An open letter to State Representative Todd Hunter

Dear Representative Hunter,

My purpose in writing is to urge you to consider the risk to your constituents by letting the fate of the many policyholders of the Texas Windstorm Insurance Association rest on a flimsy regulation that is likely to be the subject of a length court challenge. I understand your position that the statutes and regulations currently in place do not adequately share the risk of catastrophic events throughout Texas. But fundamental decisions on that matter will not be resolved by the Texas legislature before the 2014 hurricane season is well underway. You are widely considered a champion of Texas coastal interests. You have a responsibility to your constituents to think this matter through very carefully. And you need to do it now.

There is a short run emergency in the TWIA funding situation on which people, like me, and, more importantly, inland legislators might well be able to reach agreement with coastal interests on a tolerable fix.  I urge you therefore to put personalities and long-standing battles aside, and work together immediately.  You will need to plead with Governor Perry to call a short and limited special session of the Texas legislature in order to do so. I am not an expert on Texas politics, but my sense is that you will need to compromise in that request and not ask for any fundamental reforms of windstorm insurance systems; you may need to compromise further and accept a plan that at least temporarily hardens what you regard as an undue burden on the Texas coast.  The alternative, however, is so bad, that you would be doing your constituents a yet worse disservice by failure to make the request.

You asked in a recent television interview on KRIS-TV that people, and my impression from the report was that I was included, stop complaining, stop criticizing and start working together constructively.  I was a bit puzzled by this statement because I have heard such offers from you before only to find that, when I accepted, your staff informed me that your busy schedule did not permit you ever actually to talk, even by phone. Perhaps they misunderstood your desires. Not meeting is, of course, your privilege. But there is no legislative session going on right now that should prevent you from meeting now either by phone, Skype or in person. Although you and I are not likely ever to agree on the structure of windstorm insurance funding in Texas, I am definitely willing to work with you and other Texas legislators any time, any place, on either trying to find intelligent compromises or, as here, preventing absolutely needless disasters from happening.

Here’s the emergency. I know that TWIA funding is a contentious minefield, but I am going to describe it in a way on which I think everyone can agree.

1. TWIA does not and will not have enough cash on hand to pay for a significant tropical cyclone hitting Corpus Christi or other densely populated parts of the Texas coast during the 2014 hurricane season.

2. TWIA’s reinsurance is unlikely to attach at low enough levels so that it, if TWIA has difficulty borrowing, the reinsurers will provide the cash necessary to pay claims.

3. TWIA’s ability to borrow money following a tropical cyclone rests on a statute that has never been used before.

4. Lenders in the past have balked when asked whether they would loan TWIA up to $1 billion in “Class 1 Bonds” when the payback mechanism for those bonds are (heightened) premium revenues from TWIA policyholders. There is thus a substantial risk that not all of the Class 1 Bonds would be salable. The failure of Class 1 Bonds to sell, prior to 2011, would have toppled the entire post-event bonding scheme developed by the Texas legislature and would leave TWIA with no cash with which to pay claims following a significant storm.

5. In 2011, the Texas legislature considered this contingency and amended Chapter 2210 of the Texas Insurance Code to add section 2210.6136. It provides a contingency plan in the event that the Class 1 Bonds are unsalable.  The idea behind section 2210.6136 is to permit Class 2 Bonds to be issued through the Texas Public Finance Authority even if the Class 1 Bonds do not sell in full and to thereby permit Class 3 Bonds, which are repaid via assessments on insurers, to be sold if need be.

6. Given the high likelihood that Class 1 Bonds will not be fully salable and given the necessity of TWIA to borrow in order to be able to pay claims following a major storm, Texas depends on section 2210.6136 being a coherent statute, the type of statute that potential lenders believe will provide a legal basis for their claims to repayment.

7. The Texas Public Finance Authority had initial difficulty understanding section 2210.6136 based on its text and met with legislative staff in order to obtain an explanation of how it worked. TPFA described its staff and advisors as “struggling with the mechanics of financing” under section 2210.6136.

8. Legislative staff explained the intent of the statute as being one under which Class 2 Bonds would be initially paid 30% from assessments on insurers and 70% via surcharges on certain coastal insurance policies but under which TWIA policyholders would be required –insofar as possible — to repay the insurers and coastal insureds up to $500 million of their bond amortization payments.

9. The Texas Department of Insurance has issued draft regulations that implement the interpretation of the statute offered by legislative staff but acknowledge in the preface the the regulations that this interpretation is impossible or difficult to reconcile with the language of the statute.

10. Insurance companies in Texas will be forced to pay more in assessments under the TDI interpretation of section 2210.6136 than under a literal reading of the statute. Certain coastal insureds will also have to pay more.

11. Insurance companies may have duties to their shareholders and/or it may be in their best economic interests to challenge regulatory interpretations of statutes that are contrary to the language of the statute and require them to pay more than they would under a literal reading of the statute. Sophisticated coastal insureds and/or those advised of the situation may likewise have an incentive to bring legal challenges to regulations requiring them to pay more than they would under the statute.

11a.  This is the one point that I acknowledge might be contestable.  It is unlikely that a court would swiftly dismiss the claims of those challenging regulations that are, at best, difficult to reconcile with the language of the statute. Those challenging the claim have a significant chance of prevailing.

12. Lenders who might otherwise loan TWIA money via Class 2 Bonds will be reluctant to do so if they are aware of items 1-10 above. They will not lend if they believe there is likely to be a length court challenge to the bond payment mechanism.

13. If lenders do not lend TWIA money, TWIA will not have enough money to pay claims following a major storm. If so, there will be devastation of TWIA insureds, great derivative harm to almost everyone on the Texas coast, and significant derivative harm to others in the Texas economy. Although the strength of interests may vary, it is not in anyone’s interest that the TWIA funding stack collapse due to a legal technicality.

I have thought about this for some time.  And the only point on which I believe some might disagree is item 11a. If you really believe that the risk of a serious challenge is extremely low, then there is no emergency. If, however, you believe as I do, that the risk of a serious challenge is significant, then indeed we have an emergency. There is a really serious risk that TWIA policyholders will not be paid any time soon following a significant storm this summer.

What bothers me most is that, unlike many problems, this one is very solvable. The Texas Insurance Commissioner, Julia Rathgeber, appointed by Governor Perry, has already come up with a solution. Simply turn the language of the law into what legislative staff believe it was supposed to say. That will require almost no effort.  One simply has to relabel the regulatory provisions she has proposed as a statute, get the legislature to pass it, and get the Governor to sign it and the situation is resolved.No more emergency.  Lenders should feel way more comfortable loaning TWIA the money.

Yes, some insurers may balk at the solution. But the very fact that one thinks they might do so is a sign that they will in fact litigate if no statute is passed and the same result occurs through an ultra vires regulation. By claiming that insurers will object to a legislative change that purports merely to clarify the status quo, one essentially acknowledges that the current situation is untenable.

And you, Representative Hunter, are likely to find the Rathgeber solution a difficult pill to swallow. It does burden the coast with 70% of the bill for Class 2 bonds. Some of your more militant constituents could be angry about this.  Here is what you need to explain to them.  I am optimistic that there will be enough reasonable people on the Coast that such an explanation will be satisfactory.  You are not bargaining from a position of strength.  The law already was intended to burden the coast with 70% of the bill for Class 2 bonds.  There is nothing knew with the proposed statute.  What it is doing is making sure that something even worse does not happen: TWIA collapsing due a technical glitch and blue roofs staying on coastal homes for a very, very long time.  You can assure your constituents that you will seek a better solution during the next regular session of the legislature but that, for now, improving the language of the statute without changing its meaning is a major improvement.

There are, of course, other solutions.  You could, for example, try to flip responsibility for Class 2 Bonds such that 70% of the burden is on insurers and only 30% on the coast.  There are lots of other mechanisms for spreading the risk of windstorm farther inland. But do you really think you will reach agreement on such a significant reform during a special session when you were unable to do so last session? The one “focal point equilibrium,” the one thing on which you and inland representatives might agree is to make the statute actually say what, supposedly, various staff members said it intended.

