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.

 

TWIA board declines to assess insurers for Ike — for now

The board of the Texas Windstorm Insurance Association narrowly defeated a motion today that would have assessed Texas insurers $575 million for losses arising out of Hurricane Ike in 2008. Opponents of the measure — all from Texas insurance companies —  saw no urgency to an immediate assessment and, in light of what they believed was uncertain legal authority to do so under a repealed statute, wanted to await a requested legal opinion from Texas Attorney General Greg Abbott. Supporters of the measure — all representing coastal interests — asserted that an Attorney General opinion would not be definitive; in their view, the only way to determine the obligations of Texas insurers was to go ahead and demand the money, recognizing that insurers would file suit to block the assessment and that insurers would not actually pay any money until well into future hurricane seasons. The decision came after a two and a half hour closed session between the TWIA board and its attorneys.

Much other news emerged from the TWIA board meeting.

  1. The board voted to increase premiums 5% on both residential and commercial properties next year.
  2. The board heard that earlier plans to attempt to raise $500 million in pre-event securities — a bond anticipation note (“BAN”) — now appeared unlikely to continue. The board was advised that it would take 60 days to actually consummate the borrowing and that would now put receipt of funds past the peak of hurricane season. The board instead unanimously authorized the TWIA staff to pursue swiftly additional liquidity via a $200 million line of credit and $250 million in borrowing that, for reasons not made clear, would not be considered a pre-event security, and that would be secured by proceeds from any Class 2 or Class 3 securities that would be issued following a major storm. Costs on the line of credit and the additional borrowing were said to be much lower than would have been the case for the BAN.
  3. Although TWIA has thus far faced no storms of consequence this year, it anticipates being able to contribute only $15 million more to its $180 million catastrophe reserve trust fund that forms the first line of defense against any substantial claims.  This low contribution is apparently due to continuing expenses from Hurricane Ike. It also means, however, that even with a continuing spate of good luck this year from a thus -far quiet Gulf of Mexico, TWIA will go into next hurricane season perilously undercapitalized.
  4. Despite all the talk about depopulating TWIA, it continues to grow rapidly.  Exposure grew at 4% this past year and policies at 3%.  TWIA staff said they believed this trend would continue.  The substantial rate of growth is continuing notwithstanding what one board member described as concern among bankers and other lends in the area as to whether TWIA could stand up to a major storm. Since TWIA’s funding mechanisms are stated in constant dollars and not as percentages of exposure, this continued growth further weakens TWIA’s ability to withstand moderate or severe storms.
  5. The board voted 8-1 to approve a statement by one of its board members indicating the issue of whether to assess for Hurricane Ike was still open.
  6. Texas Insurance Commissioner Julia Rathgeber expressed a narrow view of her authority to supervise TWIA.  When asked whether TDI would need to approve any assessment against insurers, Commissioner Rathgeber said she viewed her authority as limited to whether TWIA had followed proper practices and procedures and that she would not second guess its decisions. When asked whether that meant TDI was neutral on assessing insurers, Commissioner Rathgeber said she would need to speak with TDI attorneys.
  7. The 4-4-1 vote came despite pleas from some coastal interests that board members from insurance companies recuse themselves based on a conflict of interest. Opponents of the recusal plea noted that the arguments might equally well apply to persons “representing” coastal interests and that, in any event, the legislature had specifically set up a board with interest group representation.

Catrisk will have more on the eventful TWIA board meeting later in the week.

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.

S.B. 1700 in stark pictures

According to newspaper accounts here and here, S.B. 1700 is heading for a vote in the Texas Senate this week.  Before the Senate votes on the bill or the House Insurance Committee considers the matter, I hope they have some understanding of how radically it transfers wealth to TWIA/TRIP policyholders from people who do not have TWIA policies. I also hope legislators understand that although a $4 billion funding stack is definitely an improvement over the status quo, there is still a significant risk to the coast.  And I also hope they understand the TWIA/TRIP depopulation plan, which would in theory be a good idea, has about as much a chance of success without giant changes to TWIA and TRIP that will greatly anger coastal residents as a plan to depopulate Texas itself.

Here are some pictures that I hope aid understanding.

The Funding Stack

Here’s a picture of the TWIA funding stack for 2013 under S.B. 1700. For each element of the stack, I’ve shown who actually pays for that layer of responsibility.

SB 1700; Labeled[BarChart[{180, 500, 500, 500, 500, 1000, 800},    ChartLayout -> "Stacked",    ChartLabels ->     Placed[{"Catastrophe Reserve Trust Fund (TWIA premiums)",       "Class 1 Assessments (Texas insureds)",       "Class 1 Securities (Coastal insured surchanges)",       "Class 2 Assessments (Texas insureds)",       "Class 2 Securities (Coastal insured surcharges)",       "Baseline Reinsurance (TWIA premiums)",       "Insurer Purchased Reinsurance (Texas insureds)"}, Center],    BaseStyle -> {FontSize -> 11, FontFamily -> "Swiss",      LineIndent -> 0},    ChartStyle -> Map[Lighter@ColorData[61][#] &, Range[8]]],   Style["TWIA Funding Stack for 2013\n(Numbers in Millions)", \ {FontSize -> 11, FontFamily -> "Swiss", LineIndent -> 0}]]

TWIA Funding Stack for 2013 under SB 1700

Distribution of expected responsibility

Here’s a pie chart based on a 10,000 year storm simulation showing how much each layer of responsibility would expect to pay under S.B. 1700. There are several features of this graph worth noting.  First, note that TWIA policyholders have paid only for the modest dark red wedge at the left and the orange baseline reinsurance at the bottom left.  That is less than half of the expected payments.  (Yes, they pay a modest portion of the coastal insured surcharges too, but we don’t know how much).  Also notice the large cherry red wedge of unfunded losses.  Although the stack goes up to $4 billion or so under this bill for 2013, and although insolvency now occurs in perhaps 1.5% of the years (26% over 20 years), when insolvency occurs, it is a huge amount of money that is unfunded.

