Insurance Commissioner tries to fix fatal bug in windstorm statute

Whether policyholders of the Texas Windstorm Insurance Association get paid following a significant storm during the coming summer of 2014 is likely to depend on a difficult legal question: whether the Texas Insurance Commissioner has the power to write regulations that clearly alter the language of a statute enacted by the Texas legislature where she believes, with reason, that the statute as written makes no economic sense.  The good news is that the new Texas Insurance Commissioner, Julia Rathgeber, agrees with an argument first propounded on this blog: there is a serious “bug” in the provisions of the Texas Insurance Code governing issuance of securities to pay for losses following a significant storm. That bug could jeopardize the entire system of post-event bonding that is supposed to cover for the shocking lack of cash TWIA, the largest windstorm insurer in Texas, actually has available to pay claims. Recognizing a problem exists is, after all, usually the first step for a cure.  It’s certainly better than pretending the problem doesn’t exist and hoping no injured party or judge will notice. The problem, however, is that it is not clear that the Commissioner, acting alone and without legislative action, has the power to cure this problem in a way that could cost other Texans considerable sums of money.

Matters would be far better if all sides in the enduring controversy over TWIA funding could agree to a minimalist statutory fix before the 2014 hurricane season begins.  The stakeholders could then then ask Governor Perry for a short special session to enact the fix as law.  The Governor might accommodate if almost all legislators agreed to the fix and the agenda were kept narrow.  Commissioner Rathgeber’s regulations contain one possible fix.  A blog entry I put forth last spring contains some others. None would “cure TWIA” — that’s a very hard problem that will likely take at least a legislative session. But at least the statutory scheme would function as well as was hoped for by the legislature. Right now it resembles a bad computer program that is about to crash from a giant bug if nature ever pushes the “Hurricane Key.” Unfortunately, for reasons that will be discussed below, it looks like getting agreement on even a simple statutory fix will be difficult.

Texas Insurance Commissioner Julia RathgeberAs a result of the Commissioner’s questionable authority to enact the changes she wants and the likelihood that a coastal resident hurt by her fix would challenge it in court (and refuse to pay in the interim), absent legislative action, it is unlikely that TWIA will have any ability swiftly to pay significant claims this summer. By “significant”, I mean those generated  by a respectable storm that causes insured losses in excess of TWIA’s cash position ($200 million to maybe $400 million) and whatever reinsurance, if any, drops down low enough to pay claims right above the cash reserve.  Lenders who just might otherwise be willing to advance TWIA money based on anticipated revenue from premium surcharges may be unwilling to do where there is no secure statutory basis for demanding at least some of the surcharges in the first place.

The problem

Let’s go through the problem that the Commissioner’s proposed regulations is intended to solve. The Commissioner actually outlines it quite well in her explanation of the proposed regulations now undergoing hearings, but I think my explanation is a bit more direct. The basic idea is that, following a tropical storm that wipes out TWIA’s cash position, TWIA can go to the borrowing market.  It can request issue three types of securities cleverly named Class 1, Class 2 and Class 3. The securities are actually issued by the Texas Public Finance Authority (TPFA), not TWIA itself. Even though TPFA issues the securities, under section 2210.615(a) of the Insurance Code they are explicitly not backed by the full faith and credit of Texas. Texas taxpayers are not on the hook to repay the borrowings if the statutory mechanism fails.

What distinguishes the three securities TWIA may issue when it runs out of money is mainly the source of repayment.  To oversimplify just a bit, Class 1 is to be repaid by TWIA policyholders through “net premium and revenue.” Class 2 is to be repaid 30% by assessments on the insurers that compose TWIA (people who write property/casualty insurance in Texas) and 70% via premium surcharges on most property insurance policies written on the Texas coast. This latter group includes not only TWIA policies but also non-TWIA homeowner or wind insurance policies, business fire insurance, personal automobile policies, and commercial automobile policies. Class 3 is to be repaid by assessments on the insurers that compose TWIA. Class 1 can be up to $1 billion. Class 2 can be up to $1 billion; and Class 3 can be up to $500 million. And the borrowings are supposed to take place in sequence.  No Class 3 before all Class 2 has been issued.  No Class 2 before all Class 1 has been issued.

There’s a big “however,” however. What happens if lenders are worried that TWIA policyholders won’t be able to pay enough in premium surcharges to amortize the loan?  In 2011, the legislature recognized this possibility and came up with a plan. You can find it in section 2210.6136 of the Texas Insurance Code, which the most recent regulatory proposal cites frequently. To the extent that the Class 1 bonds would not sell, what I have called “Class 2 Alternative” bonds can be issued. According to the statute — and this is the bug — the first $500 million (or, in some cases less) is to be repaid the same way Class 1 bonds are to be repaid: using premiums from TWIA policyholders.  The remainder of the $1 billion in Class 2 Alternative bonds are to be repaid the way ordinary Class 2 bonds are to be repaid.

The problem, as the Commissioner has recognized, is that, if the Class 1 Bonds won’t sell because lenders don’t trust TWIA policyholders to have the money to amortize the bonds, it is unlikely that they will trust “Class 2 Alternative” bonds that have exactly the same payment source. As the official explanation of the proposed regulations states, the statute has “the effect of treating class 2 public securities issued under Insurance Code §2210.6136 as class 1 public securities, which are repayable by premium and revenue assessments.

The paradox is well stated by the Commissioner:

If the association [TWIA] can issue Class 2 public securities that are to be repaid by premium, then this means the association is capable of issuing class 1 public securities. This eliminates the need for having an alternative to issue class 2 public securities when class 1 public securities.  It is not feasible to read the statute to require TPFA to issue all of the class 1 public securities it can based on the association’s net premium and other revenue, and then expect TPFA to issue additional public securities using the same funding sources simply because the name of the public security has changed.  Such a reading would render Insurance Code §2210.6136 meaningless.

