Tag Archives: catastrophe

When Nature Calls: the Need for New Models

The Earth is a living, breathing planet, rife with hazards that often hit without warning. Tropical cyclones, extra-tropical cyclones, earthquakes, tsunamis, tornados and ice storms: Severe elements are part of the planet’s progression. Fortunately, the vast majority of these events are not what we would categorize as “catastrophic.” However, when nature does call, these events can be incredibly destructive.

To help put things into perspective: Nearly 70% (and growing) of the entire world’s population currently lives within 100 miles of a coastline. When a tropical cyclone makes landfall, it’s likely to affect millions of people at one time and cause billions of dollars of damage. Though the physical impact of windstorms or earthquakes is regional, the risk associated with those types of events, including the economic aftermath, is not. Often, the economic repercussions are felt globally, both in the public and private sectors. We need only look back to Hurricane Katrina, Super Storm Sandy and the recent tsunamis in Japan and Indonesia to see what toll a single catastrophe can have on populations, economies and politics.

However, because actual catastrophes are so rare, property insurers are left incredibly under-informed when attempting to underwrite coverage and are vulnerable to catastrophic loss.

Currently, insurers’ standard actuarial practices are unhelpful and often dangerous because, with so little historical data, the likelihood of underpricing dramatically increases. If underwriting teams do not have the tools to know where large events will occur, how often they will occur or how severe they will be when they do occur, then risk management teams must blindly cap their exposure. Insurers lacking the proper tools can’t possibly fully understand the implications of thousands of claims from a single event. Risk management must place arbitrary capacity limits on geographic exposures, resulting in unavoidable misallocation of capital.

However, insurers’ perceived success from these arbitrary risk management practices, combined with a fortunate pause in catastrophes lasting multiple decades created a perfect storm of profit, which lulled insurers into a false sense of security. It allowed them to grow to a point where they felt invulnerable to any large event that may come their way. They had been “successful” for decades. They’re obviously doing something right, they thought. What could possibly go wrong?

Fast forward to late August 1992. The first of two pivotal events that forced a change in the attitude of insurers toward catastrophes was brewing in the Atlantic. Hurricane Andrew, a Category 5 event, with top wind speeds of 175 mph, would slam into southern Florida and cause, by far, the largest loss to date in the insurance industry’s history, totaling $15 billion in insured losses. As a result, 11 consistently stable insurers became insolvent. Those still standing either quickly left the state or started drastically reducing their exposures.

The second influential event was the 1994 earthquake in Northridge, CA. That event occurred on a fault system that was previously unknown, and, even though it measured only a 6.7 magnitude, it generated incredibly powerful ground motion, collapsing highways and leveling buildings. Northridge, like Andrew, also created approximately $15 billion in insured losses and caused insurers that feared additional losses to flee the California market altogether.

Andrew and Northridge were game changers. Across the country, insurers’ capacity became severely reduced for both wind and earthquake perils as a result of those events. Where capacity was in particularly short supply, substantial rate increases were sought. Insurers rethought their strategies and, in all aspects, looked to reduce their catastrophic exposure. In both California and Florida, quasi-state entities were formed to replace the capacity from which the private market was withdrawing. To this day, Citizens Property Insurance in Florida and the California Earthquake Authority, so-called insurers of last resort, both control substantial market shares in their respective states. For many property owners exposed to severe winds or earthquakes, obtaining adequate coverage simply isn’t within financial reach, even 20 years removed from those two seminal events.

How was it possible that insurers could be so exposed? Didn’t they see the obvious possibility that southern Florida could have a large hurricane or that the Los Angeles area was prone to earthquakes?

What seems so obvious now was not so obvious then, because of a lack of data and understanding of the risks. Insurers were writing coverage for wind and earthquake hazards before they even understood the physics of those types of events. In hindsight, we recognize that the strategy was as imprudent as picking numbers from a hat.

What insurers need is data, data about the likelihood of where catastrophic events will occur, how often they will likely occur and what the impact will be when they do occur. The industry at that time simply didn’t have the ability to leverage data or experience that was so desperately needed to reasonably quantify their exposures and help them manage catastrophic risk.

Ironically, well before Andrew and Northridge, right under property insurers’ noses, two innovative people on opposite sides of the U.S. had come to the same conclusion and had already begun answering the following questions:

  • Could we use computers to simulate millions of scientifically plausible catastrophic events against a portfolio of properties?
  • Would the output of that kind of simulation be adequate for property insurers to manage their businesses more accurately?
  • Could this data be incorporated into all their key insurance operations – underwriting, claims, marketing, finance and actuarial – to make better decisions?

What emerged from that series of questions would come to revolutionize the insurance industry.

The Traps Hiding in Catastrophe Models

Catastrophe models from third-party vendors have established themselves as essential tools in the armory of risk managers and other practitioners wanting to understand insurance risk relating to natural catastrophes. This is a welcome trend. Catastrophe models are perhaps the best way of understanding the risks posed by natural perils—they use a huge amount of information to link extreme or systemic external  events to an economic loss and, in turn, to an insured (or reinsured) loss. But no model is perfect, and a certain kind of overreliance on the output from catastrophe models can have egregious effects.

This article provides a brief overview of the kinds of traps and pitfalls associated with catastrophe modeling. We expect that this list is already familiar to most catastrophe modelers. It is by no means intended to be exhaustive. The pitfalls could be categorized in many different ways, but this list might trigger internal lines of inquiry that lead to improved risk processes. In the brave new world of enterprise risk management, and ever-increasing scrutiny from stakeholders, that can only be a good thing.

1. Understand what the model is modeling…and what it is not modeling!

This is probably not a surprising “No. 1” issue. In recent years, the number and variety of loss-generating natural catastrophes around the world has reminded companies and their risk committees that catastrophe models do not, and probably never will, capture the entire universe of natural perils; far from it. This is no criticism of modeling companies, simply a statement of fact that needs to remain at the front of every risk-taker’s mind.

The usual suspects—such as U.S. wind, European wind and Japanese earthquake—are “bread and butter” peril/territory combinations. However, other combinations are either modeled to a far more limited extent, or not at all. European flood models, for example, remain limited in territorial scope (although certain imminent releases from third-party vendors may well rectify this). Tsunami risk, too, may not be modeled even though it tends to go hand-in-hand with earthquake risk (as evidenced by the devastating 2011 Tohoku earthquake and tsunami in Japan).

