The coming lawsuits against insurance agents who sell TWIA policies

The next set of big lawsuits involving coastal windstorm insurance may not be targeted at the Texas Windstorm Insurance Association but rather against insurance agents in Texas who continued to sell TWIA policies without warning policyholders of the special risks involved.  Under Texas precedent, an insurance agent may be held liable for the loss suffered by a policyholder if the agent knew that “the insurer was insolvent at the time the policy was taken out.” Agents can also be held liable if “at a later time when the insured could be protected, the agent knows or by the exercise of reasonable diligence should know, of facts or circumstances which would put a reasonable agent on notice that the insurance presents an unreasonable risk.” Higginbotham  & Associates, Inc. v. Greer, 738 S.W.2d 45 (Tx. Ct. App. 1987). Given TWIA’s financial statements showing a negative surplus, the admission of a board member yesterday that, unless it gets the Texas Insurance Commissioner to reverse course and authorize a $500 million loan, it will not be able to pay claims promptly on even a moderate storm, and given the growing amount of media publicity about TWIA’s financial plight, there may well now be enough evidence to trigger the duty to disclose.

Arguments for the Defense

Arguments based on common law

To be sure, few policyholders will have an open and shut case against their agent.  The policyholder will have to show there was something they would have done differently — acquired other insurance, perhaps taken heroic steps to protect their property — in order to get damages beyond a return of premiums.  For some policyholders, there may have been little that they realistically could have done differently. Moreover agents will be able to defend on grounds that TWIA’s financial position was equivocal or on grounds that a negative surplus does not have quite the usual meaning of “insolvency” where the insurer has a statutory right to borrow or has a Catastrophe Reserve Trust Fund that perhaps should count as an asset.  Cf. Guidry v. Environmental Procedures, Inc., 388 S.W.3d 845 (Tx. Ct. App. 2012) (“We have found no Texas case applying these principles to allow recovery against an insurance agent in the absence of evidence that the carrier was insolvent”). Some agents may even say that the degree of notice that would trigger a duty did not exist.

Arguments based on statute

And, there’s actually a second type of defense agents are likely to offer: Subchapter L-1 of the Texas Insurance Code.  Agents that are sued for failure to warn will likely argue that section 2210.572 of the Texas Insurance Code, contained in Subchaper L-1, states that it provides the exclusive remedy “for a claim against the association, including an agent or representative of the association.” And what is a claim against an agent of the association? Section 2210.571 defines it very broadly as “includ[ing] any other claim against the association, or an agent or representative of the association, relating to an insured loss, under any theory or cause of action of any kind, regardless of the theory under which the claim is asserted, the cause of action brought, or the type of damages sought.” (emphasis added). So, these agents will argue that, unless a remedy can be found in Subchapter L-1, policyholders suing an insurance agent when TWIA can’t pay can’t sue on a theory of failure to warn.

The strength and the difficulty of this argument lies in the fact that when one looks at the remainder of Subchapter L-1, it provides no remedy at all against agents of the association.  Everything is in terms of claims against the association itself. While on the one hand this might fortify the agents’ argument that Subchapter L-1 gives them protection, on the other hand it suggests that the type of “agent” spoken of in section 2210.571 and 2210.572 is not the “agent” that sells the policy but rather some sort of internal agent of TWIA such as an adjuster, officer or employee, the sort of agent for which TWIA might have vicarious liability. Surely, this rejoinder proceeds, the legislature would have spoken more clearly if meant that no claim could ever be brought at all against an agent for whom TWIA is not vicariously liable when TWIA could not pay a claim for which it had accepted responsibility. Moreover, the whole point of Subchapter L-1 is really to displace bad faith type claims and to provide an administrative mechanism for cases involving disputed coverage, not to displace the entirety of the common law of insurance.

Such a rejoinder limiting the scope of L-1 preemption would be fortified by TWIA’s own documents. Set forth below is a picture of TWIA’s web site. Consistent with the idea that insurance agents selling TWIA policies are not TWIA agents, and consistent with the idea that the purpose of Subchapgter L-1 in H.B. 3 was to protect TWIA itself and less so people selling its policies, this web site indicates that TWIA does not regard people who sell TWIA policies as its agents.

A screenshot of http://www.twia.org/AboutTWIA/tabid/56/Default.aspx taken on June 19, 2013

A screenshot of http://www.twia.org/AboutTWIA/tabid/56/Default.aspx taken on June 19, 2013

So, while Subchapter L-1 may give insurance agents a defense in future litigation, it would not be prudent to rely on it 100% as a reason not to warn TWIA policyholders.

 Reasons for Concern

Notwithstanding these defenses, if I were a Texas insurance agent, or if I were the errors and omissions carrier for these agents who will actually be responsible for a duty of defense and indemnity where their insureds are sued, I’d be quite concerned. Right now, according to TWIA’s own financial statements, it has a negative surplus that many would see an indicator of insolvency. The defenses I outlined above are not iron clad. They are not the sort of defenses that would prevent many a defendant from having to settle for a substantial sum of money. They may not be the sort of defenses that prevail on a summary judgment motion or that insulate agents from juries in counties that have just been devastated by a major storm. Lawsuits like the one’s hypothesized will not be fun for agents, particularly given a concern that some jurors might be predisposed to look at error and omissions carriers or even personally wealthy agencies as providing a nice additional source of disaster relief.

