By Donald D. Brown
October 25, 2011
Florida’s property insurance market can be thought of as a “three legged stool”:
1) The Private Market,
2) Citizens Property Insurance Corporation (Citizens) and
3) The Florida Hurricane Catastrophe Fund (FHCP).
Unfortunately, all three legs of Florida’s property insurance market stool need repair.
This is due, in large measure, to a fundamental shift in public policy implemented in 2007, which purposely embraced unfunded debt as a means to finance risk. Prior to 2007 Florida relied more on private capital to finance risk. To quote Dr. Jack Nicholson from the FHCF: “It is always better to finance risk with capital than to finance risk with debt.” So, we took a wrong turn. We now have an opportunity to correct our course.
What the Florida property insurance market needs more than anything else is: CAPITAL!
What are the impediments to Capital formation in Florida? To answer that question it might be helpful to reference Frank H. Knight’s landmark book: Risk, Uncertainty, and Profit (1921). In his book Dr. Knight defined the difference between Risk and Uncertainty like this:
1. Risk is present when future events occur with measurable probability
2. Uncertainty is present when the likelihood of future events is indefinite or incalculable
When the probability of risk can be quantified there is a clear path forward. When uncertainty prevails and future events are indefinite or incalculable then the path forward is clouded and forward progress slows or, in extreme cases, stops altogether.
The following, now famous quote, expresses a concern over the unknown in a different way: “…there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know.”—Donald Rumsfeld
How do people weigh risk versus uncertainty? Consider a famous experiment that illustrates what is known as the Ellsberg Paradox. There are two urns. The first urn, you are told, contains 50 red balls and 50 black balls. The second one also contains 100 red and black balls, but the number of each color is unknown. If your task is to pick a red ball out of either urn, which urn do you choose? Most people pick the first urn, which suggests that they prefer a measurable risk to an immeasurable uncertainty. This condition is known to economists as ambiguity aversion, a kind of fear or paralysis in the face of the unknown or it could also be called “the inherent fear of the unknown.”
Today the greatest impediment to capital formation in Florida is political, legislative and regulatory uncertainty.
Private capital markets (insurers and reinsurers) observe in utter disbelief as Florida policy vacillates from one extreme to another.
Finally, to illustrate the effects of Florida’s political and regulatory uncertainty I refer you to an article that recently appeared on insurancenewsnet.com. The title to the article is “Farmers COO: Company’s Eastward Push Won’t Include Florida”. Farmers Insurance Group is one of the largest personal lines insurers in the nation.
The article says, in part:
“As Farmers moves ahead with an East Coast expansion, Florida’s mainstream property market won’t be a factor in that overall equation.
Farmers President and Chief Operating Officer Jeff Dailey said the company believes it just wouldn’t be a wise use of capital. He pointed out other insurers have had trouble maintaining surplus even without hurricanes affecting Florida’s marketplace.
It’s just not an environment that we would want to expose our capital to, Dailey said. It’s really from a property perspective. We’re not looking to expand our exposure there.”
The full text of the article can be found at:
http://bit.ly/ojmlxW
As can be seen from the article referenced above the attitude of some capital investors is not favorably inclined toward Florida. Contrary to what some will tell you, I do not believe their attitude is shaped so much by the extraordinary wind exposure Florida represents. Rather, it is the political and regulatory uncertainty to which they refer when they say: “It’s just not an environment that we would want to expose our capital to…” We desperately need to change that environment.
Before we can expect significant improvement in Florida’s property insurance market we must regain the confidence of capital investors. To do that our political and regulatory behavior must change. To follow will be a series of brief articles that suggest how some semblance of certainty can be restored to Florida’s troubled property insurance market. Stay tuned.
About the Author: Don Brown is an insurance agent in DeFuniak Springs, FL, a Senior Fellow at The Heartland Institute, former member of the Florida House of Representative and Chairman of the House Insurance Committee.
