TWIA and the quiet matter of reinsurance attachment

Could there be anything duller than a long blog entry about reinsurance attachment points? I want to argue here that there could. In fact, I want to argue here that understanding reinsurance attachment is critical to understanding the problems facing the Texas Windstorm Insurance Association — and its policyholders.

But first I must warn you of a need for some rather extensive background. You can skip ahead to the “main point,” and then come back and read the background if you prefer. Or you can just read the one sentence summary here.

The Texas Windstorm Insurance Association has selected low attachment points for its reinsurance which places the interests of Texas insurers and non-TWIA coastal insureds above the interests of its policyholders in densely populated areas of the Texas coast such as Galveston and Brazoria counties.

The Background

The Texas Windstorm Insurance Association is a state-chartered and state-regulated insurer “of last resort” for property along the Texas coast. Unfortunately, the “last resort” part has become somewhat of a joke. I won’t discuss here why this might be the case, but TWIA has for many years been the largest insurer of homes and business property on the Texas Coast.  As of April 2012, TWIA insured about $72 billion worth of property under about 260,000 policies.

So, how is this governmental creation to pay for losses?  TWIA collected about $450 million in premiums in the most recent hurricane season. But, even in a year in which Texas suffered no hurricanes and only two minimally damaging tropical storms, various expenses meant that TWIA did not add greatly to its $250 million (ish) catastrophe reserve fund.  And so, $250 million is about all that is sitting in the TWIA piggy bank available immediately to pay claims.  It might grow a bit this year, but no matter how you slice it, the catastrophe fund will not have enough money for TWIA to pay losses following many storms hitting the Texas coast.

What kind of storm does it take to cause TWIA to run out of cash  To calibrate matters, TWIA suffered losses of more than $2 billion following Hurricane Ike in 2008, which though it hit Texas in a densely propertied spot, was only a Category 2 storm. Anyone still remember Hurricane Chantal in 1989?  Track of Hurricane ChantalThat was a category 1 storm.  Experts say that if Chantal hit today, it would like cause $290 million in damages, a good chunk of which would be insured by TWIA. Or going back further, how about Hurricane Fern?  Also just a category 1 storm.  If that hit today, it would cause $500 million in damages of which TWIA would insure a high proportion.  So, it doesn’t take a monster storm to cause TWIA to run out of cash.

Beyond something like $250 million, TWIA has four sources of funds it can use before it has to confess to devastated policyholders that there isn’t enough money to pay claims fully.  The sources are stacked. Except in unusual circumstances, TWIA can’t use a source higher on the stack until it has exhausted the lower sources.

The first source is basically to take out a loan from the public.  TWIA is authorized to issue up to $1 billion in “Class 1” securities.  The owners of these “post-event bonds” get paid back by TWIA raising premiums on its policyholders.  The extra premiums get used not to protect against future hurricanes, but to pay off debts TWIA incurred because it didn’t have enough saved up to pay for a past one.

Running insurance in reverse can cause serious problems.  Purchase of TWIA policies is, after all, largely voluntary, and there are often private market competitors. If, for example, TWIA had to sell $1 billion worth of these securities and could do so at 4% with an amortization period of 10 years, TWIA policyholders would see an increase in their premiums of about 25% just to repay the borrowings.  Matters might be even worse because (a) 4% might be a low estimate given that the securities are not backed by the full faith and credit of Texas; (b) some policyholders might drop out of TWIA with a 25% increase, which would mean the remaining policyholders would face a yet-higher increase; and (c) we are talking about just one policy year here — TWIA might have to borrow yet again and charge policyholders yet more if another significant storm hit before the original Class 1 securities were paid off.

Section 2210.615 of the Texas Insurance Code

Section 2210.616 of the Texas Insurance Code. Note: no full faith and credit.

Hurricane 5 Tracking Chart

Hurricane 5 Tracking Chart

But we’re not nearly done.  After all, as proven by Hurricane Ike, Texas can certainly face storms that cause more than $1.2 billion in damages.  In fact, my own reverse engineering of work done by the two hurricane modelers on which TWIA relies, AIR and RMS, suggests that they think the annual probability of such an event is about 5% and the ten-year probability of one or more such storms occurring is about 42%. What kind of hurricane are we talking about.  “Hurricane 5” in August 1945, which hit near Port Aransas and went up the coast towards Houston, would have caused about $2.1 billion in damages if it hit today. Again, TWIA would “own” a significant portion of those damages.