The Smart Decision

The safest course for agents starting immediately will be to advise existing clients in writing about the potential for TWIA not to be able to pay claims promptly or in full and certainly to advise clients upon requests for renewal. If the agent loses a few commissions as a result, I promise that will be a fantastic tradeoff against the headaches a series of lawsuits will bring. The tone of the communication does not have to be hysterical.  There is a decent chance there will be no storm that bankrupts TWIA over the next storm season and there is also a non-zero chance that TWIA will be able to borrow as planned to meet its needs. But the communication needs to disclose that there are now special risks. Perhaps the error and omission carriers could be proactive and help the agent craft an appropriate letter?

If I were a TWIA policyholder and my agent were on real or constructive notice of TWIA’s financial condition, I would want to know.  And if my agent did not tell me and my house was damaged in a storm this summer and I found that TWIA wasn’t paying promptly or in full, I’d be going to a lot of lawyers looking for someone to sue.  That someone would, as a good lawyer would recognize, be right there in front of them.  Their insurance agent, probably with money and probably with an errors and omissions liability insurance policy that provided an additional source of money on which to collect, would be one of the first targets that lawyer would look to in order to make their client whole.

Note: Shortly after I originally posted this entry, an insurance agent reminded me that subchapter L-1 (enacted in 2011 as part of H.B. 3) of Chapter 2210 which governs the Texas Windstorm Insurance Association might have a broader scope than I realized. It might substantially alter what I had to say about agent liability. Upon further review, I believe the agent has an interesting point. The paragraphs on subchapter L-1 have thus been added to address that matter.  

Alice Gannon’s remarkable speech

At yesterday’s meeting of the TWIA Board of Directors, Alice Gannon, a director of TWIA, and its Secretary/Treasurer made a remarkable speech.  It’s remarkable because it is the first time I have heard a TWIA member at a public meeting be honest about at least some of the problems they face.  It’s also remarkable in that it is still not fully grappling (except perhaps elliptically) with the depth of the predicament in which the state’s largest coastal windstorm insurer finds itself. I might add that the speech is also remarkable for the silence that follows.  Notwithstanding the invitation of the chair to do so, there are no follow up questions by the other board members regarding Ms. Gannon’s assertions.

Screen capture of the TWIA board meeting

Screen capture of the TWIA board meeting. Ms. Gannon is at the right.

You can watch it yourself here starting at about minute 39:30 of the recording and lasting until about minute 43:30.  I’m going to provide first a transcript of what she said. I’ve also included a question posed by Mike Gerik and her response.  I’m then going to provide an annotated version of the same colloquy.  My annotations are in italic font and enclosed in square brackets. By the way, I’m not a professional stenographer, but I’ve tried to be careful to capture precisely what she said.

Alice Gannon’s Speech: A Transcript

So, the current financing structure for TWIA includes Class 1 bonds, which theoretically could be a billion dollars as authorized by statute. The problem since day one with the TPFA looking at it and talking to the investment bankers, etc., about it is that the revenue stream to support paying back that bonds is not considered adequate to support a billion dollars of bond.And, depending on any point in time, and conditions, we’ve had estimated  all the way from zero is what we could get if and when we had an event and went to the market to get the bonds all the way up to, really, five to six hundred million is the most that I’ve ever heard discussed. With the bond — One of the advantages of the bond anticipation notes is we have the partner, I think it’s Citibank — Citibank or Bank of America? — Bank of America, I apologize — who apparently is willing to assume that we could get $500 million post event on bonds and so are offering this bond anticipation note, obviously getting some return on that. So, that way we have the certainty, and then even if we are not able to issue $500 million of bonds, we still have that can be translated into a 5 year loan, so we have the assurance that we have that $500 million at that spot.

So, that gives us the comfort then going to place our reinsurance we can assume $500 million of that layer, ‘cause the higher up you can place your reinsurance for the same amount of premium, the more total reinsurance you could get.  In the particular case before us now, we are talking about an additional $250 million of coverage that we could get with the same premium dollars if we can assume we have that $500 million of the Class 1 bonding level.  So, that’s a big advantage.

And, as Pete [Gise] said, the other huge advantage is that you have that $500 million cash on hand. And he did refer to the three different scenarios they ran, the $700 million for a tropical storm/hurricane event or  a one and half billion or a three billion dollars. And in all three of those, the way the cash flow would be expected to pay out, with the bond anticipation note, we would be able to pay our claims in a timely fashion. However, I believe it’s also true that without the bond anticipation note, it’s highly likely we would not be able to pay our claims in a timely fashion.

And, for me, that is the most compelling reason to spend the money of the cost of the bond anticipation note. I think it would be tragic if we have — I mean to the people involved it’s not moderate — but a moderate event of $700 million and we’re telling our policyholders, our claimants, ‘We owe you the money. We agree we owe you the money and we’ll pay it as soon as we can, but that’s going to be a while.  And I just think that would be tragic.  And that’s why I think it is absolutely worthwhile to spend the expected expense associated with that bond anticipation note to get it. And I applaud your efforts to lay that out more clearly to our new commissioner in hopes that she will agree.

Question from Chair Mike Gerik: Alice, could you before you turn off your mike, we keep missing why there would be a delay, because it takes time to issue bonds and maybe how long that’s going to take and that’s the period of time we wouldn’t have the money if we don’t have the BAN.

Gannon: Well, there’s two. Number one is from what I understand from TPFA, they’re estimating three to six months before you could actually sell those bonds and have the cash ready to pay claims.  And that of course is assuming you could with Class 1 get $500 million. There’s a real risk that especially in whatever conditions might exist post event, that the bond market might not buy $500 million worth and then you’re short forever if you will of that piece until the legislature would take action to find money somewhere else for us.

