Corpus Christi Caller details TWIA solvency problems

There’s a worthwhile article in the Corpus Christi Caller written by Rick Spruill. It addresses both the serious funding problem faced by TWIA today and the solutions being developed by coastal legislators and some coastal interest groups.  The article relies extensively from some of the blog entries here at http://catrisk.net, including ones here and here.

I’ve sent an e-mail to Mr. Spruill on the article and want to post that email here.

I agree that this (http://m.caller.com/news/2012/dec/26/texas-windstorm-insurance-association-could-face/) is an intelligent and important article.  Moreover, even though it contains some criticism of what I have said on http://catrisk.net, it is a balanced presentation.  Two comments, neither of which reflect negatively on Mr. Spruill’s article:

1)  I don’t think Todd Hunter’s comment that Chandler “wants TWIA policyholders to pay for everything ” is quite right.  I want TWIA policyholders to pay for a much larger proportion of the losses their insurer is likely to pay and for that coverage to either be real (i.e. backed up by viable financial structures) or for very clear warnings given by TWIA and TDI to policyholders about the probabilities and consequences of TWIA insolvency.  Although in concept I agree that TWIA policyholders should pay for TWIA risks — I understand that there will be a period of transition required. But the direction of the transition should be towards the assumption of responsibility, not towards shirking it.  I would not be averse, for example, to some sort of grants or subsidized credit being made available, for example, for hardening coastal properties (“mitigation”) and would much rather see money from people other than TWIA policyholders going to reduce the scope of the risk rather than used to bail them out after a fairly foreseeable disaster occurs. I agree that our Texas economy is all interconnected and that if the coast were to suffer a hurricane in which a substantial number of policyholders had large claims against an insolvent insurer, it would hardly be only the coast that suffered.

2) The article is correct  that my computations do not take account of the double dip that TWIA policyholders with automobiles (and non-wind policies) would incur. I don’t have the data that would permit quantification of this complication in part because the Zahn Coastal Taskforce plan is not explicit enough about what sort of insurance would be subject to surcharge. I wish I did have the data. If anyone (like TDI) does have relevant data and would share it, I’d be happy to revise my conclusions.  And I will add a caveat to the existing posts reflecting this matter.  I do not think, however, that inclusion of this complication will alter the fundamental conclusions of my analysis.

Best wishes to all for a happy, healthy and hopefully hurricane-free New Year.

Some coastal politicians endorse Coastal Task Force Plan

A news story in The Brownsville Herald today indicates that some coastal politicians are lining up behind the plan released recently by the Coastal Task Force and Port Aransas attorney Charles Zahn to improve the solvency of TWIA by forcing Texans away from the coast to pay substantial parts of serious losses caused by larger tropical cyclones. Under the plan, the Catastrophe Reserve Fund will be infused with cash partly from existing premiums of TWIA policyholders but also (1) via surcharges on insurance premiums paid (on a variety of insurance policies) by non-TWIA policyholders throughout 14 “coastal” counties and (2) assessments on the Texas insurance industry that will likely be passed on one way or another to Texas insureds. Losses in excess of the Catastrophe Reserve Fund will be paid for by post-event bonds that will be repaid partly by TWIA policyholders but, again, substantially, by entities that TWIA does not insure: policyholders of all sorts in the 14 “coastal” counties, Texas insurers, who will likely figure out a way to pass costs on to their insureds, and, ultimately through a premium surcharge on insureds across Texas, including those hundreds of miles from the coast. The State of Texas will itself be financially responsible for paying TWIA policyholders for the most catastrophic hurricanes, though no funding source is identified for these payments.

The most telling quote comes from State Representative Todd Hunter out of Corpus Christi. He is quoted as telling his coastal audience: “It’s wrong to set up a hurricane system that only you pay for.” Some people, of course, would say just the opposite.

