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13 Emerging Trends for Insurance in 2016

Where does the time go?  It seems as if we were just ringing in 2015, and now we’re well into 2016. As time goes by, life changes, and the insurance industry—sometimes at a glacial pace—does, indeed, change, as well. Here’s my outlook for 2016 on various insurance topics:

  1. Increased insurance literacy: Through initiatives like The Insurance Consumer Bill of Rights and increased resources, consumers and agents are both able to know their rights when it comes to insurance and can better manage their insurance portfolios.
  2. Interest rates: The federal funds target rate increase that was announced recently will have a yet-to-be determined impact on long-term interest rates. According to Fitch Ratings, further rate increases’ impact on credit fundamentals and the longer end of the yield curve has yet to be determined. Insurance companies are hoping for higher long-term rates as investment strategies are liability-driven. (Read more on the FitchRatings website here). Here is what this means: There will not necessarily be a positive impact for insurance policy-holders (at least in the near future). Insurance companies have, for a long period, been subsidizing guarantees on certain products or trying to minimize the impact of low interest rates on policy performance. In the interim, many insurance companies have changed their asset allocation strategies by mostly diversifying their portfolios beyond their traditional holdings—cash and investment-grade corporate bonds—by investing in illiquid assets to increase returns. The long-term impact on product pricing and features is unknown, and will depend on further increases in both short- and long-term interest rates and whether they continue to rise in predictable fashion or take an unexpected turn for which insurers are ill-prepared.
  3. Increased cost of insurance (COI) on universal life insurance policies: Several companies—including Voya Financial (formerly ING), AXA and Transamerica—are raising mortality costs on in-force universal life insurance policies. Some of the increases are substantial, but, so far, there has been an impact on a relatively small number of policyholders. That may change if we stay in a relatively low-interest-rate environment and more life insurance companies follow suit. Here is what this means: As companies have been subsidizing guaranteed interest rates (and dividend scales) that are higher than what the companies are currently (and have been) earning over the last few years, it is likely that this trend will continue.
  4. Increasing number of unexpected life insurance policy lapses and premium increases: For the most part, life insurance companies do not readily provide the impact of the two prior factors I listed when it regards cash value life insurance policies (whole life, universal life, indexed life, variable life, etc). In fact, this information is often hidden. And this information will soon be harder to get; Transamerica is moving to only provide in-force illustrations based on guarantees, rather than current projections. Here is what this means: It will become more challenging to see how a policy is performing in a current or projected environment. At some point, regulators or legislators will need to step in, but it may be too late. Monitor your policy, and download a free life insurance annual review guide from the Insurance Literacy Institute (here).
  5. Increased complexity: Insurance policies will continue to become more complex and will continue their movement away from being risk protection/leverage products to being complex financial products with a multitude of variables. This complexity is arising with products that combine long-term care insurance and life insurance (or annuities), with multiple riders on all lines of insurance coverage and with harder-to-define risks — even adding an indexed rider to a whole life policy (Guardian Life). Here is what this means: The more variables that are added to the mix, the greater the chance that there will be unexpected results and that these policies will be even more challenging to analyze.
  6. Pricing incentives: Life insurance and health insurance companies are offering discounts for employees who participate in wellness programs and for individuals who commit to tracking their activity through technology such as Fitbit. In auto insurance, there can be an increase in discounts for safe driving, low mileage, etc. Here is what this means: Insurance companies will continue to implement different technologies to provide more flexible pricing; the challenge will be in comparing policies. The best thing an insurance consumer can do is to increase her insurance literacy. Visit the resources section on our site to learn more.
  7. Health insurance and PPACA/Obamacare: The enrollment of individuals who were uninsured before the passage of Obamacare has been substantial and has resulted in significant changes, especially because everyone has the opportunity to get insurance—whether or not they have current health issues. And who, at some point, has not experienced a health issue? Here is what this means: Overall, PPACA is working, though it is clearly experiencing implementation issues, including the well-publicized technology snafus with enrollment through the federal exchange and the striking number of state insurance exchanges. And there will be continued challenges or efforts to overturn it in the House and the Senate. (The 62nd attempt to overturn PPACA was just rejected by President Obama.) The next election cycle may very well determine the permanency of PPACA. The efforts to overturn it are shameful and are a waste of time and money.
  8. Long-term care insurance: Rates for in-force policies have increased and will almost certainly face future increases—older policies are still priced lower than what a current policy would cost. This is because of many factors, including the prolonged low-interest-rate environment, lower-than-expected lapse ratios, higher-than-expected claims ratios and incredibly poor initial product designs (such as unlimited benefits on a product where there was minimal if any claims history). These are the “visible” rate increases. If you have a long-term care insurance policy with a mutual insurance company where the premium is subsidized by dividends, you may not have noticed or been informed of reduced dividends (a hidden rate increase). Here is what this means: Insurance companies, like any other business, need to be profitable to stay in business and to pay claims. In most states, increases in long-term care insurance premiums have to be approved by that state’s insurance commissioner. When faced with a rate increase, policyholders will need to consider if their benefit mix makes sense and fits within their budget. And, when faced with such a rate increase, there is the option to reduce the benefit period, reduce the benefit and oftentimes change the inflation rider or increase the waiting period. More companies are offering hybrid insurance policies, which I strongly recommend staying away from. If carriers cannot price the stand-alone product correctly, what leads us to believe they can price a combined product better?
  9. Sharing economy and services: These two are going to continue to pose challenges in the homeowners insurance and auto insurance marketplaces for the insurance companies and for policy owners. There is a question of when is there actually coverage in place and which policy it is under. There are some model regulations coming out from a few state insurance companies, however, they’re just getting started. Here is what this means: If you are using Uber, Lyft, Airbnb or a similar service on either side of the transaction, be sure to check your insurance policy to see when you are covered and what you are covered for. There are significant gaps in most current policies. Insurance companies have not caught up to the sharing economy, and it will take them some time to do so.
  10. Loyalty tax: Regulators are looking at banning auto and homeowners insurance companies from raising premiums for clients who maintain coverage with them for long periods. Here is what this means: Depending on your current auto and homeowners policies, you may see a reduction in premiums. It is recommended that, in any circumstance, you should review your coverage to ensure that it is competitive and meets your needs.
  11. Insurance fraud: This will continue, which increases premiums for the rest of us. The Coalition Against Insurance Fraud released its 2015 Hall of Shame (here). Insurance departments, multiple agencies and non-profits are investigating and taking action against those who commit elder financial abuse. Here is what this means: The more knowledgeable that consumers, professional agents and advisers become, the more we can protect our families and ourselves.
  12. Uncertain economic and regulatory conditions: Insurance companies are operating in an environment fraught with potential changes, such as in interest rates (discussed above); proposed tax code revisions; international regulators who are moving ahead with further development of Solvency II; and IFRS, NAIC and state insurance departments that are adjusting risk-based capital charges and will react to the first year of ORSA implementation. And then there is the Department of Labor’s evaluation of fiduciary responsibility rules that are expected to take effect this year. Here is what this means: There will be a myriad of potential outcomes, so be sure to continue to monitor your insurance policy portfolio and stay in touch with the Insurance Literacy Institute. Part of the DOL ruling would result in changes to the definition of “conflict of interest” and possibly compensation disclosure.
  13. Death master settlements: Multiple life insurance companies have reached settlements on this issue. Created by the Social Security Administration, the Death Master File database provides insurers with the names of deceased people with Social Security numbers. It is a useful tool for insurers to identify policyholders whose beneficiaries have not filed claims—most frequently because they were unaware the deceased had a policy naming them as a beneficiary. Until recently, most insurers only used the database to identify deceased annuity holders so they could stop making annuity payments, not to identify deceased policyholders so they can pay life insurance benefits. Life insurers that represent more than 73% of the market have agreed to reform their practices and search for deceased policyholders so they can pay benefits to their beneficiaries. A national investigation by state insurance commissioners led to life insurers returning more than $1 billion to beneficiaries nationwide. The National Association of Insurance Commissioners is currently drafting a model law  that would require all life insurers to use the Death Master File database to facilitate payment of benefits to their beneficiaries. To learn more, visit our resources section here. Here is what this means: Insurance companies will not be able to have their cake and eat it too.