By Layer

SB1700; Framed@Labeled[PieChart[Mean /@ Through[funcs[rv]],    ChartLabels ->      Placed[Map[       Pane[#, 144] &, {"Catastrophe Reserve Trust Fund and operating \ funds (TWIA premiums)", "Class 1 Assessments (Texas insureds)",         "Class 1 Securities (Coastal insured surchanges)",         "Class 2 Assessments (Texas insureds)",         "Class 2 Securities (Coastal insured surcharges)",         "Baseline Reinsurance (TWIA premiums)",         "Insurer Purchased Reinsurance (Texas insureds)",         "Unfunded losses"}], "RadialCallout"],     ChartLegends ->      Placed[{"Catastrophe Reserve Trust Fund and operating funds (TWIA \ premiums)", "Class 1 Assessments (Texas insureds)",        "Class 1 Securities (Coastal insured surchanges)",        "Class 2 Assessments (Texas insureds)",        "Class 2 Securities (Coastal insured surcharges)",        "Baseline Reinsurance (TWIA premiums)",        "Insurer Purchased Reinsurance (Texas insureds)",        "Unfunded losses"}, Bottom],     ChartStyle -> Map[ColorData[61][#] &, Range[8]], ImageSize -> 580,     ImagePadding -> {{90, 100}, {20, 20}},     BaseStyle -> {FontSize -> 11, FontFamily -> "Swiss"}    ], Style[    "Distribution of expected loss payments by layer", {FontSize -> 14,      FontFamily -> "Swiss", FontWeight -> Bold}]   ]

Expected loss payments by layer based on 2013 stack

 By source

We can group the expected payments shown above so that we simply have expected payments by source.  Here is that graph.  Notice again that TWIA policyholders pay little more under this scheme than either Texas insurers (who will surely pass the cost on to non-coastal Texas insureds) and coastal insureds, many of whom have already paid for non-TWIA wind policies. And, again, notice the large chunk of unfunded losses that exists under S.B. 1700.

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Distribution of expected loss payments by layer responsibility under SB 1700

 By Cash Payments

There’s another way to look at S.B. 1700.  Don’t focus on the source of expected loss payments. Focus instead on source of expected cash flow.  The two are not the same because large chunks of cash flow get lost in TWIA/TRIP overhead and in paying reinsurers enormous amounts to bear risk (a subject discussed elsewhere). Here’s that pie chart.  Notice that TWIA policyholders now shoulder a considerably larger share of the load (about 2/3rds). There is still, however, a large chunk of the load picked up by Texas insurers/insureds (14%), coastal insureds (8%) and unfunded losses (9%).  The unfunded losses are a smaller chunk because the denominator for the pie chart is now larger.

SB 1700; Framed@Labeled[   With[{wedges =       With[{t = {#[[1]], #[[2]] + #[[4]] + #[[7]], #[[3]] + #[[5]], \ #[[8]]} &[ReplacePart[Mean /@ Through[funcs[rv]], 1 -> 460000000]]},        t/Total[t]]},     PieChart[wedges,      ChartLabels ->       Placed[Map[        Pane[#, 144] &, {"TWIA premiums", "Texas insurers (insureds)",          "Coastal insureds", "Unfunded losses"}], "RadialCallout"],      ChartStyle -> Map[ColorData[61][#] &, Range[4]], ImageSize -> 580,      ImagePadding -> {{110, 60}, {20, 20}},      BaseStyle -> {FontSize -> 11, FontFamily -> "Swiss"}]],    Style["Distribution of expected cash payments by source", {FontSize \ -> 14, FontFamily -> "Swiss", FontWeight -> Bold}]]

Distribution of expected cash payments for 2013 under SB 1700 by source

Political Power in TRIP

TRIP will be run by a Board of Directors appointed by the Texas Governor.  The graphic below shows the statutory composition of that board under new section 12 of S.B. 1700 (2210.102). Notice the little wedge representing non-seacoast interests.  Hopes, therefore, that the board will take steps to protect non-coastal Texans from having their wealth transfered to the coast would thus seem very optimistic.  Also notice how the southern areas of the Texas coast, which have less population and less insured property than the northern areas, have equal political power on the board.  This is not a one house (or one premium dollar) / one vote system.

Labeled[Framed@ Labeled[PieChart[{3, 1, 1, 1, 1, 1, 1}, ImageSize -> 200, ChartLegends -> Map[Pane[ Style[#, {FontSize -> 11, FontFamily -> "Swiss", LineIndent -> 0}], 216] &, {"insurance industry representatives who write \ wind/hail in first tier coastal counties", "Cameron-Kenedy-Kleberg-Willacy representative", "Aransas-Calhoun-Nueces-Refugio-San Patricio representative", "Brazoria-Chambers-Galveston-Jefferson-Matagorda-Harris \ representative", "non seacoast member", "engineer from second tier coastal county", "financial industry second tier coastal county"}], BaseStyle -> {FontSize -> 11, FontFamily -> "Swiss", LineIndent -> 0}], Map[Style[#, {FontSize -> 11, FontFamily -> "Swiss", LineIndent -> 0}] &, {"TRIP Board of Directors", "With ex-officio members: elected official from southern \ seacoast, elected official from northern seacost, elected official \ from non-seacoast"}], {Bottom, Top}], Style["Political Power in TRIP", {FontSize -> 11, FontFamily -> "Swiss", LineIndent -> 0, FontWeight -> Bold}], Top]

Board of Director membership in TRIP

The Depopulation of TWIA/TRIP

One of the concepts in SB 1700 is that TWIA/TRIP should be “depopulated” by reducing its total insured exposure (currently over $75 billion).  Great. The bill does not, however, come with a magic wand with which to accomplish this task. The only tool it provides is a club that threatens the insurance industry with a collective $200 million assessment that goes into an “exposure reduction plan fund” if the 2016 target of a 20% reduction from 2013 levels is not met.  It places insurers in a bit of a prisoners dilemma and creates a lot of litigation-fomenting administrative discretion on this point by saying that the assessment will only be levied against insurers that “as determined by the [TRIP] board of directors, has not met the member’s proportionate responsiiblity for reduction of the association’s total insureds exposure.” So, if all other insurers have started selling insurance — presumably at a major loss — on the coast using TWIA or sub-TWIA rates, the insurer who is left and refusing to sell insurance on the coast might find themselves with a very hefty bill even if they just have a modest share of the Texas property-casualty market.  And this, I take it, is the whole point behind the clever section 2210.212 of the bill.