So, how does TWIA cobble together more than $1.2 billion in a year?  It can borrow another $1 billion via “Class 2 Securities.”  And how are these security holders to be paid back?  Under section 2210.613 of the Texas Insurance Code it’s a 30/70 split.  Thirty percent of the debt gets paid back by TWIA “member insurers” — basically meaning any insurance company selling property/casualty insurance in Texas.  Now, in the past, insurers just fronted TWIA assessment payments; they got “paid back” via a pretty full credit against premium taxes they otherwise owed the state.  Since 2009, however, insurers really have to pay.  No tax credit to soften the blow. Presumably, therefore, up to $300 million will come partly out of the hide of private insurer shareholders and partly out of the hide of its policyholders, particularly those in Texas.Texas Insurance Code 2210.613

The remaining 70% of Class 2 repayments will be paid for by a surcharge not just on TWIA policyholders, but on anyone with virtually any form of property or casualty insurance — including automobile insurance — living in the areas TWIA protects. Thus a renter in Corpus Christi could see her automobile insurance premiums go up following a hurricane in Freeport.  So too could a small business in Harlingen which had property and liability insurance with a non-TWIA insurer.  I don’t have the data to say what percentage increase in premiums this repayment obligation would entail, but I don’t think a 5% increase in premiums for ten years would be a bad guess. And for TWIA policyholders, this increase would come on top of that required to pay off the Class 1 securities. Basically, the risk is socialized 30% throughout Texas and 70% throughout the Texas coast.

Now we get into really scary hurricanes: those that cause more than $2.2 billion in damages to TWIA.  We don’t have to talk Galveston 1900 or Carla 1961 to get there. The “Surprise Hurricane of 1943” might fit the bill.  Experts estimate this hurricane — advance information about which was suppressed due to the war — would have caused over $4 billion in damages as its winds slowed from less than105 miles per hour beating a nasty path from the Bolivar Peninsula up through the Houston Ship Channel.Damage from Surprise Hurricane of 1943

Until we introduce the complication of reinsurance — I warned you this was a long piece of background — the top of the stack is the $500 million more that TWIA has access to.  These are “Class 3 Securities” that TWIA may issue following a storm.  TWIA member insurers have to repay this tier of borrowings, which again presumably means the real cost will be borne in part by shareholders of these insurers but significantly by insureds throughout Texas from El Paso to Amarillo to Texarkana to Beaumont to Harlingen. This tier of coastal risk is almost 100% socialized. After this stack is exhausted, unless there is reinsurance, TWIA is out of money and, however much we might wish to the contrary, has no legal claim on the state or the federal government.

The Main Point

So, it’s now time to get back to reinsurance.  Under section 2210.075 of the Texas Insurance Code, TWIA can increase the amount of money it has available following a major storm (and lessen the amount it can stuff into its catastrophe fund) by purchasing reinsurance each hurricane season. It can do this quietly without legislative approval or guidance. The way reinsurance works, TWIA pays a premium to some reinsurer and, in turn, the reinsurer reimburses TWIA for certain losses that TWIA incurs.  So, for example, TWIA might have spent money so that if TWIA incurs more than, say, $2.7 billion in losses from a tropical cyclone, the reinsurer pays for certain losses above that amount.  Reinsurance thus could protect TWIA policyholders from some large losses.

But reinsurance comes in many flavors and the Texas Insurance Code does not tell TWIA what kind of reinsurance (if any) it should obtain.  A key factor that defines a reinsurance arrangement is the “attachment point.”  This is a generally stated as a dollar figure.  It’s where reinsurance inserts itself into the stack of resources available to TWIA.  If the insurer (TWIA) incurs losses that are less than the attachment point, the reinsurer pays nothing. If the losses are above the attachment point, the reinsurer pays until either all the insurer’s damages are paid off or the limits of the reinsurance policy are exhausted.  Whichever comes first. Thus, if TWIA’s reinsurance of, say, $600 million “attached” at $2.7 billion and TWIA had losses of, say, $2.6 billion in a given year, TWIA’s reinsurers would owe nothing.  TWIA policyholders would instead be paid out of the proceeds from TWIA’s catastrophe fund and the issuance of Class 1, 2 and 3 securities.

