Thanks to a friend, we have new evidence today about how much money TWIA hopes to have to pay claims this summer. The Texas Public Finance Authority, which has to deal with sober realities like the bond market, told the TWIA board back in March that its Class 1 post-event bonds won’t sell. Since Texas Insurance Commissioner Eleanor Kitzman blocked issuance of pre-event bonds that TWIA sought as a substitute, that means that in the very best case, TWIA will have about $2.7 billion. But even this rests on a House of Cards argument that is likely to topple and leave TWIA policyholders in the lurch. Here’s why.
The document in question are the minutes of the Texas Windstorm Insurance Association meeting of March 21, 2013. It sheds some light on TWIA’s own thinking at that time about how much money it was going to have to pay claims. The first clue is contained in the excerpt below.
Notice how TWIA says that if it does not approve — or, one assumes, is denied permission to get — the $500 million Bond Anticipation Note — the reinsurance would attach at $1.8 billion. Now why would TWIA pick such a low number? In the past they have spoken about reinsurance attaching at around $3 billion. The next excerpt explains it. It rests on the advice of Bob Coalter, Executive Director of the Texas Public Finance Authority. Look at this excerpt.
“Mr. Coalter stated that TWIA could not reasonably rely on $500 million in class 1 bonds if the Association waited for post-event approval.” That’s prety clear. And it’s why, I am confident, why TWIA sought the pre-event Bond Anticipation Notes. And it explains very well the $1.8 million attachment point for the reinsurance. TWIA likely thinks it will have $300 million in its Catastrophe Reserve Trust Fund and operating expenses; that’s a number that has been batted around in conversation. It thinks it will have $1 billion in Class 2 Alternative Bonds under section 2210.6136 added by H.B. 4409 in 2011. And it thinks it will have $500 million in Class 3 Bonds. That totals $1.8 billion, which is precisely where the reinsurance would attach.
So, if TWIA could get, say, $900 million of reinsurance for its authorized $100 million to attach at $1.8 billion, it would have $2.7 billion to pay claims this summer, one Ike’s-worth. So, with some rounding, it could, I suppose be said that TWIA has $3 billion, but that’s a bit of an exaggeration.
In any event, let us not, however, quibble about a trifling $300 million. Let’s instead focus our energies on scrutiny of TWIA’s logic of even thinking that it will have the $1.8 billion in funds at which the reinsurance could attach. I say that the very reasons the TPFA is giving TWIA for why TWIA’s Class 1 Bonds won’t sell apply almost equally to the Class 2 Alternative Bonds. Why? See the next paragraph. In the mean time, recognize that the Class 3 bonds can not legally be sold unless TWIA/TPFA can sell $1 billion of Class 2 Alternative Bonds. If TPFA can only sell, say, $600 million in Class 2 Alternative Bonds, then TPFA can not sell Class 3 Bonds at all, and TWIA’s funding stack would be $900 million, not $1.8 million. Yes, TWIA might have reinsurance that attached at $1.8 million, but for losses between $900 million and $1.8 million there would be no money. So, for a $1.5 million storm, TWIA would only have enough money to pay policyholders 60 cents on the dollar ($300 million in CRTF + $600 million in Class 2 Alternative Bonds all divided by $1.5 million in claims). And for a $3 billion storm, TWIA would likewise have 60 cents on the dollar. ($300 million in CRTF + $600 million in Class 2 Alternative Bonds + $900 million in reinsurance all divided by $3 billion in claims).
Why the Class 2 Alternative Bonds Are Almost As Bad As The Class 1 Bonds
OK, so why do I say — and why by the way did TWIA suggest in its report to the legislator — that the Class 2 Alternative Bonds are problematic? Why did several bills in the legislature this session seek to abolish them? Because their repayment source is largely the same problematic mammoth levy on TWIA policyholders that they might not well be able to pay. Here is section 2210.6136(b) of the Texas Insurance Code. It’s the key to understanding the urgency in calling a special session of the Texas legislature.
(b) The commissioner shall order the repayment of the cost of Class 2 public securities issued in the manner described by Subsection (a) as follows:
(1) in the manner described by Section 2210.612(a), in an amount equal to the lesser of:
(A) $500 million; or
(B) that portion of the total principal amount of Class 1 public securities authorized to be issued under Section 2210.072 that cannot be issued, plus any costs associated with that portion;
So, if the “portion of the total Principal amount of Class 1 public securities … that can not be issued” is, as TWIA itself has been told likely to be well north of $500 million, then the first $500 million of the Class 2 Alternative Bonds described in section 2210.6136 are to be paid off in the “manner described by Section 2210.612(a)” of the Texas Insurance Code. But what section 2210.612(a) calls for is for the bonds to be paid out of TWIA premiums: “The association shall pay Class 1 public securities issued under Section 2210.072 from its net premium and other revenue.” And it is precisely because potential lenders have indicated their doubts that TWIA premiums could sustain the amortization payments that TWIA has been told it can’t sell the Class 1 bonds. I don’t see any reason why the market would be any more trusting of bonds that have “Class 2” labeled on them when they won’t buy similarly sourced bonds with a “Class 1” label on them.
What we have then is, as I said, a House of Cards. In order for TWIA to even have $2.7 billion in its stack, here is what would have to happen: (1) before a storm, TWIA gets $900 million in reinsurance that attaches at $1.8 billion; and (2) after a storm, all $1 billion of the Class 2 Alternative Bonds sell notwithstanding their problematic repayment source. If I were a betting man, I would not place the odds of that House of Cards staying intact very highly. And when it tumbles, it will not be only be TWIA policyholders on the Texas coast who get hurt, but the economy of Texas as well.
Footnote for Experts
Some might object to my analysis on grounds that the repayment sources for the Class 2 Alternative Bonds set forth in section 2210.6136 are not identical to those set forth for the Class 1 bonds. That’s true, but I don’t think it matters. Read 2210.6136(b) carefully.
(2) after payment under Subdivision (1), in the manner described by Sections 2210.613(a) and (b), in an amount equal to the difference between the principal amount of public securities issued under Subsection (a) and the amount repaid in the manner described by Subdivision (1), plus any costs associated with that amount.
The first $500 million in Class 2 Alternative bonds come from TWIA revenue (premiums). As the passage I’ve highlighted indicates, it’s only after that first $500 million is exhausted — and TWIA pays what some likely thought was its fair share — that others have to chip in. Someone from those other payors (coastal non-TWIA policyholders and, more likely, the insurance industry) negotiated for that in 2011. The fact that those higher in the stack have money to pay won’t give any comfort to lenders who depend in substantial part on the dubiously sourced lower part. And this is why I persist in saying that if the Class 1 Bonds can’t be sold, the Class 2 Alternative Bonds are in serious jeopardy too.