The domino effect

The problem is even deeper, however, than this passage indicates. As I have previously noted and as the Commissioner’s explanation confirms: “TPFA cannot issue the class 3 public securities until after TPFA has issued $1 billion in class 2 public securities on behalf of the association for that catastrophe year.” In other words, if the Class 1 bonds fail, the Class 2 Alternative Bonds are likely to fail too.  And if the Class 2 Alternative Bonds fail, the Class 3 Bonds fail. There’s a domino effect. TWIA ends up with no cash to pay claims and no ability to borrow at all!

So, this is the disaster waiting for Texas if it does nothing.  It is the disaster the Commissioner is trying to avoid. Her proposal is effectively to rewrite section 2210.6136 of the statute and make all of the Class 2 Alternative Bonds payable the same way regular Class 2 Bonds would be repaid: 30% by assessments on the insurers that compose TWIA (people who write property/casualty insurance in Texas) and 70% via premium surcharges on most property policies written on the Texas coast.  To quote section 5.4127(a) of the proposed regulations:

(a) All Public Security Obligations and Public Security Administrative Expenses for Class 2 Public Securities issued under §5.4126 of this division (relating to Alternative for
Issuing Class 2 and Class 3 Public Securities) must be paid 30 percent from member assessments and 70 percent from premium surcharges on those Catastrophe Area insurance policies subject to premium surcharge under Insurance Code §2210.613.

 

The proposed regulations potentially rescue TWIA policyholders from disaster.  They provide a more plausible source of repayment and they don’t result in the Class 3 securities succumbing to the domino effect.

The Bên Tre analogy

There is only one problem.  The Commissioner has destroyed section 2210.6136 in order to save it. The law would be little different under the Commissioner’s proposal than if the legislature had never bothered with section 2210.6136 in 2011 and just kept things the way they were in 2009, except to say that Class 2 bonds can be issued first if the Class 1 bonds can’t be fully issued.  The two different subparts of section 2210.6136 elaborately specifying how each part of the money is to be repaid would appear to be unnecessary.

The legal issue

I’m not going to opine today on whether the Commissioner is within her rights in undoing a legislative enactment whose sense is indeed difficult if not outright impossible to discern. But this isn’t the somewhat simpler case of the Commissioner fixing a clearly omitted “not” in a statute or correcting some punctuation.  This is undoing an entire provision when the legislature has been alerted to the problem and has chosen to do nothing about it. Although a Texas court can choose to interpret a statute contrary to its actual words where doing so clearly fulfills the intent of the legislature, it must do so cautiously.  As set forth by the Texas Supreme Court in Presidio Independent School Dist. v. Scott, 309 S.W.3d 927 (Tex. 2010), “We thus construe the text according to its plain and common meaning unless a contrary intention is apparent from the context or unless such a construction leads to absurd results.” There are many cases, including Texas Department of Protective and Regulatory Services v. Mega Child Care, Inc., 145 S.W.3d 170 (Tex. 2004), that say about the same thing. Indeed, in my brief research I had to go back to 1898 and the case of Edwards v. Morton, 92 Tex. 152 (1898) to find a case in which the highest court found the requisite level of absurdity to exist. Perhaps there are more recent cases that some quick research did not disclose but I suspect there will not be many.

The United States Supreme Court summarizes prevailing judicial attitudes well on the subject.

Courts have sometimes exercised a high degree of ingenuity in the effort to find justification for wrenching from the words of a statute a meaning which literally they did not bear in order to escape consequences thought to be absurd or to entail great hardship. But an application of the principle so nearly approaches the boundary between the exercise of the judicial power and that of the legislative power as to call rather for great caution and circumspection in order to avoid usurpation of the latter. Monson v. Chester, 22 Pick. (Mass.) 385, 387. It is not enough merely that hard and objectionable or absurd consequences, which probably were not within the contemplation of the framers, are produced by an act of legislation. Laws enacted with good intention, when put to the test, frequently, and to the surprise of the lawmaker himself, turn out to be mischievous, absurd, or otherwise objectionable. But in such case the remedy lies with the lawmaking authority, and not with the courts.

Crooks v. Harrelson, 282 U.S. 55 (1930) (Sutherland, J.)

Clearly, what is good for the judiciary is probably good for the Insurance Commissioner as well. Commissioner Rathgeber no matter how outstanding her intentions and no matter how irksome her opposition will have an uphill battle defending her reconstruction of the statute governing the Texas Windstorm Insurance Association. She will surely face hostile judges when, contrary to the literal language of the statute, she seeks to impose an additional surcharge on some coastal Texas homeowner with insurance on a run down car who never bought a TWIA policy and indeed doesn’t even have a home to insure.

Residents of the coast have apparently caught on (see here, here and here) that the proposed regulatory change theoretically hurts them.  Under the statute as written, even if there were more than $1 billion in losses awaiting payment, insureds on the coast would be responsible for only 70% of about $500 million.  With the regulatory change, they are responsible for 70% of up to $1 billion.  So, basically, the non-TWIA insureds on the coast are objecting to helping their TWIA friends on the coast because they don’t think it’s their responsibility.

Conclusion

In a world of perfect political information, we might now see a battle between coastal residents, the non-TWIA policyholders battling the Commissioner’s proposal while the TWIA policyholders support it.  To date, however, such a lack of “coastal solidarity” has emerged.  And it is not clear what the alternative is. Where do political figures whipping up opposition to the Rathgeber plan think the money is going to come from if the Commissioner’s regulations are struck down, the goofy statute upheld as written, and TWIA finds itself following a significant storm with no money in the till? Surely they are still not marketing the elaborate fantasy that the current TWIA board can now assess insurers more money to pay for Hurricane Ike in 2008. If they really cared about the coast, they might agree to defer a fight about the perfect way to fund TWIA for a bit, and agree to a statutory fix that at least got rid of a fatal bug in the existing law which, if triggered, will devastate TWIA policyholders to be sure, but also those on the coast and off it who depend on a vibrant coastal economy.

