Why Home Insurance Markets in California and Florida Imploded

26:31So you definitely have this idea that, and by the way, what's on the reinsurers balance sheets? A bunch of bonds. Right. They should be making more money. No, because those bonds reprice down when rates go up, right? So Tracy, to your point, your intuition is exactly right, that you had both a kind of climate shock over the last couple of years and you had a capital supply shock over the last couple of years as bonds repriced on insurers' balance sheet. That's interesting. That's great. Talk to us more about that capital supply aspect. So, oh, they take a hit on their balance sheet because their bond portfolio is down.

27:07So does that mean just the sheer amount of dollars that they can then lend out? Talk to us about that, I guess, like supply chain of dollars and how it feeds down to the end homeowner. Yeah. So the supply chain of dollars is, like everything, it's kind of simple, right? You've got large pools of capital looking for return. In reinsurance, those are an increasingly diverse mix, insurance-linked securities, cap bonds, captive reinsurers. Hedge funds can go into it directly. There's a bunch of different things you can do. But they all come back to this idea that I'm sitting on a pool of capital. I'm trying to figure out what's the best way to get return for that capital.

27:44And that return is in a world of low interest rates, right? This climate risk is extremely attractive because it's uncorrelated and it provides a rate of return that is sort of set by the actuarial tables, not set by, you know, global macro. In a world where rates go way up, now that implied hurdle rate, right, the actuarial return is going to be still the same, right? It's basically set by what's the risk of a storm and what's the right way to price that. But then as the risk view rate goes way up, you know, what else should I do with this dollar? Should I just buy treasury? Should I buy corporates?

28:23Whatever it is, that sort of gets a little bit more competitive. And then the last thing, of course, is that reinsurance markets do have this unfortunate boom-bust dynamic, right? So one of the great stories about, you know, Berkshire Hathaway is that they wrote reinsurance after Hurricane Andrew, right? So they took basically no losses in Hurricane Andrew, And then they came into the market. There was very little reinsurance capacity. And so they wrote reinsurance into Florida in the wake of Hurricane Andrew. So these stories are relatively common. And you see this actually. There was a sequence of three years where reinsurance got super expensive in Florida.

29:02And over the last year, it's actually come down and flattened a little bit because people make money. Oh, then the capital piles in. Hmm. So you mentioned investments. So you have this pool of money and obviously you can invest it in different things, whether it's corporate debt or treasuries. You also mentioned technology earlier on. What levers do insurers have to pull in a situation where risks are going up, expenses are going up? In some areas of the country, they're still limited in terms of how much of a premium increase they can pass on. How do they go about reducing costs? So the first thing is insurance is all about getting the price right.

29:45And while it is hard to model, it's not impossible to model. Right. So as you said earlier, right, we're all capitalists here. We can sort of figure out, OK, well, next year, we think the chance of a hurricane is a little bit higher than it was 10 years ago. So we can adjust the price for that. So the first thing is getting the price right. And we have seen a lot of innovation around just understanding that climate science and building that into the system. The second thing is. Wait, can you can you expand on that a little bit more? Because as someone who spends a certain amount of time in New England nowadays, I feel like the weather forecast still leaves something to be desired.

30:25Yes. So the weather is hard to predict. But climate is not. The climate moves in ways that are, you don't care whether the hurricane comes on Tuesday or Thursday. You care about what's the probability of a hurricane this year. Now, even within that, right, we had Hurricane Ian and then last year was a more mild year. So it's not that they're so good at predicting the where and the when, but we can see the trends. And so you start with that. The second thing you start with is just actually getting much more sophisticated about the interactions between the house and the weather, right? So houses can be hardened, building codes, roofs.

31:09Think about California, fire breaks, right? Like, do you have a bunch of shrubbery in your lawn or do you have a bunch of pebbles? Like these actually make a real difference to your risk of catastrophe, you know? And so at least at Kin, what we see is that it really matters which house on the block you underwrite because some of the houses are just naturally harder or they're shaped a little bit differently relative to where the water might come. I learned that word today, Joe, hardened, like the idea of protecting houses in this way. And now I have this idea in my head of like these hard houses walking around going, I'm so hard.