Finally, I suppose it is possible that you believe that the rest of Texas will come in and rescue the coast if TWIA collapses and that you should not accept a solution that solidifies a current scheme that you think is fundamentally unfair.  All I can say is that this is very high risk poker. Trying to resolve TWIA funding after a major storm in some special session of the legislature is likely to stalemate and also likely to result in statutes that are actually worse for the coast than the status quo. The process is not likely to be swift and the emotional and financial stress on the coast while the matter being debated is extraordinarily ugly.

As I indicated in a somewhat similar open letter to Governor Perry this past week, I know that you can not trust me on critical item 11a. But you are a lawyer and you certainly know lots of open minded lawyers.  You also know, I suspect, lots of insurance representatives.  Ask them if they believe the regulation enacted by the Texas Insurance Commissioner on which the TWIA funding stack depends is unlikely to be challenged in court.  Ask them if they believe such challenges would survive, for example, a motion to dismiss. Or go find institutional lenders.  See if they would be willing to lend if they got wind that insurers or some coastal interests might challenge the pay back mechanism.  If all you get are assurances that the University of Houston professor is off his rocker or just scaring people, then, fine, ignore me.  I am sincerely sorry for what would be a false alarm.  My strong suspicion, however, is that these people are going to tell you that I have a serious point.

One way or another you need — right now, before hurricane season hits full swing — to be assured that lenders will loan TWIA funds on Class 2 Bonds when the Class 1 Bonds can’t issue.  Maybe there are ways of getting this other than a special session of the legislature. I am not sure what these methods would be.  But until you have that, as a champion of the Texas coast, you need to be on the front lines, making common cause with whomever you can, saying that this provision of the law needs to be fixed by the Texas legislature right now.

 

Disclaimer

The views expressed here are my own and do not necessarily reflect those of the University of Houston.

 

 

An Open Letter to Governor Perry

The following is a copy of a letter I am sending today to Governor Rick Perry.

Dear Governor Perry,

I am Seth J. Chandler, a 24-year resident of Harris County, Texas, and Foundation Professor of Law at the University of Houston specializing in insurance law.  I am also the author of the blog Texas Windstorm: The law and finance of insuring catastrophic risk in Texas (http://catrisk.net).  I have testified on numerous occasions before the Texas legislature on regulation of windstorm risk and finance. I have also served on your Texas Health Care Policy Council under the leadership of Tony Gilman.

I am writing to alert you of a serious and urgent problem that has come to light with the funding scheme for the Texas Windstorm Insurance Association. I urge you to call a Special Session of the Texas legislature to address it immediately.  I believe that you can properly confine the agenda so that even legislators who often disagree on TWIA matters can come together to fix this particular problem. If the problem is not resolved, there is a significant probability that, following even a modest tropical storm hit on a densely populated area of the Texas coast such as Galveston or Corpus Christi, the Texas Windstorm Insurance Association would not be able to pay claims in a timely way. TWIA might have grave difficulty ever paying them.  Substantial delay in payment or non-payment of claims by the largest insurer on the Texas Coast would be a needless disaster for the entire Texas economy and would likely result in a special legislative session anyway, but in the worst possible circumstances.

The problem, in a nutshell, is section 2210.6136 of the Texas Insurance Code, which addresses how “Class 2 Bonds” issued to pay TWIA claims are to be paid back. The current Insurance Commissioner Julia Rathgeber, former Commissioner Eleanor Kitzman, the Texas Public Finance Authority and others all agree that the provision is confusing and poorly drafted.  Indeed, I know of no one who thinks that section 2210.6136 is clear.  Everyone I know who has looked at the statute says that, if interpreted as it was written, it creates an unworkable plan to pay back Class 2 Bonds.

The issue is whether the Texas Insurance Commissioner has now crafted a fix to section 2210.6136 via regulation that will stand up in an inevitable legal challenge.  I believe the answer is “no.” Commissioner Rathgeber has developed a sensible idea in her regulation that might prove the foundation for future legislative action. But her regulation is, as I believe she admits on pages 10-13 of the January 28, 2014, submission of the draft, contrary to the language of the statute.  The evidence I have seen that would justify a court in interpreting the statute contrary to its language is weak. There is thus a substantial risk that, without legislative ratification, her interpretation of the existing statute will be found an invalid exercise of law-making power and struck down by the courts. Both Texas insurers subject to a heightened assessment from TWIA and, for example, automobile insurance policyholders on the Texas coast would have standing to challenge the regulation and the extra payments they would make as a result. And even if her interpretation were ultimately to be sustained by a Court, a challenge would likely have sufficient merit to avoid early dismissal. It would likely take at least a year to resolve through the judicial system and appeals.  The specter of litigation will deter needed lenders from extending up to $1 billion in credit via Class 2 Bonds that TWIA would need to pay a major claim. In the mean time, blue roofs would cover the Texas coast as a result of unpaid claims.

I have outlined my legal opinion in more detail on my blog catrisk.net.  You can see the most relevant entries at http://catrisk.net/documents-show-texas-agencies-aware-serious-problems-post-event-bonding/, and http://catrisk.net/texas-insurance-commissioner-trying-fix-fatal-bug-windstorm-statute/, and in an op-ed in the Houston Chronicle available here http://www.chron.com/opinion/outlook/article/Commentary-Windstorm-insurance-has-Texas-in-5315395.php.

I understand that, just based on a letter from a professor you do not know, you cannot call a Special Session of the legislature. I implore you, however, to trust me enough to seek urgent clarification from the Attorney General or from others qualified to provide legal advice.  If they say I am wrong and the Texas Insurance Commissioner’s fix is so clearly lawful that the risk of disruptive litigation is minimal, then great.  If they say that the problem can be resolved by other forms of non-legislative action, such as a formal letter from the Attorney General validating the Texas Insurance Commissioner’s action, good; let such a letter issue promptly. If not, however, I would urge you to call a Special Session before hurricane season starts again. I believe Commissioner Rathgeber’s regulations could be adapted swiftly and easily into a statute so that the matter could be resolved in a few days. Although coastal interests and inland interests do not always mesh on TWIA funding issues, it is in absolutely no one’s interest that TWIA fail due to a drafting problem.  I am thus optimistic that legislative leaders in the area such as Senators John Carona and Larry Taylor and Representatives John Smithee and Todd Hunter might be able to work cooperatively on this limited issue. Other issues involving TWIA on which consensus is less likely can be handled through more regular process.

I remain happy to work with your staff, the Texas Insurance Commissioner, legislators and their staff to do anything I can to help explain the issue and suggest resolutions. My other credentials are attached to this letter.

Sincerely yours,

Seth J. Chandler

Please note.  The views expressed here are my own and do not necessarily reflect those of the University of Houston.

 

Documents show Texas agencies hiding problems with TWIA funding

Documents obtained pursuant to a public records request from David Crump, a private citizen with a longstanding interest in Texas insurance finance, show the Texas Department of Insurance and the Texas Public Finance Agency have both been aware since September of 2011 of potentially fatal problems with the laws that are supposed to permit the Texas Windstorm Insurance Association to borrow money following a significant hurricane strike along the Texas coast and pay claims. The Texas legislature, instead of fixing problems with the statute during its 2013 session, however, so that its language conformed with its purported intent, chose to leave the statute as it was.  As a result, the ability of TWIA to pay claims following a significant strike will apparently depend this summer on a highly creative interpretation of the law at odds with the words actually used in the statute. It is an interpretation almost certain to breed serious court challenges.  The documents uncovered by Mr. Crump show the origins of this legal theory and efforts by the Texas Public Finance Authority to convince the former Texas Insurance Commissioner Eleanor Kitzman to change proposed regulations that might, the TPFA believed, revealed its own uncertainty as to the legitimacy of the legal theory they had developed.

The uncovered documents, which are in an archive available here, further suggest the desperate situation of the Texas Windstorm Insurance Association going into this hurricane season and the problems policyholders will face following a significant hurricane strike.  They show that both TDI and TPFA are fully aware of a serious problem with the law under which TWIA operates but have apparently persuaded themselves that they have a fix. An examination of actual Texas law in lights of the documents just uncovered show, however, that the fix, although not as strange as might initially be thought, is still highly questionable. Continued reliance on an untested fix jeopardizes both on TWIA policyholders and the Texas economy. Continued sale of policies by TWIA without more forceful disclosure of a fundamental issue in its funding scheme is, frankly, irresponsible.

