March 2011

Four Problems, Four Solutions: A Blueprint for Reforming Texass Insurance Environment
By Eli Lehrer*
This report reviews four major problems with Texass insurance environment and proposes four categories of action that elected leaders should take in order to remedy them. The Texas Windstorm Insurance The right actions will make the state Associations management, its costs, the more fiscally stable, safer, and more retreat of many private insurers, and resistant to natures worst. inadequate coastal mitigation efforts are Texass biggest property insurance problems. To solve them, efforts should be undertaken to reform TWIAs structure, change regulations to attract insurers, and invest in coastal mitigation. Although the problems with Texass property insurance system are significant, the right actions will make the state more fiscally stable, safer, and more resistant to natures worst.

Problems
One: TWIAs Management and Structure Are Problematic On February 28, 2011, the Texas Department of Insurance placed TWIA under administrative oversight, citing a number of severe management problems. Simultaneously, TWIAs longtime manager, Jim Oliver, was removed from his position.1 Among other things, Insurance

Eli Lehrer is vice president of Washington, DC operations for The Heartland Institute. A more complete bio appears on page 10. A.M. Best and Company. Texas Insurance Department Takes Oversight Control of TWIA; Manager Is Ousted, March 1, 2011.

Commissioner Mike Geeslins order creating administrative oversight a de facto state takeover of TWIAs operations alleged problems with claims adjustment, fraud reporting, and financial management practices. Press reports have alleged other problems with TWIAs management and financial practices.2 Just a few days after the allegations against TWIA were made, it was clear the agencys unique legal structure contributed to its woes. Right now, TWIA is neither public nor private: Insofar as it is mandated by state law and serves a public purpose, TWIA looks like a government entity. Insofar as it competes with private market players for some policies it writes, and doesnt have to follow state purchasing and hiring rules, it looks like a private entity. (The Texas FAIR Plan Association, which serves as a market of last resort in non-coastal counties, has the same fundamental structure.) TWIAs compensation practices, for example, were out of line with governments its head made more money than the governor but not with those of private insurance companies. As the organization is neither public nor private, oversight of TWIA is both complex and confused.

Just a few days after the allegations against TWIA were made, it was clear the agencys unique legal structure contributed to its woes. TWIA is neither public nor private.

Two: TWIA Could Cost Taxpayers Billions TWIA has existed since 1971 and is supposed to provide last resort coverage against windstorms for property owners unable to find such insurance in the private sector.3 Since its creation, however, TWIA has grown to become the second largest such market of last resort in the United States; it writes more than 3 percent of all property insurance in Texas.4 Only one state, Florida, has a larger government-run or government-mandated property insurer.5 In 2008, TWIA paid out claims of more than $3.8 billion and, at the time, had reinsurance and assessment capacity to cover them.6 Today, TWIA has no reinsurance and no meaningful ability

2011 The Heartland Institute. Nothing in this report should be construed as supporting or opposing any proposed or pending legislation, or as necessarily reflecting the views of The Heartland Institute.
2

Steve Miller, Texas government-operated property insurance agency TWIA found hazardous to the public in the wake of Texas Watchdogs reporting, February 28, 2011, www.texaswatchdog.org/2011/ 02/texas-government-operated-property-insurance-agency-twia-found/1298927853.column. Texas Windstorm Insurance Association, About TWIA, www.twia.org/AboutTWIA/tabid/56/Default.aspx. Property Insurance Service Office, 2010 Market Penetration Report, PIPSO.org. Ibid.

Texas Department of Insurance, Hurricane Ike Information Center, www.tdi.state.tx.us/consumer/storms/cpmhurrike.html.

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to charge special taxes called assessments to private insurers.7 If two particularly bad storms hit back-to-back, Texas taxpayers could end up having to pay as much as $8 billion8 something they cannot afford to do. Although recent history shows it could easily have to pay at least $4 billion in losses in a single season, it has only about $300 million in hard assets to pay them.9 The rest of its claims-paying capacity would come from a newly granted authority to issue up to $2.5 billion in bonds bonds it might not be able to sell and that, one way or another, Texans would have to pay back with interest. Three: Private Insurers Do Not Want to Write Insurance in Texas Although Texas has a pro-business reputation, the states system of insurance regulation has driven away many insurers.

Texass system of insurance regulation has driven away many insurers.

