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.
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.
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.