A love letter to Texas Legislature Online

Dear Texas Legislature Online,

Even though you are only a website, I love you so much. You are cute, simple, easy on the eyes and you have so much to say when I ask you for information. And you’re a cheap date; I don’t have to pay, except for some teeny portion of my tax dollars.  I can search you all over for bills or for statutes and you don’t mind a bit.  Plus, when I find what I want, you are so giving.  I can get a printout in PDF, Word or even plain text that I can edit, display or mash up to my heart’s content. I can’t imagine doing what I do without you. You’re the best thing for Texas democracy ever. I’ll confess that I’m not totally faithful. I look at many legal information websites around the country. And, to be honest, there are many that are good. But you’re my hometown sweetheart. I am looking forward to being with you for years to come.

Seth J. Chandler (catrisk)

The Texas Legislature could seriously use an insurance think tank

So, this may be just a little bit self serving, but I really think the Texas legislature would benefit from sponsorship of an independent think tank on insurance law and regulation. I previously served as a director of the University of Houston Law Center’s Health Law and Policy Institute, which was under a modest contract with the legislature to provide briefings on issues of importance as well as provide trained interns to work with key legislators. It didn’t — and doesn’t — cost very much and, in my view, has provided the legislature with valuable service over the years.  The legislature doesn’t have a comparable research arm in the vital field of insurance law .

A Wordle of this post

The absence of an independent research arm means that the Texas legislature sometimes flies in the dark on critical issues of insurance regulation.  Yes, staffers can get up to speed eventually, but many start as generalists, leave before achieving insurance Nirvana or, quick study notwithstanding, do not always have the technical expertise or experience needed to understand a complex field in which a mistake can have huge consequences on individuals and the economy.  The Department of Insurance, particularly in recent years, tries to be proactive but that agency is often understandably focused on the problems of the day rather than having a lot of resources to think strategically about the future. The legislature can also use assertions of advocates for clients, be they the insurance industry, chambers of commerce, consumer groups, or others with an agenda such as the Texas Public Policy Foundation. But these groups are at least somewhat constrained in the positions they can take and the agenda they promote.  And, while it is unrealistic to think that a think tank can be completely apolitical, still, having a think tank that starts with an approximation of neutrality can, I believe, be very useful.

What would such a think tank look like?  It would need to have at least one certified actuary and probably some students of actuarial science.  It would need to have at least two attorneys or faculty members with expertise in insurance law and regulation, and, again, some students to assist in research and writing.  It would probably also be well served by having expertise in the field of insurance intermediaries, accounting, finance and statistics.  All of this could, I believe, be housed within a university setting or, potentially outside one, with a budget of about $1 million per year.  The think tank could also act as a screener for those seeking the opportunity to work directly for legislators whose committee assignments include insurance.

What kind of problems could the think tank address?  The legislature could provide direction and the think tank could, as the Health Law & Policy Institute has done, provide custom research for legislators with concerns on a particular issue.  For starters, however, I believe a good look at the remedies in Texas for breach of an insurance contract would be useful, as would a study of laws regulating insurer solvency. It could examine implementation of federal health insurance programs such as Medicaid and Obamacare within Texas. The think tank might study ways in which the complexity of Texas insurance regulation with its grab bag of types of insurers each subject to different subsets of regulation might be simplified. The think tank might bring trends in other jurisdictions to the attention of the Texas legislature as well as provide it information on the effects of growing insurance regulation at the federal level. And, of course, it could think rigorously and creatively about ways of transferring catastrophic risk in Texas that keeps property insurance prices up.

Right now, to be frank, one of the only reasons I am listened to at the state legislature, is that I am one of the few “independent” voices on insurance law and regulation.  I have my own political views, to be sure, but no one pays me to say what I do.  Instead, what lets me be effective is the happy coincidence of having the time and freedom of a tenured professor, trying to stay as “objective” as I can, and having considerable accumulated expertise in insurance law and actuarial science. But my time, perhaps like others in Texas with similar inclinations, is limited.  So, while the absence of special funding does not and would not prohibit other citizens from making their voices heard on important issues of insurance law and policy, the reality is that the barriers to entry into this complex and technical area are rather high.  That’s why you may hear dozens testify on roofing regulation but far fewer come to speak with knowledge on regulatory schemes involving billions of dollars. I believe the legislature would benefit from more independent voices.  And supporting an insurance think tank here in Texas is one way to increase the chance of that happening.

An urgent problem on the coast

The coming hurricane season poses exceptional risk for Texas, mostly to persons and businesses insured by the Texas Windstorm Insurance Association but also among those who will end up picking up the pieces after a major storm.  The most recent data shows that going into the 2013 hurricane season, which is less than three months away, the Texas Windstorm Insurance Association has about $180 million in cash available from which to pay claims, access to $1 billion through issuance of Class 2 securities and access to $500 million through Class 3 securities.  There is some possibility of additional funds if TWIA can market its Class 1 securities or obtain another “bond anticipation note” as it did in 2012. This would give it another $500 million.  And, if TWIA can afford to purchase reinsurance, it might — just might — be able to squeeze out $1 billion more on top of the stack.  Thus, the best case is that TWIA’s stack will be $3.18 billion.  A more realistic assessment is that TWIA’s stack with which to pay claims will be $2.68 billion. And a pessimistic assessment is that the stack will be a scant $1.68 billion, perhaps even less if the catastrophe fund keeps bleeding from Ike claims or the Class 2 bonds prove difficult to market.  The major bill pending in the Texas legislature, S.B. 18, has many virtues but in its present form does nothing to change these computations for most of the 2013 hurricane season.