Underwriters often refer to natural peril “hot” and “cold” spots, where a hot spot means a type of natural catastrophe that is particularly severe in terms of insurance loss and is (relatively) frequent. This focus of modeling companies on the hot spots is right and proper but means that cold spots are potentially somewhat overlooked. Indeed, the worldwide experience in 2011 and 2012 (including, among other events, a Thailand flood, an Australian flood and a New Zealand earthquake) reminded companies that so-called cold spots are very capable of aggregating up to some significant levels of insured loss. The severity of the recurrent earthquakes in Christchurch, and associated insurance losses, demonstrates the uncertainty and subjectivity associated with the cold spot/ hot spot distinction.

There are all sorts of alternative ways of managing the natural focus of catastrophe models on hot spots (exclusions, named perils within policy wordings, maximum total exposure, etc.) but so-called cold spots do need to remain on insurance companies’ risk radars, and insurers also need to remain aware of the possibility, and possible impact, of other, non-modeled risks.

2. Remember that the model is only a fuzzy version of the truth.

It is human nature to take the path of least resistance; that is, to rely on model output and assume that the model is getting you pretty close to the right answer. After all, we have the best people and modelers in the business! But even were that to be true, there can be a kind of vicious circle in which model output is treated with most suspicion by the modeler, with rather less concern by the next layer of management and so on, until summarized output reaches the board and is deemed absolute truth.

We are all very aware that data is never complete, and there can be surprising variations of data completeness across territories. For example, there may not be a defined post or zip code system for identifying locations, or original insured values may not be captured within the data. The building codes assigned to a particular risk may also be quite subjective, and there can be a number of “heroic” assumptions made during the modeling process in classifying and preparing the modeling data set. At the very least, these assumptions should be articulated and challenged. There can also be a “key person” risk, where data preparation has traditionally resided with one critical data processor, or a small team.  If knowledge is not shared, then there is clear vulnerability to that person or team leaving. But there is also a risk of undue and unquestioning reliance being placed upon that individual or team, reliance that might be due more to their unique position than to any proven expertise.

What kind of model has been run? A detailed, risk-by-risk model or an aggregate model? Certain people in the decision-making chain may not even understand that this could be an issue and simply consider that “a model is a model.”

It is worth highlighting how this fuzzy version of the truth has emerged both retrospectively and prospectively. Retrospectively, actual loss levels have on occasion far exceeded modeled loss levels: the breaching of the levies protecting New Orleans, for example, during Hurricane Katrina in 2005. Prospectively, new releases or revisions of catastrophe models have caused modeled results to move, sometimes materially, even when there is no change to the actual underlying insurance portfolio.

3. Employ additional risk monitoring tools beyond the catastrophe model(s). 

Catastrophe models are a great tool, but it is dangerous to rely on them as the only source of risk management information, even when an insurer has access to more than one proprietary modelling package.

Other risk management tools and techniques available include:

  • Monitoring total sum insured (TSI) by peril and territory
  • Stress and scenario testing
  • Simple internal validation models
  • Experience analysis

Stress and scenario testing, in particular, can be very instructive because a scenario yields intuitive and understandable insight into how a given portfolio might respond to a specific event (or small group of events). It enjoys, therefore, a natural complementarity with the hundreds of thousands of events underlying a catastrophe model. Furthermore, it is possible to construct scenarios to investigate areas where the catastrophe model may be especially weak, such as consideration of cross-class clash risk.

Experience analysis might, at first glance, appear to be an inferior tool for assessing catastrophe loss. Indeed, at the most extreme end of the scale, it will normally provide only limited insight. But catastrophe models are themselves built and given parameters from historical data and historical events. This means that a quick assessment of how a portfolio has performed against the usual suspects, such as, for U.S. exposures, hurricanes Ivan (2004), Katrina (2005), Rita (2005), Wilma (2005), Ike (2008) and Sandy (2012), can provide some very interesting independent views on the shape of the modeled distribution. In this regard, it is essential to tap into the underwriting expertise and qualitative insight that the property underwriters can bring to risk assessment.

4. Communicate the modeling uncertainty.

In light of the inherent uncertainties that exist around modeled risk, it is always worth discussing how to load explicitly for model and parameter risk when reporting return-period exposures, and their movements, to senior management. Pointing out the need for model risk buffers, and highlighting that they are material, can trigger helpful discussions in the relevant decision-making forums. Indeed, finding the most effective way of communicating the weaknesses of catastrophe modeling, without losing the headline messages in the detail and complexity of the modeling steps, and without senior management dismissing the models as too flawed to be of any use, is sometimes as important for the business as the original modeling process.

The decisions that emerge from these internal debates should ultimately protect the risk carrier from surprise or outsize losses. When they happen, such surprises have a tendency to cause rapid loss of credibility from outside analysts, rating agencies or capital providers.

Claims In A Catastrophe, Part 2

This is Part 2 of a two-part series on claims management in the wake of a disaster. Part 1 of this series can be found here.

Protect All Property From Further Damage
Every policy requires that the insured protect the property from further loss. Therefore, you should turn off any water flow to broken appliances or pipes, arrange to have openings in roofs or walls covered to protect from rain damage, and seek help from the adjuster to further protect your property from losses of all types.

Take any necessary emergency measures to protect the building and personal property from any further damage. Do not throw anything away until permission of the insurance company is obtained in writing and you have documented its condition unless the damaged property presents a hazard to the health or safety of your family or others.

If the insurer delays or refuses to authorize measures to prevent further loss, confirm the insurer’s delay in a fax, email, and a letter, and take whatever reasonable measures you can afford to protect the property. If your loss is covered, the insurance company should also cover the cost of any reasonable emergency measures you took to protect your property. It is not unusual for an insurer to deny coverage for damage resulting after the initial claim on the grounds that an insured failed to comply with the policy condition to protect the property from further damage.

Document The Loss
If you were prudent and prepared, before the catastrophe, an inventory of your contents or took pictures of your contents, provide the adjuster with the inventory and photographs or videotape. Photograph, videotape, and inventory all damaged property after the loss. Make sure you record the date of the photos and videotape. It is important to document the source and the extent of damage whether by fire or water intrusion.

