Sandy Updates: $18.8 B and Counting; NFIP Plays by Its Own Rules; Cat Bonds & Sandy Should an Insured Report a Lead Abatement Order to Its Liability Insurer?

We’ll start this month by looking at some recent developments related to Sandy and then examine a situation that tests my mantra that the first three steps in claims handling are: Report, Report, and Report.

Sandy at $18.8 B and Counting The latest reports peg the insured damage from Sandy at $18.8 billion, excluding National Flood Insurance claims. That would make Sandy the third costliest windstorm, measured by insured losses, in US history. Only Andrew in 1992 ($25.6 billion) and Katrina in 2005 ($48.6 billion) were larger.1 And Sandy never even reached hurricane-force winds over land in the US. A storm similar to the 1938 hurricane, which was a category 3 storm when it made landfall on Long Island September 21, 1938, would generate a horrific loss of life and property should it ever strike our area. Highlighting the catastrophic potential of a future storm, New York with an estimated $2.933 trillion in coastal property, passed Florida (estimated at $2.862 trillion) for the first time as the state with the highest coastal exposure. And that doesn’t include the $714 billion in New Jersey and the $568 billion in Connecticut.2

NFIP Insurance Plays by Its Own Rules (Time to File Suit, Ambiguities, and Reasonable Expectations)

National Flood Insurance Program claim payments for Sandy may reach $15 billion, almost as much as the $18.8 billion that commercial insurers expect to pay.3 Not all of these claims will end happily; some insureds will want to settle their disputes with NFIP in court. If any of your insureds consider that route, they should know that NFIP claims procedures differ from those of commercial insurers.

First, the time limit to commence suit in National Flood policies is one year, not the two years provided by most commercial policies.4 But the real trap concerns the appeals process. When an NFIP claim is declined, the adjuster will add a note that the insured can appeal the decision. The NFIP Flood Insurance Claims handbook5 points out, “If you still have questions or concerns [about the settlement] contact the Federal Emergency Management Agency (FEMA)… Your letter of appeal must be submitted to FEMA within 60 days from the date of the denial letter that you receive from your flood insurer.” However, the filing of an appeal does not extend the one-year time limit to file suit and, in true catch-22 fashion, the insured cannot file an appeal if it has commenced suit. Since many disputed claims will be close to the one-year limit by the time negotiations deadlock, the insured’s choice is essentially to appeal and forgo the right to sue or to sue and forgo the right to appeal. Remember that NY Metro area Sandy claims will be one-year old starting on October 29, 2013.

Other areas where NFIP claims litigation rules differ from those that apply to a commercial policy concern ambiguity and reasonable expectations. It’s accepted contract law that ambiguities in a contract are resolved against the party that drew the contract. Since almost all insurance policies are drafted by insurance companies, this rule is particularly important for interpreting insurance contracts. Several court decisions have held that this rule does not have the same force when it comes to interpreting NFIP policies. The reason: NFIP policies are based on federal law and are funded, in part, by federal funds and should therefore be strictly interpreted.6 “Reasonable expectations” is the doctrine that coverage should match the insured’s reasonable expectations even when the policy language is clear and unambiguous. In a case in Minnesota, the lowest story in insureds’ houses had doors to the outside, referred to as a “walkout” basement. Despite the fact that the areas were below-grade on all sides, the insureds argued that it was reasonable to expect that the basement coverage limitations would not apply to walkout rooms. Minnesota courts have accepted the reasonable expectations doctrine,7 but the court said that the doctrine could not be applied to NFIP policies citing as one reason the require ment that NFIP policies be interpreted in the same manner in all states. Since many states do not accept the doctrine of reasonable expectations, the court ruled that it could not be applied even in states that do.8 New Jersey is regarded as a state whose courts have firmly embraced this doctrine. In New York it is not as clear that reasonable expectations will apply unless there is some ambiguity in the policy.9 If the Minnesota decision is a guide, it will be difficult to make the reasonable expectations argument in both New Jersey and New York NFIP cases.

Cat Bonds and Sandy Want to get vacant stares from your dinner-table companies? Tell them about cat bonds. Once they grasp that you’re talking insurance not feline S&M, I guarantee they will develop MEGO (my eyes glaze over). However, it’s a topic insurance people should know about.

“Cat Bonds” is short for catastrophe bonds (they’re also called “insurance linked securities”). They are an alternative way for insurers and insureds to transfer risk. On a very basic level, cat bonds are linked to a specified type of catastrophe, such as earthquake or flood. The bonds offer a higher interest rate than other securities because interest and even principal can be lost if the catastrophe produces losses above a specified level.

