Insurance Industry Developments for Spring 2009

NAIC Executive Committee Rejects Capital and Surplus Changes for Life Insurers
By Kevin G. Fitzgerald and Sarah E. Molenkamp

After a well attended public hearing and a contentious vote, the Capital and Surplus Relief Working Group (Working Group) put forward six changes to the National Association of Insurance Commissioners (NAIC) rules pertaining to capital and surplus requirements for life insurers. The proposals, most of which were slightly altered versions of the nine proposals recommended earlier by the American Council of Life Insurers (ACLI), were aimed at aiding life insurers with their growing solvency concerns in light of the crumbling economic condition of the country. The NAIC Executive Committee and Plenary gathered on Thursday, January 29, 2009 for a well attended conference call to address the recommendations of the Working Group and necessity of these “emergency” proposals. On the call, all six changes were rejected as a group by the Executive Committee. After the 16-1 defeat, the proposals return individually to NAIC technical committees for consideration at the March 2009 NAIC meeting in San Diego.

Citing a number of solvency concerns of their member life insurers, the ACLI proposed nine changes to the capital and surplus rules and asked the NAIC to work quickly to adopt them in light of the emergency that threatens the industry. In response, the NAIC developed an Executive Committee-level working group to analyze and make recommendations on the proposals. The Working Group held several public hearings and solicited comments on suggested changes. In late January 2009, they voted to recommend that six of the nine proposals be sent for further consideration to the NAIC Executive Committee and Plenary.

Regulators at the January 29, 2009 conference call seemed positive about the changes proposed by the ACLI, but did not feel that there was an emergency that warranted immediate action on all proposals. Unable to name any specific companies that would suffer dire consequences should these proposals not be passed immediately, regulators felt that the more prudent path would be to deal with any life insurer solvency issues on a company-by-company basis.  

The most controversy arose over a proposal to change statutory accounting guidance on handling deferred tax assets (DTA) in company accounting. The ACLI argued that the more lenient standards in the U.S. Generally Accepted Accounting Principles (U.S. GAAP) should be adopted to allow insurers to use DTAs for five years with a 25-percent cap. The Working Group felt that this adoption would not protect regulator interests and recommended an altered proposal that would allow DTAs to be used for three years with a 15-percent cap. Regulators on the call expressed discontent with even the more limited version. Several regulators noted that they would vote for the rest of the changes if the DTA proposal had not been included.

In the end, regulators on the Executive Committee were unconvinced that the industry had made its case that there was an emergency that merited immediate attention. Given leave to speak to the Executive Committee, Eric R. Dinallo, Superintendent of the New York State Insurance Department, argued that he was afraid of the message that adoption of these proposals would send at this time of national economic crisis. He did not want insurance regulators to be seen as “diluting surplus” at a critical time and thought the proposals’ adoption would certainly be “detrimental to the industry.” Sean Dilweg, Commissioner of Insurance for the State of Wisconsin, agreed, arguing that a system of “very good financial oversight” already existed and there was not an emergency in the life industry at this point. He noted that the industry would be best served by regulators dealing with solvency issues on a company-by-company, state-by-state basis.

After the proposals’ defeat, Thomas E. Hampton, Commissioner for the District of Columbia’s Department of Insurance, Securities and Banking and Chair of the Working Group, pointed out that two of the nine proposals had already been adopted for implementation later in 2009 and recommended that the other seven be returned to the technical-group level. The technical groups, working in tandem with the Working Group, will advance the remaining proposals individually during the coming months. After further consideration, some of the proposals will likely be added to the relevant committee agendas at the March 2009 NAIC meeting.

While no immediate action is being taken, the regulators are optimistic that the hard work of the Working Group will not go to waste, and that the NAIC will be able to respond affirmatively to some of the industry’s proposals. The site includes a wealth of information on the proposals, including public comment letters, hearing testimony, and draft model laws and regulations. 

Capital and Surplus Relief, Take Two: Permitted Accounting Practices
By Kevin G. Fitzgerald and Sarah E. Molenkamp

With deadlines for insurance companies to file their financial statements rapidly approaching, a few state regulators have chosen to address the concerns of their domestic insurance companies in need of capital and surplus relief. Following the NAIC Executive Committee’s rejection of nine “emergency measures” proposed by the ACLI, most insurers are left with the option of obtaining any necessary relief from their domestic regulator in the form of a permitted accounting practice (PAP). The NAIC’s Accounting Practices and Procedures Manual’s preamble empowers the domiciliary state regulator to approve a request for an accounting practice that departs from the manual. While protocol generally involves regulators processing these requests on an individual basis, at least two states have taken a different approach in light of the current economic climate.

