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.

 

Waiting for Godot: TWIA style

Sometimes, watching a TWIA board meeting is like watching an absurdist French play. In Waiting for Godot, Samuel Becket presents a two hour play in which the two characters Vladimir and Estragon waste away their existence waiting endlessly for “Godot,” who is clearly never coming. Substitute an Attorney General opinion authorizing an assessment against Texas insurers for Godot and at least some TWIA board members for Vladimir and Estragon and you get an almost perfect re-interpretation of the 1950s French existentialist classic.

Offering a carrot in Waiting for Godot

To be less high-falutin’, however, when the TWIA board spend hours saying they want to “delay” consideration of an assessment in 2013 of Texas Insurers for 2008’s Hurricane Ike until the Texas Attorney General opines that they have the power to do so, they are wasting time on something that will never happen.  To begin with, contrary to a myth that seems to have received its genesis at yesterday’s board meeting, the Texas Attorney General has not been directly asked (yet) whether TWIA currently now has authority to assess insurers for Ike. Of course, the TWIA board can wile away its time on whatever diversion it chooses; we all probably do that.  But when TWIA sees its exposure growing at 4% per year, acknowledges that it is barely solvent if one counts a paltry catastrophe reserve trust fund, acknowledges that its rates are not actuarially sound, and realizes that not a single of its legislative recommendations got any traction, a focus on this pipe dream rather than a relentless look at reality looks — and is — absurd.

The TWIA board considers an assessment

The TWIA board considers an assessment

One reason the Texas Attorney General will not provide what some TWIA board members claim to await is that no one asked the Attorney General to do so. The only pending attorney general request for an opinion that relates to TWIA comes from Corpus Christi Texas House Representative Todd Hunter in RQ-1134-GA filed in July of 2013.  But that request does not ask whether TWIA has the authority to issue an assessment today under a statute that was repealed in 2009. Rather, it asks whether it would be “negligence and/or a failure of authority or responsibility of duties” for TWIA not to assess today. But, as anyone with a background in law knows, it is quite possible for TWIA to have the authority to do something and yet, in the exercise of its business judgment, not to be “negligent” or in breach of its duties not to do so. Unless, therefore, Attorney General Abbott, a current gubernatorial candidate, is eager to step into this highly politicized thicket and lose votes on the Texas coast, he can answer the questions posed without addressing the core issue of whether TWIA has authority to assess. Only if the Attorney General wants to go out of his way to find that TWIA is negligent in assessing today would he have an obligation to resolve the predicate question of whether TWIA has authority to do so.

Moreover, to pretend that there might really be an affirmative answer to the authority question or that, really, the matter is quite unclear is, I fear, at best an exercise in undue politeness. For reasons I have set forth before here, here and here, this is, on reflection, not a particularly close question. The statute that gave TWIA authority to make the kind of half billion dollar assessment it came within one vote of making yesterday was repealed in 2009. It was repealed — by at least one of the legislators who yesterday urged an assessment — in favor of a system that provided a different system for financing losses after a tropical storm. It was repealed in part precisely because under the old system the Texas fisc was directly jeopardized by a TWIA assessment: insurers got to credit payments of the assessment against otherwise owing premium taxes.

It is just preposterous to think that the Texas legislature, if it wanted to prevent assessments for new storms but leave assessment authority in place for old storms would have chosen simply to repeal the old law rather than place a temporal limitation on the authority to assess. It is bizarre to think that if Texas was willing to place its continuing fisc in jeopardy for old storms but not for new, it would not have done something a little more nuanced that simply repealing the old law. It is even more peculiar to suggest, as may have been done yesterday, that Texas magically preserved the ability to assess for Ike but repealed the premium tax credit so as to preserve its fisc.  If it did so, that provision of the statute must have been written in invisible ink.  If TWIA’s lawyers are, as is claimed, actually telling board members, some of whom may not want to hear it, that the matter is ambiguous, that is a failure of courage or competence over reason.