 The Annotated Alice: [My comments in brackets and italics]

So, the current financing structure for TWIA includes Class 1 bonds, which theoretically could be a billion dollars as authorized by statute. [True] The problem since day one with the TPFA looking at it and talking to the investment bankers, etc., about it is that the revenue stream to support paying back that bonds is not considered adequate to support a billion dollars of bond.  [True. The problem is that TWIA would need to raise premiums 20-25%, which would reduce the size of TWIA, which would result in yet higher premium increases, which would further reduce the size of TWIA, which would put the organization into a death spiral. That’s why lenders won’t buy $1 billion of Class 1 bonds in which the repayment mechanism is TWIA premiums] And, depending on any point in time, and conditions, we’ve had estimated  all the way from zero is what we could get if and when we had an event and went to the market to get the bonds all the way up to, really, five to six hundred million is the most that I’ve ever heard discussed.  [Ms. Gannon makes clear that TWIA is never going to be able to sell $1 billion in Class 1 bonds.  This is critical because this is the very fact that triggers section 2210.6136 of the Texas Insurance Code. We’ve talked elsewhere on this blog about the serious problems that section 2210.6136 creates for TWIA. ] With the bond — One of the advantages of the bond anticipation notes is we have the partner, I think it’s Citibank — Citibank or Bank of America? — Bank of America, I apologize — who apparently [Is Bank of America still willing to do even 10%, that I take it is why Ms. Gannon used the ‘apparently’ caveat] is willing to assume that we could get $500 million post event on bonds and and so are offering this bond anticipation note, obviously getting some return [Yes, a hefty 10%] on that. So, that way we have the certainty, and then even if we are not able to issue $500 million of bonds, we still have that can be translated into a 5 year loan, so we have the assurance that we have that $500 million at that spot. [True. That’s one of the key arguments in favor of TWIA borrowing money that will be challenging to repay.]

So, that gives us the comfort then going to place our reinsurance we can assume $500 million of that layer, ‘cause the higher up you can place your reinsurance for the same amount of premium, the more total reinsurance you could get. [True] In the particular case before us now, we are talking about an additional $250 million of coverage that we could get with the same premium dollars if we can assume we have that $500 million of the Class 1 bonding level.  So, that’s a big advantage. [I agree. This is the second argument in favor of going ahead and borrowing, even at 10% and even though it will be a challenge to pay it back.  There are, however, contrary arguments.]

And, as Pete [Gise] said, the other huge advantage is that you have that $500 million cash on hand. And he did refer to the three different scenarios they ran, the $700 million for a tropical storm/hurricane event or  a one and half billion or a three billion dollars. And in all three of those, the way the cash flow would be expected to pay out, with the bond anticipation note, we would be able to pay our claims in a timely fashion. [I would not be so sure with respect to the $1.5 billion storm or the $3 billion storm.  This is where I believe Ms. Gannon and others are not coming to grips — at least in public — with the central problem. As Ms. Gannon acknowledges, it is doubtful the market will buy $500 million in Class 1 post-event bonds that are paid for by TWIA policyholders. But that makes it even less likely they would buy Class 2 bonds that TWIA policyholders have to pay back over 10 years where TWIA policyholders are already burdened, under the BAN, by a 5 year, $130 million per year obligation that already constitutes 20-25% of their premiums.  How on earth are TWIA policyholders collectively going to come up with an additional $82 million per year for 10 years (assuming 10% interest) to pay off $500 million more in Class 2 bonds?  A lot of people are going to drop TWIA under those circumstances.  And when they do, the death spiral of TWIA begins.  And, yet, under section 2210.6136 of the Insurance Code, you can’t get anyone else to pay for bonds unless the TWIA policyholders become so obligated.  So, particularly if you’ve already encumbered yourself by borrowing $500 million short term at 10%, it it will be extremely difficult to issue any more post-event bonds.  TWIA won’t just have the money short term.  It won’t have it at all.  Ever.]  However, I believe it’s also true that without the bond anticipation note, it’s highly likely we would not be able to pay our claims in a timely fashion. [Wow.  At last someone acknowledges that TWIA has a serious, serious cash flow problem.  Like someone in desperate financial straits, TWIA has a choice of encumbering itself with a payday loan (short term, high interest) and having enough cash to pay for a small storm, but basically preventing itself from borrowing funds to pay for a large storm, or having a slightly increased chance of going to the market post-event and borrowing to pay for a large storm.  There are no good options.  In light of the failure of the Texas legislature to amend the statute during the regular session and Govenor Perry’s decision not to add windstorm reform yet to any special session agenda, what Commissioner Julia Rathgeber will be revisiting is which of the bad options is less awful. Maybe when she confronts this fact, she will urge Governor Perry to change course?]

And, for me, that is the most compelling reason to spend the money of the cost of the bond anticipation note. I think it would be tragic [I agree] if we have — I mean to the people involved it’s not moderate — but a moderate event of $700 million and we’re telling our policyholders, our claimants, ‘We owe you the money. We agree we owe you the money and we’ll pay it as soon as we can, but that’s going to be a while.  And I just think that would be tragic.  And that’s why I think it is absolutely worthwhile to spend the expected expense associated with that bond anticipation note to get it. [Maybe.  Ms. Gannon has made a strong case. The problem is, however, that it’s only part of the story.  As I mention above, the BAN may be the poisoned chalice in that it will likely make almost 100% certain that TWIA will not be able to borrow additional funds post event in order to pay claimants.  It thus leaves a permanent gap between storms of $700 million and storms of $2.2 billion, at which point the reinsurance would kick in.  That’s a big gap.] And I applaud your efforts to lay that out more clearly to our new commissioner in hopes that she will agree.

