Florida Hurricane Catastrophe Fund

Transcription

1 Florida Hurricane Catastrophe Fund Hurricane Katrina Hurricane Rita Hurricane Wilma Hurricane Dennis Fiscal Year Annual Report State Board of Administration of Florida

2 The purpose of the Florida Hurricane Catastrophe Fund is to improve the availability and Hurricane Wilma, October 24, 2005 affordability of property insurance in Florida by providing reimbursements to insurers for a portion of their catastrophic hurricane losses.

3 On October 24, 2005, Hurricane Wilma is moving northeast at 25 mph with maximum sustained winds of 110 mph and gusts of 145 mph. Tropical depression Alpha is moving north at 23 mph with maximum sustained winds of 35 mph and gusts of 52 mph. Tropical Depression Alpha, October 24, 2005

4 EXECUTIVE MESSAGE It is my pleasure to present the Florida Hurricane Catastrophe Fund (FHCF) annual report for fiscal year ending June 30, This report provides the financial status and operational activities of the FHCF during the past fiscal year. The 2005 hurricane season was the most active on record with twenty-seven named storms and fourteen hurricanes. Meteorologists exhausted the list of twenty-one proper names and for the first time in history had to resort to the Greek alphabet for the remainder of the season. The 2005 hurricane season did not spare Florida, which experienced four hurricanes and two tropical storms. The FHCF again met the challenge and was responsive to the needs of its participating insurers with timely loss reimbursements. We would like to thank the State Board of Administration Trustees, the FHCF Advisory Council, the SBA/FHCF staff, and our service providers for their support and contributions during the past year. We hope you find this report informative and useful. We welcome any comments, thoughts, or ideas regarding the content of future issues. For questions or additional information regarding the FHCF, please contact our office or visit our web site at Jack E. Nicholson, Senior FHCF Officer Florida Hurricane Catastrophe Fund State Board of Administration of Florida

5 OVERVIEW The Florida Hurricane Catastrophe Fund (FHCF) is a tax-exempt trust fund created by the Florida Legislature during a special session in November Following Hurricane Andrew in August of 1992, the residential property insurance market loomed in crisis. Numerous problems developed and the availability of reinsurance for hurricanes became scarce and extremely expensive. Many insurers were forced to re-evaluate their exposure in Florida. State action was deemed necessary to maintain a stable property insurance market. S ection , Florida Statutes, created the FHCF with the purpose of providing a stable and ongoing source of reimbursement to insurers for a portion of their catastrophic hurricane losses in order to provide additional insurance capacity for the state. Supporting the private sector s role as the primary risk bearer, the FHCF operates as a public-private partnership. The FHCF currently provides $15 billion of reinsurance capacity for the state of Florida. The cost of FHCF coverage is significantly less than the cost of private reinsurance due to the FHCF s tax-exempt status, low administrative costs, and lack of a profit or risk-load. As a result, the FHCF has helped keep residential property insurance rates down, it has helped stabilize the market, it has enabled more insurance to be written in the state, and it has helped keep business out of the residual market. 1

6 The FHCF functions as a state administered reinsurance program and is mandatory for residential property insurers writing covered policies in the state of Florida. Covered policies are residential property insurance policies that provide wind or hurricane coverage on structures located in Florida, including coverage on contents and coverage for additional living expenses. Certain collateral protection policies covering personal residences are also considered covered policies if they meet the requirements of Section (2)(c), Florida Statutes. Most commercial property was exempted from the FHCF during the 1995 Legislative session. The FHCF is under the direction and control of the State Board of Administration of Florida (SBA). The SBA is the constitutional entity of Florida state government that provides a variety of investment services to various governmental entities. The SBA is composed of a three-member Board of Trustees, who oversee the SBA s charge to provide superior investment and trust services in an effort to enhance and protect Florida s future. The Trustees are Florida s Governor, Jeb Bush, as Chairman; Chief Financial Officer, Tom Gallagher, as Treasurer; and Attorney General, Charlie Crist, as Secretary. A nine member Advisory Council was established by the Legislature to provide the SBA with advice and information. The membership consists of three consumer representatives, a representative of insurers, a representative of insurance agents, a representative of reinsurers, and three technical experts a meteorologist, an engineer, and an actuary. The management and day-to-day operations of the FHCF is the responsibility of the Senior FHCF Officer, Jack Nicholson, who reports directly to the Executive Director of the SBA, Coleman Stipanovich. 2

7 Section , Florida Statutes created the FHCF and: Requires certain insurers to participate in the FHCF as a condition of doing business in the State Grants rulemaking authority Establishes the procedures for developing rates and collecting reimbursement premiums Authorizes the FHCF to inspect, examine, and verify the records of each insurer Authorizes the investment and disbursement of moneys collected by the FHCF Authorizes the issuance of debt secured by assessments and premiums Authorizes the collection of emergency assessments to retire bonds Requires insurers to participate at certain coverage levels if bonds are outstanding Limits debt issuance and the amount of the assessments Provides for debt security if the FHCF is terminated by law Establishes an Advisory Council Provides that a violation of Section , Florida Statutes, is a violation of the Insurance Code Provides explicit authority to the SBA for other legal action Provides for initial season claims paying capacity up to a limit of $15 billion Establishes additional emergency assessment authority to help fund capacity for subsequent contract years FHCF Mission Statement The mission of the Florida Hurricane Catastrophe Fund (FHCF) is to responsibly and ethically administer the FHCF by: Understanding the catastrophe financing needs of its beneficiaries and stakeholders. Striving to satisfy a portion of the hurricane catastrophe financing needs of insurers in order to create additional insurance capacity for the state. Protecting the public interest by maintaining insurance capacity in the state. Providing exceptional investment, financial, and administrative services. Headquarters of the State Board of Administration of Florida Hermitage Centre, Tallahassee, Florida 3

8 IN REVIEW 2005 Hurricane Season The 2005 Atlantic hurricane season was the most active and destructive on record shattering many long-standing records. 1 Twenty-seven named tropical storms formed breaking the old record of twenty-one set in This exhausted the list of twenty-one proper names resulting in the use of the Greek alphabet for the first time in history for the remainder of the season. Fifteen of the storms became hurricanes breaking the previous record of twelve set in Three hurricanes (Katrina, Rita, and Wilma) reached category 5 strength breaking the old record of two set in 1960 and Not since 1851 have three category 5 storms been known to occur in one season. 2 The 2005 hurricane season was the most damaging in history for landfalling storms in the United States. This was mostly due to Hurricane Katrina which shattered the old record of insured damage set by Hurricane Andrew in Seven of the hurricanes became major hurricanes, category 3 or higher on the Saffir- Simpson Hurricane Scale, tying the singleseason record for intense hurricanes set in The Atlantic hurricane season starts June 1 and ends November 30. However, Hurricane Zeta occurred on December 30 after the end of the recognized season. 4

9 Saffir-Simpson Hurricane Scale Category Wind Speed (mph) Central Pressure > > 155 < 920 Hurricanes Impacting Florida Hurricane Dennis re-intensified to a category 4 hurricane over the eastern Gulf of Mexico after making landfall in Cuba and then weakened to a category 3 hurricane before making landfall on July 10, 2005 over Santa Rosa Island between Navarre Beach and Pensacola Beach in the Florida Panhandle. Landfall was approximately in the same position as Hurricane Ivan in Considerable storm surge related damage occurred near St. Marks, Florida, well east of the landfall location. Heavy rainfall and flooding occurred across much of Florida. 2 The Florida Office of Insurance Regulation estimates total losses at $1.2 billion and 54,000 claims. ISO s Property Claims Services estimates the personal residential property losses from Hurricane Dennis at $450 million. 3 Hurricane Katrina will perhaps be recorded as the most devastating hurricane in the history of the United States. Katrina made its first landfall as a category 1 hurricane near the Miami-Dade/Broward County line on August 25, 2005 and moved southwestward across South Florida. Katrina also brought heavy rains and sustained tropical storm force winds to portions of the Florida Keys before entering the Gulf of Mexico. Once in the Gulf, Katrina strengthened sig- July 9: Hurricane Dennis nificantly to a category 5 with 5

