Breaking News: TWIA likely to go into rehabilitation

The Texas Department of Insurance has released a FAQ setting forth what will happen in the event that TWIA is placed into rehabilitation.  Insurance regulators don’t — and shouldn’t — issue unsettling documents like this unless the threat is very real and very imminent.  I’m attaching a plain text version of the document to the end of this post (after the break). I’ve done a tiny bit of formatting to accommodate the blog format.  You can see the original version in PDF format here. Things are moving very fast.  I’ll have some comments on what is going on, but for now I just wanted to apprise interested people of this important development.

Key quotes from the FAQ

  • The Annual Statement shows that, based on additional litigation filed in 2012, TWIA is now insolvent. TWIA’s liabilities exceed its assets by $183 million. Allowing TWIA to continue to operate in this condition could place new policyholders in jeopardy, and could further threaten the current policyholders.
  • “If TWIA’s funds are insufficient to pay all existing claims, it may be necessary for the Rehabilitator to make partial payments on a pro rata basis.”
  • “The hold on claims payments would not apply to losses stemming from storms occurring after TWIA was placed in Rehabilitation.”
  • “TWIA does not currently have any outstanding pre-event public securities.”
  • 18. Would Rehabilitation affect the availability of mortgages in areas covered by TWIA? Rehabilitation would not change TWIA’s ability to issue new policies, renew policies, or fulfill its obligations under current policies. [Note that the question is not actually answered — SJC]

 

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Craig Eiland: TWIA can still assess for Ike

According to ABC-13, State Representative Craig Eiland of Galveston also thinks I’m wrong about whether TWIA can still assess insurers for damages caused by Hurricane Ike in 2008.  I’ve stated here and here in this blog that the repeal of section 2210.058 of the Texas Insurance Code in 2009 certainly seems to have ended that authority.  But Rep. Eiland states: “The board can reassess the companies now — today, tomorrow, next week — for the money and premiums they paid out in claims since Hurricane Ike.” TV stations don’t usually include footnotes, so I’m genuinely curious about what Rep. Eiland’s legal authority is for his assertion.

I’m also curious to see what would happen if TWIA followed Representative Eiland’s assertion and actually tried to reassess insurers around the state to pay for persistent Ike claims.  My guess is that it would not provide cash in time for the 2013 hurricane season. I suspect that many Texas insurers would file a lawsuit before they wrote a check.

The IBNR problem: the plot thickens

Two new pieces of data have emerged on the IBNR problem and any ability or obligation on the part of TWIA to make a supplemental assessment against insurers to pay for claims arising out of 2008’s Hurricane Ike and reduce the odds of TWIA being put into receivership or conservatorship.

1. A learned student has pointed me to section 311.031 of the Texas Government Code. This is a kind of “meta-statute” on how to interpret statutes. It reads:

Sec. 311.031.  SAVING PROVISIONS. (a) Except as provided by Subsection (b), the reenactment, revision, amendment, or repeal of a statute does not affect:…

(2)  any validation, cure, right, privilege, obligation, or liability previously acquired, accrued, accorded, or incurred under it.

The student suggested that this provision might mean that liabilities acquired under section 2210.058 before it was repealed might persist after its repeal by section 44(2) of HB 4409 enacted in 2009.  Unfortunately, I think my learned student, though brilliant in finding this Government Code provision and thinking it was applicable, is wrong. I don’t think “liability” means the potential for liability.  It means an incurred liability.  Thus, if Allstate had not paid its assessment under the 2008 assessment, the fact that the statute permitting assessments was repealed would not relieve Allstate of its obligation to pay the pre-existing assessment.  It would, however, I think prevent TWIA from creating new liabilities for Allstate to pay.  Again, am I 100% certain of this?  No. But it strikes me that there is a difference between the potential for a liability and a liability itself.

2. Alex Winslow of TexasWatch suggested in an Austin American Statesman article today that TWIA might still be able to assess under the old law.  I don’t always agree with TexasWatch but I take their thoughts seriously.  On balance, however, at least so far, I think he is incorrect. If Texas had not repealed 2210.058, he might have a better case that the law in effect at the time of the disaster permitted late assessments.  But, the legislature repealed the statute authorizing assessments.  Much as it might be appealing to some to at least forestall TWIA implosion, it looks to me, for the reasons cited in this post and its predecessor, as if a supplemental assessment on insurers is not authorized under the law.