What Can You Do?

The Insurance Consumer Bill of Rights directly addresses the issues discussed in this article.

Increase your insurance literacy by supporting the Insurance Literacy Institute and signing the Insurance Consumer Bill of Rights Petition. An updated and expanded version will be released shortly  that is designed to assist insurance policyholders, agents and third party advisers.

Sign the Insurance Consumer Bill of Rights Petition 

What’s on your mind for 2016? Let me know. And, if you have a tip to add to the coming Top 100 Insurance Tips, please share it with me.

The FIO Report on Insurance Regulation

The December 2013 issuance of the Federal Insurance Office (FIO) report, How to Modernize and Improve the System of Insurance Regulation in the United States, may in hindsight be regarded as more momentous an occasion for the industry and its regulation than the muted initial reaction might suggest. History’s verdict most likely will depend on the effectiveness of the follow-up to the report by both the executive and legislative branches, but current trends in financial services regulation may serve to increase the importance and influence over time of the FIO even in the face of inaction in Washington.

Insurance regulation has traditionally been the near-exclusive province of the states, a right jealously guarded by the states and secured by Congress in 1945 after the Supreme Court ruled insurance could be regulated by the federal government under the Commerce Clause of the Constitution.

Any fear that the FIO report would call for an end to state regulation proved unfounded, but industry members might be well-advised to prepare for the eventualities that may result as the FIO uses both the soft power of the bully pulpit and the harder power of the federal government to achieve its aims. As the designated U.S. insurance representative in international forums that more and more mold financial services regulation, and as an arbiter of standards that could be imposed on the states, the FIO and this report should not be ignored.

Having met with the FIO’s leadership team, we believe there are concerns that uniformity at the state level cannot be achieved without federal involvement. We further believe the FIO plans to work to translate its potential into an actual impact in the near future, making a clear-eyed understanding of the report and what it may herald for insurers a prudent and necessary step in regulatory risk management.