Question from Chair Mike Gerik: Alice, could you before you turn off your mike, we keep missing why there would be a delay, because it takes time to issue bonds and maybe how long that’s going to take and that’s the period of time we wouldn’t have the money if we don’t have the BAN. [Surely this can not really be something that the other board members are missing! I assume the Chairman is just asking Ms. Gannon to emphasize the point again.]

Gannon: Well, there’s two. Number one is from what I understand from TPFA, they’re estimating three to six months before you could actually sell those bonds and have the cash ready to pay claims.  And that of course is assuming you could with Class 1 get $500 million. [Is Ms. Gannon actually agreeing with me? It’s possible.  Is she saying that, with Class 1 pre-event (converted) bonds already issued, you could not get $500 million in Class 2 bonds under section 2210.6136.  If so, I apologize for saying she doesn’t get it.  She’s just being a little terse.] There’s a real risk that especially in whatever conditions might exist post event, that the bond market might not buy $500 million worth and then you’re short forever [Yes, but short what?  I say you are short $1.5 billion in Class 2 bonds and Class 3 bonds.  Is Ms. Gannon agreeing with that or does she just think you are short $500 million. Of course, either way it is bad] if you will of that piece until the legislature would take action to find money somewhere else for us. [Assuming that they would, which should not be a foregone conclusion.  And, trust me, the legislature is not going to act instantly on any such request nor, I suspect, will the money be without strings and some repayment obligation.]

Senator Taylor blasts TWIA board for not enforcing the law

On Monday, at a special meeting of the House Insurance Committee, State Senator Larry Taylor blasted the decision of the board of the Texas Windstorm Insurance Association not to enforce laws requiring policyholders repairing their property to follow applicable building codes.  Senator Taylor complained vociferously that the continued disregard of the Texas Insurance Code, particularly in favor of policyholders that TWIA had paid off in litigation involving Hurricane Ike in 2008, represented a failure of TWIA to mitigate further damages to the Association. That criticism was heeded only partly Tuesday by the the TWIA board when it voted not to cancel policies that had been issued without legal authority but only to decline to renew them. The TWIA board further decided not to begin non-renewals as soon as possible but to wait instead until January of 2014 — after the 2013 storm season — before even beginning the to decline renewals.

TWIA’s position is difficult to understand. Based on comments both at the hearing Monday and the Board meeting Tuesday, TWIA officials appear to acknowledge that they have issued policies — apparently several thousand — they are not authorized to issue.  Their excuse has been compassion — that it may have been difficult in the aftermath of Hurricane Ike to bring properties up to the higher code.  But, as with the insurable interest doctrine, insurers who issue policies in violation of the law generally have a right not to pay on claims brought under them and thus, presumably, to cancel them. Cruel as it may seem, that’s the traditional way of vindicating many public policy concerns. The TWIA board did not receive any public legal advice saying it would violate any laws by simply canceling the policies forthwith. Property insurance, unlike life insurance, is not burdened with incontestability laws.

The problem with the compassion excuse is that the TWIA board is being “compassionate” spending other people’s money. Adherence to building codes greatly reduces losses.  So when TWIA’s losses are heightened due to the failure of some policyholders to make repairs up to code (for years), it ends up burdening all those who have to pay for TWIA’s losses.  This group includes other TWIA policyholders who do comply with the law, sometimes at considerable expense. These policyholders have responsibility for paying off any Class 1 bonds that are issued.   It also includes coastal residents who do not have TWIA policies but who will be surcharged following the issuance of some Class 2 Bonds, and insureds throughout Texas who will likely see rate increases when insurers are assessed to pay for Class 2 and Class 3 bonds.

The decision of TWIA’s board may also give rise to legal disputes down the road. Presumably the reason the legislature insisted on compliance with building codes was to reduce future losses to TWIA and to reduce thereby the risk that non-TWIA policyholders would have to pay post-event bonds. So, when the TWIA board declines for a lengthy period to enforce that law, they unlawfully expand the potential exposure of these third parties.  Might not some of the better advised third parties, such as large insurance companies, seize upon clear violations of state underwriting laws as a basis for declining to pay at least part of any assessment made against them? Might they not plausibly argue that some percentage of their assessment liability should be withheld due to violations of law?  Alternatively, might they not bring a cause of action against the TWIA board for breach of duty? And might even the threat of these legal challenges make it yet more difficult to market the post-event bonds in the first place. TWIA has handed those responsible for repaying these bonds an excuse not to do so.

Perhaps only the Texas Department of Insurance is entitled to compel TWIA to follow the law and some future court will find that no private rights of action exist. Perhaps some future court will hold that the statutory restrictions on underwriting were not intended to benefit third parties such as member insurers.  But, I would not be so sure. It strikes me that there is a pretty strong argument to the contrary. I remain mystified as to why TWIA would create yet more problems for itself by continuing “compassion” for people who have, for years, declined to bring their properties up to code, particularly when they were given money to do so in Ike settlements. I likewise wonder if the Texas Department of Insurance, which has significant operating authority over TWIA, might urge it act far more promptly and with far less “compassion” in shedding itself of exposure the legislature prohibited it from assuming.

 

 

News from the TWIA board meeting

I’ll have a fuller post later and the meeting is still in progress (in closed session), but here are the headlines thus far.

1. A TWIA board member (Alice Gannon, I believe) acknowledges that if TWIA does not get new Texas Insurance Commissioner Julia Rathgeber to reverse a decision of her predecessor refusing to authorize $500 million in borrowings via a Bond Anticipation Note, TWIA will not have money to pay claims promptly in the event of even a modest storm.  I do not have an exact quote, but at minute 46 of the hearing she says something to the effect of “Without the BAN, it is highly likely we would not be able to pay claims in timely fashion.” Other board commentary indicates it will take 3 to 6 months to sell post-event bonds, assuming they could be sold at all. TWIA will be meeting with Commissioner Rathgeber this Friday (June 21, 2013) to try to persuade her to reverse former Commissioner Eleanor Kitzman’s decision.

