Here’s my written testimony on S.B. 18 and related matters provided at the Senate Business & Commerce Committee today. My oral testimony was basically a shortened version of this along with some interesting colloquy with Senators Taylor, Lucio and Carona.
I am Seth J. Chandler, a professor of law at the University of Houston Law Center and writer for the blog catrisk.net, which deals with the law and finance of catastrophic risk in Texas. The views here and on catrisk.net are my own and do not necessarily represent those of the University of Houston.
Texas insurance regulation should meet at least three major demands. We must be sure that the entities bearing risk actually have clear resources following a disaster to timely pay claims. (2) Insurance underwriting and pricing must send the proper signals to property and business development markets both on the coast and elsewhere in Texas. (3) Any transition from the status quo should temper the need to move urgently with the kindness involved in protecting the reliance interests of those who invested under the long existing prior system. I have attempted over the past week to study SB 18 along with competing bills filed by Senators Hinojosa (SB 1089) and Representative Hunter (HB 2352). I am advised that there is a committee substitute filed or about to be filed for SB 18 but, from my brief review, the changes made therein does not change the thrust of my testimony.
In my view, SB 18, though not perfect, is a positive framework for beginning to meet these demands. It is superior on solvency and market signaling grounds to the Hinojosa/Hunter proposal and to the status quo. Though it deals with the problem urgently, it reflects kindness by having the rest of the state provide at least nine benefits to TWIA and its policyholders. (See Appendix 1.)
The primary concept of SB 18 is to move Texas away from an addictive system in which protection from tropical cyclone risk is concentrated in a highly subsidized and highly correlated pool run by a state-chartered insurer. The subsidization, accomplished through requiring TWIA policyholders to pay fully only for the lower layers of catastrophic risk, kind of like billing a homeowner as if its home was worth only a fraction of its declared value, sends improper signals to property and business markets throughout the state. It treats poor property insureds away from the coast worse than both poor and wealthy property insureds along the coast. The system now withholds explicit warning to policyholders, particularly those in Galveston County, as to the risks of TWIA’s undercapitalization. It relies on an untested system of post-event bonds limited in amount and inadequate to pay for large storms that will be paid for substantially by non-coastal Texans.
The concentration of correlated risk inherent in TWIA has trapped that agency into choosing each year between two bad alternatives. It can run a risk of insolvency in the current year by not purchasing reinsurance. Or it can perpetuate its poverty by paying huge sums to reinsurers whose prices reflect the need to stockpile liquid capital and consensus views on modern risk of hurricanes.
How would I describe SB 18 in a minute or two? I would say it provides all Texans not otherwise unable to meet general underwriting standards the opportunity to purchase unfragmented homeowner insurance, including coverage for windstorm, from real insurers. They do so at rates no more than 25% higher than that of a fine-grained estimate of the market price for similar coverage. It reduces the high costs of correlated risk and assures solvency by forcibly grafting coastal tropical cyclone risk onto the diversified stock of conventional and other catastrophic risk held by private insurers whose solvency is highly regulated. It ultimately stops giving special treatment to residential TWIA policyholder’s problem of high and intensely correlated risk. Instead it transitions them, with some interim rate relief effectively paid for by the state and non-coastal Texans, into a private primary or excess market that may have room to flourish once the subsidized market of TWIA is removed. And if that market does not develop, they are protected by a state created assigned risk program with capped prices in which the monitored resources of private insurers will actually pay them in the event of claims. It leaves TWIA in place but in sufficiently shrunken form so that reinsurance may be affordable and a system of assessments are manageable for the private market. Under SB 18, and as set forth further in Appendix 1 to my written testimony, non-coastal Texans will still very much pay either directly or indirectly to help their friends on the coast, whom I hope appreciate the consideration. But they will do so via a system that stands a greater chance of actually being helpful in time of need and that likely does so at lower overall cost.
Its leading current competitor, the Hinojosa and Hunter bills are premised on coastal exceptionalism and a demand for coastal development. They attempt to use benefits undoubtedly provided by the Texas coast but qualitatively little different from the benefits provided by the economies in each of your home districts, as a reason for the rest of the state to subsidize — perhaps even more than the status quo — the purchase of windstorm insurance along the coast. They perpetuate the sending of bad signals to the development market. They leave the problems created by risk concentration essentially untouched. They leaves the interest rate risk attached to funding by post-event bonds in place. They appear to finance the first layer of post-event bonds by large surcharges on whoever is left in the TWIA pool following a large disaster — an idea the bond market appears to reject. Yes, the bills do build a bigger catastrophic reserve fund to insulate policyholders from those risks, but the money to do so comes mostly from policies other than those that will benefit from the enhanced cat fund.