The concerns

The biggest surprise about the FIO report may well have been that there were no surprises. There were no strident calls for a wholesale revamp of the regulatory system, and praise for the state regulatory system was liberally mingled among the criticisms.

The lack of any real blockbusters in the details of the FIO report may seem to lend implicit support to those who foresee a continuation of the status quo in insurance regulation. But, taken as a whole, this report and the regulatory atmosphere in which it has been released should be considered a subtle warning of changes that may yet come.

The report may quietly help to usher in an acceleration of the current evolution of insurance regulation. The result could be a regulatory climate that offers more consistency and clarity for insurers and reduces the cost of regulation. The result could also be a regulatory climate that offers more stringent regulatory requirements and increases both the cost of compliance and capital requirements. Most likely, the result could be a hybrid of both.

Either way, preparing to influence and cope with any possible changes portended in the report would be preferable to ignoring the portents.

Part of the disconnect between the short-term reception and the long-term impact of this report may be because of the implicit FIO recognition in the report of the lack of political will needed to enforce any real changes in current U.S. insurance regulation, most especially any that would require increased expenditures or personnel at the federal level. In our current economic and political environment, plugging gaps in state regulation by using measures that would require federal dollars may quite reasonably be construed to be off the table.

But the difference between identified problems and feasible solutions may offer an opportunity. States, industry and other stakeholders could act together to bring needed reform to the insurance regulatory system in a way that adds uniform national standards to regulation, reduces the possibility of regulatory arbitrage and maintains the national system of state-based regulation, all while recognizing the industry’s strengths and needs and not burdening the industry with unnecessary, onerous regulation.

There is much to praise in the current state regulatory system. A generally complimentary federal report on the insurance industry and the fiscal crisis of the past decade noted, “The effects of the financial crisis on insurers and policyholders were generally limited, with a few exceptions…The crisis had a generally minor effect on policyholders…Actions by state and federal regulators and the National Association of Insurance Commissioners (NAIC), among other factors, helped limit the effects of the crisis.”

While the financial crisis demonstrated the effectiveness of the current insurance regulation in the U.S., it is also evident that, as in any enterprise, there are areas for improvement. There are niches within the industry – financial guaranty, title and mortgage insurance come to mind – where regulatory standards and practices have proven less than optimal.

There are also national concerns that affect the industry. The lack of consistent disciplinary and enforcement standards across the states for agents, brokers, insurers and reinsurers is one obvious concern. Similarly, the inconsistent use of permitted practices and other solvency-related regulatory options could lead to regulatory arbitrage. At a time when insurance regulators in the U.S. call for a level playing field with rivals internationally, these regulatory differences represent an example of possible unlevel playing fields at home that deserve regulatory attention and correction.

A Bloomberg News story in January 2014, for example, quoted one insurer as planning to switch its legal domicile from one state to another because the change would allow, according to a spokeswoman for the company, a level playing field with rivals related to reserves, accounting and reinsurance rules.

For insurers operating within the national system of state-based regulation, one would hope that that level playing field would cross domiciles, and no insurer would be disadvantaged because of its domicile in any of the 56 jurisdictions.

But perhaps one of the greatest challenges to the state-based system of regulation is the added cost of that regulation, partly engendered by duplicative requests for information and regulatory structures that have not been harmonized among states. How to respond to that may represent the biggest gap in the FIO report. It may also be the biggest opportunity for both insurers and regulators to rationalize the current regulatory system and ensure the future of state-based regulation.

Cost

The FIO report notes that the cost per dollar of premium of the state-based insurance regulatory system “is approximately 6.8 times greater for an insurer operating in the United States than for an insurer operating in the United Kingdom.” It quotes research estimating that our state-based system increases costs for property-casualty insurers by $7.2 billion annually and for life insurers by $5.7 billion annually.

According to the report, “regulation at the federal level would improve uniformity, efficiency and consistency, and it would address concerns with uniform supervision of insurance firms with national and global activities.”

Yet the report does not recommend the replacement of state-based regulation with federal regulation, but with a hybrid system of regulation that may remain primarily state-based, but does include some federal involvement.

At least one rationale for this is clearly admitted in the report. As it says, “establishing a new federal agency to regulate all or part of the $7.3 trillion insurance sector would be a significant undertaking … (that) would, of necessity, require an unequivocal commitment from the legislative and executive branches of the U.S. government.”

The result of that limitation is a significant difference between diagnosis and prescription in the FIO report. Having diagnosed the cost of the state-based regulatory system as an unnecessary $13 billion burden on policyholders, the FIO's policy recommendations may possibly be characterized as, for the most part, the policy equivalent of “take two aspirin and call me in the morning.”

Still, as the Dodd-Frank Act showed, even Congress can muster the will to impose regulatory solutions if a crisis becomes acute enough and broad enough. Unlikely as that may now seem, the threat of federal radical surgery should not be what is required for states to move toward addressing the recommendations of the FIO report.

