# Rebuttal: Protection Gap Is Not a Myth

As with most articles I read at Insurance Thought Leadership, I enjoyed The Myth of the Protection Gap. I do agree with the author (Paul Carroll) that not everything that can produce a negative outcome or loss needs to be insured. In fact, we are now in an era where we can buy insurance for nearly any property we own with a swipe of an app on a smartphone. Assuming that these companies are not charities, this approach is counterproductive, simply because it forces users to waste time having to remember to insure the thousands of small dollar items we own, when we can just afford to replace them. So place me in the camp that says insurance is for instances where we could not otherwise reasonably expect to be made whole again.

But the protection gap itself is very real. I will use Paul’s hypothetical example to illustrate a counterpoint to his conclusion:

“To make the math simple, let’s pick a country at random and make up some numbers out of whole cloth. Let’s imagine we’re Gabon, and we, as a nation, incur \$1.5 billion of losses a year, while only \$500 million is covered by insurance. We’re told we have a protection gap of \$1 billion. We should buy \$1 billion of additional coverage.

It’ll only cost us \$1.3 billion.

That’s because — again, in very rough numbers — the insurer has to tack on 20% on top of the losses to cover expenses and needs its 10% profit margin to keep shareholders happy.”

Let’s break this down: If the losses for Gabon are \$1.5 billion per year, with \$500 million covered, then how much insurance do they need to buy? The article is suggesting the answer would be an additional \$1 billion.

But that is not the right answer. The right answer is that Gabon should not buy any insurance!

How is that possible? Well, if I know with certainty that my losses over time will be \$1.5 billion, then instead of buying insurance I can set aside funds to pay those anticipated losses. To put it another way, if I were insuring an entity that will have \$1.5 billion losses each year, then the premium I would charge MUST start at \$1.5 billion (because I know for sure that those will be the losses ) and then tack on expenses for managing those claims, issuing paper and, of course, my profit margin.

Am I nitpicking? Yes, I am.

The hypothetical example likely meant that losses would average \$1.5 billion per year and not BE \$1.5 billion. But words matter, and, in this hypothetical example, the word “average” changes enough of the example to magically make the protection gap appear in full vengeance.

How?

Well, averaging \$1.5 billion per year in losses can mean lots of things. It could mean \$1.5 billion each year, every year, OR it could mean a \$30 billion loss happening exactly once in the next 20 years (or an infinite set of other combinations).

Uh-oh.

It is this uncertainty in the losses that makes insurance such a valuable tool for risk management. Insurance is that tool that allows Gabon to manage its cash flows in such a way that it can function day after day and not have to worry about finding \$30 billion at a moment’s notice. Insurance is not about paying for the average annual losses, it is about paying for the extreme losses and avoiding the cash flow crunch associated with that. The smoothing out of volatile cash flows IS the peace of mind that is often marketed to consumers of insurance.

90% of California homeowners lack earthquake insurance. The take-up for flood coverage is similar. These perils have caused hundreds of billions of dollars in property loss, the bulk of which were uninsured. Tens of thousands of families became homeless. We’ve seen it In Louisiana after Katrina and in the tri-state area after Sandy, and we will see it again. The protection gap is not a myth, it is very real, and these perils will continue to cause hundreds of billions of dollars in damage. These are losses that homeowners and businesses cannot fund themselves. They require insurance to protect them from these catastrophes.

This fact alone provides a wonderful opportunity for our entire industry to grow by solving huge and emerging problems faced by societies. This is why we exist; this is our irreplaceable contribution to society.

# 6 Lessons From Katrina, 10 Years On

In December 2005, just three months after Katrina savaged the Gulf Coast, we edited On Risk and Disaster, a book on the key lessons that the storm so painfully taught. The book was very different from most of the post-mortems that focused on the country’s lack of preparedness for the storm’s onslaught. It focused sharply on how to reduce the risk of future disasters—and how to understand how to help those who suffer most from them.

One of the most important findings highlighted by the book’s 19 expert contributors was that the storm affected lower-income residents far more than others. Reducing the exposure to potential damage before disasters occur, especially in the most hazard-prone areas, is one of the most important steps we can take. To achieve this objective in low-income areas, residents often need help to invest in measures to reduce their losses. Failing to learn these lessons will surely lead to a repeat of the storm’s awful consequences.

Now, 10 years after Katrina struck, six lessons from the book loom even larger.