The problem is that the risk of losses greater than this amount in 2013 are considerable. No one knows the exact probabilities, but based on my modeling, which is in turn based on TWIA’s commissioned studies from experts, the probability of losses to TWIA that are greater than its funding stack range from about 2% on the most optimistic views about the funding stack to 4% on the more pessimistic views about the funding stack. Those are about the same probabilities as the risk of death in the coming year for your average 67 to 75 year old. It’s roughly the same probability of flipping five heads in a row.

It could be even worse.  David Crump noted in response to an earlier version of this post that we may not even have Class 2 securities because, as a result of the 2011 legislation (section 2210.6136), if the Class 1 securities don’t sell, the first $500 million of Class 2 securities appear to rely on the same funding method as the failed Class 1 securities.  (Who thought of that?)  Only after that do we get to the more reliable method of surcharges on all coastal property insurance and an assessment on insurers.  I certainly hope David is wrong in his estimation of the Class 2 securities but, on mature reflection, he has a point. So, we need to add an additional category of gloom: “Crump gloomy.”  And, if he’s right there is about an 8% chance that the top of the TWIA stack will be lower than the amount of the claims. That is very scary indeed.

If the losses are greater than the funding stack, TWIA policyholders are likely not to be paid in full, and certainly not in a timely way. If, for example an average Category 4 storm were to hit Corpus Christi the damages would be about $4 billion.  (EMail of March 14, 2013 from Jennifer Armstrong of TWIA to David Crump).  Policyholders in that part of the coast would thus be paid between 17 cents and 80 cents on the dollar, leaving many unable to rebuild well. If a 3% deductible is going to lead to “blue roofs,” as was suggested by opponents of such an idea at the hearing of the Senate Business and Commerce committee earlier this week (because policyholders won’t be able to find the money to rebuild), consider what an effective 20% – 83% deductible is going to do.

Even losses in 2013 smaller than the full stack are going to cause trouble for TWIA.  A smaller storm in 2013, say, a half-Ike, could wipe out the catastrophe reserve fund and the Class 2 securities.  This means there would be just a very, very small stack to protect TWIA for 2014 and beyond.  The only good news is that legislation pending in the Texas legislature does try to address those later hurricane seasons.

TWIA stacks for 2013

TWIA stacks for 2013


There are several ways the situation could be improved for the coming 2013 hurricane season.  First, TWIA could attempt to make another assessment under the pre-2009 law to cover Ike losses that have continued to drain the catastrophe reserve fund.  (Clearly TWIA does not have authority to make such assessments for post 2009 storms). It appears, at least with the benefit of hindsight, that the $430 million assessment that occurred following 2008 Ike was inadequate to cover TWIA’s responsibility for Ike after the litigation dust has settled. But whether TWIA has the legal authority to do this — and don’t expect the insurance industry to take any such supplemental assessment sitting down — is still not clear. And I would not be surprised to see any litigation on this topic take considerably longer than the hurricane season to get resolved.

Second, the legislature could develop an alternate funding source for the Class 1 bonds for just the coming season.  Indeed, not that I would ever suggest such a thing, but given the somewhat desperate situation that exists, the insurance industry might acquiesce to this burden in exchange for relief from some of the responsibility it is supposed to bear under S.B. 18 for hurricane risk in 2014 and forward. The insurance industry could, for example, bear assessment risk or partial assessment risk for the Class 1 securities that now appear unmarketable since investors understandably mistrust whether TWIA policyholders will stick around and pay the huge surcharges that will be required to pay off the bonds.

Third, the legislature could actually raise explicit taxes [laughter] to pay for reinsurance that might reduce the risk.  Or maybe it could use some of the Texas budget surplus to  pay?  While this will rightly gall Texas taxpayers, particularly once the reinsurers smell blood in the water and charge accordingly, it may still be a prettier picture than picking up the pieces after TWIA goes insolvent.

Fourth, and this may be what coastal residents are counting on, is to just wait and see and try to bail out TWIA policyholders after the fact when a big hurricane strikes.  This will be galling to all.  It will be galling to those on the coast because the fight to get such relief will be slow and tough.  It will be galling to those away on the coast because the taxes that will need to be imposed either directly or indirectly to pay for the losses will be high. The taxes will be the engineered result of problematic legislation passed in 2009 and the steadfast refusal of some on the coast to accept financial responsibility for the true risk of hurricanes there. There is, of course, Uncle Sam, but somehow I would not count on Washington to be as generous following 2013 hurricane Chantal that devastates red Texas as it was to residents of the bluer northeast following Superstorm Sandy.  Besides, with the sequestration and all, it does not appear Washington is going to be eager to spend money on much of anything.

This leaves Texans with prayer as the final alternative. If, however, as many suspect, God helps those who helps themselves, it might be a good investment to deal in a more secular way, right now, with the 2013 risk.

Note: My thanks to David Crump for (1) making the public records request that generated the most recent information on this point; (2) sharing it with me; and (3) pointing out that my original post may have actually been too optimistic.

Senator Carona calls for insurers to be more constructive on windstorm legislation

Far more important, frankly, than my testimony yesterday before the Texas Senate Business & Commerce Committee, was the colloquy between influential members of that committee and representatives of the insurance industry, notably Beamon Floyd, director of the Texas Coalition for Affordable Insurance Solutions (big Texas insurers such as Allstate, State Farm, Famers, USAA), and Jay Thompson of the Association of Fire and Casualty Companies of Texas.  You can watch it all here from 1:49 to 2:00 and 2:22 to 2:25 on the video of the hearing.  John Carona (R-Dallas) and chair of the committee castigates the insurance industry for acting in bad faith, dragging its heels and apparently stonewalling on the issue of TWIA reform.  While such criticism might be expected from members along the coast or from those predisposed to criticize whatever the insurance industry does, this critique

State Senator John Carona

State Senator John Carona

came directly from Senator Carona,  a man who described himself as a friend of the insurance industry and, indirectly, from Governor Rick Perry, likewise seldom confused as an insurance basher.