But, actually, it was not so much parallels to Samuel Beckett that troubled me most in watching the TWIA board meeting yesterday.  It was the parallel to Franz Kafka and other writers who focus on tyranny. Here’s the most troubling quote: “I would have to support this assessment because it would be good for the policyholders and that’s who we represent and that’s basically who I’d have to be in support of.”  (1:42 to 1:43 of this recording) Sorry, but at best that is a hopelessly shallow analysis.  It might be equally “good” for the policyholder if Texas insurance agents had their homes confiscated and sold to pay for Ike losses or if Michael Dell was told he had to personally recapitalize TWIA.  Although Texas insurers may have a good deal of money and it takes a little imagination to see State Farm or Allstate as the victims of tyranny, the fact that a government-sponsored entity may “need” money for some public good is not authority to reach into the bank account of anyone — insurer, wealthy person or poor person — and simply take their money without legislative authorization. That is true even if the insurance industry “got away” with paying too low an assessment back in 2008. And, since Texas courts are likely to agree with this point, it is in fact not good for policyholders to have their money wasted paying lawyers defending an indefensible position.

Footnote 1: This is not to say that asking whether TWIA was negligent in not assessing more heavily back in 2009 is a bad question or an easy question. I adhere to my view that this is a reasonable question.  I am just saying that an answer to this question will not provide guidance on whether TWIA can legally assess today.

 

 

Attorney General: Texas not obliged to pay for excess TWIA losses

You heard it here first.  As I wrote back in July of 2012, if the Texas Windstorm Insurance Association does not have enough money to pay its claims, the State of Texas has no obligation to pay its unpaid claims to policyholders. This was confirmed this week by Texas Attorney General Greg Abbott in an opinion letter written to Texas State Representative (and Chair of the House Insurance Committee John Smithee).  The bottom line of the letter  providing the formal opinion of the Texas Attorney General is reprinted below. Here is a link to the full opinion.

The bottom line of Attorney General Abbott's opinion

The bottom line of Attorney General Abbott’s opinion

The Attorney General’s opinion should hardly have been necessary given the obviousness of the proposition. It is, as I suggested, not a matter over which people — particularly lawyers who can read a statute — could reasonably disagree. Perhaps the weight of the Texas Attorney General behind the proposition will, however, put to rest claims by some coastal legislators that the matter was debatable.  The AG opinion likewise vindicates Texas Insurance Commissioner Eleanor Kitzman who made the same assertion last year and who, for thereby calling into question the financial stability of TWIA, was threatened with a criminal investigation by Texas State Representative J.M. Lozano. Perhaps Representative Lozano will now issue an apology?

So, TWIA policyholders take note.  As it stands, there is no cavalry coming over the hill when a tropical cyclone empties TWIA.  Your insurer will not have money to pay your claim in full.  The State of Texas will not pay your claim. The Texas Property and Casualty Insurance Guarantee Association will not pay your claim. No one with money will have legal responsibility to pay your claim under your TWIA policy. You are very likely to be under a blue tarp and coping with a ruined house for a long time. Unless and until the legislature acts, whether in a special session or a regular session two years hence, the restoration of your property and your life may well depend on the kindness of strangers.

Photo of Katrina survivors in the Houston Astrodome

The kindness of strangers the last time a major hurricane left many people homeless

The coming lawsuits against insurance agents who sell TWIA policies

The next set of big lawsuits involving coastal windstorm insurance may not be targeted at the Texas Windstorm Insurance Association but rather against insurance agents in Texas who continued to sell TWIA policies without warning policyholders of the special risks involved.  Under Texas precedent, an insurance agent may be held liable for the loss suffered by a policyholder if the agent knew that “the insurer was insolvent at the time the policy was taken out.” Agents can also be held liable if “at a later time when the insured could be protected, the agent knows or by the exercise of reasonable diligence should know, of facts or circumstances which would put a reasonable agent on notice that the insurance presents an unreasonable risk.” Higginbotham  & Associates, Inc. v. Greer, 738 S.W.2d 45 (Tx. Ct. App. 1987). Given TWIA’s financial statements showing a negative surplus, the admission of a board member yesterday that, unless it gets the Texas Insurance Commissioner to reverse course and authorize a $500 million loan, it will not be able to pay claims promptly on even a moderate storm, and given the growing amount of media publicity about TWIA’s financial plight, there may well now be enough evidence to trigger the duty to disclose.