Indeed, actions of the NAIC over the past few years have addressed much of what is in the FIO report. Now the NAIC, industry and other stakeholders can take the opportunity provided by the report to work to resolve some of the issues identified in it. The possible outcome of an even greater federal reluctance to become involved in insurance regulation would only be a side benefit. The real goal should be a regulatory system that is more streamlined, less duplicative, more responsive, more cost-efficient and more supportive of innovation.

Kevin Bingham has shared this article on behalf of the authors of the white paper on which it is based: Gary Shaw, George Hanley, Howard Mills, Richard Godfrey, Steve Foster, Tim Cercelle, Andrew N. Mais and David Sherwood. They can reached through him. The white paper can be downloaded here

The Real Challenge for Reforming Workers’ Comp

Sifting through the claims and complaints of those involved in California’s complex workers’ compensation system could leave both the casual observer and the seasoned veteran wondering when, if ever, this multibillion-dollar program will ever get properly aligned. It would be fairly easy to say, “Not during our lifetime.” But that would be too cynical even when discussing a system that for the past several decades could easily invoke cynicism.

Every participant in workers’ compensation has two faces. Some employers provide benefits, have a compliant return to work program and enforce a culture of safety at the workplace, while other employers view employees as a necessary evil. These latter employers view adherence with the legion of local, state, and federal laws and regulations regarding the workplace as burdens that need only be acknowledged if employers are required to do so, generally in the form of a legal proceeding against them.

We have seen the abuses in the medical system from unnecessary surgeries, overuse of Schedule II medications, and downright fraud in billing insurers and other payers, and yet if there is one indispensable party in the workers’ compensation system beyond labor and management it is medical providers. As recent events have demonstrated, we have yet to figure out how to empower the noble practitioners of the healing arts while keeping the venal away from injured workers.

Claims administrators vary in expertise, motivation, and professionalism, as do the various service providers and the tactics they employ to provide services and collect fees. “Insurers” have borne an unfair brunt of criticism largely because it is an easier talking point to cast such a broad brush than to single out any one bad actor or group of them. Without the ability to transfer risk, however, the workers’ compensation system could never be sustainable.

Each system participant has a particular grudge against the others. We allow policyholders to sue insurers for claims handling practices, and, in far narrower circumstances, an injured worker may pierce exclusive remedy and sue a claims administrator when conduct is so egregious that it goes beyond the grand bargain that is at the core of workers’ compensation.  Periodically, claims administrators and service providers resort to the civil courts with a variety of complaints over unfair business practices.  And, of course, the Workers’ Compensation Appeals Board is the forum where all participants flock with even the slightest provocation.

The appellate courts weigh in on a wide range of benefit delivery challenges, as well. Their decisions in Guzman and Ogilvie were two of the main incidents inciting changes in permanent disability benefit determinations codified in Senate Bill 863 (De León). Even today, we are litigating issues over the apportionment changes brought about in Senate Bill 899 (Poochigian) enacted almost a decade ago. Litigation in federal court is rare, although not unprecedented, as the current challenge to the lien activation fee in SB 863 demonstrates.   State-imposed fee schedules have periodically worked their way into federal court on the theory that reimbursement rates are so low that they are confiscatory – a challenge unlikely in California while the fee schedule is not mandatory, but still possible given the breadth of authority that the Division of Workers’ Compensation has been given to develop fee schedules for virtually all service providers.

“Well, that’s just California workers’ comp.”  That may be the case, but such resignation does tend to take the focus away from core problems that magnify the multiple personality disorder that plagues this system. As we work our way through the implementation of SB 863, we must also recognize that not every solution to the high cost of comp, both in dollar and human terms, can be put down on paper in Sacramento or Oakland.

While compliance is part of best practices, it does not define them exclusively. To be sure, the new costs associated with complying with SB 863 are consequential. As is inevitably the case when new comprehensive workers’ compensation laws are enacted, there will be considerable friction moving from one set of rules to another. The threat of litigation will hang over the changes made in this legislation just as it has in prior iterations of reform. It will take years to sort this all out.

In the meantime, there is much work to be done to improve the system even if it is not in  reaction to a new law or regulation or judicial decision. As has been the case all too often over the past two decades, laws are driven by anecdote. The adage “bad facts make bad law” applies equally to the legislative, regulatory, and judicial processes. Navigating California’s complex system is never easy. If claims administrators expect the process by which laws are made and interpreted to provide the necessary clarity and simplicity we crave to do our jobs, then we are all sadly mistaken.

Yet, when we commit to best practices both as employers and claims professionals, we can create better outcomes than Sacramento could ever hope to achieve. The challenge, therefore, is not what legislators or regulators or justices will do for us, but rather what will we do for ourselves?

Mandatory Skilled Nursing Hours Claims: Are You Covered?

As coverage counsel for policyholders, we see a variety of cases, claims, and complaints. In recent years we have observed a growing trend in health care litigation. Specifically, claims alleging violations of California Health and Safety Code Section 1276.5, which requires skilled nursing facilities (SNFs) to provide at least 3.2 nursing hours per day for each facility resident (3.2 Requirement). In the past, the 3.2 Requirement was mainly enforced by the California Department of Public Health, not private individuals. However, skilled nursing facility residents have the right to bring a private cause of action alleging violations of the 3.2 Requirement (3.2 Claims). The Lavender, et al. v. Skilled Healthcare Group, Inc., et al. matter,1 which resulted in a 2010 jury verdict of more than $670 million for plaintiff skilled nursing facility residents asserting, among other things, 3.2 Claims, demonstrates how disastrous such claims can be for skilled nursing facilities that litigate such claims through trial.

