Assembly Insurance Committee Seminar Property & Casualty Overview March 15, 2013

1. INFORM+INSPIRE Assembly Insurance Committee SeminarProperty & Casualty OverviewMarch 15, 2013 Robert W. Peterson Professor of Law Director, Center for Insurance Law and Regulation Santa Clara University School of Law The Griffith Insurance Education Foundation

2. HOMEOWNERS INSURANCE • Homeowners (HO) insurance is a bundle of coverages and one of your most important assets. A bank will not loan on a home without out it. If triggered, it may be worth many hundreds of thousands of dollars. • Do you have that much in ready cash? • Have you read your policy? • Basic Coverages. • Structure • Contents • Appurtenant Structures • Personal Liability The Griffith Insurance Education Foundation

3. INFLATION-ADJUSTED U.S. CATASTROPHE LOSSES BY CAUSE OF LOSS, 1992-2011 (1) Estimated property losses adjusted for inflation through 2011 by ISO using the GDP implicit price deflator. Excludes catastrophes causing direct losses less than $25 million in 1997 dollars. Does not include flood damage covered by the federally administered National Flood Insurance Program.(2) Excludes snow.(3) Includes wildland fires.(4) Includes losses from civil disorders, water damage, utility service disruptions, and any workers compensation catastrophes generating losses in excess of PCS's threshold after adjusting for inflation.Source: The Property Claim Services (PCS) unit of ISO, a Verisk Analytics company. The Griffith Insurance Education Foundation

4. Add Sandy which may be second only to Katrina in storm related losses. The Griffith Insurance Education Foundation

5. Underinsurance and Wildfires • Major concern of past and present Commissioners. • There are a number of approaches to the problem. One is: • Disclosure • Do insureds know what they have? The Griffith Insurance Education Foundation

6. Coverage of Main Structure (Coverage A) 5 Kinds of Policies 1. Actual Cash Value 2. Replacement Cost 3. Extended Replacement Cost 4. Guaranteed Replacement Cost 5. Building Code Upgrade The Griffith Insurance Education Foundation

7. What kind of policy do you have? • CIC sec. 10102 requires a plain language notice be included with the policy and renewals. See handout and sample Homeowners Policy. • Did you read yours? • The notice gives a short tutorial on each class of coverage and warns in bold type that actual cash value coverage is the “most limited” level of coverage. The notice encourages the policy holder to review and maintain adequate rates. The Griffith Insurance Education Foundation

8. Demand Surge Even careful homeowners may not appreciate that the replacement cost of a home may dramatically increase after a disaster. The notice warns of this danger and encourages increasing limits to anticipate this. See Handout, p.2 The Griffith Insurance Education Foundation

9. Exclusions • Policies are ALL RISK with enumerated EXCLUSIONS. • Apart from the coverage limit, it is the exclusions that matter most. • The two major exclusions are: • Earth Movement (including EARTHQUAKE—available as a separate coverage from the California Earthquake Authority (CEA)) • Water Damage (including FLOOD—available as separate coverage subsidized by the federal government) The Griffith Insurance Education Foundation

10. Exclusions Other typical exclusions include: • Ordinance or law • Power failure (if failure takes place off premises) • Neglect • War • Nuclear Hazard • Intentional Loss • Governmental Action • (others—mold, fungus, dry rot, terrorism, insects (e.g., termites. . .) The Griffith Insurance Education Foundation

11. Other Structures Appurtenant Structures (structures on the premises separated from the dwelling by “clear space” – e.g., detached garages, sheds, guest quarters, etc.) are usually covered for 10% of you main coverage (Coverage A). The Griffith Insurance Education Foundation

12. Contents (Coverage B) • Covered as a percentage of Coverage A. Take care to elect replacement cost rather than “Actual Cash Value” or “Depreciated Loss Settlement.” • With replacement cost (or “Limited Replacement Cost Loss Settlement”) you can replace the item with new. • Again, the CIC sec.10102 Notice (See Handout, p. 2) warns of this difference, although policyholders may not understand the significance of “actual cash value” – i.e., that the property may be covered at a significantly depreciated value. The Griffith Insurance Education Foundation

