TWIA report card shows giant error on law

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

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



The problem is the turquoise area.

First, notice a few things.

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

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

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

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

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

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


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

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

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

(A)  $500 million; or

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

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


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

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

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

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

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

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

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


Texas Public Finance Authority: Class 1 Bonds Won’t Sell

Thanks to a friend, we have new evidence today about how much money TWIA hopes to have to pay claims this summer.  The Texas Public Finance Authority, which has to deal with sober realities like the bond market, told the TWIA board back in March that its Class 1 post-event bonds won’t sell.  Since Texas Insurance Commissioner Eleanor Kitzman blocked issuance of pre-event bonds that TWIA sought as a substitute, that means that in the very best case, TWIA will have about $2.7 billion.  But even this rests on a House of Cards argument that is likely to topple and leave TWIA policyholders in the lurch.  Here’s why.

The document in question are the minutes of the Texas Windstorm Insurance Association meeting of March 21, 2013. It sheds some light on TWIA’s own thinking at that time about how much money it was going to have to pay claims. The first clue is contained in the excerpt below.

TWIA board minutes

TWIA board minutes acknowledging reinsurance would attach at $1.8 billion

Notice how TWIA says that if it does not approve — or, one assumes, is denied permission to get — the $500 million Bond Anticipation Note — the reinsurance would attach at $1.8 billion. Now why would TWIA pick such a low number?  In the past they have spoken about reinsurance attaching at around $3 billion.  The next excerpt explains it.  It rests on the advice of Bob Coalter, Executive Director of the Texas Public Finance Authority. Look at this excerpt.

Texas Public Finance Authority: Post-event Class 1 Bonds are doubtful

Texas Public Finance Authority: Post-event Class 1 Bonds are doubtful

“Mr. Coalter stated that TWIA could not reasonably rely on $500 million in class 1 bonds if the Association waited for post-event approval.” That’s prety clear. And it’s why, I am confident, why TWIA sought the pre-event Bond Anticipation Notes. And it explains very well the $1.8 million attachment point for the reinsurance.  TWIA likely thinks it will have $300 million in its Catastrophe Reserve Trust Fund and operating expenses; that’s a number that has been batted around in conversation.  It thinks it will have $1 billion in Class 2 Alternative Bonds under section 2210.6136 added by H.B. 4409 in 2011.  And it thinks it will have $500 million in Class 3 Bonds. That totals $1.8 billion, which is precisely where the reinsurance would attach.

So, if TWIA could get, say, $900 million of reinsurance for its authorized $100 million to attach at $1.8 billion, it would have $2.7 billion to pay claims this summer, one Ike’s-worth.  So, with some rounding, it could, I suppose be said that TWIA has $3 billion, but that’s a bit of an exaggeration.

In any event, let us not, however, quibble about a trifling $300 million.  Let’s instead focus our energies on scrutiny of TWIA’s logic of even thinking that it will have the $1.8 billion in funds at which the reinsurance could attach.  I say that the very reasons the TPFA is giving TWIA for why TWIA’s Class 1 Bonds won’t sell apply almost equally to the Class 2 Alternative Bonds.  Why?  See the next paragraph. In the mean time, recognize that the Class 3 bonds can not legally be sold unless TWIA/TPFA can sell $1 billion of Class 2 Alternative Bonds. If TPFA can only sell, say, $600 million in Class 2 Alternative Bonds, then TPFA can not sell Class 3 Bonds at all, and TWIA’s funding stack would be $900 million, not $1.8 million.  Yes, TWIA might have reinsurance that attached at $1.8 million, but for losses between $900 million and $1.8 million there would be no money. So, for a $1.5 million storm, TWIA would only have enough money to pay policyholders 60 cents on the dollar ($300 million in CRTF + $600 million in Class 2 Alternative Bonds all divided by $1.5 million in claims). And for a $3 billion storm, TWIA would likewise have 60 cents on the dollar. ($300 million in CRTF + $600 million in Class 2 Alternative Bonds + $900 million in reinsurance all divided by $3 billion in claims).

