H.B. 3622: the hearing yesterday. And is it getting worse?

Here’s a link to the House Insurance Committee hearing of April 30, 2013. My extensive fan network can skip to minute 10 and watch until minute 26 as I take on the Bonnen Brothers and discuss H.B. 3622 with the rest of the committee. Actually, it’s worth watching the whole thing, particularly the dance around the issue of whether H.B. 3622 mandates “actuarially sound rates.”  Answer: it does not.

Dennis Bonnen

Dennis Bonnen

Greg Bonnen

Greg Bonnen

 

 

 

 

 

 

A few quick observations:

  • Unconfirmed, but there is apparently a major change in H.B. 3622 that makes the bill worse than I thought.  In fact, if what I am hearing is true, I might now answer the question posed to me by Representative Greg Bonnen yesterday somewhat differently about which was better, his bill, which I did not like, or the status quo, which I also do not like.  If it is true, as I heard after the meeting, and as Beamon Floyd, a lobbyist for major Texas insurers suggested during his testimony, that a modified version of the bill relieves TWIA policyholders from the obligation of actually paying for the reinsurance that protects them but foists that $100 millionish burden onto insurers statewide, that makes H.B. 3622 even more problematic. If that’s true — and I hope to find out later today — my better answer might then be: “I can’t say: they are both awful in different ways. The status quo is awful because it does not create a high enough stack to protect TWIA policyholders from insolvency. HB 3622 is awful because it makes non-coastal residents pay even more of the burden of insuring on the coast and thereby sends even worse signals about development patterns and hurts the poor off the coast even more.”
  • It is apparently very common practice in the Texas legislature for there to be proposed changes to a bill — a “Committee Substitute” that are not posted to the otherwise wonderful Texas legislative website.  As a result, “outsiders” such as me find themselves testifying about provisions that have either been replaced or supplemented.  Apparently, one can usually get the committee substitute by asking the bill proponent, but it might enhance democracy — and make testimony more relevant — if these substitutes were available electronically or in some regularized procedure.
  • I think I now understand Representative Craig Eiland’s ideas on trying to assess insurers for Hurricane Ike.  He doesn’t want to assess under the old law.  What he seems to suggest is a new law that would assess insurers for anything up to $600 million “for Ike” and to justify that assessment on grounds that the insurers “escaped” that responsibility under the old law when TWIA messed up and failed to assess adequately.  It’s an interesting idea and I too am troubled by the failure to assess under the old law. It is partly responsible for the current deficiency in the Catastrophe Reserve Trust Fund. But it is not an idea without legal risks. Although the ex post facto clause of the United States Constitution applies only to retroactive imposition of criminal liabilityHarisiades v. Shaughnessy, 342 U.S. 580, 594 (1952), that rule has some qualifications (Burgess v. Salmon, 97 U.S. (7 Otto) 381, 384 (1878)). Moreover, although what Representative Eiland is proposing isn’t quite a classical taking, it is a little disturbing.  The idea of taking money, even if for the public good, not as a condition of continuing to have an insurance business in Texas but as punishment for having previously done business in Texas and legally escaping what some wanted you to pay, may come close to constitutional prohibitions.  Make that assessment heavy enough and its relation to prior conduct or past legislative advocacy for the repeal of the old assessment law clear enough, and it might inspire the insurance industry to go out and find a good lawyer.
  • The Bonnen Brothers are both clearly intelligent people.  The absence of bombast in their tone is refreshing.

There will be more later today or tomorrow on the whole TWIA situation. Stay tuned as we head into the homestretch.

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]

 

 

 

A statute implementing drop down of Class 3 bonds

The concept

In a post yesterday, I suggested that the Texas legislature needs to prevent a needless insurance catastrophe this summer involving the Texas Windstorm Insurance Association. The catastrophe would be triggered by the inability of the Texas Public Finance Authority to issue Class 2 Alternative post-event bonds following a significant tropical cyclone. As the current law is drafted, such an inability would cascade into an inability to issue any Class 3 post-event bonds and, unless the contract was carefully drafted in an unusual way, jeopardize the ability to collect on any of the expensive reinsurance TWIA had purchased. I thus suggested repeal of current provisions prohibiting the Class 3 bonds from dropping down. I suggested instead that these bonds be permitted to “drop down” in the event the Class 2 Alternative bonds fail to sell and that insurers be given 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.

