TITLE insurance

Part I. Texas Department of Insurance

Chapter 5. Property and Casualty Insurance

Subchapter E. Texas Windstorm Insurance Association

The Commissioner of Insurance of the Texas Department of Insurance adopts new §5.4700, concerning rate rollback and rate credits applicable to windstorm and hail insurance policies issued by the Texas Windstorm Insurance Association (Association) for certain new residential construction and certain retro-fitted residential construction in the designated catastrophe areas, without changes to the proposed text published in the December 18, 1998 issue of the Texas Register (23 TexReg 12854). The Commissioner conducted a public hearing on the proposed rule on January 21, 1999, under Docket Number 2396.

Created in 1971 by the Texas Legislature as the Texas Catastrophe Property Insurance Association, the Association is composed of all insurers authorized to transact property insurance in Texas and operates pursuant to Article 21.49 of the Insurance Code. The Texas Legislature in House Bill 1632 (Acts 1997, 75th Legislature, chapter 438, §1, effective September 1, 1997) changed the name of the Texas Catastrophe Property Insurance Association to the Texas Windstorm Insurance Association. The purpose of the Association is to provide windstorm and hail insurance coverage to residents in designated catastrophe areas who are unable to obtain such coverage in the voluntary market. Since its inception, the Association has provided this coverage to residents of 14 coastal counties, including Aransas, Brazoria, Calhoun, Cameron, Chambers, Galveston, Jefferson, Kenedy, Kleberg, Matagorda, Nueces, Refugio, San Patricio and Willacy. The Association also provides coverage to certain designated catastrophe areas in Harris County, including (i) effective March 1, 1996, the area located east of a boundary line of State Highway 146 and inside the city limits of the City of Seabrook and the area located east of the boundary line of State Highway 146 and inside the city limits of the City of La Porte (Commissioner's Order Number 95-1200, November 14, 1995); (ii) effective June 1, 1996, the City of Morgan's Point (Commissioner's Order Number 96-0380, April 5, 1996); and (iii) effective April 1, 1997, in areas located east of State Highway 146 and inside the city limits of the City of Shoreacres and the City of Pasadena (Commissioner's Order Number 97-0225, March 11, 1997). Pursuant to Commissioner's Order Number 97-0626 (June 30, 1997), the Commissioner adopted by reference in §5.4008 of this title the Building Code for Windstorm Resistant Construction (Building Code). The Building Code specifies the applicable building code standards to qualify for coverage from the Association as required by Article 21.49, §6A of the Insurance Code for structures located in designated catastrophe areas which were constructed, repaired, or to which additions are made on and after September 1, 1998, the effective date of the Building Code, adopted by reference in §5.4008(a) pursuant to Commissioner's Order Number 98-0803 (July 8, 1998). The Commissioner adopted on an emergency basis amendments to §5.4008 under Commissioner's Order Number 98-1025, effective September 3, 1998. These amendments were adopted on a permanent basis under Commissioner's Order Number 98-1376, effective December 31, 1998. The legislature in 1997 passed House Bill 3383 which enacted a new §8E in Article 21.49 of the Insurance Code (Acts 1997, 75th Legislature, chapter 1000, §3, effective September 1, 1997). House Bill 3383 specified that the legislature finds that (i) the cost of housing will increase in the first tier coastal counties with the implementation of any new building code imposed under Article 21.49; (ii) increased costs will have a negative effect on economic development for all coastal areas, driving growth further inland where housing is more affordable; (iii) the new building code standards will lower the risk of insurers that write business in the first tier coastal counties; and (iv) legislative action in the public interest and within the police power of the state is required to eliminate the negative impact of new building code standards on consumers through insurance rate reductions. New §8E requires the Commissioner to determine the percentage of equitable across-the-board reductions in insurance rates for policies or coverages that are issued by the Association to cover new residential construction, excluding additions or repairs to existing structures, built to the standards of the Building Code. The Commissioner is to determine these percentage reductions by not later than the 180th day after the date the Building Code is implemented, and if the percentage reductions have not been determined by the 180th day, §8E requires a six percent across-the-board reduction. The new section is necessary to specify the percentage rate rollback required by §8E. In addition, the new section is necessary to provide rate credits applicable to windstorm and hail insurance policies issued by the Association for new residential construction, excluding additions or repairs to existing structures, that have been built to a higher standard of construction than that required by the Building Code, and to provide rate credits applicable to windstorm and hail insurance policies issued by the Association for residential structures constructed prior to September 1, 1998, which have been retro-fitted with exterior opening protections that meet the windborne debris criteria standards of the Building Code or equivalent criteria recognized by the Department pursuant to Building Code procedures. These rate credits provide incentives to encourage coastal residents and coastal builders to build residential structures that are safer and less susceptible to wind damage from hurricanes and thereby not only reduce the cost of insurance but also reduce the loss of property and lives. Such structures will also reduce the amount of insured losses of the Association in the event of a hurricane. The new percentage rate rollback and rate credits were developed according to the following analysis. The estimation of savings under the new building code is based on damage ratios for structures and for contents under the new and old building codes given various severities of storms (categories one through five on the Saffir-Simpson scale). These are based on engineering studies performed by Texas A&M University and are contained in the publication Cost-effectiveness of the New Building Code for Windstorm Resistant Construction Along the Texas Coast, Final Report, by N. Stubbs, et al. The damage ratios, separately for structures and contents, were weighted by the anticipated distributions of storms by Saffir-Simpson category to obtain estimated overall damage ratios under the new and old codes. The ratio of the new code average damage ratios to those under the old code provided estimates of overall savings in losses. The process was repeated twice, once for anticipated distributions of the severity of storms in the Seaward region and once for the Inland II region (more than 25 miles from the coast). The average of the two sets of indications provided estimates of savings for the Inland I region (between the Seaward region and the Inland II region). The initial loss savings estimates were "tempered" (i.e., reduced) by 25% for conservatism. Based on the loss and expense structure of the residential extended coverage benchmark rates for the first tier counties that will become effective on February 1, 1999, and estimates of the hurricane/non-hurricane split of expected losses, the overall loss savings were calculated by applying the tempered savings ratio to the hurricane portion of expected losses in the rate. No savings were anticipated on non-hurricane losses, even though this likely understates overall savings. The fixed expenses underlying the benchmark rate were added to the adjusted expected loss ratio, and the sum was divided by the complement of the variable expense ratio to obtain a relative rate need. The indicated rate rollback and rate credits percentages were equal to one minus the relative rate needs. The loss adjustment expense provision underlying the benchmark rate was considered to be a fixed expense in these calculations (i.e., there would be no loss adjustment expense dollar savings resulting from the new building code), even though there will likely be some savings given that at least some claims may be eliminated because of the reduced damageability of structures built in accordance with the new code. Based on a review of the aforementioned Texas A&M cost-effectiveness study, savings for retro-fitted buildings built prior to the introduction of the new code were selected.

