Changing the Rules Insurance Regulators Are Altering Policy Terms When Key Points Major Catastrophes Strike

BEST’S REVIEW Homeowners Insurance www.bestreview.com November 2014

After the storm: Post Sandy, regulators in New York and New Jersey ordered insurers not to invoke hurricane deductibles. These Rockaway, New York homes were among many damaged. Changing the Rules Insurance regulators are altering policy terms when Key Points major catastrophes strike. ▼ Things Change: Major catastrophes by Joshua P. Broudy and Alexander G. Henlin used to cause regulators to only make examples of slow-to-pay insurers. y necessity, property insur- swiftly. Recently, however, state reg- ers have developed extensive ulators and governmental authori- ▼ Shaken and Stirred: Now regulators inject themselves into expertise in underwriting and ties have begun to inject them- B the cat-claims adjustment process adjusting catastrophe claims. Califor- selves into the adjustment process while carriers are trying to settle with nia earthquakes, named storms on as a loss is unfolding, changing the customers. the coasts, even terror risks—and all rules of the game while carriers are

▼ World of Tomorrow: Insurers must of their associated direct loss, time actively attempting to quantify their do protective underwriting to guard element loss and ensuing loss com- liabilities and pay policyholders the against proactive regulators that alter ponents—are examples of events amounts they are due pursuant to policy conditions. that the industry is equipped to their contracts of insurance. address. Pre-emptive executive announce- California. Winds up to 65 miles an Almost inevitably, however, a ments, emergency regulations and hour quickly whipped the fire into major loss event will trigger a politi- swift political action in the immedi- a conflagration that overwhelmed cal response. In the past, insurance ate aftermath of a loss-causing event firefighting efforts. The firestorm commissioners and public officials have caused new uncertainty in the began to generate its own winds, have tended to shine a light on adjustment process. That said, there which caused it to spread rapidly.

Photo courtesy of FEMA insurers that do not adjust claims are steps that both underwriters and By the time the fire had been claims professionals can take to miti- brought under control, it had killed Contributors: gate the likelihood that these pro- 25 people and injured 150. The fire Joshua P. Broudy nouncements will adversely affect blackened 1,520 acres, destroy- (Hartford) is how property carriers approach and ing 3,354 houses and 437 apart- counsel and adjust catastrophe claims. ments. Losses amounted to about Alexander G. Two California losses illustrate the $1.7 billion. At the time, the disaster Henlin (Boston) traditional role that regulators have was the costliest and deadliest in Broudy Henlin is an associate adopted toward property insurers. California since the San Francisco with Edwards Wildman Palmer LLP. earthquake of 1906. They can be reached at jbroudy@ The Oakland Firestorm One of the issues that arose out of edwardswildman.com or ahenlin@ On Oct. 20, 1991, a small grass fire the fire was that homeowners often edwardswildman.com started on a hillside above Oakland, lacked funds to rebuild.