The problem, basically, is that the insurance industry is resisting a bill that would likely compel it to shoulder more expense for risk along the Texas coast than it does now, even if it can pass many of those expenses on, but it hasn’t been bold enough thus far to come forward at this stage of the legislative process with support for specific solutions to the short and long term problems facing TWIA and its insureds. Nor has the industry publicly (or otherwise, to my knowledge) to date presented facts showing the extent of the burden that would be created by the assigned risk plan embodied in SB 18. This silence places legislators such as Senator Carona in a difficult position. They do not wish to create crushing burdens on the insurance industry that will make insurance in Texas yet more expensive or difficult to obtain, particularly in their districts, but they are also not willing to create a situation in which a significant storm forces an insurer for which they bear responsibility to undergo a difficult forced recapitalization or, worse, leaves it unable to pay claims promptly and fully. My sense is that Senator Carona and perhaps others felt much the way I do when confronted with a student, even one who has done well in the past, who is long on generalized rhetoric but doesn’t show that they have actually done the needed homework.

Here’s what I bet Senator Carona and others would like to see. With respect to all of these numbers, it would be best if they came from certified actuaries using contemporary storm models and it would be helpful if the figures were provided in both absolute dollars and as a percentage of industry premium revenue.  Some of these numbers may well be difficult to develop, but if figures could be brought forth even on an order of magnitude basis, it might separate out real threats to the Texas insurance industry from reflexive rhetoric.

Numbers Relevant to SB 18

(a) Evidence as to the expected costs of the 2210.0561 potential for assessment; this figure might be either a measure of expected losses or an explanation of why this assessment responsibility needs to be reinsured along with the costs thereof.

(b) Evidence as to the costs of the 2210.0561 assessment to help TWIA buy up to $2 billion in reinsurance. My wild guess is that we are looking at $150 million per year in the immediate future but ramping down substantially as the take out in the assigned risk plan decreases the expected amount reinsurers would pay

(c) Evidence as to what it will cost to set up and maintain a clearinghouse that will migrate coastal residents, and perhaps others, either into a private take-out policy or into the assigned risk pool.  Perhaps I am naive, but I believe the clearinghouse could be operated for less than $10 million per year.

(d) Evidence as to what the shortfall between “market rates” and transition premiums will cost insurers AFTER premium tax credits and recoupment are taken into account.

(e) At least an order of magnitude guess as to what it will cost, net of premiums, to write policies on the riskiest policies as to which SB 18 caps the premium at 25% higher than market. Such an estimate will require at least three figures: (1) an estimate of how many policies there will be in this category; (2) an estimate of actual expected losses among the purchasers; and, importantly, (3) an estimate of the incremental costs of capital that insurers need to stockpile in order to bear this correlated risk.

(f) An estimate of the cost of servicing TWIA policyholders even for windstorm claims pursuant to section 2210.5725 of the bill.

I also suspect Senator Carona and others in the legislature would like to see at least a bargaining position from the insurance industry on how much of these costs should be transferred either to TWIA policyholders or more directly to statewide insureds.

Numbers Relevant to An Alternative Plan

For any alternative plan submitted by the insurance industry, we ought to see numbers on the following:

(a) what are the rates that will be paid for risks currently covered by TWIA policies

(b) how will it address the 2013 hurricane season — the Carona bill is weak here

(c) how does it get the stack of protection up to an amount sufficient to cover at least a 1 in 100 years storm, preferably a 1 in 500 years storm

(d) who bears the financial burden of such a stack

So, I know this is a lot of work and there isn’t much time in which to do it.  But my sense is that one outcome of yesterday’s hearing is going to be a greater sense of urgency on many sides from those who will try to scuttle the assigned risk alternative.

P.S. For those who would rather (or also) like to see my testimony, you can find it at 1:36 to 1:44 of the hearing.

Testimony on S.B. 18

Here’s my written testimony on S.B. 18 and related matters provided at the Senate Business & Commerce Committee today.  My oral testimony was basically a shortened version of this along with some interesting colloquy with Senators Taylor, Lucio and Carona.

The Texas Senate Business and Commerce Committee discusses S.B. 18

The Texas Senate Business and Commerce Committee discusses S.B. 18

I am Seth J. Chandler, a professor of law at the University of Houston Law Center and writer for the blog catrisk.net, which deals with the law and finance of catastrophic risk in Texas.  The views here and on catrisk.net are my own and do not necessarily represent those of the University of Houston.

Texas insurance regulation should meet at least three major demands. We must be sure that the entities bearing risk actually have clear resources following a disaster to timely pay claims. (2) Insurance underwriting and pricing must send the proper signals to property and business development markets both on the coast and elsewhere in Texas. (3) Any transition from the status quo should temper the need to move urgently with the kindness involved in protecting the reliance interests of those who invested under the long existing prior system.  I have attempted over the past week to study SB 18 along with competing bills filed by Senators Hinojosa (SB 1089) and Representative Hunter (HB 2352).  I am advised that there is a committee substitute filed or about to be filed for SB 18 but, from my brief review, the changes made therein does not change the thrust of my testimony.

In my view, SB 18, though not perfect, is a positive framework for beginning to meet these demands. It is superior on solvency and market signaling grounds to the Hinojosa/Hunter proposal and to the status quo. Though it deals with the problem urgently, it reflects kindness by having the rest of the state provide at least nine benefits to TWIA and its policyholders. (See Appendix 1.)