Why the Class 2 Alternative Bonds Are Almost As Bad As The Class 1 Bonds

OK, so why do I say — and why by the way did TWIA suggest in its report to the legislator — that the Class 2 Alternative Bonds are problematic?  Why did several bills in the legislature this session seek to abolish them?  Because their repayment source is largely the same problematic mammoth levy on TWIA policyholders that they might not well be able to pay. Here is section 2210.6136(b) of the Texas Insurance Code. It’s the key to understanding the urgency in calling a special session of the Texas legislature.

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

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

(A)  $500 million; or

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


So, if the “portion of the total Principal amount of Class 1 public securities … that can not be issued” is, as TWIA itself has been told likely to be well north of $500 million, then the first $500 million of the Class 2 Alternative Bonds described in section 2210.6136 are to be paid off in the “manner described by Section 2210.612(a)” of the Texas Insurance Code.  But what section 2210.612(a) calls for is for the bonds to be paid out of TWIA premiums: “The association shall pay Class 1 public securities issued under Section 2210.072 from its net premium and other revenue.” And it is precisely because potential lenders have indicated their doubts that TWIA premiums could sustain the amortization payments that TWIA has been told it can’t sell the Class 1 bonds. I don’t see any reason why the market would be any more trusting of bonds that have “Class 2” labeled on them when they won’t buy similarly sourced bonds with a “Class 1” label on them.

What we have then is, as I said, a House of Cards. In order for TWIA to even have $2.7 billion in its stack, here is what would have to happen: (1) before a storm, TWIA gets $900 million in reinsurance that attaches at $1.8 billion; and (2) after a storm, all $1 billion of the Class 2 Alternative Bonds sell notwithstanding their problematic repayment source. If I were a betting man, I would not place the odds of that House of Cards staying intact very highly.  And when it tumbles, it will not be only be TWIA policyholders on the Texas coast who get hurt, but the economy of Texas as well.

Footnote for Experts

Some might object to my analysis on grounds that the repayment sources for the Class 2 Alternative Bonds set forth in section 2210.6136 are not identical to those set forth for the Class 1 bonds.  That’s true, but I don’t think it matters.  Read 2210.6136(b) carefully.

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


The first $500 million in Class 2 Alternative bonds come from TWIA revenue (premiums). As the passage I’ve highlighted indicates, it’s only after that first $500 million is exhausted — and TWIA pays what some likely thought was its fair share — that others have to chip in.  Someone from those other payors (coastal non-TWIA policyholders and, more likely, the insurance industry) negotiated for that in 2011. The fact that those higher in the stack have money to pay won’t give any comfort to lenders who depend in substantial part on the dubiously sourced lower part.  And this is why I persist in saying that if the Class 1 Bonds can’t be sold, the Class 2 Alternative Bonds are in serious jeopardy too.



TWIA Cash Position Not Improving

 $443 million in cash and short term assets

In a recent blog entry, I attempted to estimate the amount of cash the Texas Windstorm Insurance Association had in its operating account.  I said TWIA’s cash position was likely to be between $400 million to $700 million after the recent Ike settlement of $135 million was taken into account. Thanks to a public information request from Fox 26 TV’s Greg Groogan we now have a better fix.  If anything, I was a little optimistic.

TWIA has $443,453,000 in cash and short term investments, little changed from its position at the start of the year.  Its assets are down to $444,342,000.  But those figures are before  consideration of the $135 million Ike settlement, the so-called “Mostyn settlement.” They are also before TWIA spends an anticipated $100 million or so (in cash) on reinsurance, The figures are both from the end of April, 2013. If funding of the Ike settlements comes from operating funds or TWIA succeeds in obtaining reinsurance, that figure will likely be lower shortly.  If the Ike settlement instead comes from the Catastrophe Reserve Trust Fund, that $180 million fund will be significantly depleted.

