Attached to this post is a chart prepared by TWIA for its August 7, 2012, board meeting. I didn’t make this chart up. TWIA did. At the August board meeting, it was discussed whether this chart should be made more prominently available to the public via the internet. There was an initial suggestion that it should. At the end of a two minute discussion, TWIA apparently decided that, instead, the information contained in the chart would be subsumed into some sort of “contingency plan narrative” that would, eventually, go on the web. (Don’t believe me? Listen to minutes 16:30 through 18:46 on the archived recording of the meeting). And if anyone can find that contingency plan (with or without the narrative) please let me know.
I don’t think the chart is too difficult to understand. The “problem” with the chart is that it is too easy to understand. The chart makes clear that TWIA faces a significant risk of insolvency. It shows that TWIA does not have enough money to pay for 1 in 100 year events and does not have enough money to pay for a modest storm plus a 1 in 60 year event occurring in the same hurricane season.
The chart depicts how TWIA would pay policyholders in two different scenarios. The scenario on the left is one giant storm. The scenario on the right is a small storm followed by a big storm. In the giant storm scenario, TWIA suffers $4.5 billion in losses. This is identified as a one in one hundred year event. If that’s true, it happens about 10% of the time during any 10-year stretch. According to the chart, TWIA would fund be able to fund a total of $3.15 billion of the $4.5 billion loss: $300 million (green) out of premium revenue and the catastrophe reserve trust fund, $500 million (aqua) out of bond anticipation notes (later refinanced via Class 1 securities), $1 billion (turquoise) out of Class 2 securities, $500 million (gray) out of Class 3 securities, and $850 million (purple) out of reinsurance. TWIA would have no available funds to pay the remaining $1.35 billion (yellow) of claims (and possibly loss adjustment expenses). So, on average, policyholders would get 70 cents on each dollar that TWIA owed them.
In the small + big scenario depicted on the right, the losses from the small ( $500 million) storm are funded fully. $300 million (green) is paid out of premium revenue and the catastrophe reserve trust fund and the remaining $200 million (aqua) is paid out of bond anticipation notes (later refinanced via Class 1 securities). But when the big $2.5 billion once every sixty years) storm then hits in the same hurricane season, TWIA has a serious problem. It can pay another $300 million out of bond anticipation notes, $1 billion (turquoise) out of Class 2 securities and $500 million (gray) out of Class 3 securities. That leaves TWIA policyholders with claims from the second storm initially getting only 72 cents on every legitimate dollar of claims. (And good luck to TWIA trying to get claimants from the first storm to pay back a portion of their claims so that both sets of policyholders are treated equally)
The source of the remaining $700 million under the small + big scenario is unclear. If TWIA could somehow scrape up an additional $500 million (yellow), it would then arguably trigger the obligations of the reinsurance it purchased. TWIA policyholders would ultimately be made whole in this case. But, apparently, if TWIA could not scrape up $500 million — and no one has any idea where the missing $500 million would come from — TWIA would not be entitled to any money from the reinsurance policy for which it paid $100 million in premiums. Thus, TWIA policyholders would be stuck with, say, being paid only $144,000 on a legitimate $200,000 claim.
Footnote: Part of the problem exists because TWIA’s reinsurance is apparently “occurrence based” rather than based on aggregate losses. Apparently such occurrence based policies are “industry standard” for reinsurance though not for catastrophe bonds. My bet, though, is that a sophisticated reinsurance broker could negotiate with a sophisticated reinsurer for an aggregate loss trigger on reinsurance.
So, is the chart scary? Should it be prominently displayed on the TWIA web site and by TWIA agents? Yes. Sure, being too scared of hurricane risk a problem. But being insufficiently scared is perhaps an even greater problem. I would not want to be the homeowner with a destroyed house or a destroyed business holding a TWIA policy that provided “coverage” on paper, but that did not actually get me the money to rebuild. And I wouldn’t want to be the agent that sold such a policy having not disclosed by every reasonable means — including the use of charts where appropriate — the risks involved.