The reason, by the way, that I have put “coastal” in quotes is that TWIA really insures only 13 counties that lie on the Gulf of Mexico. The 14th “coastal county” is the presumably the non-coastal, but giant, Harris County (home of Houston). Residents of the southern portions of Harris County are eligible for insurance from TWIA. But surcharging policies in Harris County hugely increases the amount of TWIA funding that comes from people with no eligibility to purchase TWIA policies and correlatively decreases the responsibility TWIA coastal insureds take for the risks posed to their property from tropical cyclones.

One way not to promote sanity

An opinion column in the Corpus Christi Caller by Nick Jiminez uses the issue of whether Insurance Commissioner should be an elected position in Texas as a vehicle for repeating bogus arguments about hurricane insurance in Texas.  Now, I don’t really have a stance on how that position should be filled — we seem to vote for an awful lot of offices here in Texas — but I do know that the points addressed in support of Mr. Jiminez’s position don’t make much sense. And I do believe that repetition of bogus arguments and this form of “messaging” is not a constructive way of addressing the serious problems facing the Texas coast.

I will list several of Mr. Jiminez’s arguments in turn and attempt to debunk them.

1. The Insurance Commissioner is unaccountable as evidenced by her inability to answer a question posed by State Rep. Todd Hunter at a hearing last month.  The question was how much the 14 coastal counties contribute to the Texas economy.  The correct answer was apparently 30% according to a study. But the question asked does not have a single “correct” answer.  To be sure, the coastal counties contribute immensely to the Texas economy, but there is not a single number that reflects this point. Moreover, I am willing to wager with Mr. Jiminez that if one were to have used the methodology employed by this study to come up with the 30% number, one would have found that the area around Dallas contributes a large percent, and similarly the area around Houston, and Austin and the Panhandle, etc. such that the total “contribution” would add up to well over 100%.  The problem, I suspect, is not with Commissioner Kitzman (or the other officials stumped by Rep. Hunter at the hearing) but with a question, that unless made far more precise, is objectionable.  Moreover, even if this Insurance Commissioner fumbled on this occasion and didn’t seek clarification of an ambiguous question posed by a good lawyer, this is hardly an argument for changing the political system.  Do you think that many of our elected officials would be able to respond on the spot to similar vague “statistical” questions?  I don’t.  Do you think that Commissioner Kitzman is unaware of the large contribution made by the coast to the Texas economy?  I don’t think so either.

Note.  I don’t begrudge Rep. Hunter making a thinly disguised argument in a legislative hearing.  I do begrudge those who would use the failure to answer an objectionable question “correctly” as a good reason to change our political system or to criticize the incumbent.

2.  Tropical cyclone insurance rates should be lower in Corpus Christi because it has not had a hurricane in 40 years.  This argument is wrong in so many ways.  First, hurricane risk is not tropical cyclone risk.  The area with 60 miles or Corpus Christi has been hit or brushed by tropical cyclones 34 times in the 140 years since records have been kept.  It gets hit by hurricanes on average once every 15 years.  TWIA and other cyclone insurers pay for high winds and named storms, not just hurricanes. As anyone who remembers Allison can say with confidence, tropical storms can be incredibly expensive events.  You can’t just ignore them. Second, the fact that Corpus Christi has been fortunate in recent years is little more likely to predict future performance well than the fact that the Astros had won four in a row on May 25, 2012, and were almost at .500.   Although it may be legitimate to claim that Corpus Christi appears to be less at risk for hurricanes than other parts of the Texas coast, it is not legitimate to cherry pick time periods and measure risk on that basis.

3. “If South Texas were a person buying car insurance, we would be getting a price break, not a huge bill as we are now.”  I won’t dispute that the bill is large, but the real issue is whether the bill is large relative to the risk.  If it were, Mr. Jiminez must explain why it is that private insurers are not beating down the door to write windstorm insurance in Nueces County.  Some vast conspiracy to not make money?  Moreover, if coastal politicians truly bought this argument, they must explain why they oppose TWIA basing its rates on geography rather than the essentially uniform rates that currently exist.

