In July, President Obama signed the Transportation Bill which incorporated a reauthorization of the National Flood Insurance Program and the Consumer Option for an Alternative System to Allocate Losses Act of 2012 (COASTAL Act). The COASTAL Act provides that the Federal Emergency Management Agency (FEMA) administrator is to develop a standard formula for allocating wind and water losses involving indeterminate losses.
Nelson Levine de Luca & Hamilton’s Chairman Mike Nelson discusses the potential impact of the indeterminate loss provisions included in the National Flood Insurance Program reauthorization legislation.
NEW YORK, October 29, 2012 – Michael Nelson, chairman of law firm Nelson Levine de Luca & Hamilton, represents insurers and reinsurers in regulatory matters as well as in complex litigation in multiple jurisdictions throughout the country.
Can you explain the concept of an “indeterminate loss”?
Private insurance plans, for the most part, do not cover flood damage. Flood coverage is instead provided by policies sold through the National Flood Insurance Program (NFIP). Adjusters, after a storm, examine structures to determine the cause of damage and whether that loss is covered by an insurance policy. Adjusters also allocate losses between existing policies where necessary. Determining the allocation of storm claims can be very complicated, particularly when the storm is a hurricane or otherwise involves flooding. Specific damage may be caused by a combination of events which can happen simultaneously or concurrently.
For example, where there is both wind and water applying pressure to a wall and the wall collapses, was the damage to the structure caused by the wind or the water? Or when wind knocks down a wall and then a storm surge destroys the structure, was the building destroyed by wind or water?
The term “indeterminate loss” refers to a situation where there is no practical way for an adjuster to determine the cause of damage because the building has been completely destroyed. The federal government is poised to develop a formula to clarify the process.
Why is the development of a standard formula important?
Indeterminate losses, and loss allocation generally, is a big issue for the insurance industry. It became a prominent issue after Hurricanes Katrina and Rita. You may recall photos of properties reduced to their slab foundations. Less than 30 percent of individuals affected by the hurricanes had flood policies. If it was determined that a house was destroyed by water and not wind, some people stood to lose everything. The process of determining the cause of a loss became very divisive as it affects the available coverage.
The attorney generals in Mississippi and Louisiana sued several insurers over their claims practices. These lawsuits led to massive settlements.
The development of a standard formula for distributing indeterminate claims is important because it will take the guess work out of allocating the damages. While it may provide some additional certainty to hurricane claims, it may also cause insurers to pay claims that they might have otherwise declined to pay.
Will the allocation formula for indeterminate claims impact policyholders?
Once the formula is developed and implemented, its impact may prove helpful for policyholders, insurance companies and the long-term financial health of the NFIP. The use of a standard formula has the potential to reduce post-storm litigation and to provide some certainty to the claims process. Still, the indeterminate claims allocation formula will not impact policyholders during this hurricane season as it will be at least two years before the formula is ready to be implemented.
“At least two years?” Why do you think that the development of an indeterminate claims allocation formula will take so long?
The models are going to be very sophisticated and will require detailed data. FEMA administrator has the authority to work with government agencies as well as private companies to develop systems to collect the information it will need, but it is going to take time. In April 2013, FEMA is scheduled to submit a plan to Congress regarding working with the Office of the Federal Coordinator for Meteorology to collect storm data. A storm event database is scheduled to be developed by July 2013. Also, by the end of 2013, FEMA is to establish a protocol for storm modeling. Storm models are needed for the development of a post-storm assessment.
Developing the means to collect all the required information is going to take time and resources. It is not clear that all of the deadlines can or will be met. Even under the current timeline, it will be almost two years before the indeterminate claims allocation formula is available.
Finally, it appears that indeterminate claims formula is a situation where a federal insurance program will affect state regulated insurers -- are state regulators and/or the Federal Insurance Office involved in the discussions related to the formula?
The indeterminate claims formula is being prepared by FEMA. Neither the Federal Insurance Office (FIO) nor state insurance regulators are directly involved, although they are undoubtedly monitoring the issue. State insurance commissioners have long been on the front line of addressing claim disputes between policyholders and insurance companies.
The FIO was tasked by the Biggert-Waters Flood Insurance Reform Act to prepare a report on natural catastrophe risk coverage in the U.S., including the ability of states, communities and individuals to mitigate their natural catastrophe risks. The FIO has also organized a Federal Government Insurance Forum in order to facilitate discussions with federal agencies that have insurance responsibilities. The FIO may have the opportunity to influence FEMA through these meetings. The FIO is also tasked with monitoring all aspects of the insurance industry. Because of the importance of this issue, the FIO will likely be watching its development.
With offices in the United States and London, Nelson Levine de Luca & Hamilton (www.nldhlaw.com) provides comprehensive services to the insurance industry on a full spectrum of concerns related to legal, business, reinsurance, risk transfer, surety and regulation.
Danielle K. Goodwin