Philip W. Barnes, PhD

Texas law should be changed to require the board of directors of TWIA to file for approval the rate recommended by its actuaries; this is a moral obligation the board owes its customers, its members, and to the Commissioner of Insurance.

The item published in this space last week focused on the Texas Windstorm Insurance Association (TWIA) and the continuing subsidies its operation provides for coastal property owners.  That article highlighted the history of the organization and recent changes made by the new law passed by the last Texas legislature and signed by the Governor. The new law made significant improvements, especially in the mechanisms provided TWIA to finance its losses.  However, the very fact mechanisms for financing losses are required – other than premiums collected – show the continuing recognition that TWIA provides a subsidy for coastal property owners.  In that sense, little has changed since 1971 when the organization was established. 

An old maxim in the property and casualty insurance business holds that “there are no bad risks, only bad rates.”  And that old saying is fundamentally true.  It is difficult to conceive of any insurable risk that the worldwide property and casualty industry would not underwrite if it could collect an adequate premium.  Actuaries – while the butt of an endless number of jokes – are very, very good at their jobs.  The problem is that an “adequate rate” for any given risk is often very high.  Why?  Rates are high because the risk presents an actuarial probability of high losses. 

We know that hurricanes will hit the Texas coast.  We have a long record of them. Without the threat of hurricanes, the risk along the Texas coast would be no greater than the risk of loss in many inland areas of South Texas!  But in the hurricane prone areas, the risk of loss is simply much greater.    Thus, an “adequate rate” must account for the probability of hurricane losses, thereby enabling the insuring entity – i.e., TWIA – to collect enough premiums to pay its losses directly and through the purchase of reinsurance.   

We know that, given our history, most of the hurricanes on the Texas coast occur after June 1 and before October 1 – even though the hurricane season begins in May and ends in November.   Actuaries have very sophisticated models that can predict the path and estimate the damage storms may cause.   So the actuaries’ advice should guide the decisions of the board of directors of TWIA as it files for rate changes.  In my view, the law should be amended to require the TWIA board to file for approval rates recommended by its actuaries.  Experience shows that the board is all too often reluctant to step up to this obligation, since any proposed increase in rates – no matter how justified – is always politically unpopular. 

Despite changes in the law in 2009, prior approval for TWIA rates remains a concern because it may not allow for the TWIA board to set adequate rates based on the risk being undertaken.  According to a report by the Insurance Council of Texas, during a TWIA hearing on rates in June 2009, actuarial testimony supported rate increases of 19% for commercial property and 26% for residential.  The TWIA board, however, ultimately voted for only a 10% increase likely due to its concern that the commissioner would not approve an increase greater than 10%.    Thus, the TWIA board abandoned its responsibility to file for adequate rates.  Rather, in an act of extraordinary hubris, the TWIA board chose to take a “political” position and filed for a lower, presumably more acceptable rate.  So the subsidy continued …

The only acceptable public policy objective of the TWIA – or any other residual market, for that matter – is to provide necessary insurance in the event the private market cannot do so, for whatever reason.  Frankly, I cannot conceive of a likely circumstance where the private insurance market will not meet the property and casualty insurance requirements of most if not all risks in coastal counties, if they can charge adequate rates.  Obviously, if the TWIA “competes” with the private market by charging an unsound rate requiring subsidies – which it certainly does now – TWIA will take business from the voluntary market, and this is inappropriate. 

If TWIA were to have an actuarially sound rate in place – an adequate rate – and ceased to be, in fact, a “preferred market” for many customers, the number of properties inured by TWIA would decline immediately.  That would be adequate evidence that TWIA is performing like an insurer of last resort and fulfilling its only legitimate public policy purpose.