Arguments for the Defense

Arguments based on common law

To be sure, few policyholders will have an open and shut case against their agent.  The policyholder will have to show there was something they would have done differently — acquired other insurance, perhaps taken heroic steps to protect their property — in order to get damages beyond a return of premiums.  For some policyholders, there may have been little that they realistically could have done differently. Moreover agents will be able to defend on grounds that TWIA’s financial position was equivocal or on grounds that a negative surplus does not have quite the usual meaning of “insolvency” where the insurer has a statutory right to borrow or has a Catastrophe Reserve Trust Fund that perhaps should count as an asset.  Cf. Guidry v. Environmental Procedures, Inc., 388 S.W.3d 845 (Tx. Ct. App. 2012) (“We have found no Texas case applying these principles to allow recovery against an insurance agent in the absence of evidence that the carrier was insolvent”). Some agents may even say that the degree of notice that would trigger a duty did not exist.

Arguments based on statute

And, there’s actually a second type of defense agents are likely to offer: Subchapter L-1 of the Texas Insurance Code.  Agents that are sued for failure to warn will likely argue that section 2210.572 of the Texas Insurance Code, contained in Subchaper L-1, states that it provides the exclusive remedy “for a claim against the association, including an agent or representative of the association.” And what is a claim against an agent of the association? Section 2210.571 defines it very broadly as “includ[ing] any other claim against the association, or an agent or representative of the association, relating to an insured loss, under any theory or cause of action of any kind, regardless of the theory under which the claim is asserted, the cause of action brought, or the type of damages sought.” (emphasis added). So, these agents will argue that, unless a remedy can be found in Subchapter L-1, policyholders suing an insurance agent when TWIA can’t pay can’t sue on a theory of failure to warn.

The strength and the difficulty of this argument lies in the fact that when one looks at the remainder of Subchapter L-1, it provides no remedy at all against agents of the association.  Everything is in terms of claims against the association itself. While on the one hand this might fortify the agents’ argument that Subchapter L-1 gives them protection, on the other hand it suggests that the type of “agent” spoken of in section 2210.571 and 2210.572 is not the “agent” that sells the policy but rather some sort of internal agent of TWIA such as an adjuster, officer or employee, the sort of agent for which TWIA might have vicarious liability. Surely, this rejoinder proceeds, the legislature would have spoken more clearly if meant that no claim could ever be brought at all against an agent for whom TWIA is not vicariously liable when TWIA could not pay a claim for which it had accepted responsibility. Moreover, the whole point of Subchapter L-1 is really to displace bad faith type claims and to provide an administrative mechanism for cases involving disputed coverage, not to displace the entirety of the common law of insurance.

Such a rejoinder limiting the scope of L-1 preemption would be fortified by TWIA’s own documents. Set forth below is a picture of TWIA’s web site. Consistent with the idea that insurance agents selling TWIA policies are not TWIA agents, and consistent with the idea that the purpose of Subchapgter L-1 in H.B. 3 was to protect TWIA itself and less so people selling its policies, this web site indicates that TWIA does not regard people who sell TWIA policies as its agents.

A screenshot of http://www.twia.org/AboutTWIA/tabid/56/Default.aspx taken on June 19, 2013

A screenshot of http://www.twia.org/AboutTWIA/tabid/56/Default.aspx taken on June 19, 2013

So, while Subchapter L-1 may give insurance agents a defense in future litigation, it would not be prudent to rely on it 100% as a reason not to warn TWIA policyholders.

 Reasons for Concern

Notwithstanding these defenses, if I were a Texas insurance agent, or if I were the errors and omissions carrier for these agents who will actually be responsible for a duty of defense and indemnity where their insureds are sued, I’d be quite concerned. Right now, according to TWIA’s own financial statements, it has a negative surplus that many would see an indicator of insolvency. The defenses I outlined above are not iron clad. They are not the sort of defenses that would prevent many a defendant from having to settle for a substantial sum of money. They may not be the sort of defenses that prevail on a summary judgment motion or that insulate agents from juries in counties that have just been devastated by a major storm. Lawsuits like the one’s hypothesized will not be fun for agents, particularly given a concern that some jurors might be predisposed to look at error and omissions carriers or even personally wealthy agencies as providing a nice additional source of disaster relief.

The Smart Decision

The safest course for agents starting immediately will be to advise existing clients in writing about the potential for TWIA not to be able to pay claims promptly or in full and certainly to advise clients upon requests for renewal. If the agent loses a few commissions as a result, I promise that will be a fantastic tradeoff against the headaches a series of lawsuits will bring. The tone of the communication does not have to be hysterical.  There is a decent chance there will be no storm that bankrupts TWIA over the next storm season and there is also a non-zero chance that TWIA will be able to borrow as planned to meet its needs. But the communication needs to disclose that there are now special risks. Perhaps the error and omission carriers could be proactive and help the agent craft an appropriate letter?