This private right of action was recently addressed by the California Court of Appeal in Shuts, et al. v. Covenant Holdco LLC, et al., where the plaintiff skilled nursing facility residents asserted 3.2 Claims under Health and Safety Code Section 1430(b).2 The Court in Shuts held that Section 1430(b) permits current or former skilled nursing facility residents to bring a lawsuit against the facility for violating any of their rights under the “Skilled Nursing and Intermediate Care Facility Patient's Bill of Rights.”3 The Patient's Bill of Rights includes the entitlement to live at a skilled nursing facility that employs an “adequate number of qualified personnel.”4 Thus, Section 1276.5's requirement that facilities maintain staffing ratios compliant with the 3.2 Requirement may be enforced by residents through Section 1430(b). Additionally, Section 1430(b) allows plaintiffs to recover monetary damages, up to a maximum of $500 per violation, as well as attorneys' fees and costs. By law, these damages may be multiplied by a factor of three if such violations caused a senior citizen or disabled person to suffer.5

Very recently, the California Court of Appeal held in Nevarrez v. San Marino Skilled Nursing and Wellness Centre that Section 1430(b) permits a maximum recovery of $500 total in a civil action for violation of the Patient's Bill of Rights.6 The Court opined that $500 is the maximum recovery available “regardless of how many rights are violated or whether such rights are violated repeatedly.”7 The trial court's award of $7,000 (based on a $500 award for each of the 14 violations alleged) was therefore reversed.8 This is an important ruling for skilled nursing facilities, and may significantly curtail litigation based on alleged violations of the Patient's Bill of Rights given the potential for very limited monetary recovery.

The Nevarrez decision is not yet final and may be reversed. Indeed, the Court of Appeal granted a petition for rehearing on the issue of the maximum recovery allowable under Section 1430(b). As a result, the decision in Nevarrez is now vacated pending rehearing.9 Thus, given the potentially significant exposure facilities still face opposing 3.2 Claims, insurance coverage is critical. Such coverage turns on the policy language at issue. Generally speaking, there are two types of liability policies: those that require physical harm and those that do not. The policies that do not require physical harm are more likely to result in coverage for 3.2 Claims, as patient-plaintiffs tend to disclaim any intent to “'seek damages for personal injuries, wrongful death or other resident-specific harm that may have been caused by inadequate staff.'”10 Such disclaimers are likely included to facilitate class certification in putative class actions; if there is any indication that individual claims of injury or death could predominate the lawsuit, the facility-defendants could possibly defeat class certification.

Despite policy language indicating coverage, insurers attempt to avoid their coverage obligations by asserting various arguments, including that 3.2 Claims amount to uncovered fines and penalties (liability policies commonly contain provisions excluding coverage for “fines and penalties”). Such arguments are unpersuasive. For example, nowhere in the statute through which patient-plaintiffs assert 3.2 Claims — Section 1430(b) — are fines or penalties mentioned. To the contrary, Section 1430(b) is entitled “Actions for injunction or civil damages.”11 Additionally, in the Shuts matter, the California Court of Appeal explained that “Section 1430, subdivision (b) authorizes statutory damages, attorney fees, and injunctive relief.”12 Further, the California Supreme Court has drawn a distinction between penalties that may be assessed by the State Department of Health Services (now the Department of Public Health) for violations, and the damages that may be recovered by a private party under the Long-Term Care, Health, Safety, and Security Act of 1973 (which includes Section 1430).13 Thus, the relief available to private party plaintiffs under Section 1430(b) constitutes covered damages, not uncovered fines or penalties.

Notwithstanding the title of Section 1430(b) — “Actions for injunction or civil damages” — and the California Supreme Court's distinction between penalties and damages, the Court of Appeal in Nevarrez referred to the amount recoverable under Section 1430(b) as a “penalty.”14 Because the Nevarrez court's reference to Section 1430(b)'s imposition of supposed “penalties” (as opposed to damages) was not an issue pending before the Court, its characterization of the relief available under Section 1430(b) is non-binding dicta.

Further, it is well established in California that insurance coverage is interpreted broadly so as to afford the greatest possible protection to the insured.15 Courts will not read words into a statute to facilitate a declination of coverage.16 Additionally, an insurer bears the burden of bringing itself within a policy's exclusionary clauses and exclusions are narrowly construed against insurers.17 Policy exclusions are strictly construed and an insurer cannot escape its basic duty to insure by means of an exclusionary clause that is unclear.18

Because Section 1430(b) is properly construed to provide for damages, not fines or penalties, and insurers must meet a high burden to avoid coverage based upon exclusionary policy language, a standard “fines or penalties” coverage limitation should not preclude coverage for 3.2 Claims.