Executive Summary

TWIA, the largest windstorm insurer on the Texas coast, does not have enough money to pay claims following a major storm.  It will have to borrow.  But documents have now come to light showing that Texas agency heads have been aware for years that there is a serious bug in that statute that may prevent the borrowing from being successful.  The legislature has not fixed the problem.  Instead, the agencies have cobbled together a very dubious legal theory that would permit TWIA to borrow.  Their efforts are likely to fail.  First, the legal theory asks courts to completely ignore the language of the statute and instead rely on what some legislators may say they actually intended.  Courts don’t usually go along with that. Second, even if ultimately the agencies’ interpretation of the statute would prevail, the matter is likely to be tied up for a long time in litigation; TWIA policyholders will likely go unpaid in the interim.  Documents uncovered by a public records request show Texas officials were aware of the problem, and, without adequate evidence, persuaded themselves to think they had solved it.  They also tried to prevent evidence of their internal doubts about the problem from getting before the public or lenders.  This failure to disclose and this failure to consider the serious problems with their “fix” is not responsible.

The Documents

The issue revolves around an obscure provision in the Texas Insurance Code, section 2210.6136, enacted in 2011 in H.B. 3 that was supposed to fix a bug in the 2009 version of the statute. That bug involved the absence of any provision in the statute for how post-event bonding would work and how TWIA would thus pay claims if Class 1 Bonds, the first layer of borrowings, were unmarketable because creditors didn’t trust the repayment source: heightened obligations on TWIA policyholders already bruised by a storm.  The higher layers of bonds couldn’t be tapped under the 2009 law unless all the Class 1 bonds had sold. The idea of H.B. 3 was to provide a Plan B. Unfortunately, as I think everyone could agree, section 2210.6136 (shown below) was drafted in, at best, an extremely confusing way.

Section 2210.6136 of the Texas Insurance Code

Section 2210.6136 of the Texas Insurance Code

The documents show recognition by the key Texas agencies that section 2210.6136 had not provided a clear fix for a problem that was becoming ever more apparent.  There was a significant likelihood that the triggering event — the credit market not accepting the Class 1 Bonds — would occur.

The documents thus show a September 13, 2011 meeting (six weeks after Governor Perry signed the law and two weeks before the new law would take effect) between the TPFA, which would be the agency issuing the bonds required for TWIA to pay claims, and staff from the heavy hitters on the House and Senate committees that had addressed the bill. The matter in question was new section 2210.6136 of the Texas Insurance Code, which had been intended to give TWIA a new “Plan B” in case, as it was being told was likely, the Class 1 Bonds that were supposed to form the first layer of protection were partly or entirely unmarketable.  In a letter summarizing the meeting and sent to both its participants and leaders at the Texas Department of Insurance and TWIA, TPFA admits that its “staff and advisors have struggled with the mechanics of financing under that section.” It then sets forth, however, an imaginative theory of how section 2210.6136 could be interpreted in a fashion that would make Class 2 Bonds marketable.

The documents likewise show concern by the TPFA on May 22, 2012 that the Texas Insurance Commissioner, Eleanor Kitzman, was drafting rules for TWIA that exposed the fragility of the interpretation in which TPFA apparently acquiesced following the September 2011 meeting.  Commissioner Kitzman had done this — responsibly — by offering two alternative ways of implementing post-event bonding in the proposed regulations. The first method implemented the theory of 2210.6136 that TPFA had acquiesced to (or possibly embraced) following the September 2011 meeting with legislative staff. That theory was contained in what was section 5.4126 of the proposed regulations. The second method was contained in section 5.4131 of the proposed regulations and provided a “Plan C” for what would happen if the Texas Attorney General determined the Plan B bonds could not be issued under 5.4126 or if there was litigation challenging issuance of securities under 5.4126.

On seeing that Commissioner Kitzman had revealed possible problems with TPFA’s construction of the statute, TPFA Executive Director Robert Coalter wrote a letter to Kitzman questioning her actions.

Also, offering two alternative interpretations in proposed rules introduces the notion that there is legal uncertainty surrounding the issuance of debt pursuant to Section 2210.6136 and this type of uncertainty generally is undesirable to potential investors. Accordingly, for these reasons as further supported below, TPFA requests that the Department eliminate the alternative offered under Section 5.413 I when publishing the rules for comment.

If the Rules support more than one construction for the authority to drop down to the issuance of Class 2 public securities, the alternatives may cause the OAG [Office of the Attorney General] to question the construction of the law and request a court interpretation before it can issue an opinion approving the public securities thereby delaying the issuance for a significant period.

 

Finally, the documents show an internal “informal draft” of the regulations file stamped May 22, 2012, that delete the alternative financing mechanism that might expose the fragility of TPFA’s saving interpretation of the statute. It is not clear whether this document was developed by TPFA, TDI or others.

In any event, what is currently being circulated in 2014 by the current Texas Insurance Commissioner, Julia Rathgeber, contains no mention of any alternative or any possibility that the Class 2 Bonds might not be lawfully issued. Instead, in a section now numbered 5.4127, it embraces TPFA’s creative reconstruction of the statute. Not surprisingly, TPFA’s March 10, 2014, comments on the proposal contain no objection to Commissioner Rathgeber’s ideas on how to construe section 2210.6136 of the Insurance Code.

The Problem

Unfortunately, although the economic lives of hundreds of thousands of Texans rest on this issue, it is not an easy one to explain. I dread being asked to explain it in a 30 second sound bite. But here’s my best try.

The issue is who has to pay back the money TWIA will need to borrow to pay claims following a significant hurricane in which cash on hand and the depleted Catastrophe Reserve Trust Fund (CRTF) are exhausted.  If there is one other thing everyone can agree on, it is that TWIA does not have enough cash on hand or money in the CRTF to pay for many Category 2 or higher strikes that would hit a densely populated area of the Texas coast such as Galveston or Corpus Christi. It will need to borrow. If TWIA does not have the ability to borrow, those claims are likely to go unpaid for a lengthy period of time. Indeed they may go unpaid forever.  It is crystal clear that the state of Texas has no legal obligation to pay policyholders in the event of TWIA’s insolvency. And if there is legal doubt about who has to pay back loans TWIA would take out, creditors are very unlikely to loan TWIA money in the first place.

The table below taken from internal TWIA documents also produced in response to a public records request by Mr. Crump shows the potential magnitude of TWIA losses.  TWIA is projected at best to have $400 million in internal resources (cash on hand plus CRTF money) to pay claims.

TWIA's internal estimate of losses from Category 2 or 3 hurricanes

TWIA’s internal estimate of losses from Category 2 or 3 hurricanes

The Conflicting Theories about the TWIA statute

There appear now to be two mutually exclusive theories about who has to pay back certain moneys TWIA would need to borrow to pay claims.  Both relate to section 2210.6136 of the Texas Insurance Code and the “Class 2 Bonds” that will need to be issued in an amount up to $1 billion if the unpaid claims following a tropical cyclone are greater than the amount that can be raised via “Class 1 Bonds.” These are both scenarios where, in some sense, TWIA policyholders have escaped at least part of their statutory responsibility for the first billion in losses of borrowings engaged in by TWIA after a storm.

There are three concepts which are useful in understanding the statute: I will call them the “Escaped Amount,” the “Capped Escaped Amount” and the “Residual Amount.”