31:47You can't get me. You raise that like, you know, sometimes when people are talking about health insurance, like the health insurance should give you incentives, like go to the gym or whatever. And my understanding is that that stuff doesn't really work that much. But I guess like with technology, in theory, are you able to say like a homeowner comes to you and you say, okay, it'd be this price. But if you do X to your property, it could be this price. Yeah. So it's probably not quite that much of a negotiation, but implicitly it is, right? How old is your roof? Okay. What are your shingles? Do you have tile or tar?

32:22And so these kinds of things are directly impacted in price. And then sometimes, I mean, we're not investors in any of these companies, but we have seen home insurers in California say like, literally, you come to us, we underwrite your house, and then we're going to tell you what to do with your backyard. Oh, and then we're going to - Some are trying to do that. Some are trying to do that.

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33:34It's built to grow with your business, whether you are just starting out or already scaling up. Plus, it's easy to use, customizable, and designed to streamline every process, so you can focus on what really matters, running your business. Thousands of businesses have made the switch, so why not you? Try Odoo for free at odoo.com. That's O-D-O-O dot com. This is Mario Lopez with one with Mario Lopez daily podcast. Toyota is moving toward a more sustainable future by giving you the freedom to choose from a full lineup of hybrids, plug-in hybrids, regular gas, and 100 % electric vehicles. So, pick from stylish cars like the Camry, Corolla, and Prius, as well as efficient and spacious SUVs like the RAV4 and Grand Highlander.

34:19All backed by Toyota's reputation for reliability. In fact, for 2025, Toyota is the best resale value brand for the fifth year in a row, according to Kelly Blue Books, KBB.com. So a smart buy today can mean higher trade in values tomorrow. With Toyota, you got more choices and less compromise. Visit buyatoyota.com for a great deal on an efficient Toyota today. Vehicle's projected resale value is specific to the 2025 model year. For more info, visit kellybluebooks, kbb.com, Toyota. Let's go places. You mentioned fire. So as you said, like this sort of like hurricane risk over time has been sort of linearly going up.

34:59Fire has been sort of less predictable. There have been a little bit more of a tipping point issue, I would call it. Does the industry feel like it has a good way of modeling fire risk? or at this point, because it's sort of hitting this tipping point, do the insurers or the reinsurers need a bigger margin of error, a bigger cushion due to the tipping point or the novelty of the risk? So there's two issues that make this question a little bit hard to answer. The first is that California is historically underpriced, as we talked about earlier. So the average home insurance cost premium in California is only about$30 more than the national average.

35:40So, and again, this is 2021 data, so it's probably moved a bit, but that is kind of interesting. It demonstrates to Tracy's point earlier that California is more behind, whereas in Florida, it's more like$2 ,400. So the first thing is the gap between what California is charging and where insurers want to be is so vast that it's a little bit of a little bit harder thing. On top of that, I do think FIRE is harder to model. A lot of the work modeling it is around these topographical models, right? So where are you relative to the wind? Where are you relative to the hills? Where are you relative? And I think there's definitely a lot of work still to be done there.

36:18But right now, it's a little bit hard to tell how much, whether the margin really is on just getting the price right or the margin is on better modeling. But either way, you come back to Tracy's word of hardening the house. Hardening the house is going to make a big difference. Oh, I would have thought for California, maybe it's drought conditions or something like that, where I guess 2023 was a historic drought in that state. And then flipping into 2024, I think we've seen a historic amount of rain. So maybe the hope was that fire premiums would start to come down. But I guess that's not the case.

36:52That's never the case. And price never goes down. It could be. I mean, we've seen this again in Florida. You see this like premiums went way up, right? 10 years ago or 13 years ago, we hit a peak of people moving into the public option, came down, come back up. I think with California, it's a little too early to know. You mentioned people going into the public option. Do insurers in places like Florida see that public option as a competitor to their business? Yes, but most of the time the states set these up so that you have to prove that you couldn't get insurance. And that's obviously ends up being a price question as well.

37:35And so, for instance, I believe in Florida, the rule is if a Florida carrier is willing to quote you within 20 percent of the citizen's price, the public price, then you no longer become eligible. So that's how they manage it. So the states generally don't want to be in this business. And so they try to set up situations where Citizens is or the fair plan in California is an insurer last resort rather than a competitor. Just out of curiosity, from the perspective of like a startup tech forward insurer, how do people believe you that you'll pay out? I mean, you know, it's like companies I've heard of Allstate or AIG or whatever.

