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In This List

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Looming Demotech downgrades could trigger more Florida property insurance M&A

HCI Group Inc.'s preliminary agreement for Homeowners Choice Property & Casualty Insurance Co. Inc. to acquire the insurance policies of Anchor Property & Casualty Insurance Co. may be the first of several potential changes in the dynamic Florida residential property market.

While the parties did not provide additional details about the circumstances leading to the announcement, the news broke the same day Demotech warned that some of the 46 Florida-focused carriers it rates may need to sell or take other action to stave off downgrades to their financial stability ratings.

That cautionary statement was the latest in a series of similar announcements issued by the rating agency in recent years ahead of its reviews of carriers' annual operating results. In this case, Demotech said underwriters that produced "realizable" operating income in the recent past are "stable," and those that have access to sufficient unencumbered cash have the capacity to continue executing their business models despite a number of adverse market forces. But others may need to restructure their debt and/or renegotiate lower interest rates to show that they still have capacity to implement their strategies. The rating agency described the levels and cost of debt as being "burdensome" in several cases.

Some companies could choose to sell rather than recapitalize themselves, Demotech said. Carriers that cannot attract capital or are unable or unwilling to find merger partners may ask the state for permission to run off their outstanding claims.

The rating agency did not mention any private carriers by name in its statement aside from American Strategic Insurance Corp., a company now owned by Progressive Corp., saying some of the carriers it rates "have the capability to emulate" that company's success.

Anchor, which currently holds an A financial stability rating from Demotech, reported an essentially stable policyholders' surplus of nearly $25.1 million between year-end 2018 and the third quarter of 2019 thanks to a $4 million October 2019 contribution by its parent. The contribution helped partially offset the impact of the company's $5.7 million statutory net loss for the year-to-date period and is included within its $48.4 million in outstanding surplus notes as of Sept. 30, 2019. The company also expected to generate a gain on the sale of two real estate investments.

Anchor posted a net loss of $22.7 million in 2018, citing significant adverse prior-year reserve development from Hurricane Irma, water losses and assignment of benefits litigation. It reported positive net income once in the past 14 quarters.

Anchor was not alone in finding it difficult to record positive earnings figures. S&P Global Market Intelligence data shows that the 36 individual Florida-domiciled, Demotech-rated entities that generated more than two-thirds of their overall 2018 premium writings from the fire, allied and homeowners lines in their home state combined to generate a net loss of $61.3 million in the aggregate for the first nine months of 2019.

Representatives of Edison Insurance Co., one of the companies meeting that criteria, outlined during a recent public rate hearing several near-term challenges it faces around the frequency and severity of water loss claims. Primary among them is that Florida House Bill 7065, a measure intended to address the escalating costs associated with non-weather-related water loss claims with an assignment of benefits, does not address the flow of first-party litigation and has not been in effect long enough to gauge its actual impact on third-party complaints.

Demotech amplified those concerns in its announcement.

"Despite the potential for long-term favorable results from 2019's legislation, the cumulative impact of the economics of the marketplace over the past several years has made it difficult for each of the carriers that Demotech reviews to sustain an [A rating] in the near term," the rating agency said.

Among the negative factors present in the market beyond balance sheet leverage, Demotech listed the following: Investor capital "appears to be exiting" the state; rising reinsurance costs were a "financial shock" to the industry and cannot be immediately offset through rate action; state-run insurer Citizens Property Insurance Corp.'s pricing structure remains "too competitive" for an insurer of last resort and may have suppressed private carriers' rate requests; and the challenges associated with booking adequate loss and loss adjustment expense reserves given changes to the state's claims settlement paradigm in recent years.

Demotech said it would begin to issue statements on "many" of the Florida carriers it rates during the week of Jan. 13. The agency said it will likely affirm the ratings for the majority of those companies and added that those who may be assigned a rating of S, Substantial, are "good carriers with the potential to return to A, Exceptional, if they adapt to the challenging market conditions."