Today, I want to post some statutory language that would actually implement this idea. I make this foray into statutory drafting because I regard the issue as one of extreme importance and would not like to see thousands of coastal Texans needlessly crippled financially following a significant hurricane because I did not make the effort. I am hardly expert in Texas statutory drafting but believe my skills in contract drafting, a subject I teach with some passion to students at the University of Houston Law Center, might transfer over to this domain. I also do so because I believe, perhaps naively, that this is a component of windstorm reform on which most politicians could actually agree, a matter that has become more imperative in my mind after having attended the most recent legislative hearing on windstorm reform. Of course to the extent that reform legislation is passed in the next 40 days (one day less than yesterday — tick, tick, tick) that would provide both for this summer and for hurricane seasons thereafter, the bandaid suggested here might well not be necessary.

In any event, here is some proposed language that would permit the drop down of Class 3 bonds as a bandaid for the upcoming hurricane season. Additions are underlined; deletions are struck through. The language could be added to many of the bills now pending in the legislature that reform TWIA. At the moment, the proposed legislation permits the drop down to occur at any time, but the permissible period could be restricted to calendar years 2013 and 2014. The bill might also need something like the following to ensure that it takes effect as soon as possible: “This Act takes effect immediately if it receives a vote of two-thirds of all the members elected to each house, as provided by Section 39, Article III, Texas Constitution. If this Act does not receive the vote necessary for immediate effect, this Act takes effect on the 91st day after the last day of the legislative session.”

The statutory language

Sec. 2210.6135. PAYMENT OF CLASS 3 PUBLIC SECURITIES. (a) The association shall pay Class 3 public securities issued under Section 2210.074 as provided by this section through member assessments. The association, for the payment of the losses, shall assess the members of the association a principal amount not to exceed $500 million per catastrophe year. The association shall notify each member of the association of the amount of the member’s assessment under this section.

(b) The proportion of the losses allocable to each insurer under this section shall be determined in the manner used to determine each insurer’s participation in the association for the year under Section 2210.052.

(c) Except to the extent permitted under Section 2210.6136, a member of the association may not recoup an assessment paid under this section through a premium surcharge or tax credit.

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

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

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

(A) $500 million; or

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

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

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

Sec. 2210.6137. BACKUP ALTERNATIVE SOURCE OF PAYMENT. (a) Notwithstanding any other provision of this chapter, on a finding by the commissioner that all or any portion of the total principal amount of Class 2 public securities authorized to be issued under Section 2210.072 or Section 2210.6136 cannot be issued, the commissioner, by rule or order, may cause the issuance of Class 3 public securities in a principal amount not to exceed the principal amount described by Section 2210.074(b).

(b) The commissioner shall order the repayment of the cost of Class 3 public securities issued in the manner described by Section 2210.074.

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

(d) For purposes of this section, the term “applicable fraction” means the ratio of

(1) the portion of the total principal amount of Class 2 public securities authorized to be issued under Section 2210.072 or Section 2210.6136 that cannot be issued to

(2) the initial principal amount of any Class 3 public securities issued pursuant to this section.

[Special Note: This post was edited at 6:30 p.m. on Monday to address some crucial formatting errors]

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.

A simulation of H.B. 2352 and S.B. 1089

H.B. 2352, a bill to reform the Texas Windstorm Insurance Association (TWIA) from Corpus Christi Representative Todd Hunter, is scheduled for hearing in the Insurance Committee of the Texas House this Tuesday afternoon at 2 p.m. I do not know yet if my teaching obligations will permit me to travel to Austin and testify, but if they do, here is about what I will say. It’s based on a Mathematica simulation of 100 sets of 100 years of storms and draws on work I’ve discussed here, herehere and here.