The rest of the story on the TWIA cash position and finances

There are at least two other pieces of information that will be useful in assessing TWIA’s position as hurricane season moves forward. They may also help Governor Perry get from “certainly possible” to “yes” in considering requests that he convene a special session of the Texas legislature to address windstorm insurance reform.  What happened to the effort to spend $100 million or so on reinsurance?  Did they acquire it and on what terms?  Second, what has happened to the effort to prepare for post-event bonding now that former Commissioner Eleanor Kitzman authorized TWIA to do so?  Unless both of those efforts are particularly successful, however, I stand by my assertion that TWIA may well have little more than $1 billion in actual cash to pay claims on $80 billion worth of exposure. Moreover, the reinsurance doesn’t do as much good as it could, if TWIA can’t sell all of its authorized post-event bonds.

So, in this case, no news — or no new news — is bad news. If something like Hurricane Ike hit — a Category 2 storm in a populated area — TWIA policyholders might get only 40 cents or so for each dollar of legitimate claims. There would be no protection from the Texas Property & Casualty Guaranty Association. There would be no lawful obligation of the state to help out. Instead Texas would be left with a hope.  Perhaps the state legislature would meet swiftly and agree on a plan (with a 2/3 majority) to come up with billions of dollars  to help bail out a devastated coast.  As I recently said to reporter Groogan in response to Senator Larry Taylor’s understandable expression of such a hope:  “Good Luck.”

Footnote 1: Say what one will about TWIA and its history, I have again found them to be responsive over the past year to public information requests.  That helps build some trust.

Footnote 2: Remember State Representative Craig Eiland’s claims that TWIA could and should assess insurers today for Hurricane Ike losses and buttress in Catastrophe Reserve Trust Fund?  I’ve found a longer statement of his position here.  It’s such a mixed picture.  On the one hand,  outgoing Representative Eiland has great information on the timeline. He presents a forceful case that TWIA had the information that would have justified a larger assessment on the insurers for Ike under the old law before a 2009 law took effect.  He is right that TWIA would look a lot stronger today with $780 million in its CRTF rather than the $180 million it has today. What Representative Eiland still lacks, however, is any legal theory under which such an assessment could occur today.  As has been discussed here at length, the law under which assessments were authorized was repealed — Representative Eiland sadly joining others who voted to do so.

Troubling news: TWIA loses $500 million in anticipated funding

The short term finances of the already shaky largest property insurer on the Texas coast took an unanticipated and significant turn for the worse Monday.  Outgoing Texas Insurance Commissioner Eleanor Kitzman rejected Monday plans of the Texas Windstorm Insurance Association to borrow $500 million via a “Bond Anticipation Note” to help pay claims this hurricane season.  The Commissioner did not reject a plan to issue post-event bonds in the event of a significant storm this season.  As a practical matter, however, it may be difficult to persuade the market to loan money to TWIA after a storm due to peculiarities in the existing law that were not ironed out during the regular session of the Texas legislature.

The refusal to permit TWIA to borrow at this time, coupled with the announced $135 million settlement earlier this week of most of the remaining lawsuits against TWIA arising out of Hurricane Ike, probably cuts in half the amount of cash TWIA would have immediately available to pay claims in the event of a storm this summer without having to rely on untested, legally questionable and potentially slow efforts at “post-event” borrowings.  The action leaves both the cash position and the long run finances of the troubled insurer in question.

My best guess is that without the Bond Anticipation Note (BAN), and including its Catastrophe Reserve Trust Fund (CRTF), TWIA probably has between $400 to $700 million in cash with which to pay claims.  That’s not much when your direct exposure is over $75 billion, your total exposure is over $80 billion and a Category 2 or 3 hit at a bad spot on the Texas coast could easily cause losses of over $2 billion. The Bond Anticipation Note would have doubled the amount of cash available to pay claims.