Understanding insurance coverage issues can be key for skilled nursing facilities facing 3.2 Claims. Not only can insurance funds provide a defense against such claims, they may also assist in resolving those claims so as to avoid potentially devastating results at trial.

Authors
Miles Holden collaborated with Samantha Wolff in writing this article. Ms. Wolff is an attorney at Hanson Bridgett LLP. She represents both public and private sector clients in a variety of matters, including insurance coverage disputes and putative and certified class actions, through all phases of litigation in federal and state court.

1Lavender, et al. v. Skilled Healthcare Group, Inc., et al.; California Superior Court, Humboldt County; Case No. DR060264.

2Shuts, et al. v. Covenant Holdco LLC, et al. (2012) 208 Cal.App.4th 609.

3Health & Saf. Code, § 1430, subd. (b); Shuts, 208 Cal.App.4th at p. 614.

4Health & Saf. Code, § 1599.1, subd. (a); Cal. Code Regs., tit. 22, § 72527, subd. (a)(25).

5Civ. Code, § 3345.

6Nevarrez v. San Marino Skilled Nursing and Wellness Centre (June 5, 2013, B235372) __ Cal.App.4th __ [2013 Cal.App. LEXIS 444].)

7Nevarrez, supra, __ Cal.App.4th __ [2013 Cal.App. LEXIS 444, at p. *46].

8Id. at p. *47.

9Cal. Rules of Court, rule 8.268(d).

10See, e.g., Shuts, 208 Cal.App.4th at p. 615.

11Health & Saf. Code, § 1430 (emphasis added).

12Shuts, 208 Cal.App.4th at p. 614 (emphasis added).

13Kizer v. County of San Mateo (1991) 53 Cal.3d 139, 142-43.

14Nevarrez, supra, __ Cal.App.4th __ [2013 Cal.App. LEXIS 444, at pp. *45-47].

15See, e.g., MacKinnon v. Truck Ins. Exch. (2003) 31 Cal.4th 635, 648; see also State of Cal. v. Allstate Ins. Co. (2009) 45 Cal.4th 1008, 1018 (where insurance policy terms are ambiguous, they must be interpreted to protect the objectively reasonable expectations of the insured).

16Code Civ. Proc., § 1858; see also Silicon Valley Taxpayers' Assoc., Inc. v. Santa Clara County Open Space Authority (2008) 44 Cal.4th 431, 444-45 (statutes are to be given their plain meaning and courts are not permitted to read into the meaning of a statute if the language is clear and unambiguous); People v. Guzman (2005) 35 Cal.4th 577, 587-88 (courts may not add provisions to a statute by inserting words).

17N. Am. Bldg. Maint., Inc. v. Fireman's Fund Ins. Co. (2006) 137 Cal.App.4th 627, 642; Charles E. Thomas Co. v. Transamerica Ins. Grp. (1998) 62 Cal.App.4th 379, 382.

18E.M.M.I. Inc. v. Zurich Am. Ins. Co. (2004) 32 Cal.4th 465, 471.

Sinkhole Peril: Reducing Exposure And Managing Risk

The sensational news of Jeff Bush, swallowed by the earth while he slept, has been widely reported by the media.1 Such dramatic incidents receive a great deal of attention, likely because they are so rare. Sinkholes, however, are not rare. They do not usually threaten lives, but in Florida they have often threatened insurance companies' balance sheets, endangering their profitability and — in at least one case — their solvency.

First we must distinguish between how the terms “sinkhole” and “catastrophic ground collapse” are used in insurance in Florida. According to Florida statutes, “'Sinkhole' means a landform created by subsidence of soil, sediment, or rock as underlying strata are dissolved by groundwater.” A “catastrophic ground collapse,” by comparison, exists when all of the following four criteria are met:

  1. The abrupt collapse of the ground cover;
  2. A depression in the ground cover clearly visible to the naked eye;
  3. Structural damage to the covered building, including the foundation; and
  4. The insured structure being condemned and ordered to be vacated by the governmental agency authorized by law to issue such an order for that structure.2

Sinkholes are fairly common in Florida and even ubiquitous in some areas. But what happened to Jeff Bush was a catastrophic ground collapse, and that's rare, even in Florida.

Much of the subsurface geology in Florida consists of limestone or dolomite and both are susceptible to gradual erosion when exposed to acidic water, which arises from a chemical reaction between rainwater percolating through the soil and decaying vegetation. This erosion can produce underground voids that are not visible on the surface and these voids will expand, usually very slowly. This slow expansion leads to a subsiding surface, which can cause cracking and other damage to structures. Very occasionally, a large void will lead to sudden collapse of the surface above it.3 A well-known historical example of this is the Winter Park sinkhole.4 A more recent example is the sinkhole into which Jeff Bush's house collapsed.