38:19It's like, yeah, they probably have the money and it's good. Kin comes along and I don't know what it is. And maybe it looks like an app or something like that? Like, is there an FDIC equivalent of insurance where it's like, OK, they have that FDIC stamp. So I feel comfortable that they'll like hold my money. Like, how do you how is that established? Yeah. So there's not an FDIC, but it is it is highly regulated. Right. And it's a combination of insurance regulation and then rating agencies. And so there are insurance specific rating agencies. And so that's why if you actually pay attention to the insurance ads that you'll get, they'll say, you know, rated by AM Best or rated by Demotech, which is the sort of predominant Florida-specific rating agency.

39:00But going back to the first part of Joe's question, how do you convince customers that you're going to pay out? Because this seems to be the focus of nearly every insurance commercial in existence. And insurance is also still one of the industries where word of mouth actually matters. So people will say, I had a good experience with this insurer when I was filing my claim. You should go with it too. How do you go about having that discussion with people for an industry where the incentives are not necessarily aligned. The insurer wants to make money and the customer wants to get as much as they can out of putting their money into premiums.

39:38Yeah. So I think you hit the nail exactly on the head, which is the dynamic is actually less about the financial strength and more about the customer experience. And that's where, you know, for us, we put a lot of effort into this idea of how do I give people the customer experience that when they come to us with a claim, they actually feel satisfied. Now, naturally, customer satisfaction post claim always drops. That's just like a rule of life. But by how much? And so I talked about like this thing about people left their homes after Ian and we sent them text messages that said, here's an aerial image of your house.

40:16We're sorry to tell you that your roof is destroyed. Would you like to start your claim now? That's an incredibly positive experience for someone usually. The other dynamic here is just, you know, within Kin, we actually did it as a capital structure issue as well. So Kin uses what's called a reciprocal. So the carrier itself is a nonprofit owned by the policyholders. And then the technology company is what's called an attorney in fact. So the technology company is managing the pricing, the underwriting, the consumer response. But the carrier itself, the risk, is all born as if it were a mutual.

40:52So we have done some interesting things. And that's why people like mutuals in the insurance industry. And so the carrier pays a fee, presumably, to the technology company. Exactly. As you mentioned, what was the peak year for Citizens? 2011? Yeah, 2011. So it sounds like even though there's a ton of focus on what's going on in Florida right now, what's going on in California, et cetera. that it's not necessarily a death spiral dynamic, that we have these crazy moves, but it doesn't mean they happen in perpetuity and that the nature of the business is such that you could just have years where things swing wildly.

41:32Yeah, that's right. I mean, unfortunately, insurance does have a little bit of this boom and bust dynamic. And that's why, you know, when we think about it, you know, when we're sitting in the boardroom, we're talking about strategy from the perspective of insurance. It's all about getting the price right. So you've been talking a lot about that boom bust cycle. And in some respects, that makes a lot of sense because you're dealing with nature and extreme events within the weather or the climate. And so you could see how one year will be terrible and then the next year will be bad. And the insurance industry is kind of trying to catch up or react to those events all the time.

42:09But is there stuff that could be done to try to smooth that boom bust cycle? So from the perspective of the actual insurance carriers that are dealing with homeowners, that's actually their core mission, right, is that there's going to be a little bit of a boom and bust cycle when you think about what's capital markets appetite to buy climate risk. And similarly, there's going to be bad years and good years when it comes to the question of what's the weather going to be like? What's the hurricane? And the whole point of insurance is to act as the buffer between those things. And so even though I talk about this boom and bust cycle, that's really more about access to capital and pricing.

42:48And it is the role of both insurance regulators and insurance companies to keep that customer interface smooth. So that's why you see a lot of pressure on both sides. But it comes out in price, right? It comes out in how do we serve our customers and then increase the prices as necessary to make it actuarially sound. And that's really the whole mission of insurance. But it puts a lot of pressure on both sides. Amayas Garrity, thank you so much for coming on AdLots. That was fascinating. My pleasure. That was our conversation with Amayas Garrity, partner at QED Investors. And now we are on to our second guest.

43:27We're going to be speaking with RJ Lehman. He is the editor and chief for the International Center for Law and Economics. RJ, thank you so much for coming on All Thoughts. Thank you for having me. Why don't you tell us a little bit, I guess, why are we telling you, what is your background and sort of like your work and understanding the sort of regulatory environment for home insurers? Sure thing. My background is I was a journalist, I was a business journalist, like y 'all. There's hope for us. There's hope. Insurance was my beat, and I recommend it to anyone who is considering going into financial journalism.

