroom, that's another story. And that's when you should reconsider if you made the right decision. But I made that decision. All right. So now I'm making the insurance decision. Now he has to get insurance for his retirement property. What does he do? What are his options? Well, first of all, having homeowners insurance is not only important, but it's required if you You have a loan, a mortgage loan that's backed by the federal government, one of the GSEs, Fannie Mae, Freddie Mac.

5:58So it's required. Some people go bare. They don't carry insurance. And there are three major sources of insurance for future retirees such as yourself, Joe. One is the national insurance market. So you're jumbo insurers that operate nationally, Allstate, State Farm, Travelers, Hartford, and the like. And there's also some companies that are the so-called Florida domestics. These are companies that were set up following catastrophes about 15 years ago that are focused on Florida. And four of them are publicly traded. And there's also citizens property insurance. Citizens property is a state-run insurer in Florida.

6:39So those are the three options. And agents are the ones that are responsible for guiding you to get the best policy for the best price. So that's the market that you'll confront, Joe, when you get there. So insurers of last resort in Florida like citizens. At what point do you get access to those? Like, I've never really understood. Is it that no one else will give you insurance? Or is it that no one else will give you insurance at a price that you like? Yeah, it's at a price that you like. So citizens is, as you say, Tracy, the insurer of last resort. So if you agent can't place it with any of the national or the Florida only domestics, then citizens is required to take that policy.

7:21However, if the citizens policy proves to be more expensive than one on the market, then you're obligated to take one that's in the private market. So people say there is an insurance crisis in Florida for due to the storms and due to other structural things. I guess I have a two part question. A, do you accept that premise that there is something broken about the Florida insurance market as it stands right now? And B, how would you describe it? I wouldn't say that it's broken, but I would say like a piece of porcelain that's cracked. It's got a bit of a, it's got cracks to it. And it's more than just the risk of hurricanes and floods because Florida is after all, mainly a peninsula jutting into warm waters of the Gulf Mexico and the Atlantic Ocean.

8:08So it's prone to catastrophes. There have been storms in Florida for as long as we've got data on that. Let's go back to 2004. In 2004, there were four landfalling storms that hit Florida. Those were Charlie, Francis, Ivan, and Gene. And in 2005, there was what we called the KRW, Katrina Rita Wilma. Now, Rita did the most damage to Florida. So there were two back-to-back years of really strong hurricanes, and the market took a licking, and as they used to say with Timex watch advertisements, but it kept on ticking. So the market continued, and what is more, fresh capital came in after 2005, because banking on the theory that, to paraphrase, that lightning doesn't strike the same place twice, Indeed, the bet was a good one.

9:00In 2006 and 2007, there were no hurricanes that made landfall in Florida. The insurance company recouped the amount that it lost. So the market was functioning. And now we're in the wake of Helene and Milton, and these questions are being asked. But for a variety of reasons, which I'd like to get into, the market is resilient. It has these walls that protect the balance sheets of these companies because the risk is recognized. So why is it cracked? The reason it's cracked is that's conventional insurance. Insurance companies are in the business. By the way, I just years ago, Tracy, we did an episode.

9:36I went through an obsession with Florida history, like an old, old, odd loss day, like 2015. Oh, yeah. And we did episodes about the 1926 hurricane and the 1928 Okeechobee hurricane that caused the Florida land, that bubble. You know, Florida's history is not just hurricanes. It's also history of bubbles and busts. Sometimes I feel we've been doing the show too long when it's like, oh, yeah, go to our back catalog for the episode on the 1920s Florida property bubble. But just the catfish bubble. But I say, but I only say this to appreciate your point that storms in Florida are certainly nothing new and nothing that catches people really by surprise at this point.

10:13So anyway, keep going on with what you were saying about why there's cracks, even if the storm story is nothing new. Right. Other other states also have catastrophe exposure. Texas, California. But Florida was special in a way that's unrelated to the risks and the premium of insurance. And that is because of the activity of the trial bar. In Florida, you have billboards on every highway advertising. If you have a truck accident, call us. We had a$2 million judgment. So a lot of legal advertising and people are responding to that. So insurance companies are getting sued in Florida more than anywhere else in the country.