On the other hand, if TWIA had reinsurance of up to $600 million “attach” lower in the stack, at, say, $1.25 billion, the other layers of protection (Class 2 and 3) move up in the protection stack. TWIA losses would be paid first by TWIA’s catastrophe fund ($250 million), then by Class 1 securities ($1 billion), then by the $600 million in reinsurance, and then by $750 million in Class 2 securities.  The insurance industry would be spared having to repay Class 3 securities.  The diagram below recapitulates how these two attachment points affect the financial burden from hurricanes.

Diagram comparing two stacks of protection

Comparison of reinsurance attachment at $2.7 billion v. $1.25 billion

What I hope this makes clear is that the point at which reinsurance attaches distributes the cost of hurricanes among different groups.  High attachment points means that the folks ultimately responsible for Class 1, 2 and 3 securities (TWIA policyholders, Texas insurers, and coastal insureds) end up paying one way or the other for most serious tropical cyclones.  Lower attachment points tend to protect Texas insurers and coastal insureds from assessments and surcharges but do so substantially at the expense of TWIA policyholders. Thus, TWIA has the discretion under the law to decide whether it wants to place the interests of its policyholders first, the interests of the coast first, or the interests of Texas insurers first.  Not an easy choice.

But reinsurance attachment points are more important still.  This is so because the amount of reinsurance one can purchase depends heavily on the point at which reinsurance attaches.  And from a policyholder’s perspective –TWIA policyholders in Galveston, Brazoria and other heavily populated areas, take special note! — what matters is the overall height of the protection stack. Reinsurance purchased with a low attachment point buys a smaller layer (or costs more) than reinsurance purchased with a high attachment point.  You can buy more reinsurance when it has a higher attachment point because the most damaging sorts of hurricanes occur less frequently than hurricanes that cause intermediate damage.  Thus, if TWIA buys reinsurance with a lower attachment point, it provides less protection of TWIA policyholders and creates a greater risk of insolvency than when it buys reinsurance “at the top of the stack” with a higher attachment point.

To put matters as simply as possible, the higher the attachment point, the taller the stack. The taller the stack, the less TWIA policyholders (and their lenders!) in densely populated areas need worry.

To be sure, the precise relationship between the amount of reinsurance protection that can be purchased and the attachment point is a complex.  It’s tricky because the cost of reinsurance includes not just the expected losses the reinsurer faces (average loss) and some profit but also reflects the amount of money the reinsurer has to set aside to cover the worst cases.  Economically it’s almost as if there was a special tax on reinsurance purchases. Still, I believe it is reasonable to assume that the relationship looks something like the graphic below. The bottom line is that higher attachment points means significantly more reinsurance protection can be purchased for the same amount of money.

Graph showing reinsurance attachment point v. layer size

Graph showing reinsurance attachment point v. layer size

And what did TWIA do in 2011-12?  It did not purchase a reinsurance policy at “the top of the stack.”  Instead, without a lot of fanfare it purchased a policy with an intermediate $1.6 billion attachment point and got $636 million worth of protection. (I’ll have another post on why it may TWIA paid an awful lot for this policy).  TWIA thus decided, implicitly or explicitly, that saving Texas member insurers and non-TWIA coastal residents from the expense of having to pay back Class 2 and Class 3 securities was more important than providing TWIA policyholders with maximum protection.  In particular, it compromised the interests of its policyholders in the most densely populated counties: Galveston, Brazoria (and to a lesser extent Nueces and Harris) because they are the ones who could most use the extra protection high-attachment reinsurance could have purchased.

On the one hand, I understand this decision:  I have argued before that TWIA policyholders should bear most of the risk they accept by owning property or running a business on the coast.  Yes, the coast provides benefits to the rest of Texas, but, frankly so does Lubbock and so does El Paso.  But Lubbock and El Paso and most of the rest of Texas do not get to socialize their property risk onto the rest of Texas. I fully understand wanting to protect middle class Larry in Lubbock from having to subsidize insurance risk created by Gary in Galveston who owns a million dollar beach home there.

texas constitution section 3

On the other hand, I have doubts that this balancing of interests against each is one that TWIA should be undertaking.  I have doubts that coastal Brownsville in Cameron County is more important than coastal Galveston. And yet, the current scheme protects Brownsville well and Galveston less so. No one elected TWIA board members or technocrats to make this choice.  Fundamentally, then, the issue of reinsurance attachment strikes me not as a matter of “expertise” but as a matter for legislative judgment.

