Insurers bracing for downgrades, preparing for chaos for homeowners [South Florida Sun-Sentinel]

Florida-based insurance companies are bracing for the impact of plans revealed by an Ohio-based financial strength ratings agency to downgrade ratings of a majority of Florida-based property insurers that it evaluates.

Angry letters from Florida Insurance Commissioner David Altmaier and Chief Financial Officer Jimmy Patronis released on Thursday blasted the ratings firm Demotech and its CEO Joe Petrelli for telling "approximately 17 insurers that their A ratings, which stand for "Exceptional" or "Unsurpassed," will be downgraded on July 26 to S "substantial," or M "moderate."

Demotech CEO Joe Petrelli declined to identify the companies in an email to the South Florida Sun Sentinel. However, he revealed that 27 insurers -- not 17 -- received notices of looming downgrades. In an earlier interview, Petrelli said his company rates 40 Florida-domiciled insurance companies.

Altmaier and Patronis said Demotech has decided to lower the companies' ratings based largely on the company's opinion that legislative reforms enacted over the past two years were not enough to bring the state's overall insurance market, which has been hemorrhaging losses over past five years, back to financial health. In doing so, the company was applying methodology that fell outside of the quantitative criteria spelled out on its website, Altmaier and Patronis said.

"This is an example of inconsistent, monopolistic power of a select rating agency and is trying to exert coercive influence over Floridians and policymakers in an effort to thwart public policy according to its own opinions," Altmaier said in the letter.

The ripple effect

The downgrades, if they happen, could create unprecedented upheaval for millions of Florida homeowners who rely on coverage from one of the affected companies. For many of the companies, Demotech is the only ratings agency willing to evaluate them and assign ratings recognized by the federal mortgage loan guarantors, Fannie Mae and Freddie Mac, that back a majority of home loans.

Fannie Mae and Freddie Mac require borrowers of loans it backs to maintain insurance coverage with A-rated insurers. Borrowers with insurance backed by companies rated below A could find themselves in default of the terms of their home loans. If that happens, Fannie and Freddie could order mortgage servicers like Wells Fargo, Bank of America and others to "force-place" more expensive coverage by acceptable insurers on their homes.

Paul Handerhan, president of the consumer-oriented watchdog group Federal Association for Insurance Reform, said he understands Petrelli's position "that more needs to be done to stabilize the marketplace," but adds, "a lot has been done" by the legislature that needs time to take effect.

"But from a consumer perspective, the timing [of the downgrades] is really bad," he said. "Can you imagine, with the height of hurricane season around the corner, if you just paid your insurance bill for the year and suddenly your mortgage servicer says, 'You're out of compliance and we're going to force-place you' and charge $5,000 or $6,000? That's a real potential."

The conflict comes at a perilous time for Florida's insurance industry. Four companies have gone into insolvency since February. The latest, Southern Fidelity Insurance, left 80,000 policyholders scrambling to find new coverage. In May, FedNat and its sister companies Monarch National and Maison received authorization from state regulators to drop more than 68,000 policies as part of a reorganization.

Gov. Ron DeSantis ordered a special legislative session in May to enact reforms that industry leaders say were needed to help companies stave off bankruptcy. Those reforms included restrictions of fees paid to attorneys who sue insurers and free access for insurers to $2 billion in state-funded reinsurance -- which is insurance that insurers buy to ensure they can pay all claims after a catastrophe.

In a May interview with the South Florida Sun Sentinel, Petrelli said it was possible that none of the 40 Florida-domiciled insurers that Demotech rates would have enough claims-paying capacity after June 1 to retain A ratings, primarily because the special session reforms were inadequate. Prior to the special session, Petrelli called on legislators to pass stricter reforms to reduce costly litigation, provide more access to reinsurance from the Florida Hurricane Catastrophe Fund, and reduce the amount of money insurers were required to pay into the fund each year.

Citizens Property Insurance Corp., the state-owned insurer of last resort, expects to have 1.2 million policies by the end of the year, up from 420,000 in 2019.

Letters and responses

None of the insurance executives contacted for this report would acknowledge publicly whether they received one of Demotech's downgrade letters. One executive who privately acknowledged receiving a letter said colleagues at other companies received letters with justifications that were "very close, if not identical to each other."

Altmaier's letter to Demotech demanded to know "why these discrepancies exist" between Demotech's quantitative methodology and the reasons cited in the letters. He challenged the company to prove the downgrades will not be made "in a capricious manner and are fairly and consistently applied."

In a June 30 news release, Demotech said it was continuing to "review, analyze, and evaluate Q1 2022 operating results, catastrophe reinsurance programs, disaster recovery plans, catastrophe response plans, the legislation emerging from the special session at the end of May 2022, and other considerations. These factors, and others, influence Demotech's quarterly assessment of financial strength ratings."