If I were a TWIA policyholder and my agent were on real or constructive notice of TWIA’s financial condition, I would want to know.  And if my agent did not tell me and my house was damaged in a storm this summer and I found that TWIA wasn’t paying promptly or in full, I’d be going to a lot of lawyers looking for someone to sue.  That someone would, as a good lawyer would recognize, be right there in front of them.  Their insurance agent, probably with money and probably with an errors and omissions liability insurance policy that provided an additional source of money on which to collect, would be one of the first targets that lawyer would look to in order to make their client whole.

Note: Shortly after I originally posted this entry, an insurance agent reminded me that subchapter L-1 (enacted in 2011 as part of H.B. 3) of Chapter 2210 which governs the Texas Windstorm Insurance Association might have a broader scope than I realized. It might substantially alter what I had to say about agent liability. Upon further review, I believe the agent has an interesting point. The paragraphs on subchapter L-1 have thus been added to address that matter.  

Alice Gannon’s remarkable speech

At yesterday’s meeting of the TWIA Board of Directors, Alice Gannon, a director of TWIA, and its Secretary/Treasurer made a remarkable speech.  It’s remarkable because it is the first time I have heard a TWIA member at a public meeting be honest about at least some of the problems they face.  It’s also remarkable in that it is still not fully grappling (except perhaps elliptically) with the depth of the predicament in which the state’s largest coastal windstorm insurer finds itself. I might add that the speech is also remarkable for the silence that follows.  Notwithstanding the invitation of the chair to do so, there are no follow up questions by the other board members regarding Ms. Gannon’s assertions.

Screen capture of the TWIA board meeting

Screen capture of the TWIA board meeting. Ms. Gannon is at the right.

You can watch it yourself here starting at about minute 39:30 of the recording and lasting until about minute 43:30.  I’m going to provide first a transcript of what she said. I’ve also included a question posed by Mike Gerik and her response.  I’m then going to provide an annotated version of the same colloquy.  My annotations are in italic font and enclosed in square brackets. By the way, I’m not a professional stenographer, but I’ve tried to be careful to capture precisely what she said.

Alice Gannon’s Speech: A Transcript

So, the current financing structure for TWIA includes Class 1 bonds, which theoretically could be a billion dollars as authorized by statute. The problem since day one with the TPFA looking at it and talking to the investment bankers, etc., about it is that the revenue stream to support paying back that bonds is not considered adequate to support a billion dollars of bond.And, depending on any point in time, and conditions, we’ve had estimated  all the way from zero is what we could get if and when we had an event and went to the market to get the bonds all the way up to, really, five to six hundred million is the most that I’ve ever heard discussed. With the bond — One of the advantages of the bond anticipation notes is we have the partner, I think it’s Citibank — Citibank or Bank of America? — Bank of America, I apologize — who apparently is willing to assume that we could get $500 million post event on bonds and so are offering this bond anticipation note, obviously getting some return on that. So, that way we have the certainty, and then even if we are not able to issue $500 million of bonds, we still have that can be translated into a 5 year loan, so we have the assurance that we have that $500 million at that spot.

So, that gives us the comfort then going to place our reinsurance we can assume $500 million of that layer, ‘cause the higher up you can place your reinsurance for the same amount of premium, the more total reinsurance you could get.  In the particular case before us now, we are talking about an additional $250 million of coverage that we could get with the same premium dollars if we can assume we have that $500 million of the Class 1 bonding level.  So, that’s a big advantage.

And, as Pete [Gise] said, the other huge advantage is that you have that $500 million cash on hand. And he did refer to the three different scenarios they ran, the $700 million for a tropical storm/hurricane event or  a one and half billion or a three billion dollars. And in all three of those, the way the cash flow would be expected to pay out, with the bond anticipation note, we would be able to pay our claims in a timely fashion. However, I believe it’s also true that without the bond anticipation note, it’s highly likely we would not be able to pay our claims in a timely fashion.