Balancing the interests of different parts of the coast against each other and balancing the interests of TWIA policyholders against Texas insurers and other coastal insurers is also an issue for the voters.  The voters should be able to decide through their election of representatives if they like the regime we have ended up with.  The current regime gives TWIA policyholders in sparsely populated Refugio, Kennedy and other more rural Texas counties far greater protection against hurricane risk.  There will never be a TWIA-busting $3 billion hurricane limited to Kleberg County because TWIA insures less than $500 million of property there. Moreover, partly because of the current reinsurance attachment point chosen by TWIA, the current regime insulates Texas insurers and non-TWIA coastal insureds from what would be a higher risk of assessments and surcharges. Many Texas voters might actually like that.

Subject to Texas and federal constitutional dictates about equal protection of the laws, the voters should also decide, however, through election of representatives whether they like the downside of the legal and financial regime that now exists.  The current statutory regime and its implementation should create massive insomnia among TWIA policyholders in Galveston and other densely populated counties every time their fate from a serious tropical cyclone depends on the vicissitudes of Gulf steering currents. And, while I would hate to emphasize the point, the inadequacy of coverage should make many current and future lenders in the densely populated counties anxious as well. Their collateral is at risk of being impaired following a major storm. Many voters might find it unacceptable that TWIA has gotten to choose low reinsurance attachment points that place the finances of Texas insurance companies above that of some TWIA policyholders.

It is probably too late to fix any of this for the 2012-13 hurricane season.  But tropical cyclones will not stop after this season is over.  There are plenty of storms ahead against which Texas can better and more transparently protect.

Note: I have attached here a PDF export of a Mathematica notebook exposing the calculations and diagrams underlying this post.

To fix the TWIA mess, focus on the fundamentals

This op-ed is reprinted from the Houston Chronicle

To fix TWIA mess, focus on the fundamentals
By Seth J. Chandler
Updated 06:52 p.m., Friday, July 27, 2012

Texas has been spared a major tropical storm so far this hurricane season, but that doesn’t diminish the fact that the state is woefully unprepared to deal with potential losses. If a significant fraction of possible Category 4 or Category 5 hurricanes were to strike, the Texas Windstorm Insurance Association (TWIA) would not be able to fully pay claims in Harris, Galveston, Brazoria and possibly other Texas counties. Since 2009, neither the state of Texas nor insurers in Texas are legally responsible to make up the shortfall. In 2013, let’s hope the Legislature stops rearranging deck chairs on the Titanic and explores more fundamental reform.

It’s not just a major hurricane problem or a Galveston problem. Right now, TWIA will not be able to pay with cash on hand or reinsurance funds many claims throughout Texas – not just the most densely populated counties – in the event of a serious storm. Instead, TWIA will be forced to borrow a limited sum, possibly at high rates, to pay the claims. The state will then have to impose significant surcharges on various forms of insurance over a number of years to pay the loans back. Running insurance in reverse and forcing policyholders to pay higher premiums just when they have been hit with losses is seldom a recipe for economic stability.

Unfortunately, as many coastal states are learning, there is no easy solution to this problem. Even those who like the free market must admit past difficulties in providing complete insurance along the coast for windstorm at rates that homeowners and businesses find tolerable. Special and explicit government subsidization of more complete windstorm insurance for the coast has its own financial costs, political problems and moral shortcomings. And the underinsurance engineered into the current law, coupled with some disguised subsidization, leaves Texas insureds at serious risk, particularly in the more densely developed areas of our coast.

The problem is tough because insurance works best where risks are known and uncorrelated. The fact that A has a fender bender with his car in Galveston County provides no information as to the likelihood that neighbor B will have an accident with her car at the same time. So auto insurance works well. Uncorrelated risk means that insurers do not have to stockpile a lot of liquid capital in order to pay expected claims. Something known in mathematics as the law of large numbers makes it unlikely that the amount of revenue an automobile insurer takes in won’t be enough to pay claims.

Windstorm risk along the Texas coast, by contrast, involves correlated risk with uncertain magnitudes. The fact that A’s house in Galveston is blown down by a hurricane informs greatly the likelihood that neighbor B’s house will be similarly destroyed. When insured risks are correlated, insurers and reinsurers have to stockpile lots of safe, liquid assets in order to pay claims in timely fashion. And keeping assets under the mattress hurts insurers and reinsurers in providing a decent return to their shareholders.