1 Best’s Review • November 2014 • reprint Copyright © 2014 by A.M. Best Company, Inc. All Rights Reserved. Reprinted with Permission. www.ambest.com Older properties tended to be sig- Northridge resulted in unprec- immediate aftermath of the storm, nificantly underinsured, both because edented losses for the property regulators directed significant atten- the properties had appreciated con- insurance industry. As a result, many tion to a highly political issue: hur- siderably in value since they were insurers simply withdrew from the ricane deductibles. Like earthquake purchased and because the coverage California market. While the sub- deductibles, hurricane deductibles had been written only to pay off the sequent creation of the California tend not to be limited to a fixed dol- balance of the mortgage loan, not to Earthquake Authority helped to lar amount, but instead are a percent- replace the lost dwelling or personal stem the loss of earthquake coverage (usually between 1% and 10%) property. Exacerbating the problem age for residential properties, the of the insured property’s value. They was that Bay Area contractors raised resulting higher premiums caused came into widespread use following their fees in the aftermath of the fire, many homeowners to forgo cover- Hurricane Andrew in 1992, which some by as much as 400%. age entirely. Today, only about 1 in caused $15.5 billion in insured prop- Well after the losses had occurred, 9 California homes are covered by erty damage, as insurers looked for the California Department of Insur- earthquake insurance. strategies to better manage cata- ance, the state’s insurance regula- strophic risks. tor, played its traditional role and Pre-emptive executive They are currently in use in 20 responded to perceived delays in states, including Connecticut, Florida, adjusting losses. It initiated inqui- announcements, Massachusetts, New Jersey, New York, ries and pursued various remedies emergency regulations and Rhode Island and Texas. against insurers that failed to make swift political action in the With Sandy, the National Weather prompt replacement-cost offers to immediate aftermath of a Service reclassified the storm from affected policyholders. In what was loss-causing event have a Category 1 hurricane to a “post- the largest fine of its kind at the tropical cyclone” shortly before it time, Allstate ultimately paid $1 mil- caused new uncertainty in made landfall in New Jersey. Based lion following the conclusion of the adjustment process. on that reclassification, regulators the California insurance commis- in both New York and New Jersey sioner’s investigations. To cope with the losses from quickly issued orders that barred Northridge, those property insurers carriers from invoking hurricane The Northridge Earthquake that remained in the market tended deductibles. Three years later, on Jan. 17, 1994, to raise premiums and also impose But regulators and governments the Northridge earthquake struck earthquake deductibles. Today, the went further. In New Jersey, Gov. Southern California. The magni- California Department of Insurance Chris Christie issued Executive tude-6.7 quake began at 4:31 a.m. recognizes that those deductibles typ- Order 107 on Nov. 2, 2012. The and lasted 20 seconds. The quake was ically range from 10% to 15% of the order warned carriers to “exercise centered in the San Fernando Valley, insured property’s value. appropriate forbearances on collec- about 20 miles northwest of down- The adoption of earthquake tion, cancellation, documentation town Los Angeles. Ground motion deductibles was not driven by any and other regulatory requirements,” was felt 220 miles away in Las Vegas. regulatory impetus. Rather, it was including notices of hospital admis- Two major aftershocks, each with driven by the industry itself. The reg- sions, claim-filing deadlines, policy a magnitude of 6.0, struck within ulator’s role was limited to approv- premium payments and cancella- 12 hours of the quake. The temblor ing policy forms that featured the tion procedures. left 61 dead and more than 5,000 new deductibles. In New York, the Department injured, and caused about $44 billion of Financial Services issued a com- in property damage, $15.3 billion of Hurricane Sandy plete moratorium on policy cancel- it insured losses (in 1994 dollars), More recently, the property lations across New York City, Long according to the Insurance Informa- insurance industry had to respond Island and several other downstate tion Institute. to Hurricane Sandy, which made its counties for 30 days. The order was Property insurance covered about way up the East Coast in late Octo- extended six times before finally one-third of the costs of the North- ber 2012. The storm caused approx- being allowed to expire at the end ridge earthquake. In 1985, California imately $18.7 billion in insured of February 2013. mandated that homeowners insur- losses, and it occasioned significant In addition, the state required ers provide earthquake coverage. As political reaction and emergency carriers to send adjusters to assess a result, at the time of the Northridge measures, particularly in New York property damage within six days earthquake, about 1 in 3 California and New Jersey. This marked a (instead of the usual 15); issued homes had coverage. change from prior practice. In the temporary licenses on an expedited

