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Catastrophe Models Allow Breakthroughs

“In business there are two ways to make money; you can bundle or you can unbundle.” –Jim Barksdale

We have spent a series of articles introducing catastrophe models and describing the remarkable benefits they have provided the P&C industry since their introduction (article 1, article 2, article 3, article 4). CAT models have enabled the industry to pull the shroud off of quantifying catastrophic risk and finally given (re)insurers the ability to price and manage their exposure to the violent and unpredictable effects of large-scale natural and man-made events. In addition, while not a panacea, the models have leveled the playing field between insurers and reinsurers. Via the use of the models, insurers have more insight than even before into their exposures and the pricing mechanics behind catastrophic risk. As a result, they can now negotiate terms with confidence, whereas prior to the advent of the models and other similar tools, reinsurers had the upper hand with information and research.

We also contend that CAT models are the predominant cause of the reinsurance soft market via the entry of alternative capital from the capital markets. And yet, with all the value that CAT models have unleashed, we still have a collective sour taste in our mouths as to how these invaluable tools have benefited consumers, the ones who ultimately make the purchasing decisions and, thus, justify the industry’s very existence.

There are, in fact, now ways to benefit customers by, for instance, bundling earthquake coverage with homeowners insurance in California and helping companies deal with hidden volatility in their supply chains.

First, some background:

Bundling Risks

Any definition of insurance usually addresses the concept of risk transfer: the mechanism that ensures full or partial financial compensation for the loss or damage caused by event(s) beyond the control of the insured. In addition, the law of large numbers applies: the principle that the average of a large number of independent identically distributed random variables tends to fall close to the expected value. This result can be used to show that the entry of additional risks to an insured pool tends to reduce the variation of the average loss per policyholder around the expected value. When each policyholder’s contribution to the pool’s resources exceeds the expected loss payment, the entry of additional policyholders reduces the probability that the pool’s resources will be insufficient to pay all claims. Thus, an increase in the number of policyholders strengthens the insurance by reducing the probability that the pool will fail.

Our collective experiences in this world are risky, and we humans have consistently desired the ability to shed the financial consequences of risk to third parties. Insurance companies exist by using their large capital base, relying on the law of large numbers, but, perhaps most importantly, leveraging the concept of spread of risk, the selling of insurance in multiple areas to multiple policyholders to minimize the danger that all policyholders will experience losses simultaneously.

Take the peril of earthquake. In California, 85% to 90% of all homeowners do NOT maintain earthquake coverage even though earthquake is the predominant peril in that state. (Traditional homeowners policies exclude earth movement as a covered peril). News articles point to the price of the coverage as the limiting factor, and that makes sense because of that peril’s natural volatility. Or does it make sense?

Is the cost of losses from earthquakes in California considerably different than, say, losses from hurricanes in Florida, in which the wind peril is typically included in most homeowners insurance forms? Earthquakes are a lot more localized than hurricanes, but the loss severity can also be more pronounced in those localized regions. Hurricanes that strike Florida can be expected with higher frequency than large damage-causing earthquakes that shake California. In the final analysis, the average projected loss costs are similar between the two perils, but one has nearly a 100% take-up rate vs. the other at roughly 10%. But why is that so? The answer lies in the law of large numbers, or in this case the lack thereof.

Rewind the clock to the 1940s. If you were a homeowner then, the property insurance world looked very different than it does today. As a homeowner back then, you would need to virtually purchase separate policies for each peril sought: a fire, theft and liability policy and then a windstorm policy to adequately cover your home. The thought of packaging those perils into one convenient, comprehensive policy was thought to be cost-prohibitive. History has proven otherwise.

The bundling of perils creates a margin of safety from a P&C insurer’s perspective. Take two property insurers who offer fire coverage. Company A offers monoline fire, whereas Company B packages fire as part of a comprehensive homeowners policy. If both companies use identical pricing models, then Company B can actually charge less for fire protection than Company A simply because the additional premium from Company B affords peril diversification. Company B has the luxury of using premiums from other perils to help offset losses, whereas Company A is stuck with only its single-source fire premium and, thus, must make allowances in its pricing that it could be wrong. At the same time, Company B must also make allowances in the event its pricing is wrong, but can apply smaller allowances because of the built-in safety margin.

This brings us back to the models. It is easy to see why earthquake and other perils, such as flood, was excluded from homeowners policies in the past. Without models, it was nearly impossible to estimate future losses with any sort of reliable precision, leaving insurers the inability to collect enough premium to compensate for the inevitable catastrophic event. Enter the National Flood Insurance Program (NFIP), which stepped in to offer flood coverage but never fundamentally approached it from a sound underwriting perspective. Instead, in an effort to make the coverage affordable to the masses, the NFIP severely underpriced its only product and is now tens of billions of dollars in the red. Other insurers bravely offered the earthquake peril via endorsement and were devastated after the Northridge earthquake in 1994. In both cases, various market circumstances, including the lack of adequate modeling capabilities, contributed to underpricing and adverse risk selection as the most risk-prone homeowners gobbled up the cheap coverage.