And, for me, that is the most compelling reason to spend the money of the cost of the bond anticipation note. I think it would be tragic if we have — I mean to the people involved it’s not moderate — but a moderate event of $700 million and we’re telling our policyholders, our claimants, ‘We owe you the money. We agree we owe you the money and we’ll pay it as soon as we can, but that’s going to be a while.  And I just think that would be tragic.  And that’s why I think it is absolutely worthwhile to spend the expected expense associated with that bond anticipation note to get it. And I applaud your efforts to lay that out more clearly to our new commissioner in hopes that she will agree.

Question from Chair Mike Gerik: Alice, could you before you turn off your mike, we keep missing why there would be a delay, because it takes time to issue bonds and maybe how long that’s going to take and that’s the period of time we wouldn’t have the money if we don’t have the BAN.

Gannon: Well, there’s two. Number one is from what I understand from TPFA, they’re estimating three to six months before you could actually sell those bonds and have the cash ready to pay claims.  And that of course is assuming you could with Class 1 get $500 million. There’s a real risk that especially in whatever conditions might exist post event, that the bond market might not buy $500 million worth and then you’re short forever if you will of that piece until the legislature would take action to find money somewhere else for us.

 The Annotated Alice: [My comments in brackets and italics]

So, the current financing structure for TWIA includes Class 1 bonds, which theoretically could be a billion dollars as authorized by statute. [True] The problem since day one with the TPFA looking at it and talking to the investment bankers, etc., about it is that the revenue stream to support paying back that bonds is not considered adequate to support a billion dollars of bond.  [True. The problem is that TWIA would need to raise premiums 20-25%, which would reduce the size of TWIA, which would result in yet higher premium increases, which would further reduce the size of TWIA, which would put the organization into a death spiral. That’s why lenders won’t buy $1 billion of Class 1 bonds in which the repayment mechanism is TWIA premiums] And, depending on any point in time, and conditions, we’ve had estimated  all the way from zero is what we could get if and when we had an event and went to the market to get the bonds all the way up to, really, five to six hundred million is the most that I’ve ever heard discussed.  [Ms. Gannon makes clear that TWIA is never going to be able to sell $1 billion in Class 1 bonds.  This is critical because this is the very fact that triggers section 2210.6136 of the Texas Insurance Code. We’ve talked elsewhere on this blog about the serious problems that section 2210.6136 creates for TWIA. ] With the bond — One of the advantages of the bond anticipation notes is we have the partner, I think it’s Citibank — Citibank or Bank of America? — Bank of America, I apologize — who apparently [Is Bank of America still willing to do even 10%, that I take it is why Ms. Gannon used the ‘apparently’ caveat] is willing to assume that we could get $500 million post event on bonds and and so are offering this bond anticipation note, obviously getting some return [Yes, a hefty 10%] on that. So, that way we have the certainty, and then even if we are not able to issue $500 million of bonds, we still have that can be translated into a 5 year loan, so we have the assurance that we have that $500 million at that spot. [True. That’s one of the key arguments in favor of TWIA borrowing money that will be challenging to repay.]

So, that gives us the comfort then going to place our reinsurance we can assume $500 million of that layer, ‘cause the higher up you can place your reinsurance for the same amount of premium, the more total reinsurance you could get. [True] In the particular case before us now, we are talking about an additional $250 million of coverage that we could get with the same premium dollars if we can assume we have that $500 million of the Class 1 bonding level.  So, that’s a big advantage. [I agree. This is the second argument in favor of going ahead and borrowing, even at 10% and even though it will be a challenge to pay it back.  There are, however, contrary arguments.]