44:03Insurance is the best beat. It touches everything. And although there are parts of it that are dry, you have the greatest panoply of potential subjects to expound upon. So I was a journalist. I entered think tank land back in 2012. I co-founded a group called the R Street Institute with Eli Lehrer. Initially, R Street was overwhelmingly insurance-focused. It has diversified over the years. I led their insurance program as long as I was there, which was until late 2020. Most notably, I produced for them an annual report card of the 50 states with respect to their insurance regulatory environment, ranking who was doing a good job, who was in need of improvement.

44:52California, in particular, was always near the bottom because of the system in California. Florida, over the years, had been, by the time I left R Street and stopped doing that report card, had been creeping up from the very bottom to towards the top. But they've certainly had some challenges in the past few years. So one thing I always wonder when we have these insurance discussions, I think there's a tendency to look at the current system and feel like it was inevitable. And this isn't just regarding insurance, but a lot of things in the financial system. But how is it that we ended up in a place where insurance premiums are regulated, especially in places like California and Florida?

45:38And we have this mix of like private insurance companies, but also, again, in places like Florida, a public backstop. So why are they regulated goes back to basically antitrust law. Just after World War II, there was a famous Supreme Court case that determined that insurance was interstate commerce. The Congress responded by passing a law called the McCarran-Ferguson Act that acknowledged that case and acknowledged that it was interstate commerce, but nonetheless left it to the states to handle regulation of the business of insurance. And insurers, particularly back then, used to file rates collectively.

46:20The reason this was an antitrust concern was because they used underwriting bureaus where they shared data because no one insurer was large enough to know what the correct rate should be. And that was collusion. And so the states initially just accepted or rejected rates from the industry as a whole. And individual insurers only differed in how much they charge for marketing expenses and things like that for their agent force. That system kind of broke apart by the late 70s when insurers started, especially the larger ones in the personal lines, which is home and auto basically, started having enough data on their own to make credible actuarial projections without using a rating bureau.

47:04And that's when you started to have actually more complicated regulatory systems, because rather than just accept or reject a rate for the whole industry, you had to look at each individual company's filing. And so initially, what most states did was leave it to the market, in most cases, to determine what the best rate would be. But some states in the 80s started having issues with rates climbing up, There was concern about, especially in auto, more than homeowners, there was concern about profiteering and gouging. And so some states responded by having a more intense, what's called prior approval regulatory system.

47:43California did this in 1988 by a ballot initiative called Prop 103. Florida does not have the same prior approval system as California, but what Florida was challenged with was after Hurricane Andrew, a number of companies simply had not been charging enough and were rendered insolvent, especially regional and domestic companies. Some of the larger companies wanted to get out of the state altogether. Florida responded by creating these entities, what are called residual markets, insurers of last resort. Florida is kind of unique in two respects. One is most states do have some kind of residual market for auto and for home, but it's usually like an assigned risk pool.

48:25If you can't get coverage, then you will be assigned to an insurer and those assignments will be made based on insurer's overall market share. In Florida, you have two entities, the Florida Citizens Property Insurance Corporation, which is a freestanding homeowners insurer, capitalized by the state, backed by the state. It competes in the market. And the Florida Hurricane Catastrophe Fund, which is a state-backed reinsurer, there's no other state that has anything quite like that. So the reinsurer, every insurance company doing business in Florida has to buy their first layer of reinsurance from the state itself.

49:06And that was both because there was concern that reinsurers were taking excess profit, but also because reinsurance rates can fluctuate wildly. And so the idea was to try to make it a little bit more stable. Two things. A, I like that you mentioned that everyone should cover insurance because I think both Tracy and I have talked about this. People talk about banks all the time, Wall Street banks, et cetera. And it is sort of remarkable, generally, how little coverage there is of insurers and what they're doing. It's also the essence of finance, right? Like estimating and pricing risk. And then the other thing I think that's really important that you mentioned here is it's funny that like there's I don't know it's funny, but, you know, a lot of the concern right now is about pricing too high and price gouging and profiteering.

49:55But pricing too low is also very, as you say, problematic because you don't want someone, an entity coming in and taking tons of market share and then not having the capacity to pay out when the hurricane hits. So, you know, you mentioned that as part of your former job, you would create these rankings of each of the state's insurance. What goes into that ranking? What makes for a good or a bad in your view? And I think maybe, you know, our street is sort of a free market bent organization. But from your view or when you're creating these rankings, what constitutes a good or a bad insurance regime?