In most states, a material misrepresentation, concealment, or omission made in connection with the claim will give the insurer a valid reason to reject the entire claim. For example, claiming that an item was destroyed that really wasn’t or substantially overstating the value of a damaged item is fraud. In most states insurance fraud is a felony that can place you in state prison if convicted.

No catastrophe is so bad as to cause you to attempt to defraud your insurer to make up for uninsured losses. You should never exaggerate, speculate, or guess about the loss or value of any particular piece of property. Make it clear to your insurer when recollection may not be accurate, when you are estimating value, and the basis for your estimate. For the value of items you are not sure about on a claim presentation, use the phrase “To Be Determined.” If you do not have receipts to show the price of an item, information can be found in catalogs, statements from retail clerks, bank statements, credit card statements, or statements from family members or friends.

If all else fails, a formal appraisal can be obtained from a professional personal property appraiser. Save this as a last resort, since the insurer will usually refuse to reimburse you for the costs of hiring an appraiser, but may hire one at no cost to you if asked courteously.

You Must Cooperate With The Insurance Company’s Investigation And Handling Of The Claim
You have a contractual obligation to cooperate with the insurer in its investigation and handling of the claim. However, you never have an obligation to allow yourself to be abused. In most states the insured and the insurance company have a mutual obligation to act in good faith and deal fairly with each other to investigate and process the claim. This means that both should avoid taking any unreasonable position or doing or saying anything that would in any way frustrate each other’s rights under the policy.

The insurer may require one or more recorded statements from you. Always request a copy of the recording and a transcript of the statement to review. You have a right to review and correct the transcript of any recorded statement.

You may also be required to appear for an “Examination Under Oath” (EUO). The insurer may, but is not required to, hire an attorney to take the Examination Under Oath to represent the insured. Since a lawyer is not required, however, the insurer will not pay for the attorney that is representing you. The Examination Under Oath is a contractual obligation and there is usually no clause in the insurance policy promising to pay a lawyer to help the insured make a claim against an insurer. You should not appear for an Examination Under Oath until you understand all rights, the insurance coverage, and the full extent of the claim, or until counsel is retained. Do not refuse to appear at an Examination Under Oath or the insurer may reject the claim because such refusal is a breach of a material condition of the policy. You may reasonably request a delay in appearance at an Examination Under Oath to obtain the services of counsel or a public insurance adjuster.

The insurer may ask you to make available various documents related to the claim, including banking statements, investment reports, receipts, and other personal financial documents. You are required to produce any documentation reasonably related to the insurer’s investigation of the claim that can include tax returns. In some states, tax returns are considered privileged and the insured cannot be compelled to produce them, while in other states the failure to produce tax returns is sufficient cause to deny the claim. [See Barry Zalma, Insurance Claims: A Comprehensive Guide, (Specialty Technical Publishers, 2002): Chapter II-5.]

The insurer can require you to produce these kinds of documents as long as they are reasonably related to its investigation. You should not provide these documents to the insurer until you understand the rights, duties, and obligations imposed by the insurance coverage and the full extent of the claim. You should never refuse to produce documents unreasonably since the requirement for document production is a condition precedent to the insurer’s obligation to provide a defense and/or indemnity to you.

Proof Of Loss Requirement
Most first party property policies require that you submit a sworn proof of loss form to the insurer within a certain amount of time, either after the loss or after being provided the proof of loss form. During a catastrophe, especially when total losses are involved, insurers will often waive this requirement.

Flood insurance policies require the proof of loss within sixty days of the loss and are applied in a draconian fashion. If you cannot produce a proof of flood loss within 60 days of the loss, obtain an extension of time, in writing from the adjuster, or you will lose all rights under the policy to indemnity.

In most states you are contractually obligated to submit the sworn proof of loss within the time limit (usually 60 days from the date of request), or at least to substantially comply with the requirement, unless the insurer agrees to dispense with the sworn proof of loss or extend the time. You should not submit the sworn proof of loss to the insurer until you understand all of the rights and obligations imposed by the policy, the insurance coverages, and the full extent of the claim. It is not unusual for an insurer to consider mistakes in the sworn proof of loss (since they are sworn to under oath) as intentional misrepresentations sufficient to allow it to reject coverage for a claim. A statement made under oath cannot, by definition, contain an innocent misrepresentation. Never sign a sworn proof of loss, even if your lawyer or professional public insurance adjuster prepares it, until you have carefully read every word and are certain that the statements made are true.

Some insurers believe that, at some point, you will refuse to comply with their requests. If you refuse to comply with reasonable requests for a recorded statement, an Examination Under Oath, a sworn proof of loss, or documents reasonably related to the insurer’s investigation, you may give the insurer a valid excuse to deny the claim based on your breach of the duty to cooperate.

If you believe that any requests made by the insurer are unreasonable, ask the insurer to explain the reason(s) for the requests in writing. Err on the side of caution and provide all documents that have some reasonable connection to the policy or loss. Before giving an insurer a reason to deny a claim because of your failure to cooperate, consult with a policyholder attorney, a public adjuster, or the state Department of Insurance before refusing a request that may, in retrospect, turn out to have been reasonable.

Get A Second Opinion
Many insureds believe that insurers make a practice of making inadequate (sometimes called “lowball”) offers of settlement. They are wary of what they think are estimates from insurance-company-friendly contractors. Whether true or not, it is a good practice to get a second, or even a third, written estimate to repair and replace damaged property from reputable, independent professionals that you would hire to do the repairs if there was no insurance.

You are entitled to have the damaged property replaced with “like kind and quality.” This means that you should insist that the amount determined to be the amount of loss is sufficient to replace the property with property of like kind and quality to the damaged property. When you cannot match the remaining undamaged tile, wallpaper, carpeting, or other portions of undamaged property, you are usually entitled to have the entire “line of sight” replaced to match. For example, if a broken water pipe destroys the hardwood floor in a kitchen and does no damage to the contiguous hardwood floor in the adjoining family room, the insurer is required to replace both the damaged and undamaged floors so that they match as long as they are in a continuous line of sight.

Some losses are paid on an actual cash value (ACTUAL CASH VALUE) basis, which in some states means either the fair market value of the property at the time of loss unless the policy defines ACTUAL CASH VALUE differently. Many policies will define ACTUAL CASH VALUE as replacement cost less physical depreciation for age and wear and tear.