10 a peak wind intensity of 175 mph. Katrina made its second landfall on August 29, 2005 in Plaquemines Parish, Louisiana as a category 3 storm. Katrina produced catastrophic damage and hundreds of casualties in the New August 28: Hurricane Katrina and deadly hurricane that significantly impacted the Florida Keys. While the center of Hurricane Rita did not make landfall in the Florida Keys, it reached category 2 intensity as the center passed approximately 50 miles south of Key West Orleans area, along the Mississippi Gulf coast, and in on September 20, Rita produced storm surge of South Florida. Katrina was directly responsible for up to five feet in portions of the Keys and caused severe an estimated 1,200 deaths in the United States making it the deadliest U.S. hurricane since the Palm tensified from a category 2 to a category 5 in about 24 flooding. After Rita entered the Gulf of Mexico, she in- Beach/Lake Okeechobee hurricane of September hours with a peak wind intensity of 175 mph. Rita weakened to a category 3 and made landfall on September , 2005 just east of the Texas/Louisiana border between Katrina also caused an estimated $80 billion Sabine Pass and Johnson s Bayou. 2 ISO s Property in damage making it the costliest U.S. hurricane on Claims Services estimated Florida s total insured losses record. 2 ISO s Property Claims Services estimated from Rita at $23 million and 8,000 claims with personal Florida s total insured losses at $468 million and residential property losses estimated at $9 million and 110,000 claims with personal residential property 3,000 claims. 3 losses estimated at $325 million and 85,000 claims. 3 Hurricane Rita was an intense, destructive, Hurricane Wilma was the most intense Atlantic hurricane on record while in the Caribbean on September 21: Hurricane Rita October 24: Hurricane Wilma 6

11 October 19, 2005 with maximum sustained winds near 185 mph and the lowest central pressure ever recorded at 882 millibars. Wilma emerged as a category 2 hurricane over the Gulf of Mexico after making landfall on October 21, 2005 as a category 4 hurricane over the Yucatan Peninsula. Wilma strengthened, turned northeastward, and accelerated toward the southern Florida peninsula. On October 24, 2005, Wilma made landfall near Cape Romano as a category 3 hurricane and moved across Florida in less than five hours. Wilma moved into the Atlantic just North of Palm Beach as a category 2 hurricane. Wilma caused 35 deaths in Florida and more than 6 million people lost power in the state. 2 ISO s Property Claims Services estimated Florida s total insured losses from Wilma at $6.1 billion and 750,000 claims. 3 However, some modeled loss estimates exceed this figure for residential property losses. As of December 31, 2005, of the 205 FHCF participating insurers, 99 insurers were expected to trigger coverage and 10 insurers were expected to exhaust their FHCF maximum limits of coverage for the 2005 hurricane season. Insurers are required to absorb a retention, which acts like a deductible, prior to triggering FHCF coverage. An individual insurer s retention (deductible) is determined by multiplying its reimbursement premium by a multiple which is calculated by dividing the $4.5 billion industry retention by the FHCF s aggregate reimbursement premium assuming all insurers select 90% coverage. Total FHCF loss payments for the 2005 season, as of December 31, 2005, were $248.3 million. The year-end proof of loss reports indicated that FHCF losses were expected to be $2.5 billion, but the total liability of the FHCF is not known at this time. The unparalleled 2004 and 2005 hurricane seasons had a tremendous economic impact on the Florida insurance market. The four significant hurricanes during the 2004 season Charley, Frances, Ivan, and Jeanne created 1.66 million insurance claims resulting in $20.9 billion dollars of insured losses in the Florida market, based on data reported to the Office of Insurance Regulation s disaster reporting data system. Insurers had losses of $11.3 billion, the reinsurance market had losses of $5.75 billion, and the FHCF had losses of $3.85 billion. Claim and loss statistics are still in development and being reported for the four significant hurricanes during the 2005 season Dennis, Katrina, Rita, and Wilma. These four storms are estimated to have generated 1.17 million insurance claims and at least $9.3 billion in insured losses in Florida Summary of 2005 Atlantic Tropical Cyclone Activity and Verification of Author s Seasonal and Monthly Forecasts, 18 November 2005, William M. Gray and Philip J. Klotzbach with special assistance from William Thorson, Department of Atmospheric Science, Colorado State University 2. National Hurricane Center, Tropical Prediction Center, 2005 Tropical Cyclone Monthly Summary, 3. Key Facts from Florida s Nightmarish 2004 & 2005 Hurricane Seasons, Florida Insurance Council, December 5, Task Force on Long-Term Solutions for Florida s Hurricane Insurance Market Office of Insurance Regulation Draft Report as of February 15,

12 Operational Activities In addition to activities related to the hurricane season, other major FHCF activities for the past fiscal year included: Six meetings of the FHCF Advisory Council Monitoring and responding to proposed legislation Development of the 2005 premium formula Publication of bonding capacity estimates in May and October Adoption of six rules Updating of bond documents Invitation to Negotiate for Loss Reimbursement Examination Services A Strategic Planning Summit A Participating Insurers Workshop Examiner Training Conferences Staff support to the Florida Commission on Hurricane Loss Projection Methodology (FCHLPM) Updating and maintaining the FHCF and FCHLPM web sites 177 Contract Year 2004 company exams of exposure data were conducted representing 99.71% of FHCF premium 8

13 Legislation During a December, 2004 Special Legislative tention (deductible) was reset to $4.5 billion for the 2005 Session, a program was created to reimburse policyholders of residential prop- growth. The bill also contract year rather than increasing with exposure erty insurance for multiple changed the retention requirements an insurer must deductibles applied by insurers for two or more hurricanes after the policy- event. Under the new law, meet for each covered holder had absorbed one an insurer is required to full hurricane deductible. meet its full retention for The program was administered by the Florida Depart- events. Upon the occur- the two largest covered ment of Financial Services rence of additional covered and would be funded with events, the retention drops up to $150 million out of the down to one-third of the Florida Hurricane Catastrophe Fund (FHCF). At the sequent covered full retention for each sub- event. conclusion of the program, only $44,646, had Old and New Capitol Buildings, Tallahassee, Florida These legislative changes to the FHCF should help ad- been transferred by the FHCF for this purpose. The dress participating insurers concerns when dealing FHCF is allowed to increase its premiums to recover with multiple hurricanes during a contract year and this cost over a five-year period beginning June 1, lessen the impact of incurring multiple retentions prior to becoming eligible for reimbursement. During the 2005 Legislative Session, the FHCF played an active role in analyzing proposed legislation. CS/SB 1486 became law on June 1, 2005 significantly impacting the FHCF and resulting in emergency rulemaking. As a result of the bill, the amount used to calculate the insurance industry aggregate re- CS/SB 1486 also impacted the Florida Commission on Hurricane Loss Projection Methodology (FCHLPM), which is staffed by the FHCF. The bill amended the FCHLPM s governing statute, Section , Florida Statutes, to provide that the Office of Insurance Regulation and the Consumer Advocate 9

14 must have access to all of the assumptions and factors that were used in developing the actuarial methods, principles, standards, models, or output ranges before those methods, principles, standards, models, or output ranges found by the FCHLPM to be accurate and reliable may be used by an insurer in a rate filing. The bill also states that the Office of Insurance Regulation and the Consumer Advocate are not precluded from disclosing this information in a rate proceeding. HB 1939 was signed into law on June 17, 2005 and exempted from the open meetings law portions of a FCHLPM meeting during which trade secrets are disclosed. The bill also exempted trade secrets provided to the FCHLPM from the public records law. This bill had a significant impact on the FCHLPM s processes and procedures which were revised in September 2005 to conform with the new law. Since the FHCF staffs the FCHLPM, it also added to FHCF responsibilities. 10