  • The Escaped Amount is the amount that the TWIA policyholders escape having to pay over time because TWIA can’t borrow the maximum amount it needs in Class 1 Bonds for which the TWIA policyholders would ordinarily be liable. You can see this concept manifesting itself in section 2210.6136(b)(1)(B) of the statute.The idea here is that TWIA policyholders are supposed to take responsibility for the first $1 billion in losses above the Catastrophe Reserve Fund and that they escape that responsibility if TWIA can’t borrow.
  • The “Capped Escaped Amount” is the lesser of $500 million and the Escaped Amount.  You can see this concept manifesting itself in section 2210.6136(b)(1) of the statute. The cap is in section 2210.6136(b)(1)(A). So, if TWIA can borrow only $200 million in Class 1 Bonds because creditors won’t loan them any more, the Escaped Amount is $800 million and the Capped Escape Amount is $500 million. If TWIA can borrow $700 million in Class 1 Bonds, the Escaped Amount is $300 million and the Capped Escape Amount is also $300 million.
  • The Residual Amount is simply the difference between the amount TWIA borrows from Class 2 creditors and the Capped Escaped Amount. This concept is found in section 2210.6136(b)(2) of the statute. So, if TWIA borrows $900 million in Class 2 Bonds and TWIA borrowed only $300 million in Class 1 bonds to pay for $1.2 billion in losses above the Catastrophe Reserve Trust Fund, then the Escaped Amount is $700 million, the Capped Escaped Amount is $500 million and the Residual Amount is $400 million.

Under one theory, which I will call the “Actual Words of the Statute Theory,” Class 2 creditors are supposed to first be paid back the Capped Escaped Amount by TWIA policyholders.  The repayment is accomplished by TWIA raising premiums on its policyholders and using the money to pay off the borrowings. The Residual Amount, if any, is paid off by assessments on insurers doing business in Texas (30%) and premium surcharges on a wide variety of coastal insurance policies (70%). Thus, under the Words of the Statute Theory, the TWIA policyholders don’t really escape responsibility from a failure of the Class 1 bonds to sell fully; they just make the payments for Class 2 Bonds rather than Class 1 Bonds, although the recapture of this Escaped Sum is limited to $500 million. And if the TWIA policyholders simply can’t pay this sum, it becomes the problem of the Class 2 creditors who loaned TWIA the money in the first place. No one else is responsible. The diagram below attempts to illustrate this theory.

Actual Words of the Statute Theory

Actual Words of the Statute Theory

Under a second theory, which I will call the “Suretyship Theory,” TWIA policyholders owe the Capped Escaped Amount to the Class 2 creditors just as under the “Actual Words of the Statute Theory,” but they have Texas insurers and other coastal policyholders acting as sureties. If the TWIA policyholders can’t pay, the Class 2 creditors are still likely to have their loans repaid.  That is because Texas insurers and coastal policyholders pay off the Class 2 creditors on a 30/70 basis. Some of these payments may be as sureties on the Capped Escape Amount obligation of the TWIA policyholders; other payments will be made as part of the Residual Amount.  If TWIA policyholders ever have the money, the sureties get repaid by the policyholders via what the law calls “subrogation.”  The one catch is that this “subrogation right” of the surety is limited to the Capped Escaped Amount. Under this theory, if the TWIA policyholders can’t pay the Capped Escaped Amount, the Class 2 creditors should still be made whole; it is the member insurers and the coastal insurers who will be paying more than they ordinarily would. This theory, if it had a basis in the statute, would thus make it far more likely that institutions would actually lend TWIA the money it needs to pay claims.

The diagram below attempts to illustrate this more elaborate theory. The subrogation lines are dashed to indicate that these payments may never materialize.

Suretyship Theory

Suretyship Theory

The documents show that TPFA and, apparently, TDI have persuaded themselves that the Suretyship Theory is correct and have now written regulations (5.4127) that would codify it. This has caused a bit of tumult since it means that coastal policyholders are likely to pick up a larger financial share for a serious hurricane — particularly if the TWIA policyholders don’t/can’t pay them back. TPFA, which initially had serious questions about section 2210.6136, obtained statements from staff for key Texas legislators such as Senator John Smithee, Senator John Carona and Representative Larry Taylor that would appear to support the Suretyship Theory. As discussed below, both TDI and TPFA have seized on the word “repayment” instead of “payment” in the statute (2210.6136(b)) to prove that suretyship was contemplated.  Both have further  reasoned that, because the Actual Words of the Statute Theory will not, in fact, work, the Suretyship Theory, peculiar as it is in light of the words of the statute, must in fact be correct. They have essentially adopted the view of Sherlock Holmes: “when you have eliminated the impossible, whatever remains, however improbable, must be the truth.”

THE SERIOUS PROBLEMS WITH THE SURETYSHIP THEORY

As I will now discuss, however, there are serious problems with the Suretyship Theory.  If that is what the legislature intended, the statute makes no sense.  Moreover, the idea that creditors will lend money on the basis of the Suretyship Theory — even if it were ultimately proven correct — seems highly fanciful. This, of course, is exactly why Commissioner Kitzman had suggested a Plan C in her draft regulations so that at least there would be no regulatory vacuum in the event courts did not accept the imaginative and non-textual interpretation of 2210.6136 developed by TPFA.  And, finally, if indeed everyone meant the Suretyship Theory, surely it would not be difficult to call a very brief Special Session of the Texas Legislature to clarify the statute and avoid difficult litigation following a major storm that gravely delays payments to TWIA policyholders whose homes have been devastated. Failure to reform the statute if everyone agrees there was just a mistake in writing it down is irresponsible where people’s lives and homes are at stake.

The Statute Makes No Sense if Suretyship was intended

If, however, Texas had intended a suretyship, there was a far simpler way to draft it.  Here is about what section 2210.6136 would likely have said. It is far simpler than the scheme set forth in the real section 2210.6136.

Sec. 2210.6136. ALTERNATIVE SOURCES OF PAYMENT. (a) Notwithstanding any other provision of this chapter, 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). In such event, the liability of each entity responsible for payment shall be only as a surety to the extent of the Capped Escaped Sum but as under section 2210.613 to the extent of the Residual Sum.

(b) As used in this section,

     (1) the term “Escaped Amount” means 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;

     (2) the term “Capped Escaped Amount” means the lesser of the Escaped Amount and $500 million; and

     (3) The term “Residual Amount” means an amount equal to the difference between the principal amount of public securities issued under Subsection (a) and the Capped Escaped Amount plus any costs associated with that amount

(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.

Instead of this structure, however, the real section 2210.6136 contains no mention of suretyship and no mention of the fact that Texas insurers and coastal insureds are supposed to pay back the entirety of the amount borrowed using Class 2 bonds. The word surety or guarantor never appears. The word “reimburse” likewise never appears. Instead, the statute has a complex two-part structure in which it firsts describes how much is to be paid back pursuant to the mechanism in section 2210.612 of the statute — under which TWIA policyholders are liable — and how much is to be paid back pursuant to the mechanism in section 2210.613 of the statute — under which Texas insurers and coastal insureds are liable.  Section 2210.6136(b)(2) makes absolutely no sense as a suretyship arrangement because it would be calling for the surety to pay itself — something that can never happen. In short, it is as almost as plausible to interpret 2210.6136 to contain an unstated desire to have all Texans repay Class 2 Bonds — after all, this too would “solve” the funding problem — as it is to interpret it to contain some sort of suretyship relationship.

The counterarguments

So, given all this, how could TPFA and TDI come to the conclusion that 2210.6136 in fact embraces a suretyship theory?  Their best argument is the (Sherlock) Holmesian one that the statute cannot possibly mean what it says.  I have noted this problem myself. If TWIA policyholders don’t have enough resources to pay off Class 1 bonds, which are on a 14-year repayment schedule, how are they going to have enough resources to pay off Class 2 bonds on a 10-year repayment schedule?  Here is what the Robert P. Coalter, Executive Director of the TPFA wrote to then Texas Insurance Commissioner Eleanor Kitzman on May 22, 2012, in a letter just revealed as a result of Mr. Crump’s Public Records request.

“To construe Section 2210.6136(b)(l) such that the Class 2 public securities ordered to be issued under Section 221 0.6136(b) are to be paid by net premium and other revenues would render Section 2210.6136 ineffective. In the construction of a statutory provision, there is a presumption that such provision is effective. It is an impossibility for Class 2 public securities secured by net premium and other revenue to be issued following the inability to issue Class 1 public securities secured by such net premium and other revenue under Section 2210.612. Put another way, if Class 1 public securities cannot be issued under Section 2210.612, how can Class 1 public securities disguised as Class 2 public securities be issued under Section 2210.6136?”

 

TPFA then bolsters this point by stating that statutes should be interpreted in the public interest and that it would very much not be in the public interest for TWIA to be unable to  borrow money following a major storm.

