Smithee bill would require TWIA to tell policyholders the truth about its solvency

John Smithee photo

John Smithee

State Representative John Smithee (R-Amarillo) has filed a bill in the state legislature  (HB 2785) that would require the Texas Windstorm Insurance Association (TWIA) to tell its policyholders on the declarations page of any policy it sells after January 1, 2014, about the limited resources available to pay claims in the event of a serious storm. The bill requires disclosure of the financial resources of TWIA, including the state of its catastrophic reserve fund and the marketability of bonds on which TWIA currently relies to pay claims for even modest tropical cyclones.  Critically, it also requires a prominent warning to policyholders right on the declarations page of the policy that the state of Texas is not obligated to come to their or TWIA’s rescue in the event that TWIA can not pay.

Needless to say, Catrisk is enthusiastic about this bill for several reasons.  First, it will enable potential insureds along the Texas coast to make intelligent decisions about the extent to which they want to try to obtain non-TWIA policies to protect them in the event of a serious storm even if those policies are more expensive.  As it stands, some TWIA policyholders may suffer from the incorrect assumption that the resources available to pay claims from policies purchased from TWIA, which currently relies on a paltry catastrophe reserve fund and a shaky structure of post-event bonds, are the same as those available from regulated private insurers, who would be put out of business if their reserves were anything near the inadequacy of TWIA’s. The misinformation suppresses demand for policies from regulated insurers and thus contributes to the self-fulfilling prophesy that the regulated market “can not do business on the coast.” Other prospective insureds, by the way, may actually have an exaggerated sense of TWIA’s instability and thus decline to purchase TWIA policies due to excessive fear. The bill, by providing the relevant facts, could help both groups of people make an informed choice.

Second, those contemplating migration or business expansion on the Texas coast will now be advised to think about whether they want to choose between going with a less expensive but flimsy insurer (TWIA), scrounging for difficult-to-obtain and often expensive wind insurance from a private insurer, or deciding that there may be better places in which to invest. This, of course, is precisely why some coastal interests, particularly those who benefit from immediate investment on the coast, oppose bills such as HR 2785. Telling people the truth about a risky product is indeed likely to drive down demand for the risky product while stimulating demand for the safer.  But getting demand for insurance products back to fair market levels, as opposed to levels inflated by subsidization and misinformation, is a good thing for Texas as a whole. Market distortion is not a zero sum game.

Third, this bill is a good idea regardless of the form in which TWIA goes forward.  Whether TWIA is transitioned out for residential policies, as proposed in the recent Carona bill, or strengthened through significant subsidies, as in the recent Hinojosa and Hunter bills, many policyholders are likely to remain in TWIA or potentially in TWIA for several years to come.  In that interim period, those policyholders should be warned of the remaining dangers posed during the transition to a system of greater solvency.  The faster and more forcefully that transition occurs, the less dire the warnings will need to be.  I am confident that Representative Smithee would be glad to include an amendment to his bill exempting TWIA from the disclosure requirements if it could show the Texas Insurance Commissioner that it would satisfy solvency requirements imposed on other Texas insurers.

At least one coastal legislator, Todd Hunter of Corpus Christi, has voiced opposition to the Smithee bill.  He did so at a hearing last year (go to go to 1:57:50 to 2:02:18 of the recording) in cross examining me about ideas similar to those found in the Smithee bill.  And he is reported today in a Corpus Christi Caller article as asking, “Why should coastal residents be the only people subject to this Miranda warning from (the association)?” Hunter asked. “Why is it not required, statewide, for all carriers?”

The rejoinder to Representative Hunter’s opposition, however, is that other Texas carriers are subject to financial solvency regulations from which TWIA is exempt and as to which TWIA would be in serious violation were it ever required to follow them. The reason TWIA policies should be stamped with bold red warning labels is the same reason that we stamp surplus lines policies in Texas with similar warnings: they are not subject to the same regulatory structure that works pretty darned well in preventing insurer insolvencies. Coastal residents are mature enough to handle the truth. Just because TWIA and State Farm both have the word “insurance” in their names does not mean that the law should treat them the same.  We don’t exempt investments in junk bonds from disclosure regulations about the risks involved just because some other forms of “investment”, such as certificates of deposit in a federally insured bank,  are not subject to as strict disclosure rules.  And, again, if equality of treatment is really the objection of some coastal legislators, an amendment exempting TWIA from disclosure in the event its financial condition would satisfy otherwise applicable solvency regulations seems a better answer than keeping TWIA policyholders in the dark under the fiction of “equal treatment.”