15 History of Legislative Changes 1995 Tax-exempt status granted to the FHCF Retention and Payout Multiples created Three coverage options 45%, 75%, and 90% Non-residential commercial property insurance excluded Exposure reporting date moved to September 1 for exposures existing as of June 30 Loss reimbursement preferences provided to limited apportionment companies 1996 FHCF Finance Corporation created Provisions established for issuance of tax-exempt debt 1998 Advances provided to limited apportionment companies and residual market mechanisms 1999 Subsequent Season Capacity created Initial Season Capacity temporarily limited to $11 billion Emergency assessments set at 4% for debt service on storms occurring in one contract year and a 6% aggregate limit applied for emergency assessments for all years Limited insurers payout except for FRPCJUA and FWUA (now known as Citizens Property Insurance Corporation) Obtained authority to examine insurers records related to covered policies and losses 2002 Added coverage for Additional Living Expense (ALE) Added coverage for certain Collateral Protection Insurance Policies Provision established for inclusion of a rapid cash buildup factor 2004 Capacity was expanded by increasing emergency assessment authority sufficient to create $15 billion of capacity and capacity to grow with exposure growth The increase in assessment authority additionally allowed subsequent season capacity to expand to $15 billion Insurance industry aggregate retention was reset to $4.5 billion and designed to grow with exposure growth Emergency assessment authority increased to 6% for debt service on storms occurring in one contract year with a 10% aggregate limit for all years Emergency assessment base expanded to include surplus lines with provision for the insurer to collect the assessments from policyholders as premiums are paid Emergency assessments may be used for debt service coverage and may also be used to refinance debt Medical malpractice insurers excluded from emergency assessments for any covered event occurring prior to June 1, 2007 Exemption exposure limit increased to $10 million Selection of reinsurers broadened Added rulemaking authority to allow for interest charges on late remittances Added rulemaking authority to allow for the exclusion of certain deductible buy-back and commercial residential excess policies Mitigation appropriations based on the most recent fiscal year-end audited financial statements Allocation of excess recoveries between Citizens Property Insurance Corporation accounts clarified Flexibility provided for ALE coverage Audit requirement language changed to reference examination in lieu of audit 2005 Insurance industry aggregate retention reset to $4.5 billion and set to grow with exposure growth Full retention required for the insurer s two largest covered events and then only one-third of the full retention required for each subsequent covered event 11

16 Rulemaking Specific policies and provisions of the FHCF are outlined in the rules of the SBA. The rulemaking process includes workshops, hearings, approval by the FHCF Advisory Council, and adoption by the SBA Trustees. All of the meetings are open to the public, and input from participating insurers and all interested parties is encouraged. The rules are continually updated in order to accommodate new procedures and forms necessary for the administration of the FHCF. This past fiscal year, the SBA repealed Rule , F.A.C., Hurricane Mitigation and adopted the following rules: , F.A.C. Reimbursement Contract Adoption of the Reimbursement Contract , F.A.C. Procedures to Determine Ineligibility and Exemption from Participation in the FHCF , F.A.C. Issuance of Revenue Bonds , F.A.C. Reimbursement Premium Formula Adoption of the Contract Year Rates , F.A.C. Insurer Reporting Requirements Adoption of the Data Reporting Requirements of Insurer Exposure (Data Call) , F.A.C. Insurer Responsibilities Establishes certain deadlines and other requirements for insurers required to participate in the FHCF Emergency Rules In response to the 2005 Legislation, Emergency Rule 19ER05-1 (Reimbursement Contract) was promulgated and became effective on June 1, 2005, incorporating Addendum No. 1 to the FHCF Reimbursement Contract. 12

17 FHCF Participating Insurers Workshop The FHCF hosted its Fifth Annual Participating Insurers Workshop on May 19 and 20, The primary focus of the workshop is to educate participating insurers on FHCF requirements, insurer responsibilities, and any changes to the previous year s requirements and responsibilities. The workshop also provides an avenue for the FHCF to receive additional comments on its rules and documents. FHCF staff also focuses on activities of the FHCF and the insurance industry. This year s workshop opened with guest speaker Lisa Miller, Chief of Staff to the Honorable Tom Gallagher, Chief Financial Officer, Florida Department of Financial Services. Other topics included were: Key legislative changes impacting the FHCF and insurers A panel discussion on proposed legislation for the 2005 Legislative Session Changes to the upcoming contract year s Reimbursement Contract and Insurer Reporting Requirements (Data Call) An in-depth review of the 2004 Hurricane Season and its impact on the FHCF A panel discussion on the 2004 Hurricane Season from an insurance company perspective An overview of the FHCF bonding process and assessments The FHCF loss reimbursement examination program and review process Ratemaking and the use of models Tips for reporting exposure and loss data accurately An interactive session was provided on loss reimbursement reporting to the FHCF with actual scenarios from the 2004 events. 13

18 Examination Programs The SBA routinely conducts examinations of exposure data submitted by participating companies. The examinations are limited in scope and are intended to verify that participating companies are properly reporting their exposure. In addition, the examinations are used to review a participating insurer s compliance with FHCF data reporting requirements. Every participating company is required to report its exposure data annually and to generate an examination file that supports the reported data. The SBA provides notification to a company at least 60 days prior to commencement of an examination. The notification includes detailed instructions to the company on the required records needed for the examination. All information that supports a company s exposure is subject to examination. Previously conducted examinations have revealed several common errors. These include, but are not limited to: Incorrectly reporting ZIP Codes and construction characteristics (e.g., reporting the mailing ZIP Code rather than the property location ZIP Code), Omitting coverages or endorsements to property coverage, Reporting policies or coverages not to be reported (e.g., builders risk, wind exclusion, business interruption), Failure to report percentage deductibles. The following table reflects the adjustments made to insurers premium as a result of the examinations of exposure data and subsequent resubmissions to correct errors. 14

19 FHCF Examination Adjustments As of Contract Year Additional Premium Due Premium Refunds Made Net Results 1994 $7,832, ($10,572,916.19) ($2,740,878.43) 1995 $4,141, ($4,975,537.28) ($834,087.37) 1996 $3,095, ($2,389,171.29) $706, $3,457, ($4,166,782.27) ($709,353.92) 1998 $9,763, ($4,724,819.63) $5,039, $8,777, ($2,286,886.83) $6,491, $592, ($2,173,802.99) ($1,581,229.16) 2001 $1,586, ($1,219,890.39) $366, $1,225, ($1,542,388.46) ($316,556.59) 2003 $2,195, ($4,315,339.68) ($2,120,080.96) 2004 $482, ($1,141,013.12) ($658,057.34) 2005 $0 ($17,684,922.12) ($17,684,922.12) The SBA only conducts loss reimbursement examinations as reimbursements from the FHCF occur. With the recent events resulting in reimbursements to participating companies, the SBA has further developed the loss reimbursement examination program. Prior to the 2004 hurricane season, the FHCF conducted 18 examinations of companies reporting losses for Hurricane Erin and Hurricane Opal in Given the number of insurers expected to seek reimbursements from the FHCF for the 2004 and 2005 hurricane seasons, the number of exams to be conducted by the SBA has increased significantly. These exams are limited in scope and are intended to verify the accuracy of reported losses. The FHCF will provide at least 60 days notice in advance of a scheduled examination and this notification will contain detailed instructions on how the company can prepare for the examination. The FHCF began examinations of companies reporting claims as a result of the 2004 events in October, Companies are required to retain detailed records of all reported exposures and losses until the FHCF has completed an examination of these specific records. Retention of records is imperative since an examination may result in a resubmission of exposure data or an update to loss reports, which could result in an adjustment to a company s FHCF premium or loss recovery. 15