Traditionally, an insurer seeking to use an accounting method that deviates from the statutory accounting principals must apply to its domestic regulator by providing the nature of the request, the quantitative effect of the change on the insurer’s financials, and the effect of the request on a legal entity basis on its parent and all affiliated insurance companies. The regulator, after evaluation of the company’s PAP request, can accept or deny it. If accepted, the regulatory authority must provide notice to all other jurisdictions in which the company is licensed and, in general, must give notice 30 days before the change will go into effect. The PAP notification should include a detailed description of the permitted accounting practice request, whether the request has previously been granted, the financial statement filing date in which the PAP will be reflected, the financial statement line items the PAP will affect, and the total financial impact to capital and surplus for all approved PAPs.

To date, Connecticut, Indiana, Illinois, and New York have granted such PAP requests in order to ease capital and surplus concerns of individual companies. Several other states have signaled a willingness to grant PAPs in the event that they are requested. Two states, Iowa and Ohio, issued bulletins on February 3, 2009 that make one form of the capital and surplus relief sought by the ACLI available to all of their domestic insurance companies. In these states, insurers can request to use the treatment for DTAs that was presented to the NAIC Executive Committee in January 2009, which allows a DTA to be used for three years with a 15-percent cap of statutory capital and surplus. While both provide DTA relief, the bulletins are not exactly alike: Ohio requires insurers that apply for the DTA benefit to have a risk-based capital level of 250 percent, while Iowa has no such specification. Iowa, however, does not consider the increase in admitted assets and statutory surplus resulting from the DTA adjustment to be in the definition of admitted assets and surplus for purposes of determining any regulatory trigger that involves such assets and/or surplus. This includes, but is not limited to, triggers in the holding company systems act, investment limitations, and grounds for rehabilitation and liquidation. The Ohio Department of Insurance says 20 companies will receive capital relief under this provision. In Iowa, 10 companies appear to benefit from the provision. In both cases, companies that seek to take advantage of the DTA changes must still file a PAP request with the state’s insurance regulator and complete all notice requirements contained in the NAIC manual’s preamble.

Shifting Landscapes for D&O Insurance in the Economic Crisis
By Ethan D. Lenz and Andrew A. Oberdeck

Evolving Issues in the Current Economic Environment
The directors & officers (D&O) liability insurance market has already been heavily affected by the economic crisis, with substantial premium increases for financial institutions and a sharp increase in the number of class action lawsuits involving such institutions. In addition, we are seeing the competitive landscape shift due to the issues facing the American International Group, Inc. (AIG) group of insurers. The effect of the financial crisis on the D&O insurance market is likely to be further intensified as the economic crisis takes a greater toll on insureds, and we see an increase in the number of corporate bankruptcies. This phenomenon will inevitably go hand in hand with increased litigation against directors and officers and potentially lead to complex coverage issues under D&O policies. A few of the areas and provisions that are likely to be heavily tested include: (1) “Order of Payments”/“Priority of Payments” provisions; (2) the insured versus insured exclusion (IVI Exclusion); and (3) the importance of Side A coverage generally.

Typical Structure of a D&O Policy
Most D&O policies contain three separate coverage agreements. In short, these are:

1. “Side A” — Coverage for both defense expenses and payments of settlements/judgments that arise from claims brought against directors and officers, when those costs cannot be indemnified by the company. Usually, no retention (deductible) applies to Side A coverage. Therefore, it affords protection against individual directors and officers having to use their own resources to pay the costs of any claims for which they are not indemnified by the company. In essence, Side A coverage provides the final layer of protection between an individual director’s or officer’s personal assets and the plaintiff(s) in a claim.
2. “Side B” Coverage — This also is often referred to as “company reimbursement” coverage. It reimburses the company for costs of claims when the company is permitted, or required, to indemnify individual directors and officers. Because the majority of claims against directors and officers are eligible for indemnification, Side B is the primary coverage under which payments are typically made under a D&O policy.
3. “Side C”/Entity Coverage — This provides coverage for claims when the company itself is a defendant in the claim. For publicly traded companies, it typically only provides coverage for securities-related claims. For example, if a securities-related lawsuit names both the company and individual directors/officers as separate defendants, Side C coverage will come into play for any defense costs and/or judgments or settlements that are attributable to the company’s separate alleged liability. On the other hand, if a D&O policy does not include Side C coverage, any amounts allocated to the company’s defense or ultimate liability in that claim would not be covered by the D&O policy.