50:29So my perspective was that there were certain tasks that it was important for a department to perform. It wasn't seeking no regulation. The two most important were solvency, doing solvency review, and the other is consumer protection. I mean, it is certainly true that in the marketplace, some consumers are abused. Some insurers might give you the runarounds and not pay claims timely and appropriately. And there's a role for a regulator to examine those cases. So we tried to emphasize in our rankings those states that we thought were doing those two tasks in particular very well. And we would ding states for mostly price regulation.

51:15because solvency regulation is kind of a separate regime than price regulation. If there is a competitive market, then I do think the market is the best price regulator. And insurance, historically, in fact, there has long been greater problems of companies seeking market share and so underpricing their product to gain market share, maybe to sell you other products. Maybe you sell auto and then you also tie in homeowners and life and possibly some banking services and that in the long run you may not be pricing appropriately or you may not be taking reserves appropriately to maintain solvency

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52:50It's built to grow with your business. Whether you are just starting out or already scaling up. Plus, it's easy to use, customizable, and designed to streamline every process. So you can focus on what really matters, running your business. Thousands of businesses have made the switch. So why not you? Try Odoo for free at odoo.com. That's O-D-O-O dot com. Hi, this is Shirley Strawberry from the Steve Harvey Morning Show. Toyotathon is on. So stop by your local Toyota dealer for incredible year-end deals on the cars, trucks, and SUVs known for their legendary reliability. Like the stylish and efficient Camry, the ready-for-anything RAV4, or check out a rough-and-rugged Tacoma or Tundra.

53:37All with great financing and lease options available to qualified customers. Visit BuyAToyota.com to find out more. Toyota, let's go places. First of all, what information are they working from when it comes to figuring out what's a reasonable or acceptable price for insurers to actually charge? And then secondly, like how do they come to that judgment? Like where does the information come from and then what strikes them as a reasonable premium increase? It is overwhelmingly past lost data. In all states, that's true. The states do differ in what factors they will allow a company to consider and in the mix of factors, how much weight you can place on any single one.

54:27I mean, to give you an example, race is not permitted to be used anywhere. That wasn't always true. There was a time when it was an actual factor that insurance companies and various kinds of insurance used. You cannot use race anywhere. It doesn't matter if it's actuarially credible or not. Certainly lost costs, things like the rising cost of both labor and replacement parts for auto or materials for homes are things that you can reflect in your rates. And in homeowners in particular, over the last 25 years or so, many companies have started using off-the-shelf catastrophe models. So a catastrophe model takes information about climate and residential patterns and projects forward what the maximum probable loss might be.

55:17That's different than a pure loss cost approach where you just look at what you paid in the past. So in California, that's particularly relevant because Prop 103 does not allow you to project forward. You can only use what is your average that you've paid out over the past 20 years in determining what your rates should be. Well, in 2017 and 2018, California had these massive wildfires. So the industry from 1991 to 2016 in the state of California had made$10 billion total in underwriting profits over that 25-year period. In 2017 and 2018, they lost$20 billion. So they more than doubled all the money they had made in the prior 25 years.

56:05So if the future doesn't look like the past and climate change and residential patterns are both reasons that the future might not look like the past, not being able to project forward is a real problem. So is California the only state that doesn't allow for these sort of more forward-looking projections of how damages might change? California is the only state that bars the use of catastrophe models altogether. Other states do have controls on how much weight you can place on CAT models in crafting your underwriting and rate setting. Florida is kind of unique in that it actually, the state created its own CAT model.

56:45So not only does it have a state-backed homeowners insurer and a state-backed reinsurer, it also has a state-backed CAT model. and it uses its cap model to judge the results of private cap models. So did you say that California was the 50th? It was the worst? Not always. It depended on the year, but it was sometimes the worst. So what else? So we have seen these stories over the last couple of years about various name brand insurance companies saying, we're leaving the state. So what is it? I mean, is it just, talk to us generally. Is it just about their inability to sort of use these cap models?