1. Disasters classified as low-probability, high-consequence events have been increasing in likelihood and severity.

From 1958 to 1972, the number of annual presidential disaster declarations ranged between eight and 20. From 1997 through 2010, they ranged from 50 to 80. The National Oceanic and Atmospheric Administration reported that the number of severe weather events—those that cause \$1 billion in damage or more—has increased dramatically, from just two per year in the 1980s to more than 10 per year since 2010. That trend is likely to continue.

2. Most individuals do not purchase insurance until after suffering a severe loss from a disaster—and then often cancel their policies several years later.

Before the 1994 Northridge earthquake in California, relatively few residents had earthquake insurance. After the disaster, more than two-thirds of the homeowners in the area voluntarily purchased coverage. In the years afterward, however, most residents dropped their insurance. Only 10% of those in seismically active areas of California now have earthquake insurance, even though most people know that the likelihood of a severe quake in California today is even higher than it was 20 years ago. Moreover, most homeowners don’t keep their flood insurance policies. An analysis of the National Flood Insurance Program in the U.S. revealed that homeowners typically purchased flood insurance for two to four years but, on average, they owned their homes for about seven years. Of 841,000 new policies bought in 2001, only 73% were still in force one year later, and, after eight years, the number dropped to just 20%. The flood risk, of course, hadn’t changed; dropping the policies exposed homeowners to big losses if another storm hit.

3. Individuals aren’t very good at assessing their risk.

A study on flood risk perception of more than 1,000 homeowners who all lived in flood-prone areas in New York City examined the degree to which people living in these areas assessed their likelihood of being flooded. Even allowing a 25% error margin around the experts’ estimates, most people underestimated the risk of potential damage; a large majority of the residents in this flood-prone area (63%) underestimated the average damage a flood would cause to their house. It is likely that “junk science,” including claims that climate change isn’t real, leads many citizens to problems in assessing the risks they face.

4. We need more public-private partnerships to reduce the costs of future disasters.

Many low-income families cannot afford risk-based disaster insurance and often struggle to recover from catastrophes like Katrina. One way to reduce future damages from disasters would be to assist those in hazard-prone areas with some type of means-tested voucher if they invest in loss-reduction measures, such as elevating their home or flood-proofing its foundation. The voucher would cover both a portion of their insurance premium as well as the annual payments for home-improvement loans to reduce their risk. A program such as this one would reduce future losses, lower the cost of risk-based insurance and diminish the need for the public sector to provide financial disaster relief to low-income families.

5. Even if we build stronger public-private partnerships, individuals expect government help if they suffer severe damage.

Just before this spring’s torrential Texas rains, there was a huge battle in the Texas state legislature about whether local governments ought to be allowed to engage in advance planning to mitigate the risks from big disasters. Many of the forces trying to stop that effort were among the first to demand help when floodwaters devastated the central part of the state. Even the strongest believers in small government expect help to come quickly in times of trouble. We are a generous country, and we surely don’t want that to change. But jumping in after disasters strike is far more expensive than taking steps in advance to reduce risks. Everyone agrees that the cost curve for disaster relief is going up too fast and that we need to aggressively bend it back down.

6. Hurricanes tend to grab our attention—but there are other big risks that are getting far less attention.

Hurricanes are surely important, but winter storms, floods and earthquakes are hugely damaging, too. Too often, we obsess over the last catastrophe and don’t see clearly the other big risks that threaten us. Moreover, when big disasters happen, it really doesn’t matter what caused the damage. Coast Guard Adm. Thad Allen, who led the recovery effort after Katrina, called the storm “a weapon of mass destruction without criminal intent.” The lesson is that we need to be prepared to help communities bounce back when disasters occur, whatever their cause; to help them reduce the risk of future disasters; and to be alert to those who suffer more than others.

The unrest that rocked Baltimore following Freddie Gray’s death reminds us that Adm. Allen’s lesson reaches broadly. The riots severely damaged some of the city’s poorest neighborhoods and undermined the local economy, with an impact just as serious as if the area had been flooded by a hurricane. Many of the same factors that bring in the government after natural disasters occurred here as well: a disproportionate impact on low-income residents, most of whom played no part in causing the damage; the inability to forecast when a random act, whether a storm surge or a police action, could push a community into a downward spiral; and the inability of residents to take steps before disasters happen to reduce the damage they suffer.

