The IBNR problem

IBNR is an acronym obscure to most but well known to those in the insurance industry.  It stands for Incurred But Not Reported and it can be the bane of insurers and insurance regulators.  It is behind some of the immediate problems facing the Texas Windstorm Insurance Association (TWIA) including its contemplation of conservatorship or receivership. That’s because Hurricane Ike, though it occurred in September 2008 and led to an assessment later that month on Texas insurers of $430 million, has ended up costing an amount which, if known at the time, likely would have justified a larger assessment.  Indeed, at least as reported by the Houston Chronicle, TWIA’s manager at the time Jim Oliver asked for an $830 million assessment  “but the board members — including several insurance company members — voted to reconvene later if further assessments are necessary.”  That reconvening to get additional money never occurred. As a result, current TWIA policyholders have effectively been paying since 2009 for losses incurred back in 2008 to the point where TWIA is now in considerable trouble even though there have been no major storms since Ike.  As discussed on this blog, TWIA is now talking publicly about conservatorship or receivership and, absent legislative intervention, entering  the 2013 hurricane season with woefully low reserves and a dubious ability to recapitalize and pay claims in the event of a significant storm.

The issue, which I don’t see explicitly on the agenda for the TWIA board meeting on March 25, 2013, is whether TWIA still has the authority to issue an assessment under the law that existed in 2008 at the time of Ike but has been substantially amended since then.  If so, that might reduce the probability of TWIA going under this summer while the legislature contemplates more serious changes. My own belief is that this is an important legal question on which I hope the TWIA board is getting paid advice from competent attorneys who are spending more than a few hours on the matter.  But, as a pretty competent attorney myself, let me offer some thoughts on the authority issue. The short version is that I do not think TWIA now has the authority to issue assessments under the old law.  Whether as a result of extremely clever legislative lobbying or just the luck of legislative drafting, in 2009 the insurance industry closed out its responsibilities under the old law. TWIA policyholders are basically left to cope with the remaining hash of Ike claims.

The key here is to understand the difference between the funding mechanism in place at the time of Ike in 2008 and the funding mechanism that the legislature put in place effective in June 2009. It’s complicated, so be patient. At the time of Ike, section 2210.058 of the Insurance Code (reprinted below) created a four tier structure for paying losses when TWIA did not have enough money in its regular accounts to pay the losses.  First, insurers throughout the state (the TWIA “members”)  would be hit for $100 million.  Second, TWIA’s catastrophe reserve fund — a special set aside account — and reinsurance would exhaust itself.  Third, insurers throughout the state would get hit with a $200 million assessment.  And, finally, if that still was not enough, insurers would be forced to pay whatever it took to pay off claims — the so-called unlimited assessment. In some sense, however, insurers mostly fronted this latter money instead of paying it outright; they recouped a good chunk of it back through credits against premium tax that they would otherwise owe.  Thus — and this was one of the major reasons for the change in the law that subsequently occurred — both insurers statewide and the State of Texas were effectively on the hook for large storms.  Insurers either had to have extra amounts of cash socked away in particularly liquid investments or had to pay to reinsure their potential assessment responsibilities.

The 81st legislature changed this arrangement and attempted to relieve both the state fisc and the insurance industry from the riskiest aspects of the prior scheme. Legally this was accomplished primarily through the addition of two new subchapters to the Texas Insurance Code: subchapters B-1 and J.  Subchapter B-1 set up tiers of post-event bonds (much discussed on this blog) that would be used to front money to TWIA policyholders with the bonds repaid over the years through assessments on TWIA policyholders, policyholders of many sorts on the coast, and, to a limited extent, property and casualty insurers in Texas. Subchapter J set up the rules for how these post-event bonds were to be issued.