Some losses are paid out on a replacement cost value (REPLACEMENT COST VALUE), where the insured is paid the difference between actual cash value and replacement cost value after the insured has actual sums necessary to complete the replacement.

You may collect the ACTUAL CASH VALUE loss immediately and advise the insurer you intend to make claim for the difference between ACTUAL CASH VALUE and REPLACEMENT COST VALUE when the structure is rebuilt. If your policy has a time-limit for rebuilding be sure to get a written extension of time since, after a catastrophe, the rebuilding process is often severely delayed.

When fire and water-damage reconstruction contractors write estimates for insurance companies they always add at the end of their estimate a sum equal to 10% of the basic contract price for “overhead,” and an additional 10% of the basic contract price for “profit.”

This technique is a fiction believed only by contractors and adjusters. Knowledgeable construction people know that no contractor could survive on 10% profit and that contractors build overhead and profit into their basic unit costs (paint, plaster, roofing, etc) and add the “profit and overhead” numbers as a fee for the extra service they provide to insurers.

In recent years, some insurers have attempted to withhold 20%, an amount equal to the contractor’s “profit and overhead” numbers to arrive at an ACTUAL CASH VALUE amount. There is no basis in the policy that allows withholding profit and overhead as a means of calculating ACTUAL CASH VALUE. In fact, ACTUAL CASH VALUE is defined either as the difference in the fair market value of the property before the loss and the fair market value of the property after the loss or the full cost of replacement using like kind and quality, less physical depreciation.

You should insist that any amounts withheld from payment pending completion of the work, be documented in writing and justified by the adjuster objectively. Policyholder attorneys and some insurance regulators have successfully prevented insurers from withholding these amounts.

Investigate Contractors
Thoroughly investigate the qualifications, license, and references of your insurance company’s approved contractor before agreeing to hire them to perform the repairs. The State Contractors Licensing Board will usually provide the consumer, by telephone or over the Internet, with the contractor’s license status and history of discipline. At a minimum, the licensing entity and a reference should be checked before a contract is signed. You do not have to use consultants or contractors recommended or approved by the insurer to perform repairs. Approved contractors are typically contractors who have agreed to discount their labor and costs and follow insurer guidelines in exchange for a volume of business from the insurance company. If your insurer promises to guarantee the approved contractor’s work, the guarantee is generally limited to replacing any defective materials or correcting faulty workmanship. The insurer is not insuring against any contractor delays, negligence, or liability. Accordingly, do not use the approved contractor unless it is a contractor that you would independently hire to do the work after a thorough screening. Check that each contractor’s license is valid and for any complaints against the license. Ensure that the contractor is bonded and insured.

Seek Proper Legal Advice
Never sign a release, waiver, indemnity, or “hold harmless” agreement without proper legal advice. If the insurer, adjuster, consultant, or contractor asks you to sign a release, waiver, indemnity, or hold harmless agreement, ask them to explain why in writing. These kinds of agreements can be used to deprive an insured of rights and benefits and may obligate you to pay thousands of extra dollars for issues that arise. Consult a policyholder attorney to determine your rights before signing any such agreement.

Seek professional help, if needed. If you reach an impasse with the insurer, document the dispute fully in writing. Explain your position and why the insurance company’s position is unreasonable. If the dispute does not require legal advice, you may be able to resolve it by calling your state’s Department of Insurance or by hiring a lawyer or public adjuster. If the dispute does require legal advice, contact a lawyer who is experienced and specializes in representing policyholders. There are many consultants who claim to be “insurance claims experts” who do not have adequate training, skill, or experience. Before you retain one, investigate the person diligently by contacting licensing bodies and references.

Be Aware Of Deadlines
Make sure you know all the deadlines that may cut off the right to file a lawsuit. California has a four-year statute of limitations for breaches of written contracts but most insurance policies require suit within one or two years of the loss or the denial of a claim. If your claim is denied, seek legal advice promptly.

In most states the insurance company is required to tell you, in writing, that the claim is denied, and that the limitations clock is running. That is, if you disagree with the insurer’s conclusion to deny your claim you have a limited time to file suit. Make sure you understand all possible deadlines. Consult with a policyholder attorney as soon as possible. The time limitation can be as short as one year from the date the loss occurred and can be put on hold by actions of the insurer. If you wish to sue, it is best to contact counsel as soon as possible before the expiration of the time limit.

Report all Unfair Claims Handling to the Department of Insurance or an Insurance Regulator
The state Insurance Department tracks policyholder complaints about their insurers and compiles the results. Most states have proactive consumer advocates in their insurance departments who will jump in to help you if they believe the insurer is not treating you fairly.

Conclusion
Many insurers involved in catastrophes provide their adjusters with policy limits authority and instruct the adjuster to be generous. If your house was one of those totally destroyed and coverage is available, there is a good probability that you will receive the full policy limits immediately.

If you did not carry sufficient insurance to totally rebuild your house and replace your contents consider the acquisition of a factory built home which can be trucked to your site and completed, with all appliances included, for much less than a conventionally constructed home.
Almost all claims will be handled promptly and fairly. A person knowledgeable about insurance claims can better deal with an insurance company. Don’t take advantage of your insurer and don’t let an insurer take advantage of you. You are entitled to indemnity. You and your insurer should work together to make you whole.

This article is adapted from Barry Zalma’s book, “Insurance Claims: A Comprehensive Guide” and his book “Mold: A Comprehensive Claims Guide” published by Specialty Technical Publishers, Vancouver, BC, Canada; 800-251-0381; http://www.stpub.com.

Claims In A Catastrophe, Part 1

This is Part 1 of a two-part series on claims management in the wake of a disaster. Part 2 in the series can be found here.

Presenting a Claim
If your house was damaged or destroyed by fire, windstorm, or flood as a result of state declared catastrophes and you had a fire, homeowners, flood insurance, tenant's homeowners or condominium policy, you will be dealing with an insurance adjuster. You should recognize that dealing with an insurance adjuster in a catastrophe is usually fairly easy because of the number of claims the adjuster is required to deal with in a short time.