Conclusion

Big risks command a governmental response. Responses after disasters, whatever their cause, cost more than reducing risks in advance. Often, the poor suffer the most. These issues loom even larger in the post-Katrina years.

Natural disasters have become more frequent and more costly. We need to develop a much better strategy for making communities more resilient, especially by investing—in advance—in strategies to reduce losses. We need to pay much more attention to who bears the biggest losses when disasters strike, whatever their cause. We need to think about how to weave integrated partnerships involving both government and the private and nonprofit sectors. And we need to understand that natural disasters aren’t the only ones our communities face.

Sensible strategies will require a team effort, involving insurance companies, real estate agents, developers, banks and financial institutions, residents in hazard-prone areas as well as governments at the local, state and federal levels. Insurance premiums that reflect actual risks coupled with strong economic incentives to reduce those risks in advance, can surely help. So, too, can stronger building codes and land use regulations that reduce the exposure to natural disasters.

If we’ve learned anything in the decade since Katrina, it’s that we need to work much harder to understand the risks we face, on all fronts. We need to think about how to reduce those risks and to make sure that the least privileged among us don’t suffer the most. Thinking through these issues after the fact only ensures that we struggle more, pay more and sow the seeds for even more costly efforts in the future.

This article was first published on GovEx and was written with Donald Kettl and Ronald J. Daniels. Kettl is professor of public policy at the University of Maryland and a nonresident senior fellow at the Brookings Institution and the Volcker Alliance. Daniels is the president of Johns Hopkins University.

# 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.

# Lessons Learned From Hurricane Sandy

Hurricane Sandy is said to have been the most damaging hurricane recorded in U. S. history. There appears, however, to be some dispute as to whether Hurricane Katrina holds that dubious honor. The loss estimates and concerns are changing daily. The cost of the storm, estimated by private firms including PricewaterhouseCoopers and the PFM group, points to the fact that Hurricane Sandy destroyed or damaged more units of housing, affected more businesses and caused more customers to lose power. Here is the breakdown provided on November 26, 2012: http://www.governor.ny.gov/press/11262012-damageassessment.

 Sandy in New York ALONE Katrina & Rita in Louisiana Housing units damaged or destroyed 305,000 214,700 Power Outages (peak) 2,190,000 800,000 Businesses Impacted 265,300 18,700
• Number of deaths is more than 110 from Hurricane Sandy http://articles.latimes.com/2012/nov/03/nation/la-na-nn-hurricane-sandy-deaths-climb-20121103
• The official death toll from Katrina was 1,723. http://robertlindsay.wordpress.com/2009/05/30/final-katrina-death-toll-at-4081/
• 7.5 million power outages throughout Hurricane Sandy's two day assault on land
• Moody's Analytics estimates the loss in the vicinity of the storm to be \$50 billion, of which \$30 billion will be directly from damage to property and the remaining \$20 billion from economic activity, not all of which is going to come from an insurance policy.
• 60% of the losses in economic activity, or about \$12 billion, will come from the New York City metropolitan area.
• Because of the storm's intensity and the breadth and scope of the damage, President Obama declared New York and New Jersey federal disaster zones without waiting for any damage estimates.
• As of 12/3/2012, the Federal government has already issued \$180 million in federal contracts related to Sandy.
• The President has declared several areas as disaster areas, which means that federal funds will now be available to storm victims. (This is not limited to those without flood insurance.) This federal disaster assistance usually takes the form of low-interest loans to help home and business owners rebuild, which you can learn more about on the Disaster Loan page.

The statistics are staggering as are the losses (both covered and not covered) that are emerging from the storm. We will attempt to discuss some of the unique and troublesome issues that are arising from the storm.

Article Discussion Points:

• Definition of “Storm” and its impact on insurance
• Flood or NOT Flood?-that is the question (or the hope)
• Personal Auto salvage concerns
• The Lawyers are out to get you

### Definition Of “Storm” And Its Impact On Insurance

A storm reaches tropical storm status by reaching sustained winds of 39 miles per hour. The National Hurricane Center creates annual lists of names from the database of names maintained and updated by the World Meteorological Organization. If a storm causes significant damage and /or loss of life, the name is retired from the list permanently. Thus, there will be no Katrina II or Sandy II.

1. What Does The Definition Of “Storm” Have To Do With Insurance? There May NOT Be Coverage On The DIC.
Thousands of businesses were affected by Sandy. Many times those larger clients have flood and wind coverage, but written on a large property or DIC (Difference in Conditions) policy.