2. TWIA has acquired $1 billion in reinsurance with an attachment point of $1.7 billion.  It has the right until July 15 to increase its reinsurance to $1.25 billion but increase its attachment point of $2.2 billion.

3. As feared, TWIA’s financial condition is already having an effect. Premium finance companies are refusing to lend more than $16,000 to pay TWIA premiums. Lenders don’t want to try to bring claims for unearned premiums against an insolvent insurer.

4. TWIA actually has only $340 million in cash after having paid much of the recent $135 million Ike settlement.  It believes it will have $400 million in cash by August and through the end of the year.

5. TWIA will ask the Texas Department of Insurance to permit it to change accounting practices so that it can count the Catastrophe Reserve Trust Fund on its books as its assets.  Doing so would move TWIA from being seen as having a negative surplus to perhaps having a positive surplus.

6. TWIA will not cancel over 2,000 policies that it has knowingly issued in violation of provisions of the Texas Insurance Code governing compliance with building codes.  Instead, starting in January, after this year’s hurricane season it will decline to renew such policies as they come up for renewal.  This refusal to enforce the law was the subject of sharp criticism yesterday from State Senator Larry Taylor and may give rise to claims by those assessed to pay for post-event bonds that TWIA’s exposure was unlawfully increased.

7. TWIA did not vote to consent to imposition of a receivership.

8. TWIA will not try to assess insurers based on a law that was repealed in 2009. It acknowledges that that there are “uncertainties” as to whether it has authority to do so and that actually collecting such assessments would be difficult.

Another confusing graphic from TWIA

At yesterday’s hearing of the House Insurance Committee, leadership of the Texas Windstorm Insurance Agency presented a packet of three graphics to the members.  These graphics joined a crucial presentation created for today’s meeting of TWIA’s board of directors that falsely identified how post-event bonds would be paid off under existing law. Together, it presents a picture of an insurer less interested in forthrightly informing legislators than in trying to preserve its troubled existence.

As discussed in blog entries yesterday, the first two of the graphics presented yesterday to the House Insurance Committee were highly confusing if not downright misleading.  The first graphic, which purported to project TWIA going from insolvent to a positive surplus position over the next two years simply assumed away the possibility of any large claims being made against TWIA. What insurer can’t improve its position when no large claims are filed? There would be little need for solvency regulation if insurers never incurred large claims.

The second graphic presented yesterday purported to show that TWIA could pay off the borrowing of $500 million it wants to make in that its underwriting profit was greater than its debt service.  Again, however, TWIA simply assumed that it would not have any large claims that would deplete its profit.  Lots of people who borrow too much on their credit cards might have been able to pay them off it nothing else had happened.  Problem is, stuff happens.  And then, the borrower can’t pay.

Today, I want to tackle the third graphic submitted to the House Insurance Committee by TWIA.  It appears to continue what may be a pattern of misleading visual information.  Here’s the picture.

TWIA's stack size with misleading information on 2008 and failure to adjust for exposure

TWIA’s stack size with misleading information on 2008 and failure to adjust for exposure

Let’s look at that left hand bar, the one for 2008.  It would appear to show that TWIA had only a $2.1 billion stack for that year.  I believe legislators were supposed to gain comfort from the fact that the stack for 2013, with or without $500 million in pre-event borrowings known as a BAN (bond anticipation note) is actually higher than that amount.

But the stack appeared to be only $2.1 billion for 2008 because TWIA staff had simply not counted the leading source of protection for TWIA that existed at that time. TWIA’s graph simply deleted the key fact: TWIA had the ability to make unlimited assessments against the insurance industry.  TWIA thus had essentially a 100% guaranty of being able to pay claims. A proper picture would have had another gray bar extending high above the purple one showing this ability to assess. The gray bar would be just like the $230 million one it made lower in the stack.  It would be just like the one I am confident TWIA would have stuck over the 2013 stack if such an ability existed today.  I can think of absolutely no good reason why this bar should have been eliminated from the graphic.

Now, it is true that TWIA disclosed in a fine print footnote to the graphic “unlimited additional funding available via reimbursable assessments.”  Do you see it?  Look after the semi-colon in the first line at the bottom. But, again, that’s relegating the central point to a footnote and leaving the big graphic in a highly misleading condition.

I’ve got two other problems, by the way, with the graphic.

Stack size is best measured relative to exposure

Comparisons of stack size can be misleading without taking exposure into consideration.  A stack of $2.7 billion might be just fine if TWIA had exposure of $20 billion whereas a bigger stack of $3.5 billion might be inadequate if TWIA had exposure of $80 billion.  Once we do this, the picture becomes a little less cheery.  In 2008, for example, when TWIA’s stack was essentially unlimited, TWIA direct exposure was $64 billion. Today, it is about $75 billion. To have a $2.1 billion stack in 2008, is roughly the same as having a $2.46 billion stack today.

There is no apparent reason to have ignored Hurricane Dolly payments

I do not understand why TWIA excluded money paid for Hurricane Dolly from the 2008 stack.  That would have made it a little higher.  I suppose the purpose was to contrast preparedness for Ike with preparedness for today’s storms.  Again, though, that seems a peculiar choice. In assessing TWIA’s ability to pay claims, a more relevant comparator is stack size at the start of hurricane season. Had TWIA done this properly the stack in 2008 — the year of Ike — would have been much higher even without consideration of TWIA’s ability at the time to make unlimited assessments.