 

TWIA board declines to assess insurers for Ike — for now

The board of the Texas Windstorm Insurance Association narrowly defeated a motion today that would have assessed Texas insurers $575 million for losses arising out of Hurricane Ike in 2008. Opponents of the measure — all from Texas insurance companies —  saw no urgency to an immediate assessment and, in light of what they believed was uncertain legal authority to do so under a repealed statute, wanted to await a requested legal opinion from Texas Attorney General Greg Abbott. Supporters of the measure — all representing coastal interests — asserted that an Attorney General opinion would not be definitive; in their view, the only way to determine the obligations of Texas insurers was to go ahead and demand the money, recognizing that insurers would file suit to block the assessment and that insurers would not actually pay any money until well into future hurricane seasons. The decision came after a two and a half hour closed session between the TWIA board and its attorneys.

Much other news emerged from the TWIA board meeting.

  1. The board voted to increase premiums 5% on both residential and commercial properties next year.
  2. The board heard that earlier plans to attempt to raise $500 million in pre-event securities — a bond anticipation note (“BAN”) — now appeared unlikely to continue. The board was advised that it would take 60 days to actually consummate the borrowing and that would now put receipt of funds past the peak of hurricane season. The board instead unanimously authorized the TWIA staff to pursue swiftly additional liquidity via a $200 million line of credit and $250 million in borrowing that, for reasons not made clear, would not be considered a pre-event security, and that would be secured by proceeds from any Class 2 or Class 3 securities that would be issued following a major storm. Costs on the line of credit and the additional borrowing were said to be much lower than would have been the case for the BAN.
  3. Although TWIA has thus far faced no storms of consequence this year, it anticipates being able to contribute only $15 million more to its $180 million catastrophe reserve trust fund that forms the first line of defense against any substantial claims.  This low contribution is apparently due to continuing expenses from Hurricane Ike. It also means, however, that even with a continuing spate of good luck this year from a thus -far quiet Gulf of Mexico, TWIA will go into next hurricane season perilously undercapitalized.
  4. Despite all the talk about depopulating TWIA, it continues to grow rapidly.  Exposure grew at 4% this past year and policies at 3%.  TWIA staff said they believed this trend would continue.  The substantial rate of growth is continuing notwithstanding what one board member described as concern among bankers and other lends in the area as to whether TWIA could stand up to a major storm. Since TWIA’s funding mechanisms are stated in constant dollars and not as percentages of exposure, this continued growth further weakens TWIA’s ability to withstand moderate or severe storms.
  5. The board voted 8-1 to approve a statement by one of its board members indicating the issue of whether to assess for Hurricane Ike was still open.
  6. Texas Insurance Commissioner Julia Rathgeber expressed a narrow view of her authority to supervise TWIA.  When asked whether TDI would need to approve any assessment against insurers, Commissioner Rathgeber said she viewed her authority as limited to whether TWIA had followed proper practices and procedures and that she would not second guess its decisions. When asked whether that meant TDI was neutral on assessing insurers, Commissioner Rathgeber said she would need to speak with TDI attorneys.
  7. The 4-4-1 vote came despite pleas from some coastal interests that board members from insurance companies recuse themselves based on a conflict of interest. Opponents of the recusal plea noted that the arguments might equally well apply to persons “representing” coastal interests and that, in any event, the legislature had specifically set up a board with interest group representation.

Catrisk will have more on the eventful TWIA board meeting later in the week.

News from the TWIA board meeting

I’ll have a fuller post later and the meeting is still in progress (in closed session), but here are the headlines thus far.

1. A TWIA board member (Alice Gannon, I believe) acknowledges that if TWIA does not get new Texas Insurance Commissioner Julia Rathgeber to reverse a decision of her predecessor refusing to authorize $500 million in borrowings via a Bond Anticipation Note, TWIA will not have money to pay claims promptly in the event of even a modest storm.  I do not have an exact quote, but at minute 46 of the hearing she says something to the effect of “Without the BAN, it is highly likely we would not be able to pay claims in timely fashion.” Other board commentary indicates it will take 3 to 6 months to sell post-event bonds, assuming they could be sold at all. TWIA will be meeting with Commissioner Rathgeber this Friday (June 21, 2013) to try to persuade her to reverse former Commissioner Eleanor Kitzman’s decision.

2. TWIA has acquired $1 billion in reinsurance with an attachment point of $1.7 billion.  It has the right until July 15 to increase its reinsurance to $1.25 billion but increase its attachment point of $2.2 billion.

3. As feared, TWIA’s financial condition is already having an effect. Premium finance companies are refusing to lend more than $16,000 to pay TWIA premiums. Lenders don’t want to try to bring claims for unearned premiums against an insolvent insurer.

4. TWIA actually has only $340 million in cash after having paid much of the recent $135 million Ike settlement.  It believes it will have $400 million in cash by August and through the end of the year.

5. TWIA will ask the Texas Department of Insurance to permit it to change accounting practices so that it can count the Catastrophe Reserve Trust Fund on its books as its assets.  Doing so would move TWIA from being seen as having a negative surplus to perhaps having a positive surplus.

6. TWIA will not cancel over 2,000 policies that it has knowingly issued in violation of provisions of the Texas Insurance Code governing compliance with building codes.  Instead, starting in January, after this year’s hurricane season it will decline to renew such policies as they come up for renewal.  This refusal to enforce the law was the subject of sharp criticism yesterday from State Senator Larry Taylor and may give rise to claims by those assessed to pay for post-event bonds that TWIA’s exposure was unlawfully increased.

7. TWIA did not vote to consent to imposition of a receivership.

8. TWIA will not try to assess insurers based on a law that was repealed in 2009. It acknowledges that that there are “uncertainties” as to whether it has authority to do so and that actually collecting such assessments would be difficult.

Texas Public Finance Authority: Class 1 Bonds Won’t Sell

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.

TWIA board minutes

TWIA board minutes acknowledging reinsurance would attach at $1.8 billion

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.

Texas Public Finance Authority: Post-event Class 1 Bonds are doubtful

Texas Public Finance Authority: Post-event Class 1 Bonds are doubtful

“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.