Insurers will be in a very generous mood. They will be seeking good publicity by taking care of victims of the catastrophe quickly and fairly. To make the claims process go easily, the insured person must understand that both the insured and the adjuster have duties when damage caused by fire, windstorm, flood or other insured perils are discovered. The following list outlines the most important of these duties:

  1. You should be sure there is no unnecessary delay in reporting the fact of the discovery of damage to your insurer as a claim.
  2. You and the adjuster should establish that there is no unnecessary delay in responding to any fire, fire fighting, flood or water-related cause of loss where “mold” may result as a natural result of water, warmth, and existence of mold spores in all building.
  3. You may be asked to sign a non-waiver agreement.
  4. You may receive a reservation of rights letter advising you of your duties under the policy, the conditions that apply or might apply, and the exclusions that may apply to the facts of the loss.
  5. You, as the insured, should readily, and without objection, sign the non-waiver agreement or accept the reservation of rights as an expression of the status quo.
  6. The adjuster should remind you, as part of the reservation of rights letter and explanation of the duties of the insured, to preserve and protect the damaged property and to mitigate the loss with due diligence and dispatch.
  7. You can request from the adjuster the identity of respected, competent, and professional contractors experienced in fire reconstruction or the drying out of buildings and the prevention or restriction of further loss including mold growth.
  8. You should follow up regularly with the adjuster to ensure that he or she is meeting contractual obligations since a catastrophe often makes communications difficult.
  9. If you have failed to protect the property from further loss, the adjuster must remind you, in writing, of your failure and how that could effect your claim.
  10. The adjuster should consider advance payments to avoid any unnecessary difficulties so that you and your family will have a place to live while your house is being rebuilt.

    1. If your house is destroyed, you can expect an advance of $10,000 to $20,000 to carry you over.
    2. Even if your house was not damaged, you are entitled to additional living expense payments if you were ordered out of your house by the state government, federal government, Homeland Security, or the local fire department.
    3. Remember that additional living expense coverage does not pay all of your post loss expenses, only those over and above your normal expenses.

Insurance claims require personal attention to detail by the insured. You and the adjuster must meet in person. If the claim is to be resolved expeditiously and fairly, both you and the adjuster should work to establish a personal relationship and to resolve, if coverage is available, the problems caused by the damage to the dwelling or business structure.

Once the rights, obligations, and duties of the insured and the insurer have been stated, and the initial investigation is complete, the insurer is obligated to conduct a prompt analysis of the policy wording and the law to determine whether coverage exists for the damage claimed. Once the investigation is complete and the decision made, it is the adjuster’s obligation to advise you, promptly and in detail, of the decision of the insurer. If coverage is available, it is also the obligation of the adjuster to advise you of your duties and obligations to obtain complete indemnity from the insurer and to protect the property from further loss.

The Notice Of Loss
If you believe that your property was damaged or destroyed by a peril insured by your policy, you should call or write the insurance agent, broker or insurer immediately (or as soon as practical) to report your claim. Follow up the phone call with a fax, an email, and a letter. If the house was not destroyed but a great deal of fire fighting water or subsequent rain or flood water entered the property, try to get a remediation team into the home or business within the first 48 hours to begin drying out the property. If you do not know one, ask your insurer for a referral. This is crucial to preventing or containing mold growth and rot.

If the agent, insurance company, independent adjuster, or restoration company delays the claim, follow up with a fax, an email, and a letter confirming their delay in responding. It would be helpful to send copies of the follow-up letters to the consumer protection unit of the state’s Department of Insurance. Take detailed notes of every conversation, including the name, company, phone number, address, and job title of every insurance adjuster, representative, consultant, and contractor you deal with. Confirm all agreements in writing and insist that appointments and deadlines be honored. Keep a log of all notes and letters and ask for and keep business cards from everyone involved in your claim.

Immediately after the telephone call, write a letter to the broker or agent, with a copy to the insurer, providing the same information. The letter need not be formal. It can be handwritten on any available paper. Make a photocopy.

The notice of loss should include the following information:

  • Your full name.
  • The location of the property.
  • The policy number.
  • The effective dates of the policy.
  • The date when damage first occurred.
  • The type of property damage.
  • The cause or causes of the damage.
  • How the adjuster can contact you.
  • That you need immediate contact from the adjuster.

By providing the information to the agent, the broker and/or the insurer, you have fulfilled the first obligation under the policy: to provide immediate notice of loss to the insurer.

If the insurer is working effectively and has a catastrophe team of adjusters in place, you should receive contact from an adjuster within 24 hours of the notice. The first call should arrange an appointment to inspect the property. You should arrange for inspection as soon as possible and have the entire property available for the inspection if possible. If emergency efforts are required, you should so advise the adjuster so that he or she can help you take emergency measures to protect against further loss.

If possible, you or the adjuster should arrange to have one or more contractors present at the first meeting to determine the extent of the damage. If the damage is extensive, consider retaining the services of a public insurance adjuster [if you determine a public insurance adjuster would be helpful, it is appropriate to seek one who is a member of the National Association of Public Insurance Adjusters (NAPIA), a professional membership organization that seeks to instill professionalism in the trade] or an attorney experienced in representing policyholders in the claims process to represent your interest. The lawyer will usually work on an hourly fee basis while the public insurance adjuster will expect a percentage of the amount paid by the insurer. You must recognize that the public insurance adjuster will ask for a 10 – 15% negotiable fee. Do not hesitate to negotiate with the public insurance adjuster. Never pay the first fee quoted. Considering the volume of work in a catastrophe, you should be able to negotiate a fee between 3% and 10%.

Insurance Company Response
Your insurer should respond to typical catastrophe claims by written or verbal contact within 24 hours of your notice of the claim. The insurer should share information regarding emergency repairs, additional living expenses, temporary advance payments and prevention of further loss with you.

Your insurer should, and in California is obligated to, advise you of your responsibilities under the policy. Many require their representatives to be at your home within 24 to 72 hours of notice of claim. If you explain that your fire loss is severe, the insurer should attempt to have a representative at your house within 24 hours.

The insurer is obligated by statute, state administrative regulations, or by the terms of the policy to determine whether your claim is covered and provide an initial estimate of damage within seven to 14 days after the insurer’s first on-site visit. This first estimate is subject to change. Within the same time frame, your insurer should attempt to provide you with a written statement confirming or denying coverage. These time limits are usually waived in catastrophes and may be impossible to meet with regard to Hurricane Katrina event and other massive catastrophes.