Whereas new auto insurers have flocked to the state, many major national insurers have stopped writing new property insurance policies in coastal areas. Even the major Texas-based insurer that has expanded its overall policy count along the coast simultaneously non-renewed some policies.10 Getting private insurers back into the state is key to shrinking TWIA and making insurance more affordable. Texas already has most of the things population growth, a good business climate that should attract insurers, but they are not coming. A smaller TWIA and lower rates cannot be achieved without more competition, and changes to insurance regulation are needed to achieve that. Four: Texas Properties Are Not Secure Enough Against Storms Texass coastal counties some of the poorest in the state are not sufficiently secure against major storms. Houses are not strong enough, and too many wetlands, which help mitigate damage from storms, are being destroyed.

Technically, TWIA still can assess private insurers but the tax credits the state offered to offset the assessments have been tapped for decades to come. Larger insurers would experience losses as a result, while some smaller ones might have their viability threatened.

In the wake of the 2004 and 2007 storm seasons, Florida, Louisiana, and Mississippi bailed out their TWIA-equivalents. No state has ever allowed a similar mechanism to fail. Texas Windstorm Association, Fiscal Year 2008/2009 Report. www.twia.org/AboutTWIA/PublicFinancialInformation.aspx
10 Patrick Danner. USAA to Expand Wind Coverage, San Antonio Express-News, January 12, 2011. www.mysanantonio.com/business/article/USAA-to-expand-wind-coverage-953379.php. 9

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Without any sort of statewide building code, many areas of coastal Texas have homes that could not withstand high winds.11 Moreover, the Gulf Coast Restoration network estimates roughly 1,800 acres of Texas coastal wetlands disappear every year.12 This is a problem because wetlands absorb storm surge from hurricanes and thus protect inland communities from windstorms.

Solutions
Texass legislature can protect the states taxpayers, its environment, and its citizens lives through a reasonable and simple series of steps.
Although solving these problems wont be easy, Texass legislature can protect the states taxpayers, its environment, and its citizens lives through a reasonable and simple series of steps.

One: Clarify TWIAs legal status as a hybrid entity and create a new office within the Texas Department of Insurance specifically intended to oversee TWIA and the related Texas FAIR Plan Association. Much remains unknown about the depth, extent, and causes of TWIAs alleged management problems. Solving the problems eventually discovered, however, requires resolving the tension at the heart of TWIAs existence its public or private status and then creating appropriate oversight for it. The legislature and governor would best protect taxpayers by making it clear that, although state-mandated, TWIA is a private entity administered mostly by the insurance industry, and as such it cannot borrow money on the states credit or make direct claims on the public treasury. Because it exists only as a result of state law, however, TWIA should still have to comply with state freedom of information laws and open all of its meetings to the public. To strengthen oversight of TWIA further, the legislature should create a special office within TDI solely to oversee TWIA and the Texas FAIR Plan Association (which serves as a market of last resort for inland property owners). This new Office of Residual Property Insurance Market Oversight would be run by a manager within the Property and Casualty Insurance Division of the Texas Department of Insurance. In concert with other TDI staff, it would have the power to promulgate rules that apply only to TWIA and/or the Texas FAIR Plan, examine all TWIA rate filings, and continuously monitor all

Daniel Sutter, Reforming the Texas Windstorm Insurance Association, testimony to the Texas House of Representatives, Mercatus Center, February 24, 2009. mercatus.org/sites/default/files/publication/ Texas%20House%20Insurance%20Committee%20Testimony%20Feb09.pdf.
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Gulf Coast Restoration Network, healthygulf.org/our-work/gulf-fish-forever/habitat-loss.

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of TWIAs actions. The offices head would sit as a nonvoting ex officio member of the TWIA and FAIR plan boards and make periodic public reports about both TWIA and the FAIR Plan. Two: Protect taxpayers by requiring TWIA to have sufficient resources to cover two back-to-back events with a combination of cash and private-sectorrecognized risk-transfer instruments. State lawmakers shouldnt try to micromanage TWIAs operations, but they have an obligation to do everything they can to mitigate the risks the fund poses to the states taxpayers. To do this, the legislature should do two things.

State lawmakers have an obligation to do everything they can to mitigate the risks TWIA poses to the states taxpayers.