I suspect, however, that the $200 million assessment will be unlikely to lure many insurers back to the coast.  There is going to be a first mover problem.  If very few large insurers choose to avoid the 2210.212 club by selling on the coast, then no insurer ends up paying a very large 2210.212 assessment. Question for any other lawyers (or law students) reading this entry: would it violate federal antitrust laws, as modified by the McCarran Ferguson Act, for insurers collusively to refuse to sell; would it violate Texas law?

The other point — and this is the one to which the picture below relates — is that the reduction targets are ambitious.  Although they are stated as reductions from the 2013 status quo, they will in fact be larger.  That’s because TWIA/TRIP is likely to continue growing at significant rates.  Thus, to make a 20% cut from the 2013 status quo, one needs to make perhaps a 30% cut from the 2016 expected status quo. The graph below illustrates this point by comparing 3% TWIA growth to the depopulation targets stated in section 2210.212.

 

Labeled[Show[ DateListPlot[{{"January 1, 2013", 1}, {"January 1, 2016", 1.03^3}, {"January 1, 2018", 1.03^5}, {"January 1, 2020", 1.03^7}, {"January 1, 2022", 1.03^9}, {"January 1,2024", 1.03^11}}, PlotRange -> {0, 1.4}, PlotMarkers -> Automatic, PlotStyle -> Green, FrameLabel -> {"Time", "Total Insured Exposure As Fraction of 2013"}, BaseStyle -> {FontSize -> 11, FontFamily -> "Swiss"}, Epilog -> {Arrow[{{3.6238320000000005*^9, 0.28615669133896926}, {3.6578745686249995*^9, 0.7181793832820529}}], Inset[TextCell["Assessment of $200\nmillion if not reached", GeneratedCell -> False, CellAutoOverwrite -> False, CellBaseline -> Baseline, TextAlignment -> Left], {3.588546672*^9, 0.19378500614472127}, {Left, Baseline}, Alignment -> {Left, Top}]}], DateListPlot[{{"January 1, 2013", 1}, {"January 1, 2016", 0.8}, {"January 1, 2018", 0.65}, {"January 1, 2020", 0.55}, {"January 1, 2022", 0.45}, {"January 1,2024", 0.4}}, PlotMarkers -> Automatic, PlotStyle -> Red]], Style["Natural Growth of TWIA/TRIP (green) compared to 2210.212 \ \"requirements\" (red)", {FontSize -> 11, FontFamily -> "Swiss"}] ]

Natural growth of TWIA/TRIP compared to 2210.212 requirements

My final picture is of Albus Dumbledore and the most powerful wand in the universe: the Elder Wand.  I show it because, I suspect, that is what it is going to take for TRIP to actually accomplish the targets set forth in the legislation without infuriating the very political constituencies that have, with SB 1700, again kicked the fundamental problems of catastrophic risk transfer down the road.

The Elder Wand

Perhaps the only thing that will actually be able to implement the SB 1700 targets without infuriating coastal Texans

TRIP could raise premiums drastically to market rates.  That would likely reduce total insured exposure, but somehow I don’t think that is the idea in the legislation. It could refuse to take on new customers. Imagine the squeals that will produce. It could do what I have suggested for years and refuse to insure beyond some basic amount and rely on market-provided excess insurance for the rest. To do so to the extent of the targets contained in SB 1700 will likely require that excess policies kick in at about $100,000.  Again, I have doubts that his what the proponents of this legislation have in mind. Or, finally, TRIP could just realize that its impossible to reduce total insured exposure without taking steps that are going to be extremely unpopular with the very constituencies that put forth this bill. They could, instead, giggle. They could recognize that the “must” language in the bill is basically a legislative joke — a pretext for extracting in disguise another $200 million out of Texas insureds throughout the state to subsidize, yet again, coastal property, owned by poor and wealthy alike.

TWIA Board tries to borrow $500 million and get $1.15 billion in reinsurance

The TWIA board met Friday.  I could not listen in on the meeting so my information is very limited.

Pre-Event Bonds

It appears that TWIA is going to seek $500 million in pre-event bonds for the 2013 hurricane season in order to augment its skimpy $180 million catastrophe reserve fund.  Although the total of $680 million is inadequate to address the $70 billion plus in total insured value, it is still an improvement over the $180 million that might be the only certain funding.  My AIR/RMS derived hurricane models  (CompoundPoissonDistribution[0.54, WeibullDistribution[0.42, 177000000]]) suggest this reduces the probability that TWIA will be unable to pay claims in full for hurricanes this year down from 14% to about 9%.  Yes, TWIA may be paying a high interest rate to engage in this sort of borrowing, and from what I understand the borrowing has yet to be consummated, but this is a significant step.

Reinsurance efforts

I also understand from a Rick Spruill Twitter post that TWIA is going to seek $1.15 billion in reinsurance.  What I can’t tell you right now is

  • at what level will the reinsurance attach, i.e. atop the Class 3 as I have recommended or inserted between Class 2 and Class 3 as a Guy Carpenter presentation suggested might occur
  • will the reinsurance “drop down” in the event any of the post-event bonds underlying it can not be sold; if not this reinsurance may well be worthless
  • what premium will TWIA pay for this reinsurance; TWIA in the past has paid very high rates for reinsurance that probably had higher attachment points
  • will the market in fact sell TWIA this much reinsurance; reinsurance capacity is not unlimited
  • is the reinsurance per occurrence or per year; it matters a lot if we have multiple storms
  • if per occurrence, what right of reinstatement will TWIA have and at what price

These are all very important questions in assessing the extent to which TWIA policyholders are at risk for this summer while the Texas legislature considers alternative short and long run fixes.

