The importance of a catastrophe review

Over the past few years, the United States has suffered a number of serious and devastating catastrophes from hurricanes to wildfires and even volcanoes. As always, multiple insurance issues arise whenever there are catastrophic losses. The past few years are no exception.

We are very familiar with issues arising after a hurricane: the fact that homeowners policies do not provide coverage for flood, that people severely underestimate their flood risk, and the overall lack of coverage in force when a hurricane occurs. The Federal Emergency Management Agency (FEMA) is underfunded due to subsidized rates, although coverage is perceived to be expensive and is for the areas most at risk of flooding. Even so, the rates are not actuarially sound.

Insuring water hazards

However, living near the water presents obvious hazards and to be actuarially sound, premiums need to be high. The problem is the continued building and rebuilding of properties in flood-prone areas. While it should be obvious that oceanfront, riverfront or low-lying areas are susceptible to flooding, people still live in these areas without considering the inherent risks involved. The misunderstanding as to how the 100-year flood truly works adds to the misperceptions of risk.

Even in areas where insurance was in force after a hurricane, there are still issues. In 2017, Hurricane Irma devastated the Virgin Islands and once clean up began it was discovered that many people were unaware they were underinsured. There are many reasons for underinsurance: insureds may have modified the homes without notifying the carrier, the property value appreciated over time and coverage was not adjusted, the insured refused to increase coverage due to premium concerns and others.

Due to of the prevalence of underinsurance, the insurance department issued a bulletin that now requires insurers to explain underinsurance to insureds, advise insureds if they are currently underinsured, advise insureds of the claim settlement process when the property is underinsured, and have the insureds sign a statement that all this has been explained to them and they understand it.

Updating FEMA policies

On January 23, 2019, Houston approved a federal grant application to provide funds for the elevation of homes and buyouts. For homes that have suffered repetitive floods and severe damage, the grant covers the entire cost of elevations and buyouts, although homeowners must contribute funds as well. Elevating and removing structures in repetitive flood areas should reduce the repeated damage to property. Currently, 81 homes are being considered for elevation and four for demolition.

While many suggestions have been made concerning revising FEMA, it has still not been updated. Meanwhile, ISO has drafted a new commercial and personal property program for flood, which gives insurers a standard form with which to work. This makes it easier for carriers to consider writing flood coverage.

The existence of better technology for modeling potential losses from storms makes it possible for standard carriers to develop rates and consider offering the coverage. Barriers still exist due to pricing and the insured’s belief about their odds of a loss, but it is something, and carriers may be wary of entering a market fraught with misunderstandings.

Covering wildfires

Wildfires present a different issue. Fire is a covered peril, so that is not a problem. However, underinsurance rears its ugly head again. California has suffered from historic wildfires and again, insureds are finding that they did not have sufficient coverage to restore them to pre-loss conditions. The reasons for underinsurance are similar to the reasons for underinsurance for flood coverage; modifications to the building or appreciation in value without corresponding increases in coverage, lower coverage to keep premiums lower, rising construction costs, and others.

In the event of a disaster such as Paradise, where the entire community was destroyed, shortages of construction workers and supplies will increase costs, making replacement more expensive, which can push the cost of replacement above the coverage on the property. Surge pricing cannot be contemplated when setting rates. Since insurers cannot predict high levels of underinsurance, California has approved two bills requiring carriers to provide homeowners replacement cost estimates for the insured homes every other year.

Because of the significant wildfires over the past two years, the homeowners market in California is tightening. Carriers are seriously considering increasing rates, and even nonrenewing homes that are in wildland-urban interface areas. A wildland-urban interface is an area of land where human developments are built near or among lands consisting of unoccupied, wild areas prone to wildfires.

Even before last year’s wildfires, premiums were rising and carriers were nonrenewing policies for properties in dangerous areas. Almost half of California has an elevated risk for fires, and people continue to move into dangerous areas because they value living close to the areas full of trees. However pretty these areas may be, they are a significant fire risk. The risk can be mitigated by clearing brush and taking other steps, but if the rest of the neighborhood has not taken such steps, the risk is still quite large.

Volcanic risks

Mt. Kilauea erupted in 2018 for several months, cutting off neighborhoods, filling a lake and creating new land. While fire is a covered peril, policies in Hawaii are written so that there is generally no coverage provided for damage caused by a volcano or by lava flow. Losses caused by an earthquake, land shock waves or tremors are also not covered under a homeowners policy, so if the home damage is caused by an earthquake or tremor there will not typically be coverage.

These insureds often have to go to surplus lines carriers in order to find coverage for their homes. Soon after the eruption started, the insurance commissioner made it clear that any property that caught fire due to contact with molten rock was considered fire damage. There are lava zones that indicate the level of risk of a particular structure, and rates are set and coverage is available accordingly.

An increasing number of catastrophic events are occurring on a more regular basis. In order to cope with these events, insureds need to understand their risks and coverages. Insurers are a large part of insured education; agents are the first line, but as people buy insurance, online insurers need to ensure that those insureds are exposed to instruction as to how to assess their needs and purchase proper coverage.

Christine G. Barlow, CPCU, (cbarlow@alm.com ) is the managing editor of FC&S Online, the authority on insurance coverage interpretation and analysis for the P&C industry. It is the resource agents, brokers, risk managers, underwriters, and adjusters rely on to research commercial and personal lines coverage issues.