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urgency to an immediate assessment and, in light of what they believed was uncertain legal authority to do so under a repealed statute, wanted to await a requested legal opinion from Texas Attorney General Greg Abbott.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.

Alice Gannon’s remarkable speech

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

Screen capture of the TWIA board meeting

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

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

Alice Gannon’s Speech: A Transcript

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

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

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

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

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

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

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

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

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

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

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

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

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

Interest rates on the Bond Anticipation Note were potentially 10%

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

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

Texas Insurance Commissioner Julia Rathgeber

Texas Insurance Commissioner Julia Rathgeber

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

TWIA tips its hand

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

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

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

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

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

 

TWIA shows how it could pay off a BAN

TWIA shows how it could pay off a BAN

A BAN could impede fundamental reform

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

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

 

 

 

Smithee’s urgent warning to Governor Perry

I’ve decided that Representative John Smithee’s letter of May 29, 2013, to Texas Governor Rick Perry is of sufficient importance that I should just simply reprint it right here. It contains an urgent warning that TWIA is likely to have a $1 billion gap and will not be able to pay claims promptly for even a low severity storm.  No links to click.  Just read it.

John Smithee warns Governor Perry that TWIA likely has a $1 billion gap and will not be able to pay claims promptly for even a low severity storm

John Smithee warns Governor Perry that TWIA likely has a $1 billion gap and will not be able to pay claims promptly for even a low severity storm

If you want to understand why John Smithee is saying this, read entries in this blog such as this one and this one.