 

 

TWIA Cash Position Not Improving

 $443 million in cash and short term assets

In a recent blog entry, I attempted to estimate the amount of cash the Texas Windstorm Insurance Association had in its operating account.  I said TWIA’s cash position was likely to be between $400 million to $700 million after the recent Ike settlement of $135 million was taken into account. Thanks to a public information request from Fox 26 TV’s Greg Groogan we now have a better fix.  If anything, I was a little optimistic.

TWIA has $443,453,000 in cash and short term investments, little changed from its position at the start of the year.  Its assets are down to $444,342,000.  But those figures are before  consideration of the $135 million Ike settlement, the so-called “Mostyn settlement.” They are also before TWIA spends an anticipated $100 million or so (in cash) on reinsurance, The figures are both from the end of April, 2013. If funding of the Ike settlements comes from operating funds or TWIA succeeds in obtaining reinsurance, that figure will likely be lower shortly.  If the Ike settlement instead comes from the Catastrophe Reserve Trust Fund, that $180 million fund will be significantly depleted.

The rest of the story on the TWIA cash position and finances

There are at least two other pieces of information that will be useful in assessing TWIA’s position as hurricane season moves forward. They may also help Governor Perry get from “certainly possible” to “yes” in considering requests that he convene a special session of the Texas legislature to address windstorm insurance reform.  What happened to the effort to spend $100 million or so on reinsurance?  Did they acquire it and on what terms?  Second, what has happened to the effort to prepare for post-event bonding now that former Commissioner Eleanor Kitzman authorized TWIA to do so?  Unless both of those efforts are particularly successful, however, I stand by my assertion that TWIA may well have little more than $1 billion in actual cash to pay claims on $80 billion worth of exposure. Moreover, the reinsurance doesn’t do as much good as it could, if TWIA can’t sell all of its authorized post-event bonds.

So, in this case, no news — or no new news — is bad news. If something like Hurricane Ike hit — a Category 2 storm in a populated area — TWIA policyholders might get only 40 cents or so for each dollar of legitimate claims. There would be no protection from the Texas Property & Casualty Guaranty Association. There would be no lawful obligation of the state to help out. Instead Texas would be left with a hope.  Perhaps the state legislature would meet swiftly and agree on a plan (with a 2/3 majority) to come up with billions of dollars  to help bail out a devastated coast.  As I recently said to reporter Groogan in response to Senator Larry Taylor’s understandable expression of such a hope:  “Good Luck.”

Footnote 1: Say what one will about TWIA and its history, I have again found them to be responsive over the past year to public information requests.  That helps build some trust.

Footnote 2: Remember State Representative Craig Eiland’s claims that TWIA could and should assess insurers today for Hurricane Ike losses and buttress in Catastrophe Reserve Trust Fund?  I’ve found a longer statement of his position here.  It’s such a mixed picture.  On the one hand,  outgoing Representative Eiland has great information on the timeline. He presents a forceful case that TWIA had the information that would have justified a larger assessment on the insurers for Ike under the old law before a 2009 law took effect.  He is right that TWIA would look a lot stronger today with $780 million in its CRTF rather than the $180 million it has today. What Representative Eiland still lacks, however, is any legal theory under which such an assessment could occur today.  As has been discussed here at length, the law under which assessments were authorized was repealed — Representative Eiland sadly joining others who voted to do so.

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.

 

Fixing TWIA for this hurricane season will require a two-thirds vote

Section 39 of Article III of the Texas Constitution reads as follows:

Sec. 39.  TIME OF TAKING EFFECT OF LAWS; EMERGENCIES; ENTRY ON JOURNAL. No law passed by the Legislature, except the general appropriation act, shall take effect or go into force until ninety days after the adjournment of the session at which it was enacted, unless the Legislature shall, by a vote of two-thirds of all the members elected to each House, otherwise direct; said vote to be taken by yeas and nays, and entered upon the journals.

 

This constitutional provision, which the legislature can not change, means that unless a windstorm bill is passed that is acceptable to two thirds of both houses, it will not take effect until about September 1, 2013, well into hurricane season.  And that means even if a bill is passed — but passed by less than the constitutionally required super-majority —  all that stands between the weather and a major problem in Texas between now and September could well be less than $1 billion.  If so, Texas runs the serious risk of an insolvent insurer that covers 62% of the exposure for real property — residences, businesses, government facilities — unable to pay claims.  Without making things too scary, it might not be able to pay even 50% of clams.

This means two things.

Thing 1) All sides of this debate need to have some flexibility and take very seriously their obligations as legislators.  If there is deadlock, or even if there is simply less than a super-majority in favor of one bill, legislators might consider lowering the stakes.  If you can’t get a really good bill — and I fear that is probably where we are right now — put something in place that people can be confident will not be etched in stone. I would suggest that either of the two alternative “minmalist, last-minute fixes” I proposed this month qualify. But there are alternatives that might also suffice.

Thing 2) If no bill passes or a bill passes without two-thirds support, we need to turn urgent attention to what is actually going on in TWIA.  It is attempting to obtain a pre-event “Bond Anticipation Note” so that they would at least have about $700 million with which to pay claims on their $70 billion plus of total exposure.  Without that, we are down to a Catastrophe Reserve Fund that stands at $180 million and possibly less in light of both continuing Ike litigation and some severe storms this past month. We also need to pay heightened attention to TWIA’s efforts to obtain reinsurance — and the terms of that reinsurance. The details matter here.  Where will the reinsurance attach?  Will it leave a gap?  Does the reinsurance cover one storm (occurrence) or does it permit “reinstatement” — an ability to cover multiple storms, although possibly for an additional premium.  And how much will an over-a-barrel TWIA have to pay to the reinsurance industry, which has historically charged prices of five times the expected value of risk assumed, under these circumstances?  Every dollar spent is one less dollar available for succeeding years.

So, high stakes in the days ahead. We’ll keep a watch out and I urge you to make sure your legislators understand the importance of the issues here both for the Texas coast and in the rest of the state.

