TWIA board declines to assess insurers for Ike — for now

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urgency to an immediate assessment and, in light of what they believed was uncertain legal authority to do so under a repealed statute, wanted to await a requested legal opinion from Texas Attorney General Greg Abbott.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

Much other news emerged from the TWIA board meeting.

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

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

Texas Insurance Commissioner still mulling bond anticipation notes

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

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

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

Great news or the calm before the storm?

Great news or the calm before the storm?

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

News from the TWIA board meeting

I’ll have a fuller post later and the meeting is still in progress (in closed session), but here are the headlines thus far.

1. A TWIA board member (Alice Gannon, I believe) acknowledges that if TWIA does not get new Texas Insurance Commissioner Julia Rathgeber to reverse a decision of her predecessor refusing to authorize $500 million in borrowings via a Bond Anticipation Note, TWIA will not have money to pay claims promptly in the event of even a modest storm.  I do not have an exact quote, but at minute 46 of the hearing she says something to the effect of “Without the BAN, it is highly likely we would not be able to pay claims in timely fashion.” Other board commentary indicates it will take 3 to 6 months to sell post-event bonds, assuming they could be sold at all. TWIA will be meeting with Commissioner Rathgeber this Friday (June 21, 2013) to try to persuade her to reverse former Commissioner Eleanor Kitzman’s decision.

2. TWIA has acquired $1 billion in reinsurance with an attachment point of $1.7 billion.  It has the right until July 15 to increase its reinsurance to $1.25 billion but increase its attachment point of $2.2 billion.

3. As feared, TWIA’s financial condition is already having an effect. Premium finance companies are refusing to lend more than $16,000 to pay TWIA premiums. Lenders don’t want to try to bring claims for unearned premiums against an insolvent insurer.

4. TWIA actually has only $340 million in cash after having paid much of the recent $135 million Ike settlement.  It believes it will have $400 million in cash by August and through the end of the year.

5. TWIA will ask the Texas Department of Insurance to permit it to change accounting practices so that it can count the Catastrophe Reserve Trust Fund on its books as its assets.  Doing so would move TWIA from being seen as having a negative surplus to perhaps having a positive surplus.

6. TWIA will not cancel over 2,000 policies that it has knowingly issued in violation of provisions of the Texas Insurance Code governing compliance with building codes.  Instead, starting in January, after this year’s hurricane season it will decline to renew such policies as they come up for renewal.  This refusal to enforce the law was the subject of sharp criticism yesterday from State Senator Larry Taylor and may give rise to claims by those assessed to pay for post-event bonds that TWIA’s exposure was unlawfully increased.

7. TWIA did not vote to consent to imposition of a receivership.

8. TWIA will not try to assess insurers based on a law that was repealed in 2009. It acknowledges that that there are “uncertainties” as to whether it has authority to do so and that actually collecting such assessments would be difficult.

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.

 

 

 

How much will TWIA pay on losses?

How much will TWIA pay on losses? With the information about reinsurance discussed yesterday, we now have a pretty good sense of what the Texas Windstorm Insurance Association’s finances are going to look like this summer. This lets us build an interactive property insurance calculator for Texas. Yes, if there’s a special session, all of this could change, but unless there is a special session and the bill that emerges out of it passes by a two thirds vote of both Houses, it won’t take effect until deep into this hurricane season anyway. So, in the mean time, what I’m about to show should be quite useful. It’s an interactive property insurance calculator for Texas that lets you see how much your claim against TWIA might be worth.

If you install a CDF player, which you can get for free right here, you will have an interactive widget appear below that produces a pie chart showing the percent of claims that TWIA will be able to pay (green) and the percent that it will not (red).  You get to vary the size of the Catastrophe Reserve Trust Fund, the amount of Class 2 (or Class 2 alternative bonds) TWIA will sell, and, if all the Class 2 bonds are sold, the amount of Class 3 bonds that will sell.  You also get to choose the size of the loss TWIA will face. Or, if you want to watch a movie that shows how the percentages are affected by varying these parameters, click the little arrow in the top right of the widget. The output is an easy to read pie chart that shows how much TWIA will be able to pay.

[WolframCDF source=”http://catrisk.net/wp-content/uploads/2013/06/twia-cents-on-the-dollar.cdf” width=”600″ height=”515″ altimage=”http://catrisk.net/wp-content/uploads/2013/06/Screenshot_6_7_13_12_24_PM.png” altimagewidth=”553″ altimageheight=”580″]

For those who don’t want to install a CDF player, here’s a snapshot showing some sample output.