Old legacies die hard, but models stand ready to help responsibly underwrite and manage catastrophic risk, even when the availability of windstorm, earthquake and flood insurance has been traditionally limited and expensive.

The next wave of P&C industry innovation will come from imaginative and enterprising companies that use CAT models to economically bundle risks designed to lower the costs to consumers. We view a future where more CAT risk will be bundled into traditional products. As they continue to improve, CAT models will afford the industry the confidence needed to include earthquake and flood cover for all property lines at full limits and with flexible, lower deductibles. In the future, earthquake and flood hazards will be standard covered perils in traditional property forms, and the industry will one day look back from a product standpoint and wonder why it had not evolved sooner.

Unbundling Risks

Insurance policies as contracts can be clumsy in handling complicated exposures. For example, insurers have the hardest time handling supply chain and contingent business interruption exposures, and rightly so. Because of globalization and extreme competition, multinational companies are continuously seeking value in the inputs for their products. A widget in a product can be produced in China one year, the Philippines the next, Thailand the following year and so on. It is time-consuming and resource intensive to keep track of not only how much of a company’s widgets are manufactured, but also what risks exist surrounding the manufacturing plant that could interrupt production or delivery. We would be hard-pressed to blame underwriters for wanting to exclude or significantly sublimit exposures related to supply chain or business interruption; after all, underwriters have enough difficulty just to manage the actual property exposures inherent in these types of risks.

It is precisely this type of opportunity that makes sense for the industry to create specialized programs. Unbundle the exposure from the remainder of the policy and treat it as a separate exposure with dedicated resources to analyze, price and manage the risk.

Take a U.S. semiconductor manufacturer with supply exposure in Southeast Asia. As was the case with the 2011 Thailand floods or the 2011 Tohoku earthquake and tsunami, this hypothetical manufacturer is likely exposed to supply chain risks of which it is unaware. It is also likely that the property insurance policy meant to indemnify the manufacturer for covered losses in its supply chain will fall short of expectations. An enterprising underwriter could carve out this exposure and transfer it to a new form. In that form, the underwriter can work with the manufacturer to clarify policy wording, liberalize coverage, simplify claims adjusting and provide needed additional capacity. As a result, the manufacturer gets a risk transfer mechanism that more precisely aligns with the balance sheet affecting risks it is exposed to. The insurer gets a new line of business that can provide a significant source of new revenue using tools such as CAT models and other analytics to price and manage those specific risks. By applying some ingenuity, the situation can be a win/win all around.

What if you are a manufacturer or importer and rely on the Port of Los Angeles or Miami International Airport (or any other major international port) to transport your goods in and out of markets? This is another area where commercial policies handle business exposure poorly, or not even at all. CAT models stand ready to provide the analytics required to transfer the risks of these choke points from business balance sheets to insurers. All that is required is vision to recognize the opportunity and the sense to use the toolsets now available to invent solutions rather than relying on legacy group think.

At the end of the day, the next wave of innovation will not come directly from models or analytics. While the models and analytics will continue to improve, real innovation will come from creative individuals who recognize the risks that are causing market discomfort and then use these wonderful tools to build products and programs that effectively transfer those risks more effectively than ever. Those same individuals will understand that the insured comes first, and that rather than retrofitting dated products to suit a modern-day business problem, the advent of new products and services is an absolute necessity to maintain the industry’s relevance. The only limiting factor preventing true innovation in property insurance is imagination and a willingness to no longer cling to the past.

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 Next Jolt That Will Hit California

Losses from Sunday’s 6.0-magnitude earthquake near Napa, the largest in California in 25 years, seriously damaged more than 170 structures and injured more than 200 people. Overall earthquake-related losses are expected to exceed $1 billion.

Many unreinforced masonry buildings risk being declared a total loss. But even retrofitting doesn’t always ensure earthquake immunity. The charming 1901 stone Goodman Library in downtown Napa was seismically retrofitted at a cost of $1.7 million a few years ago, yet the top of the building toppled over in the earthquake. A nearby historic brick building was retrofitted for $1.2 million after a 2000 Napa earthquake, and it was red-tagged Monday with serious damage, as well.

Unfortunately, the repair and rebuilding costs will be the next jolt that rocks the budgets of businesses and homeowners. It’s estimated that less than 12% of homeowners in California have earthquake coverage – a figure that was as high as 22% last year, according to the California Earthquake Authority. CEA underwrites more than 800,000 policies representing 70% of the homeowner earthquake insurance in the state.