In those policies there may be restrictions, sub-limits or different deductibles that apply to “Named Storms.” Those policies will define what that is, and should include flood, wind, wind gusts, storm surges, tornadoes, cyclones, hail or rain into this category once the storm has been declared by the National Weather Service to be a hurricane, typhoon, tropical cycle, tropical storm or tropical depression, thus bringing into focus the entire life cycle that a storm may go through.

We have found a number of articles written by law firms that are already taking on the issue of “named storm,” claiming that even though the National Weather Service had named the storm, it was not at hurricane strength when it reached landfall. A comprehensive definition of “named storms” would be helpful to clarify coverage. The fact that the meteorologists are discussing the attributes of this storm to be more like a winter storm rather than a tropical storm may end up on the chopping block of justice in a civil court or two and test the insurance policy coverages.

2. What Is Unique About Hurricane Sandy?

• Sandy has defied normal storm behavior by moving east to west; it acted both like a hurricane and a cyclone simultaneously.
• The result of this last odd wind pattern was the root cause of the flood tides and the inundation of the New York subway system.
• The storm qualified as a hurricane at the time of landfall and its wave “destruction potential” reached a 5.8 on the National Oceanic and Atmospheric Administration's 0 to 6 scale.

3. One Storm or Two Storms:
Bad memories of the World Trade Center came immediately to mind when I read about this potential concern relating to Hurricane Sandy in the Daily Report. You might remember there was a significant concern that a second storm, following the initial impact of Sandy, was going to hit which would have further devastated the area.

Richard Mackowsky, a member of the Cozen O'Connor's global insurance group, said “new damage from a second storm could result in a separate occurrence, potentially requiring a separate set of deductibles.”

“If there is damage caused by a second storm but related to the first storm, issues arise as to whether there were one or two occurrences. A second storm could impact causation as to what is really driving the loss. If the only reason the second storm caused damage was because of damage from Sandy, the question then becomes whether that is a covered cause of loss,” Mackowsky said. “A second storm could trigger a separate limit of liability if it's a big enough situation,” he said.

But even one storm can create causation questions. Was the damage from wind or flooding? Not a simple question to answer, litigation stemming from previous storms has shown.

Excerpted from the Daily Report

Saved by the bell on this one — the second storm never hit, but the insurance pundits were armed and ready.

### Flood … Not Flood? — That Is The Question

This appears, at first glance, to be Insurance 101 — most of this damage was either directly or indirectly caused by the condition of flooding. That is sure what it looked like to me and that is not a very popular observation. Why? Because most people did not have flood insurance and if they did, the flood insurance policy has limited amounts of insurance and significant restrictions such as no business income coverage.

1. Dilemma Of The Federal Flood Insurance Program — It's A Problem:
Even if it is covered on the flood insurance policy, there is real concern about the overall program. See this article from Reuters for more information.

2. Flood Or Not Flood
Whether talking about homeowner's insurance (including renters and condominium owners) or commercial property insurance, those forms most often include an exclusion for flood. So, here is where it gets a little tricky:

1. Did the property owner sustain damage from storm surge?
2. Was the loss due to rising flood waters?
3. Was the loss due to too much rain that entered into the building because the wind removed the roof, blew out the windows or knocked a part of the building down?

“It is an ongoing saga,” says insurance lawyer Frank Darras, who has worked extensively on litigation scenarios following Katrina. “If you are a homeowner, you are going to argue that you have damage caused by wind and wind-driven rain. If you are the carrier, you are going to say the damage was caused by flood, tidal surge or a hurricane, which requires hurricane coverage.”

Excerpted from The Street

In a unique twist, New York has a specific website that contains a regularly updated scorecard on insurance company performance. Here's the link. For example, State Farm has had 48,109 claims; 6,363 closed with payment; 5,229 closed without payment.

3. Problems With The Flood Insurance Solution
FEMA says that less than 15% of homeowners nationally carry flood coverage. Federally backed lenders have been lax in enforcing the obligation to purchase flood insurance (that may change due to higher penalties being imposed upon the banks as of July, 2012).

The National Flood Insurance Program anticipates claims between \$6 and \$12 billion but has borrowing power at \$2.9 billion. Reauthorization from Congress would be required, and Homeland Security is expected to request appropriation soon. Those current and new policyholders of National Flood Insurance Program coverage will be getting a scheduled rate increase that predates Sandy.