 

 

 

TWIA leadership further confuses House Insurance Committee

Associated Press reports are successfully repeating the message the Texas Windstorm Insurance Association leadership sought to convey at today’s special meeting of the House Insurance Committee: “Coastal Group Expects Surplus” is the headline, for example, that the Houston Chronicle attaches to the AP report.  Unfortunately for TWIA policyholders or any legislators misled by today’s presentation, the surplus scenario is essentially a picture of the best possible world in which no significant storms affect the largest windstorm insurer on the Texas coast.  Thus, while the graphic is not false, all it really does is confirm that insurance companies, even ones with premiums that do not reflect risk, make money  if they never have any large claims. It is not, however, an accurate depiction of reality.

Here’s the happy picture that TWIA wants the world to see. Surplus goes in a predictable linear way from that troublesome negative (red) $183 million in the fourth quarter of 2012 to a cheerier (blue) positive $211 million by the fourth quarter of 2014. That’s the picture presented by TWIA lawyer David Durden, TWIA chief actuary James Murphy and Pete Gise, TWIA’s comptroller at yesterday’s special meeting of the House Insurance Committee.  It is a picture that will make unquestioning TWIA policyholders breathe a sigh of relief, lessen pressure to reform TWIA, forestall efforts to place the insolvent insurer into receivership and let those who profit from the band playing on continue to do so for a time.

A misleading projection of TWIA finances

A misleading projection of TWIA finances

But look carefully at the fine print in the foonotes for this graphic. “Surplus amounts include operational expenses, non-catastrophe losses, projected changes in Ike reserves, and state sales tax refunds.”  What’s not included?  TWIA doesn’t say in the graphic, but I can tell you.  What TWIA does not include is the main thing TWIA was set up to handle and for which it needs catastrophe reserves: large losses from tropical cyclones.  (I’m also not sure they are taking account of reinsurance premiums, which now consume more than 20% of TWIA premiums). In other words, TWIA could have shown roughly the same “projected” increase in surplus  in any year it chose, ranging from the year before Hurricane Ike to the year before Hurricane Alicia. And TWIA would have been equally misleading in doing so.

And what is the probability that over the next two hurricane seasons TWIA will incur no tropical cyclone expenses. Assuming we have normal hurricane seasons over the next two years– which itself is rather optimistic given the unanimous forecasts of weather experts — the probability is about 1/3. Even with the most optimistic estimates of Texas hurricane frequency, the probability that the TWIA graph accurately projects reality is less than half. So, yes, less than half the time, the graphic produced by TWIA might be accurate.

The majority of the time, however, the TWIA graphic will be wrong. And some of the time it will be seriously wrong. This is exactly why every actuary who has consulted for TWIA or TDI in recent times has noted that TWIA takes in too little revenue relative to expenses to sustain a surplus. On average, in any two year period during which TWIA suffers a significant loss (i.e. a loss greater than $50 million), the average total loss during that time period is well over $500 million. Such losses would in fact significantly increase the deficit TWIA now suffers from. This is based on the Compound Poisson Distribution discussed on this blog as a way of modeling annual losses to TWIA and emulating the sophisticated work of state-of-the-art storm modelers such as AIR and RMS.  The Mathematica code proving this point is shown at the bottom of this post.

When we actually take possible storm losses into account, the two year position of TWIA is likely to be worse or no better than it is today.

I’ve tried in this blog to stay away from accusations of bad faith.  People have honest disagreements and different values.  And I have had respect for people doing what must be difficult work at an insurer with little money.  And this graphic did, after all, have a footnote from which one knowledgable in the area might recognize that the graphic was missing critical information. And TWIA did disclose at the hearing — after a lengthy exposition of the graphic — that their graphic assumes no storm losses.  But to me it is like presenting a graphic projecting how well the Astros are likely to do this year based on how they do during their best periods without taking into account the fact that they also suffer a lot of losing streaks. It is, at best, an insulting partial truth, one that I hope reporters,  legislators and, tomorrow, the TWIA Board of Directors, are smart enough to see through.

The code

Mean[Total /@Map[Max[# – 50000000, 0] &,

DeleteCases[Partition[RandomVariate[CompoundPoissonDistribution[0.54,WeibullDistribution[0.42, 177000000]], 10000], 2, 1], {0,

0}], {2}]]

Interest rates on the Bond Anticipation Note were potentially 10%

Officials from the Texas Windstorm Insurance Association and the Texas Public Finance Agency revealed today at a special meeting of the House Insurance Committee that TWIA would have had to pay interest rates of 10% for 5 years in order to pay off borrowings of $500 million it had sought to obtain via a “Bond Anticipation Note.” These sky-high interest rates would have forced TWIA to pay about $132 million per year for more than five years or over 25% of its gross premiums.  The 10% rate that would be paid following a storm is significantly higher than the 4-6% that was previously being quoted and explains rumors that the rate was in fact higher than 4-6%.  There are two rates.  The low one, as it turns out,  would have applied only if there were no storm and TWIA paid the money back at the end of hurricane season.

The revelation about the interest rates that the lender would charge if TWIA actually used the money to pay claims better explains the decision of outgoing Texas Insurance Commissioner Eleanor Kitzman to refuse to let TWIA borrow the money. (It also explains how badly the market regards TWIA’s finances). Paying 25% of premiums for debt service would likely have prevented TWIA from making any substantial contribution to its Catastrophe Reserve Trust Fund. This level of debt service might have required significant premium hikes in order to keep the operation going.