Note 1. The Smithee bill closely follows Recommendation #10 posted on this blog on September 10, 2012.  In “Ten fixes for TWIA: What I’m planning to say in Austin this week” I wrote as follows.

10. Require prominent disclosure to TWIA policyholders created by the financing structure in place (as modified by the reforms suggested here or otherwise enacted). This disclosure should, at a minimum, advise policyholders of the approximate probability, computed using the best historical data and contemporary models, of the risk that TWIA will become insolvent, will be impelled to increase premiums to pay off Class 1 securities and will be impelled to impose surcharges to pay off Class 2 securities. Disclosure should be made (a) on a document signed by applicants for TWIA policies (new or renewal); (b) stamped (similar to surplus lines stamping) on policies issued by TWIA; and (c) on a web site one or fewer clicks from the main TWIA page.


Note 2. The bill also echoes thoughts expressed in this blog here:

Policyholders don’t need to be scared about every unlikely event, but they have a right as adults to know of a substantial risk.  Losing your house and facing an insolvent insurer qualifies. We warn holders of surplus lines policies of lesser protections against insurer insolvency with a great big stamp on the policy.  Why not the same for an equally unguaranteed and often far riskier insurer. And while we’re warning, let’s also warn them of the potential for post-event Class 1 assessments, for which the risk is yet far higher and uniform throughout the TWIA territory.

Note 3. Although I suspect many insurance agents will not immediately embrace the Smithee bill, enlightened ones should do so.  This is because the bill should provide some protection to insurance agents who now find themselves in a difficult position.  Right now, insurance agents who don’t warn their policyholders of TWIA risks may be setting themselves up for a lawsuit.  The dangers of TWIA are so palpable that a plausible claim of negligence or intentional non-disclosure is definitely something these agents need to be concerned about in the event TWIA either can not play claims or is highly delayed in paying claims.  It is wishful thinking and ostrich-like behavior to pretend this serious risk does not exist. On the other hand, insurance agents who do warn their policyholders of TWIA risks may find business going elsewhere. The bill probably saves agents the dilemma of whether or not to tell the truth by leaving disclosure to the policy itself.



A second look at S.B. 18


In a post yesterday, I provided some preliminary analysis of S.B. 18, a bill filed by Texas State Senator John Carona that would completely overhaul the system by which most coastal Texans transfer the risk of windstorm.  Basically, the Texas Windstorm Insurance Association (TWIA) is phased out by 2015 as an insurer of residential coastal property and replaced with an assigned risk plan, the Texas Property Insurance Program (TPIP) that will ultimately charge “market” rates and will be administered by a Managing General Agent. In the interim, TWIA finances are shored up with statewide insurance surcharges to build up the catastrophe reserve fund, potential assessments on insurers of $2 billion in the event of a storm, and actual assessments on insurers of whatever it takes to to purchase $2 billion of reinsurance. (Insurers mostly recoup any storm assessments with premium tax credits but do not recoup reinsurance assessments).  Many TWIA policyholders are somewhat protected for a few years by a requirement that TPIP market rates be phased in, with the public effectively paying for the continued subsidization via likely insurer pass throughs and further premium tax credits.


The first page of S.B. 18

The first page of S.B. 18

I did a second read this morning and found several matters on which I had not previously focused.  I suspect I and others will find more in the days ahead or find areas in which these findings need clarification or correction.