20 FHCF Loss Reimbursement Prior to 2004, only two hurricanes had resulted in reimbursement to participating insurers; however, the 2004 and 2005 hurricane seasons brought numerous loss recoveries from the FHCF. For companies submitting complete requests and having no outstanding FHCF issues, disbursements were made within 2-7 business days. A recap of FHCF reimbursements to participating insurers as of year end follows: As of Number of Total Total Companies Recovery Expected (In millions) with FHCF Paid (Excess to be Recoveries of Retention) Paid 1995 Erin, Opal 9 $13 $ Charley, Frances Ivan, Jeanne 132 $3,386 $3,850* 2005 Dennis, Katrina Rita, Wilma 24 $248 $2,586** Note: - Total of 137 insurers are expected to seek loss reimbursement from the FHCF for Total of 99 insurers are expected to seek loss reimbursement from the FHCF for 2005 * including reserves ** excluding reserves Bonding Program Revenue bonds are required to be issued if the FHCF s cash balance is anticipated to be insufficient to reimburse losses. There are two ways in which revenue bonds can be issued. One is in conjunction with counties or municipalities and the other is through the FHCF Finance Corporation. The FHCF Finance Corporation was created in the statute to allow the FHCF greater flexibility in planning. 16 In 2004 the FHCF Finance Corporation obtained an upgrade in its credit rating from Moody s, Standard and Poor s, and Fitch. Moody s upgraded the FHCF credit rating from A1 to Aa3, Standard and Poor s upgraded the FHCF credit rating from A+ to AA-, and Fitch upgraded its credit rating from A+ to AA. The FHCF Finance Corporation has validated the issuance of up to $10 billion of revenue bonds with the Florida Supreme Court. The FHCF Finance Corporation also has a United States Internal Revenue Service private letter ruling regarding the ability to issue tax-exempt debt. The initial ruling was granted on March 27, 1998 for five years until June 30, The ruling was renewed on June 13, 2003 for an additional five years, expiring on June 30, The FHCF has prepared preliminary bond documents and has a team of professionals in place to facilitate a series of bonding transactions should the cash available to pay claims be exhausted. The FHCF has been able to pay all reimbursements out of the FHCF s cash balance and bonding has not been required to date. As loss data is updated and reported quarterly, the FHCF will monitor the situation for adverse loss development trends that could trigger bonding. The funding source for the repayment of revenue bonds issued is through emergency assessments on all property and casualty lines of business in the state, including surplus lines, but excluding worker s compensation premiums and temporarily excluding medical malpractice premiums until June 1, 2007.

21 Estimated FHCF Claims Paying Capacity ($ billions) Projected Initial Subsequent 12/31 Season Claims Season Claims Year Bonding Capacity Fund Balance Paying Capacity Paying Capacity 1994 $2.0 $0.3 $ May October $ Initial/Subsequent Season Initial/Subsequent Season / $ / / / / / / / / / / / / The 1995 Legislative Session required bonding estimates to be published twice a year reflects a private letter ruling granting tax-exempt status to bonds. The 1999 Legislative Session resulted in limiting the overall capacity of the FHCF to $11 billion and providing for subsequent season capacity. Initial Season and Subsequent Season Claims Paying Capacity is based on the October Bonding Capacity Estimates. Subsequent Season Claims Paying Capacity consists of bonding plus available cash. The 2004 Legislative Session expanded the overall capacity of the FHCF to $15 billion. 17

22 Litigation The FHCF was not involved in any litigation during the fiscal year. Public Contributions When the Internal Revenue Service (IRS) issued a private letter ruling granting tax-exempt status to the FHCF, it contained a requirement that a certain amount of the funds in the FHCF be devoted to hurricane mitigation purposes. The purposes are specified in Section (7)(c), Florida Statutes: Each fiscal year, the Legislature shall appropriate from the investment income of the Florida Hurricane Catastrophe Fund an amount no less than $10 million and no more than 35 percent of the investment income from the prior fiscal year for the purpose of providing funding for local governments, state agencies, public and private educational institutions, and nonprofit organizations to support programs intended to improve hurricane preparedness, reduce potential losses in the event of a hurricane, provide research into means to reduce such losses, assist the public in determining the appropriateness of particular upgrades to structures or in the financing of such upgrades, or to protect local infrastructure from potential damage from a hurricane. Moneys shall first be available for appropriation under this paragraph in fiscal year Moneys in excess of the $10 million specified in this paragraph shall not be available for appropriation under this paragraph if the State Board of Administration finds that an appropriation of investment income from the fund would jeopardize the actuarial soundness of the fund. Beginning in 1999, the Florida Legislature created Section , Florida Statutes, which annually appropriates $10 million from the FHCF to the Department of Community Affairs for the Hurricane Loss Mitigation Program. 18

23 2005 Legislative Session Mitigation Funding Department of Community Affairs: Hurricane Loss Mitigation Program: retrofit public hurricane shelters $3,000,000 hurricane loss mitigation programs $7,000,000 Total Appropriation $10,000,000 FHCF Hurricane Mitigation Funding Appropriations Total Total Carried Forward Current Year Available for Appropriated Vetoed by Funded Year From Prior Years Appropriation Appropriation by Florida Governor by FHCF (a) (b) (c) = (a) + (b) Legislature 1997 $0 $10,000,000 $10,000,000 $10,000,000 $2,822,400 $7,177, $2,822,400 $10,000,000 $12,822,400 $12,500,000 $0 $12,500, $322,400 $10,000,000 $10,322,400 $10,300,000 $2,200,000 $8,100, $2,222,400 $10,000,000 $12,222,400 $12,200,000 $0 $12,200, $22,400 $30,000,000 $30,022,400 $30,000,000 $0 $30,000, $22,400 $19,075,309 $19,097,709 $19,075,309 $0 $19,075, $22,400 $10,000,000 $10,022,400 $10,000,000 $0 $10,000, $22,400 $10,000,000 $10,022,400 $10,000,000 $0 $10,000, $22,400 $10,000,000 $10,022,400 $10,000,000 $0 $10,000, $22,400 Total Funds provided to the State of Florida from the FHCF $119,052,909 19

24 CONSUMER INFORMATION Following Hurricane Andrew, residential property insurers began to re-evaluate their commitment to the Florida market in light of the fact that there were major difficulties obtaining private reinsurance. The Florida Hurricane Catastrophe Fund (FHCF) was created in a special legislative session in November 1993 in the aftermath of Hurricane Andrew in order to provide additional reinsurance capacity to enable insurers to continue to write business in the state. The FHCF has been important in helping insurers meet their responsibilities to Florida residential policyholders following the catastrophic hurricanes that hit Florida. The FHCF has no underwriting costs since it is a mandatory state program requiring a certain level of participation by all insurers who write residential property insurance in the state. Since the FHCF is a program that benefits the citizens of the state and is under the control of elected officials, the FHCF is a tax-exempt entity that does not pay federal income taxes or state taxes. The FHCF has the ability to issue tax-exempt debt which will result in lower financing costs should the need arise to finance losses with revenue bonds. The FHCF provides very economical coverage for insurers writing residential insurance in the state. It is estimated that coverage purchased through the FHCF costs insurers between one-fourth to onethird what it would cost in the private reinsurance market. There are several reasons for these cost savings, which include the following: The FHCF operating cost is less than 1% of the annual premium collected compared with the operating costs associated with private reinsurance, which can range between 10% to 15% of the premium collected. The FHCF does not include a factor for profits in its rates, neither does it pay reinsurance brokerage commissions. The FHCF is financed by three sources: 1) reimbursement premiums charged to participating insurers, 2) investment earnings, and 3) emergency assessments on all Florida property and casualty business (including surplus lines, but excluding medical malpractice until June 1, 2007, and workers compensation). Emergency assessments have never been levied, but may be necessary in the future if the available cash balance of the fund becomes insufficient to reimburse losses to insurers. For additional information regarding the FHCF, please review the information provided on the FHCF web site at Most of the documents, including the FHCF s most recent annual report, are published on the web site along with a current listing of FHCF participating insurers. If you have additional questions, please feel free to contact the FHCF staff. 20

25 FHCF AT-A-GLANCE Fiscal Year (as of ) Created: November, 1993 No. of Participating Insurers: 205 Premium Billed: $735.6 million Exposure: $1.53 trillion Projected Fund Balance: $3.07 billion Mitigation Funding for 2005: $10 million Claims Paying Capacity: Initial Season Subsequent Season $15 billion $15 billion Bonding Capacity: Initial Season Subsequent Season $11.95 billion $14.20 billion Emergency Assessments (available): $1,881 million (6%) Initial Season (required) $775.8 million (2.47%) Subsequent Season (required) $935.7 million (2.99%) Assessment Base: $31.3 billion includes Surplus Lines and all P&C lines except worker s compensation, and accident and health, and medical malpractice until June 1, Retention Multiples: 90% % % Payout Multiple: Moody s, Standard & Poor s, and Fitch Ratings: Aa3/AA-/AA Tax Status: Tax-Exempt Trust Fund Tax-Exempt Bonds 21