Order of Payments/Priority of Payments Provisions
Order of payments provisions are intended to govern payments when amounts are potentially due under Side A, B, and/or C of the D&O policy. These provisions typically provide that payments will be made under the Side A coverage (to the individual directors and officers) first, and before any payments are made under Sides B and/or C of the D&O policy (in which payments would be made to the company). The primary purpose of the order of payments provision is to protect individual directors and officers from an attempt by a bankruptcy trustee or other successor to deny payments to the individual directors and officers under the rationale that the D&O policy and its proceeds are an “asset of the bankruptcy estate.” See, e.g., In re Vitek, Inc., 51 F.3d 530, 535 (5th Cir. 1995). Such provisions also may protect the directors and officers where the aggregate limit of liability under the D&O policy is insufficient to discharge the covered liability of both the directors and officers of the company and the company itself.

In practice, the often vague or incomplete wording of order of payment provisions may create a situation that is ripe for dispute. For example, instead of clearly stating that the order of payments provision automatically applies and requires payment under Side A first in all claims situations, it may instead provide that it only applies in instances where the aggregate liability under the D&O policy exceeds the policy limits. In other instances, it may be worded such that it only applies upon a request from the company. Thus, in situations like these where the order of payments provision does not “automatically” apply, the resulting lack of clarity could lead to disputes in the bankruptcy context regarding whether the D&O policy is an asset of the individual directors and officers, or whether it is an asset of the bankruptcy estate. While there may be risks associated with drafting the order of payments provision to provide that payments under Side A are always first and automatic, the benefit of unambiguous policy language may well outweigh the downside risk.

Insured Versus Insured Exclusion Carve Out for Bankruptcy Trustee
Virtually every D&O policy will contain an insured versus insured exclusion that bars coverage for claims “brought by” or claims “brought by or on behalf of” one insured party (e.g., the company) against another insured party (e.g., the officers and directors). In the bankruptcy context, coverage disputes have sometimes arisen when an insurer asserts that the bankruptcy trustee stands in the shoes of the debtor company and, therefore, should be treated as the alter ego of the company, subject to the insured versus insured exclusion. The typical response from insureds has been to assert that the purpose of the insured versus insured exclusion is to prevent collusion among insureds at the expense of the insurer and that there is no concern of collusion where a bankruptcy trustee stands in the shoes of the debtor. Where the argument put forth by the D&O insurer is successful, the insured versus insured exclusion applies and there is no coverage under the D&O policy for claims of the bankruptcy trustee against the directors and officers. See, e.g., Reliance Ins. Co. of Illinois v. Weis, 148 B.R. 575, 580 (E.D.Mo. 1992).

In recent years, insureds and insurers have more frequently dealt with this issue upfront, by revising the insured versus insured exclusion so that it contains a specific carve out (i.e., the exclusion does not apply) for claims brought by bankruptcy trustees. Negotiating the D&O policy in this manner may be beneficial for both the insured and the insurer, as it can create more certainty regarding the scope of coverage in the bankruptcy context, and the insurer can price the policy with the knowledge that it may be covering some claims brought by a bankruptcy trustee if the insured finds itself in an insolvency situation. However, as the market for D&O insurance hardens, and if corporate bankruptcies become more frequent, D&O insurers may look more closely for opportunities to limit the scope of this carve out or eliminate it altogether.

Importance of A-Side Coverage
As noted above, one of the primary situations where Side A coverage is triggered is where the company is insolvent — that is, in the bankruptcy context. Therefore, while Side B coverage (where the company indemnifies the directors and officers and is then entitled to reimbursement from the D&O insurer) has traditionally received the most attention, the increased financial stress facing many companies in the current economic environment will almost certainly lead to an increase in the number of Side A claims due to insolvent companies’ inability to indemnify their directors and officers.

Given the heightened importance of Side A coverage in the bankruptcy/insolvency context, both insurers and insureds need to focus more carefully than ever on this coverage and the myriad of issues potentially arising under Side A. For example, if no retention applies, has the coverage been appropriately priced for the increased risk of providing first dollar coverage on Side A claims? Has the Side A coverage been written such that it is nonrescindable, regardless of any misrepresentations in the application? Are the directors and officers protected by separate Side A coverage, and does that coverage simply provide excess limits over the traditional Side A, B, and C underlying policies, or does it also provide “difference in conditions” coverage that will drop down and provide the directors and officers with additional protection in situations where there is no underlying coverage, or where the underlying insurers are refusing to pay? Although many of the questions have no “right” answer, they should be carefully evaluated by both insurers and insureds to make sure that all parties understand the consequences of a bankruptcy on the coverage that has been put in place.

Conclusion
An increase in corporate bankruptcies and insolvencies is likely to raise a number of new, or at least different, issues under D&O policies than we have seen in recent years. As a result, both insureds and insurers would be well served to carefully review and consider the impact of a bankruptcy on the coverage available to both the corporate insured and the individual officers and directors. Many of these issues can be dealt with prior to policy inception, through careful negotiation of the policy language, in order to create more certainty for all parties regarding the scope of coverage should the insured actually find itself in financial straits. On the contrary, the failure to anticipate and deal with such issues during the policy negotiation can also open the door to potential gaps in coverage for the insureds and expensive coverage litigation down the road. 