There are fundamental ways of addressing high magnitude, correlated risk that can be more successful. One solution is to reduce the magnitude of correlated risks. There is an awful lot of research showing that we can lessen the damage hurricanes cause through hardening: very tough building codes and other infrastructure improvements. A hardened site in Galveston, after all, is currently considered safe enough to house the smallpox virus. Burying power lines allows people to return to their homes sooner, which reduces the losses from a storm. Limiting publicly subsidized insurance plans to lower levels of coverage and requiring individuals to obtain private insurance for the excess also reduces the magnitude of correlated risk held by government plans. Lessening the economic consequences of hurricanes could attract private insurers back to the Texas coast, make state schemes less expensive, and make people feel more secure. The biggest bang for the buck will come from hardening the densely populated counties.

A second approach is to try to decorrelate the risks. Texas could pool its windstorm risk with California’s earthquake risk, Washington state’s volcano risk or windstorm risk from another region. Alternatively, Texas could pool its risk in, say, 2013 together with its risks in 2014 and 2015 by requiring coastal residents who purchase insurance from TWIA to commit to three-year contracts. There are many challenges with each of these plans, but given the absolute magnitude of the issue, even modest gains are worth exploring.

And the third approach is, frankly, to develop a greater tolerance for the high rates that come with insuring correlated risk. Hardening the coast and looking for opportunities to pool our catastrophe risks with uncorrelated catastrophes will help. But Texans on our coast need to let it sink in that they are holding property that is unavoidably expensive to insure and budget for the higher premiums that result. And their legislators who deny this reality do their constituents no service by leaving them catastrophically underinsured.

Chandler is Foundation Professor of Law at the University of Houston Law Center, former co-director of its Health Law and Policy Institute and director of its Program on Law and Computation.

A 1.5-2% risk per year of losing your home with inadequate insurance is a serious risk

For the 2011-12 hurricane season, the Texas Windstorm Insurance Association managed to purchase $636 million in reinsurance coverage for a net cost of about $83 million.  As a result of this purchase, having about $150 million in a piggybank, and the legality of TWIA borrowing about $2.5 billion following a serious loss, this means that TWIA had — roughly $3.2 billion — available to pay claims.  TWIA admits and my own computations based on the Weibull Distribution confirm that this leaves a 1.5-2% chance that TWIA, even with a lot of borrowing, will not have enough money to honor its obligations in full.

Here’s a picture of the TWIA funding stack.

TWIA Funding Stack

One and a half to two percent may not sound that awful.  That’s what some coastal Texas Representatives such as Todd Hunter are asserting. But their reassurances should not bring much comfort nor deflect attention from the serious problem facing Texas.

First — one and a half to two percent risks in fact occur. The fact that the risk is relatively small does not mean you should not insure against it.  Would you, for example, tell a 65 year old with a family to support not to worry about life insurance for the next year because there was only a 1.5% chance or so of dying during that time period  Would you, for example, tell a homeowner not to worry that their automobile insurance policy did not cover them for, losses during three months of each year because only about 1.5% of homeowners make claims during any three month period? (http://research3.bus.wisc.edu/file.php/129/Papers/PredModelHomeowners21July2010.pdf).  Or, let’s play a game.  Flip a coin six times in a row.  If it comes up all heads, you lose your house.  That’s about a 1.5% risk.  Want to play?  Perhaps you are all more courageous than I am, but I would worry.

Second, although a 1.5-2% risk may be unlikely to occur in any given year, just looking at a one year period is a strange way of thinking about it.  Say you own your home for 10 years or are thinking of investing in a business in Galveston.  If TWIA does not mend its ways, suddenly the risk of TWIA suffering a bankrupting loss during your period of investment jumps to 14-18%.  That’s calculated using something called the binomial distribution. Would you worry that if you rolled a single die and it came up 6 you would lose your house.  Again, maybe some politicians are particularly courageous, but I would be concerned.

Third, the 1.5-2% risk of TWIA going insolvent in any year is not the only risk created by the current funding structure.  There is something like a 15% chance that the next year will bring a storm large enough to force TWIA to borrow.  And the way TWIA first pays that money back is first by raising premiums on TWIA policyholders, pure and simple. The statute I’ve set forth below (section 2210.612 of the Texas Insurance Code makes that clear).  If we expand to our 10 year time horizon, the probability that TWIA will have to borrow goes into the 70% range.