10:57Let me give you a statistic here. Florida has got about 8 % of the country's population. So it's got about 8 % of the homes and the homeowner insurance policies in the country, but it has 78 % of the homeowners litigation. So the state of Florida alone has got four fifths of the entire country's litigation. And what are the lawsuits? A lot of them are related to what's called AOB, assignment of benefits. So if you have a house that sustains some damage, someone will come to your house, an adjuster, and ask you to sign a form saying, we'll take care of the insurance for you. We'll put in a claim.

11:35So they put in a claim, and the damage was not something that was caused by the storm. it's discovered, for example, and the insurance company denies the claim. And then the attorneys will sue the insurance company for a high five-figure amount. And rather than fight it and spend a lot of money, more than the case is worth, they settle. So this has attracted a cottage industry in filing frivolous suits and giving Florida the reputation of being owned and driven by the trial bar.

12:22How did Florida become an environment for this type of litigation to begin with? Why is the trial bar so big in that particular state? Yeah, I don't want to get into politics. No, it's fine. We might actually have to get into politics. But politics does play a hand. A lot of the donations, the contributions that are made to local politicians' campaigns comes from the trial bar. This is on a national basis in not just Florida. But in Florida, it's especially the case. And also there was some bad legislation that was passed in Florida which permits these things. So the statutes are unfavorable compared to others where a case that doesn't meet the pleading standard is just not advanced.

13:12So you have this situation. The good news is, though, about a year and a half ago, the governor of Florida signed tort reform into law that would stop the process of assignment of benefits. and also one-way attorney fees where the insurance company pays the legal fees of the plaintiff. A couple of other measures as well were struck down by the tort reform that was signed into law. But that was sort of a rare event because in order to get that done, it required the president of the Florida Senate and the leader of the House and the governor pushing in the same direction and with someone in the Florida legislature taking this on to drive it through.

13:54So this is a situation that you don't get. I mean, imagine if it happened on a national level, we'd have the House and the Senate and the White House pushing in the same direction. Not likely, but in Florida, it happened. Something similar happened in Texas about 15 years ago. And the results of tort reform are already being seen where the number of suits, I mentioned the 78 % of the national total of homeowners insurance litigations, Florida, that's coming down. And also there's a formal document that announces the intention to sue. Those numbers are coming down as well. So Florida seems to have turned a corner in terms of whether the sky is falling and the place is uninsurable.

14:38What does Wall Street say? Well, there's four of those Florida-only insurance companies - Yeah, give us a ticker. ... that are publicly traded. And when the news was coming out of NOAA about the approaching hurricanes, people started selling the stock of those companies, about 25 % reduction in the stock price. But when, as you say, Joe, it was a disaster averted, it didn't go to Tampa, So neither Helene nor Milton, and it's skewed north or skewed south, stocks rebounded and went up by about 15%. So this was really just another manifestation of what people in the industry used to say about Florida insurance stocks.

15:22Sell in May and go away. Wait, can you tell us some of these names? Do you have any names? I actually want to look them up. Allstate would be one, right? No, no, the Florida-specific insurance. Oh, the Florida-specific ones. Yeah, the four Florida—yeah, who are they? Heritage, HCI. Heritage Insurance Holding. Someone needs to make a Florida insurance ETF so we can just flip these four up. So you can just directly get exposure to, oh yeah, there you go. Okay. It's still down. Down, but it recovered. It didn't continue to go down. Yeah, that's right. So the rebound when it was a bullet that was dodged because Helene went north of Tampa.

15:58It landed in Apalachicola. And then when Milton was coming and headed towards the Tampa Bay, it turned south at the last minute and did damage to Sarasota. But Tampa St. Pete spared. An HCI group? An HCI. That's actually at all-time highs right now. Is it? Yeah. So that's actually a really interesting chart because it did plunge in the middle of October. But now it's currently at all-time highs. Also, if you zoom out on a lot of these, they are up quite a bit over the past year or so. Oh, not quite. By the way, HCI, sorry, I misspoke. HCI is not at all-time highs. it's at like a new 52 week high.

