It looks as if we are down to the wire in the Texas legislature on reforming the state’s public system for addressing catastrophic risk. No one has developed a solution that is economically sensible and politically acceptable. This leaves Texas in an extremely difficult position. One alternative is to just leave the status quo in place. This choice subjects coastal residents to a substantial risk of a cataclysmic failure of their insurance system. Derivatively, it leaves the rest of Texas vulnerable to a Herculean task of picking up the huge financial pieces after a major tropical storm. The failure of the legislature to act also gives the Texas insurance commissioner extra cause to throw TWIA into receivership. The other alternative is to burden Texas for years with a very bad bill, S.B. 1700, which is the only proposal to emerge from a committee thus far. I thus offer a minimalist last-minute fix for TWIA. Actually, I offer two.
This chart summarizes the situation today.
|Days until the start of hurricane season||1|
|Days until the end of the legislative session||0|
|Next hearing of Senate Business and Commerce Committee||None scheduled|
|Next hearing of House Insurance Committee||None scheduled|
|Size of Catastrophe Reserve Trust Fund||$180 million|
|Bond Anticipation Notes (pre-event bonds)||None. Approval refused by Commissioner Eleanor Kitzman|
|Reinsurance sought||$1.15 billion at an attachment of $2.2 billion (not yet obtained)|
|Probability of TWIA losses in 2013 exceeding size of Catastrophe Reserve Trust Fund and Bond Anticipation Notes||TWIA Estimate: 7.7% My Estimate: 10%-- could be higher if forecasts of active-hyperactive hurricane season prove accurate Estimates for 2013 and 2014 seasons are between 15-18% assuming no growth in Catastrophe Reserve Trust Fund|
|Bills enacted addressing TWIA problems for 2013 hurricane season||None|
|Bills enacted addressing TWIA problems for hurricane season past 2013||S.B. 1702 (still requires signature of Governor Perry and does very little)|
Texas must somehow get out of this trap between rotten choices. It should not permit exploitation of a largely self-created crisis by coastal legislators to hurt the rest of the Texas economy for years to come. Here is my suggestion. It is not what I would want. It is not a very good scheme. But it is better than the status quo and it is better than SB 1700, which perpetuates morally unjust and sneaky wealth transfers, makes a mockery of commitments to the free market, and has, in the end and notwithstanding its innovative use of the word “must” in various provisions, no real plan to end the cycle of dependency on government mandated subsidies, often from poor to rich. My hope is that this suggestion can be politically acceptable if a lot of people suck up their pride and think about their constituents, both within their district and outside it. In fact, I will offer two schemes. I am hardly expert on parliamentary procedure in Texas, but I am hopeful that both could be implemented through amendments to SB 1700. I am even hopeful that both schemes might conjure up the ⅔ vote necessary to get this bill in place in time for the 2013 hurricane season, which starts essentially as soon as the 83rd Texas Legislature recesses.
TWIA Fix 1: The absolute minimalist fix.
1. Fix the worst bugs in the system of post-event bonds in place. Reduce the Class 1 Funding scheme to a $200 million maximum. Such a bond could probably be amortized by only a 5% surcharge on TWIA policyholders after a major storm. Those policyholders would grumble about being kicked when they were down, which would be true, but most could probably pay. Their ability to pay provides the needed foundation for Class 1 Bonds to be marketable. Keep Class 2 Bonds in place and raise 70% of $1 billion from coastal insureds (including TWIA policyholders) via a premium surcharge and raise 30% of $1 billion from insurers. If the Class 1 bonds fail, just start with Class 2. Ditch the buggy and unworkable Class 2 Alternative Bond scheme in section 2210.6136. Keep Class 3 funding in place to raise an additional $500 million. This will create something like a $2 billion stack for the 2013 and 2014 hurricane seasons. Maybe a little more for 2014 if we are lucky in 2013.
2. Require TWIA to put at least two dollars into its CRTF off the top for every dollar that it spends in reinsurance. That will make TWIA think carefully about the costs of purchasing reinsurance in a system where reinsurers charge about 5 times the expected risk and instead consider more carefully putting that money into the CRTF where there is close to dollar for dollar return.
3. Tell policyholders in the most forceful way about the risks posed to them by TWIA’s funding problem. Tell them with actual numbers derived from the best models available what the risk is that TWIA will not have enough money to pay claims and what the expected shortfall is likely to be. If, for example, TWIA’s stack for 2013 is $2 billion, then advise policyholders that the risk of their insurer being insolvent is about 3-4% per year. Tell them further that if TWIA becomes insolvent, they are most likely to get only 50 cents for each dollar that TWIA owes them. (My calculation). Finally, let them know that neither the state of Texas nor the Texas Property and Casualty Insurance Guaranty Association has any legal obligation to pay for losses not covered by TWIA. It reeks of Enron not to be as explicit as one can about the special risks TWIA policyholders face.