57:20What is the environment or the situation that caused, I guess your rankings were legit if they like now they're running out of it. Sure. I guess you're vindicated. But overall, what is the situation that caused them to be ranked so low in your models or in your ranking and that now we see insurers fleeing the state? The reason California is different, it does have a prior approval system. It's not the only state that has that. It doesn't allow catastrophe models to be used. It doesn't allow anything to be used that was not specifically enumerated in this ballot initiative, Prop 103, that was passed in 1988.

57:56There basically were no catastrophe models in 1988. They were in their infancy. In auto, people weren't really using credit yet, which is now a common thing to use in auto insurance. And so you can't use it in California. Also, Prop 103 created this system called the intervener system, where private parties, consumer advocates, every time an insurer files a rate, whether it's an increase or not, is actually only somewhat relevant. But any time an insurer files a rate, files a form, these private parties get to object. And you have to go through a hearing process to get that rate, which even if it's ultimately approved, that can take up to two years.

58:37So it is a very inflexible system. and insurers have made do with it because California is one fifth of the country. And so you don't want to exit the California market unless the circumstances are really bad, but it is terribly brittle. You cannot change these rules without either a new proposition to be passed by the voters and the voters are not going to pass something that raises their insurance rates, or the legislature by super majorities in both chambers can make adjustments to Prop 103, but only if they, in the view of the court, forward the purpose of Prop 103. So you can't undo anything that's in the statute, but you can make tweaks.

59:24So there's been some effort in California over the last year, the insurance commissioner recognizing that there's a problem, a serious problem of not having insurance available has taken some emergency regulatory actions that would permit in some limits limited circumstances things like being able to use cat models being able to reflect the cost of reinsurance which is another thing that prop 103 doesn't specifically allow but it's going to take the legislature taking action for any of those things to be permanent so one of the things i always think about when we talk about insurance insurance premiums going up and the regulatory regime that sort of limits them in places like California or limits those increases.

1:00:09So the idea of having expensive insurance is partly it's supposed to deter you from doing stupid things, right? It's supposed to shape your behavior to some extent. So when it comes to things like climate change, you're disincentivized from building a house in a place that's prone to floods or in a place that is now prone to wildfires. How do regulators balance that aspect of this entire question? Awkwardly, is the short answer. Regulators are chosen in different ways in different states. So as you might imagine, ones that are directly elected, and there's about 11 of those, are probably most attuned to public sentiments as opposed to the nuts and bolts of, say, solvency.

1:01:00And so those who are appointed will vary. Some are appointed in kind of unusual ways. In the state of Florida, we have this weird system called the cabinet where the four directly elected executive officers have to vote together on who to appoint and also who to remove. So the Florida Insurance Commissioner is actually unusually insulated. If he has the vote of either the CFO or the governor, basically cannot be removed. Flood, which isn't actually underwritten very much by private parties. It's mostly underwritten by the federal government. There is a direct relationship between where and how you build and the flood risks that are being generated.

1:01:48wildfire is a little bit stranger because there are various tipping points. Like if I built more densely in a floodplain, I'm going to have more flood risk because there's more people there, there's more structures there, you're covering the ground. If you build more densely in an area of wildfire, initially you may be having more properties exposed to the risk, but after a certain point, you actually are reducing the risk because wildfire is generated in less dense places. In essence, it sounds silly, but you can choose to get rid of the trees. Yeah. If we pave over all of California, there will be wildfires.

1:02:27If everyone moves to a wildfire risky area, then the wildfire risk goes down. Right. Disappears. Yeah. So it's not correlated linearly in the same way with that risk as it is with flood. But obviously, there are things that you can do in terms of creating defensible space around a property, making sure that you don't have wood decks and wood roofs and fire-retardant materials, sprinklers, et cetera. These can all contribute. But it's not as simple as saying charging more yields the more environmentally responsible solution. Not necessarily. It depends on the particulars. That's extremely interesting.

1:03:07So Florida, you mentioned that it had over the years climbed up the rankings. That being said, you know, we've all seen these headlines over the last couple of years just about these like eye-popping insurance premium increases for homeowners in the state of Florida and increased dependence on citizens, the public option backstop. Why don't you explain that? So what did Florida do to improve its rankings? And yet, you know, still it feels like just intuitively and maybe the market justifies it, but it feels like there's a problem still take you back to 2006 uh florida had just had in 2004 four major hurricanes two category threes two category fours make landfall in one year in 2005 they had hurricane wilma that was also the year of hurricane katrina which did massive damage and kind of took the the reinsurance markets for a loop florida was a basket case back then and essentially any remaining major national homeowners insurers that were doing business in Florida left.