Commutations and Settlements With Financially Distressed Companies — How Voidable Preferences Can Unwind the Perfect Deal
By Brian S. Kaas and Kenyatta Bolden

There is no doubt that the current global financial crisis is taking its toll on nearly every industry. The insurance industry has not been spared from this crisis, and insurers are taking a hard look at their operations to identify strategies to preserve capital and minimize exposure. As part of this risk assessment, many insurers are reviewing the credit risk presented by their reinsurance and considering the use of commutations and settlements to alleviate exposure to financially troubled counterparties. Depending on the circumstances, however, such commutations run the risk of being voided as a preference if the reinsurer subsequently becomes insolvent and is put into liquidation.

Many state insurance statutes limit the ability of a financially impaired insurer to transfer or place a lien upon its assets for the benefit of a creditor if the effect would be to enable the creditor to receive a greater percentage of the insurer’s assets in a liquidation proceeding. In general, these statutes permit a receiver to recover assets transferred by an insurer on account of prior debts, which result in some creditors receiving a preference over other creditors similarly situated. Such transfers are generally referred to as voidable preferences or transfers.

Elements of a Voidable Preference
Voidable preference statutes require the presence of four elements (and in some states five elements) before a transfer may be voided as a preference. Generally speaking, it is the effect of the transaction, rather than the debtor’s or creditor’s intent, that is controlling. Thus, if all elements of a voidable preference are present, the preference can be unwound regardless of the intent of the parties. These elements are as follows:

1. The transfer must involve the property of the insolvent insurer.
2. The transfer must occur during the statutorily defined preference period.
3. The transfer must be made on account of an antecedent debt of the insolvent insurer. Although the “antecedent debt” requirement is not expressly stated in all voidable preference statutes, this requirement generally is implied under common law as an essential element of a voidable preference.
4. The transfer must result in a preference in which a creditor obtains payment of a greater percentage owed to that creditor than what another creditor of the same class would have received from the estate for a similar debt. Transfers of property made to or for the benefit of an unsecured creditor within the preference period would be preferential if other unsecured creditors falling within the same class of creditors would not receive the same percentage of payment for debts owed to them in a liquidation proceeding as that received by the preferred creditor. Transfers of property to fully secured creditors generally do not constitute preferences because secured creditors will ordinarily receive the value of the assets held as collateral even in the context of a receivership proceeding.

In addition to these elements, some state statutes require that a receiver establish that the transfer in question was made with an intent to create a preference. If each of these elements can be established, then a receiver will be permitted to void such a transfer as a voidable preference, unless the transfer falls within one of the common law or statutory exceptions to the general voidable preference rule. For example, transfers made as part of a contemporaneous exchange for new value or in the ordinary course of business are protected under common law (and in some cases, statutory law) from a preference attack. A transfer lacking any of the elements of a voidable preference or falling within one of the “safe harbor” exceptions will be unassailable as a preference.

Recommended Course of Action
Although insurers can defend a preference attack on the grounds that a reinsurance commutation constitutes a contemporaneous exchange for new value to the reinsurer (i.e., the reinsurer is relieved of the uncertainty of future adverse loss development on the covered business in exchange for a fixed sum of assets), the strength of this defense hinges somewhat on whether the consideration provided to the ceding insurer under the commutation is considered fair and reasonable. Regulators likely will assume that any transfer of assets under a commutation will diminish the amount of assets available to pay other creditors of the estate. This is especially true if the commutation deprives assets that otherwise would be available to satisfy claims of creditors in higher claim priority classes such as policyholders.

Apart from the passage of time, there is no bulletproof defense to a preference attack. Nonetheless, certain measures can be taken to reduce the risk that assets received from an insolvent reinsurer will later be recovered as a voidable preference. A few of these measures are as follows:

• In certain states, insurers may be able to seek regulatory approval of a commutation if the reinsurer is deemed to be financially impaired or insolvent. If regulatory approval is granted, the commutation cannot be challenged as a preference.
• As an alternative to a commutation, ceding insurers can attempt to novate and transfer their business from a financially troubled reinsurer to another reinsurer.
• Ceding insurers should not allow large or aged receivables to accumulate with financially troubled reinsurers. Payment of a large or aged receivable by a financially distressed company, whether as part of a commutation or otherwise, can create an easy target for being challenged as a preference.
• Ceding insurers should bill all amounts owed to financially troubled reinsurers on a regular and timely basis. This will help to reduce the size and age of the receivable owed by such reinsurers.
• Ceding insurers should collect all amounts billed to financially troubled reinsurers on a regular and timely basis. Amounts paid by such reinsurers in the ordinary course of business are much more difficult to challenge as a preference.
• Ceding insurers should consider requesting a letter of credit from financially troubled reinsurers in lieu of, or in addition to, holding funds in a trust account. While letters of credit can be attacked as an indirect preference, this risk is somewhat less than the transfer of assets into a trust account. A letter of credit secured with assets provided by a different entity (e.g., an affiliate of the financially troubled reinsurer) would be best.
• Ceding insurers should (if they cannot get a letter of credit) have financially troubled reinsurers deposit as much collateral as possible into a trust account. Although subject to a potential preference attack, collateral deposited into a trust account, to the extent possible, should be characterized as security for incurred but not reported (IBNR) reserves. Transfers made on account of present or future obligations (i.e., IBNR reserves) are harder to challenge as a preference than transfers made on account of past debts.
• If possible, ceding insurers should characterize all deposits into trust accounts as ordinary transfers made in accordance with the terms and conditions of the underlying agreements. This approach will help establish a position that such deposits are made in the ordinary course of dealings between the parties. This is a defense to a preference attack.

Florida Legislature to Consider a Broad Range of Responses to a Worsening Property Insurance Crisis
By Leonard E. Schulte

The Florida Legislature is poised to consider a wide variety of property insurance legislation during its regular legislative session, which convened on March 3, 2009. Proposals before the Legislature reflect divergent philosophies and approaches, ranging from a dramatic increase in the regulatory power of the Florida Office of Insurance Regulation (OIR), to an increased role for market-driven decisions, to a state takeover of all residential hurricane risk.

Background
The global financial meltdown and several Florida-specific circumstances have made legislative action to address Florida’s ongoing property insurance crisis a virtual certainty during the 60-day regular legislative session that began on March 3, 2009. Factors that will drive legislative action include:

• Shortfalls in the Florida Hurricane Catastrophe Fund (FHCF). The FHCF’s ability to honor its promise to provide up to $29 billion in hurricane reinsurance for Florida residential property insurers depends on its ability to access credit markets. Because of current credit market constraints, the FHCF currently anticipates that its total resources for the 2009 hurricane season would be limited to $10.6 billion, leaving a potential shortfall of $18.4 billion. Insurers are required to participate in the $17 billion “basic” layer of FHCF coverage. While participation in the additional temporary increase in coverage limits (TICL) layer of FHCF coverage is optional, insurers’ rate filings may not include reinsurance costs that duplicate FHCF coverages.¹
• Reactions of rating agencies to the FHCF shortfall. Both A. M. Best Co. and Demotech, Inc., have announced that the FHCF shortfall could impact their ratings of Florida property insurers.²
• The withdrawal of major insurers from the Florida property insurance market. State Farm Florida Insurance Co., which writes approximately 1.2 million property insurance policies in the state, announced a two-year plan to withdraw from the Florida market on January 27, 2009. The OIR issued an order conditionally approving the withdrawal on February 13, 2009. Encompass Floridian Insurance Co. and Encompass Floridian Indemnity Co., two members of the Allstate Insurance Group, have recently announced their intent to withdraw from the homeowners’ multiperil and inland marine markets in Florida.
• Citizens Property Insurance Corporation (CPIC) rate issues. CPIC, the state-created property insurer of last resort, is the largest writer of property insurance in Florida and one of the top 10 homeowners’ insurers in the nation by market share. Legislative action in 2007 froze CPIC’s rates at 2005 levels. Current law requires that CPIC make an “actuarially sound” rate filing to take effect on January 1, 2010, and annually thereafter.³ A statutorily created task force recently recommended that CPIC’s rates could achieve actuarial soundness over time if they were increased by 10 percent a year for each of the next three years.⁴ CPIC’s financial resources are limited to the premiums it charges its policyholders and debt backed by assessments on all property and casualty insurance premiums in Florida other than workers’ compensation and medical malpractice premiums.

Proposal: State Takeover of the Hurricane Risk

The people of Florida are already responsible for a substantial portion of the state’s potential hurricane losses through the FHCF and CPIC. Two bills, HB 1157 and SB 2384,⁵ have been filed that would make the state the insurer for residential hurricane losses.

Creation of the program. The legislation would establish the Florida Hurricane Protection Program (FHPP) within the FHCF. The FHPP would function as a direct insurer of residential properties for hurricane losses. Its policies would be administered by the licensed insurers that provide personal lines and commercial lines of residential coverage for non-hurricane perils. The program would be administered by the State Board of Administration (SBA), which consists of the governor, the state chief financial officer, and the state attorney general.