As it stands, and as set forth below, I now believe it is not unduly pessimistic to set the odds of a TWIA insolvency this summer at 10%. If we consider two summers until the next regular legislative session, this risk roughly doubles. Given the grave effects of a TWIA insolvency on the entire Texas economy, this is way, way too high a risk.

Cash position

To understand this, take a look a TWIA’s 2012 Annual Statement. TWIA ended 2013 with about $430 million in cash (Assets, line 5; column 1) and total admitted assets (including the cash) of about the same amount, $430 million. (Assets, line 28, column 3) It has agreed to pay about $135 million in cash to settle the bulk of the Ike lawsuits. How much that will reduce the $323 million in loss reserves (Liabilities, Surplus and Other Funds, line 1, column 1) is unclear.  Because lawsuits remain, it is unlikely to reduce those reserves down to zero.  It will, however, likely reduce TWIA’s cash position by the full $135 million in relatively short order, depending on the details of the settlement. That would leave TWIA with just $295 million in cash.

Of course, it’s a little more complicated.  I don’t have access to TWIA’s financial statements for the first quarter of 2013 or thereafter. TWIA has likely earned some cash since January 1, 2013. It has been earning and collecting premiums, although it has had to pay off about $50 million on a thunderstorm in Hitchcock.  So, let’s be generous and credit TWIA with about $120 million more in new cash. This brings a guesstimate of its cash levels back up to around $415 million.

The problem is that not all of this cash is available to pay policyholder claims.  Some of it will be used to pay for operations, for commissions, and for other matters, including the Ike claims not resolved earlier this week.  So, I would be surprised if someone were to audit TWIA today and found it had more than $400 million in cash available to pay claims before resort to the CRTF. I would not be surprised if the number actually came out in the $300 million range.  And both of these figures will be reduced by $100 million or so less if TWIA succeeds in its plan to purchase reinsurance.

So, without the hoped-for borrowings, TWIA might have had $300 million to pay claims out of operating funds and another $180 million out of its CRTF.  TWIA might have had a total of $500 million.  (If the settlement came out of the CRTF rather than operations, the total would stay the same).  If the BAN had been approved, at least in the short run before TWIA had to pay the loan back, TWIA might have had $1 billion.  Both sums are, of course, grossly inadequate to deal with the $80 plus billion in TWIA exposure. Nonetheless, $1 billion in cash would have left TWIA in a better short run position.

Long run finances

Perhaps the greater impact, however, of the BAN ban is on the ability of TWIA to sell post-event bonds following a storm.  We’ve been through this matter before on this blog, but it is worth repeating because it is so very important.  The short version is, however, that there is a significant risk that very little in post-event bonds will actually be able to be sold.  And, thus, TWIA may very well have less than $1 billion with which to pay claims even after borrowing.  I would not be surprised if it ended up with as little $700 million.  The probability of such losses occurring this summer would be about 7-9% if this were a normal hurricane season.  If, as climate experts agree, however, this proves to be a bad hurricane season the probability of TWIA going broke and unable to pay claims fully could rise to 10-14%.

Here’s the longer version.  I, by the way, am not alone in my alarm on this matter. TWIA itself raised the issue in its submission to the Texas legislature.  the Texas Public Finance Authority (TPFA) had trouble last year trying to help TWIA borrow. And several of the pieces of proposed legislation this session would have fixed this particular problem.  But all of these bills failed during the regular session. Governor Perry has thus far resisted calls that he add windstorm insurance reform to the agenda for a special legislative session.