Altmaier's letter complained that Demotech did not provide companies a formal process to appeal the decisions by raising more capital or proving that their financial condition -- which includes surplus, income, ratio of losses to premium, claim frequency, amount of reinsurance and other factors -- met Demotech's criteria for A ratings.

Petrelli said those remedies are no longer enough to maintain an A rating, according to an excerpt from one of the Demotech letters obtained by John Rollins, former chief risk officer for state-owned Citizens Property Insurance Corp.

Previously when a company's operating results failed to meet Demotech's financial metrics, it accepted remedies including capital infusion and revisions to business plans or business models, the letter said. "In these limited cases, our decision to do so anticipated legislative reform(s) to reverse the revisions to the legislative, regulatory, or judicial environment that was the proximate cause of operating results being unfavorable," it said. "In Florida, the unwillingness or inability of the legislature to address longstanding disparate, disproportionate levels of litigation, and increasing claims frequency has resulted in a level of dysfunction that renders our previous accommodation inapplicable."

Patronis, in letters to the heads of Fannie Mae, Freddie Mac, and the agency that oversees them, the Federal Housing Finance Agency, called Demotech a "rouge ratings agency" and said he was concerned that Fannie and Freddie's recognition of Demotech's ratings have "inadvertently" allowed Demotech to play "havoc with the financial lives of millions of Floridians."

Patronis urged the government-backed loan guarantors "to reconsider your reliance on Demotech as the primary ratings agency for rating the strength of Florida's domestic insurance market, and to give Florida leaders time to identify a suitable alternative ratings body to evaluate the financial strength of Florida insurers."

Asked by email for comment on the letters by Altmaier and Patronis and a critical news release by the Florida Association of Insurance Agents, Petrelli said, "Each communication has errors in facts and logic. Also, we are not the insurance industry's rating monopoly." Petrelli said Demotech would respond to the letters early next week.

Ratings

The best-known insurance ratings agency in the nation, A.M. Best, has long determined that Florida-based carriers are not capitalized well enough to warrant its rating. But some large Florida-based insurers are A-rated by A.M. Best, and others have been applying for ratings by another agency, Kroll Bond Rating Agency.

Fannie and Freddie accept policies by insurers with A.M. Best ratings one notch below its A rating, while Fannie but not Freddie accepts Kroll's BBB rating, Handerhan said. The possibility that mortgage services would force-place insurance on borrowers would disappear, he said, if Fannie Mae and Freddie Mac accepted Demotech policies similarly downgraded to S, as Demotech has been seeking for years.

The Florida Association of Insurance Agents, in a statement distributed by the Office of Insurance Regulation with the Altmaier and Patronis letters, questioned whether convincing Fannie and Freddie to accept Demotech's S rating was an "ulterior motive" driving the downgrades.

Handerhan said little difference exists between the financial strength of Demotech's A-rated company compared to an S-rated one. An A rating indicates a 97% confidence level that the company can pay all claims after a 1-in-100-year storm while an S rating lowers that confidence level to 95%, he said.

"None of these companies [facing downgrades to S] are in jeopardy of failing or going into receivership," he said.

Handerhan said he understands Petrelli's conflict. "He's saying, 'If you're not an A, should I just give you an A? What if a storm hits and you can't pay all your claims? I've got to do what I feel is legitimate for my credibility and for consumers who should know if their insurance company is really an S.'"

On the flip side, he said, "companies are saying, 'We meet your quantitative methodology and your qualitative measurements are based on an insurance environment in Florida that we can't control.'"

Rollins, who now raises capital to invest in insurance companies for the Texas-based firm Evans Insurance Group, said some of Demotech's concerns could be a result of this year's reinsurance contracts requiring companies to pay more money upfront and not covering as many potential catastrophes as in the past. Some contracts, he said, limit coverage to named storms, such as tropical storms and hurricanes, but not the hailstorms and tornados that have been hitting parts of the state more frequently.

"Because of that, a lot of companies that say they're prepared for hurricane season are less prepared than they say," Rollins said.

Rollins warns that an unintended consequence of Demotech not allowing companies to maintain their A ratings with an infusion of new capital is that investors could decide their only safe play is to fund new companies. "Essentially the letter says, 'We're tired of dealing with existing insurers. If you want to invest capital, you have to start from scratch.'"

Mark Friedlander, corporate spokesman for the industry-funded Insurance Information Institute, said the downgrades weren't unexpected, considering the financial shape of the insurance industry.

"The marketplace reaction to the legislative special session has been very negative, as seven insurers placed a moratorium on writing new business in Florida since late May," Friedlander said in an email. "The global reinsurance market also reacted very negatively, criticizing the legislature for not taking strong enough actions to stop the contractor schemes and excessive litigation being filed against Florida insurers."

Ron Hurtibise covers business and consumer issues for the South Florida Sun Sentinel. He can be reached by phone at 954-356-4071, on Twitter @ronhurtibise or by email at [email protected].

(C)2022 South Florida Sun-Sentinel. Visit sun-sentinel.com. Distributed by Tribune Content Agency, LLC.