One additional note

Although the decrease from 14% risk of failure to a 9% risk of failure is significant, one must recognize that over a long period of time, 9% risks materialize.  There is, for example, an 85% chance that a 9% risk will materialize at some point during a 20 year period.  So, getting funds up to $680 million is a positive development, it is not by any means a long run solution.

An analysis of S.B. 1700 and H.B. 3622

Note: I’ve taken a second look at this bill and done a better job in analyzing it. Look here.

S.B. 1700 from Senator Larry Taylor of  Friendswood and its House cognate, H.B. 3622 from Representative Dennis Bonnen of Brazoria/Matagorda are the only bills among the major contenders in the legislature this session that addresses the short run problem with the Texas Windstorm Insurance Association.  And H.B. 3622 is set for a hearing in the Texas House Insurance Committee this April 30, 2013, at 2 p.m.  As with H.B. 2352 from Representative Todd Hunter and its cognate S.B. 1089 from Senator Juan “Chuy” Hinojosa, however, the Taylor/Bonnen bills prop up TWIA largely with money from people other than TWIA policyholders. In this instance, the entities that pay for much of the windstorm risk on the Texas coast are (1) Texas taxpayers via a reduction in otherwise owing premium tax revenue and (2) owners of insured homes, autos and other insured property (or liability insurance) throughout Texas via an assessment on insurers likely to be passed on in higher premiums. Here’s a legislative analysis.

The key to S.B. 1700 and H.B. 3622 is to make sure that no storm that causes less than about $1 billion in losses to TWIA needs to try to use post-event Class 1 Bonds to pay claims — a good idea considering that these bonds have been found to be unrateable and probably could not be issued in a large amount. Right now, it only takes a storm causing more than $180 million before TWIA will first look to Class 1 Bonds in order to pay claims. The padding between storms and the tenuous Class 1 Bonds is, at least for the 2013 hurricane season, not additional money from TWIA policyholders but instead an assessment on property and casualty insurers statewide. This assessment could be up to $800 million.

The bill softens the blow of this $800 million exposure in two ways.  First, up to $300 million of such an assessment could be credited against premium taxes the insurers would otherwise owe to Texas.  This crediting would take place in installments, however, lasting a minimum of 5 years.  Thus, in essence, Texas insurers are compelled to fork over up to $500 million and to front an interest-free $300 million loan to the state in order to pay clams.  (And even if they never pay, they will have to stockpile some reserves to address this contingent liability.) I have suggested elsewhere that it would insult the insurance industry to suggest that they will not find a way to get this money back. An obvious target will be Texas policyholders. Second, for each dollar the insurers pay at the lower attachment point (just above the end of the Catastrophe Reserve Trust Fund) they reduce the exposure they now have at a higher attachment point, one that lies above the top of the Class 2 Bonds or the Class 2 Alternative Bonds.  And the insurers no longer have to really pay fully for Class 3 assessments. Instead, up to $300 million, they just make an interest-free loan to the state that gets paid back over a minimum of 5 years via a reduction in otherwise owing premium taxes.

Here’s an interactive visualization of the effect of S.B. 1700. You’ll need to obtain and install the free CDF player to actually be interactive with this medium.

[WolframCDF source=”http://catrisk.net/wp-content/uploads/2013/04/SB-1700.cdf” CDFwidth=”560″ CDFheight=”800″ altimage=”http://catrisk.net/wp-content/uploads/2013/04/SB-1700.png”]

 

So, if I had to guess at the realistic size of the TWIA stack today, I would say it was perhaps  $600 million: $180 million in CRTF, perhaps a sale of 25% of the amount authorized in Class 1 Bonds, and perhaps 25% of the amount authorized in Class 2 Alternative Bonds. If S.B. 1700 were to pass, the stack would grow to perhaps $1.5 million: $180 million in CRTF, $800 million in insurer assessments (some of which would just be an interest free loan), and, again, perhaps  sale of 25% of the amount authorized in Class 1 Bonds, and perhaps 25% of the amount authorized in Class 2 Alternative Bonds. Due to the bug in the existing statute — one that is not (yet) fixed in the Taylor bill — it’s my opinion that no Class 3 securities are likely to be issued. I also have doubts that useful reinsurance can currently be purchased by TWIA due to confusion about the appropriate attachment point.

A few additional comments.

1. I’d like to run analysis similar to that done on H.B. 2352 about how much of the expected risk of tropical cyclones is born by each group under S.B. 1700 and H.B. 3622. My suspicion is that a great deal will be borne by insureds statewide due to the low assessment attachment point. A great deal will be eaten by TWIA policyholders themselves in uninsured losses because, unless pieces of the statute are fixed, the realistic height of the stack is not the touted $4 billion but a number far lower than that.  In other words, S.B. 1700 and H.B. 3622, though they raise the height of the TWIA stack, still leaves a substantial risk of insolvency.

2. The bill has a provision I like: it prohibits TWIA from purchasing reinsurance with low attachment points.  This prohibition prevents TWIA from deciding to sacrifice policyholder interests in favor of insurance company interests.  How to trade these two interests off is a matter that should be resolved, as this bill does, by the legislature.

3. This bill does nothing to address major structural problems with TWIA.  These include:

  • low deductibles and no coinsurance that lead to problems of moral hazard
  • failure to warn TWIA policyholders about the risk of insolvency
  • continued subsidization by poor people throughout Texas of million dollar homes on the Texas coast
  • continued concentration of risk in a single entity that invariably leads to a difficult tradeoff between paying extremely high rates for reinsurance — and thereby preventing growth of an internal catastrophe reserve fund — or subjecting policyholders to a substantial risk of insolvency
  • fails to address the needless fragility of Class 3 Bonds. [This is not right, see my update]

 

 

 

Drop down Class 3 bonds: a bandaid for TWIA

A lot of ink has been spilled on this blog about fixing TWIA in the long run.  Having attended the hearing this past week in Austin and looking at my calendar, which shows 41 days until hurricane season, I am becoming less hopeful that a good long-run fix is in the works.  Moreover, two of the leading bills (S.B. 18 and H.B. 2352) do nothing to address the desperate situation for 2013.  I thus offer up the following as a minimalist bandaid for TWIA.  It will not by any means solve TWIA’s problems.  If, however, a solid solution can not be found, what I offer here may at least provide some assistance and, in my naive view, should be politically feasible. The Executive Summary is that the legislature needs to repeal the provisions prohibiting the Class 3 bonds from dropping down and instead permit them to drop down in the event the Class 2 Alternative bonds fail to sell, offering insurers a premium tax credit to the extent the drop down Class 3 bonds increase their subsidization of tropical cyclone losses along the Texas Gulf Coast.

