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.

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.

 

 

 

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.

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.