January 16, 2017

US - Property insurance risk: Dangers lurk in short memories

One of Spanish surrealist painter Salvador Dali’s most famous works is called “The Persistence of Memory,” featuring melting clocks on a barren landscape. Another bit of surrealism in a property insurance context is the persistence of short memories. Property owners, and sometimes, their insurance companies, tend to forget the mistakes of the past.

Why does human nature make people and businesses forget the lessons of history? Catastrophes such as earthquakes, floods and hurricanes raise awareness of nature’s random and destructive forces, but in the absence of such events, people become complacent.

Tropical storm Matthew, which reached hurricane strength September 29 and subsequently intensified to a Category 5 hurricane, was the strongest storm in the Atlantic basin since 2007. After devastating Haiti and other areas in the Caribbean, Matthew made landfall in the United States on October 8 as a Category One and caused widespread flooding in the Carolinas, due to storm surge. Prior to Matthew, no hurricane had hit the U.S. mainland since July 2014, according to the National Oceanic and Atmospheric Administration. By contrast, the decade of the 2000s saw remarkable frequency in named storms making landfall. 2005 produced such a bumper crop that NOAA actually ran out of names, relying on its default system of Greek letters.

Communities that see property catastrophes with some frequency usually are better prepared for the next one. Unfortunately, a dearth of activity often leads people to falsely conclude their catastrophe exposure is somehow reduced. New York in October 2012 during Superstorm Sandy experienced its worst hurricane since the “Long Island Express” struck in 1938. In the intervening years, property owners that placed expensive equipment in sub-basements in New York City forgot that storm surge can cause severe inland flooding. Sandy’s inundation proved that point in dramatic fashion, causing a weeklong power outage for much of Lower Manhattan.

Lessons from major loss events

Despite the relatively sparse hurricane activity in the past eight years, property insurers have responded to a number of major loss events in the United States. In 2015, for example, insured catastrophe losses totaled $16.1 billion, according to the Insurance Information Institute. These losses included: $9.6 billion related to severe thunderstorms, $3.5 billion from winter storms and cold waves, and $1.9 billion from wildfires, heat waves and drought. Atlantic hurricane losses in 2015 totaled only $60 million, well below the 10-year average of $6.5 billion.

Some of the key lessons that underwriters have learned from such events are:

Words matter in insurance policies

Underwriters have become more precise in their policy language when it comes to defining first-party property damage. So has the brokerage industry. Hurricane Katrina in 2005, for example, caused a massive amount of flood losses and led many insurers to tighten their wordings related to flood coverage. Such tightening was specifically in response to efforts by policyholders and their brokers to suggest policy language and offer creative legal arguments to do just the opposite. But that was far from universal, and in fact, disputes over flood coverage were still happening when Sandy struck New York seven years later and are still in full swing today.

Sublimits mitigate insurance risk

Insurers can reduce the risk they assume by lowering the coverage limits they offer, but that could inadvertently encourage policyholders to shop for more generous limits elsewhere. An alternative is to implement sublimits in policies for specific perils or types of damage. Peril- or damage-based deductibles, common in policies covering coastal exposures, are another tool available to underwriters. Similarly, contingent business interruption coverage is now sometimes limited to a single tier of direct suppliers.

Property loss control is a high-yield investment

For insurers and their insureds, the best loss is the one that never occurs. Property loss control services, offered by many insurers, provide the opportunity to identify and remedy vulnerabilities in an insured’s facilities. In a market environment where high-return investments are scarce, property loss control can pay off handsomely.

Like it or not, insurers do business in a volatile environment for property claims. The Atlantic hurricane season traditionally extends to December. Persistent drought heightens the wildfire risk, flooding can occur at any time, and there is no season for earthquake peril. In such conditions, insurers must pay close attention to how they construct their policies, be acutely aware of brokers’ efforts to broaden coverage through the use of their own manuscripted policies and consult legal counsel to minimize uncertainty where appropriate. The world of property risk is uncertain enough.

Robert W. Fisher is the managing partner of the Atlanta office, a member of the U.S. Management Board and head of the firm’s U.S. first party coverage practice.