California has two-thirds of the nation’s earthquake risk, with 2,000 known faults producing 37,000 measurable earthquakes a year. Besides California, the U.S. Geological Survey maps show major earthquake risks in nearly half the U.S.

In 1994, after a 6.7-magnitude earthquake hit the Northridge area of Southern California, 93% of homeowner insurance companies restricted or refused to write earthquake insurance policies. In response, the California legislature established the California Earthquake Authority (CEA) in 1995 to provide a reduced-coverage (“no-frills”) earthquake policy for homeowners in the state — things like swimming pools, decks and detached structures are not included. Insurance carriers in California can offer their own earthquake coverage or be a participating member of the CEA, which made the CEA one of the largest providers of residential earthquake coverage in the world.

Currently, 21 major insurance carriers participate in CEA, and its assets total nearly $10 billion. Its A.M. Best rating is A- (excellent). CEA policies are available to homeowners and renters, including for mobile homes and condominiums, if their primary homeowners’ coverage is with one of the CEA insurers. Keep in mind that many condominium communities have common ownership, which means that the condo owners could have joint and several liability for repairs after an earthquake. CEA reports that it uses 83% of the premiums it collects for claims or reinsurance, 14% for broker commissions and 3% for operations/overhead.

The likelihood that state or federal disaster relief may be available is a risky proposition for home or business owners. The president needs to declare a disaster before the Federal Emergency Management Agency (FEMA) can grant any limited assistance. States surplus funds for relief, on the other hand, are simply non-existent.

So why are people buying less earthquake coverage when the hazards of a potential devastating earthquake are growing? Unlike other natural disasters like hurricanes, tornadoes, and wildfires that are usually covered under homeowners’ insurance policies, earthquake coverage is a separate insurance policy with a deductible of 10% or 15% of the structure’s estimated replacement cost.

The average earthquake policy in California in 2013 cost $676 a year, according to the California Department of Insurance. The current average cost of a home in California, according to Zillow, is $429,000. Even with a minimum 10% deductible, a homeowner would be out of pocket $42,900 before earthquake insurance coverage kicks in.

Business properties suffer a much larger risk factor considering the additional exposure of damaged inventory, a red-tagged (unusable) building risk and loss of use and income.

In contrast, flood insurance is available in most of the country with a $1,000 building and $1,000 contents deductible as part of the property coverage. The Insurance Information Institute reports that the average flood damage claim in 2013 was $26,165 for the 13% of U.S. homeowners who buy the additional flood coverage – sometimes as a condition to their mortgage, if they are located in a flood zone.

Low-frequency, high-severity risks like earthquakes represent a bet that few home or business owners can afford to lose. Unfortunately, Californians, who own the nation’s highest-valued properties, also have the most money on the table when the next big shake comes.

Employee Concentration Impacting Workers' Compensation Renewals

Workers' compensation continues to be a challenged line, with historically poor results, a benign interest rate environment, and diminished prior year reserve redundancy. Another issue worth noting is the uncertainty around the potential 2014 extension of the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), which has heightened the focus on aggregation of workers' compensation risk.

Employee Concentration
For years, carriers have monitored workers' compensation exposure aggregations (their cumulative exposures in a geographic area) as a way of assessing the potential impact that an earthquake would have on their book of business. Such analysis has been commonplace in earthquake prone areas, such as California, for many years. However, after the September 11, 2001 terrorist attack, workers' compensation carriers and reinsurers immediately began to focus on employee concentration in large cities which were deemed high risk targets for terrorist events.

Insurance carriers continue to view risks from a concentration perspective — both on an individual accounts basis as well as the aggregate across their portfolio and correlated lines of business. Some carriers will decline a risk outright simply because they are “overlined” in a particular zip code or city. Or, the carrier might impose a surcharge on the premium for the use of their limited capacity for a particularly large workers' compensation risk.

Reinsurers similarly set a maximum amount of capacity they can offer in a particular geographic area and for catastrophic loss scenarios. Insurers purchase this capacity as one way to reduce their potential to incur an outsized catastrophic loss and manage their modeled worst case scenario within their financial risk tolerance.

To that end, catastrophic models have been developed. Catastrophic models allow carriers to gauge their potential exposures in a geographic area under a variety of different event scenarios that are either probabilistic or deterministic in nature. During the last 10 years, carriers have made adjustments to their books of business according to the output of these models to limit their potential exposure to terrorist events — sometimes across multiple product lines.

A unique consideration with workers' compensation over other insurance contracts is workers' compensation policies have statutory coverage (in this case being synonymous with unlimited) rather than a stated limit which could cap a carrier's liability for a certain loss. Given the statutory nature of the coverage, it is difficult for carriers to estimate their maximum exposure to workers' compensation.