The bills include legislative findings stating that:

• The regulatory, financial, and insurance mechanisms employed since Hurricane Andrew have failed to meet Florida’s goals of available, affordable, residential property insurance
• The failure burdens the state’s economy; that the inability of the FHCF to meet its obligations to insurers threatens insurer solvency
• CPIC remains unacceptably large despite depopulation efforts
• The state’s failure to resolve the hurricane insurance problem may mean that hurricanes are an uninsurable peril within the traditional insurance system
• FHPP serves a compelling state interest in maintaining a property insurance market and is necessary to abate a significant threat to the state’s economy

Plan of operation and coverages. The SBA would adopt a plan of operation for FHPP. In general, the plan would specify forms for contracts between participating insurers and FHPP, underwriting standards, mitigation discounts, standards for cancellations and nonrenewals, recordkeeping requirements, and coverage requirements and limitations.

The program would issue a policy providing hurricane coverage to each personal lines residential risk and each commercial lines residential risk covered by any insurer holding a certificate of authority to write property insurance (participating insurer), except that it will not be required to issue a policy to a risk that does not meet FHPP underwriting standards.

The coverage provided under FHPP policies will include structure, contents, additional living expenses, emergency debris removal, and temporary repairs, subject to certain specified limitations and requirements, including the following:

• Policies would include a deductible equal to two percent of the structure’s (Coverage A) insured value, but FHPP also would make five-percent and 10-percent deductibles available.
• The structure coverage (Coverage A) limit for the FHPP policy would be the same as the Coverage A limit of the underlying property insurance policy. However, for properties valued at more than $2 million, structure coverage would be limited to $2 million, and other coverages would have limits consistent with the $2 million structure limit.
• No coverage would be provided for swimming pool enclosures, patio enclosures, patio covers, or awnings. No coverage would be provided for fences, outbuildings, or other detached structures, but the policyholder would be able to buy replacement cost coverage for outbuildings or other permanently affixed detached structures, up to an insured value of $100,000, for an appropriate premium.
• Properties would be eligible for coverage under the program only if they maintain a National Flood Insurance Program flood policy or similar flood insurance coverage, if such coverage is available.

Participating insurers. The plan of operation would provide a schedule of fees to be paid by FHPP for administrative costs and expenses incurred by participating insurers, including policy servicing and loss adjustment expenses, and would provide fees to be paid to participating insurers for acquisition costs, without affecting the insurer’s ability to determine the commission or other compensation to be paid to agents. The plan also would provide for reimbursement of actual costs not covered by the fee schedule.

Each insurer holding a certificate of authority to write residential property insurance (including CPIC) would enter into a contract with FHPP under which FHPP would agree to provide hurricane coverage to each residential insured for which the participating insurer provides a policy covering other perils, and under which the participating insurer agrees to administer the FHPP in compliance with standards and requirements established by FHPP. The requirement to provide a FHPP policy would not apply with respect to ineligible properties or properties for which the owner has exercised the option to exclude hurricane coverage.

The contract would require the participating insurer to collect premiums and apply the deductibles, discounts, credits, surcharges, and limits established by FHPP. The participating insurer also would be required to provide application processing, premium processing, claims processing, and adjusting services. The participating insurer would provide claims payments to FHPP insureds, drawn on an account established and funded by FHPP. The contract between the FHPP and the insurer also would establish that the participating insurer has a fiduciary duty to fairly adjust claims and allocate losses between the non-hurricane perils covered by the participating insurer and the hurricane peril covered by FHPP. An audit process would verify compliance.

A participating insurer could make supplementary coverage available to its insureds, but a participating insurer could not make available to its residential property insureds any coverage that is the same as or similar to coverage provided by FHPP.

Rates. Each year, the SBA would submit a rate plan for FHPP policies to the OIR, after receiving recommendations from an independent consultant. Rates would be required to be as close as possible to actuarially indicated rates, taking into account the need for affordability and the cost of reinsurance. The legislation would establishes a floor for FHPP rates by requiring that the rates generate revenue at least equal to the statewide average annual insured hurricane loss plus expenses. Each year, the SBA will adopt a rate plan and submit it to the OIR for review and approval. The rate plan would remain in effect until a subsequent plan is adopted.

Reinsurance. The FHPP would be required to have the resources to cover all losses and expenses attributable to a one-in-100 year seasonal probable maximum loss (PML), relying on a combination of cash, debt, appropriated state funds, or federal funding, if any, and reinsurance. The FHPP would calculate its projected fund balance and the maximum amount of funding it could be expected to obtain through bonding and other debt and through federal funding, taking into account both the amount of revenue that can be generated from assessments and the actual capacity of the credit markets to absorb FHPP’s debt. The FHPP would then subtract the results of these calculations from its one-in-100 year PML to determine its minimum reinsurance needs, and it would be required to procure at least that amount of reinsurance. The FHPP also would have the option of procuring reinsurance to reduce its assessment potential or to transfer a portion of its risk in excess of the one-in-100 year PML.