There are questions I have about SB 18 and important implementation details about which I have reservations. I set more of them out in Appendix 2 to my written testimony. Chief among them (1) I want the immensely powerful Managing General Agent of the TPIP subject to Chapter 552 of the government code. (2) I want, as you should too, numbers from full time professional actuaries about the burden of the bill on Texas insurers, non-coastal insureds and coastal insureds. The concept at the core of SB 18, however, of an assigned risk pool with rates ceiling by a multiple of market rates, coupled with transition relief for TWIA residential policyholders, represents a welcome advance beyond conceptualizing the best form of bandaid to put on system that may be fatally infected.
Appendix 1: Ways in which non-coastal Texans will continue to subsidize the coast under SB 18
- Subjects insurers statewide (“TWIA members”) to front $2 billion for an assessment in the event TWIA does not have enough money to pay claims. (2210.0561). The State of Texas and taxpayers ultimately pay the bill via premium tax credits.
- Insurers statewide (“TWIA members”) pay each year for a $2 billion reinsurance policy for the benefit of TWIA and its policyholders (2210.0561)
- Assessment on insurers statewide (“TWIA members”) to pay to establish, maintain and administer a clearinghouse that will significantly service coastal residents. (2210.103 and 2210.104)
- Surcharge for up to 33 months of 1% on policyholders outside of the “catastrophe area”) (the coast) on most forms of property/casualty insurance including homeowner policies and automobile policies. Proceeds from the surcharge go to build up a catastrophe trust fund used exclusively for the benefit of TWIA policyholders. Section 2210.4521.
- Surcharge for up to 33 months of 5% on non-TWIA policyholders in the “catastrophe area”) (the coast) on most forms of property/casualty insurance including homeowner policies and automobile policies. Proceeds from the surcharge go to build up a catastrophe trust fund used exclusively for the benefit of TWIA policyholders. Section 2210.4521.
- Insurers receiving less than assigned risk premiums due to transition relief for TWIA policyholders authorized to include a provision in their residential property insurance rates to recoup up to 50% of the shortfall. Policyholders statewide thus likely to pay to keep rates low for coastal policyholders formerly insured by TWIA. (Section 2214.458).
- State of Texas and/or taxpayers pay for the same transition relief for TWIA policyholders by giving insurers a premium tax credit for 50% of the shortfall each year.
- Insurers obliged to write policies for no more than 25% above “market” for certain policyholders on the coast and elsewhere even where doing so costs more than 25% above market due to correlation of risk and limitations on permissible underwriting criteria. This cost borne directly by insurers and indirectly by insureds statewide. Section 2214.406
- Insurers writing policies on the coast with wind exclusions apparently compelled to adjust windstorm claims without compensation. Section 2210.5725.
Appendix 2: Questions and reservations about the bill.
- A spreadsheet or similar document should be developed by experienced actuaries that estimates each of the costs identified in Appendix 1 with recognition that such estimates will, of necessity, often be rough.
- Section 2214.352 of the bill would permit Texans to obtain coverage for tropical cyclone or wildfire within 72 hours of application. This poses a serious adverse selection risk since modern wildfire and tropical cyclone forecasting often provides good estimates of heightened risk more than 72 hours beforehand. Suggested change: change 72 hours to 168 hours (one week).
- Section 2214.105 and 2214.153 exempt the Managing General Agent from Chapter 552 of the Government Code. This exemption is inconsistent with the quasi-governmental power over issues of statewide importance provided to the MGA and hinders accountability. Suggested change: either leave the matter to court interpretation or make the matters described subject to Chapter 552 of the Government Code, which itself contains numerous protections.
- Section 2210.453 requires TWIA to purchase $2 billion in reinsurance even after TWIA is largely depopulated. This number may actually be excessive and forcing TWIA to use reinsurance as a risk transfer mechanism gives too much bargaining power to reinsurers as opposed to alternative methods of catastrophic risk finance such as pre-event catastrophe bonds. This may have been changed in the revised bill that was filed very recently. If not … Suggested change: Amend subsection (b) of proposed 2210.453 to place the cap on the risk stack at an amount determined sufficient by the Insurance Commissioner to cover TWIA against a 1 in 1000 year storm or $5 billion, whichever is lower and change “reinsurance” to “reinsurance or its equivalent.”
- Section 2210.5725 requires insurers providing conventional coverage to holders of a TWIA policy to adjust claims even for wind losses excluded by their policies. Suggested change: Clarify how, if at all, insurers are to compensated for the additional costs of such an adjustment.
- How does one reconcile Section 2210.211’s mandatory migration migration of TWIA’s policies to similar but non-identical coverage with various prohibitions against state-induced breaches of contract? Suggested change: require TWIA to insert into all policies an incorporation of its right to terminate under 2210.211.
- Do the limitations in section 2210.507 on maximum limits and minimum deductibles on TWIA policies issued after January 1, 2014, apply just to policies on new properties or do they also apply to renewals of existing TWIA policies? Suggested change: clarify.
- What procedures are available to challenge a determination under section 2214.501 by an assigned risk insurer that an insured structure does not meet building code standards set forth in the TPIP plan of operation and that the policyholder is thus subject to a surcharge? What constraints exist on the amount of the surcharge the insurer can impose? Suggested change: clarify.