History

I start with some history to explain the current problem.

In 2011, the legislature recognized that the system of post-event bonds it had established in 2009 as the means of recapitalizing TWIA following a significant storm was extremely vulnerable to a cascade of failures. Lenders could refuse to purchase the Class 1 bonds on whose sale higher levels of bonds legally depended and thus leave TWIA with only the money it had in its Catastrophe Reserve Trust Fund to pay the claims of its policyholders. And lenders might very well refuse because repayment of the Class 1 bonds depended on TWIA policyholders remaining with TWIA even after it raised its premiums (perhaps 25%) to pay off the bonds. So, the legislature developed this complex scheme now codified in section 2210.6136 of the Insurance Code.

Unfortunately, the fix, which appears to have been developed deep into the legislative session, suffers a risk of the same infirmity as the legislative provisions it attempted to supplement. Class 1 bonds remained theoretically available but a contingency plan was developed: the Class 2 Alternative Bond (my name). This Class 2 Alternative Bond could be sold in the event that the entire $1 billion authorized in Class 1 bonds failed to sell in whole or in part. But, as with the Class 1 bonds, the Class 2 Alternative Bonds contained in the fix depend for their repayment in significant part in extracting large sums of money from a TWIA pool of insureds (a) after a significant hurricane has struck and (b) who can and may leave the pool if insurance premiums get too high. And while coastal residents and insurers share partial responsibility for the repayment and thus reduce the size of the TWIA premium increase, it is unclear if that contribution will be enough to persuade lenders that TWIA policyholders will remain in the pool and pay enough to amortize the bonds. Moreover, the legislation provided that Class 3 bonds, which provide an additional $500 million of borrowing capacity to pay for windstorm damages, can not be sold — repeat, can not be sold — unless every dime of borrowing capacity under the Class 2 Alternative Bonds is exhausted.

The current situation

The result of all this is a potential catastrophe. If, as many observers, including the Texas Insurance Commissioner expect, the Class 1 bonds fail in whole or in part because the market won’t accept them, the Class 2 Alternative Bonds may fail too. Why? Because their repayment source is infected — not as badly, but still infected — with the same problem as the Class 1 bonds. And if the Class 2 bonds fail even a little bit, the Class 3 bonds fail. And if the Class 3 bonds fail, there may well not even be any reinsurance protection. This is so because, if TWIA is not careful and does not purchase reinsurance — at a higher price — that drops down in the event the Class 2 and/or 3 bonds don’t sell, the reinsurer isn’t obligated to pay a dime. The $100 million of policyholder money dumped into reinsurance will have been 100% wasted. (I sure hope TWIA’s lawyers and reinsurance brokers understand this last point.). And so, TWIA will have only the $180 million or so in its Ike-depleted, failure-to-properly-assess-depleted Catastrophe Reserve Trust Fund to pay claims. As my friend David Crump has pointed out, it may not even take a named tropical storm to generate damages of that magnitude to the $72 billion TWIA pool.

We thus end up with a short run problem in addition to a long run problem with TWIA. The long run problem is that the system of post-event bonds on top of a thin Catastrophe Reserve Trust Fund is extremely unstable and potentially depends on massive subsidization by people other than policyholders to prop it all up. That is a hard problem to fix. Perhaps, as been suggested here, an assigned risk plan would be a better alternative. Perhaps, as others believe, the funding structure can be made more stable with yet greater subsidization. Those are hard and politically contentious issues. I am not certain they will be ironed out this legislative session before hurricane season begins in 41 days. And, sorry to say to, but it is a bit irksome to have to bail TWIA out yet again when doing so also rescues from humiliation the legislators who have shortsightedly engineered a system that beautifully served the short run interests of their constituents by underfunding their insurer but that has predictably betrayed those same constituents long run interests. Still, one can not help feeling a bit sorry for those on the coast who may have been fooled, perhaps eagerly so, by these false heroes.

The bandaid

What to do? Triple the minimum amount available for this summer. How?

1. Permit the Class 3 bonds to drop down. Repeal section 2210.6136(c), which currently prohibits the issuance of Class 3 bonds until all the Class 2 or Class 2 Alternative Bonds are sold. Instead, permit the Texas Insurance Commissioner to authorize sale of Class 3 bonds notwithstanding the failure of all Class 2 or Class 2 Alternative Bonds to sell if, in the opinion of the Commissioner, the failure to do so would reduce the amount available to pay claims of TWIA policyholders.

2. To the extent that Class 3 bonds drop down, make the assessments that are required to repay them simply a no-interest loan from insurers to the state rather than an outright payment. This can and has been done by making providing a premium tax credit for the assessments.  I dislike this philosophically because it is less transparent than simply taxing Texans and potentially reduces the amount available for government programs, but it is one way to raise money. To do this will require repeal of section 2210.6135(c) of the Insurance Code and perhaps some other statutory tinkering. The idea, however, is that to the extent an extra obligation has been imposed on the insurers of the state, it is one they should bear only as a vehicle for fronting money rather than in any ultimate sense. I believe sensible insurers should be willing to go along with this alteration. Moreover, as the state bears actual responsibility for up to $500 million, the costs of having the rest of the state subsidize TWIA will be more apparent to the electorate. It will thus be a great — albeit costly — learning opportunity.