13. You were skiing with a friend when you accidentally pushed them out of the lift chair. Your former friend sues you. Covered? • Personal Liability (Coverage L). May be as low as $100,000, but often is raised by the insured. A higher limit me be required if the insured wants to supplement it with an umbrella policy to cover higher limits. • Many do not understand that this coverage extends to non-auto accidents outside the home. The accident need not happen in the home or on the premises. If you suffer a rafting accident, skiing accident, accidentally trip someone, etc., you are covered. The Griffith Insurance Education Foundation

14. Some Additional Approaches to Wildfires • Realpolitik—When underinsured homes burn in the ordinary course, that presents a serious problem for the insured. When hundreds of underinsured homes burn in a wildfire, this also becomes a public policy question. • Other Possible Solutions Addressing Underinsurance • In the event of a disaster like a wildfire, automatically increase policy limits by 15%? 5%? • How price these policies? Apply only to policies written in wildfire areas, or to all HO policies written in California (cross-subsidies?) Encourage homeowners to underinsure? How define “disaster?” • Require Insurers and the Agents more accurately to estimate replacement cost. Training? Mandatory list of factors to be considered whenever any estimate is given? • This is the approach the Commissioner took through regulations. • Possibly drive policyholders to unofficial, non-regulated sources of valuing their home? • Building Codes—flame resistant materials and sprinkler systems. • Zoning and Defensible Space Requirements • Funds for More Effectively Fighting Wildfires (Recently Enacted Fire Prevention Fee assessment--$115/parcel in wildfire areas). The Griffith Insurance Education Foundation

15. Earthquake Coverage Legislative History • Homeowner Insurers were required to write earthquake. • In January 1994, the 6.7-magnitude Northridge earthquake struck on a previously undocumented fault.  It was the costliest earthquake in U.S. history. • Following this earthquake, most insurers threatened to stop writing HO policies or to leave the state. • In 1996 Commissioner Quackenbush and the Calif. Legislature created the California Earthquake Authority (CEA). • The CEA is a privately funded, publicly managed not-for-profit organization. • Most insurers (approximately 2/3) participate in the CEA (others may still offer their own policies) Source: CEA web site. http://www.earthquakeauthority.com/index.aspx?id=7&pid=1 The Griffith Insurance Education Foundation

16. Earthquake • H.O insurers must offer the CEA policy. • The insurers service the policies (i.e., market them and adjust the losses). • The CEA pays the losses and expenses. • The CEA has a governing board of three voting members (Governor, Insurance Commissioner and Treasurer), and two non-voting members (Speaker of the Assembly and Chair of the Senate Rules Committee). • In addition, The CEA is regulated by the Department of Insurance. The Griffith Insurance Education Foundation

17. The CEA Policy • One MUST HAVE an HO policy to have a CEA policy. • The most important coverage is for the Structure (Coverage A in the HO policy) • Coverage for the Structure in the CEA Policy must equal the Coverage A of the HO policy. • The deductible for the HO policy is 15% of Coverage A. • The deductible on a home insured for $500,000 would be $75,000. Thus, only damages in excess if $75,000 would be covered. • Note the pressure this puts on a policyholder’s decision to adequately insure for wildfire coverage. The higher the Coverage A limit for fires, the higher the deductible for earthquake. The Griffith Insurance Education Foundation

18. “Penetration” • 800,000 policyholders located throughout the state.  The CEA policy currently has approximately a 12% penetration. Thus, 82% of the insurable risks in California are still not covered by earthquake. • Covers homeowners and renters, not commercial or governmental infrastructure (not, e.g., the Cyprus Overpass which collapsed in the 1989 Loma Prieta earthquake) • If an earthquake causes insured damage greater than the CEA’s claims-paying capacity, policyholders who are victims of that quake may be paid a prorated portion of their covered losses.  The Griffith Insurance Education Foundation