Here’s the difficulty.  It is true that section 2210.6136 is a very bad law if it is interpreted as it was written. It is bad for precisely the reasons identified by Mr. Coalter and, actually, by current Texas Insurance Commissioner Julia Rathgeber more recently. But, if Holmes maxim governs, a court could find that it was impossible for a legislator that meant to create a suretyship relationship to have said so using the words contained in section 2210.6136 and therefore that the improbable theory — that the legislature just drafted a dopey law — must be embraced. Moreover, is it really “impossible” that if the Class 1 bonds failed, the Class 2 bonds repaid from the same source would fail as well?  Perhaps during the time period after it was learned that the Class 1 bonds would fail, the situation of TWIA policyholders improved so that they could repay Class 2 bonds.  Or perhaps Class 2 bonds secured partly by payments from insurers would attract lower interest rates than Class 1 bonds secured only by payments from policyholders.  Likely? No.  Impossible?  I am less sure.

The TPFA mustered two additional arguments for its suretyship theory in that critical letter to Kitzman.  The first rested on a distinction between the use of the word “repayment” in describing an obligation under section 2210.6136 and the use of the word “payment” in describing obligations under other provisions calling for repayment of bonds.  According to the TPFA, “In giving the ordinary meaning to the use of the words “pay” or “paid” and “repayment,” one could conclude that repayment means the reimbursement of an amount initially paid.”  Well, I suppose one could, but the TPFA ignores the fact — indeed cuts it out of its letter — that section 2210.6136 actually uses the term “payment” in section 2210.6136(b)(2) to describe this alleged reimbursement obligation.  If repayment meant reimbursement then, in describing the obligation, presumably such a careful legislature would again use the term “repayment” rather than the term “payment.” Moreover, in three other sections of the Chapter addressing Texas Windstorm Insurance (2210.056, 2210.609 and 2210.6165) the legislature uses “repayment” to describe things that are clearly not reimbursement obligations. In short, the legislature appears to have used payment and repayment synonymously.  You just can’t conclude much of anything based on a one-time use of the word “repayment” in one part of section 2210.6136.

The final argument TPFA advances is legislative history. Here is what TPFA says in its May 22, 2012 letter to Commissioner Kitzman.

Legislative history may be considered in construing a statute, whether or not the statute is considered ambiguous on its face. TPFA staff met with representatives of Representative Smithee, Representative Larry Taylor, Senator Carona and Senator Jackson who affirmed that the use of the words “pay” and “repay” in Section 2210.6136 was purposeful to provide a manner whereby the Association could access the markets to obtain financing if Class 1 public securities cannot be issued in the amount authorized under Section 2210.072, and still ensure that as much as possible of the first one billion dollars of losses were ultimately paid by premium and other revenue. Thus, the new Section 2210.6136 authorized the Commissioner to order the issuance of Class 2 public securities payable from premium surcharges and member assessments as provided in Section 2210.613; furthermore, requires that the Association repay the policyholders and members for premium surcharges and member assessments assessed to pay the drop down Class 2 public securities in the amounts specified in Section 221 0.6136(b)(1 ).

 

This analysis is one-sided and shallow.  Yes, there is language in some Texas cases indicating that legislative history can be used if the plain language of a statute would lead to absurd results. But it is also true that this is to be done only in the most extreme cases and that different judges have different thresholds of absurdity before they embrace the separation of powers problems inherent in essentially fabricating law. Moreover, before courts decide to ignore the language of the statute, there needs to be”room for construction,” a reasonable alternative, and no way of interpreting the statute consistent with its text. To quote an earlier Texas Supreme Court case, Simmons v. Arnim, 220 S.W. 66, 70 (Texas 1920),

Courts must take statutes as they find them. More than that, they should be willing to take them as they find them. They should search out carefully the intendment of a statute, giving full effect to all of its terms. But they must find its intent in its language, and not elsewhere. They are not the law-making body. They are not responsible for omissions in legislation. They are responsible for a true and fair interpretation of the written law. It must be an interpretation which expresses only the will of the makers of the law, not forced nor strained, but simply such as the words of the law in their plain sense fairly sanction and will clearly sustain.

Or, as the Texas Supreme Court said as recently as 2009, “Enforcing the law as written is a court’s safest refuge in matters of statutory construction, and we should always refrain from rewriting text that lawmakers chose ….” Entergy Gulf States, Inc. v. Summers, 282 S.W.3d 433, 443 (Tex. 2009). See also, City of Round Rock v. Rodriguez, 399 S.W.3d 130, 140  (Tex.  2013) (“it would be a usurpation of our powers to add language to a law where the [L]egislature has refrained” and citing numerous cases on the topic);  J. Woodfin Jones, The Absurd-Results Principle of Statutory Construction in Texas, 15 Rev. Litig. 81 (Winter 1996).

The “legislative history” offered here to support the TPFA/TDI construction of the statute is not of a traditional sort: statements made by legislators to other legislators before the bill was enacted.  Statements of some legislators — even key legislators — after the fact about what they think a bill meant is deeply problematic because their theory was not presented for other legislators to consider.  As United States Chief Justice William Rehnquist summarized matters in Public Employees Retirement System of Ohio v. Betts, 492 U.S. 158 (1989), “We have observed on more than one occasion that the interpretation given by one Congress (or a committee or Member thereof) to an earlier statute is of little assistance in discerning the meaning of that statute.”  Justice Willett of the Texas Supreme Court has recently written that legislative history, even when permissibly used, “hits rock bottom” when considering post-enactment commentary on a bill. See Ojo v. Farmers Group Ins., 356 S.W.3d 421, 444, note 30 (Tex. 2011)(concurrence).

Moreover, here we don’t even have comments from the legislators themselves.  We have only reconstructed hearsay from staffers based on what they think their bosses meant and likely based on leading questions from a TPFA that had already constructed its theory. That is weak legislative history, possibly beneath rock bottom.  How much these staffers or the legislators for whom they work would recall anything as a result of litigation in 2014 or 2015 about events in 2009 and how much of that testimony would survive cross examination is very much open to doubt.

My point, anyway, is not to establish that the Suretyship Theory adopted by TPFA and TDI is a sure fire loser. My point is to establish that the public needs to be told about the problem. The original presentation of legal argument as to why it should be accepted was one-sided and shallow. The arguments in favor of the suretyship approach continue to be sufficiently problematic that it is a fantasy to imagine that persons hurt by it — such as coastal businesses and legislators who end up being converted into sureties with doubtful subrogation rights — will not be able tie matters up in litigation for a protracted period of time.  TPFA and TDI may have persuaded themselves that they have the best interpretation of the statute, but what creditor is going to be willing to lend $1 billion when the payment (or repayment) source is open to this level of doubt.   And, yes, the documents uncovered by Mr. Crump speak periodically about a comfort letter coming from the Office of Attorney General, but I (a) am not aware that such a letter has been issued; (b) have concerns as to whether the AG would issue such a letter; and (c) fear that such a letter, even if it were issued, might not provide adequate comfort to lenders when the final issue, after all, will be determined by the courts.

Conclusion

The real argument in favor of doing nothing, however, and simply accepting the Suretyship Theory now being promulgated by TDI is that it is a pretty good bluff.  Even if the theory is nonsensical, is there a court in Texas which, when the alternative is TWIA going insolvent, would have the guts to say that the law should be interpreted as it was written and that, if the legislature was aware of the issue and did nothing, the remedy is throw the rascals out and/or vote for relief after the fact under a new law? Perhaps not.  But given the pleas that will be made by individuals and businesses along the Texas coast who will be additionally burdened by the TDI Suretyship interpretation of section 2210.6136 and the attractiveness of the Actual Words of the Statute Theory, that is hardly a certainty. Moreover, given the internal doubts that have surfaced about the interpretation of section 2210.6136 — and the very real basis for those doubts — the responsible thing to do is to warn TWIA insureds about the problem. Yes, warnings about people’s homes and insolvent insurers are scary, but that is better I believe than burying one’s doubts in favor of a dubious and untested interpretation of a critical statute. It is not responsible for TWIA to bury the problem, for insurance agents to fail to disclose, or, frankly, for insurance regulators to be as quiet as they have been. Note to Governor Perry: neither your legacy nor your career will be helped by blue roofs on coastal houses as litigation grinds through the courts regarding 2210.6136 and the legislature deadlocks on now to proceed.