The primary concept of SB 18 is to move Texas away from an addictive system in which protection from tropical cyclone risk is concentrated in a highly subsidized and highly correlated pool run by a state-chartered insurer. The subsidization, accomplished through requiring TWIA policyholders to pay fully only for the lower layers of catastrophic risk, kind of like billing a homeowner as if its home was worth only a fraction of its declared value, sends improper signals to property and business markets throughout the state. It treats poor property insureds away from the coast worse than both poor and wealthy property insureds along the coast.  The system now withholds explicit warning to policyholders, particularly those in Galveston County, as to the risks of TWIA’s undercapitalization. It relies on an untested system of post-event bonds limited in amount and inadequate to pay for large storms that will be paid for substantially by non-coastal Texans.

The concentration of correlated risk inherent in TWIA has trapped that agency into choosing each year between two bad alternatives. It can run a risk of insolvency in the current year by not purchasing reinsurance. Or it can perpetuate its poverty by paying huge sums to reinsurers whose prices reflect the need to stockpile liquid capital and consensus views on modern risk of hurricanes.

How would I describe SB 18 in a minute or two?  I would say it provides all Texans not otherwise unable to meet general underwriting standards the opportunity to purchase unfragmented homeowner insurance, including coverage for windstorm, from real insurers.  They do so at rates no more than 25% higher than that of a fine-grained estimate of the market price for similar coverage.  It reduces the high costs of correlated risk and assures solvency by forcibly grafting coastal tropical cyclone risk onto the diversified stock of conventional and other catastrophic risk held by private insurers whose solvency is highly regulated.  It ultimately stops giving special treatment to residential TWIA policyholder’s problem of high and intensely correlated risk. Instead it transitions them, with some interim rate relief effectively paid for by the state and non-coastal Texans, into a private primary or excess market that may have room to flourish once the subsidized market of TWIA is removed. And if that market does not develop, they are protected by a state created assigned risk program with capped prices in which the monitored resources of private insurers will actually pay them in the event of claims. It leaves TWIA in place but in sufficiently shrunken form so that reinsurance may be affordable and a system of assessments are manageable for the private market. Under SB 18, and as set forth further in Appendix 1 to my written testimony, non-coastal Texans will still very much pay either directly or indirectly to help their friends on the coast, whom I hope appreciate the consideration.  But they will do so via a system that stands a greater chance of actually being helpful in time of need and that likely does so at lower overall cost.

Its leading current competitor, the Hinojosa and Hunter bills are premised on coastal exceptionalism and a demand for coastal development.  They attempt to use benefits undoubtedly provided by the Texas coast but qualitatively little different from the benefits provided by the economies in each of your home districts, as a reason for the rest of the state to subsidize — perhaps even more than the status quo — the purchase of windstorm insurance along the coast.  They perpetuate the sending of bad signals to the development market. They leave the problems created by risk concentration essentially untouched. They leaves the interest rate risk attached to funding by post-event bonds in place.  They appear to finance the first layer of post-event bonds by large surcharges on whoever is left in the TWIA pool following a large disaster —  an idea the bond market appears to reject. Yes, the bills do build a bigger catastrophic reserve fund to insulate policyholders from those risks, but the money to do so comes mostly from policies other than those that will benefit from the enhanced cat fund.

There are questions I have about SB 18 and important implementation details about which I have reservations.  I set more of them out in Appendix 2 to my written testimony. Chief among them  (1) I want the immensely powerful Managing General Agent of the TPIP subject to Chapter 552 of the government code.  (2) I want, as you should too, numbers from full time professional actuaries about the burden of the bill on Texas insurers, non-coastal insureds and coastal insureds.  The concept at the core of SB 18, however, of an assigned risk pool with rates ceiling by a multiple of market rates, coupled with transition relief for TWIA residential policyholders, represents a welcome advance beyond conceptualizing the best form of bandaid to put on system that may be fatally infected.

Seth Chandler before the Texas Senate Business and Commerce Committee

Seth Chandler before the Texas Senate Business and Commerce Committee

Appendix 1: Ways in which non-coastal Texans will continue to subsidize the coast under SB 18

  1. Subjects insurers statewide (“TWIA members”) to front $2 billion for an assessment in the event TWIA does not have enough money to pay claims. (2210.0561).  The State of Texas and taxpayers ultimately pay the bill via premium tax credits.
  2. Insurers statewide (“TWIA members”) pay each year for a $2 billion reinsurance policy for the benefit of TWIA and its policyholders (2210.0561)
  3. Assessment on insurers statewide (“TWIA members”) to pay to establish, maintain and administer a clearinghouse that will significantly service coastal residents. (2210.103 and 2210.104)
  4. Surcharge for up to 33 months of 1% on policyholders outside of the “catastrophe area”) (the coast) on most forms of property/casualty insurance including homeowner policies and automobile policies. Proceeds from the surcharge go to build up a catastrophe trust fund used exclusively for the benefit of TWIA policyholders. Section 2210.4521.
  5. Surcharge for up to 33 months of 5% on non-TWIA policyholders in the “catastrophe area”) (the coast) on most forms of property/casualty insurance including homeowner policies and automobile policies. Proceeds from the surcharge go to build up a catastrophe trust fund used exclusively for the benefit of TWIA policyholders. Section 2210.4521.
  6. Insurers receiving less than assigned risk premiums due to transition relief for TWIA policyholders authorized to include a provision in their residential property insurance rates to recoup up to 50% of the shortfall.  Policyholders statewide thus likely to pay to keep rates low for coastal policyholders formerly insured by TWIA. (Section 2214.458).
  7. State of Texas and/or taxpayers pay for the same transition relief for TWIA policyholders by giving insurers a premium tax credit for 50% of the shortfall each year.
  8. Insurers obliged to write policies for no more than 25% above “market” for certain policyholders on the coast and elsewhere even where doing so costs more than 25% above market due to correlation of risk and limitations on permissible underwriting criteria.  This cost borne directly by insurers and indirectly by insureds statewide.  Section 2214.406
  9. Insurers writing policies on the coast with wind exclusions apparently compelled to adjust windstorm claims without compensation. Section 2210.5725.