19. How is the CEA financed? By law, no more than 3% of annual written premiums can be spent on CEA operating expenses. Where Does a Premium Dollar Go? Since its inception in 1998, the CEA has accumulated almost $4.6 billion in capital. The CEA has grown its capital through positive retained earnings and currently collects about $600 million in gross premium each year. The CEA's total claims-paying capacity now exceeds $9.5 billion. Source: CEA web site http://www.earthquakeauthority.com/index.aspx?id=10&pid=1 The Griffith Insurance Education Foundation

20. Leveraging Reserves • The CEA does not pay federal income tax, and that tax status allows it to maximize the growth of its reserves.  • Note—The CEA has a claims-paying capacity over $9.5 billion, but has accumulated only $4.6 billion in capital. How is this possible? • Reinsurance—note the $104,650,000 in premium devoted to the purchase of “reinsurance.” The Griffith Insurance Education Foundation

21. What is REINSURANCE? • Simply put—Insurance for Insurers. When an insurer has inadequate reserves or assets, or wants to modulate its risk of losses, it may purchase insurance against its own losses from a reinsurance company. • The CEA may not have enough cash on hand to cover claims for a “BIG ONE,” so the CEA purchases reinsurance to increase its ability to pay claims in the event of a large, insured loss. • The CEA is the LARGEST PURCHASER OF REINSURANCE IN THE WORLD! • Reinsurance is only as good as the reinsurer, so the CEA spreads its reinsurance purchases among a number of reinsurance companies. The Griffith Insurance Education Foundation

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23. Attachment Points • Various reinsurers have different “attachment” points in the orange bar. • Some “reinsurance” levels (called “Transformer Reinsurance Contracts”) are actually catastrophe bonds sold in the marketplace. http://www.artemis.bm/blog/2011/07/21/embarcadero-re-ltd-the-california-earthquake-authority-catastrophe-bond-comes-to-market/ • As a quid pro quo for moving earthquake off of HO policies, HO carriers originally agreed, like reinsurers, to accept a layer of risk. That rolled off in 2008. They currently still have some exposure that attaches at the very top (the green and purple bands). These, too, will roll off over time. The Griffith Insurance Education Foundation

24. How does reinsurance work? • Reinsurance allows a growing company with insufficient assets to cover large losses to continue to grow by purchasing reinsurance. The reinsurance is treated as a cash asset (“credit for reinsurance”) available to pay claims, thus the insurer may continue to write new policies (take on more risk) without appearing insolvent. • --Reinsurance allows larger companies to hedge against catastrophic losses (E.g., Hurricanes, wildfires, and earthquakes). • --Reinsurers, who generally work in a global market, can take on these risks because premiums which would be devoted to paying disaster claims in one part of the world can be offset by premiums collected to cover disasters in other parts of the world that never occurred. Geographic diversity is one sound way to pool risk. • --Reinsurers can, and often do, reinsure some of their obligations with yet other reinsurers (retrocessionaires, in insurance speak!). The Griffith Insurance Education Foundation

25. A Few Helpful Terms • “Reinsurer” or “Market” is the party assuming a reinsurance risk • “Primary Insurer” or “Cedent” is the primary insurer who transfers the risk to the reinsurer. • To “Cede” is to transfer the risk to a reinsurer. • There are two basic types of reinsurance policies: • “Facultative”—this reinsures one policy (e.g., on one large building) • “Treaty”—this reinsures a book of business (e.g., reinsuring 80% of the losses on a group of 1,000 policies). You will be spared other, less helpful terms. The Griffith Insurance Education Foundation

26. A Few Examples Assume an insurer insures one building for $3,000,000 but does not want to (or perhaps cannot) accept the risk of a total loss on its books. It may enter a “facultative” reinsurance agreement with one or more reinsurers to accept any loss over a certain amount. The Griffith Insurance Education Foundation

27. Pro Rata Share Another structure may require the reinsurer to accept 80% of each loss (for 80% of the premium). If a claim is settled for $100,000, the reinsurer pays $80,000 of the claim to the cedent. Likewise for any other claim. The Griffith Insurance Education Foundation