Finally, if indeed everyone indeed agrees on what was intended, would it not be the far more responsible thing, instead of playing poker with the judiciary, to just get a stronger hand by having a very brief special session of the Texas legislature — right now — and conform the law to its supposed intent? I know the Suretyship Theory if enacted into a clear law in a special session of the Texas legislature would not be ideal for many people along the Texas coast.  I know many along the coast would like the burden shared more widely across the Texas.  But that is a battle those interests will never win before the start of the 2014 hurricane season.  If they really believe in coastal solidarity, as it is sometimes termed, they should recognize that the current system is very likely to fail TWIA insureds following a large storm and that a fix after a storm will be very difficult.  In the few weeks remaining, they should not let perfection be the enemy of the good.

Insurance Commissioner tries to fix fatal bug in windstorm statute

Whether policyholders of the Texas Windstorm Insurance Association get paid following a significant storm during the coming summer of 2014 is likely to depend on a difficult legal question: whether the Texas Insurance Commissioner has the power to write regulations that clearly alter the language of a statute enacted by the Texas legislature where she believes, with reason, that the statute as written makes no economic sense.  The good news is that the new Texas Insurance Commissioner, Julia Rathgeber, agrees with an argument first propounded on this blog: there is a serious “bug” in the provisions of the Texas Insurance Code governing issuance of securities to pay for losses following a significant storm. That bug could jeopardize the entire system of post-event bonding that is supposed to cover for the shocking lack of cash TWIA, the largest windstorm insurer in Texas, actually has available to pay claims. Recognizing a problem exists is, after all, usually the first step for a cure.  It’s certainly better than pretending the problem doesn’t exist and hoping no injured party or judge will notice. The problem, however, is that it is not clear that the Commissioner, acting alone and without legislative action, has the power to cure this problem in a way that could cost other Texans considerable sums of money.

Matters would be far better if all sides in the enduring controversy over TWIA funding could agree to a minimalist statutory fix before the 2014 hurricane season begins.  The stakeholders could then then ask Governor Perry for a short special session to enact the fix as law.  The Governor might accommodate if almost all legislators agreed to the fix and the agenda were kept narrow.  Commissioner Rathgeber’s regulations contain one possible fix.  A blog entry I put forth last spring contains some others. None would “cure TWIA” — that’s a very hard problem that will likely take at least a legislative session. But at least the statutory scheme would function as well as was hoped for by the legislature. Right now it resembles a bad computer program that is about to crash from a giant bug if nature ever pushes the “Hurricane Key.” Unfortunately, for reasons that will be discussed below, it looks like getting agreement on even a simple statutory fix will be difficult.

Texas Insurance Commissioner Julia RathgeberAs a result of the Commissioner’s questionable authority to enact the changes she wants and the likelihood that a coastal resident hurt by her fix would challenge it in court (and refuse to pay in the interim), absent legislative action, it is unlikely that TWIA will have any ability swiftly to pay significant claims this summer. By “significant”, I mean those generated  by a respectable storm that causes insured losses in excess of TWIA’s cash position ($200 million to maybe $400 million) and whatever reinsurance, if any, drops down low enough to pay claims right above the cash reserve.  Lenders who just might otherwise be willing to advance TWIA money based on anticipated revenue from premium surcharges may be unwilling to do where there is no secure statutory basis for demanding at least some of the surcharges in the first place.

The problem

Let’s go through the problem that the Commissioner’s proposed regulations is intended to solve. The Commissioner actually outlines it quite well in her explanation of the proposed regulations now undergoing hearings, but I think my explanation is a bit more direct. The basic idea is that, following a tropical storm that wipes out TWIA’s cash position, TWIA can go to the borrowing market.  It can request issue three types of securities cleverly named Class 1, Class 2 and Class 3. The securities are actually issued by the Texas Public Finance Authority (TPFA), not TWIA itself. Even though TPFA issues the securities, under section 2210.615(a) of the Insurance Code they are explicitly not backed by the full faith and credit of Texas. Texas taxpayers are not on the hook to repay the borrowings if the statutory mechanism fails.

What distinguishes the three securities TWIA may issue when it runs out of money is mainly the source of repayment.  To oversimplify just a bit, Class 1 is to be repaid by TWIA policyholders through “net premium and revenue.” Class 2 is to be repaid 30% by assessments on the insurers that compose TWIA (people who write property/casualty insurance in Texas) and 70% via premium surcharges on most property insurance policies written on the Texas coast. This latter group includes not only TWIA policies but also non-TWIA homeowner or wind insurance policies, business fire insurance, personal automobile policies, and commercial automobile policies. Class 3 is to be repaid by assessments on the insurers that compose TWIA. Class 1 can be up to $1 billion. Class 2 can be up to $1 billion; and Class 3 can be up to $500 million. And the borrowings are supposed to take place in sequence.  No Class 3 before all Class 2 has been issued.  No Class 2 before all Class 1 has been issued.

There’s a big “however,” however. What happens if lenders are worried that TWIA policyholders won’t be able to pay enough in premium surcharges to amortize the loan?  In 2011, the legislature recognized this possibility and came up with a plan. You can find it in section 2210.6136 of the Texas Insurance Code, which the most recent regulatory proposal cites frequently. To the extent that the Class 1 bonds would not sell, what I have called “Class 2 Alternative” bonds can be issued. According to the statute — and this is the bug — the first $500 million (or, in some cases less) is to be repaid the same way Class 1 bonds are to be repaid: using premiums from TWIA policyholders.  The remainder of the $1 billion in Class 2 Alternative bonds are to be repaid the way ordinary Class 2 bonds are to be repaid.

The problem, as the Commissioner has recognized, is that, if the Class 1 Bonds won’t sell because lenders don’t trust TWIA policyholders to have the money to amortize the bonds, it is unlikely that they will trust “Class 2 Alternative” bonds that have exactly the same payment source. As the official explanation of the proposed regulations states, the statute has “the effect of treating class 2 public securities issued under Insurance Code §2210.6136 as class 1 public securities, which are repayable by premium and revenue assessments.

The paradox is well stated by the Commissioner:

If the association [TWIA] can issue Class 2 public securities that are to be repaid by premium, then this means the association is capable of issuing class 1 public securities. This eliminates the need for having an alternative to issue class 2 public securities when class 1 public securities.  It is not feasible to read the statute to require TPFA to issue all of the class 1 public securities it can based on the association’s net premium and other revenue, and then expect TPFA to issue additional public securities using the same funding sources simply because the name of the public security has changed.  Such a reading would render Insurance Code §2210.6136 meaningless.

The domino effect

The problem is even deeper, however, than this passage indicates. As I have previously noted and as the Commissioner’s explanation confirms: “TPFA cannot issue the class 3 public securities until after TPFA has issued $1 billion in class 2 public securities on behalf of the association for that catastrophe year.” In other words, if the Class 1 bonds fail, the Class 2 Alternative Bonds are likely to fail too.  And if the Class 2 Alternative Bonds fail, the Class 3 Bonds fail. There’s a domino effect. TWIA ends up with no cash to pay claims and no ability to borrow at all!

So, this is the disaster waiting for Texas if it does nothing.  It is the disaster the Commissioner is trying to avoid. Her proposal is effectively to rewrite section 2210.6136 of the statute and make all of the Class 2 Alternative Bonds payable the same way regular Class 2 Bonds would be repaid: 30% by assessments on the insurers that compose TWIA (people who write property/casualty insurance in Texas) and 70% via premium surcharges on most property policies written on the Texas coast.  To quote section 5.4127(a) of the proposed regulations:

(a) All Public Security Obligations and Public Security Administrative Expenses for Class 2 Public Securities issued under §5.4126 of this division (relating to Alternative for
Issuing Class 2 and Class 3 Public Securities) must be paid 30 percent from member assessments and 70 percent from premium surcharges on those Catastrophe Area insurance policies subject to premium surcharge under Insurance Code §2210.613.

 

The proposed regulations potentially rescue TWIA policyholders from disaster.  They provide a more plausible source of repayment and they don’t result in the Class 3 securities succumbing to the domino effect.