1:04:11Citizens became the largest, not only the largest insurer in Florida, but one of the top 10 in the country. So Charlie Crist was elected in 2006, been a Republican on an insurance reform platform. The state legislature in early 2007 passed this platform, which included rolling back rates, making it much easier to join citizens doubling the size of the hurricane catastrophe fund and this was basically a bet that in florida no realistic assessment of what florida did in 2007 would say that the state if it got a major hurricane could finance those costs because it put enormous costs on potential costs on the state but charlie christ uh and he said this in congressional testimony made the bet that the federal government would pass a national catastrophe fund that would bail out Florida if need be.

1:05:06So what Florida did in the intervening years and why they were improving was they did allow rates to rise. They shrank the size of citizens significantly. The cat fund was put on better financial footing. But what allowed this to happen was a very lucky streak, which is that between Wilma in 2005 and Hurricane Irma in 2017, Florida had no major hurricanes. And the historic record doesn't show that ever happening before. So the markets got much more solid just based on good luck, more or less. There were still problems. Notably, the litigation environment in Florida deteriorated significantly. It was a very attractive place for the trial bar.

1:05:54As you can see, if you drive our hideways and see many billboards advertising the services of our local trial attorneys, and I have no objection to them. But in the last decade and a half, 9 % of all homeowners insurance claims originated in the state of Florida, but 80 % of all homeowners insurance lawsuits. Oh, that's funny. You know what? I quoted that exact statistic to Joe yesterday after we recorded our conversation. But yeah, that is a stunning statistic. It is. It is. So we weren't quite as healthy as probably we should have been given our good luck. But that lucky streak did allow capital to accumulate and for a more robust market to evolve.

1:06:41That market still always had problems because it was reliant heavily on companies that only do business in Florida and only wrote homeowners. So not diversified at all. And they were relatively small, relatively thinly capitalized. Then Irma came in 2017. We had Michael in 2018. We had Ian in 2022. We had Adalia last year. And those were just the knockout blow for what was for these thinly, we've had a dozen that have gone insolvent in the last couple of years. There are many more that are teetering. There needed to be a significant adjustment. And that's what you've seen is rates have risen significantly.

1:07:20Now the average homeowner's rate in Florida is estimated to be about$6 ,000 a year, which is probably double the next state. And I'm not even certain what that next state would be. It's been wrenching. I do think we're to a better place, at least in terms of availability, that right now, in sure, looking at the Florida market would say those rates are attractive. And if I have a clean balance sheet, maybe I'll start writing business there, even if I haven't in many years. But it's going to be a painful adjustment for sure. Recent steps in Florida aside, and I realize I'm talking very generally about insurance in the U.S.

1:07:58and it varies state to state, as you pointed out. But if we have a situation where insurers are pulling out of markets because they say they can't raise premiums because of these regulatory limits, and meanwhile, the risk of catastrophic events is increasing, and then what ends up happening is people lean on either state or federal insurance, whatever backstop might be in place there, why not cut out the middleman and just have a public insurance entity? Well, as we were sort of alluding to earlier, if you underprice the risk, and that would be the assumption here, right, is that the reason that private companies would not write this business but the government entity would is because they are underpricing the risk, then that is just shifting the problem to the taxpayer.

1:08:48And you can make that decision, sure. That's a policy decision that has been made in many contexts. It's certainly the way the crop insurance program works is that it's a subsidy. It's an explicit subsidy for our farmers. Whether this should be something subsidized, whether building beach homes is something that we want as a matter of public policy to subsidize. I don't. But, you know, someone can make that case. It's a democracy. Someone believes that. And so, you know, that's where we are. Is the Florida's state-backed reinsure, is that re-reinsured at all? It's reinsurance all the way down.

1:09:29Re-reinsurance does exist, right? Yes. And a bit is the answer. There's largely through catastrophe bonds that the CAT fund has issued, and those are a form of reinsurance. There isn't much facultative or treaty. I'm not aware of any currently with the Florida CAT fund, but I will admit that I haven't looked at their balance sheet in a couple of years. What is your prescription for both states would be? It sounds like California has to do much more, but it does seem like Florida has issues with the fact that it has to be a solely, you know, these sort of undiversified companies definitely seems like an issue.