The Department received comments requesting that the Department perform an actuarial review as soon as data is available to determine credible rate reductions and that the Department consider frequent, if not annual, review of the rate rollback and rate credits promulgated in the rule. As sufficient data becomes available, the Department intends to review periodically the amount of the rate rollback and rate credits and to propose changes to the rule in accordance with this periodic review.

For: Texas Association of Builders and City of Corpus Christi. Against: Allstate Insurance Company (comments were withdrawn at the January 21 hearing on the proposal), Office of Public Insurance Counsel, and Texas Insurance Organization. Not in opposition: Texas Windstorm Insurance Association.

Six commenters submitted written comments and/or presented oral comments at the January 21 hearing on the proposal. However, one of the commenters against the proposal withdrew its comments at the January 21 hearing on the proposal.

Comment: One commenter requested that the Department consider frequent, if not annual, reviews of the rate rollback and rate credits promulgated in the rule. Another commenter urged the Department to commit to performing an actuarial review as soon as data is available to determine credible rate reductions.

Response: The Department agrees. As sufficient data becomes available, the Department intends to review periodically the amount of the rate rollback and rate credits and to propose changes to the rule in accordance with this periodic review.

Comment: One commenter stated that although insurance rate reductions benefit new home buyers, the reductions do not come close to offsetting the increase in construction costs required by the new code, and, therefore, the goal of providing affordable housing remains negatively affected by the new code in spite of these reductions.

Response: The Department agrees that the rate reductions may not offset the entire increase in costs for construction that is required by the new building code. The Department believes, however, that the proposed reductions will, at a minimum, offset a large portion of the additional construction costs arising from the new building code. Whether the ultimate savings from the reductions adopted in this rule will be more or less than these additional costs depends on a number of unknown factors, including the actual building costs associated with implementing the new code for a particular property, future changes in the replacement cost of dwellings, and future levels of rates.

Comment: One commenter stated that the proposed reductions are not only larger than anticipated but they are based on significant assumptions without the benefit of the kind of actuarial review that is normally employed in the development of rate and rate credit decisions.