And, as Pete [Gise] said, the other huge advantage is that you have that $500 million cash on hand. And he did refer to the three different scenarios they ran, the $700 million for a tropical storm/hurricane event or  a one and half billion or a three billion dollars. And in all three of those, the way the cash flow would be expected to pay out, with the bond anticipation note, we would be able to pay our claims in a timely fashion. [I would not be so sure with respect to the $1.5 billion storm or the $3 billion storm.  This is where I believe Ms. Gannon and others are not coming to grips — at least in public — with the central problem. As Ms. Gannon acknowledges, it is doubtful the market will buy $500 million in Class 1 post-event bonds that are paid for by TWIA policyholders. But that makes it even less likely they would buy Class 2 bonds that TWIA policyholders have to pay back over 10 years where TWIA policyholders are already burdened, under the BAN, by a 5 year, $130 million per year obligation that already constitutes 20-25% of their premiums.  How on earth are TWIA policyholders collectively going to come up with an additional $82 million per year for 10 years (assuming 10% interest) to pay off $500 million more in Class 2 bonds?  A lot of people are going to drop TWIA under those circumstances.  And when they do, the death spiral of TWIA begins.  And, yet, under section 2210.6136 of the Insurance Code, you can’t get anyone else to pay for bonds unless the TWIA policyholders become so obligated.  So, particularly if you’ve already encumbered yourself by borrowing $500 million short term at 10%, it it will be extremely difficult to issue any more post-event bonds.  TWIA won’t just have the money short term.  It won’t have it at all.  Ever.]  However, I believe it’s also true that without the bond anticipation note, it’s highly likely we would not be able to pay our claims in a timely fashion. [Wow.  At last someone acknowledges that TWIA has a serious, serious cash flow problem.  Like someone in desperate financial straits, TWIA has a choice of encumbering itself with a payday loan (short term, high interest) and having enough cash to pay for a small storm, but basically preventing itself from borrowing funds to pay for a large storm, or having a slightly increased chance of going to the market post-event and borrowing to pay for a large storm.  There are no good options.  In light of the failure of the Texas legislature to amend the statute during the regular session and Govenor Perry’s decision not to add windstorm reform yet to any special session agenda, what Commissioner Julia Rathgeber will be revisiting is which of the bad options is less awful. Maybe when she confronts this fact, she will urge Governor Perry to change course?]

And, for me, that is the most compelling reason to spend the money of the cost of the bond anticipation note. I think it would be tragic [I agree] if we have — I mean to the people involved it’s not moderate — but a moderate event of $700 million and we’re telling our policyholders, our claimants, ‘We owe you the money. We agree we owe you the money and we’ll pay it as soon as we can, but that’s going to be a while.  And I just think that would be tragic.  And that’s why I think it is absolutely worthwhile to spend the expected expense associated with that bond anticipation note to get it. [Maybe.  Ms. Gannon has made a strong case. The problem is, however, that it’s only part of the story.  As I mention above, the BAN may be the poisoned chalice in that it will likely make almost 100% certain that TWIA will not be able to borrow additional funds post event in order to pay claimants.  It thus leaves a permanent gap between storms of $700 million and storms of $2.2 billion, at which point the reinsurance would kick in.  That’s a big gap.] And I applaud your efforts to lay that out more clearly to our new commissioner in hopes that she will agree.

Question from Chair Mike Gerik: Alice, could you before you turn off your mike, we keep missing why there would be a delay, because it takes time to issue bonds and maybe how long that’s going to take and that’s the period of time we wouldn’t have the money if we don’t have the BAN. [Surely this can not really be something that the other board members are missing! I assume the Chairman is just asking Ms. Gannon to emphasize the point again.]

Gannon: Well, there’s two. Number one is from what I understand from TPFA, they’re estimating three to six months before you could actually sell those bonds and have the cash ready to pay claims.  And that of course is assuming you could with Class 1 get $500 million. [Is Ms. Gannon actually agreeing with me? It’s possible.  Is she saying that, with Class 1 pre-event (converted) bonds already issued, you could not get $500 million in Class 2 bonds under section 2210.6136.  If so, I apologize for saying she doesn’t get it.  She’s just being a little terse.] There’s a real risk that especially in whatever conditions might exist post event, that the bond market might not buy $500 million worth and then you’re short forever [Yes, but short what?  I say you are short $1.5 billion in Class 2 bonds and Class 3 bonds.  Is Ms. Gannon agreeing with that or does she just think you are short $500 million. Of course, either way it is bad] if you will of that piece until the legislature would take action to find money somewhere else for us. [Assuming that they would, which should not be a foregone conclusion.  And, trust me, the legislature is not going to act instantly on any such request nor, I suspect, will the money be without strings and some repayment obligation.]

Interest rates on the Bond Anticipation Note were potentially 10%

Officials from the Texas Windstorm Insurance Association and the Texas Public Finance Agency revealed today at a special meeting of the House Insurance Committee that TWIA would have had to pay interest rates of 10% for 5 years in order to pay off borrowings of $500 million it had sought to obtain via a “Bond Anticipation Note.” These sky-high interest rates would have forced TWIA to pay about $132 million per year for more than five years or over 25% of its gross premiums.  The 10% rate that would be paid following a storm is significantly higher than the 4-6% that was previously being quoted and explains rumors that the rate was in fact higher than 4-6%.  There are two rates.  The low one, as it turns out,  would have applied only if there were no storm and TWIA paid the money back at the end of hurricane season.