1:10:07Like, what would be the ideal reforms we're looking at? In both cases, I think the ideal reform is to bring down the level of risk, which means shifting investment through the front end to mitigation. And both states do that to some extent. Florida could do much more in helping to raise properties in places where they're at risk of flood, ensure that the building codes are appropriately measured to the size of the risk. California's regulatory environment ultimately will have to be a thing that the people of California are leveled with about what is realistic and possible over the long term. and that's a democracy challenge because no one wants to pay more to be fair in california they do actually pay less than although they in hawaii are the most expensive states uh certainly for the cost of housing they pay less than one would predict and that is a function of the regulatory environment in florida that's not true in fact if anything it may be current rates there we're probably peeking out at a level that will naturally come down with more competition.

1:11:21But we'll have to wait and see on that. RJ Lehman, thank you so much for coming on Odd Lots. That was great and clarified a bunch of things for us. So really appreciate you taking the time. Absolutely. Thank you.

1:11:43Tracy, those conversations cleared up a lot of things for me. Let's just start there. Yes. I have been wanting to dig a little bit more into the Florida fraudulent roof replacement schemes for a while. That was really fun. That was really fun. There were so many interesting things. First of all, Well, like I think one thing that helps crystallize for me the huge surge in insurance premiums is a not only the increase in climate risk, but be just the surge in home values themselves. Because it doesn't matter, as we talked about, like you might have bought your home in the 1980s, but to replace it, you have to replace it at twenty twenty four dollars.

1:12:20And so if you are in a boom state, which many people have been, particularly if you've been in Florida or California over the last several years, where home prices have gone nuts, it just makes sense just sort of mathematically right there that your premiums are going to go up. Absolutely. I also thought the differentiation in the way some of these disasters happen is also interesting. So the idea that forest fires are maybe a little bit different in nature to something like a hurricane, they wipe out a lot more, they can occur sort of unexpectedly. I mean, obviously, you can determine how dry the weather is, what the fire risk conditions are at any one time.

1:12:59But you don't necessarily have a good handle on whether a single power line is going to come down or whether, I don't know, a crazy person starts a fire on purpose or a camper starts accidentally burning brush. Then I guess it's factoid about like fire risk where it's like if you build in an area in which there is fire risk, like, OK, maybe your insurance premiums go up. But if everyone builds in an area where there's fire risk and you just clear cut all of the trees, then the risk goes down, which is sort of, I guess it's funny in some way, not necessarily funny haha, but funny perverse. I think also just in, you know, talking with RJ, the sort of the diversity of state models.

1:13:40And so the fact that we really do have, you know, every state has an insurance commissioner and every state has its own rules about how pricing works, I think contributes to the difficulty understanding this market. Absolutely. And also just the cyclical nature, the sort of boom bust cycle of insurance, it feels like, and the degree to which some of the capital behind the insurers. So the reinsurers is kind of cyclical. There are so many moving parts here. I'm really glad that you brought up the reinsurers part because, you know, one of the things and we talked about it a little bit on our recent inflation episode with Omer and Skanda is these sort of backdoor ways in which higher Fed rates can contribute to higher inflation.

1:14:23And so here this sort of a bias, as he explained it, it's like the Fed hikes rates, the reinsurers take losses on their bond portfolio. The reinsurer then has less money, less capacity to back home insurers. And so then they hike up their rates and the home insurers hike up their rates. And so this sort of very backdoor way in which higher rates almost linearly flow through right to higher consumer prices. Yeah. And no one ever really talks about it except us. All right. And the insurer and the reinsurers and the dedicated insurance reporters have probably talked about this, but don't get enough attention.

1:15:00Yes, that is a very good point. All right. Shall we leave it there? Let's leave it there. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our guests, Amias Garrity. He's at AmiasMG. And RJ Lehman. He's at Ray Lehman. Follow our producers, Carmen Rodriguez at Carmen Erman. Dasho Bennett at Dashbot. And Kale Brooks at Kale Brooks. And thank you to our producer, Moses Andam. And for more OddLots content, go to bloomberg.com slash oddlots, where we have transcripts, a blog, and a newsletter.

1:15:35And if you enjoy OddLots and want to chat with fellow listeners 24-7, check out the Discord, discord.gg slash oddlots. And don't forget, if you like OddLots, if you want more insurance content, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is connect your Bloomberg subscription to Apple Podcasts. Thanks for listening.

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