Response: The Department disagrees. The proposed reductions are based on an extensive actuarial review of the sort that is normally employed in the development of rates, rating factors, and discounts or additional charges for new products or coverages where historical insurance statistical data does not exist. All reasonably available data and information were used in the calculations of the proposed reductions, as were reasonable, conservative actuarial assumptions.

Comment: This commenter also stated that the proposal exceeds the 6% reduction mandated by the legislature in Article 21.49, §8E of the Insurance Code, to take effect in the event the Commissioner has not established rate reductions before the 181st day after the date a new building code is implemented. The commenter stated that the 6% reduction is a reasonable measure of legislative intent on the matter.

Response: The Department agrees that the proposed reductions exceed the 6% figure contained in Article 21.49, §8E of the Insurance Code. The Department, however, disagrees that the 6% figure represents legislative intent as to what the reduction should be regardless of what the Commissioner determines is the appropriate reduction. To the Department's knowledge, the 6% figure was not based on any kind of actuarial analysis, and it is the Department's position that the 6% reduction was intended to provide some reduction to homeowners if the Commissioner failed to adopt a reduction. The statute clearly directs the Commissioner to determine a percentage reduction either above or below the 6% stated in §8E based on the evidence adduced in a rulemaking hearing. The data and information and the reasonable, conservative actuarial assumptions used by the Department to calculate the reductions do not support the 6% reduction.

Comment: The commenter also stated the belief that if the proposed reduction is adopted, it will be difficult to adjust the reduction once sufficient data is available.

Response: The Department disagrees. As previously indicated, as sufficient data becomes available, the Department intends to review periodically the reductions to determine if changes need to be made in the adopted rate rollback and rate credits and to propose changes to the reductions in accordance with this periodic review. Also, because the reductions are adopted in a rulemaking hearing under Chapter 2001 of the Government Code (Administrative Procedure Act), the Commissioner may consider changes to the reductions on the Department's motion or upon a petition by an interested person. It is the Department's position that as additional evidence emerges, the rule will be amended to lower or increase the reductions as the experience warrants.

Comment: One commenter argued that several aspects of the calculation of the proposed reductions are too conservative. First, according to this commenter, the fixed and variable expense percentages used by the Department in determining the reductions appear high relative to the Association's actual expenses based on a review of annual statement data. The commenter states that the Association's average expenses as a percentage of earned premium exclusive of statutory fund costs and allocated loss adjustment expenses were about 27% for 1996-97 based on a review of the Association's annual statements. The 27% includes a tax penalty of roughly $1 million paid in 1997. The total fixed and variable expense loading in the staff proposal is just under 29%. According to the commenter, since the Department rightly calculates the hurricane loss ratio as the complement of the expense percentage added to the non-hurricane loss ratio, higher expenses translate into a lower hurricane loss ratio and consequently, a lower indicated discount. Further, according to the commenter, the Department decided to treat allocated loss adjustment expenses (ALAE) as a fixed cost percentage of premium which assumes no impact from the new building code on ALAE, despite the high likelihood of fewer claims.

Response: The Department disagrees in part and agrees in part. The noncommercial rates of the Association are set by statute as a multiple of the extended coverage benchmark rates established by the Commissioner (§8(h)(2) of Article 21.49 of the Insurance Code). These benchmark rates are based on industrywide loss and expense experience, including a provision for underwriting profit which the commenter appears not to have considered. The Department used the underlying components of the benchmark rates effective February 1, 1999 in its calculations. While the Association's expenses are marginally lower than those underlying the benchmark rates, it is not clear from the evidence that this would necessarily translate into proportionately greater expected losses for the Association, especially if some contribution to the Association's catastrophe reserve trust fund were to be considered. As for the treatment of allocated loss adjustment expenses, the Department testified at the January 21 hearing that it held all loss adjustment expenses (not just allocated loss adjustment expenses) constant in its calculations, even though it recognized that this was undoubtedly conservative. It is likely, as the commenter suggests, that some claims would be eliminated entirely because of the new code. The Department believes, however, that given the uncertainties surrounding any pricing of this sort, the Department's conservative approach is reasonable since the proportion of claims that would be eliminated is unknown.

Comment: This same commenter argues that the Department's failure to account for a reduction in non-hurricane losses as a result of the implementation of the stricter building code is unreasonable. Non-catastrophe windstorms and thunderstorms can and do occur, and therefore, according to the commenter, it seems unreasonable to assume there would be no loss reductions when such events occur. The commenter argues that because the designated catastrophe area is not especially hail-prone, much of the non-hurricane losses experienced by policyholders in this area result from tornadoes and wind related damage from severe thunderstorms. The commenter states that clearly such losses will be mitigated or eliminated for many structures complying with the new building code requirements. According to the commenter, an argument could easily be made that loss savings for non-hurricane losses should be proportionally greater than for hurricane losses to the extent that such losses occur due to storms of low relative intensity.