Even if the person or business purchased flood coverage, there are still problems and concerns.

1. The limits of insurance available through the National Flood Insurance Program are small.
2. Replacement cost coverage applies only to a dwelling and not to commercial structures.
3. There may be wind damage to the building that the flood insurer will not pay but is covered in the homeowner's policy.
4. The insured will get to pay two deductibles for those two separate policies.
5. What kind of coverage is there if the first layer of property coverage is the NFIP coverage and the insured purchases excess layers of flood coverage above that policy?

1. Will it drop down to pick up the replacement cost difference? No.
2. Will it drop down to pick up business income, extra expense coverage? It should. Check the policy language.

4. The Future Of Flood Insurance
The future of the entire program is bleak enough. Add to that the impact of Hurricane Sandy on the future purchase of flood insurance. Homeowners in storm-damaged coastal areas who had flood insurance, and many more who did not, still now may be required to carry flood insurance and will face premium increases for flood from an estimated 20 to 25 percent per year beginning January. This is due in part to legislation enacted in July to shore up the debt ridden National Flood Insurance Program and is exacerbated by Hurricane Sandy.

“Because private insurers rarely provide flood insurance, the program has been run by the federal government, which kept rates artificially low under pressure from the real estate industry and other groups. Flood insurance in higher-risk areas typically costs \$1,100 to \$3,000 a year, for coverage capped at \$250,000; the contents of a home could be insured up to \$100,000 for an additional \$500 or so a year,” said Steve Harty, president of National Flood Services, a large claims-processing company.

Excerpted from The New York Times)

Lenders, in addition, will be affected by Hurricane Sandy if they fail to enforce the requirement for their lenders to carry flood insurance. They will face even higher penalties then they have in the past.

5. Ordinance Or Law

1. Many of those properties damaged by Hurricane Sandy had been built a number of years ago. So here are the questions:

1. Does the Homeowner's Policy, Commercial Property Policy or Difference in Conditions include contingent ordinance or law coverage, demolition coverage and increased cost of construction coverage?
2. What about the loss of use for the homeowner as well as the business interruption coverage?
2. The National Flood Insurance Program policy is out as there is no coverage for the indirect loss.
3. Many Difference in Conditions policies do not include ordinance or law automatically and many more do not include ordinance or law — increased period of restoration to cover the additional down time due to code or law enforcement.

6. Power Loss
Earlier we quoted the statistic of there being approximately 7.5 million power outages throughout Hurricane Sandy's two day assault on land. Many of these outages lasted days and weeks. There are several issues relating to insurance in terms of the power outages:

1. Requirement Of An Off Premises Endorsement: In order for businesses to have coverage for either direct or indirect losses relating to power outage, the insurance would first have “off premises” or “utility coverage” on the policy. Typically, losses stemming from off premises situations are excluded on property insurance policies.
2. Causation Of The Power Outage: If there was coverage on the property policies for the off premise loss, the situation that occurred off premises would have to be covered. For example, if the off premises loss were caused by a windstorm, that cause of loss is typically covered on a Commercial Property Policy or personal form. If the loss were caused by flooding, then that cause of loss is excluded and the off premises endorsement would not apply.
3. Off Premises Deductible: Off premises coverage oftentimes has a “time” deductible or waiting period of 72 hours unless endorsed. This waiting period would have eliminated coverage for many of the properties that had their power back in three days or less.
4. Direct vs. Indirect Loss: An Off Premises Endorsement would have to cover both direct damage and indirect to pick up a loss for Business Income.
5. Other Perils such as Equipment Breakdown (EB): The cause of off premises loss may be due to a power surge that results from the storming. If the Equipment Breakdown policy has off premises coverage and business income coverage, then recovery can be sought under that policy.
6. Some Off Premises Policies Have Distance Limitations: It must be ascertained if there is any distance indication on the policy to which the off premises is being attached. For example, some policies have a 500-foot distance radius which means the source of the off premises loss must be within 500 feet of the insured's premise.
7. Spoilage: It may be that the loss the insured sustained while the power was out was spoilage, such as loss to refrigerated items and the business income that stems from that loss. This could be covered on either an Equipment Breakdown Form depending on whether there was a “breakdown” or on a Commercial Property Spoilage Form. Some Homeowners have limited coverage built in for refrigeration loss but not for the peril of flood.