28. A third model • The insurer is willing to retain up to a certain amount of the risk on its total book of business. When those total losses exceed the retention (assume $300,000 on total potential losses of $3,000,000), then the reinsurer pays the difference. • This is the model used by the CEA. Their reinsurers assume risks for total losses beyond the CEA’s “retention.” All for a fee, of course! The Griffith Insurance Education Foundation

29. SURPLUS LINES • Unneeded insurance companies? • Assume you are a concert pianist and you want to insure your hands for $5,000,000? Or you want to insure your fireworks factory? After diligent search, you cannot find an admitted carrier willing to write the insurance. What now? • Contact a Surplus Lines Broker who will search non-admitted insurers to see if the risk can be placed.¹ Broker must certify that no admitted insurer writes the risk, or that three admitted insurers who actually write the risk have declined.² • Broker may place the risk with a qualifying, non-admitted insurer.³ • Insured must be notified and sign a notice that, among other things, informs that the insurer is non-admitted and is not covered by the insurance guarantee fund (CIGA).4 ¹ CIC secs. 1760-1780.67. See generally: http://www.sla-cal.org/about_us/abt_general_history.html ² CIC sec. 1763(a) ³ Capital and surplus requirements are set out in CIC sec. 1765.1. 4 CIC sec. 1764.1. The Griffith Insurance Education Foundation

30. SURPLUS LINES • To facilitate the process, the Department of Insurance and the Surplus Lines Association maintain a “White List” of approve surplus lines insurers (LASLI). • http://www.sla-cal.org/carrier_info/cr_lasli.html?sort=company_name&order=ASC&letter=S • http://www.insurance.ca.gov/0100-consumers/0030-licensee-info/0031-surplus-lines/lasli.cfm • Both also maintain an “Export List” of risks which, on a yearly basis after hearing, the Commissioner finds there is not a reasonable or adequate market among admitted insurers. • [Some examples: Tattoo and Body Piercing Shops; Event Cancellation; Explosive Manufacturing/Sales/Storage (Bingo! There is your fireworks factory); Kidnap and Ransom, etc.] • The export list may be viewed at: http://www.slacal.org/broker_info/br_export_list.html The Griffith Insurance Education Foundation

31. ADVANTAGES OF SURPLUS LINES • Not subject to state rate and form regulations. • Can negotiate price and contract terms. • Otherwise, consumers would be limited to self-insurance or no insurance. • Unsophisticated consumers would be limited to self-procurement in the non-admitted market. • Surplus lines serve distressed risks, unique risks, high-capacity risks (beyond the underwriting capacity of the admitted market), niche markets (who will insure your $250,000 antique car?) • State collects a 3% gross premium tax on surplus lines writings. The Griffith Insurance Education Foundation

32. Surplus Lines Brokers • Other than full-time risk managers of industrial clients, virtually all surplus lines placement is done through surplus lines brokers. • Required to be licensed as a surplus lines broker (a licensed broker not licensed as a “surplus lines” broker may be personally responsible both for claims by the insured and claims by third-parties against the insured.¹ • Bonded • Verify and certify that the risk is eligible for non-admitted placement • Negotiate the insurance contract • Collect the premium tax • May have some binding authority where immediate coverage is required ¹ Nowlonv. Koram Insurance Center, Inc., 1 Cal.App4th 1437 (1991) The Griffith Insurance Education Foundation

33. RECENT FEDERAL LEGISLATION • Dodd-Frank included the “Nonadmitted and Reinsurance Reform Act” (NRRA). • NRRA supersedes state law and provides that only the home state of the insured may collect the premium tax in the absence of an interstate compact or other uniform, national tax allocating procedure. • There are two competing models—NCOIL (National Conference of State Legislatures) and NAIC (National Association of Insurance Commissioners). • California has yet to act. Sources: http://www.ncsl.org/issues-research/banking/surplus-lines-insurance-2012-legislation.aspx • http://www.naic.org/index_financial_reform_surplus_lines.htm The Griffith Insurance Education Foundation