Will this solve the TWIA problem for 2013. Absolutely not. This is a bandaid on a gaping wound. $680 million ($180 million in CRTF plus $500 million in dropped down Class 3) is not nearly enough to protect TWIA policyholders from even a minor tropical cyclone. Even $1.68 billion ($180 million in CRTF plus $500 million in Class 2 Alternative plus $500 million in dropped down Class 3 plus maybe $500 million in incredibly costly reinsurance) is not enough. At its current $72 biliion girth, TWIA at a minimum needs a $5 billion stack. But if you don’t have the time, will or ability to do major surgery, a bandaid is better than watching the patient bleed dry in front of you.  So, if the long run problem can not be solved before the start of hurricane season, or if the long run fix starts only in 2014, this extra money this bandaid creates for 2013 should be sorely appreciated when the wind and water starts roiling in the Gulf.

Senator Carona calls for insurers to be more constructive on windstorm legislation

Far more important, frankly, than my testimony yesterday before the Texas Senate Business & Commerce Committee, was the colloquy between influential members of that committee and representatives of the insurance industry, notably Beamon Floyd, director of the Texas Coalition for Affordable Insurance Solutions (big Texas insurers such as Allstate, State Farm, Famers, USAA), and Jay Thompson of the Association of Fire and Casualty Companies of Texas.  You can watch it all here from 1:49 to 2:00 and 2:22 to 2:25 on the video of the hearing.  John Carona (R-Dallas) and chair of the committee castigates the insurance industry for acting in bad faith, dragging its heels and apparently stonewalling on the issue of TWIA reform.  While such criticism might be expected from members along the coast or from those predisposed to criticize whatever the insurance industry does, this critique

State Senator John Carona

State Senator John Carona

came directly from Senator Carona,  a man who described himself as a friend of the insurance industry and, indirectly, from Governor Rick Perry, likewise seldom confused as an insurance basher.

The problem, basically, is that the insurance industry is resisting a bill that would likely compel it to shoulder more expense for risk along the Texas coast than it does now, even if it can pass many of those expenses on, but it hasn’t been bold enough thus far to come forward at this stage of the legislative process with support for specific solutions to the short and long term problems facing TWIA and its insureds. Nor has the industry publicly (or otherwise, to my knowledge) to date presented facts showing the extent of the burden that would be created by the assigned risk plan embodied in SB 18. This silence places legislators such as Senator Carona in a difficult position. They do not wish to create crushing burdens on the insurance industry that will make insurance in Texas yet more expensive or difficult to obtain, particularly in their districts, but they are also not willing to create a situation in which a significant storm forces an insurer for which they bear responsibility to undergo a difficult forced recapitalization or, worse, leaves it unable to pay claims promptly and fully. My sense is that Senator Carona and perhaps others felt much the way I do when confronted with a student, even one who has done well in the past, who is long on generalized rhetoric but doesn’t show that they have actually done the needed homework.

Here’s what I bet Senator Carona and others would like to see. With respect to all of these numbers, it would be best if they came from certified actuaries using contemporary storm models and it would be helpful if the figures were provided in both absolute dollars and as a percentage of industry premium revenue.  Some of these numbers may well be difficult to develop, but if figures could be brought forth even on an order of magnitude basis, it might separate out real threats to the Texas insurance industry from reflexive rhetoric.

Numbers Relevant to SB 18

(a) Evidence as to the expected costs of the 2210.0561 potential for assessment; this figure might be either a measure of expected losses or an explanation of why this assessment responsibility needs to be reinsured along with the costs thereof.

(b) Evidence as to the costs of the 2210.0561 assessment to help TWIA buy up to $2 billion in reinsurance. My wild guess is that we are looking at $150 million per year in the immediate future but ramping down substantially as the take out in the assigned risk plan decreases the expected amount reinsurers would pay

(c) Evidence as to what it will cost to set up and maintain a clearinghouse that will migrate coastal residents, and perhaps others, either into a private take-out policy or into the assigned risk pool.  Perhaps I am naive, but I believe the clearinghouse could be operated for less than $10 million per year.

(d) Evidence as to what the shortfall between “market rates” and transition premiums will cost insurers AFTER premium tax credits and recoupment are taken into account.

(e) At least an order of magnitude guess as to what it will cost, net of premiums, to write policies on the riskiest policies as to which SB 18 caps the premium at 25% higher than market. Such an estimate will require at least three figures: (1) an estimate of how many policies there will be in this category; (2) an estimate of actual expected losses among the purchasers; and, importantly, (3) an estimate of the incremental costs of capital that insurers need to stockpile in order to bear this correlated risk.

(f) An estimate of the cost of servicing TWIA policyholders even for windstorm claims pursuant to section 2210.5725 of the bill.

I also suspect Senator Carona and others in the legislature would like to see at least a bargaining position from the insurance industry on how much of these costs should be transferred either to TWIA policyholders or more directly to statewide insureds.

Numbers Relevant to An Alternative Plan

For any alternative plan submitted by the insurance industry, we ought to see numbers on the following:

(a) what are the rates that will be paid for risks currently covered by TWIA policies

(b) how will it address the 2013 hurricane season — the Carona bill is weak here

(c) how does it get the stack of protection up to an amount sufficient to cover at least a 1 in 100 years storm, preferably a 1 in 500 years storm

(d) who bears the financial burden of such a stack

So, I know this is a lot of work and there isn’t much time in which to do it.  But my sense is that one outcome of yesterday’s hearing is going to be a greater sense of urgency on many sides from those who will try to scuttle the assigned risk alternative.

P.S. For those who would rather (or also) like to see my testimony, you can find it at 1:36 to 1:44 of the hearing.

Testimony on S.B. 18

Here’s my written testimony on S.B. 18 and related matters provided at the Senate Business & Commerce Committee today.  My oral testimony was basically a shortened version of this along with some interesting colloquy with Senators Taylor, Lucio and Carona.

The Texas Senate Business and Commerce Committee discusses S.B. 18

The Texas Senate Business and Commerce Committee discusses S.B. 18

I am Seth J. Chandler, a professor of law at the University of Houston Law Center and writer for the blog catrisk.net, which deals with the law and finance of catastrophic risk in Texas.  The views here and on catrisk.net are my own and do not necessarily represent those of the University of Houston.