4. “Electing a commissioner would allow the poor and low-income voters, who often can’t afford steep windstorm rates, to have a say in who sets insurance rates.”  This point has some merit, but I have serious doubts it would help the Texas coast.  A lot of the poor and low-income voters about whom Mr. Jiminez appears concerned do not live on the coast.  They are currently subsidizing coastal residents — many of whom have houses far more valuable than theirs and owned by people who are considerably more wealthy — by letting  rich and poor on the coast alike purchase coverage at rates that do not reflect actuarial reality.  And the more expensive the house, the greater that subsidy. It is those poor about whom Mr. Jiminez claims concern who will end up paying parts of the assessments and surcharges to pay for claims suffered by rich and poor TWIA policyholders.  So, I’m not so sure the poor of El Paso and Dallas and, yes, Amarillo, will be eager in an election to vote for the candidate who pledges to continue the sort of subsidies for the coast that now exist.

All of that might explain why, in the end, Mr. Jiminez kills his own straw man  — is there a serious push to make the position elective?  He concedes that “[t]he real focus of an effort to bring some sanity to coastal insurance rates ought to be the next Texas Legislature, not fighting to get the insurance commissioner on the ballot.”  On this point, I probably agree, although I guess I wonder why one would then embark on a long rhetorical journey so hostile to the current Commissioner.  But sanity will not be made more likely by use of coastal newspapers to advance arguments that, no matter how frequently repeated, just do not hold water.

Why do coastal politicians urge low TWIA rates?

The title of this blog entry may seem a particularly dumb question. Coastal legislators, the simple answer proceeds, want the Texas Windstorm Insurance Association to keep rates low because it helps their constituents’ pocketbooks. But is that really true? Or, more precisely, under what circumstances would that be true?

The first thing to recognize is that low premiums have a somewhat different effect when they go to Allstate than when they go to TWIA. One can quite understand policyholders not wanting to pay Allstate very much money because its profits simply go for the benefit of Allstate’s shareholders. TWIA, on the other hand, has no shareholders. To the extent TWIA collects “too much” in premiums, that is extra money available to pay future claims of future coastal policyholders. Over collection by TWIA favors future coastal residents in a way that over collection by Allstate does not.

One can get at a better answer to this question by asking why TWIA insists that policyholders pay much or, indeed, anything in advance premiums at all. Since the risk of tropical cyclones is difficult to quantify, why not just have a post-disaster assessment scheme? It would work as follows: when we know how large the damages are from some hurricane relative to TWIA cash on hand (which might be zero if there were no premiums), TWIA simply “post-assesses” its policyholders to pay in that much money over some period of time. We wouldn’t need no stinkin’ models; we’d just see what happens. Take imaginary Hurricane Barry that creates claims (plus lost adjustment expenses) of $1 billion above any cash TWIA happens to have on hand. Because TWIA has about $70+ billion of property under its control, if TWIA could spread the payback period over 5 years, some back of the envelope math suggests that the consequence of this scheme would be that someone with $200,000 worth of coverage would have to pay roughly $571 per year to take care of the claims caused by Barry.

This proposed post-assessment alternative sounds pretty good. I bet many TWIA policyholders with $200,000 properties would be delighted to pay only $571 per year for tropical cyclone coverage.

Unfortunately, the proposed alternative won’t work as inexpensively as described. This baseline figure of $571 is a significant underestimate. There are two reasons: interest expenses and post-assessment shrinkage.

The interest issue is easy to understand. Few policyholders with demolished properties want to wait 5 years living in a tent or in a home decorated with blue tarp until all the assessments are collected before getting their claims paid. So, to pay for Barry, TWIA has to borrow the $1 billion. But now TWIA policyholders don’t have to just pay back $1 billion, they have to pay it back with interest. Interest expenses alone can raise the annual payback amount substantially.

