The Gainesville Sun
by Don Brown
April 25, 2011
In a April 19, 2001 FoxNews.com article Tampa-Based lawyer Josh Burnett was quoted as saying: “…any time water is pumped out of one area and into another, that can cause the ground in the area where the water originated to be susceptible to a sinkhole…”
I think it is correct to conclude that there is a human behavior component in the number of sinkhole claims being filed. I do believe, however, that higher water use by itself doesn’t begin to explain the magnitude of the problem. It is pretty clear to me that 2005 legislation repealing “Replacement Cost Holdback” has contributed significantly to the sinkhole claims problem.
The truth is Florida’s regulated property insurance rates must include just losses, grossed up for expenses and a small ( 3.5%) profit margin, therefore “cost drivers” are “rate drivers” for consumers.
A careful analysis will reveal that expenses have been largely steady in the past few years with no hurricanes since 2005. What’s interesting is that loss costs (per dollar of premium) have exploded by 80 percent since 2005, when the “holdback” elimination law was enacted, and on current pace would increase another 40 percent by end of 2012.
Rate increases have been common and significant since 2009, directly reflecting the loss explosion. The consequence of these factors are:
1) Rates will continue to rise until loss drivers, such as “holdback” law, are addressed.
2) Citizens will continue to function as a competitor unless the rate cap “glide path” keeps pace with average private market rate increases.
I said all that to say this: The up-front payment of replacement cost is exactly what is funding Private Adjuster involvement, particularly as it relates to the sinkhole peril.
For decades (for that matter, centuries) insurance contracts were based upon the principle of indemnity. That is, after a claim the insured should enjoy exactly the same financial position they enjoyed just prior to the claim.
The payment of replacement cost is a relatively recent departure from that principle.
Unfortunately, to the extent you depart from the principle of indemnity you also create (in direct proportion) moral hazard, i.e., the easier you make it for someone to cheat the more cheaters you will have.
The requirement that an insured repair or replace damaged property is simply a means to control the increase in the moral hazard created by the departure from the principle of indemnity. Once the holdback (and requirement to repair or replace) is eliminated then centuries of experience would predict a significant increase in claims activity.
When it is perfectly legal to claim and be paid large sums for unproveable sinkhole damage and not be required to repair the claimed damage then, in an increasing number of cases, you begin to see an entirely predictable human behavior: make the claim; take the money; pay off the mortgagee or buy a bass boat, and (by the way) pay the PA his fee.
Everyone agrees that sinkhole claims are up dramatically. What exactly is causing this increase is up for considerable debate. Higher water use – maybe. Public Adjuster involvement because of a ready source of cash up front is – in my opinion, a much more likely cause.
Don Brown is a former member of the Florida House of Representative, the Chairman of the Insurance Committee and is currently a Senior Fellow with The Heartland Institute.
http://www.gainesville.com/article/20110425/NEWS/110429709/1109/sports?p=1&tc=pg