The Bên Tre analogy

There is only one problem.  The Commissioner has destroyed section 2210.6136 in order to save it. The law would be little different under the Commissioner’s proposal than if the legislature had never bothered with section 2210.6136 in 2011 and just kept things the way they were in 2009, except to say that Class 2 bonds can be issued first if the Class 1 bonds can’t be fully issued.  The two different subparts of section 2210.6136 elaborately specifying how each part of the money is to be repaid would appear to be unnecessary.

The legal issue

I’m not going to opine today on whether the Commissioner is within her rights in undoing a legislative enactment whose sense is indeed difficult if not outright impossible to discern. But this isn’t the somewhat simpler case of the Commissioner fixing a clearly omitted “not” in a statute or correcting some punctuation.  This is undoing an entire provision when the legislature has been alerted to the problem and has chosen to do nothing about it. Although a Texas court can choose to interpret a statute contrary to its actual words where doing so clearly fulfills the intent of the legislature, it must do so cautiously.  As set forth by the Texas Supreme Court in Presidio Independent School Dist. v. Scott, 309 S.W.3d 927 (Tex. 2010), “We thus construe the text according to its plain and common meaning unless a contrary intention is apparent from the context or unless such a construction leads to absurd results.” There are many cases, including Texas Department of Protective and Regulatory Services v. Mega Child Care, Inc., 145 S.W.3d 170 (Tex. 2004), that say about the same thing. Indeed, in my brief research I had to go back to 1898 and the case of Edwards v. Morton, 92 Tex. 152 (1898) to find a case in which the highest court found the requisite level of absurdity to exist. Perhaps there are more recent cases that some quick research did not disclose but I suspect there will not be many.

The United States Supreme Court summarizes prevailing judicial attitudes well on the subject.

Courts have sometimes exercised a high degree of ingenuity in the effort to find justification for wrenching from the words of a statute a meaning which literally they did not bear in order to escape consequences thought to be absurd or to entail great hardship. But an application of the principle so nearly approaches the boundary between the exercise of the judicial power and that of the legislative power as to call rather for great caution and circumspection in order to avoid usurpation of the latter. Monson v. Chester, 22 Pick. (Mass.) 385, 387. It is not enough merely that hard and objectionable or absurd consequences, which probably were not within the contemplation of the framers, are produced by an act of legislation. Laws enacted with good intention, when put to the test, frequently, and to the surprise of the lawmaker himself, turn out to be mischievous, absurd, or otherwise objectionable. But in such case the remedy lies with the lawmaking authority, and not with the courts.

Crooks v. Harrelson, 282 U.S. 55 (1930) (Sutherland, J.)

Clearly, what is good for the judiciary is probably good for the Insurance Commissioner as well. Commissioner Rathgeber no matter how outstanding her intentions and no matter how irksome her opposition will have an uphill battle defending her reconstruction of the statute governing the Texas Windstorm Insurance Association. She will surely face hostile judges when, contrary to the literal language of the statute, she seeks to impose an additional surcharge on some coastal Texas homeowner with insurance on a run down car who never bought a TWIA policy and indeed doesn’t even have a home to insure.

Residents of the coast have apparently caught on (see here, here and here) that the proposed regulatory change theoretically hurts them.  Under the statute as written, even if there were more than $1 billion in losses awaiting payment, insureds on the coast would be responsible for only 70% of about $500 million.  With the regulatory change, they are responsible for 70% of up to $1 billion.  So, basically, the non-TWIA insureds on the coast are objecting to helping their TWIA friends on the coast because they don’t think it’s their responsibility.

Conclusion

In a world of perfect political information, we might now see a battle between coastal residents, the non-TWIA policyholders battling the Commissioner’s proposal while the TWIA policyholders support it.  To date, however, such a lack of “coastal solidarity” has emerged.  And it is not clear what the alternative is. Where do political figures whipping up opposition to the Rathgeber plan think the money is going to come from if the Commissioner’s regulations are struck down, the goofy statute upheld as written, and TWIA finds itself following a significant storm with no money in the till? Surely they are still not marketing the elaborate fantasy that the current TWIA board can now assess insurers more money to pay for Hurricane Ike in 2008. If they really cared about the coast, they might agree to defer a fight about the perfect way to fund TWIA for a bit, and agree to a statutory fix that at least got rid of a fatal bug in the existing law which, if triggered, will devastate TWIA policyholders to be sure, but also those on the coast and off it who depend on a vibrant coastal economy.

 

Third special session, but still no windstorm insurance reform on the agenda

Texas Governor Rick Perry called a third special session of the Texas legislature yesterday to address transportation issues in Texas but did not add windstorm insurance to the agenda items. In his statement explaining the special session for transportation, Governor Perry wrote, “Inaction is a Washington-style attempt to kick a can down the road – but everybody in Texas knows we’re rapidly running out of roads to kick that can down.” Unfortunately, this assertion applies equally well to windstorm insurance reform.  As set forth repeatedly on this blog and in the press, the failure to address this issue right now and reform the currently broken system leaves coastal residents at serious risk and threatens the state economy.

Alas.

Texas Insurance Commissioner still mulling bond anticipation notes

Texas Insurance Commissioner Julia Rathgeber has not reached a decision yet on whether to accede to the request of the Texas Windstorm Insurance Association and others that she overturn the refusal of her predecessor Eleanor Kitzman to borrow about $500 million to help pay any claims that the financially troubled insurer might have  this summer. A response by TWIA to a public information request states that “TWIA is working with the Texas Department of Insurance and the Texas Public Finance Authority to explore all funding options, including the BAN [bond anticipation notes].” According to TWIA, it has not heard anything further from lenders about whether they are still willing, in light of rising market interest rates, to enter into a BAN deal on the same terms as they apparently were this spring. The failure to obtain a reversal likely means, as TWIA Board Member Alice Gannon candidly acknowledged at a June board meeting, that TWIA would not be able to pay many claims in timely fashion should a significant storm occur during the remainder of the 2013 hurricane season.

Although Commissioner Rathgeber has not made a decision yet, in some sense the absence of a decision comes close to an upholding of her predecessor’s determination. One of the touted advantages of the BAN had been that it would have permitted TWIA to purchase reinsurance that attached at $2.2 billion of losses and provided an extra $250 million worth of reinsurance. Right now, the attachment point on its $1 billion of reinsurance stands at $1.7 billion, creating what TWIA hopes (unrealistically perhaps) is a $2.7 billion stack of protection. But the election to go to the higher level attachment point appears to have expired on July 15.  So, unless a new deal with the reinsurers can be struck, that advantage of pre-event borrowing seems to have disappeared. Moreover, it is not clear that a bond anticipation note can be obtained on the same terms as were available in the spring when interest rates were lower. Renegotiating the terms of a BAN will take some time even if Rathgeber ultimately overturns the decision in whole or in part.  (I say in part because some of the arguments against a BAN have less force if the amount borrowed were, say $100-$200 million rather than $500 million). Each day that goes by with the Kitzman decision in force is a day deeper into the heart of hurricane season in which TWIA is particularly vulnerable.

One possible reason for the Rathgeber delay is the relationship between the BAN and the desire of many to shrink TWIA. Many believe that TWIA’s problems would be more manageable if it’s maximum exposure were reduced to the levels that existed before Hurricane Ike or even earlier. They believe TWIA’s problems become progressively more intractable as ever more people develop the Texas coast based on an assumption of continued subsidized rates.  If TWIA borrows money that requires it to repay various fixed sums, it is going to depend on its premium base not shrinking much.  Indeed, if I were a lender I might want various covenants protecting me from a depopulation of TWIA. I would at least price that risk into the interest rate charged. Borrowing money via a bond anticipation note therefore makes it more difficult for any special session of the legislature to develop a plan substantially to reform TWIA.  Thus, although the prospects of such a special session on windstorm insurance reform seem rather dim at present, Governor Perry has not taken it entirely off the table. Commissioner Rathgeber, who likely has her pulse on the mood of the legislature and the governor, may well be balancing the timing of any decision with beliefs on the prospects for reform.

Great news or the calm before the storm?