26 STATISTICAL INFORMATION 2005 Exposure Concentration by County ($ billions) Total % of Total County Exposure* Exposure Palm Beach $ % Broward Miami-Dade Orange Hillsborough Pinellas Lee Duval Collier Brevard Other Total $1, % 2004 Exposure Concentration by County ($ billions) Total % of Total County Exposure* Exposure Palm Beach $ % Miami-Dade Broward Orange Hillsborough Pinellas Lee Duval Collier Brevard Other Total $1, % 79% of the FHCF exposure is located in Florida s thirty-five coastal counties, making Florida particularly vulnerable. *Updated as of 12/31/05 22

27 Participating Insurers by Coverage Option Selection FHCF Premium by Coverage Option 45% 75% 90% # of % of % of # of % of % of # of % of % of Insurers Insurers Premium Insurers Insurers Premium Insurers Insurers Premium 1995/ % 12.2% % 2.8% % 85.0% 1996/ % 9.9% % 2.2% % 87.9% 1997/ % 7.0% % 2.0% % 91.0% 1998/ % 6.2% 8 2.6% 1.3% % 92.5% 1999/ % 5.2% 8 2.8% 1.2% % 93.6% 2000/ % 4.06% 5 1.7% 0.025% % 95.91% 2001/ % 2.14% 2 0.7% 0.001% % 97.86% 2002/ % 1.30% 2 0.8% 0.001% % 98.70% 2003/ % 1.56% 1 0.4% 0.000% % 98.44% 2004/ % 1.00% 1 0.4% 0.000% % 99.00% 2005/ % 0.50% 0 0.0% 0.000% % 99.50% 23

28 Statistical Summary as of 12/31/05 ($ billions) October Projected Claims Projected Contract FHCF Bonding 12/31 Paying Payout Number of Year Premium (1) Capacity Fund Balance (2) Capacity (3) Multiple Exposure (4) Participants (a) (b) (c)=(a)+(b) 95/96 $0.439 $4.0 $0.9 $ $ / / / / / / / , / , /05a /05b , / , (1) - FHCF premium for contract years 95/96, 96/97, and 97/98 are as of 12/31/03. - FHCF premium for contract years 98/99 and 99/00 is the premium received as of 12/31 each year. By definition, these premium factors were used to calculate the Projected Payout Multiple for each contract year, and as such, have not been updated to reflect subsequent changes. - FHCF premium for contract years 00/01 through 04/05 is the premium billed as of 12/31 of each year. By definition, similar to the above, this premium is locked. - FHCF premium for contract year 04/05a is as if all companies chose the transitional option. FHCF premium for Contract Year 04/05b is as if all companies did not choose the transitional option. Actual FHCF premium billed for contract year 04/05 at 12/31/04 was $ million. (2) Beginning with Contract Year 02/03, Fund Balance represents the Net assets: Unrestricted as reported on the 12/31 FHCF Statement of Net Assets. (3) The 1999 Legislative Session resulted in limiting the overall single-season capacity to $11 billion and provided for subsequent season capacity. (4) Excludes Section II (Excess insurance). Retention Multiples Contract Year 45% 75% 90% 95/ / / / / / / / / /05 $11B xs $4.9B /05 $15B xs $4.5B /

29 2005 TROPICAL CYCLONES IN THE ATLANTIC BASIN TS TS H H H TS TS TS H TS H TS H H Arlene Bret Cindy Dennis Emily Franklin Gert Harvey Irene Jose Katrina Lee Maria Nate H H H H TS H H TS H TS TS H TS Ophelia Philippe Rita Stan Tammy Vince Wilma Alpha Beta Gamma Delta Epsilon Zeta TS Tropical Storm H Hurricane Storms making landfall in Florida The FHCF was required to pay losses for the 2005 hurricane season. Number of Insurers Having Losses in Over $500 million $100 million to $500 million $25 million to $100 million 33 No Losses 35 $5 million to $25 million $7.893 Billion incurred ultimate loss reported as of 12/31/05 88 Less Than $5 million 25

30 2004 TROPICAL CYCLONES IN THE ATLANTIC BASIN H TS H H TS H TS TS H H H TS TS TS TS Alex Bonnie Charley Danielle Earl Frances Gaston Hermine Ivan* Jeanne Karl Lisa Matthew Nicole Otto TS Tropical Storm H Hurricane Storms making landfall in Florida *made landfall in Alabama with extensive damage in Florida The FHCF was required to pay losses for the 2004 hurricane season. Top 10 Most Expensive U.S. Catastrophes Insured Loss (in $ millions) Dollars In 2005 Rank Date Peril When Incurred Dollars 1 Aug Hurricane Katrina $38,100 $38,100 2 Aug Hurricane Andrew 15,500 21,579 3 Sep World Trade Center, Pentagon terrorist attacks 18,800 20,716 4 Jan Northride, CA earthquake 12,500 16,475 5 Oct Hurricane Wilma 8,400 8,400 6 Aug Hurricane Charley 7,475 7,729 7 Sep Hurricane Ivan 7,110 7,352 8 Sep Hurricane Hugo 4,195 6,608 9 Sep Hurricane Rita 5,000 5, Sep Hurricane Frances 4,751 4,751 (1) Property coverage only. As of November Source: ISO; Insurance Information Institute. 26

31 THE PEOPLE WHO MAKE IT POSSIBLE STATE BOARD OF ADMINISTRATION OF FLORIDA Trustees The Honorable Jeb Bush Governor, State of Florida The Capitol Tallahassee, FL The Honorable Charlie Crist Attorney General, State of Florida The Capitol Tallahassee, FL The Honorable Tom Gallagher Chief Financial Officer, State of Florida The Capitol Tallahassee, FL Florida Hurricane Catastrophe Fund Staff 1801 Hermitage Boulevard, Suite 100, Tallahassee, FL Jack E. Nicholson, Ph.D., CLU, CPCU Senior FHCF Officer Ph: (850) Anne T. Bert, CPM Director of Operations Ph: (850) Tracy L. Allen, J.D., LLM Senior Attorney Ph: (850) Donna Sirmons Management Review Analyst Ph: (850) Ramona A. Worley Budget Analyst II Ph: (850) Marcie Vernon, CPM Audit Program Analyst Ph: (850) Executive Director Coleman Stipanovich State Board of Administration of Florida 1801 Hermitage Boulevard, Suite 100 Tallahassee, FL Ph: (850) Gina Wilson, CPA (GA), CPM, CPCU, ARe Manager, FHCF Audit Program Ph: (850) Patti Elsbernd Management Assistant, Audit Program Ph: (850) (as of 12/31/05) 27

32 FHCF Advisory Council Members John Auer, CPCU (Vice Chair) American Strategic Insurance Corp. St. Petersburg, FL Leslie Chapman-Henderson FLASH, Inc. Tallahassee, FL Jim W. Henderson, CPA, CPCU Brown & Brown, Inc. Daytona Beach, FL Leslie Hudson WESH-TV Winter Park, FL William H. Huffcut Tallahassee, FL Larry Johnson, FCAS, MAAA Allstate Insurance Company Northbrook, IL Robert M. Peduto GE Insurance Solutions Overland Park, KS Michael J. Svaldi Miami, FL Joseph Varon, P.E. (Chair) Quick Tie Products, Inc. Jacksonville, FL FHCF Service Providers Financial Services: Raymond James & Associates 880 Carillon Parkway St. Petersburg, FL Ph: (727) Administrative Services: Paragon Strategic Solutions Inc American Boulevard West Suite 700 Minneapolis, MN Ph: (800) Actuarial Consulting Services: Paragon Strategic Solutions Inc American Boulevard West Suite 700 Minneapolis, MN Ph: (800) Exposure Examination Services: Timothy J. Butler, CFE, ARe, CPM President Regulatory Insurance Consulting Services, Inc. Tallahassee, FL Kevin Machia, CFE Montgomery, VT Wendell McDavid, AIE Ellenwood, GA James E. Salter, CPA, CFE President BD Regulatory Services, LLC Williston, VT Harold S. Tattershall, AIE San Antonio, TX Loss Examination Services: Examination Resources, LLC Atlanta, GA Financial Auditing Services: Ernst & Young LLP Minneapolis, MN 28