A minimalist last-minute fix for TWIA

It looks as if we are down to the wire in the Texas legislature on reforming the state’s public system for addressing catastrophic risk.  No one has developed a solution that is economically sensible and politically acceptable.  This leaves Texas in an extremely difficult position.  One alternative is to just leave the status quo in place. This choice subjects coastal residents to a substantial risk of a cataclysmic failure of their insurance system. Derivatively, it leaves the rest of Texas vulnerable to a Herculean task of picking up the huge financial pieces after a major tropical storm. The failure of the legislature to act also gives the Texas insurance commissioner extra cause to throw TWIA into receivership. The other alternative is to burden Texas for years with a very bad bill, S.B. 1700, which is the only proposal to emerge from a committee thus far. I thus offer a minimalist last-minute fix for TWIA.  Actually, I offer two.

This chart summarizes the situation today.

IssueAnswer
IssueAnswer
Days until the start of hurricane season1
Days until the end of the legislative session0
Next hearing of Senate Business and Commerce Committee None scheduled
Next hearing of House Insurance CommitteeNone scheduled
Size of Catastrophe Reserve Trust Fund$180 million
Bond Anticipation Notes (pre-event bonds)None. Approval refused by Commissioner Eleanor Kitzman
Reinsurance sought$1.15 billion at an attachment of $2.2 billion (not yet obtained)
Probability of TWIA losses in 2013 exceeding size of Catastrophe Reserve Trust Fund and Bond Anticipation NotesTWIA Estimate: 7.7% My Estimate: 10%-- could be higher if forecasts of active-hyperactive hurricane season prove accurate Estimates for 2013 and 2014 seasons are between 15-18% assuming no growth in Catastrophe Reserve Trust Fund
Bills enacted addressing TWIA problems for 2013 hurricane seasonNone
Bills enacted addressing TWIA problems for hurricane season past 2013S.B. 1702 (still requires signature of Governor Perry and does very little)

Texas must somehow get out of this trap between rotten choices. It should not permit exploitation of a largely self-created crisis by coastal legislators to hurt the rest of the Texas economy for years to come. Here is my suggestion.  It is not what I would want.  It is not a very good scheme.  But it is better than the status quo and it is better than SB 1700, which perpetuates morally unjust and sneaky wealth transfers, makes a mockery of commitments to the free market, and has, in the end and notwithstanding its innovative use of the word “must” in various provisions, no real plan to end the cycle of dependency on government mandated subsidies, often from poor to rich. My hope is that this suggestion can be politically acceptable if a lot of people suck up their pride and think about their constituents, both within their district and outside it.  In fact, I will offer two schemes. I am hardly expert on parliamentary procedure in Texas, but I am hopeful that both could be implemented through amendments to SB 1700. I am even hopeful that both schemes might conjure up the ⅔ vote necessary to get this bill in place in time for the 2013 hurricane season, which starts essentially as soon as the 83rd Texas Legislature recesses.

TWIA Fix 1: The absolute minimalist fix.

1. Fix the worst bugs in the system of post-event bonds in place.  Reduce the Class 1 Funding scheme to a $200 million maximum. Such a bond could probably be amortized by  only a 5% surcharge on TWIA policyholders after a major storm.  Those policyholders would grumble about being kicked when they were down, which would be true, but most could probably pay.  Their ability to pay provides the needed foundation for Class 1 Bonds to be marketable. Keep Class 2 Bonds in place and raise 70% of $1 billion from coastal insureds (including TWIA policyholders) via a premium surcharge and raise 30% of $1 billion from insurers.  If the Class 1 bonds fail, just start with Class 2.  Ditch the buggy and unworkable Class 2 Alternative Bond scheme in section 2210.6136. Keep Class 3 funding in place to raise an additional $500 million.  This will create something like a $2 billion stack for the 2013 and 2014 hurricane seasons. Maybe a little more for 2014 if we are lucky in 2013.

2. Require TWIA to put at least two dollars into its CRTF off the top for every dollar that it spends in reinsurance. That will make TWIA think carefully about the costs of purchasing reinsurance in a system where reinsurers charge about 5 times the expected risk and instead consider more carefully putting that money into the CRTF where there is close to dollar for dollar return.

3. Tell policyholders in the most forceful way about the risks posed to them by TWIA’s funding problem. Tell them with actual numbers derived from the best models available what the risk is that TWIA will not have enough money to pay claims and what the expected shortfall is likely to be.  If, for example, TWIA’s stack for 2013 is $2 billion, then advise policyholders that the risk of their insurer being insolvent is about 3-4% per year.  Tell them further that if TWIA becomes insolvent, they are most likely to get only 50 cents for each dollar that TWIA owes them. (My calculation). Finally, let them know that neither the state of Texas nor the Texas Property and Casualty Insurance Guaranty Association has any legal obligation to pay for losses not covered by TWIA. It reeks of Enron not to be as explicit as one can about the special risks TWIA policyholders face.

Warning : The Texas Windstorm Insurance Association is not expected \ to have adequate funds to pay claims in years where total losses \ exceed about $2 billion. There is about a 4% risk of this occurring \ in 2013. In such circumstances you may receive 50 cents or less for \ each legitimate dollar of claims you file. Neither the State of Texas \ nor the Texas Property Casualty Insurance Guaranty Association has \ any legal obligation to pay claims for which the Texas Windstorm \ Insurance Association lacks adequate funds.

TWIA warning label

Will this scare lenders? Only dumb ones that haven’t been following the situation.  It will, however, alert TWIA policyholders to the desirability of at least seeing if other insurance alternatives are available and, in any event, taking every possible precaution against loss if a storm approaches.

4. Eliminate this nonsense in SB 1700 of shielding the entities running TWIA from public scrutiny by giving them special exemption from disclosure laws.  If there were ever an entity affecting the public trust that ought to be subject to public information requests, which already have protection from undue burdens built in, it is TWIA.