Response: The Department disagrees in part and agrees in part. The Department believes that its decision to assume no savings in non-hurricane losses is reasonable given the nature of the pricing, even though staff did testify at the January 21 hearing that this might well result in an understatement of likely savings. The main difficulty in estimating savings in this area is that little information is readily available on the effect of the new building code on non-hurricane losses likely to be incurred by the Association. For example, the Texas A&M study (Cost-effectiveness of the New Building Code for Windstorm Resistant Construction Along the Texas Coast, Final Report, by N. Stubbs, et al) cited by Department staff in the proposal notice and at the January 21 hearing did not directly consider such losses. As the Department staff testified at the hearing, one could reasonably infer from the savings predicted in the Texas A&M study for Category 1 hurricanes that there would be substantial savings in the case of storms with wind velocities slightly below to somewhat below hurricane strength. It is not clear, however, as to what proportion of Association non-hurricane losses arise from such storms, or even as to the nature of such non-hurricane losses. The Department believes that it is prudent to assume no effect given the overall uncertainties surrounding the determination of the savings. This area can be reexamined in subsequent reviews of the reductions if more evidence becomes available.

Comment: The commenter disagrees with the Department's use of a 25% factor to temper the initial loss savings estimates indicated by the Texas A&M study on damage ratios. According to the commenter, the use of this factor as well as its magnitude is not explained in the hearing notice. The commenter believes that the inclusion of higher than actual expenses in concert with no savings assumed for non-hurricane losses already creates a significant margin of error in favor of insurers, and the commenter, therefore, argues that an additional tempering factor is unnecessary and detrimental to Association policyholders. The commenter proposes an across-the-board elimination of the 25% tempering factor in the calculation of the discounts.

Response: The Department disagrees with the commenter's proposal of an across-the-board elimination of the 25% tempering factor in the calculation of the discounts. The Department was aware of the conservatism in the areas indicated by the commenter when it selected the 25% tempering factor, and, in fact, discussed many of these conservative elements at the January 21 hearing. The 25% figure was selected as being reasonable even with the existence of these other margins for conservatism. It is the Department's position that the methodology used by the Department in determining the rate reductions, including the use of the underlying components of the benchmark rates effective February 1, 1999, for the expense experience, the assumption of no savings in non-hurricane losses, and the 25% tempering factor, results in fair and reasonable rate reductions that are not detrimental to the Association or the Association policyholders. The hearing notice of the proposal published in the December 18, 1998 issue of the Texas Register (23 TexReg 12854) explained the methodology used in determining the proposed reductions and stated that "The initial loss savings estimates were "tempered" (i.e., reduced) by 25% for conservatism. Based on the loss and expense structure of the residential extended coverage benchmark rates for the first tier counties that will become effective on February 1, 1999, and estimates of the hurricane/non-hurricane split of expected losses, the overall loss savings were calculated by applying the tempered savings ratio to the hurricane portion of expected losses in the rate."

Comment: The commenter recommends, as an alternative to the across-the-board elimination of the 25% tempering factor in the calculation of the rate reductions, reducing the tempering factor from 25% to 10% and adjusting the non-hurricane loss ratio. The commenter notes that the Department proposed a 10% tempering factor in calculating the indicated discounts for dwelling large deductibles in 1997. The commenter submitted two exhibits to illustrate this approach. In commenter's Exhibits Nos. 1 and 2, which show the calculation of the overall reduction for seaward structures, the tempering factor is reduced from 25% to 10%, and savings to non-hurricane losses equal to 50% of the tempered savings used by the Department for hurricane losses are reflected. According to the commenter, this alternative makes no adjustments to expense percentages; estimates of loss mitigation for non-hurricane losses are conservative; and a tempering factor is included. This results in a reduction of 35.2% in Exhibit Number 1 compared to the Department's 27.7% reduction. Commenter's Exhibit Number 2 produces an increase in the indicated reduction from 23.7% to 32.8% using the Department's second hurricane ratio scenario. The commenter states that using the average of the two hurricane loss scenarios, as the Department did, to calculate the overall indicated discount yields a reduction of 34% compared to the Department's proposed reduction of 25.7%. The commenter states that it is important to stress that this approach is also conservative.