33 AUDITED FINANCIAL STATEMENTS Financial Statements and Other Financial Information Florida Hurricane Catastrophe Fund Years ended June 30, 2005 and 2004 Report of Independent Auditors The Trustees of the State Board of Administration of Florida Florida Hurricane Catastrophe Fund We have audited the accompanying financial statements of the Florida Hurricane Catastrophe Fund as of and for the years ended June 30, 2005 and These financial statements are the responsibility of the Florida Hurricane Catastrophe Fund s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States and the standards for financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Florida Hurricane Catastrophe Fund s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Florida Hurricane Catastrophe Fund s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As described in Note 1, the financial statements present only the financial position of the Florida Hurricane Catastrophe Fund and are not intended to present fairly the financial position of the State Board of Administration of Florida and the results of its operations and cash flows of its proprietary fund types and nonexpendable trust funds, in conformity with accounting principles generally accepted in the United States. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Florida Hurricane Catastrophe Fund as of June 30, 2005 and 2004, and the results of its operations for the years then ended, in conformity with accounting principles generally accepted in the United States. In accordance with Government Auditing Standards, we have issued our report dated September 1, 2005, on our consideration of the Florida Hurricane Catastrophe Fund s internal control over financial reporting and our tests of its compliance with certain provisions of laws, regulations, contracts, and grants. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be read in conjunction with this report when considering the results of our audits. Minneapolis, Minnesota September 1, 2005, except for Note 10, as to which the date is October 31, 2005 A Member Practice of Ernst & Young Global 29

34 Florida Hurricane Catastrophe Fund Statements of Net Assets (In Thousands) June Assets Current assets: Cash and cash equivalents $ 1 $ 35,005 Short-term investments 2,488,541 3,477,920 Security lending receivable 1,361 1,245 Security lending collateral 716, ,050 Accrued interest 7,009 8,383 Loss reimbursement advances receivable 20,485 Excess loss payments receivable 704 Premiums receivable, net 67 2 Total current assets 3,235,131 4,476,605 Long-term assets: Long-term investments 819,180 1,989,587 Capital assets, net of accumulated depreciation of $94 and $85 for June 30, 2005 and 2004, respectively Total long-term assets 819,190 1,989,602 Total assets $4,054,321 $6,466,207 Liabilities and net assets Current liabilities: Hurricane losses: Unpaid hurricane losses $ 925,827 $ Losses payable 22,619 Obligation under security lending agreement 699, ,017 Premium refunds payable 19 Accrued expenses 1,712 1,134 Pending investment purchases 34,998 Security lending pending investment purchases 17,696 2,781 Total current liabilities 1,667, ,930 Long-term liabilities: Compensated absences, net of current portion Total long-term liabilities Total liabilities 1,667, ,015 Net assets: Unrestricted 2,288,307 5,476,155 Invested in capital assets, net of related debt Restricted by legislature 98,725 Restricted for hurricane mitigation Total net assets 2,387,064 5,476,192 Total liabilities and net assets $4,054,321 $6,466,207 See accompanying notes. 30

35 Florida Hurricane Catastrophe Fund Statements of Revenues, Expenses, and Changes in Net Assets (In Thousands) Year Ended June Operating revenues: Current contract year premium revenue $ 617,208 $ 488,465 Prior contract year adjustment: Premium billed 2,020 1,729 Premium refunded (2,276) (1,612) Premium interest 137 (27) Net premium revenue 617, ,555 Net interest on loss disbursements and adjustments 1,118 Total operating revenues 618, ,555 Operating expenses: Hurricane losses 3,750,000 Administrative and actuarial fees 2,409 2,305 Other professional fees Personnel expenses Depreciation 9 15 Other Total operating expenses 3,754,161 3,928 Operating (loss) income (3,135,954) 484,627 Nonoperating revenue (expense): Investment income 107,689 56,953 Investment advisor fees (685) (882) Security lending income 20,744 10,864 Security lending expense (19,076) (8,808) Security lending net appreciation (571) 418 Total nonoperating revenue 108,101 58,545 (Loss) income before transfers (3,027,853) 543,172 Transfers to other funds (61,275) (10,000) Change in net assets (3,089,128) 533,172 Net assets, beginning of year 5,476,192 4,943,020 Net assets, end of year $2,387,064 $5,476,192 See accompanying notes. 31

36 Florida Hurricane Catastrophe Fund Statements of Cash Flows (In Thousands) Year Ended June Operating activities Premium received $ 617,043 $ 488,459 Hurricane losses paid (2,479,869) Administrative and actuarial fees (2,293) (2,219) Loss reimbursement advances and related interest (341,756) Other professional fees (848) (810) Personnel expenses (677) (648) Other operating expenses (137) (149) Net cash (used in) provided by operating activities (2,208,537) 484,633 Investing activities Purchases of investments (102,453,214) (65,142,090) Sales and maturities of investments 104,585,517 64,618,062 Interest received 101,523 83,276 Investment advisor fees (718) (879) Security lending 1,705 2,011 Net cash provided by (used in) investing activities 2,234,813 (439,620) Financing from noncapital activities Transfers to other funds (61,275) (10,000) Financing from capital activities Purchases of capital assets (5) (11) Net (decrease) increase in cash and cash equivalents (35,004) 35,002 Cash and cash equivalents at beginning of year 35,005 3 Cash and cash equivalents at end of year $ 1 $ 35,005 See accompanying notes. 32

37 Florida Hurricane Catastrophe Fund Reconciliations of Operating Income to Net Cash Provided by Operating Activities (In Thousands) Year Ended June Operating (loss) income $(3,135,954) $484,627 Adjustments to reconcile operating (loss) income to net cash (used in) provided by operating activities: (Increase) decrease in premiums receivable, net (65) 118 Increase (decrease) in premium refunds payable 19 (214) Increase in unpaid hurricane losses 925,827 Increase in losses payable 22,619 Increase in loss reimbursement advances receivable (20,485) Increase in excess loss payments receivable (704) Increase in accrued expenses Depreciation 9 15 Net cash (used in) provided by operating activities $(2,208,537) $484,633 See accompanying notes. Florida Hurricane Catastrophe Fund Notes to Financial Statements 1. Organization Business June 30, 2005 The Florida Hurricane Catastrophe Fund (the Fund), which was created in November 1993 during a special legislative session following Hurricane Andrew, provides catastrophic reinsurance coverage to all authorized primary insurers of habitational structures with wind/hurricane coverage in the state of Florida. Premiums are calculated for each of the approximately 230 insurers using rates developed based on hurricane modeling of the trended data from the prior year. The modeling takes into consideration factors such as historical records of hurricane strength and landfall patterns, geographic location, type of business, construction, coverage selected, and deductions. The Fund is administered by the State Board of Administration of Florida (SBA), which has contracted for administrative and actuarial services. Basis of Presentation The Fund is classified as an enterprise fund, which is a type of proprietary fund. The financial statements of proprietary funds are prepared using the economic resources measurement focus and the accrual basis of accounting. All assets and liabilities associated with the operations of this fund are included in the statement of net assets. The statement of revenues, expenses, and changes in net assets presents increases (revenues) and decreases (expenses) in net total assets. The statement of cash flows provides information about how the Fund finances and meets the cash flow needs of its activities. 33