Appendix 2: Questions and reservations about the bill.

  1.  A spreadsheet or similar document should be developed by experienced actuaries that estimates each of the costs identified in Appendix 1 with recognition that such estimates will, of necessity, often be rough.
  2.  Section 2214.352 of the bill would permit Texans to obtain coverage for tropical cyclone or wildfire within 72 hours of application. This poses a serious adverse selection risk since modern wildfire and tropical cyclone forecasting often provides good estimates of heightened risk more than 72 hours beforehand.  Suggested change: change 72 hours to 168 hours (one week).
  3.  Section 2214.105 and 2214.153 exempt the Managing General Agent from Chapter 552 of the Government Code.  This exemption is inconsistent with the quasi-governmental power over issues of statewide importance provided to the MGA and hinders accountability.  Suggested change: either leave the matter to court interpretation or make the matters described subject to Chapter 552 of the Government Code, which itself contains numerous protections.
  4.  Section 2210.453 requires TWIA to purchase $2 billion in reinsurance even after TWIA is largely depopulated. This number may actually be excessive and forcing TWIA to use reinsurance as a risk transfer mechanism gives too much bargaining power to reinsurers as opposed to alternative methods of catastrophic risk finance such as pre-event catastrophe bonds. This may have been changed in the revised bill that was filed very recently.  If not … Suggested change: Amend subsection (b) of proposed 2210.453 to place the cap on the risk stack at an amount determined sufficient by the Insurance Commissioner to cover TWIA against a 1 in 1000 year storm or $5 billion, whichever is lower and change “reinsurance” to “reinsurance or its equivalent.”
  5.  Section 2210.5725 requires insurers providing conventional coverage to holders of a TWIA policy to adjust claims even for wind losses excluded by their policies. Suggested change: Clarify how, if at all, insurers are to compensated for the additional costs of such an adjustment.
  6.  How does one reconcile Section 2210.211’s  mandatory migration migration of TWIA’s policies to similar but non-identical coverage with various prohibitions against state-induced breaches of contract?  Suggested change: require TWIA to insert into all policies an incorporation of its right to terminate under 2210.211.
  7. Do the limitations in section 2210.507 on maximum limits and minimum deductibles on TWIA policies issued after January 1, 2014, apply just to policies on new properties or do they also apply to renewals of existing TWIA policies?  Suggested change: clarify.
  8. What procedures are available to challenge a determination under section 2214.501 by an assigned risk insurer that an insured structure does not meet building code standards set forth in the TPIP plan of operation and that the policyholder is thus subject to a surcharge?  What constraints exist on the amount of the surcharge the insurer can impose? Suggested change: clarify.


Catrisk is at the Capitol!

The Senate Business and Commerce Committee has convened a hearing this morning on SB 18, the bill by Senator John Carona that would transition residential TWIA policyholders to an assigned risk program known as the Texas Property Insurance Program. We’ve discussed that bill here and here.  I’ll be testifying on the bill and trying to report on proceedings during some additional blog entries today or tomorrow.

The Committee has posted some exhibits to today’s hearing that you can find here.

Update: The Committee spent the morning focusing on a mitigation bill that appeared to have broad support EXCEPT for a provision that would have required registration of roofers.  The bad news, however, is that the discussion of SB 18 has been deferred until after the Senate meets in session.  It is not clear when that session will end. They are going strong at 12:30 pm.

Smithee bill would require TWIA to tell policyholders the truth about its solvency

John Smithee photo

John Smithee

State Representative John Smithee (R-Amarillo) has filed a bill in the state legislature  (HB 2785) that would require the Texas Windstorm Insurance Association (TWIA) to tell its policyholders on the declarations page of any policy it sells after January 1, 2014, about the limited resources available to pay claims in the event of a serious storm. The bill requires disclosure of the financial resources of TWIA, including the state of its catastrophic reserve fund and the marketability of bonds on which TWIA currently relies to pay claims for even modest tropical cyclones.  Critically, it also requires a prominent warning to policyholders right on the declarations page of the policy that the state of Texas is not obligated to come to their or TWIA’s rescue in the event that TWIA can not pay.

Needless to say, Catrisk is enthusiastic about this bill for several reasons.  First, it will enable potential insureds along the Texas coast to make intelligent decisions about the extent to which they want to try to obtain non-TWIA policies to protect them in the event of a serious storm even if those policies are more expensive.  As it stands, some TWIA policyholders may suffer from the incorrect assumption that the resources available to pay claims from policies purchased from TWIA, which currently relies on a paltry catastrophe reserve fund and a shaky structure of post-event bonds, are the same as those available from regulated private insurers, who would be put out of business if their reserves were anything near the inadequacy of TWIA’s. The misinformation suppresses demand for policies from regulated insurers and thus contributes to the self-fulfilling prophesy that the regulated market “can not do business on the coast.” Other prospective insureds, by the way, may actually have an exaggerated sense of TWIA’s instability and thus decline to purchase TWIA policies due to excessive fear. The bill, by providing the relevant facts, could help both groups of people make an informed choice.

Second, those contemplating migration or business expansion on the Texas coast will now be advised to think about whether they want to choose between going with a less expensive but flimsy insurer (TWIA), scrounging for difficult-to-obtain and often expensive wind insurance from a private insurer, or deciding that there may be better places in which to invest. This, of course, is precisely why some coastal interests, particularly those who benefit from immediate investment on the coast, oppose bills such as HR 2785. Telling people the truth about a risky product is indeed likely to drive down demand for the risky product while stimulating demand for the safer.  But getting demand for insurance products back to fair market levels, as opposed to levels inflated by subsidization and misinformation, is a good thing for Texas as a whole. Market distortion is not a zero sum game.