if there is a storm that pierces the CRTF, TWIA will need to rely on post-event Class 1 bonds.  But, unless something has changed, per the Texas Public Finance Authority they won’t sell, at least not up to $1 billion authorized.  But if the Class 1’s don’t fully sell, then TWIA/TPFA is prohibited from selling the regular Class 2 bonds. (Section 2210.073). Instead, we go to the Class 2 Alternatives under section 2210.6136.  But if less than $500 million of Class 1 bonds have sold — which is likely to be the case —  the first $500 million of the  Class 2 bonds  are paid in the same problematic way as the Class 1 bonds (surcharges on TWIA policyholders).  (Section 2210.6136(b)(1)). And there is a serious question as to whether anyone will loan TWIA money on those terms. Why? Because as soon as substantial policy surcharges are issued on TWIA policies, some TWIA policyholders will either find other insurance, reduce the sizes of their policy, or simply choose to go bare.  This is particularly likely if a storm has impoverished many TWIA policyholders. And if enough TWIA policyholders reduce their premiums, the percent surcharge will need to go up to compensate in order to pay off the bonds.  But if the surcharge rate goes up, more TWIA policyholders will drop out.  And, we get into a death spiral.

But here’s the catch.  Under section 2210.6136(c), if TWIA/TPFA can’t sell every dollar of the $1 billion in Class 2 Alternatives, then TWIA/TPFA can not issue the class 3 bonds of $500 million.  The statute is crystal clear on this point.  And this means that TWIA has no Class 1 bonds, no Class 2 bonds, little or no Class 2 Alternative bonds and no Class 3 bonds.  The system has completely collapsed in a cascade of failures.  TWIA basically has no money beyond cash on hand, and the CRTF. That means policyholders will not be paid in full.  If the storm is bad enough, they won’t be paid even half of their legitimate claims.

Reinsurance — assuming that TWIA can get it — will not help a lot. The reinsurance will not kick in until losses exceed the “reinsurance attachment point.”  But the reinsurance attachment point is likely to be set on the false assumption that the post-event securities will succeed.  So, for losses less than the reinsurance attachment point, the reinsurance won’t pay at all.  TWIA will be just as bankrupt as if it did not have reinsurance at all.  Actually, it will be more bankrupt because  it will have paid $100 million in premiums.  And even if the storm is so bad that the reinsurance kicks in, there is still a gap between the top of the CRTF plus any post-event bonds and the reinsurance attachment point.  So, TWIA won’t have enough money to pay claims fully.

Why would Commissioner Kitzman do such a thing?

I’m not privy to her reasoning or all the facts, but there are concerns we have outlined before about pre-event borrowing such as a Bond Anticipation Note.  The problem with loans is that you have to pay them back — and at interest.  Thus, in the long run, particularly if interest rates rise or if TWIA is deemed high risk and thus charged high rates even now, borrowing perpetuates your insufficient capitalization.  Whatever the benefits in the short run — and there may have been many here that incoming Commissioner Julia Rathgeber will want to examine — it is not the ideal long run solution for insurance risk. It may well be that Commissioner Kitzman refused as her final act to be complicit in the bandaiding of TWIA in the hopes that a sufficiently obvious problem would spur the Governor to call a special session and the legislature to develop a sustainable fix.  If so, let us hope that gamble proves correct.


TWIA Financial Statement appears to confirm insolvency

I have received a copy of the 2012 TWIA financial statement.  You can see it at the link at the bottom of this post. If you look on page 3 of the document, line 37, you will see the figure $182,979,043 in parentheses. In accounting notation, parentheses denote  a negative number.  The balance sheet looks even a little worse  if one consults page 14 of the financial statement.  There it appears to say that if one uses national standards for insurance accounting, the NAIC SAP basis, rather than Texas-specific rules, TWIA is $217,188,190 in the hole. This is considerably worse than in 2011, when its surplus was a negative $7,381,879.

Screenshot_3_22_13_6_26_PMThe income statement isn’t pretty either.  TWIA’s net income in 2012 was a negative $180 million. (Page 4, line 20). And, on a cash flow basis, it looks as it TWIA lost $47 million in cash in 2012. (page 5, line 18).

Anyway, although I do know a tad and wish I knew more, and although I am definitely not expert in the arcane field of insurance accounting, it does look as if there is support for the contention that TWIA is insolvent.

2012 Annual Statement. (Obtained from Texas Department of Insurance via Elizabeth Christian & Associates Public Relations)