38 The financial statements presented herein relate solely to the financial position and results of operations of the Fund and are not intended to present the financial position of the SBA or the results of its operations and cash flows. The Fund follows Governmental Accounting Standards Board (GASB) pronouncements and only Financial Accounting Standards Board pronouncements issued before December 1, 1989, that do not conflict with or contradict GASB pronouncements. Limited Liability of the Fund The Fund s obligation to participating insurers, in the event of a hurricane(s) that causes reimbursable losses, is limited to the claims-paying capacity of the Fund. For the purpose of defining claims-paying capacity, the SBA shall use the unrestricted net assets as of December 31 of the applicable contract year, to which is added reported fund losses (including loss adjustment expense) for the then-current contract year, whether paid or unpaid by the Fund, as of December 31; any reinsurance purchased by the Fund; and the amount the SBA is able to raise through the issuance of revenue bonds up to the statutory annual aggregate fund limit; and from which is subtracted any reinsurance recovered prior to, or recoverable as of, December 31; any obligations paid or expected to be paid with bonding proceeds or receipts from emergency assessments; amounts needed for administration for the then-current state of Florida fiscal year which have not been spent and which are not reflected on the statement of net assets; and the amount of mitigation funds appropriated for the then-current state of Florida fiscal year. If revenue bonds are issued under authorization of Section (6) of the Florida Statutes, the SBA shall direct the Florida Office of Insurance Regulation to levy an emergency assessment on each insurer writing property and casualty business in this state. The Fund, therefore, has no risk that it will be unable to meet its contractual obligations to participating insurers because its obligation is limited to its ability to pay. If bonds are issued on behalf of the Fund, the state of Florida assumes no liability for the repayment of the bonds. Additionally, the state of Florida has no legal responsibility to make any contribution to the Fund should its obligations exceed available resources. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Although estimates are considered to be fairly stated at the time the estimates are made, actual results could differ from those estimates. 2. Significant Accounting Policies Measurement Focus As mentioned in Note 1, the Fund uses the economic resources measurement focus and the accrual basis of accounting. Under the accrual basis of accounting, premium revenues are recognized when billed. Expenses are recorded at the time they are incurred Investments The Fund invests all funds in relatively low-risk, highly liquid fixed-maturity securities. These investments are recorded at fair 34

39 value, and the fair values are primarily obtained from independent quoted market prices. No investments were recorded at amortized cost as of June 30, 2005 and The Fund considers all investments with maturity dates of less than one year to be short-term investments. Investments with maturity dates in excess of one year are included in long-term investments. Investment advisory services are provided by the SBA. Security Lending The Fund, under authorization of Section (16) of the Florida Statutes, engages in security lending. In a security lending program, a lender (i.e., the Fund) loans various securities to a borrower for collateral with a simultaneous agreement to return the collateral for the same securities in the future. The market value of the loaned securities is monitored on a daily basis with additional collateral obtained or refunded as the market value of the loaned securities fluctuates. Initial collateral on cash or U.S. government securities is required at a rate of at least 100% of the market value of a loaned security. The obligation recorded as a current liability represents the obligation to return the collateral received. Interest earned on shortterm investments purchased with the cash collateral held is recognized as revenue. Lending agent costs and borrower rebate fees are recognized as expenses when incurred. Premiums Receivable Premiums receivable represent amounts from previous billings that have not yet been collected and are net of any allowances management has established to anticipate uncollectible billings. Loss Reimbursement Advances Receivable Certain companies may qualify for advances from the Fund, which are in essence loans based on a company s potential recoveries from the Fund (e.g., based on incurred losses rather than paid losses). Loss reimbursement advances receivable represent amounts currently outstanding on these advances, including accrued interest. Capital Assets Capital assets, primarily electronic data processing equipment, are stated at cost, less accumulated depreciation. Depreciation is recorded on a straight-line basis over the estimated useful lives, ranging from three to seven years. Premium Refunds Payable Premium refunds payable represent amounts due to participating insurers where provisional or estimated premium payments are in excess of amounts actually owed based upon the current exposure data. Also included are premium amounts received from companies pending exemption. These amounts are returned once an exemption is granted. Compensated Absences Compensated absences represent the Fund s obligation to accrue a liability for employees rights to receive compensation for future absences, such as vacation and sick leave. The Fund allows vested employees to carry forward any unpaid leave indefinitely. The short-term portion of this liability, $42,000 in 2005 and $43,000 in 2004, is included in accrued expenses on the statements of net assets. The remaining liability is included as compensated absences with long-term liabilities on the statements of net assets. 35

40 Current Contract Year Premium Revenue Premium revenue is recognized when billed. Coverage is provided to the participating insurers on a contract-year basis, which runs from June 1 to May 31. Premiums are billed in three installments, with provisional payments due August 1 and October 1 and a final payment due December 1. Prior Contract Year Adjustments Participating insurers remit premium to the Fund based upon current policyholder exposure information. When insurers provide updated or corrected exposure information, the Fund may bill and receive additional premium relating to a prior contract year; the Fund may also be required to refund amounts to insurers relating to a prior contract year. Operating Revenues and Expenses Operating revenues are those revenues that are generated directly from the primary activity of the proprietary fund. For the Fund, these revenues are primarily the premiums charged to all participating insurers. Operating expenses include incurred losses and necessary costs incurred to provide and administer catastrophic reinsurance to the Fund s participants. Net Interest on Premium Adjustments Participating insurers have the option of paying the billed provisional premium or estimating premium for the August and October installments. If the provisional or estimated payments were too high, interest is returned to the insurer on the overpayment. Likewise, if estimated premiums were underpaid, interest is charged to the insurer with the December installment. For the contract years ended May 31, 2005 and 2004, the interest rate was 1.65% for overpayments of premium and 4.65% for underestimated payments. Hurricane Losses Hurricane losses represent the estimated ultimate cost of all reported and unreported claims incurred during the year that exceed the participating insurers individual company retention levels. The reserves for unpaid claims are estimated primarily by management s review of reported loss information obtained from the participating insurers. Although considerable variability is inherent in such estimates, management believes that the reserves for hurricane losses are adequate. The estimates are continually reviewed and adjusted as experience develops or new information becomes known, and such adjustments are included in current operations. Operating Transfers Pursuant to Section (7)(c) of the Florida Statutes, the Florida Legislature will appropriate from the Fund an amount no less than $10,000,000 and no more than 35% of the investment income from the prior fiscal year, providing that the actuarial soundness of the Fund is not jeopardized, for the purpose of providing funding for governments, agencies, and educational institutions to support programs intended to improve hurricane preparedness or reduce potential losses in the event of a hurricane. For these purposes, in fiscal year and , $10,000,000 and $10,000,000, respectively, was appropriated from the Fund, and $22,400 was available from prior years. The remaining $22,400 available for transfer in fiscal year has been restricted in the June 30, 2005, net assets for future transfer. 36

41 Pursuant to Chapter of House Bill Number 9A, the Legislature appropriated $150,000,000 for the Hurricane Multiple Deductible Reimbursements Program for reimbursements to residential property insurance policyholders for the expense of multiple hurricane deductibles. Of this appropriation, $51,275,300 had been paid and $98,724,700 remained restricted as of June 30, Income Taxes The Fund is exempt from federal and state income taxes. This tax-exempt status was affirmed by a private letter ruling obtained from the Internal Revenue Service in November Investments The Fund is authorized to invest in accordance with Section of the Florida Statutes, which includes, but is not limited to, certificates of deposit, commercial paper, U.S. government agency notes, U.S. Treasury bills, repurchase agreements, and variable rate notes that enhance the Fund s investment income while maintaining liquidity. As of June 30, 2005, the Fund held the following investments (in thousands): Fair Value Weighted Average Investment Type Maturity (Days) Certificates of deposit $ 99, Commercial paper 1,651, Corporate bonds and notes 859, U.S. agencies callable 347, U.S. agencies callable stepped 348, Total fair value 3,307,721 Portfolio weighted average maturity 62 Securities lending short-term collateral investment pool 716, $4,024,684 Interest Rate Risk Liquidity being a primary concern, the investment policy objective is to invest in highly liquid, relatively short-term investment strategies which are reviewed on an annual basis to ensure the appropriateness of the strategic goal. The Fund utilizes the weighted average maturity method to limit exposure to interest rate risk. In accordance with the policy, no individual security shall have a final maturity date longer than five years and the weighted average maturity of the portfolio shall not exceed 365 days. For purposes of this calculation, the maturity date is assumed to be the next reset date rather than the stated maturity. At June 30, 2005, the Fund held $348,868,706 in callable stepped notes issued by the Federal Home Loan Bank System. A stepup note grants the issuer the option to call the note on certain specified dates. At the call date, should the issuer not call the note, the coupon rate of the note increases (steps up) by an amount specified at inception. 37