Texas Insurance Commissioner Julia Rathgeber

Texas Insurance Commissioner Julia Rathgeber

If the interest rate on the bond anticipation notes can not be negotiated lower — and interest rates appear to be slightly rising in the economy — the difficulty of amortizing the debt will likewise make it difficult for TWIA and coastal legislators to succeed in their efforts to get new Texas Insurance Commissioner Julia Rathgeber to overturn the decision   Apparently, Ms. Rathgeber is not willing to explicitly overturn the Kitzman decision, but has left the door slightly open to further pleadings brought under a theory that circumstances have changed.

TWIA tips its hand

At the hearing today, TWIA representatives previewed some of the arguments they will likely make to Commissioner Rathgeber later this week in order to revive its efforts to borrow.  Perhaps the most telling of these is that getting $500 million in loans would do more than double the amount of cash TWIA actually has to pay claims.  That’s a big deal in and of itself.  But it would also permit TWIA to purchase $250 million more in reinsurance because that reinsurance could now attach at a higher level. It thus raises the money available to pay claims not by $500 million but by $750 million. A second argument is that the number of Ike claims being filed has come down drastically, which creates less uncertainty about TWIA’s financial situation.

Unfortunately for proponents of the BAN and those who would like an easy fix to TWIA’s financial plight, this information does not appear either terribly new or particularly relevant. Commissioner Kitzman may well have known of the reinsurance differential at the time she made her decision and certainly could have surmised that at least some significant differential would exist.  And I can not imagine that people expected many more Ike claims to be filed more than 4.5 years after the storm at a time when most statutes of limitation have likely run.

Unless the new facts lower interest charges, what really has changed?

The more fundamental problem, however, is that these facts — even if new — do not change the debt equation. I really doubt the market will charge TWIA lower interest rates because of a reduced number of new Ike claims. And how does someone earning $450 million or so a year in premiums and that expects at most to make $200 million or so a year in underwriting profit that is supposed to be salted away into a Catastrophe Reserve Trust Fund, really afford to spend over 60% of that profit on debt service?  TWIA made a stab at such an answer in its presentation to the House Insurance Committee today, contrasting what it estimated as $127.5 million in amortization payments to what it hoped would be $220 million in “underwriting gain.” But, as the footnotes to this presentation conceded, this underwriting gain assumed no non-catastrophe losses. Significant losses in even one of the years over which the bond is supposed to be retired might well cause TWIA to default.

Also, a question.  Do the operating profit figures quoted in the graphic below include reinsurance premiums?  If not, the graphic is misleading.

 

TWIA shows how it could pay off a BAN

TWIA shows how it could pay off a BAN

A BAN could impede fundamental reform

The other issue that legislators will need to consider before they take sides in the BAN debate is the extent to which a BAN conflicts with the goal of making TWIA smaller.  Once TWIA takes on fixed debt obligations, shrinking TWIA becomes all the more difficult. With $82 billion in exposure, bond payments of $127-133 million take up 62% of one’s underwriting profit. With, say, $50 million in exposure as a result fo reform efforts, they take up 100% of one’s underwriting profit.  Thus, to the extent legislators are seeking the “grand solution” that makes TWIA smaller, reliance on a BAN makes that goal even more difficult to achieve. Legislators would likely need to find a substantial amount of cash from somewhere to pay off the BAN ahead of time.

There are some significant short run upsides to TWIA acquiring $500 million right now to deal with its short run finances. It is indeed hard to understand why one would deny a desperate insurer the ability to borrow money.  But the revelations from today’s hearing suggest that, just as payday loans can trap borrowers with short run needs into a cycle of indebtedness with only bad outcomes, so too with borrowings by desperate government created insurers. Until one way addresses the fundamental problem — too little income and too little in assets defending too much exposure, borrowing at high interest rates is a very risky path out of trouble.  For this reason, persuading the new insurance commissioner that TWIA can successfully discharge this large a debt and pay its other expenses — all while retaining the flexibility to endure fundamental reform — will be a tough sell indeed.

 

 

 

TWIA report card shows giant error on law

TWIA has just submitted its 2013 report card to the legislature. I hope the House Insurance Committee calls TWIA leaders on the carpet for it.  In addition to exhibiting a “band played on” mentality that fails to note the grave situation facing the organization and its policyholders, it contains a graphic purporting to explain its projected funding that is simply wrong because it reflects a grave misunderstanding of the laws that govern it.

Here’s the graphic.  It is found on page 23 of the annual report.

Screenshot_6_17_13_10_28_AM

 

The problem is the turquoise area.

First, notice a few things.

TWIA has written off the Class 1 bonds.  They do not appear on the graphic.   TWIA has apparently acknowledged that not even one dime of post-event Class 1 Bonds can be sold.  The reason they have done so is that the market does not believe TWIA policyholders and their premium dollars will provide a sustainable basis for repayment of bonds.

TWIA believes it has just $200 million in premiums and its Catastrophe Reserve Trust Fund to pay claims.  This is less than this blog has given TWIA credit for.

TWIA believes, as we suggested earlier, that it will have $1 billion in reinsurance that will attach at $1.7 billion and that the premiums will be $106 million (a little more than we thought).

But now notice the problem.  It’s the turquoise area labeled “$1 billion Class 2 Post Event Bonds.”  Notice the repayment source. “Repaid by Non-Recoupable Assessments to Pool (30%) and Surcharges to Catastrophe Area P & C Policyholders (70%).” This is wrong, wrong, wrong.  This source of bond repayment can not be used under Texas law when, as will occur here, the Class 1 Bonds are resold.