First, create a special rate-filing process for TWIA that expedites any requests it makes for higher rates, eliminating the ability of the commissioner to disapprove rate requests unless they endanger the solvency of TWIA or violate civil rights laws. This process would apply only to TWIA, not to private insurers. This is not a recommendation to eliminate all rate regulation in the private market. At present, TWIA and private insurers alike have a very difficult time raising rates to reflect risk; TWIA, in particular, has had its requests denied frequently.13 A quicker rate regulation process will allow TWIA to build up larger cash reserves and afford more risk-transfer products by charging higher rates. This will have the added, positive, side effect of encouraging TWIA customers to look for coverage in the private market. Second, require that TWIA purchase risk-transfer products such as reinsurance and catastrophe bonds sufficient to pay at least $8 billion in claims. The exact mix of products for risk transfer should be left up to TWIA management, but in overseeing the mix, regulators at the Texas Department of Insurance should hold TWIA and the reinsurance it purchases to the same standards it would impose on a private-sector firm. Requiring TWIA to acquire more cash and purchase more reinsurance or other risk-transfer products will have two positive, directly connected consequences. First, it will require TWIA to raise its rates and thus make more room for the private sector to provide coverage. Second, and more importantly, it will save Texas taxpayers from the possibility of having to put up with a combination of tax increases and service cuts totaling $8 billion.

Insurance Day, TWIA Rate Hike Request Rejected, October 20, 2009, www.insuranceday.com/insday/liability%20&%20claims/Run-off/twia-rate-hike-request-rejected/233058.ht m;jsessionid=740DDE72CA41F23590A86B1630F3FEAC.wa1. Regulators later accepted a smaller rate hike.

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Three: Improve market competition by reforming rate regulation and Texass insurance regulatory bureaucracy, modifying nonrenewal laws, and improving the provision of information to consumers. Attracting more private insurers into the Texas market will require an overhaul of the states insurance regulatory system aimed at replacing the cumbersome, innovationsapping bureaucracy with a nimble, twentyfirst century regulatory system that protects consumers and promotes competition. Several steps should be taken to accomplish this.

Attracting private insurers into the Texas market will require an overhaul of the insurance regulatory system.

Texas must implement the insurance statutes as they are written. Since 2003, the state has operated under a file and use system that, in theory, means insurers submit rate filings to the Texas Department of Insurance, an agency that can either accept or reject them within a set period of time. In practice, however, this system is followed only in the breach: Rate filings from large companies are often rejected before they are filed or the companies are told they will be rejected; other rates end up in court hearings.14 This perverts the idea of the file and use system and, even worse, leads to uncertainty that makes it difficult to attract competition. If Texas wants more private insurers to enter the state, the system needs to be implemented as the language of the law suggests. The Texas Department of Insurance (TDI) and related Office of Public Insurance Counsel should be analyzed from top to bottom and cut significantly. There is evidence to indicate both are bloated. TDI is the nations largest insurance regulator. In 2009, the last year for which comparable numbers are available, TDI had a total of 1,693 employees (todays counts are lower). Texas is the second largest state, but the largest one, California, employed only 1,261 in its department of insurance in 2009, while the third largest, New York, had 919.15 Theres little doubt that some of the difference comes from the different responsibilities of the departments: TDI maintains a large workers compensation division, which is separate in some other states, and also serves as the chief fire-safety regulator for the state. But even when these differences are taken into account, Texass insurance department appears top-heavy and could be cut even while increasing oversight of TWIA. A comparison with New Yorks insurance department can be instructive. New Yorks department, which oversees many of the nations biggest insurers, is much smaller than Texass, which oversees only two insurers with a significant national presence. In 2009, New York had 37 lawyers and 12 support staff; Texas had 67 and 17. New York had 37 professionals and 12 support staff handling rate and form filings; Texas had 63 and 10. TDI had 39 employees listed

For one example of such a rejection see: KWTX.com, State Farm Rate Hike Rejected, October 6, 2007, www.kwtx.com/home/headlines/10286977.html.
15 National Association of Insurance Commissioners. Insurance Department Resources Report 2009, 3-4. Washington, DC: NAIC, 2010.