Response: The Department disagrees with the alternative recommended by the commenter. The Department, while not disputing the accuracy of the commenter's calculations, believes that its own calculations reflect an appropriate degree of conservatism given the uncertainties inherent in the determination of the reductions. The Department disagrees with the use of the 10% tempering factor. The calculation of the large deductible credits differed from the calculation of the building code rate reductions. In the calculation of the large deductible credits, the pricing was based on actual historical insurance claims data, adjusted to various common deductible levels. No such data is available for the building code rate reductions. It is the Department's position, therefore, that greater uncertainty exists in the building code rate reduction calculations, so a larger tempering factor is appropriate. The degree of tempering employed in any actuarial pricing of this sort is ultimately a matter of professional judgment. The degree employed by Department staff is consistent with their experience in similar cases.

Comment: This same commenter argues that it is only fair that the 10% rate credit proposed for certain retro-fitted residential structures be extended to Association policyholders who build additions to existing property or engage in repairs to the existing structure that are subject to the new building code requirements.

Response: The Department disagrees. The 10% rate credit for retro-fitting all exterior openings with protection contemplates a reduction in damage to the interior of the structure based on the premise that it is necessary for all openings to be protected to eliminate the exposure of flying debris. The building of additions to existing structures in compliance with the new building code and the repair of existing structures in compliance with the new building code will not result in all of the exterior openings of a home being protected, and therefore, there may still be substantial exposure of flying debris. It is the Department's position that the building of additions to existing structures in compliance with the new building code and the repair of existing structures in compliance with the new building code without retro-fitting all of the exterior openings in the remainder of the structure in compliance with the new building code would not change the loss exposure in a significant enough manner to warrant any rate credit. A single weak link in protection for flying debris nullifies the effectiveness of those exterior openings that are protected.

Comment: The commenter also recommended that in instances where very substantial repairs are made to a structure, such as repairs exceeding 50% of the structure's insured value, that the rebuilt property be eligible for the applicable discount adopted for new construction.

Response: The Department disagrees. The rate reductions for new structures contemplate a reduction in damage to the entire structure itself as well as to the interior of the structure. It is the Department's position that unless the entire structure, including all exterior openings, are built in compliance with the new building code, there will not be a significant enough change in the loss exposure to warrant a rate credit. The parts of a structure that are not built in compliance with the new building code would nullify the effectiveness of those parts that are built in compliance with the new building code.

The new section is adopted pursuant to the Insurance Code, Articles 21.49 and 1.03A, and in accordance with the Government Code, §§2001.004-2001.038. Pursuant to Article 21.49, §8E of the Insurance Code (Acts 1997, 75th Legislature, chapter 438, §1, effective September 1, 1997), the Commissioner shall hold a rulemaking hearing under Chapter 2001, Government Code, to determine the percentage of equitable across-the-board reductions in insurance rates required for windstorm and hail insurance coverage written by the Association for new residential construction, excluding additions or repairs to existing structures, built to the standards of a new building code. Article 21.49, §5A provides that after notice and hearing, the Commissioner may issue any orders considered necessary to carry out the purposes of Article 21.49 (Texas Windstorm Insurance Association Act), including, but not limited to, maximum rates, competitive rates, and policy forms. It is the position of the Department that the proposed rate credits for new residential construction built to higher standards than required by the Building Code (proposed subsection (d)) and the proposed rate credits for certain retro-fitted residential structures (proposed subsection (e)) are necessary to encourage coastal residents to build safer residential structures that are less susceptible to wind damage from hurricanes and that this goal is consistent with the purposes of Article 21.49. Article 21.49, §5A, by its terms, delegates the foregoing authority to the State Board of Insurance. However, under Article 1.02 of the Insurance Code, a reference in the Insurance Code or another insurance law to the State Board of Insurance means the Commissioner of Insurance or the Texas Department of Insurance, as consistent with the respective powers and duties of the Commissioner and the Department under Article 1.02. Article 1.03A authorizes the Commissioner of Insurance to adopt rules and regulations, which must be for general and uniform application, for the conduct and execution of the duties and functions of the Texas Department of Insurance only as authorized by statute. The Government Code, §§2001.004-2001.038 (Administrative Procedure Act), authorizes and requires each state agency to adopt rules of practice stating the nature and requirements of available formal and informal procedures and prescribe the procedures for adoption of rules by a state agency.

This agency hereby certifies that the adoption has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority.

Filed with the Office of the Secretary of State on February 5, 1999.

TRD-9900775

Lynda H. Nesenholtz

General Counsel and Chief Clerk

Texas Department of Insurance

Effective date: February 25, 1999

Proposal publication date: December 18, 1998

For further information, please call: (512) 463-6327