Section 2210.612 of the Texas Insurance Code

And it gets worse.  If TWIA raises premiums substantially to pay off these “Class 1 Public Securities,”  some people will drop out of TWIA and find alternatives.  This means the rates TWIA will need to charge go up even more.  And more people drop out.  Reverse funding insurance creates a risk that TWIA will unravel — a risk lenders will surely take into account in figuring out what interest rate to charge TWIA in the event it has to borrow.

Actually, it gets yet worse, but I will save that and one other matter for other posts.

It’s a Weibull

To understand the premiums charged by the Texas Windstorm Insurance Association and the current legal and financial issues being debated in Austin, you have to get your hands a little dirty with the actuarial science.  You need to have some ability to model the damages likely to be caused by a tropical cyclone on the Texas coast.  Now, to do this really well, it might be thought you need an awful lot of very fine data.  In fact, however, you can do a pretty good job of understanding TWIA’s perspective by just reverse engineering publicly available information.

What I want to show is that the perceived annual exposure to the Texas Windstorm Association can be really well modeled by something known in statistics as a Weibull Distribution. To be fancy, it’s a zero-censored three parameter Weibull Distribution: 

CensoredDistribution[{0, ∞},
 WeibullDistribution[0.418001, 1.26765*10^8, -4.81157*10^8]]

We can plot the results of this distribution against the predictions made by TWIA’ s two consultants: AIR and RMS. The x-axis of the graph are the annual losses to TWIA.  The y-axis of the graph is the probability that the losses will be less than or equal to the corresponding amount on the x-axis. As one can see, it is almost a perfect fit.  For statisticians, the “adjusted R Squared” value is 0.995. 

Image

 

How did I find this function? Part of it is some intuition and some expertise about loss functions.  But a lot of it comes from running a “non-linear regression” on data in the public domain.  Here’s a chart (an “exceedance table”) provided by reinsurance broker Guy Carpenter to TWIA.  It shows the estimates of two consultants, AIR and RMS, about the losses likely to be suffered by TWIA.  Basically, you can use statistics software (I used Mathematica) to run a non-linear regression on this data and assume the underlying model is a censored Weibull distribution of some sort.  And, in less than a second, out pop the parameters to the Weibull distribution that best fit the data. As shown above it fits the AIR and RMS data points really well.  Moreover, it calculates the “AAL” (the mean annual loss to TWIA) pretty well too.

 

Image

In some forthcoming posts, I’ m going to show what the importance of this finding is, but suffice it to say, it explains a lot about the current controversy and suggests some matters to be examined with care.

The Op Ed on TWIA run by the Austin American Statesman

This op ed was run by the Austin American Statesman on July 10.  I am reprinting it here.

Leaving denser coastal counties out to dry if major windstorms strike

Seth J.Chandler, Special Contributor

Published: 7:11 p.m. Tuesday, July 10, 2012

 

The biggest windstorm in Texas so far this summer has been generated not by the warm waters of the tropics but by the courage of Texas Insurance Commissioner Eleanor Kitzman.

In June, Kitzman responded to a request from state Rep. John Smithee, R-Amarillo, by stating that the Texas Windstorm Insurance Association would be unable to pay claims fully if some Category 4 or higher hurricanes hit.

The state-created operation provides insurance against tropical storms and hurricanes on $72 billion worth of property owned by 259,000 people living on the Texas coast.

Kitzman further said the law did not require the State of Texas to rescue either an insolvent TWIA or Texas homeowners and businesses left with incompletely paid claims.

For this statement, Kitzman has been vilified by some coastal media outlets and by some coastal politicians, culminating in a call this week by state Rep. J.M. Lozano, R-Kingsville, for Texas Attorney General Greg Abbott to investigate her for breaking Texas law.

What was Kitzman’s possible crime? Lozano says her letter may have made a “misleading representation regarding the financial condition of an insurer” or somehow violated a state pledge not to impair collection of assessments on bonds that TWIA might issue following a major hurricane.

Kitzman’s real crime was daring to tell the truth to people who do not want to be confronted, now that hurricane season has started again, with the consequences of an irresponsible decision. In summer 2009, the Texas Legislature, to much praise, did fix a flaw in the old system of insulating Texas coastal residents from the cruelties of the private insurance market.

