CEA funding structure to be revamped under legislation sent to governor

By | September 24, 2007

By a wide margin, California lawmakers have approved a compromise between the California Earthquake Authority’s governing board and its participating homeowner insurers to replace a significant portion of the CEA’s statutory funding set to expire next year. The legislation was approved less than 48 hours before the Legislature adjourned its regular session for 2007.

If Gov. Arnold Schwarzenegger signs SB 430 into law, it would avert potential solvency and rating problems for the CEA. The governor has not taken a position on the measure, according to a spokeswoman, Sabrina Lockhart.

Under the CEA’s authorizing legislation enacted in 1996, the CEA is authorized to assess participating insurers up to $3.6 billion to pay claims after a major earthquake. The legislation calls for that portion of the so-called “layer cake” of the CEA’s funding to expire Dec. 1, 2008, 12 years after the CEA began operations as a state-administered, insurer funded residential seismic risk pool.

The new funding scheme would give the CEA the capacity to pay claims arising from a one-in-500-year event.

Under the terms of SB 430, authored by Senate Banking, Finance and Insurance Committee Chairman Mike Machado, D-Stockton, that funding layer would be replaced by a smaller industry assessment that would roll off over a 10-year period at the rate of 5 percent per year.

SB 430 sets the new maximum post-event assessment layer at $1.78 billion. That works out to $1.3 billion based on the CEA’s current level of participating insurers representing 73 percent of California’s homeowners market, according the committee’s analysis of SB 430. That amount is slightly higher than the $1.2 billion post-event assessment layer agreed to by the CEA governing board and insurers in August.

The period of the assessment could be extended by up to two years if the CEA pays out $500 million or more to pay claims arising from a single earthquake.

As approved by the Legislature, SB 430 rejects calls by State Treasurer Bill Lockyer, a CEA governing board member, and the Foundation for Taxpayer and Consumer Rights to extend the post-event insurer assessment layer put in place under the 1996 authorizing legislation beyond next year’s sunset.

Such a provision would have likely sparked litigation by insurers challenging the extension and potentially prompting homeowner insurers to cut back their writings in California. That provision also could have led to an availability crisis like that which occurred in the mid-1990s following the January 1994 Northridge earthquake that led to the CEA’s formation.

“Carriers would have been forced to consider such a move,” said Rex Frazier, president of the Personal Insurance Federation of California. “In the end, a fair deal was needed in order to ensure that the participating insurers wouldn’t fight the bill in the Legislature and, equally important, to ensure that the participating insurers would sign their contract modifications to agree to the additional $1.3 billion liability,” Frazier said.

Erin Ryan, a consultant to the committee, described the negotiations leading to SB 430 as challenging and on the verge of collapse in the final month preceding SB 430’s approval by the Legislature.

“It was a very hard negotiation,” Ryan told Insurance Journal. “There were multiple players, the CEA governing board and staff, and insurers with different ideas of what should be essential” to financially restructure the CEA in light of the pending expiration of the post-event assessment layer.

Ryan said there was also pressure to resolve the issue during the current legislative session because waiting to do so until 2008 could have adversely affected the CEA’s ratings and reinsurance costs and reduced the time required by the Internal Revenue Service to review the new funding structure to ensure it doesn’t affect the CEA’s tax-exempt status. SB 430 takes effect July 1, 2008, to provide the IRS sufficient time to review the changes put in place by the bill, Ryan noted.

A sticking point in the negotiations over SB 430, Ryan said, was a proposal by insurers to essentially privatize the expiring post-event assessment layer by selling the CEA reinsurance to replace it.

Driving that proposal, Ryan explained, are Department of Insurance regulations barring insurers from taking into account the cost of funding the post-event assessment layer when setting rates. “That complicated matters immensely and was the biggest challenge at the end,” Ryan said.

Lockyer opposed that aspect of the deal, protesting it would require CEA policyholders to pay an average of $55 more for basic policies. Lockyer, who played an instrumental role in the passage of legislation setting up the CEA in 1996, also complained the CEA has accumulated far too little premium and investment income in its nearly 11 years of operation.

According to the state treasurer, insurers projected those revenue sources would generate total capitalization of $6 billion during that period, but instead, less than half that amount is in the CEA’s coffers.

“The amendments to SB 430 made small improvements to the original version that worked to consumers’ benefit,” Lockyer spokesman Tom Dresslar said. But Dresslar termed SB 430 a “temporary fix” that does not address the long-term financial issues facing CEA such as strengthening the CEA’s ability to accumulate capital and reducing its reliance on reinsurance.

Topics Mergers Carriers California Legislation Earthquake

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Insurance Journal West September 24, 2007
September 24, 2007
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