TWIA Fix 2: A minimalist fix

1. Scrap the whole opaque layering scheme for post-event bonds.  It just disguises the foundation of wealth transfers on which the whole current scheme rests. If we are going to use post-event bonds to fund storm losses above the catastrophe reserve fund, have them paid for explicitly and transparently by insureds throughout the state. Pay for losses in excess of the TWIA CRTF  by permitting the Texas Department of Insurance to impose a premium surcharge on essentially all property/casualty insurance sold in Texas sufficient to amortize an aggregate $3 billion over 10 years.  The surcharge should be clearly labeled “to subsidize coastal property windstorm insurance” so that insureds throughout the state know exactly why they are paying this extra money.  Depending on interest rates, a $3 billion initial principal balance will require a payment of about $380 million per year, which I believe is on the order of a 1% premium surcharge for 10 years.  (Computation based on http://www.naic.org/state_report_cards/report_card_tx.pdf (page 6)). TWIA policyholders pay a double surcharge.

2. Start pre-funding this potential $3 billion obligation.  Create some sort of trust fund akin to the TWIA CRTF and fund it by imposing a 0.5% premium surcharge starting as soon as possible on the same set of Texas property/casualty insurance policies that would have to pay the surcharge described in paragraph 1. Again, the surcharge should be clearly labeled “to provide a reserve fund that subsidizes coastal property windstorm insurance.” That way, insureds throughout the state would know why their hard-earned dollars are being taken away.  Use these dollars to reduce initial principal balance on post-event bonds that will need to be issued (up to $3 billion) to pay for storm losses suffered by TWIA policyholders.

3. Again, tell policyholders in the most forceful way about the risks posed to them by TWIA’s funding problem. Tell them with actual numbers derived from the best models available what the risk is that TWIA will not have enough money to pay claims and what the expected shortfall is likely to be. If, for example, TWIA’s stack for 2013 is $3.2 billion, then advise policyholders that the risk of their insurer being insolvent is about 2% per year.  Tell them further that if TWIA becomes insolvent, they are most likely to get about 90 cents for each dollar that TWIA owes them. (My calculation). Finally, let them know that neither the state of Texas nor the Texas Property and Casualty Insurance Guaranty Association has any legal obligation to pay for losses not covered by TWIA.

4. Again, require TWIA to put at least two dollars into its CRTF off the top for every dollar that it spends in reinsurance. That will make TWIA think carefully about the costs of purchasing reinsurance in a system where reinsurers charge about 5 times the expected risk and instead put it into the CRTF where there is close to dollar for dollar return.

 5. Give inland interests more substantial representation on the TWIA board and give the TWIA board authorization to reduce its exposure (and therefore reduce the risk of insolvency) through a variety of steps, including placing a limit lower than currently exists on the maximum limit on residential properties (primary and secondary), imposition of higher deductibles or coinsurance than currently exists and ability to place different restrictions on policies on new properties than policies on existing properties. This will impel the TWIA board to do what it should have been doing all along — prioritize between affording higher and better coverage to people but running a substantial risk of insolvency, or providing more moderate coverage — perhaps with a focus on the less wealthy — for which money will actually exist in the event of a major storm.

Final Thoughts

I’ve been writing a lot over the past 10 months about ways of addressing the system of catastrophic risk insurance in place for the Texas coast.  It’s not so hard to be an academic theorist in which one can assume away the world of political constraints. But now, at the least, we have those realities to face and some scary deadlines coming up.  Maybe what I am proposing comes too late.  I hope not.  Because while my proposals are hardly perfect — indeed they should sunset by the 84th legislature — I do think each of them is considerably better than the horrible choice now facing the Texas legislature.  Maybe some future session will feature less inflammatory and unproductive bombast, fewer attempts at special interest legislation and more serious and informed reflection about ways in which mechanisms thought good enough for the rest of Texas and its insurance markets can again be made the primary method of catastrophic risk transfer along the Texas coast. In the mean time, you have my thoughts on what might currently be achieved.

 

TWIA validates risk of insolvency and threat of small weather events

A letter from TWIA in response to a public information request validates the methodology used on this blog to assess alternative legislative proposals to fund catastrophic risk in Texas. This response to a public information request also shows that, given TWIA’s thin capitalization and growing exposure, even small weather events can have a serious effect. A redacted copy of that response is provided in the link below. The redaction is to protect the identity of the requestor (not me) who fears retaliation for having submitted it.

[Copy of letter temporarily deleted until redaction can be improved]

May 8, 2013 letter from TWIA

May 8, 2013 letter from TWIA

Insolvency Risk

Here is TWIA’s risk of insolvency based on what it apparently believes it can achieve in pre-event funding, post-event bonding and reinsurance.  For reasons I have set forth elsewhere, I believe these estimates of how much funding TWIA can receive are financially and legally unrealistic.

Source of FundingAmountCumulative AmountProbability Exceedance
Source of FundingAmountCumulative AmountProbability Exceedance
Premiums and CRTF$200 million$200 million17.4%
Class 1 Bonds$500 million$700 million7.7%
Class 2 Bonds$1 billion$1.7 billion3.2%
Class 3 Bonds$500 million$2.2 billion2.5%
Reinsurance$1.15 billion$3.35 billion1.5%

Regular readers of this blog — actually an impressively growing number — will note two things.  First, these estimates are close to estimates I have made of the risk to TWIA.  I have not been crying “wolf” or (needlessly) imitating Chicken Little on this topic for these many months. There is a very serious problem on the coast of Texas and, derivatively, a very serious problem for the rest of Texas. Also, since my estimates of the burden on various constituencies posed by various legislative proposals are based on these same models (see here, here and here for examples), the TWIA data tends to validate my estimates.  Bills such as SB 1700 indeed force non-TWIA policyholders to pay a stunningly large portion of the claims of TWIA policyholders.

Second, these estimates are one year values.  If one looks at the risk of insolvency over longer period of time, the risk increases significantly.  So, for example, if TWIA is not substantially fixed until the 84th legislative session and its catastrophe reserve trust fund does not grow, there is about a 32% probability that TWIA will have to go beyond its catastrophe reserve fund in order to pay claims.

Reinsurance

TWIA confirms in its response that it is trying to obtain $1.15 billion in reinsurance. Its hope is to spend $106 million and get an attachment point atop Class 3 bonds of $2.2 billion. It confirms that it may be able to get between $900 million and $1.1 billion of insurance coverage for this money.