Texas insurance regulation should meet at least three major demands. We must be sure that the entities bearing risk actually have clear resources following a disaster to timely pay claims. (2) Insurance underwriting and pricing must send the proper signals to property and business development markets both on the coast and elsewhere in Texas. (3) Any transition from the status quo should temper the need to move urgently with the kindness involved in protecting the reliance interests of those who invested under the long existing prior system.  I have attempted over the past week to study SB 18 along with competing bills filed by Senators Hinojosa (SB 1089) and Representative Hunter (HB 2352).  I am advised that there is a committee substitute filed or about to be filed for SB 18 but, from my brief review, the changes made therein does not change the thrust of my testimony.

In my view, SB 18, though not perfect, is a positive framework for beginning to meet these demands. It is superior on solvency and market signaling grounds to the Hinojosa/Hunter proposal and to the status quo. Though it deals with the problem urgently, it reflects kindness by having the rest of the state provide at least nine benefits to TWIA and its policyholders. (See Appendix 1.)

The primary concept of SB 18 is to move Texas away from an addictive system in which protection from tropical cyclone risk is concentrated in a highly subsidized and highly correlated pool run by a state-chartered insurer. The subsidization, accomplished through requiring TWIA policyholders to pay fully only for the lower layers of catastrophic risk, kind of like billing a homeowner as if its home was worth only a fraction of its declared value, sends improper signals to property and business markets throughout the state. It treats poor property insureds away from the coast worse than both poor and wealthy property insureds along the coast.  The system now withholds explicit warning to policyholders, particularly those in Galveston County, as to the risks of TWIA’s undercapitalization. It relies on an untested system of post-event bonds limited in amount and inadequate to pay for large storms that will be paid for substantially by non-coastal Texans.

The concentration of correlated risk inherent in TWIA has trapped that agency into choosing each year between two bad alternatives. It can run a risk of insolvency in the current year by not purchasing reinsurance. Or it can perpetuate its poverty by paying huge sums to reinsurers whose prices reflect the need to stockpile liquid capital and consensus views on modern risk of hurricanes.

How would I describe SB 18 in a minute or two?  I would say it provides all Texans not otherwise unable to meet general underwriting standards the opportunity to purchase unfragmented homeowner insurance, including coverage for windstorm, from real insurers.  They do so at rates no more than 25% higher than that of a fine-grained estimate of the market price for similar coverage.  It reduces the high costs of correlated risk and assures solvency by forcibly grafting coastal tropical cyclone risk onto the diversified stock of conventional and other catastrophic risk held by private insurers whose solvency is highly regulated.  It ultimately stops giving special treatment to residential TWIA policyholder’s problem of high and intensely correlated risk. Instead it transitions them, with some interim rate relief effectively paid for by the state and non-coastal Texans, into a private primary or excess market that may have room to flourish once the subsidized market of TWIA is removed. And if that market does not develop, they are protected by a state created assigned risk program with capped prices in which the monitored resources of private insurers will actually pay them in the event of claims. It leaves TWIA in place but in sufficiently shrunken form so that reinsurance may be affordable and a system of assessments are manageable for the private market. Under SB 18, and as set forth further in Appendix 1 to my written testimony, non-coastal Texans will still very much pay either directly or indirectly to help their friends on the coast, whom I hope appreciate the consideration.  But they will do so via a system that stands a greater chance of actually being helpful in time of need and that likely does so at lower overall cost.

Its leading current competitor, the Hinojosa and Hunter bills are premised on coastal exceptionalism and a demand for coastal development.  They attempt to use benefits undoubtedly provided by the Texas coast but qualitatively little different from the benefits provided by the economies in each of your home districts, as a reason for the rest of the state to subsidize — perhaps even more than the status quo — the purchase of windstorm insurance along the coast.  They perpetuate the sending of bad signals to the development market. They leave the problems created by risk concentration essentially untouched. They leaves the interest rate risk attached to funding by post-event bonds in place.  They appear to finance the first layer of post-event bonds by large surcharges on whoever is left in the TWIA pool following a large disaster —  an idea the bond market appears to reject. Yes, the bills do build a bigger catastrophic reserve fund to insulate policyholders from those risks, but the money to do so comes mostly from policies other than those that will benefit from the enhanced cat fund.

There are questions I have about SB 18 and important implementation details about which I have reservations.  I set more of them out in Appendix 2 to my written testimony. Chief among them  (1) I want the immensely powerful Managing General Agent of the TPIP subject to Chapter 552 of the government code.  (2) I want, as you should too, numbers from full time professional actuaries about the burden of the bill on Texas insurers, non-coastal insureds and coastal insureds.  The concept at the core of SB 18, however, of an assigned risk pool with rates ceiling by a multiple of market rates, coupled with transition relief for TWIA residential policyholders, represents a welcome advance beyond conceptualizing the best form of bandaid to put on system that may be fatally infected.

Seth Chandler before the Texas Senate Business and Commerce Committee

Seth Chandler before the Texas Senate Business and Commerce Committee

Appendix 1: Ways in which non-coastal Texans will continue to subsidize the coast under SB 18