My name is Seth Chandler. I am a law professor at the University of Houston Law Center and author of the blog catrisk.net, which addresses the law and finance of catastrophic risk with a focus on Texas. The views expressed here are my own and do not necessarily reflect those of the University of Houston.

I have attempted to simulate the effects of H.B. 2352 and its companion bill S.B. 1089. The details of that simulation, including the source code, are available in the written submission made to the committee and available at catrisk.net. Basically, I have run 100 100 year storm simulations using models calibrated to mimic those used by AIR and RMS, the two leading modeling companies on which TWIA has relied. Should members of the committee or staff have any questions on the technical details of the model or how variants of the law would affect the conclusons here, I am willing to try to assist.

Based on that research I find that over the initial 20 years of H.B. 2352 with a runoff, and assuming TWIA does not purchase reinsurance, TWIA policyholder premiums will cover about 68% of the losses suffered during that time period. The remaining losses will be paid 6% from replenishment of the catastrophe reserve fund, 8% from class A bonds, 5% from class B bonds, and 9% from class C bonds. Troublingly, 4% of the losses have no identified source of funding. If one assumes instead that TWIA purchases reinsurance at the top of the bonding stack in an amount equal to 1.4% of its direct exposure, as it has done in the past, TWIA policyholder premiums and reinsurance paid for by TWIA policyholder premiums cover a total of 61% of losses suffering during that time period. The remaining losses will be paid 8% from replenishment of the catastrophe reserve fund, 10% from class A bonds, 6% from Class B bonds, and 11% from class C bonds. The percent of losses that have no identified source of funding has decreased, but still rests at 3%. These numbers are, of necessity approximate, and they indeed vary based on a variety of assumptions that need to be made. I have not had the luxury of a large amount of time in which to refine the analysis. In general, however, I believe they accurately reflect the benefits and burdens of H.B. 2352 and S.B. 1089.

This simulation attempts to quantify the benefits and risks to TWIA policyholders created by H.B. 2352 as well as the burden it places on those not receiving direct benefit from TWIA policies. Personally, I do not like what occurs if H.B. 2352 were used to prop up a $72 billion TWIA. The concentration of correlated risk in that entity inevitably makes it an expensive proposition in which the organization either pays exorbitant prices to reinsurers or continues to run the risk of an inadequate stack of protection against larger storm. I believe there is much to the idea of significantly depopulating TWIA with an assigned risk plan or similar mechanism that decorrelates the risk by forced pooling with non-windstorm risk throughout Texas.

If, however, you want to persist with a large propped up TWIA but want to avoid otherwise inevitable biennial fights, it is crucial that the bonding limits contained in this bill with respect to Class A, B and C securities be stated not as absolute numbers, $1 billion, $900 million, $2.75 billion but, as you have wisely done in this bill with the CRTF, percentages of some measure of overall risk to the pool, perhaps direct exposure. Without this modification, the risk grows of storms overwhelming TWIA’s bonding capacity.

Finally, for reasons I have outlined elsewhere I persist in my view that wealthy people on the coast receive subsidized property insurance from poor people away from the coast. This bill continues that inequity although it masks the subsidization by terming what amounts to regional and statewide property taxes as premium surcharges or assessments on insurers. I would thus suggest that the bulking up of the CRTF that takes place in the early years of the HR 2352 plan be made less by non-TWIA policyholders on the coast and assessments on insurers, but more heavily by TWIA policyholders themselves, who will, notwithstanding the benefit that each part of Texas bestows on the other, be the primary beneficiaries of the CRTF protection.

 

I’m showing below a condensed version CDF on which this analysis depends.  You can get the full version here. If you don’t see anything substantive, you need to download the free CDF player so that you can interact within your browser with the model I have created.