If addition of Subchapters B-1 and J were all that the 81st legislature, the legal issue would be even harder.  But the legislature did more.  In section 44 of HB 4409, the Texas legislature explicitly repealed section 2210.058.  Moreover, various references in the statute to section 2210.058 were deleted. And, through repeal of sister provision 2210.059, the legislature eliminated any requirement that it be notified of any loss in tax revenue resulting from the tax credits that would potentially be triggered by an assessment. And in section 51 of the bill, it specified that the relevant provisions of the bill took effect immediately. Thus, when HB 4409 took effect in June of 2009, it appears that the authority to assess members under 2210.058 ended. The insurance industry gained its freedom — and derivatively the State of Texas protected its tax revenue — not just for future hurricanes but for hurricanes that had already occurred but whose claims were … IBNR.

Am I 100% certain this is correct?  No, but I am not finding any place else in any unrepealed sections of the former law that authorized insurer assessments to pay for hurricane losses. And without that statutory authority, I don’t see how the state can compel insurers to pay TWIA much of anything for losses created before 2009. Am I particularly happy about this answer? Actually not.  I was definitely not a big fan of the old law but if it had been applied the way TWIA leaders apparently wanted, we might have been in less of a mess today. Did the TWIA board breach some duty of care by issuing what turned out to be a low assessment in 2008?  Conceivably, but unless TWIA directors have $400 million lying around it may not much matter; moreover, it might well have been hard to forecast the scope and magnitude of Ike claims back then. There’s a lot of literature and disagreement on various factors that have caused Ike claims to grow. At bottom, it looks like the legislature made a choice in 2009 and Texans along the coast and, derivatively, the rest of Texas are now seeing some of the consequences of representative government in action.

Appendix

2210.058 as it stood at the time of Hurricane Ike (taken from http://www.statutes.legis.state.tx.us/StatutesByDate.aspx)

Insurance Code 2210.058 on 9/25/2008


Text of section effective until June 19, 2009

Sec. 2210.058.  PAYMENT OF EXCESS LOSSES; PREMIUM TAX CREDIT. (a) If, in any calendar year, an occurrence or series of occurrences in a catastrophe area results in insured losses and operating expenses of the association in excess of premium and other revenue of the association, the excess losses shall be paid as follows:

(1)  $100 million shall be assessed against the members of the association as provided by Subsection (b);

(2)  losses in excess of $100 million shall be paid from the catastrophe reserve trust fund established under Subchapter J and any reinsurance program established by the association;

(3)  for losses in excess of those paid under Subdivisions (1) and (2), an additional $200 million shall be assessed against the members of the association, as provided by Subsection (b); and

(4)  losses in excess of those paid under Subdivisions (1), (2), and (3) shall be assessed against members of the association, as provided by Subsection (b).

(b)  The proportion of the losses allocable to each insurer under Subsections (a)(1), (3), and (4) shall be determined in the manner used to determine each insurer’s participation in the association for the year under Section 2210.052.

(c) Expired.

(c)  An insurer may credit an amount paid in accordance with Subsection (a)(4) in a calendar year against the insurer’s premium tax under Chapter 221.  The tax credit authorized under this subsection shall be allowed at a rate not to exceed 20 percent per year for five or more successive years beginning the calendar year that the assessments under this section are paid.  The balance of payments made by the insurer and not claimed as a premium tax credit may be reflected in the books and records of the insurer as an admitted asset of the insurer for all purposes, including exhibition in an annual statement under Section 862.001.

Added by Acts 2005, 79th Leg., Ch. 727, Sec. 2, eff. April 1, 2007.

Amended by:

Acts 2007, 80th Leg., R.S., Ch. 932, Sec. 21, eff. June 15, 2007.

 

Section 44 of HB 4409

SECTION 44.  The following laws are repealed:

(1) subdivisions (5) and (12), Section 2210.003, Insurance Code;

(2) Sections 2210.058 and 2210.059, Insurance Code;

(3) Sections 2210.205 and 2210.206, Insurance Code;

(4) Sections 2210.356, 2210.360, and 2210.363, Insurance Code; and

(6) Subchapter G, Chapter 2210, Insurance Code

[Note: I have no idea what happened to paragraph (5) of Section 44.]