  1. Subjects insurers statewide (“TWIA members”) to front $2 billion for an assessment in the event TWIA does not have enough money to pay claims. (2210.0561).  The State of Texas and taxpayers ultimately pay the bill via premium tax credits.
  2. Insurers statewide (“TWIA members”) pay each year for a $2 billion reinsurance policy for the benefit of TWIA and its policyholders (2210.0561)
  3. Assessment on insurers statewide (“TWIA members”) to pay to establish, maintain and administer a clearinghouse that will significantly service coastal residents. (2210.103 and 2210.104)
  4. Surcharge for up to 33 months of 1% on policyholders outside of the “catastrophe area”) (the coast) on most forms of property/casualty insurance including homeowner policies and automobile policies. Proceeds from the surcharge go to build up a catastrophe trust fund used exclusively for the benefit of TWIA policyholders. Section 2210.4521.
  5. Surcharge for up to 33 months of 5% on non-TWIA policyholders in the “catastrophe area”) (the coast) on most forms of property/casualty insurance including homeowner policies and automobile policies. Proceeds from the surcharge go to build up a catastrophe trust fund used exclusively for the benefit of TWIA policyholders. Section 2210.4521.
  6. Insurers receiving less than assigned risk premiums due to transition relief for TWIA policyholders authorized to include a provision in their residential property insurance rates to recoup up to 50% of the shortfall.  Policyholders statewide thus likely to pay to keep rates low for coastal policyholders formerly insured by TWIA. (Section 2214.458).
  7. State of Texas and/or taxpayers pay for the same transition relief for TWIA policyholders by giving insurers a premium tax credit for 50% of the shortfall each year.
  8. Insurers obliged to write policies for no more than 25% above “market” for certain policyholders on the coast and elsewhere even where doing so costs more than 25% above market due to correlation of risk and limitations on permissible underwriting criteria.  This cost borne directly by insurers and indirectly by insureds statewide.  Section 2214.406
  9. Insurers writing policies on the coast with wind exclusions apparently compelled to adjust windstorm claims without compensation. Section 2210.5725.

Appendix 2: Questions and reservations about the bill.

  1.  A spreadsheet or similar document should be developed by experienced actuaries that estimates each of the costs identified in Appendix 1 with recognition that such estimates will, of necessity, often be rough.
  2.  Section 2214.352 of the bill would permit Texans to obtain coverage for tropical cyclone or wildfire within 72 hours of application. This poses a serious adverse selection risk since modern wildfire and tropical cyclone forecasting often provides good estimates of heightened risk more than 72 hours beforehand.  Suggested change: change 72 hours to 168 hours (one week).
  3.  Section 2214.105 and 2214.153 exempt the Managing General Agent from Chapter 552 of the Government Code.  This exemption is inconsistent with the quasi-governmental power over issues of statewide importance provided to the MGA and hinders accountability.  Suggested change: either leave the matter to court interpretation or make the matters described subject to Chapter 552 of the Government Code, which itself contains numerous protections.
  4.  Section 2210.453 requires TWIA to purchase $2 billion in reinsurance even after TWIA is largely depopulated. This number may actually be excessive and forcing TWIA to use reinsurance as a risk transfer mechanism gives too much bargaining power to reinsurers as opposed to alternative methods of catastrophic risk finance such as pre-event catastrophe bonds. This may have been changed in the revised bill that was filed very recently.  If not … Suggested change: Amend subsection (b) of proposed 2210.453 to place the cap on the risk stack at an amount determined sufficient by the Insurance Commissioner to cover TWIA against a 1 in 1000 year storm or $5 billion, whichever is lower and change “reinsurance” to “reinsurance or its equivalent.”
  5.  Section 2210.5725 requires insurers providing conventional coverage to holders of a TWIA policy to adjust claims even for wind losses excluded by their policies. Suggested change: Clarify how, if at all, insurers are to compensated for the additional costs of such an adjustment.
  6.  How does one reconcile Section 2210.211’s  mandatory migration migration of TWIA’s policies to similar but non-identical coverage with various prohibitions against state-induced breaches of contract?  Suggested change: require TWIA to insert into all policies an incorporation of its right to terminate under 2210.211.
  7. Do the limitations in section 2210.507 on maximum limits and minimum deductibles on TWIA policies issued after January 1, 2014, apply just to policies on new properties or do they also apply to renewals of existing TWIA policies?  Suggested change: clarify.
  8. What procedures are available to challenge a determination under section 2214.501 by an assigned risk insurer that an insured structure does not meet building code standards set forth in the TPIP plan of operation and that the policyholder is thus subject to a surcharge?  What constraints exist on the amount of the surcharge the insurer can impose? Suggested change: clarify.

 

Corpus Christi Caller details TWIA solvency problems

There’s a worthwhile article in the Corpus Christi Caller written by Rick Spruill. It addresses both the serious funding problem faced by TWIA today and the solutions being developed by coastal legislators and some coastal interest groups.  The article relies extensively from some of the blog entries here at http://catrisk.net, including ones here and here.

I’ve sent an e-mail to Mr. Spruill on the article and want to post that email here.

I agree that this (http://m.caller.com/news/2012/dec/26/texas-windstorm-insurance-association-could-face/) is an intelligent and important article.  Moreover, even though it contains some criticism of what I have said on http://catrisk.net, it is a balanced presentation.  Two comments, neither of which reflect negatively on Mr. Spruill’s article:

1)  I don’t think Todd Hunter’s comment that Chandler “wants TWIA policyholders to pay for everything ” is quite right.  I want TWIA policyholders to pay for a much larger proportion of the losses their insurer is likely to pay and for that coverage to either be real (i.e. backed up by viable financial structures) or for very clear warnings given by TWIA and TDI to policyholders about the probabilities and consequences of TWIA insolvency.  Although in concept I agree that TWIA policyholders should pay for TWIA risks — I understand that there will be a period of transition required. But the direction of the transition should be towards the assumption of responsibility, not towards shirking it.  I would not be averse, for example, to some sort of grants or subsidized credit being made available, for example, for hardening coastal properties (“mitigation”) and would much rather see money from people other than TWIA policyholders going to reduce the scope of the risk rather than used to bail them out after a fairly foreseeable disaster occurs. I agree that our Texas economy is all interconnected and that if the coast were to suffer a hurricane in which a substantial number of policyholders had large claims against an insolvent insurer, it would hardly be only the coast that suffered.

2) The article is correct  that my computations do not take account of the double dip that TWIA policyholders with automobiles (and non-wind policies) would incur. I don’t have the data that would permit quantification of this complication in part because the Zahn Coastal Taskforce plan is not explicit enough about what sort of insurance would be subject to surcharge. I wish I did have the data. If anyone (like TDI) does have relevant data and would share it, I’d be happy to revise my conclusions.  And I will add a caveat to the existing posts reflecting this matter.  I do not think, however, that inclusion of this complication will alter the fundamental conclusions of my analysis.

Best wishes to all for a happy, healthy and hopefully hurricane-free New Year.