Bonding. In general, the FHPP would be able to rely on debt in the same manner as currently provided in the FHCF law. The FHPP also would be able to rely on emergency assessments under the same process as is currently provided for the FHCF, but with different restrictions on the types of insurance premiums subject to assessment and different caps on the assessments.

Beginning June 1, 2011, when the SBA determines that other resources are insufficient to fund the FHCF’s revenue bonds, debt service, and other obligations, the SBA would be able to order the levy of emergency assessments on all personal lines and commercial property insurance policies. Assessments, which could continue until the debt is retired, would be capped at 10 percent of premium with respect to an FHCF deficit incurred in any year, and there would be no cap on the total amount of assessments that may be levied to address multiple years’ deficits. (Current law applies FHCF emergency assessments to all property and casualty insurance premiums except for workers’ compensation and medical malpractice, and caps assessments at six percent with respect to any one year’s deficit and 10 percent with respect to multiple years’ deficits.)

Transition. The legislation provides a one-year transition period, beginning March 1, 2010, during which a participating insurer would continue to provide hurricane coverage to a policyholder until the renewal date of the policy, at which time the hurricane coverage would be replaced with a FHPP policy. During the transition period, a participating insurer would continue to be eligible for an FHCF reimbursement contract to the extent that it still has policies in force that are eligible for FHCF coverage. After the transition year, the FHCF would no longer issue reimbursement contracts to insurers. Renewal notices would be required to include a statement, in a form specified by the SBA, to the effect that as of the renewal date, hurricane coverage will be provided under a FHPP policy and the participating insurer will continue to insure the property for other perils.

The bills express legislative intent that, after the FHPP has sufficient experience with residential hurricane coverage, the program be expanded to nonresidential properties valued at $2 million or less, contingent on evidence that the expansion is feasible and needed. The SBA would provide a report to the Legislature no later than December 31, 2012, analyzing the feasibility of and need for such an expansion of the program.

The bills also contain provisions limiting coverage under the TICL layer of the FHCF and limiting sinkhole coverage in specified counties.

Proposal: Increased Regulatory Power

Legislation enacted in 2008⁶ included several provisions affecting the insurance regulatory process that were supported by insurers, including provisions for transparency in the rate review process and provisions that increased the powers of administrative law judges (ALJ) in reviewing OIR decisions on rates. In an apparent response to the 2008 legislation, SB 1820 dramatically changes the balance of power between the regulator and insurers. The bill also includes several provisions that are not limited to property insurers. Some of the more significant provisions of the bill are as follows:

Trade secrets. SB 1820 includes new language relating to “abuse of trade secret protection.” A person who submits information marked as a trade secret to the insurance regulator could be liable for fines, attorneys’ fees, and costs if a court or administrative tribunal determines that the information is not a trade secret. The new provision does not explicitly require that the incorrect designation be knowing or intentional.

Property insurance nonrenewals. The bill would prohibit an insurer from nonrenewing more than two percent of its residential property insurance policies in any calendar year.

Administrative proceedings related to rate filings. SB 1820 would repeal a statutory provision enacted in 2008⁷ relating to administrative review of OIR actions on rate filings. The 2008 provision allowed the ALJ to issue a recommended order that modifies the rate filing, rather than merely approving or rejecting the rate filing. It also specified that certain findings of an ALJ (whether factors in a rate filing are consistent with reasonable actuarial judgment, whether the underwriting profit and contingency factor is reasonable or excessive, and whether the cost of reinsurance is reasonable or excessive) are findings of fact. The 2008 statute also required an appellate court to set aside a final order of OIR when the regulator substituted its findings of fact for the ALJ’s findings of fact.

Ratemaking. The bill would restrict a residential property insurer’s acquisition expenses and general expenses to 20 percent of premium. It also would restrict a residential property insurer’s reinsurance costs by providing that annual expected recoveries must be at least 20 percent of the reinsurance premium, in the case of a transaction with an unaffiliated company, or 40 percent of the reinsurance premium, in the case of an affiliated company. The bill also would require that a rate filing for property insurance include a statement under oath from the insurer’s chief executive officer (CEO) or chief financial officer (CFO) and from the insurer’s chief actuary that the filing complies with all applicable laws and rules.

Attorney-client privilege. The 2008 legislation limited OIR’s ability to rely on attorney-client privilege by applying the principles of Florida’s public records and open meetings laws. These principles, in effect, allow government agencies to rely on attorney-client confidentiality only with respect to communications directly related to civil or criminal proceedings or adversarial administrative proceedings. SB 1820 limits this provision to circumstances when the principle can be applied “without providing the insurers an unfair advantage,” and when an insurer agrees to waive its attorney-client and work-product privileges.