[WolframCDF source=”http://catrisk.net/wp-content/uploads/2013/04/HB-2352-Analysis.cdf” CDFwidth=”600″ CDFheight=”1600″ altimage=”http://catrisk.net/wp-content/uploads/2013/04/overview-getplayer_off.png”]

Some further caveats and comments

  1. I am fully aware that this work done on short notice by an individual and not one certified as an actuary, though I do believe I have the skills to produce what I have done. As I have written elsewhere, the Texas legislature should seriously consider establishing an insurance think tank to help it with issues like this.
  2. The premiums in this model are static.  There is some possibility that as the size of the catastrophe reserve fund grows and TWIA is better able to handle storms without resort to post-event bonding, the premiums could decline.
  3. The basic problem with TWIA is that its risk is correlated.  If it were decorrelated, the premiums policyholders pay would likely be adequate to cover its losses and no cross subsidization would be needed.  The problem is that TWIA needs to build up its catastrophe reserve fund to the point where it is no longer dependent on the risks of post-event bonding or the expense of reinsurance.  Until it does this, a system that bundles up correlated risk is going to remain either really expensive or run a risk of insolvency.

 

The destructive power of legislative fantasies

While fantasies may have their place in literature or otherwise, they are an unhealthy basis on which to premise legislative hearings. By distracting legislators from the real work that needs to be done before the end of session and providing false hope to constituents who need to take real action before the start of hurricane season, they are at least as destructive as any hurricane. That’s why the Corpus Christi Caller’s account this morning of yesterday’s meeting of the Texas Senate Committee on Business and Commerce should profoundly disturb residents of the Texas coast who depend on a viable windstorm insurance system. It should equally disturb those throughout the State of Texas whose fates are intertwined with their coastal friends. The meeting unfortunately perpetuates the absurdities of the meeting of the Texas Windstorm Insurance Association board that took place on Monday in which false villains were created and the very legislators who voted for the scheme that contributes to the current deplorable state of coastal windstorm insurance attempt through distraction to escape accountability.

Let’s identify the distracting fantasies.

Fantasy 1. TWIA can escape insolvency by assessing Texas insurers in 2013 for Hurricane Ike.

We’ve been through this before on this blog but let’s do it again now that we have an idea of the opposing arguments. The statute authorizing TWIA to assess insurers under former section 2210.058 of the insurance code was repealed in 2009 by section 44(2) of HB 4409. I’ll reprint that statute at the bottom of this post so you can see for yourself. Government can’t just take people or business’ property for the purpose of enriching others, no matter how worthy the cause, based on a repealed statute.  That’s called tyranny, and it is a violation of, among other things, the same Fifth Amendment protections that prevents the state from taking your house away to pay for worthy state expenditures and the same section 17 of the Bill of Rights contained in the Texas Constitution in which our state’s belief in those same principles is enshrined.

Until Monday, I had not heard a single argument opposed to the proposition that section 2210.058 no longer justified assessments against insurers. And, until I heard the contrary arguments, I was not prepared to say with 100 percent certainty that I was correct. But in light of a letter from several state representatives submitted to the TWIA board and made public Monday and in light of Representative Eiland’s reported comments at the hearing yesterday, we now appear to know the arguments of those who would contradict this apparently evident proposition. All I can say is, “that’s your best shot?” Here’s what they are apparently saying. If there are other arguments that I am missing, bring them on.

Argument 1: The potential to assess insurers is an “obligation, or liability previously acquired, accrued, accorded, or incurred under [a repealed statute] and is thus saved from repeal by section 311.031 of the Texas Government Code.” This argument misunderstands the nature of an obligation and a liability. An obligation or liability refers to something already existing.  Thus, if State Farm did not pay an assessment already imposed prior to the repeal, HB 4409 did not eliminate the already existing powers to force State Farm to pay. But at the time when the repeal took effect, there was no “obligation,” there was no “liability” to pay an assessment based on Hurricane Ike beyond the $430 million the TWIA board did assess in 2008. The fact that TWIA might have made an assessment is no more an “obligation” or a “liability” than a tax that the legislature might have but did not impose or a penalty that a court might have but did not impose.

Argument 2: There is some sort of contractual right on the part of 2008 policyholders to an assessment. I teach contracts and I like creative arguments.  But there is no such contractual right.  I’ve looked at TWIA contracts and there is absolutely nothing in those contracts creating a right to an assessment. Zero. Would a Texas legislator please show the public a TWIA contract containing a right to an assessment.