Third, this bill is a good idea regardless of the form in which TWIA goes forward.  Whether TWIA is transitioned out for residential policies, as proposed in the recent Carona bill, or strengthened through significant subsidies, as in the recent Hinojosa and Hunter bills, many policyholders are likely to remain in TWIA or potentially in TWIA for several years to come.  In that interim period, those policyholders should be warned of the remaining dangers posed during the transition to a system of greater solvency.  The faster and more forcefully that transition occurs, the less dire the warnings will need to be.  I am confident that Representative Smithee would be glad to include an amendment to his bill exempting TWIA from the disclosure requirements if it could show the Texas Insurance Commissioner that it would satisfy solvency requirements imposed on other Texas insurers.

At least one coastal legislator, Todd Hunter of Corpus Christi, has voiced opposition to the Smithee bill.  He did so at a hearing last year (go to go to 1:57:50 to 2:02:18 of the recording) in cross examining me about ideas similar to those found in the Smithee bill.  And he is reported today in a Corpus Christi Caller article as asking, “Why should coastal residents be the only people subject to this Miranda warning from (the association)?” Hunter asked. “Why is it not required, statewide, for all carriers?”

The rejoinder to Representative Hunter’s opposition, however, is that other Texas carriers are subject to financial solvency regulations from which TWIA is exempt and as to which TWIA would be in serious violation were it ever required to follow them. The reason TWIA policies should be stamped with bold red warning labels is the same reason that we stamp surplus lines policies in Texas with similar warnings: they are not subject to the same regulatory structure that works pretty darned well in preventing insurer insolvencies. Coastal residents are mature enough to handle the truth. Just because TWIA and State Farm both have the word “insurance” in their names does not mean that the law should treat them the same.  We don’t exempt investments in junk bonds from disclosure regulations about the risks involved just because some other forms of “investment”, such as certificates of deposit in a federally insured bank,  are not subject to as strict disclosure rules.  And, again, if equality of treatment is really the objection of some coastal legislators, an amendment exempting TWIA from disclosure in the event its financial condition would satisfy otherwise applicable solvency regulations seems a better answer than keeping TWIA policyholders in the dark under the fiction of “equal treatment.”

Note 1. The Smithee bill closely follows Recommendation #10 posted on this blog on September 10, 2012.  In “Ten fixes for TWIA: What I’m planning to say in Austin this week” I wrote as follows.

10. Require prominent disclosure to TWIA policyholders created by the financing structure in place (as modified by the reforms suggested here or otherwise enacted). This disclosure should, at a minimum, advise policyholders of the approximate probability, computed using the best historical data and contemporary models, of the risk that TWIA will become insolvent, will be impelled to increase premiums to pay off Class 1 securities and will be impelled to impose surcharges to pay off Class 2 securities. Disclosure should be made (a) on a document signed by applicants for TWIA policies (new or renewal); (b) stamped (similar to surplus lines stamping) on policies issued by TWIA; and (c) on a web site one or fewer clicks from the main TWIA page.


Note 2. The bill also echoes thoughts expressed in this blog here:

Policyholders don’t need to be scared about every unlikely event, but they have a right as adults to know of a substantial risk.  Losing your house and facing an insolvent insurer qualifies. We warn holders of surplus lines policies of lesser protections against insurer insolvency with a great big stamp on the policy.  Why not the same for an equally unguaranteed and often far riskier insurer. And while we’re warning, let’s also warn them of the potential for post-event Class 1 assessments, for which the risk is yet far higher and uniform throughout the TWIA territory.

Note 3. Although I suspect many insurance agents will not immediately embrace the Smithee bill, enlightened ones should do so.  This is because the bill should provide some protection to insurance agents who now find themselves in a difficult position.  Right now, insurance agents who don’t warn their policyholders of TWIA risks may be setting themselves up for a lawsuit.  The dangers of TWIA are so palpable that a plausible claim of negligence or intentional non-disclosure is definitely something these agents need to be concerned about in the event TWIA either can not play claims or is highly delayed in paying claims.  It is wishful thinking and ostrich-like behavior to pretend this serious risk does not exist. On the other hand, insurance agents who do warn their policyholders of TWIA risks may find business going elsewhere. The bill probably saves agents the dilemma of whether or not to tell the truth by leaving disclosure to the policy itself.



Hinojosa/Hunter file bills that buttress TWIA by forcing non-coastal property holders to pay for coastal risk

State Senator Juan “Chuy” Hinojosa (D-McAllen) and State Representative Todd Hunter (R-Corpus Christi) have filed companion bills in the State Senate (SB 1089) and State House (HB 2352) that would buttress the resources available to the Texas Windstorm Insurance Association (TWIA) to pay claims in the event of a tropical cyclone hitting the Texas coast but would do so by placing most of the burden either directly or indirectly on policyholders living away from the Texas coast.  The bill, like the current system and as heralded in recommendations of the Coastal Windstorm Task Force, would rely primarily on post-event bonding as a way of financing catastrophic risk.  But, by impelling insurers statewide and coastal policyholders to increase the size of the catastrophe reserve that pays before any bonds are issued, the bill would make it less likely that this  system of “insurance in reverse” would need to be used. The new system would come into effect in September of 2013.  It would apparently leave the current system in place for much of this hurricane season.

In a nutshell, here’s how the Hinojosa/Hunter plan works.  TWIA builds up its catastrophe reserve trust fund (a/k/a CRTF, a/k/a “cat fund”) so that it equals 1.5% of its “direct exposure” for the prior year.  (Section 2210.456). Since TWIA lists its current direct exposure at $72 billion, this means the catastrophe reserve fund is supposed to grow to at least $1.08 billion. Catrisk’s earlier modeling suggests that such a catastrophe reserve fund would be able to cover something like a 1 in 20 year storm.