About $44 billion of cat bonds have been issued since they were first introduced in 1996 and sales of the securities have been accelerating, with $4.17 billion so far this year compared to $3.87 billion in the same period in 2012.10 It’s predicted that this year’s total will be a record, exceeding the record amount of $7 billion issued last year.11

It’s not the higher interest rate that’s the key attraction to investors, rather it’s the diversification cat bonds provide for an investment portfolio. Investment portfolio theory holds that a diversified portfolio is the gold-standard for investing. Owning assets that do not move in lock-step or even move in the opposite direction when changes occur in the economic environment, reduces portfolio volatility and overall risk. For you and me diversification may mean stocks and bonds of companies of varying sizes, real estate and possibly some foreign stocks. The largest investors reach out more broadly in their search for investments that don’t move up or down together. As the Great Recession showed, almost all investments move in the same direction when really put to the test. Cat bonds are an exception; they’re not affected by the typical economic boom-or-bust economic cycles.

Like all fixed income investments, they are subject to interest rate risk.12 However, short-term investments decline in value much less than long-term holdings when interest rates rise and cat bonds are typically issued for terms of only a few years at most. Credit risk13 is very low as the funds are held by a trust and are not exposed to the possible insolvency of the issuer. Cat bonds have an added attraction at the moment to the issuers (in effect the insureds or reinsureds): the major cost of using them is the interest paid on the bonds and interest rates are at all-time lows. So where does Sandy come into this? NY’s Metropolitan Transit Authority (MTA), whose subway and bus infrastructure was so devastated by Sandy, is readying a cat bond issue as a form of insurance against future storm-surge losses. The transaction, the first of its kind, will be for $200 million—increased from the originally planned $125 million due to investor interest. It will be for a term of three years and will pay interest at a rate of 4 . percent (450 basis points) over Money Market Treasury Fund earnings.14

The MTA would be paid the principal from the bonds if a named-storm resulted in a storm surge of at least 8.5 feet at the Battery, Sandy Hook and the Rockaway Inlet or a 15.5-foot surge in the East Creek and at Kings Point.15 In that event the bondholders will lose their investment. If there are no storms that generate the specified storm surge in the three-year term of the bonds, investors will be repaid their principal plus interest. Only two hurricanes since 1900 would have generated storm surge sufficient to trigger payment: Hurricanes Donna (1960), and, of course, Sandy.16 Not my cup of tea—I’m risk-averse. I’d rather keep cash in my mattress, but cat bonds are attractive to the largest investors looking for situations that aren’t linked to other investments. It’s the new kid on the insurance block; an example of the broadened sources of protection available to insureds and reinsurers.

Interestingly, in a challenge to the diversification claim, Franklin “Tad” Montross, Chairman and CEO of General Re Corporation, has pointed out that investors may be overlooking the collapse that might occur when the “big one” strikes, for example, California. Cat bonds linked to California quakes will, as expected, take a hit, but all cat bonds may be in trouble as investors head for the door on the entire class of investments. He also pointed out that cat bonds depend on catastrophe modeling, which has been notoriously fallible.17 We should recognize, however, that Montross is not a disinterested observer. Cat bonds put downward pressure on reinsurance rates and selling reinsurance is what Gen Re does.

To Report or Not to Report, That is the Question. Should an Insured Report a Lead Abatement Order to Its Liability Insurer?

My advice for liability claims handling is: Report, Report, and Report. But, like most generalizations, there are always borderline cases.18

Lead-paint claims pose a serious exposure to both property owners and their liability insurers. Some insurers handle the problem by excluding the coverage. Insureds who can find coverage face sizable premium increases or loss of coverage if they have lead-paint claims.

The first inkling of a problem is often an order from a City agency to abate a lead condition in a tenant’s apartment. While the notice doesn’t indicate that anyone has been injured, in a perfect world it would seem best to send a copy of the notice to the insurer to avoid late notice issues and to get a jump on any claim that may develop. Upon receipt of the report, the insurer typically opens a file and records a potential lead claim. When the policy comes up for renewal, underwriters look askance at an insured with lead claims. Especially in the current firm market, a premium increase is almost certain and non-renewal is a real possibility. You can hardly blame the insured for wondering if it’s smart to report the potential claim; perhaps it would be best to wait until an actual claimant materializes. In August 2007, Metro Property Group received a lead abatement order for an apartment in the building it owned on Valentine Avenue in the Bronx. It didn’t give notice to its insurer, Tower Insurance Co., until it received a summons on behalf of a child residing the apartment claiming injuries due to elevated lead blood-levels. Tower denied liability alleging late notice and the insured sued for coverage. The Supreme Court, New York County, rejected Tower’s motion of summary judgment holding that the notice of abatement was not sufficient to trigger a duty to give notice to the insurer. The decision was just upheld by the Appellate Division, First Department.19 That would seem to indicate that an insured can wait to file the report until it knows of an actual claim of injury. This case originated prior to the change in duty-to-report law enacted by the NY State legislature that applies to all policies issued and delivered after January 17, 2009. That law makes it more difficult for the insurer to deny a similar claim today.