It is particularly galling, I might add, to contend, as Representative Eiland apparently did at the hearing yesterday, that TWIA policyholders deserve such a right (even if they don’t actually have one?) because of the premium they paid. In fact, precisely because of actions by legislators such as Craig Eiland,TWIA policyholders were not asked to pay a premium that would permit their insurer to be capitalized adequately and that might have provided better protection against hurricanes such as Ike. Instead, those legislators forced TWIA policyholders to become dependent on the TWIA board — a politically constituted body significantly chosen from the insurance industry — exercising their discretion to assess Texas insurers adequately in the event of a major storm.

Now, it may (or may not) be that the TWIA board breached some sort of duty to policyholders by failing to assess. A letter sent by coastal legislators earlier this week contains a disturbing account of board inaction. Unfortunately, however, the choice not to include a right to an assessment in the contract takes the matter out of contract claims against TWIA itself and put it into the murky area of fiduciary duty claims against TWIA board members. And, with fiduciary duty rather than contract providing the source of rights, the remedies become far more limited. Yes, you can sue a board member for breach of fiduciary duty, but section 2210.106 of the Insurance Code promised those board members immunity from suit unless one can show bad faith, intentional misconduct, or gross negligence.  And even if you get over this qualified immunity hurdle, I doubt there are too many board members who have $400 million lying around, the additional amount that TWIA officials recommended be assessed to pay for Ike.

Fantasy 2. Going into receivership would make it harder for TWIA to borrow money either before a hurricane or after a hurricane.

A lot of people at the TWIA board meeting Monday testified about the terrible problems that would be created if TWIA were thrown into receivership: sending the wrong signals, threatening continued development, threatening mortgage covenants, and threatening  the Texas economy (even national security) by challenging energy production on the Eagle Ford Shale. Unfortunately, these people have confused treatment with either symptoms or disease.  It is fine to be angry about cancer, but anger at being treated for cancer after a positive test comes back is misplaced indeed. And it’s insolvency here that is causing the problems and that is going to cause more problems. Receivership is a treatment for the disease of insolvency (here a disease caused by a combination of legislative dysfunction, human greed and fallibility, and a Category 2 hurricane that hit in a particularly vulnerable spot). In fact, although perhaps the matter could be deferred for a week or two to get plans in order, receivership makes a lot of sense. It would likely, as Representative Taylor appears to recognize, actually help most TWIA policyholders.

Here’s why.

Reason 1: Without receivership, there will be even less money available to pay claims for any hurricanes that hit this season. TWIA is being picked apart by claims for Hurricane Ike that are still pending.  Projections are that, even if no serious hurricane hits, TWIA will have even less money by the time the year ends. Thus, if Tropical Storm Barry or Hurricane Rebekah hits this season, there is going to be even less money around to pay the new claimants.  This is particularly true, if, as many fear, the recapitalization structure envisioned by the current Texas Insurance Code, is not going to work and if one of the bills pending in the legislature continues not to address issues for 2013. Those whose houses are decimated this summer by a storm are very much going to wish that someone through TWIA into receivership this spring so that 2008 policyholders and 2013 policyholders were treated more equally. So equity among TWIA claimants is one good reason for a receivership.

Reason 2: The recapitalization structure envisioned by the current Insurance Code may well  be more likely to work with a receivership than without one. Someone who lends money to TWIA now has to be concerned that their claims will be paid out of the same pot as Ike claimants or other TWIA creditors. Given TWIA’s insolvency, that is worrying. It’s likely to cause lenders to demand a particularly high rate of interest if they are willing to lend at all.  Although I am not certain of this, if Texas receivership is like federal bankruptcy, post-receivership financing even in a rehabilitation case can be separated out and given a higher priority that other claims.  That appears to be true in Texas insurance liquidation (section 443.154(j)) and I would be surprised if it were not true in a rehabilitation as well. Now, if the rehabilitation failed, such a refinancing might hurt existing (Ike) claimants of TWIA, and one can see how they might oppose a cavalier refinance on that basis, but if one wants to give TWIA some hope or making it through another hurricane season, giving new lenders some additional protection makes a lot of sense.  I don’t see how that can be done absent a receivership.