  1. This particular bill does not appear to touch TWIA’s ability to sell policies that cover property other than residences (either owned or tenanted). Thus, unless I am missing something or there is a companion bill ahead, it appears TWIA will persist as an insurer that offers coastal businesses and government windstorm coverage for commercial structures. and public buildings. Currently, since “non-dwellings” comprise just 1/6 of TWIA’s exposure, such a reduction in the exposure of TWIA would likely make a buttressed catastrophe reserve fund, $2 billion in potential storm assessments, and $2 billion in reinsurance fully adequate to pay the remaining TWIA policyholders even in the worst cases — a welcome change from the status quo. The mandatory migration described in sections 2210.212 and 2210.213 speaks in terms of “residential structures” and “dwellings.” The provisions governing liability limits and deductibles in section 2210.507 likewise speak about residential properties.
  2. The bill does away with the system of post-event bonding that exists under the current law and whose functionality has been called into serious question.  Section 3 of the bill amends section 2210.056 to eliminate the ability of TWIA to use its assets to pay obligations incurred under Subchapter B-1, which is where the authority to actually repay bonds appears. Various other provisions of the bill likewise delete references to the post-event bonding program.
  3. Even during the transition period, TWIA will not be adjusting as many claims on future storms as it is currently required to do. Instead of keeping TWIA on perpetual standby for large scale adjusting requirements following a storm, the bill piggybacks on the claims adjusting stables of the major insurers and requires them to adjust claims on TWIA losses after June 1, 2013 acting as agents for TWIA. (Section 2210.5725).  If a private insurer covers a coastal homeowner for fire but a hurricane damages that homeowner’s residence, it appears as if the private insurer must adjust the claim unless — and I believe this would be quite unusual — that particular insurer provides windstorm coverage on 90% or more of the policies it writes on the coast. Otherwise, I assume TWIA continues to adjust the claim.
  4. It is not clear to me if and how the private insurers get paid for undertaking this expensive obligation or whether this is going to be just a cost of writing conventional property insurance along the coast.  If the latter, be prepared for attempts at rate increases by the private insurers or reduced willingness to sell even conventional policies in that area. I suppose insurers could also recoup these costs if they offered windstorm coverage in addition to conventional coverage.
  5. One upside for undertaking claims adjustment on behalf of TWIA is that, under the Carona bill, private insurers doing so will gain the protections of existing section 2210.014 of the Insurance Code, which protects TWIA from lawsuits brought by policyholders (or other private entities) under the unfair trade practices provision of Chapter 541 of the Insurance Code, which provides for treble damages, and Chapter 542 of the Insurance Code, which imposes penalty interest of 18% for statutorily described delays in claims adjusting. Private insurers adjusting claims on behalf of TWIA also gain the protections of existing section 2210.572 of the Insurance Code, which provides more favorable to them than the otherwise existing substantive and procedural rules in Texas for breach of contract and bad faith claims against an insurer.  Presumably, although it is not clearly stated in the draft Carona bill, they also gain the protections of the rest of Subchapter L-1 of the Insurance Code to which section 2210.572 makes reference. For an earlier discussion of this point, look here.
  6. The Managing General Agent, who basically runs the new insurance program, is neither elected nor appointed in the traditional sense.  Rather the MGA is awarded a contract to run the new TPIP for a period of up to five years. Section 2214.151. There is not much detail in the Carona bill on how the award of this contract is to be made.


Bill filed to migrate Texas coastal insurance to an assigned risk plan

Texas State Senator John Carona has filed an 83-page bill (S.B. 18) that would completely overhaul the system by which most coastal Texans transfer the risk of windstorm.  Under the existing system, most coastal insureds get their windstorm insurance through the Texas Windstorm Insurance Association (TWIA), a state-created entity which has (correctly) been found unsustainable by the current Texas Insurance Commissioner Eleanor Kitzman.  The Carona bill, a copy of which may be found here (Corona SB 18 TWIA), rapidly transitions TWIA to an assigned risk plan, the Texas Property Insurance Program (TPIP), under which Texas insurers would be impelled to take on coastal risk.

Catrisk will be doing a much more thorough analysis of this important bill in the days ahead, but here are some key points on a quick read. Clearly, this bill was drafted by professionals.  It’s intricate and covers a lot of ground. There is a lot to digest.  So, I hope I don’t make too many errors in saying this.