Florida Commission on Hurricane Loss Projection Methodology. Currently, hurricane loss projection models used in rate filings are subject to review by the Florida Commission on Hurricane Loss Projection Methodology. The commission is a panel of experts, including several government officials serving in an ex-officio voting capacity and several state university faculty members from specified disciplines. SB 1820 would replace these designated officials with five members appointed by the governor and four members appointed by the state CFO, subject only to the requirement that a member “not be a person who may profit personally or professionally from the work product of the commission.”

Motor vehicle insurance. The bill provides that a motor vehicle insurance rate filing seeking a rate increase must be made on a prior approval basis.

Citizens Property Insurance Corp. The bill prohibits CPIC from issuing a new windstorm-only policy after July 1, 2009. Currently, CPIC issues approximately 400,000 windstorm-only policies in a designated high-risk area, and policyholders obtain coverage excluding windstorm either from CPIC or from other insurers.

Residual market assessment recoupment. The bill includes detailed rate filing requirements for insurers’ recoupment of assessments levied to cover residual market deficits.

Proposal: Nonassessable, Non-Rate-Regulated Policies

Another proposal, HB 1171 and SB 2036, takes a different approach, allowing consumers to choose between regulated rates and potential assessment liabilities on the one hand, and unregulated rates and freedom from assessment liability on the other. Under these bills, insurers would be able to offer residential policies that are not subject to assessment by the FHCF or CPIC. These nonassessable policies would not be subject to rate regulation for excessiveness, but the OIR would still have the power to reject a rate that was inadequate.

Proposal: “Glide Path” to a Smaller Catastrophe Fund and Higher CPIC Rates

As noted above, the FHCF’s commitments appear to exceed its resources, and a state task force has recognized that the currently frozen CPIC rates are not actuarially sound. Many legislators, however, recognize that an immediate replacement of CPIC coverage with private reinsurance and an immediate shift to actuarially sound rates for CPIC would result in a “sticker shock” for many consumers that might be politically unacceptable. One approach under consideration would create a glide path to bring FHCF coverage closer to its ability to pay and CPIC rates closer to actuarial soundness over a period of years.

Under current law, the FHCF’s $12 billion TICL layer will not be available after May 31, 2010. HB 1495 continues the TICL layer and provides for its phase-out over a six-year period. Currently, an insurer’s TICL coverage is equal to 90 percent of covered losses (except for a very small number of insurers that select a 45-percent coverage level for both their basic FHCF coverage and their TICL coverage). Under the bill, the TICL would cover 75 percent of losses in the 2010 – 2011 contract year, 65 percent in 2011 – 2012, 55 percent in 2012 – 2013, 45 percent in 2013 – 2014, 30 percent in 2014 – 2015 (eliminating the 45-percent option), and 15 percent in 2015 – 2016, which would be the last year in which TICL would be available. Another proposal, HB 437, would reduce the TICL coverage level to 70 percent for the 2009 – 2010 coverage year and allow TICL to expire after that time.

HB 1495 addresses the problem of rate inadequacy in CPIC by requiring CPIC to implement a statewide average rate increase that does not exceed 10 percent each year (and does not exceed 15 percent in any rating territory or result in a premium increase of more than 20 percent for any policyholder) until its rates are actuarially sound. The bill also specifies that an actuarially sound rate is one that generates sufficient revenue to cover expected losses, plus a capital charge of 15 percent.

Proposal: Continue the CPIC Rate Freeze

SB 862 and HB 1273 provide an alternative to the glide path for CPIC rates. Under these bills, the requirement that CPIC implement actuarially sound rates would be delayed by one year, to January 1, 2011, and the current rate freeze would remain in place until that time.

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¹ FHCF staff testimony before the Florida Senate Ways and Means Committee, February 9, 2009.
² See “Global Credit Crisis Threatens Florida Catastrophe Fund” in Insurance Industry Developments for Winter 2008, available online at http://www.foley.com/publications/pub_detail.aspx?pubid=5494.
³ See § 627.351(6)(m), Florida Statutes.
⁴ Citizens Property Insurance Corporation Mission Review Task Force Final Report, January 30, 2009, available online at https://www.citizensfla.com/about/mrtf.cfm?show=pdf&link=/shared/mrtf/ComprehensiveFinalReport.pdf.
⁵ These bills, and the other bills referred to in this report, are available online from the Web sites of the Florida House of Representatives, www.myfloridahouse.gov, and the Florida Senate, www.flsenate.gov.
⁶ Chapter 2008-66, Laws of Florida.
⁷ § 627.0612, Florida Statutes.