Reason 3: The parade of horribles brought forth by representatives of the coast at the hearing Monday was mostly about the problems created by insolvency, not by receivership.  Mortgage companies who have imposed covenants to maintain insurance on their borrowers don’t care as much about whether the insurer is in receivership as whether that insurer has enough money to pay claims that threaten their collateral. And, yes, workers in the Eagle Ford Shale and elsewhere will be hurt if their windstorm insurance premiums go up and their corporate employers don’t respond with higher wages, but what happens to premiums is not particularly dependent on a receivership.  It is dependent on an understanding of why TWIA went insolvent and the proposals pending in Austin to reform TWIA.

At best, the argument against receivership is thatTWIA, a so-called “residual market” carrier, was not really “insolvent” in the same way a private insurer would be if its liabilities exceeded its assets. That’s because, this point proceeds, TWIA has a statutory right to recapitalize through assessment and surcharge that other insurers do not following a major disaster.  So, it is true that, at least for a while TWIA will be able to pay its bills. But inability to pay bills is not and should not be the only basis to justify a receivership.  Another reason is equal treatment of claimants.  The recapitalization mechanism was never very solid and is now so dubious that there is a serious question whether TWIA can treat current policyholders fairly.

Fantasy 3: Resolutions of the receivership issue and assessment issue are very important.

Receivership is an issue, but it is not the main issue. It will just determine at the margin how current and future TWIA claimants get paid and may have some effect on solvency this summer.  Even an assessment of another $400 million or $500 million to fully pay for Ike, though it would help current TWIA claimants, will do little to fix the most fundamental problems with that entity, which include its perpetual undercapitalization and the instability and unfairness of its funding mechanisms. Even with an assessment and with or without a receivership, the current law means that TWIA is running a very substantial risk of going insolvent this year from another serious storm. Or, in plain English, if you own property on the coast and it is hit by a tropical cyclone this summer, there is a troubling chance TWIA will not actually be able to pay what it owes you and you may have trouble rebuilding.

The main issue is how to address windstorm insurance on the coast both for the coming hurricane season and thereafter. There are two serious proposals before the legislature. One basically proposes depopulating TWIA and moving toward a market-based system backstopped by an assigned risk plan for those areas in which the market fails to provide insurance close to some affordability threshhold. Under this system, although people across Texas very definitely help, coastal policyholders bare most the burden of the risk posed to their property. Coastal propertyholders get the benefits of owning real estate near the Texas coast, but they also pay for it. The second proposal continues to force people — poor people and rich people alike, Amarillo residents, El Paso residents and Nacogdoches residents — to subsidize risk along the coast even more than has been done before. While this system at least reduces the risk of a hurricane leaving insureds with claims only against an insolvent insurer, it sends bad signals to the development market and, gallingly, frequently transfers money from the poor to the wealthy. I have my own views on how that debate should come out but respect the view of others.  I just wish it was that debate that was preoccupying the Texas legislature and not a judicial remedy for addressing the existing insolvency.

Here’s what Representative Craig Eiland reportedly said yesterday:

“I see no way you could ever say that’s there no assessment authority with TWIA based on the contractual rights the 2008 policyholders have for the premium they paid for the coverage they purchased,” he said. “Why are we dancing around the question? If we go into receivership the judge is going to assess the companies and have an answer. Why are we not trying to have an answer? Before you make the decision that we cannot assess, how about go assess and find out the final answer.”

 

Text of section 44 of HB 4409 (found here)

 SECTION 44.  The following laws are repealed:
             (1)  Subdivisions (5) and (12), Section 2210.003,
Insurance Code;
             (2)  Sections 2210.058 and 2210.059, Insurance Code;
             (3)  Sections 2210.205 and 2210.206, Insurance Code;
             (4)  Sections 2210.356, 2210.360, and 2210.363,
Insurance Code; and
             (6)  Subchapter G, Chapter 2210, Insurance Code.