Although the process that produces sinkholes occurs naturally over tens of thousands of years, it can be accelerated by human-induced depletion of underground aquifers. In Tampa, the problem has become so significant that one of the first desalination plants in the United States has been built to reduce the use of underground water supplies.5 The groundwater depletion that has resulted from increased water use has in part contributed to extremely frequent sinkholes in Pasco and Hernando counties.6

Initial Legislative Efforts
In 1981, Florida passed a law mandating that insurance companies cover the sinkhole peril as part of home insurance.7 By 2006, the sinkhole loss ratio in Hernando County for Citizens Property Insurance Corporation, an insurer created by the state for those who cannot acquire coverage elsewhere, had reached 242%. The average sinkhole claim for Citizens was about $139,000.8 Claims were often not for catastrophic ground collapse or even damage that affected the load-bearing capacity of the structure, but were cosmetic in nature. There came to be a widespread perception in the industry that marginal claims were being paid out, partially as a result of aggressive solicitation of insureds by public adjusters.

In response, Florida lawmakers passed legislation that still required insurers to offer sinkhole coverage, but allowed policyholders to exclude it. The territories that Citizens used for rating the sinkhole peril were the same as it used for other perils — generally counties divided into a coastal region and an inland region. This method did not adequately capture the differentiation in sinkhole risk and once policyholders were allowed to exclude sinkhole coverage, those who believed they were at lower risk chose to do so.

The losses for the remaining, higher-risk insureds had to be spread over a smaller amount of premium, pushing the loss ratio up, and causing Citizens to file for rate increases. Those rate increases encouraged more low-risk insureds to opt out of sinkhole coverage, creating a self-reinforcing cycle of adverse selection. The sinkhole loss ratio, especially in the area of the state susceptible to sinkholes, increased. By 2009, it had reached 683% in Hernando County. The number of sinkhole claims for Citizens in Hernando county alone had increased from 186 in 2006 to 520 in 2009 — nearly tripled — while premiums to cover them had decreased from about $9.2 million to about $6.0 million.

Private insurers began withdrawing from the market in Pasco and Hernando counties entirely, and the share of the market for Citizens increased rapidly. Between 2008 and 2010, the number of policies Citizens wrote in Hernando County increased by 50%.9 HomeWise Insurance Company was forced into liquidation in 2011, despite no hurricanes affecting Florida since 2005, because of sinkhole claims.10 The insurance of damage from sinkholes led to an insurance crisis in Florida.

Bill SB408
Although there had been several previous rounds of legislation to address the crisis in 2005, 2006, 2007, and 2009, the crisis only worsened.11 Another bill, SB408, was passed in 2011. An analysis performed by Insurance Services Office (ISO) on behalf of Citizens estimated that this bill would reduce losses by about 54.7% based on several changes:12

  • The majority of the expected savings came from a change in definition; instead of covering “physical damage,” sinkhole coverage would now cover “structural damage.” The report estimated the impact of this change in definition by reviewing a random sample of closed claims and estimating what the loss would have been under the new definition.
  • Previously, many policyholders did not use the proceeds they received from their sinkhole claims to repair damage, but instead used it to pay off their mortgages or for some other purpose. In a sample of claims from HomeWise, for example, only 27% of insureds used the money to make repairs.13 SB408 requires that loss payments be used to repair sinkhole damage based on the specifications of an engineer's report.
  • When the insured uses a public adjuster, claims for which a sinkhole is not confirmed have much higher losses than when the insured does not use a public adjuster. In the analysis performed by ISO, it was determined that the losses for claims of Citizens with no confirmed sinkhole activity were 140% higher when a public adjuster was involved. SB408 limits public adjuster compensation to reduce the incentive to inflate sinkhole claims.14
  • SB408 excludes sinkhole damage to appurtenant structures, such as driveways, sidewalks, decks, or patios.
  • Policyholders with a previously denied sinkhole claim were granted the right to sinkhole testing at the expense of the insurance company. Under SB408, the policyholder must pay part of the cost of this testing, which is reimbursed if the testing demonstrates that a sinkhole exists.

In addition to these provisions, companies can exclude sinkhole coverage until an inspection is performed. If there is evidence of prior sinkhole activity, they can exclude the sinkhole peril from coverage. They can also now require a sinkhole deductible equal to 10% of coverage A for HO-3 policies.15

The cumulative impact of these reforms and improvements in underwriting is unclear. Although the reaction in the industry has been positive, it has been less than two years since SB408 was implemented and it will take time to see if it results in a real decrease in costs. In 2006, SB1980, another sinkhole reform bill, was passed and was expected to produce up to 14.4% savings, according to a report from Deloitte commissioned by the Florida Office of Insurance Regulation.16 As it turned out, this was just before a rapid escalation in sinkhole costs. It is very difficult to predict the impact of legislation, and while there is a lot of favorable anecdotal evidence, it is probably too soon to say for certain whether the Florida sinkhole crisis is over.

What Insurers Can Do To Manage Their Risk
Excluding sinkhole coverage and offering it as a buyback with a 10% mandatory sinkhole deductible after an inspection is one of the most important tools that insurers currently have. However, the dramatic example of adverse selection that occurred in recent years in Pasco and Hernando counties should serve as a reminder of the importance of risk differentiation. Adverse selection occurs because policyholders or competitors have more information about an insured risk. Insurers can reduce this risk by adopting granular rating plans that align the premium charged as closely as possible with the expected loss.