34. Top Ten Most Expensive And Least Expensive States For Automobile Insurance, 2009How do we measure up? We are neither the best nor the worst– California was 19th most expensive with expenditure of $794 Based on average automobile insurance expenditures. Source: 2012 National Association of Insurance Commissioners. The Griffith Insurance Education Foundation

35. AUTOMOBILE INSURANCE • Minimum liability insurance requirements for private passenger vehicles¹ • $15,000 for injury/death to one person. • $30,000 for injury/death to more than one person. • $5,000 for damage to property. • Coverage is mandatory, and no private automobile may be registered or remain registered without it. • In addition, an uninsured driver may not recover pain and suffering from another at-fault driver.² • These minimum limits have not changed in over a decade. ¹ CIC sec. 11580.1b ² Calif. Civil Code sec. 3333.4(a)(3). The Griffith Insurance Education Foundation

36. Low Cost Automobile Insurance Low income automobile owners may be eligible for the California Low Cost Automobile Insurance Program.. • Eligibility—May not exceed 250% of the federal poverty level. E.g., Family of 3—maximum income of $47,725. • The premium is not subsidized. • Insurers are assigned a quota of low cost insureds on a rotating basis based on their market share. • See: http://www.mylowcostauto.com/ • or the Department’s most recent report:   http://www.insurance.ca.gov/0100-consumers/0060-information-guides/0010-automobile/lca/upload/CLCA_LegReport_Website.pdf The Griffith Insurance Education Foundation

37. The low cost policy satisfies minimum insurance requirements even though it has lower limits than those required for other drivers. • $10,000 for injury/death to one person. • $20,000 for injury/death to more than one person. • $3,000 for damage to property. • Other coverages are available (comprehensive, Med Pay, Uninsured Motorist), but only at an additional charge. • The program was originally offered in only two counties, but it is now available in all counties. The Department of Insurance must report to the legislature on the program every year (see link to report, above). • Since the program’s inception (1999), 79,629 Californians have applied for insurance through the program, of which 66,375 assignments were made. Approximately 59% of the assigned motorists had previously been uninsured. There were 9,791 policies in force at the end of 2011. The Griffith Insurance Education Foundation

38. A Quick Review of an Auto Policy • Liability Coverage: provides an insured driver (this includes permissive users) protection (up to the stated limit) for bodily injury or property damage for which they are deemed responsible. Also provides legal defense – a potentially very valuable coverage. • Comprehensive Coverage: covers losses in the case of theft, natural disaster, collisions with animals, cracked windshields, falling object or any other damage to your vehicle not caused by collision. Comprehensive coverage is not required by the state and is subject to a deductible. Lenders will likely require it. • Collision: covers loss that occur when the insured auto (even when the driver is at fault) strikes another object or vehicle in the event of an accident. Collision coverage is not required by the state and is subject to a deductible. Lenders will likely require it. The Griffith Insurance Education Foundation

39. A Quick Review of an Auto Policy, Cont. • Medical Coverage: “MedPay” pays medical bills for medical expenses, hospital visits and health-related costs for the policyholder, any passengers in the vehicle, and any pedestrian that result in the event of an accident. This is not required and is usually if a fairly modest amount--$1,000-$5,000. It is paid regardless of fault, but will likely not cover much more than the ambulance ride. • Uninsured/Underinsured Motorist-- provides protection for the insured if he/she is “hit” (no phantom drivers) by an uninsured/underinsured driver who is at fault. When carried, it is in the same amount as your liability limit. This includes drivers who do not carry insurance, whose insurance is less than you limits (in which case your insurer will pay you the difference), drivers whose insurance companies are insolvent, and hit-and-run drivers who cannot be identified. Under these circumstances you claim is directly against your own insurance company and is subject to arbitration. • Some Other Coverages: Policies may also contain clauses for Gap Coverage (the difference between you loan and the car value), rental reimbursement coverage, and towing and roadside assistance. The Griffith Insurance Education Foundation