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The IBNR problem

IBNR is an acronym obscure to most but well known to those in the insurance industry.  It stands for Incurred But Not Reported and it can be the bane of insurers and insurance regulators.  It is behind some of the immediate problems facing the Texas Windstorm Insurance Association (TWIA) including its contemplation of conservatorship or receivership. That’s because Hurricane Ike, though it occurred in September 2008 and led to an assessment later that month on Texas insurers of $430 million, has ended up costing an amount which, if known at the time, likely would have justified a larger assessment.  Indeed, at least as reported by the Houston Chronicle, TWIA’s manager at the time Jim Oliver asked for an $830 million assessment  “but the board members — including several insurance company members — voted to reconvene later if further assessments are necessary.”  That reconvening to get additional money never occurred. As a result, current TWIA policyholders have effectively been paying since 2009 for losses incurred back in 2008 to the point where TWIA is now in considerable trouble even though there have been no major storms since Ike.  As discussed on this blog, TWIA is now talking publicly about conservatorship or receivership and, absent legislative intervention, entering  the 2013 hurricane season with woefully low reserves and a dubious ability to recapitalize and pay claims in the event of a significant storm.

The issue, which I don’t see explicitly on the agenda for the TWIA board meeting on March 25, 2013, is whether TWIA still has the authority to issue an assessment under the law that existed in 2008 at the time of Ike but has been substantially amended since then.  If so, that might reduce the probability of TWIA going under this summer while the legislature contemplates more serious changes. My own belief is that this is an important legal question on which I hope the TWIA board is getting paid advice from competent attorneys who are spending more than a few hours on the matter.  But, as a pretty competent attorney myself, let me offer some thoughts on the authority issue. The short version is that I do not think TWIA now has the authority to issue assessments under the old law.  Whether as a result of extremely clever legislative lobbying or just the luck of legislative drafting, in 2009 the insurance industry closed out its responsibilities under the old law. TWIA policyholders are basically left to cope with the remaining hash of Ike claims.

The key here is to understand the difference between the funding mechanism in place at the time of Ike in 2008 and the funding mechanism that the legislature put in place effective in June 2009. It’s complicated, so be patient. At the time of Ike, section 2210.058 of the Insurance Code (reprinted below) created a four tier structure for paying losses when TWIA did not have enough money in its regular accounts to pay the losses.  First, insurers throughout the state (the TWIA “members”)  would be hit for $100 million.  Second, TWIA’s catastrophe reserve fund — a special set aside account — and reinsurance would exhaust itself.  Third, insurers throughout the state would get hit with a $200 million assessment.  And, finally, if that still was not enough, insurers would be forced to pay whatever it took to pay off claims — the so-called unlimited assessment. In some sense, however, insurers mostly fronted this latter money instead of paying it outright; they recouped a good chunk of it back through credits against premium tax that they would otherwise owe.  Thus — and this was one of the major reasons for the change in the law that subsequently occurred — both insurers statewide and the State of Texas were effectively on the hook for large storms.  Insurers either had to have extra amounts of cash socked away in particularly liquid investments or had to pay to reinsure their potential assessment responsibilities.

The 81st legislature changed this arrangement and attempted to relieve both the state fisc and the insurance industry from the riskiest aspects of the prior scheme. Legally this was accomplished primarily through the addition of two new subchapters to the Texas Insurance Code: subchapters B-1 and J.  Subchapter B-1 set up tiers of post-event bonds (much discussed on this blog) that would be used to front money to TWIA policyholders with the bonds repaid over the years through assessments on TWIA policyholders, policyholders of many sorts on the coast, and, to a limited extent, property and casualty insurers in Texas. Subchapter J set up the rules for how these post-event bonds were to be issued.

If addition of Subchapters B-1 and J were all that the 81st legislature, the legal issue would be even harder.  But the legislature did more.  In section 44 of HB 4409, the Texas legislature explicitly repealed section 2210.058.  Moreover, various references in the statute to section 2210.058 were deleted. And, through repeal of sister provision 2210.059, the legislature eliminated any requirement that it be notified of any loss in tax revenue resulting from the tax credits that would potentially be triggered by an assessment. And in section 51 of the bill, it specified that the relevant provisions of the bill took effect immediately. Thus, when HB 4409 took effect in June of 2009, it appears that the authority to assess members under 2210.058 ended. The insurance industry gained its freedom — and derivatively the State of Texas protected its tax revenue — not just for future hurricanes but for hurricanes that had already occurred but whose claims were … IBNR.