Great news or the calm before the storm?

Of course, the one good piece of news is that the Gulf of Mexico has, contrary to most predictions, been quiet so far this summer. As a result, TWIA’s financial situation has not been tested. Indeed, it should be running a solid profit for the past few months. Unfortunately, someone might have made the same observation about the first half of the tornado season in the midwest this spring.  Remember all those articles expressing puzzlement about where all the tornados were?  You can find some here, here and here. As residents of Granbury, Texas, Moore, Oklahoma, El Reno, Oklahoma and others can attest, however, predictions about long run climactic events can not be based on a few months of experience. Whether or not TWIA gets to borrow $500 million or some lesser some based on a decision later this summer by Commissioner Rathgeber, the state and TWIA’s policyholders need to hope that Hurricanes 2013 is not like Tornados 2013 in which all was quiet for the first half of the season, only to see historically devastating outbreaks during the second half.

Houston Chronicle publishes op-ed on TWIA problems

A protracted blue roof does not make for a happy voter

A protracted blue roof does not make for a happy voter

It’s by me.  So as not to infringe the Houston Chronicle’s copyright, I’m just going to publish an excerpt of it here.  But you can (and should!) read the whole thing by clicking on this link.

Chandler: Legislature should fix state’s storm insurance model

By Seth J. Chandler | July 6, 2013 | Updated: July 6, 2013 6:59pm

This hurricane season is looking very bad for property owners on the Texas Gulf Coast. That’s not just because climate experts are predicting more storms than average, but also because the coast’s largest windstorm property insurer, the state-sponsored Texas Windstorm Insurance Association, is on the edge of insolvency. Unfortunately, Gov. Rick Perry declined to add windstorm insurance reform to the agenda of the Legislature’s first special session and isn’t likely to add it to the ongoing second.

Texas cannot wait until 2015. The governor needs to show leadership and force legislators to try to avoid a calamity even if a positive outcome and a grand fix is not a sure bet.

What could break the impasse? Coastal legislators must recognize that it is simply not sustainable to keep the market out forever and ask inland insureds, who have problems of their own, to pay heavily and in perpetuity for the special risks found on the Texas coast. It doesn’t matter whether that is done directly with surcharges or indirectly through assessments or forcing insurers to sell policies at a major loss along the coast.

The alternative of providing coastal insureds with lower-priced insurance that does not pay when the time comes does their coastal constituents no favors. Inland legislators must recognize that it will take some time to wean the coast off the existing system. And everyone should realize that the law covering how much “extracontractual damages” victims of insurer misconduct should receive does not matter much when the insurer cannot pay its contractual obligations. If a long-term solution cannot be reached, the Legislature could at least clean out bugs in the statute that could reduce the odds of an insurance disaster for a few years.

Pity the governor and legislators who, after a storm leaves blue tarps on unpaid policyholders’ roofs and forces inland Texans to pick up the pieces, explain that they were awaiting the perfect time for legislative action or holding out for something a little better.

Chandler is Foundation Professor of Law at the University of Houston Law Center and principal of the blog catrisk.net, which addresses catastrophic risk transfer in Texas.

 

P.S. This op-ed is indeed similar to one published a few weeks ago in the Austin American Statesman. But is was originally behind a pay wall and is now almost impossible to find. I appreciate the Statesman for consenting to the repetition.

 

 

Return of the Vampire Argument

One of the amazing things about debates over the Texas Windstorm Insurance Association is the extent to which, like vampires, some arguments never die. It doesn’t matter how meritless the argument is, it doesn’t matter how thoroughly it has been beaten back in the past by logic or legislation. It just keeps being brought out of its grave when needed by advocates.  Many of these arguments are pernicious because they distract from the real issues facing Texas and because they divert attention from study of the real solutions.  They provide red meat for zealots but do absolutely nothing to solve their problems. Until, however, coastal residents drive a stake through the heart of them by driving their proponents out of office, they are likely to persist.

One of the more amazing of these vampire arguments is that the Texas Windstorm Insurance Association can make an assessment today against Texas insurers for damages caused by Hurricane Ike based on a statute that was repealed in 2009.  And yet, according to the Corpus Christi Caller, coastal legislators such as Corpus Christi’s Todd Hunter are again casting about looking for someone in authority who might believe this particular fantasy. This time the argument has been hurled at the new Teas Insurance Commissioner, Julia Rathgeber. According to a Corpus Christi Caller article of July 3, “[c]oastal lawmakers again are reaching out to Texas Insurance Commissioner Julia Rathgeber to seek about $400 million in assessments for insurance companies to help replace funds paid for claims in the wake of Hurricane Ike.”  I will be stunned if Commissioner Rathgeber does anything other than send of a polite message that she does not believe such an assessment to be possible. It hardly creates the business friendly environment that her boss, Governor Perry, desires when businesses can be threatened with arbitrarily having hundreds of millions of dollars taken away from them based on the ghost of a former statute. A swift and unambiguous “no” from the Commissioner will be at least put the vampire back in its coffin for a while and permit more serious approaches to TWIA’s insolvency to be examined.

Why do I use such strong language in denigrating the argument.  Mostly because I can read. There is no statute today authorizing assessments against TWIA member insurers unless a post-event bond has been issued.  That hasn’t happened. Government can’t just come in and take private property  — even the money of insurance companies — unless there’s a constitutional law that justifies the taking. That’s one of the things that separates us from a tyranny. So the only conceivable basis in for an assessment is the old law, former section 2210.058 of the Insurance Code, which was used back in 2008 to assess insurers for Hurricane Ike.

The problem is that this law was repealed by section 44 of H.B. 4409, which was enacted in 2009 after Hurricane Ike basically destroyed TWIA. Here it is:

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.

There it is in black and white.  I’m not sure how it could be any clearer.

So the only argument coastal legislators might have left to keep this vampire out of its coffin is that, somehow, the word “repeal” doesn’t really mean repeal. And the only sliver of hope in that regard would appear to be section 311.031 of the Government Code. 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.

I suppose the legislators’ argument is that the “assessment” was an obligation or liability previously acquired, accrued, accorded or incurred.” But this argument, which a law professor might briefly admire for its creativity, fails because the possibility that TWIA might assess insurers more for Ike is not a liability or obligation. The fact that TWIA might have made an assessment is no more an “obligation” or a “liability” than a tax that the legislature might have but did not impose or a penalty that a court might have but did not impose. 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, prevent TWIA from creating new liabilities for Allstate to pay.

Moreover, think about it. If the legislature wanted to preserve TWIA’s ability to assess after 2009 for storms that occurred before that time but not afterwards, you would not repeal the statute.  Instead, it would far more direct and far clearer simply to amend the statute to limit the set of storms for which assessments would be permitted.

Now, perhaps the strategy of coastal legislators such as Todd Hunter is to keep asking Commissioner Rathgeber for lots of things in the hopes that she will, as a compromise, give them the one thing that might possibly make sense, a pre-event bond. But, really,  pre-event bonds should rise or fall on their own merits. Granting them or not should not depend on legislators asking for things that are plainly illegal, such as confiscating the property of insurers.

I understand why coastal legislators are upset.  Their strategies in the 83rd legislature failed. It is, despite the protestations of some to the contrary who want to pro-development illusion that the band can keep playing on, a “crisis situation.” Although they are not the only parties at fault, these legislators have contributed to the horrible risk now confronting their constituents. And Governor Perry has thus far resisted calling a special session of the legislature to repair the damage. These legislators likely will (and should) be held responsible by their constituents if a tropical cyclone bankrupts TWIA. And, they are right that, with the benefit of hindsight, TWIA policyholders would be better off if TWIA had issued a greater assessment for Ike while its statutory authority to do so was still in force.

The bottom line, however, is that TWIA did not make an extra assessment for Ike and the time to have done so has long run out. And even if the 1% chance materialized that a court would ultimately order insurers to pay based on a new Ike assessment, the lengthy court fight involved would delay receipt of funds well into the next legislative session.  Honestly, all that bringing this vampire argument out of the coffin again accomplishes is to diminish the credibility of those who will need every ounce of it if they are persuade fellow legislators to engage in sensible, needed reform of the Texas Windstorm Insurance Association.

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.