Could the guaranty fund help TWIA policyholders?

We’ll know more in the coming days, but, if I am right in believing that the Texas Windstorm Insurance Association is about to be placed into receivership, there is a substantial chance that the claims of at least some TWIA policyholders and other TWIA creditors will not be paid in full.  The Texas Department of Insurance admits as much in paragraph 10 of its recently issued FAQ. Now, ordinarily when a Texas property insurer goes insolvent and is placed in receivership, the Texas Property and Casualty Guaranty Association comes in and pays at least part of the unpaid portion of legitimate policyholder claims. So, the question is, could TPCIGA help out TWIA policyholders? And thereon rests a complex statutory thriller.

We start with the statute creating and regulating TPCIGA, the exciting Chapter 462 of the Texas Insurance Code. Let’s take a look at what claims are protected by TPCIGA.  That’s found in section 462.201.  Here it is.

Sec. 462.201.  COVERED CLAIMS IN GENERAL. A claim is a covered claim if:

(1)  the claim is an unpaid claim;

(2)  the claim is made under an insurance policy to which this chapter applies that is:

(A)  issued by an insurer authorized to engage in business in this state; or

(B)  assumed by an insurer authorized to engage in business in this state that issues an assumption certificate to the insured;

(3)  the claim arises out of the policy and is within the coverage and applicable limits of the policy;

(4)  the insurer that issued the policy or assumed the policy under an assumption certificate issued to the insured is an impaired insurer; and

(5)  the claim:

(A)  is made by a liability claimant or insured who is a resident of this state at the time of the insured event; or

(B)  is a first-party claim for damage to property that is permanently located in this state.

Most of this statute should be easily satisfied by TWIA policyholders.  It will relate to property permanently located in Texas. It will be unpaid (or they wouldn’t be complaining). It has to actually be covered by and within the limits of the policy.  It’s not as if you get a better insurance policy from TPCIGA than you got from your impaired insurer. But there are two tricky bits that I’ve highlighted in orange: (1) it has to relate to an insurance policy to which this chapter (462) applies and (2) the insurer that issued the policy has to be an impaired insurer.  Let’s turn to each of those in turn.

Leaf to section 462.004 of the statute.  It reads, in excerpted form,

Sec. 462.004.  GENERAL DEFINITIONS. In this chapter:

(5)  “Impaired insurer” means a member insurer that is:

(A)  placed in:

(i)  temporary or permanent receivership or liquidation under a court order, including a court order of another state, based on a finding of insolvency; or

(ii)  conservatorship after the commissioner determines that the insurer is insolvent; and

(B)  designated by the commissioner as an impaired insurer.

(6)  “Member insurer” means an insurer, including a stock insurance company, a mutual insurance company, a Lloyd’s plan, a reciprocal or interinsurance exchange, and a county mutual insurance company, that:

(A)  writes any kind of insurance to which this chapter applies under Sections 462.007 and 462.008, including reciprocal or interinsurance exchange contracts; and

(B)  holds a certificate of authority to engage in the business of insurance in this state.

 

So, in order to be an impaired insurer you have to be a “member insurer” (and be in receivership).  But what’s a member insurer?  If you were a stock insurance company, a mutual insurance company, a Lloyd’s plan or some other things, the matter would be easy. You’d be in.  But TWIA isn’t one of those things.  It’s just TWIA. But that’s not the only way to qualify.  See the word “includes.”  That generally means that the items listed are not the exclusive way to qualify.  If TWIA meets the conditions in parts (A) and (B) it should qualify as a “member insurer,” which, you will recall, is what we need before TWIA policyholders can seek protection from TPCIGA.

Now we are deep into the plot. Does TWIA write “any kind of insurance to which this chapter [462] applies under Sections 462.007 and 462.008?

We’re going to skip section 462.008.  Trust me, it has absolutely no relevance.  So, let’s focus instead on section 462.007.  It reads:

Sec. 462.007.  APPLICABILITY IN GENERAL; EXCEPTIONS.