You should expect your insurer to return all phone calls within 24 hours. Initial contact may be with your insurance agent or broker or a claims office or the toll-free phone number included in the policy. Because of the volume of claims after a catastrophe like those in the 2005 hurricane season and the 2008 California wildfire season, this time frame will probably not be feasible.

First Contact With The Adjuster
Your first contact with the adjuster is usually an informative meeting where you discuss the cause of the loss, the type of loss, when the loss was discovered, and make an initial effort to agree on a tentative scope of loss.

You should expect the adjuster to do the following:

  1. ask for a walk-through inspection of the entire dwelling or building.
    1. You should make every effort to point out each item of damage or suspected damage during the walk-through inspection.
    2. You, or your representative, should assist the adjuster in viewing both the damage and the source of the damage.
  2. ask you to submit to a recorded statement;
  3. ask you for the identities of each family member or vendor who can give the adjuster information about the loss;
  4. ask for the recorded statements of the persons identified;
  5. ask permission to allow experts retained by the insurer to inspect the property and do minor destructive testing to establish the appropriate methods of reconstruction and repair; and,
  6. ask permission to contact others who know information about the loss and to obtain from those people within your control a detailed recorded statement and documents relating to their knowledge of the loss and the extent of the loss.

First Meeting With The Adjuster
An adjuster is a person professionally trained to assess the damage to your property. He or she will probably visit your home or business before you are asked to complete any forms. The more information you have about your damaged home or business and belongings, the sooner your claim will be settled.

Your adjuster generally will come prepared to do a thorough and complete evaluation of the damage to your property. If the adjuster is unable to complete a thorough inspection due to time constraints or the extent of damage, he or she should prepare a scope of the loss report. This is a brief listing of the findings of damage determined at the initial inspection of the damage. The adjuster should ask you to agree to the scope of loss. Agreeing to a scope of loss is not presenting a claim. It is understood by the adjuster that the scope is incomplete and will be added to as new damage is discovered. It is usually supplemented with a second visit after the reports of experts are received to complete the inspection.

The “scope of loss” should include the following:

  • degree of damage;
  • a description of each location where damage was observed;
  • a description of the adjuster’s and your own best estimates of the type of damage observed;
  • a list of all personal property damaged or destroyed;
  • quality of the materials and workmanship; and,
  • measurements needed to calculate quantities, including length, width, and height of rooms and the number of “openings” (windows and doors) in each room.

The scope of loss, usually referred to by claims people as the “scope,” differs from the finished estimate in two ways:

  • the scope does not necessarily list any prices, although prices can be used to describe quality; and,
  • the scope does not list the calculated quantities — it includes just the raw counts and measurements needed to calculate quantities for the estimate.

This article is adapted from Barry Zalma’s book, “Insurance Claims: A Comprehensive Guide” and his book “Mold: A Comprehensive Claims Guide” published by Specialty Technical Publishers, Vancouver, BC, Canada; 800-251-0381; http://www.stpub.com.

Addressing Objections to a Second Look at a Reinsurance Recovery

Most ceding companies avail themselves of catastrophe reinsurance, a product that pays anywhere from 90 to 100% of aggregated event loss after the ceding company’s retention up to the limits obtained. Generally the retention is determined as some fraction of the company’s surplus and the exposure profile of the company from any one catastrophe. The ceding company wants that retention high enough to not merely be swapping dollars with the reinsurer for frequency events, but low enough that the “shock” of the sudden demand for cash to pay claims does not impair the company.When a broker tells a ceding company what the rate-on-line is for a catastrophe treaty … (the rate for a limit of coverage) or the inverse of a payback period, that number is not assuming any reinstatement of limits occurring. The reinsurers have now worked it that the reinstatement premium will in effect accelerate the payback period and increase the actual rate-on-line by requiring 100% as to time in reinstatement calculations. This was not always the case — at one time the reinsurer only charged for the reinstatement limits at a pro rated factor of the time remaining on the treaty.

Catastrophe reinsurance is somewhat unique in that its limits must be reinstated, but reinstating those limits now generally comes at a price higher than the original limits costs. This is so because the reinstated limits are only good for the remainder of the treaty period, not for the entire annual contract period as were the original limits. For example, suppose a Texas ceding company had a catastrophe treaty for the period from Jan 1, 2012 to December 31, 2012 and a hurricane came through Houston on October 1, 2012, exhausting the cedant’s treaty limit. The cost to reinstate that entire limit is the same dollars as it was to initially secure the original limit, but the second limit is good only from October 1, 2012 to December 31, 2012. Thus, the limits costs are the same for a three-month period reinstatement as they were for a twelve-month original limit of the same amount.

Reinsurers may tell ceding companies at renewal time that they are renewing at the expiring rate, but what the ceding company must be aware of is that a reinsurer’s practice is not unlike the federal government saying it will not raise tax rates, but then taking away some deductions so that the net effect is to increase the tax owed. At renewal, the ceding company may find that because of some change in the treaty definitions initiated by the reinsurer, it will have to pay more for the treaty even thought the “rate” stayed the same. The net effect may be that while the rate did not change, the measurement against that rate did change, making the actual treaty costs increase or coverage decrease.

Consider also that if the ceding company had been carrying its original limits equal to the one in one hundred year storm, and such limits were appropriate, the reinstatement limit is now being carried for a second one in one hundred year event occurring in the same year, but happening again in the next three months, a highly unlikely scenario. The reinsurer is actually making the ceding company reinstate the catastrophe limit at a higher cost for an event that is even less likely to occur … but never fear, the reinsurer will offer to sell the ceding company yet another product that will cover the reinstatement costs … a treaty now for a charge slightly below the reinstatement costs that will pay the reinstatement premiums for the catastrophe treaty so that the ceding company will have reinstatement limits available in the event a second one in one hundred year catastrophe strikes within the next three months. (A pre loss, pre pay option treaty so to speak, where the ceding company can prepay the reinstatements now at a discounted rate!)

One of the primary attributes making for sound-rating analysis is the law of large numbers. That is, enough units are insured providing that sufficient losses are experienced in order to provide predictability to an event. By its very nature, catastrophes are generally unusual events as far as the individual ceding company is concerned. Regional ceding companies may experience an event that exceeds its retention only once every several years. Reinsurers thus, by in large, do not price catastrophe treaties for ceding companies on the individual cedant’s catastrophe experience.