Because insurers based their calculations on territories designed for wind risk — consisting of a coastal and inland region — they failed to adequately differentiate risk within these counties based on underlying geology, changes in underground aquifers, and claim patterns. Further, since sinkhole claims are relatively uncommon, albeit very severe, companies often lack credible data, which encourages them to utilize territories that are not homogenous.

SB408 has diminished the sense of crisis in the industry and creates an opportunity for insurers to get ahead of the risks they face. Companies are now able to charge a separate premium for the sinkhole peril and they should begin utilizing territories that better reflect the variation in the underlying risk from that peril. Doing so, coupled with other important risk management strategies, will decrease the likelihood that they will have the sort of unfavorable experience that has been so damaging to the industry in recent years.

Although Florida has by far the highest rate of sinkholes in the United States, they also occur in many other parts of the country, such as Alabama, Kentucky, Missouri, Pennsylvania, Tennessee, and Texas — anywhere, in fact, where acidity erodes subsurface limestone. About 20% of the United States is susceptible to sinkholes.17 Less than two months after Jeff Bush was swallowed by the earth, a sinkhole in Chicago devoured three cars.18 Insurers would be wise to review their policy language and the law in all states where they have potential sinkhole exposure and consider steps to address this exposure. The most dangerous peril for any insurer is the one they did not realize they were covering.

Notes

1 New York Times (March 2, 2013). Crews halt effort to find man lost in Florida sinkhole that swallowed his room. Associated Press. Retrieved April 18, 2013, from http://www.nytimes.com/2013/03/03/us/florida-sinkhole-growing-as-engineers-investigate.html.

2 Section 627.706(2)(a), Florida Statutes.

3 Beck, B.F. & Sinclair, W.C. (1986). Sinkholes in Florida. Florida Sinkhole Research Institute, Universityi of Central Florida. Retrieved April 18, 2013, from http://publicfiles.dep.state.fl.us/FGS/FGS_Publications/FGS Library Documents/SinkholesInFlaAnIntroBeck1986a.pdf.

4 In May 1981, the Winter Park sinkhole in Central Florida swallowed a house, five Porsches, and part of the city's swimming pool. The sinkhole eventually measured 350 feet wide, 75 feet deep and had caused $4 million dollar in damage. Orlando Sentinel (November 13, 2013). Looking back at Winter Park's famous sinkhole. Retrieved April 18, 2013, from http://articles.orlandosentinel.com/2012-11-13/news/os-fla360-looking-back-at-winter-parks-famous-sinkhole-20121113_1_sinkhole-orlando-sentinel-winter-park

5 U.S. Geological Survey (November 2003). Ground-Water Depletion Across the Nation. Fact Sheet 103-03. Retrieved April 18, 2013, from http://pubs.usgs.gov/fs/fs-103-03/.

6 U.S. Geological Survey (January 2013). Groundwater Depletion. Retrieved April 18, 2013, from http://ga.water.usgs.gov/edu/gwdepletion.html.

7 Florida Senate (December 2010). Issues Relating to Sinkhole Insurance. Interim Report 2011-104. Retrieved April 18, 2013, from http://publicfiles.dep.state.fl.us/FGS/WEB/sinkholes/FlaSenateSinkholeIssues.pdf.

8 Florida Senate, ibid., p. 18.

9 Florida Senate, ibid., p. 26.

10 Florida Dept. of Financial Services (November 18, 2011). Notice of Liquidation of HomeWise Insurance Company. Retrieved April 18, 2013, from http://www.myfloridacfo.com/agents/industry/news/hwicliq.htm.

11 Florida Senate, ibid.

12 Ericksen, P. (July 19, 2012). Citizens Property Insurance Corporation: Senate Bill 408 Sinkhole Analysis. Insurance Services Office. Retrieved April 18, 2013, from https://www.citizensfla.com/about/mDetails_boardmtgs.cfm?show=PDF&link=/bnc_meet/docs/419/07AH_Citizens_SB408__Sinkhole__Analysis.pdf.

13 Florida Senate, ibid.

14 Ericksen, ibid.

15 Section 627.706 (1)(b), Florida Statutes. Retrieved April 18, 2013, from http://www.leg.state.fl.us/Statutes/index.cfm?App_mode=Display_Statute&Search_String=&URL=0600-0699/0627/Sections/0627.706.html.

16 Florida Office of Insurance Regulation (September 7, 2006). Press release: Sinkhole factor adoption will lead to consumer savings. Retrieved April 18, 2013, from http://www.floir.com/PressReleases/viewmediarelease.aspx?id=1480.

17 U.S. Geological Survey (March 11, 2013). The Science of Sinkholes. Science Feature. Retrieved April 18, 2013, from http://www.usgs.gov/blogs/features/usgs_top_story/the-science-of-sinkholes/.

18 Jamieson, A. (April 18, 2013). Sinkhole swallows three cars on Chicago's South Side. NBC News. Retrieved April 18, 2013, from http://usnews.nbcnews.com/_news/2013/04/18/17810648-sinkhole-swallows-three-cars-on-chicagos-south-side.