Doubt me?  Read section 2210.6136 of the Texas Insurance Code.

Sec. 2210.6136.  ALTERNATIVE SOURCES OF PAYMENT. (a)  Notwithstanding any other provision of this chapter and subject to Subsection (b), on a finding by the commissioner that all or any portion of the total principal amount of Class 1 public securities authorized to be issued under Section 2210.072 cannot be issued, the commissioner, by rule or order, may cause the issuance of Class 2 public securities in a principal amount not to exceed the principal amount described by Section 2210.073(b).

 

How those Class 2 bonds are to be repaid is set forth in section (b) of the same statute.

(b)  The commissioner shall order the repayment of the cost of Class 2 public securities issued in the manner described by Subsection (a) as follows:

(1)  in the manner described by Section 2210.612(a), in an amount equal to the lesser of:

(A)  $500 million; or

(B)  that portion of the total principal amount of Class 1 public securities authorized to be issued under Section 2210.072 that cannot be issued, plus any costs associated with that portion; and

(2)  after payment under Subdivision (1), in the manner described by Sections 2210.613(a) and (b), in an amount equal to the difference between the principal amount of public securities issued under Subsection (a) and the amount repaid in the manner described by Subdivision (1), plus any costs associated with that amount.

 

Thus, the method is not the 70/30 split that would be used if the Class 1 bonds had been sold and set forth in section 2210.613 of the Texas insurance Code.  Instead, because the TWIA policyholders would not yet have been burdened as much as that section contemplated, the TWIA policyholders pay the first $500 million under section 2210.6136 and only then is the 70/30 split invoked on the remaining possible $500 million authorized in Class 2 securities. You can read more about this issue here and elsewhere in this blog.

And here, we can see the problem.  If the market won’t lend TWIA money for Class 1 securities because it does not trust in the ability of TWIA policyholders to repay, why would it lend TWIA money for functionally identical securities that just say “Class 2 on them”?  Thus, TWIA should not be counting on being able to sell Class 2 securities.  And certainly not on being able to sell more than $500 million. The turquoise area should just be labeled, just as Chairman John Smithee suggested in his warning letter of May 29, 2013, to Governor Perry:  “GAP.”

And the situation is worse. It’s why Chairman Smithee spoke of a $1 billion gap.  For not only should the turquoise area be labeled GAP.  But the gray area above it for Class 3 securities should also be labeled GAP.  Read section (c) of the (in)famous section 2210.6136.  It states:

(c)  If Class 2 public securities are issued in the manner authorized by this section, Class 3 public securities may be issued only after Class 2 public securities have been issued in the maximum amount authorized under Section 2210.073.

If the Class 2 Alternative securities described in sections (a) and (b) don’t sell in full, then the Class 3 securities can not be sold AT ALL.

Thus, the graphic in question misleads the legislature by falsely asserting that TWIA will be able to sell Class 2 securities backed by a different pool of money than in fact will be used and by failing to note that the ability sell Class 3 securities is contingent on being able to sell every dime of $1 billion in securities whose repayment source is one that market appears already to have rejected.

Kind of a serious problem, yes? Let us hope the legislature gets to the bottom of this at the hearing today and TWIA is forced to issue a corrected report.

 

Smithee’s urgent warning to Governor Perry

I’ve decided that Representative John Smithee’s letter of May 29, 2013, to Texas Governor Rick Perry is of sufficient importance that I should just simply reprint it right here. It contains an urgent warning that TWIA is likely to have a $1 billion gap and will not be able to pay claims promptly for even a low severity storm.  No links to click.  Just read it.

John Smithee warns Governor Perry that TWIA likely has a $1 billion gap and will not be able to pay claims promptly for even a low severity storm

John Smithee warns Governor Perry that TWIA likely has a $1 billion gap and will not be able to pay claims promptly for even a low severity storm

If you want to understand why John Smithee is saying this, read entries in this blog such as this one and this one.

House Insurance Committee to hold special hearing today on TWIA finances

The House Insurance Committee will meet this morning (June 17, 2013) to “hear invited testimony relating to the current financial condition of the Texas Windstorm Insurance Association.” Here’s the link you need to watch the hearing live. http://www.house.state.tx.us/video-audio/

The decision to hold a special hearing comes in the wake of the decision of Texas Governor Rick Perry not to add windstorm reform to the agenda of the special session and the failure of the legislature to pass any significant legislation reforming the finances of the troubled windstorm insurer.  We have now learned that House Insurance Committee Chairman, Rep. John Smithee, had added his name to a plea to Governor Perry to add windstorm insurance reform to the agenda.  In a letter of May 29, 2013, and published here (for the first time, I believe), he said that what he regarded as a “prudent and sound decision” by outgoing Texas Insurance Commissioner Eleanor Kitzman to disapprove $500 million in loans via a Bond Anticipation Note (BAN) to TWIA “raises significant concerns regarding TWIA” and presented a $1 billion gap in TWIA’s finance structure.” Smithee further wrote:

“Without availability of the $500 million BAN, there appears to be a legitimate concern regarding TWIA’s liquidity to pay losses in the 30-90 days following a 2013 storm of even low to moderate severity.”

 

As this blog has indicated on many occasions, the problem, however, goes even beyond liquidity.  As will likely be discussed at today’s hearing, there is a serious question as to whether TWIA, under the current finance structure, will in fact ever be able to get significantly more than the piddly amount of cash it now has on hand in order to pay claims following a storm of moderate severity.

Here’s a copy of the full Smithee letter. It is the most stark assessment to date by a legislator of the serious problem facing Texas.

Smithee Governor TWIA call