40. Some Emerging Issues • Penetration and Adequacy. Mandatory limits are low, given the potential danger of automobiles. There are still many uninsured drivers. • Pay-as-you-drive (PAYD). The second mandatory rating factor (annual miles driven) is notoriously unreliable because usually based on estimates. PAYD requires verification, but bases rates on actual miles driven. • “ Telematics/Usage-Based Insurance (UBI).” More sophisticated tools accurately reflect how you drive and the risk you present—quick starts, rapid decelerations, speeding, time and place, etc. These may present some challenging privacy issues. See: http://www.insurancenetworking.com/news/70-percent-insurers-planning-piloting-implementing-telematics-31840-1.html • Self-Driving Cars • How shall they be rated (especially given the “mandatory” provisions of Prop. 103), and • Who shall be responsible when they, or their computers, “crash?” The Griffith Insurance Education Foundation

41. WORKERS COMPENSATION • Yesterday we discussed the “workers compensation” crisis caused by the failure of some large insurers, but what is workers compensation? • In one line: It is strict liability of employers for injuries to, or illness of, workers caused in the course of their employment. The Griffith Insurance Education Foundation

42. Workers Compensation Benefits In California • Medical care • Temporary disability benefits • Permanent disability benefits • Supplemental job displacement benefits • Vocational rehabilitation • Death benefits • These are the exclusive claims against the employer by the employee. With rare exceptions, the “workers compensation tradeoff” is the fact that the employer is LIABLE WITHOUT FAULT and the employee is NOT permitted to sue the employer for tort damages, including pain and suffering or punitive damages. • Note—employees are not barred from suing others: E.g., the driver of another vehicle that hit the employee or the manufacturer of a defective machine that injured the employee. The Griffith Insurance Education Foundation

43. Coverage is Mandatory • It is a misdemeanor to fail either to:¹ • Carry workers compensation coverage or • File and receive a certificate as a qualified self insurer ¹Calif. Labor Code sec. 3700.5 The Griffith Insurance Education Foundation

44. Major Workers Compensation Reform in California • Senate Bill 863, which makes wide-ranging changes to California’s workers’ compensation system, including increased benefits, cost-saving, and speedier remedies, took effect on Jan. 1, 2013. Not all of its provisions will be effective immediately. • For an overview of the bill, go to: http://www.dir.ca.gov/dwc/SB863/SB863_Overview.htm The Griffith Insurance Education Foundation

45. SOME OTHER COMMON COMMERCIAL AND LIABILITY POLICIES • Commercial Auto • Commercial General Liability (CGL) • Umbrella Liability (business or personal) • Directors and Officers (D&O)(for claims of wrongdoing by officers and directors—usually purchased by the entity) • Environmental Impairment Liability (EIL)(Pollution, etc. Now Excluded from CGL policies) • Employment Practices Liability(E.g., wrongful termination, sexual harassment, discrimination, invasion of privacy, false imprisonment, breach of contract, emotional distress) • Professional Practices Liability (Malpractice, including MedMal—compare MICRA) • Errors and Omission (E&O)(Similar to Professional Liability, but the term is more often used outside the legal and medical fields) The Griffith Insurance Education Foundation

46. SOME ISSUES: • Most liability policies have moved from “occurrence” policies to “claims made” policies to avoid the “long tail” of coverages such as: • Asbestos • Pollution • In both cases, there may be multiple policies on the risk, keeping lawyers very busy. • Even current “occurrence” policies present some interesting issues • Twin towers—one occurrence, or two? That issue put a lot of lawyer’s children through college. The Griffith Insurance Education Foundation

47. INFORM+INSPIRE Questions?and“Thank You” Feel free to contact me: Robert W. Peterson Center for Insurance Law and Regulation School of Law Santa Clara University Santa Clara, CA 95053 Tel: (408) 554-4141 Email: rpeterson@scu.edu The Griffith Insurance Education Foundation