An example of how much TWIA might pay: output from the interactive property insurance calculator for Texas

An example of how much TWIA might pay

Good news: TWIA looks to have reinsurance for this summer

According to industry publication The Insurance Insider, TWIA has secured the rights to $1 billion in reinsurance attaching at $1.7 billion.  TWIA also has the option of instead obtaining a larger $1.25 billion in reinsurance but with a higher $2.2 billion attachment point.  Both policies apparently cost about the same, likely around $100 million or about 23% of TWIA’s available cash. Purchase of the reinsurance, while helping to protect the struggling state-sponsored insurer for this summer, will, however, reduce TWIA’s ability to increase its internal Catastrophe Reserve Trust Fund. Purchase will thus keep Texas’ largest coastal windstorm nsurer dependent on this expensive form of protection.

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.

 

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

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

Pre-Event Bonds

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

Reinsurance efforts

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

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

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

One additional note

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

TWIA Board to Consider 2013 Reinsurance, Bonds

With just 30 days to go before the start of hurricane season, the Board of the Texas Windstorm Insurance Association (TWIA) will meet tomorrow, Friday, May 3, 2013, in Austin to discuss issues critical to its survival.  Among the items on the agenda are purchases of reinsurance and attempts to sell both pre-event and post-event bonds.  Both of these items are likely to prove extremely difficult for TWIA to manage.  Not on the public agenda is any further consideration of having TWIA placed into receivership.

Reinsurance

Let’s look at the reinsurance issue first. TWIA will be receiving a presentation from its long time insurance broker, Guy Carpenter. You can get a copy of that presentation here. It’s a fascinating document. It rests on an awfully cheerful view of TWIA’s ability to sell post-event bonds.  That’s not a view shared by the Texas Insurance Commissioner or, for what it is worth, by me. It shows TWIA is considering a reinsurance purchase option that would help insurers but would hurt policyholders. And it exposes yet again the extent to which the never-ending need to purchase reinsurance created by the undercapitalization of TWIA, forces TWIA to pay extremely high rates for that protection. If one wanted Exhibit A for why TWIA should be substantially depopulated rather than propped up so it can expand, the material for this board meeting would not be a bad place to start.

WHY IS GUY CARPENTER ASSUMING REINSURANCE CAN ATTACH AT $2.3 BILLION?

The Guy Carpenter presentation proceeds on the dubious assumption that TWIA can sell post-event bonds and thus can attach as high as $2.3 billion in the funding stack.   Look at the following picture found on Slide 8. (You may need to click on it, which will cause it to zoom in).

Proposed reinsurance arrangement for 2013

Proposed reinsurance arrangement for 2013

 

Notice that it presupposes that TWIA will be able to sell $2 billion worth of Class 1, Class 2  bonds and thus explores attachment at the top of the Class 2 stack.  But this is a very strange assumption to make.  First, as the Texas Public Finance Authority and the Texas Insurance Commissioner have stated, and as seems clearly correct, TWIA will not be able to sell the full $1 billion of Class 1 bonds.  And has been discussed on this blog before, the Class 2 bonds can’t sell if the Class 1 bonds don’t sell out and the Class 2 Alternative bonds have difficulties as well. So, the whole discussion of reinsurance attaching no lower than about $2.3 billion rests on what sure looks like unwarranted optimism.

Now, to be sure, TWIA’s got a document in its packet for the meeting Friday that suggests it still thinks it can sell $500 in pre-event securities, $1 billion in Class 2 public securities and $500 million in Class 3 securities.  This document appears, however, to ignore section 2210.6136 of the Texas Insurance Code, which says that Class 2 Bonds can’t be issued unless the full $1 billion of Class 1 bonds sell out.  If the Class 1 bonds don’t fully sell, then one has to resort to the Class 2 Alternative bonds.  But as I’ve pointed out before, the Class 2 Alternative bonds may be almost as dubious as the Class 1 bonds. And the Class 3 bonds legally depend on all the Class 2 or Class 2 Alternative bonds selling out.  So, again it looks to me as if TWIA is still looking at this summer with very rosy glasses or has some interpretation of the Texas Insurance Code I don’t understand.

Note 1: There is an alternative presentation on slide 13 in which Guy Carpenter explores the possibility of the reinsurance attaching at $1.7 billion, but even this is an awfully optimistic perspective on TWIA’s ability to sell post-event bonds.

Note 2: In fairness to Guy Carpenter, there is a footnote attached to the graph stating “Actual amounts of bond tranches are subject to marketability.” Yes. But unless there’s been some miraculous turn around in TWIA’s bonding ability, this seems like the main point, rather than a footnote.

Why is Guy Carpenter not having the reinsurance attach at the top of the Class 3 bonds?

If you’ve ready my blog entry on The Curious Matter of Reinsurance Attachment, you’ll know that the TWIA board has to make a crucial tradeoff in determining where any reinsurance should attach.  Inserting the reinsurance between the Class 2 and Class 3 bonds protects insurers from assessments but buys, dollar for dollar, less protection for TWIA policyholders. Inserting the reinsurance on top of the Class 3 bonds gives policyholders more protection but increases the likelihood that insurers will have to pay.