But just because TWIA’s catastrophe reserve fund could cover a 1 in 20 year storm, does not mean that TWIA’s policyholders would be paying to cover that risk.  That’s because under the Hinojosa/Hunter plan, the catastrophe fund is financed mostly with other money.  To get from the paltry $180 million that now stands in the fund to $1.08 billion, the plan would assess  property insurers statewide, regardless of the extent to which they choose to do business on the Texas coast, 1/10 of the desired amount of the catastrophe reserve fund each year.  (Section 2210.456(c) (0.15% of the direct exposure)).  As it stands, this would amount to  $108 million per year for many years into the future. These are real assessments, not compelled loans by the insurance industry.  The  assessments are not creditable against premium taxes otherwise owed and are not supposed to be passed on — at least directly — by a premium surcharge on policyholders. It would demean the insurance industry, however, to suggest that they will not be clever enough to find a way to pass much of this cost on to policyholders.

Coastal insureds — including non-TWIA homeowner insureds and coastal residents with automobile insurance or other forms of property insurance — also pay to protect TWIA policyholders from risk. Under the Hinojosa/Hunter plan, a 3.9% premium surcharge is issued on all such policies. How much would this surcharge bring in?  Unclear. I don’t have the data, yet, particularly on automobile policies along the coast.  But we do know how much TWIA policyholders would pay on their TWIA policies to increase the protection available to them: about $17 million (0.039 x $446 million in premium taxes).  And since TWIA reports that it 62% of the coastal homeowner wind market (measured by exposure and not premiums), one can approximate that non-TWIA homeowner insureds would pay roughly $11 million.  Thus, TWIA policyholders would, at most, pay about 13% of the amount it will take to strengthen the catastrophe reserve fund that would be exclusively available to those policyholders to pay claims in the event of a tropical cyclone. If, as I suspect, non-wind homeowner policies, automobile policy premiums and other property insurance premiums along the coast are at least as large as TWIA premiums, the surcharge on TWIA policies will, at least for a few years, in fact pay perhaps just 7% of the actual cost of this portion of the risk posed by such policies.

And even this last figure of somewhere between 7 and 13% potentially understates the degree to which TWIA policies will be funding the risk they pose.  This is because under section 2210.083 of the Hinojosa/Hunter bill, when the cat fund needs to be restocked following a disaster that wipes it out, insurers doing business anywhere in the state must promptly pay, in addition to the regular shortfall assessment and in addition to whatever else they may be paying their own policyholders, half the amount of any public securities (up to $1 billion) issued to pay TWIA policy losses and, as I read section 2210.084, the entirety (up to $900 million) of additional public securities issued to pay TWIA losses.  Thus, following a serious hurricane, even more of the money used to pay for future hurricane losses will be coming from sources other than TWIA policies. Of course, the Hinojosa/Hunter bill permits insurers to “reinsure” against these potential assessments (section 2210.088), but this just means that insurers will be paying cash for the risk imposed on them by the law rather than perhaps just making an accounting entry for contingent liabilities on their books.


Layering of Protections Under Hinojosa/Hunter Bill

Layering of Protections Under Hinojosa/Hunter Bill

The Hinojosa/Hunter provides for at least three heightened layers of protection in the event of a storm that pierces the catastrophe reserve fund.  Each of the layers is provided by bonds, issued after the disaster, by the Texas Public Finance Authority. The layers (Classes A, B and C) differ primarily in their amortization periods and in the source of money used to repay the debts. Up to the first $1 billion is to be provided by Class A securities with an amortization period of 10 years.  The money to repay this debt each year — probably about 1/8 of the amount borrowed — will come from TWIA itself.  If the full $1 billion were borrowed, this would likely amount to a charge of $125 million per year for 10 years, which in turn would increase existing TWIA premiums by 25%. It is not clear whether the market would trust the ability of TWIA to actually obtain these funds, since some TWIA policyholders might be reluctant to renew with TWIA in the event such a hefty increase were imposed. The Texas Public Finance Authority has published grave doubts about the ability to market similar bonds authorized by the current law. 

Class B bonds can be issued in an amount up to $900 million and likewise must be amortized in no more than 10 years.  The source of repayment, though, is different. Although TWIA premiums could in theory be used to repay this obligation — I rather suspect they will be tied up elsewhere — the vast bulk of the funding is likely to come from yet another surcharge: this one on all premiums on coastal property insurance, including non-TWIA wind insurance, conventional coastal homeowner insurance, automobile insurance, and other forms of property insurance. The surcharge won’t be another 25% because the base is bigger.  But since it will cost $110 billion or more each year to amortize the debt, I would not be surprised to see an additional 5 to 7% surcharge.

If the catastrophe reserve fund indeed bulks up to $1.08 billion and the Class A bonds are indeed marketable, the Class B bonds should cover TWIA against the 1 in 50 year storm.  For storms bigger than that, the Hinojosa/Hunter bill provides for $2.75 billion in Class C bonds.  These have an amortization period of 14 years.  They are to be paid by a surcharge on all premiums on property insurance statewide.  The rate will be about 1/10 of the amount borrowed divided by a denominator that I would love to know the value of: the amount of premiums on property insurance sold in this state. If you forced me to make an educated guess, however, I would guess that property insurance premiums in Texas are about $20 billion per year, which would put the needed surcharge at 1-2% per year for 14 years. Of course, if the amount borrowed were not the full $2.75 billion, the surcharge would be less.

There are two other sources of funds worth mentioning.  The Hinojosa/Hunter plan continues to permit TWIA to purchase reinsurance and imposes no price constraints upon their doing so.  Such reinsurance is notoriously expensive and often difficult to obtain.  There is no explicit provision or encouragement for other forms of protection such as pre-event catastrophe bonds. There are also, in theory, Class D securities that provide an unlimited amount of protection to TWIA policyholders.  The problem: no source of funds is identified to pay back the bonds. Section 2210.639 simply mentions that these borrowings could be paid by TWIA premiums (yeah, right) or “money received from any source for the purpose of repaying Class D public securities.”  In other words, no one has a clue.