The best procedure is to have the insurance company agree that reporting the receipt of a lead abatement notice is for informational purposes only and that it will not open a file until there’s notice of claimed injuries. If the insurer won’t agree, give the insured the facts and let him or her make the decision.

1 Dr. Robert P. Hartwig, CPCU “Overview and Outlook for the P/C Insurance Industry: Focus on Louisiana Markets” ttp://www.iii.org/presentations/overview-andoutlook- for-the-pc-insurance-industry-focus-on-louisiana-markets.html Loss values for Andrew and Katrina have been converted to 2013 dollars to make them comparable. (Bob Hartwig, CPCU is president and chief economist of the Insurance Information Institute and a member of the Westchester-Fairfield CPCU chapter.

2 “Insured Property Values in Coastal States Top $10 Trillion” Insurance Journal, June 17, 2013 http:// www.insurancejournal.com/magazines/features/2013/ 06/17/295207.htm

3 Rawle O. King “The National Flood Insurance Program: Status and Remaining Issues for Congress” February 6, 2013, Congressional Research Service www.fas.org/sgp/crs/misc/R42850.pdf

4 A one-year limit is applicable to some coverages in almost all states and to all coverages in a few states, even for commercial insurance companies. I wrote about insurance coverage time-limits in the April 18, 2011 issue of the Insurance Advocate: “The Clock is Ticking—Set an Alarm for Your Insureds.”

5 “Flood Insurance Claims Handbook” FEMA F-687 February 2009

6 See, for example: Jacobson v. Metro. Prop. & Cas. Ins. Co., 672 F.3d 171 (2d. Cir. 2012) and McGair v. American Bankers Insurance Company of Florida, No. 11-2179 (1st Cir. Sep. 4, 2012) However,

7 Atwater Creamery Co. v. Western National Mutual Insurance Co., 366 N.W.2d 271 (Minn. 1985)

8 Gunard A. NELSON, M.D.; and others v. Julius BECTON, Director, Federal Emergency Management Agency; Federal Emergency Management Agency; and National Flood Insurance Program No. 90-5204. United States Court of Appeals, Eighth Circuit. Decided April 8, 1991.

9 John N. Ellison, Frederick A. Pettit and Darin J. McMullen “Are You Getting What You Expected (And Paid For)? The Reasonable Expectations of Insurance Policyholders, and the Need for Courts to Enforce Them, Including After Hurricane Katrina.” Coverage, Committee On Insurance Coverage Litigation, American Bar Association Published by LexisNexis Volume 1 Number3. JanuaryFebruary 2007

10 Charles Mead “Pension Funds Investing in Cat Bonds Overlook Risk: Gen Re’s Montross” Carrier Management June 6, 2013 http:// www.carriermanagement.com/news/2013/06/ 06/107681.htm

11 “Global Cat Bond Issuance To Hit Record For Jan-June” Nikkei English News June 27 evening edition http://propfpn.advisen.com/fpnHomepagep.sh tml?resource_id=201575927- 396437601&userEmail=jtrupin@aol.com#top

12 Interest rate risk reflects the relationship between the value (price) of fixed-rate investments and interest rates: when interest rates rise, the price of fixed-rate investments fall.

13 Credit risk is the risk of that the issuer may default on its obligations—think the City of Detroit.

14 Janet Babin “MTA Bond Tied to Storm Surge a Big Hit” WNYC Transportation Nation www. wnyc.org/blogs/transportationnation/ 2013/jul/26/bond-tied-storm-surgebighit/? utm_source=sharedUrl&utm_media=metat ag&utm_campaign=sharedUrl

15 Benjamin Kabak “MTA Issues Reinsurance Catastrophe Bond Tied To Storm Surge Levels” http:// secondavenuesagas.com/2013/07/17/mtaissues- resinsurance-catastrophe-bond-tied-tostorm- surge-levels

16 The insurance won’t cover all MTA’s possible woes should another “Sandy” strike. Just repairing the R train tube between Brooklyn and Manhattan, on which work just started, will cost over $300 million. See: Matt Flegenheimer “On R Train, Unwelcome Reminder of Storm’s Impact” New York Times August 4, 2013

17 ibid

18 Remember the old cliché: All generalizations are false, including this one.

19 Tower Ins. Co. of N.Y. v Metro Prop. Group, LLC. 2013 NY Slip Op 03612 May 21, 2013. Appellate Division, First Department.