(a) Except as provided by Subsection (b), this chapter applies to each kind of direct insurance.

(b)  Except as provided by Subchapter F, this chapter does not apply to:

(1)  life, annuity, health, or disability insurance;

(2)  mortgage guaranty, financial guaranty, or other kinds of insurance offering protection against investment risks;

[stuff that clearly does not apply omitted]

(8)  a transaction or combination of transactions between a person, including an affiliate of the person, and an insurer, including an affiliate of the insurer, that involves the transfer of investment or credit risk unaccompanied by the transfer of insurance risk, including transactions, except for workers’ compensation insurance, involving captive insurers, policies in which deductible or self-insured retention is substantially equal in amount to the limit of the liability under the policy, and transactions in which the insured retains a substantial portion of the risk; or

(9)  insurance provided by or guaranteed by government.

Assume for the moment that TWIA policies are “direct insurance.” If so, then Chapter 462 applies unless there’s an exception in subsection (b) of 462.007.  It’s quite clear that exceptions (1)-(8) do not apply.  TWIA is not selling ocean marine insurance. But there is this exception 9.  It says that the chapter does not apply to “insurance provided by or guaranteed by government.” Is TWIA provided by or guaranteed by government? Protestations of some notwithstanding, it is abundantly clear that TWIA policies are not (except conceivably for TPCIGA itself!) guaranteed by government. But might TWIA policies be insurance provided by government?!

And we have now reached the crucial moment in our mystery thriller.  Is TWIA insurance government provided insurance?  If it is, TWIA is not a member insurer and, as such, is not an impaired insurer, and, as such, is not the sort of insurer with respect to which TPCIGA offers policyholders any protection.

I would not laugh at someone who suggested that TWIA was not a government insurer.  It is, to be sure, a government-chartered insurer. Unlike Allstate, State Farm and the rest of the gang, TWIA does business not by satisfying general incorporation and licensure statutes but as a result of a special act of the legislature. But is not the federal or state government itself acting as an insurer. Moreover, a court that recently confronted the issue as to whether TWIA was entitled to sovereign immunity appears to have left the issue open.

Unfortunately, this argument, though not frivolous, runs into several obstacles.  First, I believe TWIA has treated itself and TPCIGA has treated it as if TWIA were a government insurer.  That’s because being a member insurer creates many duties. Chief among those duties is to pay assessments when other insurers go insolvent and TPCIGA has to pay claims. (Check out section 462.151). Non-members don’t have to pay assessments. TPCIGA issued assessments to members in 2001, 2002, 2003 and 2006. (see here). My belief — and if I am wrong it is strong evidence that I am wrong — is that TWIA did not pay any of these assessments and was not asked to do so.  Here, for example is the TWIA financial statement for 2006/2007. I don’t see anywhere that it shows a TPCIGA assessment.

Second, I’m not aware of instances where Texas itself acts as an insurer other than on its own property. So if insurer just meant instances where the state itself is an insurer the exception in the statute would have no application.  There are canons of statutory interpretation that say you try not to construct statutory provisions so that they have no purpose. Instead, I suspect, the term “insurance provided by government” means insurance provided by government created entities such as TWIA, the Texas Fair Plan and entities such as TPCIGA itself.

At the end of the day, then, if you asked me, I would say TPCIGA is unlikely to come to the rescue of TWIA policyholders.  I would not say, however, that this is an open and shut case.  I do suspect, however, that the exclusive protection of TWIA policyholders is instead  the funding mechanism set up in Chapter 2210 of the insurance code and whatever amendments may come thereto.  Unfortunately, that’s not looking very good right now and, absent legislative rescue, is going to look abysmal in the event our Texas coast is socked with a significant storm this rapidly approaching hurricane season.

Breaking News: TWIA likely to go into rehabilitation

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

Key quotes from the FAQ

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

 

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Craig Eiland: TWIA can still assess for Ike

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

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

The IBNR problem: the plot thickens

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

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

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

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

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

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

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