42 Credit Risk Funds are invested in accordance with Section of the Florida Statutes, which includes, but is not limited to, certificates of deposit, commercial paper, U.S. government agency notes, U.S. Treasury bills, repurchase agreements, and variable rate notes that enhance the Fund s investment income while maintaining liquidity. The investment policy further states that all securities must be investment grade at the time of purchase. For short-term ratings, this has been defined as the highest applicable rating by at least one nationally recognized statistical rating organization. For long-term ratings, this has been defined as BBB or better by at least two nationally recognized statistical rating organizations. The schedule below provides the credit quality ratings by Standard and Poor s and Moody s Investor Services at June 30, 2005 (in thousands). Investment Type Fair Value S&P Moody Certificates of deposit $ 99,998 A Not rated Commercial paper 33,155 A-1 Not rated Commercial paper 1,589,230 A-1 P-1 Commercial paper 29,371 Not rated P-1 Corporate bonds and notes 35,000 AAA Aaa Corporate bonds and notes 49,975 AA Not rated Corporate bonds and notes 35,000 A-1 Aaa Corporate bonds and notes 345,020 A Aa Corporate bonds and notes 240,260 A A Corporate bonds and notes 153,854 A Not rated U. S. agencies 696,858 AAA Aaa Total fair value 3,307,721 Securities lending short-term collateral investment pool 716,963 Not rated Not rated $4,024,684 Concentration of Credit Risk Securities of a single issuer shall not represent more than 5% of portfolio amortized cost (excluding U.S. Treasuries and Agencies) if less than one year to final maturity. If greater than one year to final maturity, single issuer exposure will be limited to 3% of portfolio amortized cost. At June 30, 2005, the Fund held $609,495,957 in U.S. Agencies issued by the Federal Home Loan Bank System which represents 18.4% of total investments. Custodial Credit Risk Custodial credit risk is defined as the risk that the Fund may not recover securities held by another party. The Fund does not have a formal investment policy for custodial credit risk. At June 30, 2005, all investments held were either insured or registered and held by the Fund or its agent in the Fund s name. Foreign Currency Risk No exposure to foreign currency risk existed at June 30,

43 Securities Lending Transactions The Fund, under authorization of Section (16) of the Florida Statutes, engages in security lending transactions. Cash collateral invested in the lending agent s short-term investment pool at June 30, 2005 had a weighted average maturity of 26 days. There was no credit risk exposure to borrowers at year-end. The investment pool is not rated. The fair value of the Fund s investments and security lending collateral is as follows (in thousands): June Short-term investments Investments: Certificates of deposit $ 99,998 $ 224,951 Commercial paper 1,651,755 2,360,843 U.S. government and federally guaranteed obligations 198,188 Federal agencies 447,929 Repurchase agreements 1 Corporate bonds and notes, fixed rate 28,370 Corporate bonds and notes, variable rate 288, ,567 Total short-term investments $2,488,541 $3,477,920 Long-term investments Investments: Certificates of deposit $ $ 50,000 Federal agencies 248, ,527 Corporate bonds and notes, variable rate 570,250 1,012,060 Total long-term investments $ 819,180 $1,989,587 Security lending short-term collateral investment pool $ 716,963 $ 954, Security Lending The Fund has a contract with Dresdner Bank to act as a lending agent in the performance of security lending transactions. Under the security lending program, Dresdner Bank delivers various securities of the Fund to authorized brokers in return for collateral in the form of cash or U.S. government securities. Borrowers under the transactions must be approved by Dresdner Bank s credit department, and Dresdner Bank is required to indemnify the Fund if the borrower fails to return the underlying securities or fails to pay income distributions on them. The Fund is contractually limited from pledging or selling collateral represented by loaned securities except in the event of borrower default. No violations of legal or contractual provisions occurred, and no losses were incurred due to borrower or lending agent defaults in The collateral held represents 102% in 2005 and 101% in 2004 of the market value of the securities lent. Dresdner Bank monitors daily the market value of the securities lent and requests additional collateral if the collateral for any loan is less than 100% of the market value of the underlying securities for that loan. The Fund had no credit risk exposure to borrowers at June 30, 2005 or 2004, because the amounts the Fund owes the borrowers exceed the amounts the borrowers owe the Fund. 39

44 The collateral held as assets is recorded in the balance sheet at fair value in accordance with Statement No. 31. Obligations under the program are recorded as liabilities based on the cash value of the collateral received. Details of the lending transactions for the Fund at June 30, 2005 and 2004, are as follows (in thousands): Fair Value Cash Fair Value of Underlying Collateral of Collateral Securities on Loan Securities Lent Held Investment Pool 2005 U.S. obligations $686,840 $699,292 $716, U.S. obligations 937, , ,050 As of June 30, 2005 and 2004, the Fund held $699,291,575 and $951,017,288, respectively, of cash collateral from Dresdner Bank. The cash was reinvested in various short-term instruments as authorized by the security lending agreement. Maturities of investments made with cash collateral generally are not matched to maturities of the securities loans, due to securities loan agreements being open-ended with no fixed expiration date. 5. Capital Assets A summary of the Fund s capital assets and the related accumulated depreciation for the years ended June 30, 2005 and 2004, is as follows (in thousands): Accumulated Equipment Depreciation Net Balance as of June 30, 2003 $138 $(109) $29 Additions 1 (15) (14) Sales or disposals (39) 39 Balance as of June 30, (85) 15 Additions 4 (9) (5) Sales or disposals (1) 1 Balance as of June 30, 2005 $103 $(93) $10 6. Hurricane Losses The state of Florida was hit by four hurricanes during August and September of These hurricanes were category 4 Hurricane Charley on August 13, category 2 Hurricane Frances on September 4, category 3 Hurricane Ivan on September 16, and category 3 Hurricane Jeanne on September 25. Hurricane losses incurred for the year ended June 30, 2005, were $3.75 billion. Hurricane losses paid during the year ended June 30, 2005, were $2.82, billion resulting in remaining reimbursable losses of $926 million at June 30, There were no hurricane losses for the year ended June 30,

45 7. Compensated Absences Compensated absences were as follows (in thousands): Balance as of June 30, 2003 $119 Increases 63 Decreases (54) Balance as of June 30, * Increases 59 Decreases (53) Balance as of June 30, 2005 $134* * Includes long-term and short-term balances, of which $42 and $43 is estimated due within one year of June 30, 2005 and 2004, respectively. 8. Premium Revenues Fiscal year premiums, net of prior contract year adjustments, as reported in the statements of revenue, expenses, and changes in net assets, relate to contract years as follows (in thousands): Year Ended June Contract year 2004 $617,262 $ Contract year 2003 (236) 488,329 Contract year (28) Contract year Contract year 2000 (37) $617,089 $488, Related Parties The Fund paid the SBA approximately $760,000 and $957,000 in the fiscal years ended June 30, 2005 and 2004, respectively, for investment advisory services. 10. Subsequent Events The state of Florida was hit by four hurricanes during July through October These hurricanes, at the time they impacted Florida, were: category 3 Hurricane Dennis on July 10, category 1 Hurricane Katrina on August 25, category 1 Hurricane Rita on September 20, and category 3 Hurricane Wilma on October 24. The participating insurers are required to submit a Proof of Loss Report for each storm by December 31, The Fund s liability for losses will not be known until that time. Preliminary modeling results indicate that the Fund should have sufficient unrestricted net assets to cover this liability. 41

46 OTHER FINANCIAL INFORMATION Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards The Trustees of the State Board of Administration of Florida Florida Hurricane Catastrophe Fund We have audited the financial statements of the Florida Hurricane Catastrophe Fund (the Fund) as of and for the years ended June 30, 2005 and 2004, and have issued our report thereon dated September 1, We conducted our audit in accordance with auditing standards generally accepted in the United States and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Internal Control Over Financial Reporting In planning and performing our audit, we considered the Fund s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide an opinion on the internal control over financial reporting. Our consideration of the internal control over financial reporting would not necessarily disclose all matters in the internal control over financial reporting that might be material weaknesses. A material weakness is a reportable condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements caused by error or fraud in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving the internal control over financial reporting and its operation that we consider to be material weaknesses. Compliance and Other Matters As part of obtaining reasonable assurance about whether the Fund s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit and, accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. This report is intended solely for the information and use of the Florida Auditor General and the management of the State Board of Administration of Florida and is not intended to be and should not be used by anyone other than these specified parties. Minneapolis, Minnesota September 1,

47 Hurricane Dennis, July 8, 2005 PHOTO CREDITS: FEMA, NASA, NOAA