16:31It was higher in 2021 for a while. So, okay. I like looking at charts. This helps ground me. Joe, stop looking at charts. Let me ask a tort reform question. Okay. Tort law. Tort, by the way, for those who don't know, is like a legal framework for addressing compensation for wrongdoing. It's not criminal stuff. It's the civil stuff. And the only reason I know that is because I read a book about the Station House fire in Rhode Island. And that was, I don't recommend it. It's a good book, but don't read it because it's one of the most disturbing cases of all time. But anyway, I guess my question is, so tort reform happened in Florida a couple of years ago, as you point out, Jerry.

17:12But what was the turning point at which the state decided, actually, this is a really big deal and we need to do something about it? Yeah, that's a great question. It was, I think, when it became evident that the number of lawsuits and the volume of the lawsuits was getting so stratospheric that it was really impacting the balance sheets of the companies that were there and driving some to leave Florida to exit the state because they couldn't make a buck there. Why stay and throw good money after bad? So a couple of years ago, I was at a conference of the Florida Chamber of Commerce, and the mood was all gloom and doom.

17:46And the market is broken. There were strains on the reinsurer that is obligatory, an obligatory reinsurer. These companies, Joe, you looked up in a couple of seconds. I'm very impressed. Well, we have the Bloomberg terminal plug for our core product here at Bloomberg. But yes, it makes it very easy. So those companies, Heritage, Universal, HCI, and the other, they're aware of the risk. In order to protect their capital, they buy a lot of reinsurance, which means that if you hear that, oh, Heritage had$600 million in losses or something. Well, most of that, a lot of that, about 80, maybe 90 % of that is reinsured.

18:27So the risk is passed on to these reinsurance companies. But the first one that's involved is the Florida Hurricane Catastrophe Fund, FHCF, Florida Hurricane Catastrophe Fund. And one of the reasons why people were in gloom and doom mood a couple of years ago prior to tort reform is because there appeared to be strains on that fund. How is it funded? It gets the premiums from the seedants. A company, a primary insurer like Heritage or any other company will seed reinsurance and they pay a premium for that. And that's the revenue of the fund. But because it's a public entity, it was underpricing the reinsurance.

19:10Reinsurance is provided mainly by these mammoth giant reinsurance companies in Europe like Hanover Re, Swiss Re, Munich Re, SCORE Re, and there's also capital market instruments, catastrophe funds, insurance-linked securities, so third-party capital coming in. You've got reinsurance available in Bermuda, a big source of Florida reinsurance capacity, and also Lloyd's of London and less so in the United States. So these companies are really protected because they're aware of the risk that's there. So the reinsurance picture is one that's very important because when you see that a company had X amount of loss, well, what's the net loss after reinsurance?

19:50It'll be a fraction of the gross loss because of the impact of reinsurance. So these are like walls around the balance sheet. But presumably if the gross losses for like the domestic insurer, the first layer of insurance keep going up, then the reinsurance premiums go up as well eventually, right? That's right. And here's some other news, which is good news. Prior to Helene and Milton, reinsurance rates started to come down. Reinsurance rates started to come down. The June renewals, the mid-year renewals showed some decreases in the cost of reinsurance. So whereas there are some henny penny, the sky is falling, chicken little folks out there saying, oh, insurance is going to just get more and more expensive.

20:31It's got nowhere to go but up. And we can't buy insurance. Not necessarily. It's not true because the rate or the premium follows the risk that's there. So if the risk goes down, then the rates go down. If you look at workers' compensation, a different line of insurance, for the last 12 years, the rates for workers' compensation have been coming down because of improvements in safety at manufacturing plants, other places, automation. So there we have a good example of rates coming down because the risk has come down. But people like ignore that because it's more fun to talk about bad things happening.

21:09That's true. That's true. If everything's so fundamentally, I guess, structurally sound, you know, Wall Street does its thing. It assesses the risks of a hurricane. It lays off the risks of catastrophes to the catastrophe bonds, et cetera. Why does the citizens even need to exist? And why do so many Florida homeowners either end up with citizens or end up just going bare and not having insurance? In Florida, the impact of the out-of-control lawsuit abuse is what ended up driving up premiums. So that was apart from the risk. And this happens in other states as well, where you have some sort of damage to the private market, when the free market is having trouble making a decent return.

