A GREATER SHARE OF THE RISK:
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When a catastrophe such as a hurricane or earthquakes strikes a wide area, the insured losses can easily add up to the billions of dollars. As property values have risen over the years, so have insurers’ catastrophe losses. To limit their own risks, carriers are more often requiring property owners to retain a greater share of the exposure through percentage deductibles based on the overall value of the property at risk, rather than flat deductibles set at a specific monetary value. While percentage deductibles can leave insureds facing much higher losses, there are strategies brokers can use to help lessen the impact.

A HISTORICAL PERSPECTIVE

As insurers added up their losses after Hurricane Andrew devastated Florida in 1992, they recognized that their potential losses from future storms could be much higher than previously thought. Due primarily to ever increasing asset values coupled with relentless construction, particularly along coastlines, insurers were beginning to understand the massive losses that could arise if a major storm were to hit a metropolitan area. Thirteen years later in 2005, Hurricane Katrina confirmed their fears as New Orleans and the surrounding area were devastated with insured losses of $41 billion. Primary insurers, reinsurers, and homeowners insurers determined that they could not, or did not want to, assume such exposure and looked to the property owners to take on more of the risk through percentage deductibles.

The concept of tying an insured’s retained loss, or deductible, to the value of the assets, including business income exposure, has been used for quite some time with regard to earthquake/earth movement due to the potentially severe losses that might arise from a major earthquake, especially on the West Coast of the United States. As the risk from tropical storms increased, insurers looked to percentage deductibles to help mitigate their losses from other catastrophic natural disasters, including wind, flood, earthquake – and more recently, hail.

WHAT TRIGGERS THE DEDUCTIBLE?

While an earthquake, flooding, or hail may trigger a percentage deductible, carriers usually require percentage deductibles for wind damage from named tropical storms. Such storms receive a name from the National Weather Service or The National Hurricane Center (NOAA), when sustained wind speed reaches 39 mph. Most insurers insist on percentage deductibles in the “first tier” of counties and cities along the coastline. For perspective, suppose a customer has a building valued at $1 million, with $500,000 in contents and $400,000 in business income exposure. A 5% named storm deductible would impose a $95,000 deductible ($1.9M x 5%) – significantly higher than a typical “all other perils” (AOP) deductible that would likely apply to a risk of this size.

Before Hurricane Sandy caused widespread damage to the New York metropolitan area in 2012, most insurers imposed this “Tier 1” percentage deductible only along the coast from Virginia to Texas (usually including the entire State of Florida). Since Sandy, many carriers now also include the Northeast states – making the coast from Maine to Texas often susceptible to percentage named storm deductibles. Further, many carriers now impose such deductibles for all damage resulting from, or in concert with, a named storm, or its remnants, regardless of how far inland such damage occurs. For example, Hurricane Ike in 2008 caused more than $1 billion in damages in Ohio.

HOW CAN THE APPLICATION AND IMPACT BE MINIMIZED?

While insurers are more often insisting on percentage deductibles the broker can employ several strategies to lessen the impact to their insured during the program negotiations.

1. First, make sure the program contains wording such that only the single highest applicable deductible apply to an “occurrence.” This will prevent the duplication or pyramiding of various policy deductibles in a multi-faceted loss.
2. Determine the lowest percentage deductible a carrier will accept (i.e. 1%, 2%, 5%). Typically, this will be driven by modeling results, geographic dispersion of exposure, or certainly competitive forces.
3. Limit the percentage deductible to apply only to assets in Tier 1 localities and to the fewest states as can be negotiated. This prevents the imposition of the percentage deductible for losses further inland and in non-coastal states.
4. Seek to apply the percentage deductible only to “hurricanes” (wind speeds 74+ mph). The standard AOP deductible would apply otherwise. Some carriers will do this.
5. One of the best ways to help the insured is to have the percentage calculation apply separately to different classes of affected assets (referred to as “units of insurance”). While such units can be defined differently, a good example would be:
   • Each building sustaining damage
   • Stock and inventory in each such building
   • Other personal property in each such building
   • Personal property in the open
   • Business income or other time element loss attributable to each building or structure

Having the percentage deductible apply only to such separate “units of insurance” suffering damage can minimize the insured’s retention versus applying the percentage deductible to the aggregate of all asset values at an impacted location. For instance, if the building suffers damage but inventory and personal property is unaffected and operations continue unabated, having the percentage deductible calculated against just the building values significantly minimizes the insured’s retention. Of course, typically, some minimum retention will be incorporated within the percentage deductible calculation (i.e. the AOP deductible used as a minimum).

BOTTOM LINE

As property values continue to increase along coastlines, storms become more intense or frequent, and losses from hail and flooding rise, carriers are looking to their insureds to bear more of the risk. Catastrophe modeling tools are also playing a role as insurers are better able to fine tune their exposures by more clearly identifying at-risk properties. Insureds must be prepared to accept substantially higher losses should a catastrophe strike, as carriers impose percentage deductibles throughout the country. An experienced CRC Group producer who specializes in property risks can help to minimize the insured’s burden by employing the appropriate strategies.

Contact your CRC Group Producer for more information.

Contributors

• Robert Marsh is a retired Senior Vice President in CRC’s Red Bank, NJ office who specialized in all facets of property and marine insurance coverages.