There is, however, a troubling paragraph in the public information request response. The one contingency mentioned in the response is that TWIA might not be possible to sell the Bond Anticipation Notes (BAN) and thus might need an attachment point on the reinsurance of $1.7 billion. Fair enough. But the problem is actually considerably more serious. If the BAN does not sell — indeed if any of the authorized $1 billion in Class 1 Securities can not fully be issued — then TWIA can not issue $1 billion in regular Class 2 Securities.  It has to issue what I have called Class 2 Alternative Securities.  But the Class 2 Securities depend on the same dubious funding source as the Class 1 Securities, so the market might not buy those either.  And, if the Class 2 Alternative Securities don’t sell the Class 3 Securities can not be sold.

TWIA actually noticed at least part of this problem back in December when it made its recommendations to the Texas legislature.  Read pp. 30-32 of this TWIA document. Six months later, however, TWIA appears to be ignoring that major problem even though the law under which it operates remains unchanged.   If TWIA and/or its reinsurance broker is not paying attention to this point, it could be about to make dubious use of $106 million in TWIA policyholder money.  Because if TWIA buys reinsurance with an attachment point of $1.7 billion or $2.2 billion and it has only, say, $900 million in actual cash available to pay claims, TWIA will have no money to pay losses between $900 million and the attachment point. There’s a gap. It’s like buying catastrophic health insurance with a big deductible when you don’t even have enough money to pay for modest claims. The reinsurance will not kick in and it will not “drop down.” And so, TWIA will be able to pay only a small fraction (perhaps as little as 50%) of its losses with unusable reinsurance just sitting there.

For what it’s worth,  I’ve talked about all this before (here and here, for example, and here too).  And its a bug that many of the proposals now floating about the legislature fix.  But who knows if any of these proposals will actually become law.

The CRTF

TWIA confirms that at the end of March it stood at $180 million. At least it has not gone down more since the beginning of the year.

Recent Hailstorms

A friend has stated that “TWIA doesn’t even have enough to pay for a thunderstorm.” I had always taken this to be an exaggeration.  But the Public Information Request confirms that a thunderstorm in Santa Fe and Hitchcock on April 2, 2013 — a localized non-catastrophic weather event —  generated about $50 million in losses (what would be 28% of its CRTF). Fortunately, this storm did not get beyond the budgeted amount for 2013 non-catastrophe losses and did not require a dip into the CRTF. But think about it.  This moderate weather event cost TWIA more than 10% of its premiums.  What if there’s another severe thunderstorm or two this year?  What does this say about premiums?  What does it say about the needed capitalization of a bulked up TWIA?

The problem is one of exposure.  TWIA now insures so much property and the coast — thanks partly to TWIA subsidized insurance rates — has become sufficiently developed  that even moderate or localized weather events can potentially wipe out TWIA’s Ike-depleted catastrophe reserve trust fund and force TWIA onto the uncharted waters of post-event financing.

Thanks

Maybe TWIA isn’t this helpful all the time to everybody, but in my experience TWIA has made an effort to provide timely and reasonable responses to reasonable public information requests.  So, a thanks to Jennifer Armstrong and the staff there on this point.

Caveats

It might be worth repeating that the views expressed on this blog are my own and do not necessarily reflect those of the University of Houston.

Also, the views expressed in this posts do not necessarily reflect those of the recipient of the public information request at issue.

TWIA Board to Consider 2013 Reinsurance, Bonds

With just 30 days to go before the start of hurricane season, the Board of the Texas Windstorm Insurance Association (TWIA) will meet tomorrow, Friday, May 3, 2013, in Austin to discuss issues critical to its survival.  Among the items on the agenda are purchases of reinsurance and attempts to sell both pre-event and post-event bonds.  Both of these items are likely to prove extremely difficult for TWIA to manage.  Not on the public agenda is any further consideration of having TWIA placed into receivership.

Reinsurance

Let’s look at the reinsurance issue first. TWIA will be receiving a presentation from its long time insurance broker, Guy Carpenter. You can get a copy of that presentation here. It’s a fascinating document. It rests on an awfully cheerful view of TWIA’s ability to sell post-event bonds.  That’s not a view shared by the Texas Insurance Commissioner or, for what it is worth, by me. It shows TWIA is considering a reinsurance purchase option that would help insurers but would hurt policyholders. And it exposes yet again the extent to which the never-ending need to purchase reinsurance created by the undercapitalization of TWIA, forces TWIA to pay extremely high rates for that protection. If one wanted Exhibit A for why TWIA should be substantially depopulated rather than propped up so it can expand, the material for this board meeting would not be a bad place to start.

WHY IS GUY CARPENTER ASSUMING REINSURANCE CAN ATTACH AT $2.3 BILLION?

The Guy Carpenter presentation proceeds on the dubious assumption that TWIA can sell post-event bonds and thus can attach as high as $2.3 billion in the funding stack.   Look at the following picture found on Slide 8. (You may need to click on it, which will cause it to zoom in).

Proposed reinsurance arrangement for 2013

Proposed reinsurance arrangement for 2013

 

Notice that it presupposes that TWIA will be able to sell $2 billion worth of Class 1, Class 2  bonds and thus explores attachment at the top of the Class 2 stack.  But this is a very strange assumption to make.  First, as the Texas Public Finance Authority and the Texas Insurance Commissioner have stated, and as seems clearly correct, TWIA will not be able to sell the full $1 billion of Class 1 bonds.  And has been discussed on this blog before, the Class 2 bonds can’t sell if the Class 1 bonds don’t sell out and the Class 2 Alternative bonds have difficulties as well. So, the whole discussion of reinsurance attaching no lower than about $2.3 billion rests on what sure looks like unwarranted optimism.