There’s also a shrinkage problem. Once the price of being a TWIA policyholder jumps due to the assessment, TWIA will no longer be assessing the amount of property it did prior to the storm. Thus, to continue with our example, to compute the necessary assessment, TWIA won’t be dividing the amount of damages by the $70+ billion; the denominator will be smaller. And this means that the assessment, because it will be spread over less property, will have to be larger. But the larger assessment means that yet more people will drop out of TWIA, which means that the assessment will have to be yet larger. One can’t easily say whether and if this spiral will stop, but one can be confident that the size of the assessment will increase significantly due to both the interests costs on the loan and due to the reduced size of the TWIA pool.

Footnote here. There is another way to run an assessment scheme: don’t assess future policies; assess policies in place at the time the disaster struck. Such a method avoids shrinkage as I’ve described it, but it creates another problem: collection. Instead of just cancelling policies that don’t pay assessment, TWIA now has to actually track down over a period of many years former policyholders some of whom just will not have the money to pay what is due. That’s expensive and will not yield a 100% recovery rate. And, as I read the Texas statute, it’s not what’s contemplated in the event of a large storm. Anyway, whether done by assessments on future or in-place policies, post-assessment has problems.

I don’t think it’s unreasonable to believe that for something like Hurricane Barry, interest and shrinkage would raise the post-assessment by about 25% over its baseline cost. But no one knows this number with any certainty. And this means that there is a substantial risk that the scheme won’t work or, that conservative lenders, will worry that it won’t work and will accordingly charge very high interest rates. Indeed, TWIA appears to have discovered that, although the Texas statute will let it borrow $1 billion following a disaster to be repaid with policyholder assessments, the market appears willing only to lend $500,000. So, post-assessment schemes are risky.

There’s an additional problem, however. And, this one is a killer. I just provided an example with a $1 billion Hurricane Barry. If we start increasing the size of the storm to, say $2 billion (over cash on hand) hypothetical Hurricane Tanya (or we add another smaller hurricane in the year such as $1 billion hypothetical Chantal), the shrinkage problem starts to grow. Indeed, with a more serious storm such as Tanya (or Barry + Chantal), there is a significant risk of a death spiral in which there are not enough TWIA policyholders left to repay the assessment.

What this means is that a sensible insurance scheme has to balance at least two factors: you don’t want insureds paying too much because — well — that’s money out of the hands of insureds and doing so could needlessly depress the coastal economy. On the other hand, you don’t want insureds paying too little because that creates the risk of a storm large enough to plunge any assessment scheme into a death spiral.

So, what an intelligent discussion of this issue needs to do is to discuss a balance of these two problems with actuarial and climate science in mind. By focusing only on the over-collection issue, certain coastal legislators are sadly distorting and deterring an intelligent political debate. The consequence of this distortion could be quite serious for coastal residents. They may find that the assessment scheme they counted on to help TWIA pay for losses just does not work. They will then need to come begging to the state or Uncle Sam for a bailout. Indeed, that is precisely what the latest actuarial study engaged by TWIA/TDI predicts will occur a substantial percentage of the time if coastal premiums are not raised substantially.

Now, what I could imagine a coastal politician saying in response to this blog (I do hope they read it — and read it all the way to the exciting end), is that the post-assessment problem is overstated because the Texas statute limits the size of assessments that can be made. Moreover, they might say, TWIA does not depend exclusively on policyholder assessments to pay for tropical cyclones that cause damages in excess of cash on hand. And, to some extent, this rebuttal is true. But, if we break it down, what the politicians are really saying then is that small premiums aren’t a problem because they expect someone else to pick up the pieces if a big storm hits. That is, TWIA policyholders aren’t to be treated like ordinary policyholders who are in serious difficulty if their insurer (predictably) goes insolvent after charging too low premiums; TWIA policyholders stand in a privileged position relative to other Texans.