Rates for catastrophe insurance are based on “cat models.” Cat models are used against the ceding company’s risk locations and dollars of exposure at those locations. That is, all other things being equal, having 5 billion dollars of insurance exposure along the coast where the models predict a hurricane will strike will cost the ceding company more to reinsure than 5 billion dollars of inland exposure, where the models show the effects of a hurricane are less intense.

During any catastrophe, claims are filed in multiples of what the ceding company may be used to dealing with on a normal basis, and the ceding company may be required to utilize the services of independent adjusters to augment their own claims personnel services. The combination of high volume, tyranny of the urgent, and utilization of temporary staff provides ample opportunity for mistakes in coding, reinsurance reinstatement premium calculations, and event identification.

Event identification is simply the realization that the loss may not be correctly identified to the named event covered. Not all policyholders may immediately turn in a claim, and a claim that is turned in months after the event may be miscoded and missed in reinsurance recovery. Additionally, not all reinsurance recovery is utilized because the cedant did not realize that certain subsequent events are covered.

For example, suppose a claim is paid and closed, and a recovery is made from the reinsurer for the event. Two years later the ceding company receives a suit alleging bad faith and deceptive practices and other allegations that the claim was mishandled. Many insurance companies will put its Errors and Omissions carrier on notice of the allegation being made. However, not all will notify the reinsurer of possible additional development under the treaty for the catastrophe under the ECO/XPL* portion of the cat treaty, which treaty has already been tapped. The ceding company will likely have a per claim retention under its Errors and Omissions policy, plus it is responsible for the stated limits of the policy it issued to the insured before its Errors and Omissions coverage kicks in. Whereas the cat treaty retention has already been met, meaning the ECO/XPL coverage of the cat contract will essentially provide Errors and Omissions coverage sooner to the cedant.

Additionally, depending on the definition of net retained loss under the treaty, it is possible under given circumstances that the ceding company could collect twice for the same Errors and Omissions loss, once under the treaty’s ECO/XPL and if large enough, additionally under its Errors and Omissions policy. An argument by the reinsurer that a collection under the Errors and Omissions policy inures to the treaty should be challenged with a claim that then the premium of the Errors and Omissions policy must similarly reduce the measure (earned premium) against the rate the reinsurer is charging. In other words the reinsurer does not get the inuring benefit of the Errors and Omissions without a corresponding allowance for its costs to the cedant. However, the cedant may be better off arguing the definition of retained loss under the treaty than to argue for the inuring costs.

During the turmoil of a catastrophic event, it is entirely likely that other reinsurance treaties will be overlooked or receive lesser attention. Most per risk treaties have a single occurrence limit, so that the per risk treaty is not used for catastrophic events. However, in many instances the per risk treaty inures to the cat treaty, so that the costs of the per risk treaty reduces the measure against which the cat rate is multiplied. In other words the costs of the per risk treaty reduces the costs of the cat treaty, because technically, the per risk treaty is supposed to be used up to the measure of its occurrence limit before the cat treaty is utilized; the recovery paid by the per risk treaty reduces the catastrophe loss.

As well, premiums may be missed or double paid, inuring contracts overlooked, or checks directed to the wrong reinsurer. I have seen the case during a catastrophe where a premium payment check was directed to the wrong Lloyds Syndicate, and such Syndicate was either so disorganized or so unethical, that it did not return the misdirected funds until after a formal request was made by the ceding company for the return over a year later. You can’t tell me the Syndicate thought that it was entitled to the money or did not realize it was not in the ceding company’s program.

The reinsurers are not your “friends.” They are not in the business to watch out for the interests of the ceding company — reinsurers are in business to make money, just as ceding companies are in business to make money. In 2010, just the top five reinsurers wrote over 98 billion dollars in premiums.

In a brokered market, the intermediaries do not only work for the interests of the ceding companies — they are in many cases dual agents. The word “intermediary” means go between, and for purposes of finances, intermediaries are the agent of the reinsurer, as provided in a standard intermediary clause ever since the federal case of 673 F.2d 1301; The Matter of Pritchard & Baird, Inc., which held that for purposes of money transfer, the broker is the agent of the reinsurer. Money received by the intermediary from the ceding company is considered money to the reinsurer, but money received by the intermediary from the reinsurer is not considered money to the ceding company.

Even all these years after Pritchard and Baird, I have recently witnessed where an unscrupulous reinsurer told the ceding company that it must collect from the intermediary the refund funds portion representing the intermediary brokerage fees. I have also witnessed where this same ceding company signed and agreed to placement slip terms but some 9 months later when the contract wording was finally provided, change the minimum premiums to equal the deposit premiums within the contract, successfully slipping this change by the cancer chemo patient general manager of the small ceding company and then arguing that it had no record of any change. Such behavior is inexcusable and would never have been caught without an independent reinsurance recovery review.

If reinsurers did things right, then the National Association of Insurance Commissioners would not have needed to adopt a rule requiring that final contract wordings must be signed within 9 months of the contract’s effective date to allow for accounting treatment as prospective, as opposed to retroactive, reinsurance.

It’s absurd to think that this type of rule should be necessary in the first place. The 9-month rule, which really comes out of Part 23 of SSAP 62, requires that the reinsurance contract be finalized — reduced to written form and signed within 9 months after commencement of the policy period. In effect the reinsurers being remiss in generating a timely reinsurance contract punishes the ceding company. The National Association of Insurance Commissioners also found it necessary to adopt the so-called 90-day rule. This rule requires the US ceding companies to take a penalty to surplus in an amount equal to 20% of reinsurance recoverables on paid losses 90 days past due. The rule also requires a 20% penalty to surplus for all recoverables due from so-called “slow payers.”

In effect reinsurers have been so remiss in generating timely contracts and paying bills in a timely manner that the National Association of Insurance Commissioners had to create rules to prod them into doing the right thing by punishing the ceding company if they don’t.

It also never ceases to amaze me the attitude of ceding companies in their thrill of receiving a 25% ceding commission from the reinsurer in a proportional treaty for business that costs the ceding company 33% to generate. Or how the reinsurer now “did them a favor” by allowing a 27% ceding commission in the renewal. Or how that so called quota share treaty that the reinsurer is supposedly a “partner” in has a catastrophe cap included for the benefit of the reinsurer. If this represents what it is like to partner and be the “friend” of ceding companies, then the plaintiff’s bar should certainly also be considered a friend of ceding companies.

