I recently read an article regarding how the U.S. Senate wants to investigate how well reserved Florida Citizens is because of their expressed concern that if a large hurricane destroys enough property insured by Florida Citizens, will Florida Citizens have the wherewithal to pay claims?

That seems like a pretty reasonable question to ask and because the state is the insurer, a reasonable person might conclude that a bias exists if the state insurance department reviews the state insurance company (read the lawsuits/charges between the California Department of Insurance and the California state insurance company for interesting perspectives on this point).

A commentary in the article struck me as circular logic. Some Florida insurance people think Florida Citizens is the best capitalized insurance company in the U.S. because in the event of a storm, "... Florida law [requires] surcharges and assessments on its policyholders and all Florida insurance consumers ... ." That is a reciprocal, though being a state insurance company, it is not called a reciprocal.

If a huge storm, maybe a Hurricane Andrew-level storm, hits causing a problem with Florida Citizens being able to pay all its claims, then the state will assess its policyholders per this perspective. Due to the storm, some portion of its policyholders will have lost all their property and they will experience long delays to rebuild -- if, and it's a big IF (look at Ft. Myers for proof) they can afford to rebuild. And yet, the state is mandating those policyholders pay them more money so they can afford to pay that money back to resolve the claim.

Given how many people have decided to go naked relative to homeowners insurance in Florida, would the pool of insureds not affected by a large storm be big enough? And I wonder how everyone else in the state would react if they were assessed a large sum given how much money they are already paying? If I were one of those policyholders, I might advise them to stick their assessment where the sun doesn't shine.

It seems the Senate has a reasonable point unless you believe the assumption that all the good citizens of Florida will gladly and willingly pay more for someone else's claims or even their own claim for which they've already paid premiums. Clearly that is the religion some people are practicing.

The same goes though for regular assessable reciprocals. Quite a few property reciprocals have been created from scratch in the last few years. If you have one where all their surplus is in the form of a loan and/or the potential to assess policyholders, how secure is their true surplus? How happy will their lenders be if the carrier goes insolvent due to claims and, simultaneously, how happy will policyholders be when their home has been destroyed and they get their assessment bill in whatever mailbox might still exist?

Sure, on paper it all works out. Given the private equity compensation model some of these carriers have developed, some of the executives will be just fine since they get paid upfront, not based on performance and without claw backs in case of insolvency.

To be clear, I am not picking on Florida. They just provide an easy example for readers to digest. More reciprocals exist than most agents know. I have met many agents selling reciprocal products across the country who did not realize the carrier was a reciprocal. I have met many agents who have had no idea what is different about a reciprocal. To varying degrees, reciprocal insurance companies do not have to have money in the bank or in bonds to the extent regular carriers must, because they theoretically have the ability to assess their clients.

Maybe these official solvency calculations work on paper, but are they ivory tower calculations? If push comes to shove, how much money will actually be collected from an insured in Ft. Myers, Florida, who has lost their home, possibly because they did not purchase or their carrier did not offer adequate ordinance and law coverage (and if their loss is deemed a flood loss, that policy typically has limits far too low for rebuilding to current code), can't rebuild, and they must find a new home while paying an assessment? This could just as easily be a wildfire or some other event.

If you are the agent, what duty do you have to explain to a client that they, the insured, are the insurance company? By buying insurance from an assessable reciprocal, do they understand they're promising some of their own money to pay for claims? This might be a point worth disclosing even though the reciprocal carriers are supposed to provide additional disclosures to insureds explaining this. The agent might want to provide an additional explanation because the agent is the one who will have to deal with the problem.

Not all reciprocals have the same issues. Some have proven their ability to pay without assessing clients for decades. Not all reciprocals are assessable either. As with any market, agents have a duty to understand the carrier with whom they are placing business. This duty extends to your staff because they likely place most personal lines accounts, so your staff having this knowledge is extremely important.

Do regulators and politicians understand that a small reciprocal with no material geographic dispersion is really rolling the dice with policyholders' futures? I understand the level of desperation in some states, but not all states are in the same position. And maybe even in the more desperate states, better knowledge could help regulators better craft consumer protections.

Similarly, everyone in the agency needs to understand the difference between surplus lines and admitted markets. They need to understand the extra risks of surplus lines. I find many people don't know the critical differences resulting in materially higher risks than necessary. They need to understand how some of these newer carriers are really MGAs and how this affects the way an application must be written.

This goes for the regulators, too. In some cases, states are so desperate for any carrier, no one seems to want to look too hard. "It's better to have some carrier than no carrier." I agree, until the carrier can't pay claims.

The solution varies by line and state, but in general, why would smart capital enter a market where poorly capitalized companies can take on market share and whose owners will be paid well regardless of whether the market survives the next storm? Why should they enter a market where the state fund underprices them because the state fund "can't" go insolvent? Why should they enter a market where some carriers' surplus is accepted but maybe not actually in equity or cash? The ROI is too small for well capitalized carriers. The deck is stacked in favor of weak carriers.

A stable insurance market is more likely if the surplus requirements in quantity and quality are such that the barrier to entry is too high for marginal players. The idea of needing a "sandbox" for discovery of new solutions is great, provided enough surplus exists. A funny fact exists in the insurance world and that is, no matter the model, eventually a carrier needs to be profitable and generate quality surplus adequate to support its premiums. Sandboxes should always require adequate (use a BCAR rating equal to industry average as a good benchmark) surplus regardless of the model.

Solid surplus, in quantity and quality, correlates strongly to market stability. This boring fact needs to be appreciated by regulators and agents. And disclosures to policyholders is critical to their well-being and agents' E&O.

Chris Burand

Burand is the founder and owner of Burand & Associates LLC based in Pueblo, Colo. Phone: 719-485-3868. E-mail: chris@burand-associates.com.