I have a lot of problems with this rebuttal. First, there is still a problem because, as I have pointed out at some length, the other sources (limited assessments on non-TWIA coastal policies; limited assessment on Texas insurers) will not yield enough cash to pay fully for losses incurred after serious storms in the densely populated parts of the Texas coast. Even the coastal politicians now appear to recognize this fact but poo-poo what they believe is a 1.5% annual risk of this occurring. But even if there were zero risk of a TWIA default, the rebuttal rests on the dubious premise that coastal residents are entitled to some special privilege that the rest of Texas does not enjoy.

And, here, we get to the core of the issue. After you put all the smokescreen rhetoric aside, what certain coastal politicians are really saying is that the coast is indeed special. But why? Yes, many find the coast lovely, but so too do many find the Texas Hill Country or even the stark beauty of the northern panhandle with its silos, vistas and hints of ancient vulcanism. Yet neither Kerrville nor Dumas insureds have the benefit of getting full insurance on their $200,000 property while paying the premiums sufficient to cover only a policy with a $50,000 limit. If the preference for the coast is based on aesthetics, then let us be explicit and subsidize coastal beauty. Yes, the coast contributes to the Texas economy. But so does Houston, so does Dallas, so does El Paso, so does Stephenville and so does Dalhart and Childress and Texarkana. Dollars are dollars. Should Galveston residents assume the risks posed by locating property in Dallas because Dallas contributes greatly to all of us here in Texas?

So, in my opinion, the “coast contributes” justification is completely bogus.

Are coastal residents disproportionately afflicted by some imperfection in the insurance market from which the rest of Texas is exempt? Might that justify the privilege? I see no evidence of any special, irrational animus towards the Texas coast on the part of the insurance industry. Greedy insurers would as much enjoy profiting from coastal consumers as they do profiting from those in Stephenville. Why, if they could do so at a rate they thought profitable, would insurers collectively sit back and let a government entity take over the coastal insurance business? The fact that many (and not all) companies won’t write on the coast is more easily explained by the low prices of its publicly subsidized competitor — TWIA — or by feared regulatory price constraints than by some vast conspiracy. The most likely reason prices are high on the coast is because risks there are particularly uncertain and particularly correlated and because stockpiling the requisite cash to pay for large claims is expensive.

Now, is it the “fault” of a Galveston policyholder that they live in a place subject to uncertain, correlated risk? No. There is no moral failing. Is it a “choice?” That depends. For some, such as the owner of a second home, quite probably. Moreover, even for a first home, people choose to have a million dollar home rather than a $500,000 home. For others, however, less so. The current scheme in Texas, however, treats TWIA insureds as special regardless of the degree to which their ownership of property is a choice. In general, it’s a good idea for insurance prices to reflect risk accurately because that, in the long run, encourages intelligent investment decisions. Societies that subsidize risky activities for long periods of time end up with more risky activities and become, as the pandering of some coastal politician suggests, addicted to them at great expense to the rest of society.

The better rebuttal — and the one I actually hope starts to gain prominence — is that giving TWIA lots of money has enabled it to waste money purchasing incredibly expensive reinsurance in a market whose competitiveness is open to question. Because reinsurance has cost TWIA something like six times the actuarial value of the risk it assumes, policyholders would do better, this argument proceeds, for TWIA to charge less in premiums or to charge the same in premiums, pray for a few good years, and to stockpile the extra funds. This argument, by the way, has some support in the recent report of TWIA’s actuarial consultants. But, if wasting money on reinsurance is the issue, the better solution is to restrict TWIA’s discretion in using its funds for this purpose. TWIA could, after all, buy reinsurance even if premiums were reduced. Now, how exactly to intelligently restrict TWIA’s discretion in reinsurance purchasing is the subject for another day. In the mean time, however, the purported advocates of coastal policyholders had best be very careful lest their concerted advocacy in support of what they wish for, lower premiums, succeeds and a large insurer has insufficient resources to pay claim as a result. Pity the coastal politician seeking another term after they deprived the insurer of residents in their districts the resources that insurer needed to pay claims fully.