I answer a reader’s question about Bond Anticipation Notes

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

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

The longer answer

The longer answer starts with section 2210.612 of the Texas Insurance Code.  It is captioned “PAYMENT OF CLASS 1 PUBLIC SECURITIES.”  Subsection (a) reads: “The association [TWIA] shall pay Class 1 public securities issued under Section 2210.072 from its net premium and other revenue.” And what does section 2210.072 say?  It says: “Losses not paid under Section 2210.071(b) shall be paid as provided by this section from the proceeds from Class 1 public securities authorized to be issued in accordance with Subchapter M before, on, or after the date of any occurrence or series of occurrences that results in insured losses.”  I’ve stuck the “before” in italics, because this is the provision in the Insurance Code that authorizes TWIA  to borrow up to $1 billion ahead of a storm. That’s basically a description of a “Bond Anticipation Note.”

So, now we’ve got three more provisions to examine in our ever exploding web of law. (1) What are the losses not paid under section 2210.071(b)? It’s the Catastrophe Reserve Trust Fund.  The provision states: “The association shall pay losses in excess of premium and other revenue of the association from available reserves of the association and available amounts in the catastrophe reserve trust fund.” So, after TWIA runs out of money from its CRTF, it can go to these Class 1 borrowings.

(2) What’s this Subchapter M business? Subchapter M is the “Public Securities Program.” And it includes the section 2210.612 where we began.  So we’ve kind of closed the circle on that one.

(3) But we need to “read on” as my old Civil Procedure professor (Arthur Miller) exhorted us. If we look at the rest of section 2210.072, it says a couple of things of interest.  It notes that the Texas Insurance Commissioner has to approve the use of these pre-event borrowings. Specifically, it says “Public securities described by Subsection (a) that are issued before an occurrence or series of occurrences that results in incurred losses: (1)  may be issued on the request of the board of directors with the approval of the commissioner.”  That’s the authority Eleanor Kitzman used last week to refuse to let TWIA borrow.  And it makes clear that TWIA can borrow using “commercial paper.” Subsection (d) states, “The association may borrow from, or enter into other financing arrangements with, any market source, under which the market source makes interest-bearing loans or other financial instruments  to the association to enable the association to pay losses under this section or to obtain public securities under this section.   For purposes of this subsection, financial instruments includes commercial paper.” This is the provision, I believe, that TWIA was specifically seeking to use to obtain funds from Bank of America via a bond anticipation note.

Why it matters

The reason this all matters, by the way, is that TWIA would have to pay the money back with interest.  And if TWIA is borrowing at a fairly high rate of interest rather than using internally generated funds, this sort of perpetual borrowing doesn’t work very well.  It’s not quite a payday loan, but it can get TWIA stuck in a debt spiral because every dollar it pays in interest is one less dollar available to go into the Catastrophe Reserve Fund for future claims. But the real worry is what happens if a storm occurs.  Then TWIA would first have to try to borrow with the source of repayment being policyholder premiums. But what would happen if TWIA had to pay $130 million a year to pay back a $1 billion loan?  That would require a 25% premium increase.  But if there were a 25% premium increase, some policyholders would drop out.  But that would mean that paying 130 million per year would require more than a 25% increase.   But that would cause yet more policyholders to drop out.  And the thing could just turn into a death spiral.  Which is why the market is very reluctant to lend TWIA money based on these Class 1 Funds.

So, perhaps more than these readers wanted to know, but there you have it.

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