7. Business Income
Now we are talking about one of the bigger claims that will result from Hurricane Sandy and much of it will not be covered. Here are some of the pressure points of this coverage:

1. Cause of Loss — back to that one. Flood is excluded on the Commercial Property form so there will be no response for business income.
2. The Flood insurance policy does not cover business income.
3. If the cause of loss is determined to be “windstorm” and the insured has Business Income insurance, then the policy should respond from the causation point of view assuming they had direct damage.
4. The insured will have to prove that their income loss is directly attributable to Hurricane Sandy.
5. The policy has a waiting period for coverage typically 72 hours unless endorsed.
6. The policy would have to be endorsed with Off Premise coverage for the Business Income stemming from loss of power to apply.
7. There is no building ordinance for the business income — it would have to be endorsed.
8. Civil Authority: Many of the businesses did not sustain direct damage but were closed by civil authority.

1. There is limited coverage on the Business Insurance form
2. There may be distance limitations
9. Ingress/Egress: A bigger problem is the ingress/egress issue which basically means “because of the condition, itself, access to an area is affected or unavailable.” For example, if a road is flooded out so that there is no access to a grocery store, the grocery store will be able to demonstrate they are losing customers. However, if the store was not directly affected by the physical loss, there will be no trigger on their business income form. Civil Authority did not close down the area — it was closed due to natural events in this case.

Traditional Business Income Policies require that there be direct damage to the premises by a peril insured against for there to be any business income insurance response. However, there is talk, in the aftermath of Hurricane Sandy, of what is referred to as Non-Damage Business Interruption or Non Physical Business Interruption Insurance. It is referred to as NDBI. While articles are referring to these coverages, as if they are readily available, I believe they are truly exceptional in availability and accessibility. Sometimes these forms are part of a “supply line coverage” for very large businesses that often have an international component. There is also the TDI or CDI coverage — Trade Disruption which could come into play — however, that coverage has a very limited market. Bottom line, the average business that sustained damage as a result of Hurricane Sandy had neither one of these types of coverage. Liberty International apparently has a program.

8. Automobile Losses From Hurricane Sandy
Autos are the easiest part of this equation: whether wind, flood or a combination, all are covered under the “Other Than Collision” coverage. The salvaging of these autos is where it gets interesting. Canadian officials are now bewailing the fact that thousands of autos — some estimates are as high as 250,000 — are likely making their way to Canada. Those storm-damaged vehicle are classified in Canada as “non-repairable” and are illegal to sell. But, in the aftermath of Katrina, Canadian citizens were buying these vehicles in the thousands, and they expect the same thing to happen again. What I wonder is, who is selling those vehicles? The original owner? The salvage company the insurer uses?

### The Lawyers Are Out To Get You

Errors And Omissions Litigation
Well, as if all the foregoing isn't depressing enough, we cannot end this article without a little nudge to the insurance agent and broker.

If you are relying upon “conversations” with your client along the lines of “Do you want flood insurance? No. OK, then,” you are going to be sadly mistaken that your client is not going to enjoin you in litigation over your standard of care. Your client is going to claim an increased standard of care, yes including New York residents, and that you had a duty to advise and quote coverage for them or at the very least, tell them in writing of the limitations of coverage in the policies they purchased and that they relied upon you for your expertise. Many agents simply renew, year after year, their direct bill homeowner's and small business clients without any documentation of coverage offers. Even those handling larger accounts somehow rely upon the client's memory and good will not to sue you. So, again, for the millionth time already, please, please document your file, in writing, to the insured, with a rejection signature every year or, for larger accounts, an authorization to bind affirmation from the insured.

As we were all glued to the TV, watching reporters being blown around reporting the devastation, my insurance brain immediately went to “flood exclusions.” I saw the wind ravaging the houses, the uprooted trees blocking the roads, but also saw the rising waters in the streets, along the shores, in the housing areas.

The question will come down to that simple reality — was the damage due to flooding or not? The attorneys are out in force, fighting for first page on the Google search engine so you get to them first. It reminds me of an old Gun Smoke movie — ready, aim, fire. Barrels are being loaded against the insurance companies.

There is no easy way to end this article, although I am sure all of you who reached the very end are hopeful that I will. The storm was one of the biggest ever, and the insurance story will not end soon. There is so much more we could say but best end this with a heads up to watch and see how these claims unravel; and, for those of you who did not insure any of these damaged properties, I say a toast of champagne is in order.