The revelation about the interest rates that the lender would charge if TWIA actually used the money to pay claims better explains the decision of outgoing Texas Insurance Commissioner Eleanor Kitzman to refuse to let TWIA borrow the money. (It also explains how badly the market regards TWIA’s finances). Paying 25% of premiums for debt service would likely have prevented TWIA from making any substantial contribution to its Catastrophe Reserve Trust Fund. This level of debt service might have required significant premium hikes in order to keep the operation going.

Texas Insurance Commissioner Julia Rathgeber

Texas Insurance Commissioner Julia Rathgeber

If the interest rate on the bond anticipation notes can not be negotiated lower — and interest rates appear to be slightly rising in the economy — the difficulty of amortizing the debt will likewise make it difficult for TWIA and coastal legislators to succeed in their efforts to get new Texas Insurance Commissioner Julia Rathgeber to overturn the decision   Apparently, Ms. Rathgeber is not willing to explicitly overturn the Kitzman decision, but has left the door slightly open to further pleadings brought under a theory that circumstances have changed.

TWIA tips its hand

At the hearing today, TWIA representatives previewed some of the arguments they will likely make to Commissioner Rathgeber later this week in order to revive its efforts to borrow.  Perhaps the most telling of these is that getting $500 million in loans would do more than double the amount of cash TWIA actually has to pay claims.  That’s a big deal in and of itself.  But it would also permit TWIA to purchase $250 million more in reinsurance because that reinsurance could now attach at a higher level. It thus raises the money available to pay claims not by $500 million but by $750 million. A second argument is that the number of Ike claims being filed has come down drastically, which creates less uncertainty about TWIA’s financial situation.

Unfortunately for proponents of the BAN and those who would like an easy fix to TWIA’s financial plight, this information does not appear either terribly new or particularly relevant. Commissioner Kitzman may well have known of the reinsurance differential at the time she made her decision and certainly could have surmised that at least some significant differential would exist.  And I can not imagine that people expected many more Ike claims to be filed more than 4.5 years after the storm at a time when most statutes of limitation have likely run.

Unless the new facts lower interest charges, what really has changed?

The more fundamental problem, however, is that these facts — even if new — do not change the debt equation. I really doubt the market will charge TWIA lower interest rates because of a reduced number of new Ike claims. And how does someone earning $450 million or so a year in premiums and that expects at most to make $200 million or so a year in underwriting profit that is supposed to be salted away into a Catastrophe Reserve Trust Fund, really afford to spend over 60% of that profit on debt service?  TWIA made a stab at such an answer in its presentation to the House Insurance Committee today, contrasting what it estimated as $127.5 million in amortization payments to what it hoped would be $220 million in “underwriting gain.” But, as the footnotes to this presentation conceded, this underwriting gain assumed no non-catastrophe losses. Significant losses in even one of the years over which the bond is supposed to be retired might well cause TWIA to default.

Also, a question.  Do the operating profit figures quoted in the graphic below include reinsurance premiums?  If not, the graphic is misleading.

 

TWIA shows how it could pay off a BAN

TWIA shows how it could pay off a BAN

A BAN could impede fundamental reform

The other issue that legislators will need to consider before they take sides in the BAN debate is the extent to which a BAN conflicts with the goal of making TWIA smaller.  Once TWIA takes on fixed debt obligations, shrinking TWIA becomes all the more difficult. With $82 billion in exposure, bond payments of $127-133 million take up 62% of one’s underwriting profit. With, say, $50 million in exposure as a result fo reform efforts, they take up 100% of one’s underwriting profit.  Thus, to the extent legislators are seeking the “grand solution” that makes TWIA smaller, reliance on a BAN makes that goal even more difficult to achieve. Legislators would likely need to find a substantial amount of cash from somewhere to pay off the BAN ahead of time.