Will this scare lenders? Only dumb ones that haven’t been following the situation. It will, however, alert TWIA policyholders to the desirability of at least seeing if other insurance alternatives are available and, in any event, taking every possible precaution against loss if a storm approaches.
4. Eliminate this nonsense in SB 1700 of shielding the entities running TWIA from public scrutiny by giving them special exemption from disclosure laws. If there were ever an entity affecting the public trust that ought to be subject to public information requests, which already have protection from undue burdens built in, it is TWIA.
TWIA Fix 2: A minimalist fix
1. Scrap the whole opaque layering scheme for post-event bonds. It just disguises the foundation of wealth transfers on which the whole current scheme rests. If we are going to use post-event bonds to fund storm losses above the catastrophe reserve fund, have them paid for explicitly and transparently by insureds throughout the state. Pay for losses in excess of the TWIA CRTF by permitting the Texas Department of Insurance to impose a premium surcharge on essentially all property/casualty insurance sold in Texas sufficient to amortize an aggregate $3 billion over 10 years. The surcharge should be clearly labeled “to subsidize coastal property windstorm insurance” so that insureds throughout the state know exactly why they are paying this extra money. Depending on interest rates, a $3 billion initial principal balance will require a payment of about $380 million per year, which I believe is on the order of a 1% premium surcharge for 10 years. (Computation based on http://www.naic.org/state_report_cards/report_card_tx.pdf (page 6)). TWIA policyholders pay a double surcharge.
2. Start pre-funding this potential $3 billion obligation. Create some sort of trust fund akin to the TWIA CRTF and fund it by imposing a 0.5% premium surcharge starting as soon as possible on the same set of Texas property/casualty insurance policies that would have to pay the surcharge described in paragraph 1. Again, the surcharge should be clearly labeled “to provide a reserve fund that subsidizes coastal property windstorm insurance.” That way, insureds throughout the state would know why their hard-earned dollars are being taken away. Use these dollars to reduce initial principal balance on post-event bonds that will need to be issued (up to $3 billion) to pay for storm losses suffered by TWIA policyholders.
3. Again, tell policyholders in the most forceful way about the risks posed to them by TWIA’s funding problem. Tell them with actual numbers derived from the best models available what the risk is that TWIA will not have enough money to pay claims and what the expected shortfall is likely to be. If, for example, TWIA’s stack for 2013 is $3.2 billion, then advise policyholders that the risk of their insurer being insolvent is about 2% per year. Tell them further that if TWIA becomes insolvent, they are most likely to get about 90 cents for each dollar that TWIA owes them. (My calculation). Finally, let them know that neither the state of Texas nor the Texas Property and Casualty Insurance Guaranty Association has any legal obligation to pay for losses not covered by TWIA.
4. Again, require TWIA to put at least two dollars into its CRTF off the top for every dollar that it spends in reinsurance. That will make TWIA think carefully about the costs of purchasing reinsurance in a system where reinsurers charge about 5 times the expected risk and instead put it into the CRTF where there is close to dollar for dollar return.
5. Give inland interests more substantial representation on the TWIA board and give the TWIA board authorization to reduce its exposure (and therefore reduce the risk of insolvency) through a variety of steps, including placing a limit lower than currently exists on the maximum limit on residential properties (primary and secondary), imposition of higher deductibles or coinsurance than currently exists and ability to place different restrictions on policies on new properties than policies on existing properties. This will impel the TWIA board to do what it should have been doing all along — prioritize between affording higher and better coverage to people but running a substantial risk of insolvency, or providing more moderate coverage — perhaps with a focus on the less wealthy — for which money will actually exist in the event of a major storm.
I’ve been writing a lot over the past 10 months about ways of addressing the system of catastrophic risk insurance in place for the Texas coast. It’s not so hard to be an academic theorist in which one can assume away the world of political constraints. But now, at the least, we have those realities to face and some scary deadlines coming up. Maybe what I am proposing comes too late. I hope not. Because while my proposals are hardly perfect — indeed they should sunset by the 84th legislature — I do think each of them is considerably better than the horrible choice now facing the Texas legislature. Maybe some future session will feature less inflammatory and unproductive bombast, fewer attempts at special interest legislation and more serious and informed reflection about ways in which mechanisms thought good enough for the rest of Texas and its insurance markets can again be made the primary method of catastrophic risk transfer along the Texas coast. In the mean time, you have my thoughts on what might currently be achieved.