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as Executive, whereas New Yorks department had 14; Texas had 94 in the administrative category, New York just 44.16 This comparison suggests significant room for cuts in the size and scope of the Texas insurance department without imperiling its core functions and adding staff to oversee TWIA. The Office of Public Insurance Counsel, which serves as a sort of second (although powerless) consumer protection agency, also should be considered for elimination: the insurance department itself should make consumer protection properly understood its most important goal. Changing Texass nonrenewal laws should come next: The state should adopt a free nonrenewal system. Current Texas law relating to insurance policy nonrenewal is anticompetitive and bizarre. Explaining why this matters requires a little background.

Current Texas law relating to insurance policy nonrenewal is anticompetitive and bizarre.

Insurers make their money by pooling together properties with roughly the same risks of making similar claims in each year. That way, even when they pay out mammoth claims to homeowners whose houses burn down, they can make money on most other policies they write. Sometimes, however, because of behavior, suspected fraud, bad luck, or changing business needs, insurers find that certain policies no longer make sense for them because their risk profiles have changed. For example, if an insurer finds that a homeowner makes two expensive theft claims in 12 months, while most of that homeowners neighbors had none, it might conclude the person in question is particularly careless and refuse to renew a policy. In most states, insurers that decide they do not want to renew a policy after it expires must send consumers advance notice and check a few other bureaucratically mandated boxes. Texas law, however, makes homeowners insurance nonrenewals almost impossible. Decades of reasonably minor amendments to nonrenewal laws have turned Texass insurance law into a complicated morass that even insurance company lawyers cant understand. Sections dealing with matters as arcane as appliance-related losses and numbers of claims take a legal expert to sort out. As a result, insurance companies continue to write policies they know are money losers. Texass nonrenewal laws make things harder on most consumers. Instead of losing money, insurers simply raise premiums for all their other customers to make up for the money-losing policies they must renew. Higher rates, however, do not end the insult to consumers: Because nonrenewals are so difficult to carry out, many insurers are reluctant to write policies in the first place for people in higher-risk areas. This makes shopping around much more difficult than it should be. Texas already allows reasonably free nonrenewal of automobile insurance policies; it should do the same for homeowners insurance. Doing so would lower most consumers rates and make companies more likely to offer insurance in the state.

16

Ibid.

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Finally, although the departments regulatory overreach needs to end, TDI also must work harder to focus its efforts on the states insurance consumers. Despite a large consumer affairs staff, TDI does not provide consumers as much information about insurance options as it might, and it has not done enough to publicize its own Web-based insurance comparison tools. Although a tight budget situation will make any growth in services difficult, TDI and the legislature should look for ways to make sure these services are not overlooked. Four: Promote coastal conservation and safety by restricting subsidies for coastal development and, to the extent practicable, helping people of modest means to retrofit their homes. Texas must do what it can to make its properties safer from hurricanes. It can do this best by promoting conservation of wetlands and encouraging individuals in the state to retrofit their homes against natures worst. To promote conservation and protect inland areas from storms, Texas should end government policies that lead to wetlands destruction. The legislature should forbid TWIA from writing new policies on currently undeveloped coastal wetlands (areas that are damp for at least six months per year) and investigate ways to withdraw other subsidies for everything from road-building to government space leasing in these areas. Individuals who own properties in these areas and wish to develop them should be allowed to do so as long as they respect whatever local laws exist.

To promote conservation and protect inland areas from storms, Texas should end government policies that lead to wetlands destruction.

Texas also should promote property protection efforts to help individuals in the state retrofit their homes against storms. Given that the above recommendations even if they reduce Texans average insurance rates and fiscal liabilities overall are almost certain to raise average insurance rates in some of the states poorest areas, the state should investigate what it can do to help residents of modest means. The best and most cost-effective way to do this, most insurance experts agree, isnt long-term assistance with paying premiums, but, instead, onetime efforts to make homes more resistant against natures worst. This can involve things like roof tie-downs, storm shutters, and garage-door reinforcement, forms of mitigation that reduce likely claims.17 People who live in the most hurricane-prone parts of Texas ought to pay more for insurance, and those higher prices will give them an incentive to retrofit their homes, as retrofitting is one of the few ways to reduce high rates.

17 For one states view, see Florida Office of Insurance Regulation, Premium Discounts for Hurricane Loss Mitigation, www.floir.com/Hurricanes/HurricaneLossMitigation.aspx.