basis to out-of-state public adjust- was contemplated in the original emergency regulations would also ers; and created a “report card” sys- bargain, which the carrier did not be helpful. tem that graded insurers on their take into account when evaluating • Push back against unreason- timeliness in responding to policy- the risk and pricing the policy. able proposals and regulations. holders’ claims. Industry groups can be particularly Risk Mitigation Strategies helpful in this effort. Coming Attractions? As regulators have shifted These points have particular New York’s Department of Finan- from reacting to perceived delays salience given likely future loss cial Services has explicitly advised in adjusting claims and approv- scenarios, such as the long-feared property carriers that they can ing industry proposals to proac- “Big One”—a major California expect to see more action along tively suspending policy terms and earthquake. To offer an example: the lines of what was taken in modifying their conditions, prop- Northern California has been the aftermath of Sandy when the erty underwriters and claims pro- bracing for a magnitude-7.0-plus next significant loss-causing event fessionals alike may be justifiably earthquake for decades. The U.S. occurs. The DFS’s Insurance Circu- concerned about regulators issu- Geological Survey has stated that lar Letter No. 8, dated Oct. 28, 2013, ing directives in the midst of a loss there is a 63% chance of one or advised that New York regulators event. As part of their own plan- more earthquakes of magnitude may in the future: ning strategies for addressing the 6.7 or greater striking the Bay Area • Impose a moratorium on uncertainty of actions by insurance before 2040. policy cancellations of up to six regulators, property carriers can: Just this summer, the Bulletin of months. • Carefully review the terms and the Seismological Society of Amer- • Expect carriers to make “rea- conditions of their policies. Insur- ica reported on the possibility that sonable accommodations” for poli- ance policies are contracts. If the Northern California could experi- cyholders that experience difficulty insuring agreements precisely spec- ence clusters of large, damaging making timely premium payments. ify what is covered, and what is earthquakes, with events of mag- • Expect carriers to process and not, actions by regulators may have nitudes 6.8 to 7.2 occurring every adjust claims quickly, allow insureds little practical effect. five years. Studies undertaken by the to make immediate and necessary • Ensure that existing policies city of San Francisco estimate that repairs and accept a wider variety accurately state what is covered, a magnitude-7.2 quake along the of documents as proof of loss. and what is not. It is desirable to northern section of the San Andreas • Take steps to expedite the minimize the number of endorse- Fault could kill up to 300, injure an temporary licensing of out-of-state ments or blanks in a particular additional 7,000, and cause up to independent and public adjusters. insurance policy, to reduce the $30 billion in property damage. • Impose claims-data reporting likelihood that the policy could be These questions take on new requirements on carriers for the deemed ambiguous. importance in light of the Napa purpose of creating and posting • Keep reinsurers apprised of quake on Aug. 24, 2014, where a online “report cards” about indi- the risks being written, and where magnitude-6.0 event in a primarily vidual carriers’ claims-adjustment they are located. agricultural area caused an esti- processes. Ceding carriers, particularly, mated $2 billion in overall economic • Create and implement a man- should be aware of the risks they losses, which included damage to datory mediation process to resolve are writing, and should communi- property, infrastructure and winer- contested claims. cate that information to their rein- ies. In the city of Napa alone, at least New York’s authorities have stated surers even as they try to ensure 1,120 homes and other buildings that the above list is not exhaus- that all reinsurance is back-to-back were structurally damaged, accord- tive. That it has been issued at all, with their policies. ing to a Sept. 9 report by Aon Ben- however, suggests that increased • Prepare to report on claims- field Analytics. regulatory activity could become adjustment efforts to regulators. In any loss scenario, govern- the “new normal” in the wake of a Developing internal protocols to ment authorities, businesses and significant claim event. measure and report compliance individuals alike are all going to What is troublesome for carriers with loss-adjustment deadlines and look to insurance to be part of is that the effective revision of pol- payment goals could be useful for their recovery plans. Anticipating icy terms by regulation, made after future “report card” grades. Having whether and how the regulatory the policies have been underwrit- plans at the ready for accepting ecosystem may change can help ten and issued, raises the specter of alternative loss documentation and carriers be prepared when natural policyholders receiving more than flags for claims in areas affected by disasters strike. BR

3 Best’s Review • November 2014 • reprint