There is more in the Hunter bills and the Hinojosa bill that Catrisk will try to address in the near future.  And there are some simulations we can run to get some better ideas of the relative burdens borne throughout Texas under this bill. But this should provide an explanation of the basics.


Footnote: I bet that I am going to hear the double dipping criticism of this post again.  The point of these critics is that TWIA policyholders also have conventional homeowner insurance and automobile insurance.  Thus, their burden is higher than I have reported because they get hit with a double or triple whammy.  There is some truth to this criticism.  My defenses are (a) I have tried to report data here as policy based rather than policyholder based; thus the conclusions reached here should be accurate; (b) I can;t find and no one has volunteered the data needed to make the needed computational adjustments; if I had them I could and would do so. My suspicion is that, while a few numbers would change, the themes of the Hinojosa/Hunter bills would not.  They believe coastal risk should be socialized and these bills very much reflects that philosophy.


A second look at S.B. 18


In a post yesterday, I provided some preliminary analysis of S.B. 18, a bill filed by Texas State Senator John Carona that would completely overhaul the system by which most coastal Texans transfer the risk of windstorm.  Basically, the Texas Windstorm Insurance Association (TWIA) is phased out by 2015 as an insurer of residential coastal property and replaced with an assigned risk plan, the Texas Property Insurance Program (TPIP) that will ultimately charge “market” rates and will be administered by a Managing General Agent. In the interim, TWIA finances are shored up with statewide insurance surcharges to build up the catastrophe reserve fund, potential assessments on insurers of $2 billion in the event of a storm, and actual assessments on insurers of whatever it takes to to purchase $2 billion of reinsurance. (Insurers mostly recoup any storm assessments with premium tax credits but do not recoup reinsurance assessments).  Many TWIA policyholders are somewhat protected for a few years by a requirement that TPIP market rates be phased in, with the public effectively paying for the continued subsidization via likely insurer pass throughs and further premium tax credits.


The first page of S.B. 18

The first page of S.B. 18

I did a second read this morning and found several matters on which I had not previously focused.  I suspect I and others will find more in the days ahead or find areas in which these findings need clarification or correction.

  1. This particular bill does not appear to touch TWIA’s ability to sell policies that cover property other than residences (either owned or tenanted). Thus, unless I am missing something or there is a companion bill ahead, it appears TWIA will persist as an insurer that offers coastal businesses and government windstorm coverage for commercial structures. and public buildings. Currently, since “non-dwellings” comprise just 1/6 of TWIA’s exposure, such a reduction in the exposure of TWIA would likely make a buttressed catastrophe reserve fund, $2 billion in potential storm assessments, and $2 billion in reinsurance fully adequate to pay the remaining TWIA policyholders even in the worst cases — a welcome change from the status quo. The mandatory migration described in sections 2210.212 and 2210.213 speaks in terms of “residential structures” and “dwellings.” The provisions governing liability limits and deductibles in section 2210.507 likewise speak about residential properties.
  2. The bill does away with the system of post-event bonding that exists under the current law and whose functionality has been called into serious question.  Section 3 of the bill amends section 2210.056 to eliminate the ability of TWIA to use its assets to pay obligations incurred under Subchapter B-1, which is where the authority to actually repay bonds appears. Various other provisions of the bill likewise delete references to the post-event bonding program.
  3. Even during the transition period, TWIA will not be adjusting as many claims on future storms as it is currently required to do. Instead of keeping TWIA on perpetual standby for large scale adjusting requirements following a storm, the bill piggybacks on the claims adjusting stables of the major insurers and requires them to adjust claims on TWIA losses after June 1, 2013 acting as agents for TWIA. (Section 2210.5725).  If a private insurer covers a coastal homeowner for fire but a hurricane damages that homeowner’s residence, it appears as if the private insurer must adjust the claim unless — and I believe this would be quite unusual — that particular insurer provides windstorm coverage on 90% or more of the policies it writes on the coast. Otherwise, I assume TWIA continues to adjust the claim.
  4. It is not clear to me if and how the private insurers get paid for undertaking this expensive obligation or whether this is going to be just a cost of writing conventional property insurance along the coast.  If the latter, be prepared for attempts at rate increases by the private insurers or reduced willingness to sell even conventional policies in that area. I suppose insurers could also recoup these costs if they offered windstorm coverage in addition to conventional coverage.
  5. One upside for undertaking claims adjustment on behalf of TWIA is that, under the Carona bill, private insurers doing so will gain the protections of existing section 2210.014 of the Insurance Code, which protects TWIA from lawsuits brought by policyholders (or other private entities) under the unfair trade practices provision of Chapter 541 of the Insurance Code, which provides for treble damages, and Chapter 542 of the Insurance Code, which imposes penalty interest of 18% for statutorily described delays in claims adjusting. Private insurers adjusting claims on behalf of TWIA also gain the protections of existing section 2210.572 of the Insurance Code, which provides more favorable to them than the otherwise existing substantive and procedural rules in Texas for breach of contract and bad faith claims against an insurer.  Presumably, although it is not clearly stated in the draft Carona bill, they also gain the protections of the rest of Subchapter L-1 of the Insurance Code to which section 2210.572 makes reference. For an earlier discussion of this point, look here.
  6. The Managing General Agent, who basically runs the new insurance program, is neither elected nor appointed in the traditional sense.  Rather the MGA is awarded a contract to run the new TPIP for a period of up to five years. Section 2214.151. There is not much detail in the Carona bill on how the award of this contract is to be made.