The Legislature saved Texas insurers, even ones not writing insurance near the coast, from the potential of unlimited assessments to pay for a major hurricane. But in doing so, it deliberately chose to reject a competing plan that would have forced TWIA to use actuarially sound rates and that took modern science on global warming into account.

The state Legislature instead used two sleights of hand in 2009 to make the tough medicine go down.The first was to keep current premiums lower by running insurance in reverse. Rather than forcing TWIA to collect enough premiums now to have cash on hand in the event of a major hurricane, the legislators chose to rely on “post-event bonding” vehicles called Class 1, 2 and 3 Securities.

Texas insurers will raise premiums and not just on windstorm insurance and not just on the coast after a hurricane, when people would already be hurting, to pay for these classes of securities that it assumes it will be able to sell following a major storm.

Texas’ second trick was to choose not to insure fully against the costliest hurricanes, such as a Category 4 or 5 hitting Galveston County. As TWIA itself puts the matter, “currently, there is no funding for TWIA losses in excess of Class 3 public securities” or about $3.6 billion.

The Texas Legislature saved money the same way you could if you insured your $8,000 or your $32,000 car for a maximum of $8,000 loss with the thought that fender-benders are frequent, but really catastrophic events seldom happen.

Such a system would indeed lower your premiums, and it might fully protect the less expensive car. And, if all went well, such a policy might even protect the more expensive car. But it still places your expensive car at risk.

Whether consciously or not, in 2009 the less-propertied Texas coastal counties, such as Kleberg and San Patricio, from which Lozano hails, hornswoggled the rest of the state into accepting a system that probably can pay even their major claims fully (like totaling the $8,000 car) but left the more propertied coastal counties, Galveston and Brazoria, at risk for major claims or totals.

So, if we’re shooting messenger, Kitzman, for telling Texas the truth about its underfunded public windstorm insurance system or, possibly worse, for promoting its restructuring, shoot me, too.

I declare again, as a law professor who has studied TWIA’s statutes and its finances for many years: The Texas Windstorm Insurance Association does not have the financial capacity to pay claims fully in the event a major hurricane strikes a property-rich Texas county and neither the state nor anyone else is under any current legal obligation to make up the difference.

Perhaps you should shoot me first because, unburdened by whatever political constraints may keep Commissioner Kitzman more polite, I further declare that the coastal counties, having deliberately chosen to underinsure and reap the benefits of lower premiums, have no moral claims on Texas, either.

Chandler is Foundation Professor of Law at the University of Houston Law Center and director of its Program on Law and Computation; schandler@uh.edu.

Why I blog on Texas Windstorms

I am blogging because Texas, and other coastal states, have set themselves up for disaster by engineering flimsy legal and financial regimes to address the risks of tropical cyclones.  I read accounts in the press or on the Internet that are based on incredible misinformation and wishful thinking that nature will not respect. I see many politicians in a cycle of untruths with their constituents that leave coastal residents and businesses at significant risk of a catastrophe. Selfishly, I know that I, a semi-coastal resident, will be asked, one way or another to help pick up the pieces in an expensive way if a major storm hits a densely populated part of the Texas Coast.

I am also blogging because, immodestly, I have considerable expertise in this area and can’t just submit every thought to the Houston Chronicle and hope that they publish it. As a law professor at the University of Houston Law Center with a deep interest in actuarial science and finance, I’ve studied the legal and financial operations of the Texas Windstorm Insurance Association for many years.

Finally, I guess I am blogging because I want to give some courage to people who want to look at the Texas insurance scene with an open mind.  I have seen one Texas political figure, Insurance Commissioner Eleanor Kitzman, vilified by many coastal politicians and residents for daring to tell the truth about the risks now being run.  That is just wrong.   We say we want politicians to tell us the truth.  But do we really?  So, my hope is to give useful information and analysis to people who dare to look without prejudice at Texas windstorm situation. 

I’ll be using several tools to present information.  WordPress supports text and pictures and all the usual stuff.  I’ll  use those modes of expression to the best of my ability. But it also supports interactive tools (CDF technology) that let you, the reader, really explore the situation and make up your own mind.  And, ultimately, I suspect that is how we will all learn best.

So, enjoy, read and think.