Now, to be sure, TWIA’s got a document in its packet for the meeting Friday that suggests it still thinks it can sell $500 in pre-event securities, $1 billion in Class 2 public securities and $500 million in Class 3 securities.  This document appears, however, to ignore section 2210.6136 of the Texas Insurance Code, which says that Class 2 Bonds can’t be issued unless the full $1 billion of Class 1 bonds sell out.  If the Class 1 bonds don’t fully sell, then one has to resort to the Class 2 Alternative bonds.  But as I’ve pointed out before, the Class 2 Alternative bonds may be almost as dubious as the Class 1 bonds. And the Class 3 bonds legally depend on all the Class 2 or Class 2 Alternative bonds selling out.  So, again it looks to me as if TWIA is still looking at this summer with very rosy glasses or has some interpretation of the Texas Insurance Code I don’t understand.

Note 1: There is an alternative presentation on slide 13 in which Guy Carpenter explores the possibility of the reinsurance attaching at $1.7 billion, but even this is an awfully optimistic perspective on TWIA’s ability to sell post-event bonds.

Note 2: In fairness to Guy Carpenter, there is a footnote attached to the graph stating “Actual amounts of bond tranches are subject to marketability.” Yes. But unless there’s been some miraculous turn around in TWIA’s bonding ability, this seems like the main point, rather than a footnote.

Why is Guy Carpenter not having the reinsurance attach at the top of the Class 3 bonds?

If you’ve ready my blog entry on The Curious Matter of Reinsurance Attachment, you’ll know that the TWIA board has to make a crucial tradeoff in determining where any reinsurance should attach.  Inserting the reinsurance between the Class 2 and Class 3 bonds protects insurers from assessments but buys, dollar for dollar, less protection for TWIA policyholders. Inserting the reinsurance on top of the Class 3 bonds gives policyholders more protection but increases the likelihood that insurers will have to pay.

Most of the bills pending in the legislature would prohibit TWIA from doing exactly what the Guy Carpenter presentation appears to suggest: protecting insurers from having to pay back Class 3 bonds rather than maximizing policyholder protection. Given the incredibly precarious situation facing TWIA policyholders this summer — sorry insurers — but the reinsurance should attach at the highest level possible, buying the most protection for policyholders with a provision for drop down in the event the post-event bonds can’t be sold.

The pricing of reinsurance continues to be incredibly high

The Guy Carpenter proposal suggests that TWIA is again going to have to pay through the nose for reinsurance partly as a result of it never having an adequate internal catastrophe reserve trust fund.  As I’ve spoken about on many occasions, this reinsurance trap — almost like borrowing from payday lenders to address financial vulnerability — basically insures that TWIA never escapes its poverty.

How can I say this?  Look at the models AIR and RMS provide both Guy Carpenter and TWIA.  Here’s slide 6 of the presentation.

AIR and RMS risk estimates

AIR and RMS risk estimates

If one assumes that the distribution of annual losses is a Compound Poisson distribution, with the Poisson parameter being 0.54 (as found in this scholarly article) and one assumes that the underlying distribution is a Weibull with parameters 0.42 and 177,000,000, you can generate data that matches up extremely well with that found by AIR and RMS.  If you then run, say, 10,000 years of simulations using that distribution, you find that the mean losses to an insurer who writes a maximum of  $850 million worth of coverage over a $2.3 billion retention is only about $20 million.  That is 4-5 times less than what the reinsurers are apparently proposing to charge.  And, thus, the cost of having to reinsure rather than internally finance is something like $65-$75 million per year, or about 1/6 of all TWIA’s premiums. You dont, by the way, get qualitatively different results using the three parameter Weibull distribution that I’ve used on this blog before to replicate the AIR/RMS models.

There’s a lot more that is odd about the reinsurance pricing. If we think of the price as being composed partly of expected losses and partly of having to withdraw the maximum exposure from illiquid high-earning investments and place it in low return, highly liquid investments — this is the Wharton School model — the pricing only makes sense if reinsurers lose about 7.8% on their capital by having to make it particularly liquid. ((-expectedLosses + premiums)/maxExposure). Given the market right now, that’s a pretty high number.

There are a couple of explanations between the actual pricing for reinsurance and the pricing that the models would suggest.  One, which is rather scary, is that the reinsurance market is not behaving as competitively as one would like.  The other, scary for different reasons, is that the reinsurance market doesn’t trust the AIR/RMS model and thinks the risk of a major hurricane is considerably greater.  If that’s true, however, then even the dire warnings that I  and others have been sounding about TWIA are understated.

Bonds

The Bond Anticipation Note

The other main item on the agenda appears to be the issuance of bonds.  There is a a proposal from First Southwest that TWIA sell by June 27, 2013, a “Bond Anticipation Note” for $500 million that would basically be an advance on a hoped-for similar Class 1 post-event bond. First Southwest apparently believes these unrated bonds could be sold at between 4 and 6%. My own 2 cents is that if TWIA can get this loan, it should grab it.  Increasing the amount it has to pay claims from its CRTF funds of $180 million to something like $680 million will help.  And if all it has to pay is some interest, that’s a good deal. But there’s a lot to do before this money will be available to TWIA and it looks as if it is going to have go through at least the first month of the 2013 hurricane season without it.

Post-Event Bonds

There’s also apparently a resolution on the table authorizing TWIA to asks the Texas Public Finance Authority to issue post-event bonds. I’ll confess I don’t understand this one.  There haven’t been any tropical cyclones yet in Texas for 2013.  Maybe TWIA is getting this resolution done to see what can actually done for 2013?  Maybe it is an attempt to see if things are as bad as some people have been saying?

Conclusion

The TWIA board is in a very tough spot.  With fewer than 30 days to go in the legislative session and 30 days until the start of hurricane season, it doesn’t really know what its resources are to pay claims. It’s being (understandably) threatened with receivership by the Texas Insurance Commissioner. And its existing reinsurance expires on May 31, 2013, before the start of hurricane season.  If and until TWIA gets some legislative relief or is put partly out of its misery by a Texas shift to an assigned risk plan or other mechanism that deconcentrates risk, it doesn’t have many good options. My hope is that the board will have the courage to confront its moral and legal obligation to warn policyholders in the clearest possible terms of the risks that, unless powerful legislative relief swiftly occurs, their claims will not be paid fully should a significant hurricane hit this summer.