The issue of employee aggregation affects any employer with a large number of employees in a single location, but is highlighted in industries such as financial institutions, hospitals, defense contractors, higher education, hotels, professional services, and nuclear.

Impact Of Pending TRIPRA Expiration
Because of the significant financial impact of the September 11 terrorist attacks, Congress created the Federal Terrorism Risk Insurance Act (TRIA) to provide a financial backstop to the insurance industry that would cap losses in the event of another large-scale terrorist event. The Act was initially set to expire at the end of 2005, but because of the ongoing risk of terrorism, and the reliance on it by insurance carriers, it has been extended several times. It is now set to expire on December 31, 2014.

When most people think of TRIA/TRIPRA, they think of the property insurance marketplace. Without this backstop in place, many high-profile properties would not be insurable in the commercial marketplace. However, workers' compensation is also deeply impacted, as there are large amounts of people working in highly concentrated areas.

Although the expiration of the Terrorism Risk Insurance Program Reauthorization Act is almost two years away, the impact of this is already being seen in the marketplace. Employers in certain industries, employers with large employee concentrations, or in certain cities can expect less available capacity with some carriers scaling because of the increased exposure to their balance sheet created by losing some or all of the protections provided under the Federal Terrorism Risk Insurance Act. This trend has the potential to escalate and broaden as we get closer to the TRIPRA expiration date.

In addition, more employers may face increased rates for their workers' compensation coverage because of the combination of less competition and capacity, as well as an increased potential exposure for the carriers. If a policy is being issued that provides coverage beyond the TRIPRA expiration date, and the future of the legislation is not known, carriers will likely price this under the assumption those protections will be allowed to sunset or may be significantly modified.

What To Expect At Renewal
When faced with a potentially challenging renewal and one that may be impacted by this issue, what can you do? We recommend starting the renewal process early, at least 120 days (or more) prior to the policy or program effective date. In the case of Marsh, we will work with you to develop a communications strategy and presentation tactic around all key risk exposures, including modeling and risk analytics in support of your renewal objectives.

For carrier presentations and Q-and-A, insureds must be thoroughly conversant with details of exposures and operations; mergers, acquisitions, and divestitures; loss trends, safety programs, and risk management practices; and future plans, to the extent that they can be shared publicly.

We will help you be familiar with respective insurers' cost of capital and pricing strategy — understanding how carriers evaluate your firm's experience and risk profile, and how they initially develop rates and premiums.

High quality data differentiates employers in the eyes of insurance carriers. In today's environment, it is imperative that organizations provide underwriters with complete, accurate, and thorough data and analysis in order to differentiate their risk profile.

There has already been a significant increase in questions that carriers are asking at renewal that focus on the risks associated with a potential terrorist event. Employers with a large concentration of workers, especially those in major metropolitan areas, should be prepared to provide the following details to carriers:

  • Information on employee marital/dependency status.
  • Employee telecommuting/hospitality practices and impact on concentration.
  • Physical security of the building including information about guards, surveillance cameras, parking areas, HVAC protections.
  • How access to the building is controlled.
  • Construction of the building and location of the offices.
  • Management policies around workplace violence, weapons, and employment screening.
  • Employee security procedures.
  • Emergency response/crisis management plan.
  • Fire/life safety program.
  • Security staff.
  • Crisis management procedures.

In addition, carriers may wish to send their loss control engineers for a physical inspection of larger facilities and to interview building/facility management.

The Increasing Demand For Better Data
Because both insurance carriers and reinsurers focus on catastrophic models, it is extremely important that employers provide the highest quality of employee accumulation data, as this will ensure they are favorably differentiated by insurance carriers.

If your company has multiple shifts or operates in a campus setting, make sure you report both the total number of employees and the number working during peak shifts — as well as the actual buildings where the employees are located.

The number of employees working during peak shifts is the actual exposure to a terrorist event, not the total number of employees. Also, some businesses have a large percentage of their workforce in the field or telecommuting, rather than the office where their payroll is assigned. Providing this information to carriers significantly reduces the potential exposures associated with employee concentration. In addition, identifying the actual building where employees work on a campus — rather than a single building — helps overcome pitfalls of the catastrophic model. This also better reflects an employer's exposure to catastrophic losses.

As options about future real estate plans are considered (i.e. in terms of consolidation of employees from multiple locations in a city to a single location, or the impact of closing or consolidating satellite locations and relocating employees in major metropolitan areas), it is wise to review and consider the potential impact on workers' compensation pricing and capacity.

Because of the current political and economic climate in the US, renewal of the TRIPRA by Congress is far from certain. Marsh is continuing to monitor this issue closely, and we are working with employers and insurance industry representatives to raise awareness of the important role that TRIPRA plays in the insurance marketplace.

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.