  1. Starting in January of 2014 (or as soon as the TPIP gets off the ground), the TPIP clearinghouse will make existing TWIA policies up for grabs by existing insurers.  It looks as though existing Texas property and casualty insurers can prevent TWIA from forming a contract with a coastal insureds if they agree to take on the risk for the same terms as TWIA and a premium that is not more than 110% of the TWIA premium.  (Section 2210.211(g))I would initially expect this program to permit Texas insurers to cherry pick off the properties currently insured by TWIA but that are actually somewhat farther from the coast than other TWIA policies.
  2. TWIA policy limits are going down and deductibles going up.  If I read section 2210.507 correctly, after TPIP gets off the ground, TWIA policy limits on residences will max out at $500,000 (down a lot from the $1.something million that now exists) and deductibles will be at least 5%. Also, the bill will prevent some of the water v. wind disputes that have occurred recently by requiring that property in Zone V of the National Flood Insurance program must have flood insurance. (2214.251(a)(2)).
  3. After April 2015, TWIA won’t write policies on any residences that it wasn’t already insuring: renewals only. (section 2210.212(1)).  And it looks as if the new entity, the TPIP clearinghouse, will have a right of first refusal on these renewals. (section 2210.213). See also very similar provisions in 2211.1515, et. seq.
  4. After October 2015, TWIA won’t be writing policies on residences, period.  No renewals, no new policies. (section 2210.212(2))
  5. Rates on policies written through TPIP are ultimately going to be market rates. Under 2214.402, “the rating classes, territories, and method used to determine the market rate must be designed in a manner to ensure that the the assigned program rating manual is as compatible as possible with the voluntary market’s rating method.” Territorial rating appears to be quite permissible (i.e. truly coastal properties may pay rates different than slightly inland coastal properties). The one constraint is that insurers can not break up zip codes. (Section 2214.402(f)). The bill provides for hearings — won’t those be fun! — before the Texas Insurance Commissioner who gets to approve or disapprove the rate calculation method proposed by the Managing General Agent who is going to be running the TPIP. (Section 2214.404).
  6. There are, however, transition rules that will protect some TWIA insureds from the market for a while.  For existing TWIA insureds with residences worth less than $250,000 with contents worth less than $80,000, there is some protection. (Section 2214.456). The period of transition protection depends on the value of the property.  Basically, it is at most 10 years for property worth less than $100,000, at most 5 years for property worth $100,000-$150,000, and at most three years for property worth $150,000-250,000.  (2214.456(c)(2)). Property worth more than $250,000 is not eligible for transition protection. The actual period of transition may be less if the difference between market rates and pre-existing TWIA rates is not that large.
  7. By way of example, if TWIA rates are X and market rates are 1.3X, a dwelling with a value of $140,000 would see rates go up 6% every year for 5 years until the rates increased 30%.  If TWIA rates are X and market rates are 1.4X, a dwelling with a value of $200,000 would see rates go up 13.3% per year for three years until the rates increased 40%.
  8. And who is going to eat the difference between the market rate and the transition rate that these policyholders pay?  It looks like Texas insureds and the state.  Under section 2214.458 of the bill, an insurer “may include a provision in its residential property insurance rates to recoup up to 50% of the transition premiums not collected by the insurer in the previous calendar year.”  Moreover, the insurer is entitled to take as a credit against otherwise owed premium taxes, the remaining 50% of the shortfall between the market premiums that it would otherwise be receiving and the transition premiums that it does receive.
  9. TPIP policies will have maximum limits of $1 million for dwellings, and 40% of that amount for personal property. TPIP policies will have deductibles of 3% for dwellings and the greater of $1,500 or 3% for condominium and tenant policies.  (Section 2214.602)
  10. Insurers throughout Texas and insureds throughout Texas are going to pay in several ways to bail out TWIA.  This may be a necessary evil, but is going to cost. It won’t be done through things that are called “taxes,” but it is going to take money out of the hands of non-coastal Texans and their insurers.
  11. First, Texas insurers are going to be required to force their insureds — even if they live in Amarillo, Childress, Waco or Texarkana — to pay a special surcharge from January 2014 through September 2016 not just on homeowner insurance but on all forms of property and casualty insurance, including automobile insurance (Section 2210.4521). For property in the areas covered by TWIA, the surcharge is 5%.  Elsewhere it is 1%. That money is going to go to shore up the catastrophe reserve fund.
  12. It looks like we are going back to the old system of insurer assessment as a way of fronting money to bail out current TWIA if we get hit with a significant storm that exhausts the catastrophe reserve fund (even as shored up). I say “fronting” and not “paying” because the new bill also restores the premium tax credits under which insurers get to credit against premium tax they would otherwise owe, 20% per year for five years of the assessments that they pay. (Section 2210.0561(e)). So, for at least a while, it’s really the Texas taxpayer or beneficiaries of Texas tax dollars that will be paying for a lot of coastal insurance risk.   Section 2210.0561(c) of the bill says that member insurers — that’s TWIA lingo for insurers selling property/casualty insurance in Texas — will be liable for up to $2 billion in assessments in excess of the rather catastrophe reserve trust fund that is now rather puny but that may grow through the assessment scheme described above. After that, reinsurance, pays for losses.  After that, who knows.  If, however, TWIA depopulates, as is projected, the expected exposure of these “member insurers” and reinsurers will rapidly decline.
  13. Insurers throughout Texas have to pay to buy reinsurance for TWIA to give its policyholders additional protection.  $2 billion of reinsurance.  (Section 2210.453). Apparently this requirement exists regardless of the price reinsurers want to pay (which may not be the best bargaining position from which to start).  I guess we should assume that insurers will figure out a way to pass this cost (which might be at least $100 million) on to their insureds throughout Texas.
  14. The TPIP is going to be run by a Managing General Agent that is going to have a lot of authority.  The MGA may also have a lot of protection against members of the public who want to know how it is running its operation.  Under 2214.153 of the Carona bill, “information, analyses, programs or data acquired or created by the [MGA] … are property of the state” and, critically, “exempt from public disclosure under Chapter 552 of the Government Code.”