Most of the bills pending in the legislature would prohibit TWIA from doing exactly what the Guy Carpenter presentation appears to suggest: protecting insurers from having to pay back Class 3 bonds rather than maximizing policyholder protection. Given the incredibly precarious situation facing TWIA policyholders this summer — sorry insurers — but the reinsurance should attach at the highest level possible, buying the most protection for policyholders with a provision for drop down in the event the post-event bonds can’t be sold.

The pricing of reinsurance continues to be incredibly high

The Guy Carpenter proposal suggests that TWIA is again going to have to pay through the nose for reinsurance partly as a result of it never having an adequate internal catastrophe reserve trust fund.  As I’ve spoken about on many occasions, this reinsurance trap — almost like borrowing from payday lenders to address financial vulnerability — basically insures that TWIA never escapes its poverty.

How can I say this?  Look at the models AIR and RMS provide both Guy Carpenter and TWIA.  Here’s slide 6 of the presentation.

AIR and RMS risk estimates

AIR and RMS risk estimates

If one assumes that the distribution of annual losses is a Compound Poisson distribution, with the Poisson parameter being 0.54 (as found in this scholarly article) and one assumes that the underlying distribution is a Weibull with parameters 0.42 and 177,000,000, you can generate data that matches up extremely well with that found by AIR and RMS.  If you then run, say, 10,000 years of simulations using that distribution, you find that the mean losses to an insurer who writes a maximum of  $850 million worth of coverage over a $2.3 billion retention is only about $20 million.  That is 4-5 times less than what the reinsurers are apparently proposing to charge.  And, thus, the cost of having to reinsure rather than internally finance is something like $65-$75 million per year, or about 1/6 of all TWIA’s premiums. You dont, by the way, get qualitatively different results using the three parameter Weibull distribution that I’ve used on this blog before to replicate the AIR/RMS models.

There’s a lot more that is odd about the reinsurance pricing. If we think of the price as being composed partly of expected losses and partly of having to withdraw the maximum exposure from illiquid high-earning investments and place it in low return, highly liquid investments — this is the Wharton School model — the pricing only makes sense if reinsurers lose about 7.8% on their capital by having to make it particularly liquid. ((-expectedLosses + premiums)/maxExposure). Given the market right now, that’s a pretty high number.

There are a couple of explanations between the actual pricing for reinsurance and the pricing that the models would suggest.  One, which is rather scary, is that the reinsurance market is not behaving as competitively as one would like.  The other, scary for different reasons, is that the reinsurance market doesn’t trust the AIR/RMS model and thinks the risk of a major hurricane is considerably greater.  If that’s true, however, then even the dire warnings that I  and others have been sounding about TWIA are understated.

Bonds

The Bond Anticipation Note

The other main item on the agenda appears to be the issuance of bonds.  There is a a proposal from First Southwest that TWIA sell by June 27, 2013, a “Bond Anticipation Note” for $500 million that would basically be an advance on a hoped-for similar Class 1 post-event bond. First Southwest apparently believes these unrated bonds could be sold at between 4 and 6%. My own 2 cents is that if TWIA can get this loan, it should grab it.  Increasing the amount it has to pay claims from its CRTF funds of $180 million to something like $680 million will help.  And if all it has to pay is some interest, that’s a good deal. But there’s a lot to do before this money will be available to TWIA and it looks as if it is going to have go through at least the first month of the 2013 hurricane season without it.

Post-Event Bonds

There’s also apparently a resolution on the table authorizing TWIA to asks the Texas Public Finance Authority to issue post-event bonds. I’ll confess I don’t understand this one.  There haven’t been any tropical cyclones yet in Texas for 2013.  Maybe TWIA is getting this resolution done to see what can actually done for 2013?  Maybe it is an attempt to see if things are as bad as some people have been saying?

Conclusion

The TWIA board is in a very tough spot.  With fewer than 30 days to go in the legislative session and 30 days until the start of hurricane season, it doesn’t really know what its resources are to pay claims. It’s being (understandably) threatened with receivership by the Texas Insurance Commissioner. And its existing reinsurance expires on May 31, 2013, before the start of hurricane season.  If and until TWIA gets some legislative relief or is put partly out of its misery by a Texas shift to an assigned risk plan or other mechanism that deconcentrates risk, it doesn’t have many good options. My hope is that the board will have the courage to confront its moral and legal obligation to warn policyholders in the clearest possible terms of the risks that, unless powerful legislative relief swiftly occurs, their claims will not be paid fully should a significant hurricane hit this summer.

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.