Am I 100% certain this is correct?  No, but I am not finding any place else in any unrepealed sections of the former law that authorized insurer assessments to pay for hurricane losses. And without that statutory authority, I don’t see how the state can compel insurers to pay TWIA much of anything for losses created before 2009. Am I particularly happy about this answer? Actually not.  I was definitely not a big fan of the old law but if it had been applied the way TWIA leaders apparently wanted, we might have been in less of a mess today. Did the TWIA board breach some duty of care by issuing what turned out to be a low assessment in 2008?  Conceivably, but unless TWIA directors have $400 million lying around it may not much matter; moreover, it might well have been hard to forecast the scope and magnitude of Ike claims back then. There’s a lot of literature and disagreement on various factors that have caused Ike claims to grow. At bottom, it looks like the legislature made a choice in 2009 and Texans along the coast and, derivatively, the rest of Texas are now seeing some of the consequences of representative government in action.

Appendix

2210.058 as it stood at the time of Hurricane Ike (taken from http://www.statutes.legis.state.tx.us/StatutesByDate.aspx)

Insurance Code 2210.058 on 9/25/2008


Text of section effective until June 19, 2009

Sec. 2210.058.  PAYMENT OF EXCESS LOSSES; PREMIUM TAX CREDIT. (a) If, in any calendar year, an occurrence or series of occurrences in a catastrophe area results in insured losses and operating expenses of the association in excess of premium and other revenue of the association, the excess losses shall be paid as follows:

(1)  $100 million shall be assessed against the members of the association as provided by Subsection (b);

(2)  losses in excess of $100 million shall be paid from the catastrophe reserve trust fund established under Subchapter J and any reinsurance program established by the association;

(3)  for losses in excess of those paid under Subdivisions (1) and (2), an additional $200 million shall be assessed against the members of the association, as provided by Subsection (b); and

(4)  losses in excess of those paid under Subdivisions (1), (2), and (3) shall be assessed against members of the association, as provided by Subsection (b).

(b)  The proportion of the losses allocable to each insurer under Subsections (a)(1), (3), and (4) shall be determined in the manner used to determine each insurer’s participation in the association for the year under Section 2210.052.

(c) Expired.

(c)  An insurer may credit an amount paid in accordance with Subsection (a)(4) in a calendar year against the insurer’s premium tax under Chapter 221.  The tax credit authorized under this subsection shall be allowed at a rate not to exceed 20 percent per year for five or more successive years beginning the calendar year that the assessments under this section are paid.  The balance of payments made by the insurer and not claimed as a premium tax credit may be reflected in the books and records of the insurer as an admitted asset of the insurer for all purposes, including exhibition in an annual statement under Section 862.001.

Added by Acts 2005, 79th Leg., Ch. 727, Sec. 2, eff. April 1, 2007.

Amended by:

Acts 2007, 80th Leg., R.S., Ch. 932, Sec. 21, eff. June 15, 2007.

 

Section 44 of HB 4409

SECTION 44.  The following laws are repealed:

(1) subdivisions (5) and (12), Section 2210.003, Insurance Code;

(2) Sections 2210.058 and 2210.059, Insurance Code;

(3) Sections 2210.205 and 2210.206, Insurance Code;

(4) Sections 2210.356, 2210.360, and 2210.363, Insurance Code; and

(6) Subchapter G, Chapter 2210, Insurance Code

[Note: I have no idea what happened to paragraph (5) of Section 44.]

 

 

TWIA board to consider receivership

An agenda posted recently by the Texas Windstorm Insurance Association for its meeting on March 25, 2013, in Austin, Texas shows that the state-chartered insurer will at least be considering options consistent with those of insurers who are insolvent or whose solvency is threatened.  Item 2A of the agenda reads: “Review options for addressing the current financial condition of the Association and alternatives including supervision, conservation and rehabilitation in receivership”

Several points worth noting before I head off to a meeting:

1.  This does not mean that TWIA is insolvent.  It does suggest, however, that its board is taking seriously the financial straits in which the insurer now lies.

2. One has to assume this mention of conservation and rehabilitation in receivership was not done casually.  Its authors must understand that, however responsible it may be to consider these very options, just saying it in a public document has significant repercussions.

 

[Update: 3/21/2013.  The Corpus Christi Caller, which seems to be the only Texas newspaper not asleep at the switch on this issue, has a story today discussing this matter and reaction among some on the coast.]

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.