21:54And the insurance industry is not a rich industry. It's not like other industries, the S &P. I think the average margin is 14%. And the insurance industry is about 6%. So it's not as if these are fat, rich companies. They operated relatively slim margins. So when there is an exodus of insurance companies from a particular state, then the state will often establish its fund, which is supposed to be a temporary stopgap until the market, the private market, reattains stability. This happened in California with SCIF, the state-run workers' compensation. entity and other places as well have had this sort of accordion type results where business expands, like citizens expanded a lot.

22:40And then you have depopulation, which is the effort to take policies out of citizens. So depopulation was happening and is still happening. Wait, depopulation efforts to take policies out of citizens? That's right. To put them back into the private market because the private market now is out of the intensive care unit. It's just in a recovery room. What's been the success rate on that? I don't have the numbers, but it started with a trickle and it's continuing. We'll see what happens now in the wake of Milton to see how much depopulation there will be. So one thing I wanted to ask, just going back to tort reform, is I take the point that making it more difficult to file ridiculous lawsuits has made the ease of business for insurers in the state a little bit better.

23:28But I guess the downside is if you're a consumer who experiences some sort of damage to your house, maybe it makes, you know, having actual conversations, much less litigation with your insurance company, a lot more difficult. How do you balance, I guess, the balance of power between the consumer and the insurance company here? Yeah, the upper hand was held by the trial bar where the concept of civil litigation, and again, this is civil litigation, not criminal litigation. These are torts, civil wrongs. The emphasis in tort law or the purpose in tort law is not to punish, but to compensate. So many of the large verdicts and settlements that have made it difficult on the commercial side for people to create products, pharmaceuticals, do research, are being hit by these very large outsides judgments that have no real place in tort law.

24:31So you have the expansion of juries, verdicts, and settlements that are exacerbated by misbehavior on the part of the plaintiff bar, new legal theories, and aggressive attempts to extract those large amounts, punitive damages that are multiples of actual damages sustained. So this is entering the topic of social inflation, the expansion of the concept of tort. And a lot of states have tried to put an end to that with legislation, like Florida did, in order to keep services and businesses at prices that are not unaffordable. Because this ends up driving up the costs of things. When you have companies that are paying hundreds of millions of dollars or tens of millions for actions that are not necessarily caused by their activity, it's a distortion of the legal system.

25:39Coming back to insurance for a second, and I take all this point about torts. Insurance is a key part of what makes Florida a habitable place, a place where people are going to invest assets to build. One aspect of insurance or one aspect of risk is flood insurance. And my understanding is that a big part of flood insurance is national and federal funded. What is the role of flood insurance in making parts of Florida safe to build in? And who pays for that flood insurance? And right you are, Joe. Flood insurance is provided mainly through a government program called the National Flood Insurance Program.

26:18And the program has been around for several decades, and it covers flood insurance because flood damage is not covered in the conventional homeowners policy, say the HO3 homeowners insurance policy. So people buy flood insurance policies separately from the National Flood Insurance Program, the NFIP. So in Florida, which is aware of the risk that's there, 18 % of homeowners buy flood insurance. Whereas in North Carolina, which got hit really bad, tragically bad, a lot of loss of life as well in Western North Carolina, only 1 % of the Tar Heel State homeowners bought flood insurance from the NFIP.

27:04Now, there's been pressure because it's a government program. A lot of it is underpriced, It's subsidized, really. It runs at a deficit. There's been pressure to have the private market come in and provide flood insurance. And here, the good news is that the private market is finally starting to grow. NFIP has got about$3.1 billion in premiums, whereas the private market is estimated to have about 1.4. So almost half of the federal flood is now provided by the private market, whereas a couple of years ago, the private market was virtually non-existent because nobody would buy it at the risk-adjusted rates.

27:40So now you have a healthier situation. Problem is, though, that the NFIP is going to bear a lot of the losses from Helene and Milton, because we know about the storm surge, one, two feet of water, and these torrential, violent rains that brought down mud and flooded homes, really destroying lots of property. So the flood and the storm surge were not covered by the H.R. 3 policies, but are covered by the NFIP. And the gap there, with only 18 % of Floridians having the insurance, I think is going to send a message because the message that we've been trying to send as we educate folks about insurance and how it works is that you need to spread the risk.