By Matt Kelly

On February 17th, 2015, Florida state Senator Anitere Flores filed SB 1006, which would place restrictions on shifting insurance policies from state-backed Citizens Property Insurance Corporation to private sector insurers. Citizens’ policyholders would be notified before being transferred to private insurers, who would be barred from increasing premiums more than 10% annually for three years. Most importantly, SB 1006 would require written consent from policyholders before their policies could be transferred. Though intended to protect Citizens’ customers, legislators will ultimately need to decide the best course for the state as a whole. This policy change could delay productive reform and expose Floridians to undue risk.

Citizens Property Insurance Corporation has the advantage of being able to exact assessments from insurance companies of nearly every kind throughout Florida. Yet Citizens was actuarially unsound until only recently, requiring policyholders across the state to cover its deficits. Even with the company’s current surplus of $7.5 billion, a one-in-one-hundred year storm could deplete this reserve and require an additional $1.69 billion in emergency assessments to cover losses.

Citizens functions to shift the risk of natural disasters from private property owners to the general public. Such socialization of risk is problematic for several reasons. Foisting higher premiums on low-risk customers in order to make up for the artificially low premiums of high-risk customers creates what economists call an “adverse selection” problem: higher risk customers will opt into the system in order to transfer financial risk to the low-risk policyholders  The imbalance among policyholders’ risk levels then leads low-risk policyholders to exit the market and go uninsured, while attracting ever more high-risk customers.

A 2013 policy brief from the University of Pennsylvania makes clear that even without adverse selection problems, behavioral biases plague the hurricane and flood insurance industry. Consumers often underestimate the impact of low-probability, high-impact events, such as one-in-one hundred year hurricanes, making it difficult for insurance companies to price policies.

By failing to reflect a property’s true risk level, Citizens sends misleading market signals to policyholders. Policy analysts Jeffrey Pompe and James Rinehart from the Independent Institute have pointed out that failing to reflect true risks in insurance policies also creates a moral hazard. “Government involvement in property insurance has encouraged coastal development in hazardous areas, which is responsible, in part, for increased damage costs from storms.”

Lawmakers and company managers have done much to improve this situation by reducing Citizens’ portfolio from 1.5 million policyholders in November 2007 to its current level of 727,000, lowering the risk to Florida taxpayers. This has brought Citizens’ loss exposure down from $511 billion to $229 billion. State regulators recently announced they will soon allow private insurers to assume another 132,440 policies.

Citizens has received criticism from former customers in the process, many of whom say they were saddled with expensive premiums without warning. These complaints are understandable: Given Citizens’ artificially low rates, who would want to cancel their insurance policy with them? But these artificially low rates encourage risky behavior and are supported at the expense of other lower risk policyholders in the state.

Giving notice to customers is fair, but allowing Citizens’ policyholders to remain with the state-run insurer and retain these artificially low premiums would be unfair to the other policyholders in Florida who effectively subsidize them. A better policy strategy would be to allow Citizens to charge actuarially fair premiums that reflect a policyholder’s true risk, ultimately balancing the property market through more transparent pricing.

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