Reinsurance intermediaries are required to be licensed in most states. Penalties are imposed on unlicensed intermediaries. In some states, led by New York through its Rule & Regulation 98, reinsurance intermediaries must have written authorization from a reinsured before procuring reinsurance for the reinsured. The reinsurance intermediary must provide the reinsured with written proof that a reinsurer has agreed to assume the risk. The reinsurance intermediary also must inquire into the financial condition of the reinsurer and disclose its findings to the reinsured and disclose every material fact that is known regarding the reinsured to the reinsurer.

Record keeping requirements also exist, mandating that the reinsurance intermediary keep a complete record of the reinsurance transaction for at least 10 years after the expiration of the reinsurance contract. Reinsurance intermediaries under these regulations are now responsible as fiduciaries for funds received as reinsurance intermediaries. Funds on reinsurance contracts must be kept in separate, identifiable accounts and may not be comingled with the reinsurance intermediaries’ own funds.

Most of the time the intermediary’s sales pitch to the ceding company emphasizes how it has a great relationship with the reinsurers, the inference being that such a relationship will ultimately provide for a better price for the ceding company in the negotiation process, as if the reinsurer will do a “favor” for the intermediary which will directly benefit the ceding company. Such fairy tale thinking is best left to children’s books and not in the board rooms of ceding companies. The truth is the intermediary is more dependent for its success on the relationship it has with the reinsurer than it is on the ceding company, and the intermediary is not about to alienate the reinsurer for the sake of a ceding company.

In the brokered market, the ceding company typically has no say in the treaty terms. What most small to medium ceding companies fail to realize is that just as an insurance policy that it issues is subject to being a contract of adhesion by virtue of the legal maxim of contra proferentem, so too is the reinsurance treaty to the reinsurer.

The Latin phrase “contra proferentem” is a standard in contract law, which provides that if a clause in a contract appears to be ambiguous, it should be interpreted against the interests of the person who insisted that the clause be included. In other words, if you speak ambiguously in a contract, your words can literally be used against you. This is designed to discourage people from including ambiguous or vague wording in contracts because it would run against their interests. This is a decisive advantage for many ceding companies in what are often ambiguously defined treaties produced by reinsurers.

All too often the ceding company simply falls in line with what the reinsurer says is the proper interpretation of the treaty language. Whether such complicity is reflective of the incorrect notion that the reinsurer is their “friend” and operates in its best interests or just ignorance, the fact is that ceding companies are often not fully utilizing the product for which they have dearly paid.

The services offered by such entities as Boomerang Recoveries, LLC provide for the ceding company a second look at the treaties it purchased and how it structured its recoveries from its various treaties. Every “touch point” along the recovery process provides for possible missed opportunity. An expressed reluctance by a ceding company to have its recoveries reviewed by an independent reinsurance professional represents misplaced loyalties. The loyalty of a ceding company is to its policyholders or its stockholders, not to its reinsurers.

Good faith and fair dealing owed by a ceding company to the reinsurer does not include foregoing rightful reinsurance recoveries or agreeing with every position of the reinsurer. In this day of increased litigation for Errors and Omissions and Directors and Officers issues, ceding companies should be more concerned with demonstrating their due diligence and exhibiting fiduciary responsiveness by trying to recover every dollar that they are entitled to receive under the treaty contracts, than in worrying about what reinsurers may think about an independent review of its reinsurance recovery process.

Think of it this way, if the ceding company obtained some tax advice on a return it had filed which showed that by refiling, it would be refunded $1,000,000 on the taxes it paid to Uncle Sam, will the officers of that company argue that filing an 1120X (Corporate Amended Tax Return) is a bad idea because it might look like an admission that the company had not taken every deduction entitled to it when it was originally filed or that the IRS might think poorly of the company? That would be absurd, but so too are the arguments that recasting and review of past reinsurance recoveries is a bad idea.

As we have seen:

  1. Every touch point in the recovery process is a potential to miss recovery … its just human nature to make more mistakes at the time of crisis than otherwise.
  2. Catastrophe treaties are not priced for individual company experience, but by models, so that additional recoveries will not directly impact the future rate charged the ceding company.
  3. Reinsurers are not in business to be your friend. Ceding companies pay sufficient premiums to collect all that they are entitled to collect under the treaty.
  4. Reinsurers will not tell ceding companies when a mistake is made or that it owes a ceding company more money.
  5. Intermediaries do not make a commission and are not paid to assure that the ceding company appropriately and fully utilizes the treaties that are placed.
  6. Reinsurance treaties are esoteric and a ceding company cannot rely on an intermediary to watch out for its best interests or interpret contracts in its favor.
  7. Increasing Directors and Officers exposures demand that officers and managers demonstrate their due diligence and the full filling of fiduciary duties. Even if no additional funds are shown as recoverable after a review, the effort is demonstrative of duties fulfilled.
  8. Intermediaries are dual agents and primarily “sell” their services to ceding companies by emphasizing the great relationship they have with reinsurers. Ceding companies need to understand that great reinsurer relationships do not mean better terms for ceding companies or that the intermediary is willing to sacrifice that relationship for the sake of the ceding company. Indeed, intermediary relationships with reinsurers are an extension of and built upon their loyalty to those reinsurers, not the ceding companies.
  9. Reinsurance treaties follow the legal maxim that ambiguities are construed against the drafter of the contract. Ceding companies need a truly independent expert that is not tied to the reinsurer, as is the intermediary, to argue for them and review recoveries on their behalf.

Cronyism has no place in today’s economy. Insurance managers are not reinsurance recovery experts, and utilizing the services of independent reinsurance recovery experts should be thought of as no different than utilizing the services of legal or tax experts to maximize the financial position of the ceding company. The deference ordinarily given to a reinsurer by a ceding company is substantially more than it would ever give to say, an insurer that carried its fleet auto coverage or its Directors and Officers coverage. Ceding companies should stop thinking of reinsurance as some sort of friendship pact and start considering it as they would any other insurance protection it purchased for its financial stability.

* Excess of policy limits, extra contractual obligations