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However, the legislature also should recognize that a policy forcing long-term incumbent homeowners living on below-average fixed incomes to move out of their homes because they are unable to afford homeowners insurance would cause a massive outcry and likely prove the undoing of any free-market reforms. Thus the state should work to provide help for people who need it. Cutting the size of TDI which, as discussed above, appears top-heavy would free up some money that could be used for competitive grants to counties and municipalities that help individuals retrofit homes. Texas also should seek more flexibility in using federal grant funding to promote mitigation. Two programs community development block grants and weatherization assistance funding deserve particular attention in this regard. Texass executive branch should seek permission to use the Community Development Block Grant Program a catch all federal program that is already used to pay for property renovations in certain cases to do mitigation retrofits. In smaller jurisdictions (those with fewer than 100,000 residents) where the state administers CDBG funds, this permission alone could be used to establish a mitigation program. Larger jurisdictions could decide to do the same. Given that most of Texas has reasonably Some sort of property protection warm weather, the state should seek assistance is vital to the effectiveness permission to use funds from the U.S. and acceptance of free-market reforms Department of Energys Weatherization Assistance Program, funding formulas for of the property insurance system. which strongly favor colder-weather states, to pay for items such as roof tie-downs, which save energy and also make a home more hurricane-resistant. Given that these programs are likely to be cut back or, in the case of weatherization assistance, perhaps eliminated altogether, Texas cannot hope to use them to help every person affected by higher insurance rates. But some sort of property protection assistance is vital to the effectiveness and acceptance of free-market reforms of the property insurance system.

Conclusion
Texass property insurance environment has problems. TWIA threatens the states fiscal future, the states system of insurance regulation is dated, and Texass coastal properties are insufficiently protected against natures worst. These problems wont go away by themselves, but the right legislative and executive actions can solve them.

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About the Author Eli Lehrer is vice president for Washington, DC operations of The Heartland Institute, overseeing the DC office and field offices in Tallahassee, Florida and Austin, Texas. He also played a major role in founding smartersafer.org, a coalition of taxpayer, environmental, insurance, and free-market groups dedicated to risk-based insurance rates, mitigation, and environmental protection. He is the coauthor of The Heartland Institute monograph Ten Principles of Property and Casualty Insurance Regulation and editor of Heartlands Seven Big Ideas for Congress and several academic book chapters on emergency management and insurance topics. He holds a B.A. (cum laude) from Cornell University and an M.A. (with honors) from The Johns Hopkins University, where his Masters thesis focused on the Federal Emergency Management Agency and flood insurance. His work has appeared in The New York Times, Washington Post, USA Today, Washington Times, Weekly Standard, National Review, The Public Interest, Salon.com, and other publications. About The Heartland Institute The Heartland Institute is a national nonprofit organization based in Chicago. Founded in 1984, it began as a state-based free-market think tank but soon evolved into a regional and, since 1993, a national organization. Heartland now has policy advisors and supporters in all 50 states. Approximately 120 academics and professional economists participate in its peer review process, and more than 150 elected officials serve on its Legislative Forum. Heartland currently has a full-time staff of 35 and a 2010 budget of $7 million. The Heartland Institute contacts more elected officials, more often, than any other free-market think tank in the United States. According to a telephone survey of randomly selected state and local officials conducted in 2009, 85 percent of state legislators and 63 percent of local officials say they read and rely on Heartland publications. Some 120,000 of the nations most influential people including every state and national elected official receive at least one Heartland publication every month. Heartland also operates PolicyBot, an online clearinghouse for the work of some 350 think tanks and advocacy groups. Heartlands full-time staff of government relations professionals interacts daily with hundreds of elected officials across the country, and its public relations and media specialists help shape public opinion by writing and placing dozens of letters to the editor and opinion editorials each week. For more information, visit our Web site at www.heartland.org, call 312/377-4000, or write to The Heartland Institute, 19 South LaSalle Street # 903, Chicago, Illinois 60603.

2011 The Heartland Institute. Distributed by The Heartland Institute, a nonprofit and nonpartisan public policy research organization. Nothing in this report should be construed as reflecting the views of The Heartland Institute, nor as an attempt to aid or hinder the passage of legislation. Additional copies of this Policy Brief are available for $5.95 from The Heartland Institute, 19 South LaSalle Street #903, Chicago, IL 60603; phone 312/377-4000; fax 312/377-5000; email think@heartland.org; Web www.heartland.org.

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