There are some significant short run upsides to TWIA acquiring $500 million right now to deal with its short run finances. It is indeed hard to understand why one would deny a desperate insurer the ability to borrow money.  But the revelations from today’s hearing suggest that, just as payday loans can trap borrowers with short run needs into a cycle of indebtedness with only bad outcomes, so too with borrowings by desperate government created insurers. Until one way addresses the fundamental problem — too little income and too little in assets defending too much exposure, borrowing at high interest rates is a very risky path out of trouble.  For this reason, persuading the new insurance commissioner that TWIA can successfully discharge this large a debt and pay its other expenses — all while retaining the flexibility to endure fundamental reform — will be a tough sell indeed.

 

 

 

The op-ed I just pulled

As discussed in the previous post, Governor Rick Perry decided today not to add windstorm insurance to the agenda for a special session of the Texas legislature.  Among the lesser effects of this decision is that it moots out an op-ed piece I had pending with the Austin American Statesman. Here’s what I would have said and why I have problems with the Governor’s decision.

The op-ed

Texas Can’t Wait Much Longer for Windstorm Insurance Reform:

By Seth J. Chandler

This hurricane season is looking very bad for property owners on the Texas Gulf Coast.  That’s not just because climate experts are predicting more storms than average but also because the coast’s largest windstorm property insurer, the state-sponsored Texas Windstorm Insurance Association (TWIA), is on the edge of insolvency.  Unfortunately, Texas Governor Rick Perry hasn’t been able to get from “certainly possible” to an urgent “yes” in answering calls to add windstorm insurance reform to the agenda for a special session of the Texas legislature.

The problem with waiting is that TWIA is broke and its funding model is broken. As it stands there may end up being only a paltry $1 billion to pay claims. That sum is inadequate to cover the $2 billion or far higher losses that might be sustained when an insurer with $80 billion in potential exposure collides with a Category 2 or higher storm. And for every day that now goes by with no special session and no bill passed by a two thirds majority of both Houses, that’s one more day deeper into this hurricane season in which the Texas coast is at risk.  Indeed, given the interdependencies in the Texas economy, an inability of TWIA to pay claims would place the entire state economy in jeopardy.

Why such little cash?  As a result of dubious management, underfunding before Hurricane Ike, and 2009 legislation that cut off TWIA’s former ability to soak Texas insurers and inland policyholders for large losses, TWIA just didn’t have what it took to shrug off Hurricane Ike claims. And, given the way it currently spends money and the modern risk of hurricanes to an ever developing Texas coast, TWIA’s premiums just aren’t enough to let it escape a cycle of perpetual underfunding. The situation is sufficiently bad that the Texas Insurance Commissioner wouldn’t even let TWIA prop itself up by borrowing $500 million now, ahead of a storm.

Borrowing after a storm — the current plan — is likewise in doubt. Soundings of the market suggest little appetite to lend TWIA money based on shaky sources of repayment such as massive surcharges on TWIA policyholders. And a bug inserted into the law as the 2011 session makes things worse. The inability of TWIA to market bonds at one level is likely to prevent it from marketing bonds — even ones that might otherwise be salable — at other levels.

Texas legislators wrestled this session with numerous fixes but the result was impasse. Disagreements about how much of a subsidy inland Texans should provide TWIA insureds, coupled with the time-tested Texas tangle about damages in lawsuits against insurers, meant that few bills could escape committee and no bill actually made it to a vote.

What could break the impasse? Coastal legislators must recognize that it is simply not sustainable to keep the market out forever and ask inland insureds, who have problems of their own, to pay heavily and in perpetuity for the special risks found on the Texas coast. It doesn’t matter whether that is done directly with surcharges or indirectly through assessments or forcing insurers to sell policies at a major loss along the coast. The alternative of providing coastal insureds with lower-priced insurance that does not pay when the time comes does their coastal constituents no favors.  Inland legislators must recognize that it will take some time to wean the coast off the existing system.  And everyone should realize that the law about how much “extracontractual damages” victims of insurer misconduct should receive does not matter all that much when the insurer can not pay even its contractual obligations. If a long term solution can not be reached, at least bugs in the current statute can be eliminated.

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

 

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.

 

 

I answer a reader’s question about Bond Anticipation Notes

One of the nice things about WordPress is that it tells you what searches are being used to find your blog.  For whatever reason, I’ve been getting a bunch of searches recently that ask who pays — or would have paid — for the $500 million class 1 Bond Anticipation Notes (BAN) issued to cover windstorm losses in Texas. So, let’s answer that question.

The short answer is that TWIA policyholders would have been obligated to repay the loan, with interest.

Continue reading

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.