The YogiBerraism "It ain't over till it's over" is overused. But just because it is overused does not mean it is wrong.  AES has stayed up late digesting the insights of one of baseball's greatest. Its homework has paid off. On January 17 the Virginia Supreme Court entered a terse order (attached) granting rehearing in Steadfast Insurance Co v AES Corp.

Jump to the next paragraph if you are familiar with the case. For those unfamiliar, AES is a defendant in Native Village of Kivalina v ExxonMobil Corp., a lawsuit alleging that certain carbon dioxide emitters are responsible for global warming, which has melted arctic sea ice resulting in disastrous erosion of the plaintiffs' community.  (For our most recent blog on Kivalina, click here)   AES tendered the claim to Steadfast, who accepted the defense and then filed a declaratory judgment action seeking to avoid coverage. AES lost on summary judgment on whether there was an occurrence and then lost its appeal before the Virginia Supreme Court last September. 

Or maybe not.  AES filed a petition for rehearing (attached) asserting that the Court "radically redefined 'accident' to exclude coverage in virtually all negligence cases." Petition at 1. Normally such hyperbole is a sign of weakness. Here, however, it is in large measure accurate.

The Court held that "When the insured knows or should have known [as the Kivalina plaintiffs alleged] of the consequences of his actions, there is no occurrence and therefore no coverage." See Petition at 4. It relied on two treatises and an Eighth Circuit decision.  Id. Yet, as AES shows in its petition, each of those authorities requires that the insured should have known to a substantial probability or a substantial certainty. Id. at 4-6. Since plaintiffs made no such allegation, and the chain of causation was attenuated (to say the least, see Petition at 7-8), AES asserts the Court's decision was in error.

And this was not something of little consequence. It potentially affected all general liability insurance. The quote from the Eighth Circuit's decision is worth repeating: 

To adopt [the policy] that an injury is not caused by accident because the injury is reasonably foreseeable would mean that only in a rare instance would the comprehensive general liability policy be of any benefit to [the insured] .... Under [this] construction of the policy language if the damage was foreseeable then the insured is liable, but there is no coverage, and if the damage is not foreseeable, there is coverage, but the insured is not liable. This is not the law. The function of an insurance company is more than that of premium receiver.

Petition at 10, quoting City of Carter Lake v. Aetna Cas. & Sur. Co., 604 F.3d 1052, 1058 (8th Cir. 1979).   

What does it all mean?  We conducted an unscientific review of reported cases where the Court granted rehearing in the last 10 years. In all of them, the Court revised its opinion. See Tanner v. State Corp. Comm’n, 266 Va. 170 (2003); Jaynes v. Commonwealth, 276 Va. 443 (2008); Uniwest Const. v. Amtech Elev. Serv., Inc., No. 091495 (Apr. 21, 2011).  All of them.  If we were AES, we would be somewhat optimistic.  Yogi Berra also said: "You can observe a lot by watching."  Oral argument in Richmond in February is likely to demonstrate the truth of that rule as well.

20111017 Petition for Rehearing (by AES), AES Corp. v. Steadfast Ins. Co..pdf (453.91 kb)

20120117 Order (granting petition for rehearing), AES Corp. v. Steadfast Ins. Co..pdf (33.13 kb)

Notwithstanding that millions tune in to the long-running reality TV show America's Next Top Model, the real modeling action is not in Hollywood.  Instead, it is on computer mainframes churning out annual simulations of 100,000 years or more of catastrophes such as hurricanes, earthquakes and terrorist attacks. Such analysis drew the attention of the Maryland Court of Appeals in its seminal opinion last Wednesday in People's Insurance Counsel Division v. Allstate Insurance Co. (attached), which affirmed the appropriateness of modeling in an insurer's decision to issue, or not, homeowners' insurance policies.

The facts in Allstate were relatively simple. In 2006 Allstate determined that it would no longer write homeowners' policies on Maryland properties within one mile of the Atlantic Ocean. It subsequently extended that decision to completely exclude from new policies five Maryland counties, and portions of an additional six counties (all identified by zip code). It relied on a model developed by Applied Insurance Research, Inc. (AIR), which showed that the hurricane losses Allstate would suffer in the identified zip code areas were too high. Dutifully Allstate filed the appropriate papers with the Maryland Insurance Administration. The Administration found nothing exceptional about the application. The People's Insurance Counsel Division (PICD) (a part of the Office of the Attorney General) did, however, and requested a hearing.  It lost before the Commissioner of Insurance, then before the Circuit Court and again before the Court of Special Appeals (see our post).  

PICD then appealed to Maryland's highest court and argued before the Court of Appeals that Allstate had failed to meet its burden of showing that its decision was not "arbitrary, capricious or unfairly discriminatory."  See Md. Ins. Code § 27-501(a)(1).   Following from that, PICD further argued that the designation of areas by zip code did not have an objective basis and therefore was arbitrary and unreasonable. See Md. Ins. Code § 19-107(a).  Allstate's proofs consisted primarily of computer modeling evidence, which the Commissioner found sufficient.

Much of the opinion is directed to the parsing of Maryland's Insurance Code and its legislative history to determine whether § 27-501 even applied (the Court of Special Appeals had found it did not, and the Court of Appeals reversed that portion of the decision). We leave it to the insurance blogosphere to address that further.

What is of interest to this readership is how modeling came into the decision and where modeling stands as a result.

In the proceeding Allstate offered a model that simulates hurricanes from genesis to decay and the damages that would be suffered.  Basically, AIR modelers "developed mathematical functions that describe the interaction between buildings and their contents and the local intensity to which they are exposed." PICD at 7.  Allstate established with expert evidence that catastrophe risk is not diversified ("adding additional catastrophe risk does not reduce overall risk because of pooling but actually increases the overall risk") and that historical loss data is incomplete and outdated "making it difficult to estimate losses."  PICD at 7.  Accordingly, "it has become standard practice for insurance companies to use catastrophe models to anticipate the likelihood and severity of potential future catastrophes before they occur." PICD at 5-6.

The advantages of modeling are substantial; 

(1) It was able to capture the effects on catastrophic loss distribution of changes over time in population patterns, building codes, amounts insured, and construction costs;
(2) It provides a complete picture of the probable distribution of losses rather than just estimates of probable maximum losses;
(3) Because simulation models can be tested more easily than other approaches, it leads to greater stability in estimating expected annual losses;
(4) It provides a means to determine the impact of new scientific information; and
(5) It provides a framework for performing sensitivity analyses and “what if” studies. PICD at 6

As the Court noted, "By using computer models, they can get 100,000 years of simulated loss experience, which is good not just for State-wide pricing but also for loss characteristics related to hurricanes down to the ZIP Code level." PICD at 7. 

PICD retained an actuary to rebut Allstate's proofs; he testified with respect to "actuarial science." He was hampered, perhaps fatally, when the Commissioner refused to allow him "to express any opinion with respect to the model that formed the basis of Allstate's amended filing." PICD at 11. We were not there but the Court of Appeals paints a picture of a non-committal expert. He offered that the decision to not write new policies was unreasonable "'because there is no showing that it is reasonable.'" And he "declined to choose" the method Allstate should have chosen to reduce its risk.  PICD at 11.

In a post-hearing submission PICD argued that "Allstate was required to produce valid statistical data demonstrating the probability of a hurricane sufficiently strong to cause catastrophic damage actually making landfall in Maryland and that it failed to do so."  PICD at 23.  The statistical standard was based on dicta in an earlier Court of Special Appeals decision, Crumlish v Ins. Comm'r, 520 A.2d 738 (1987), which the Commisioner and the Court distinguished.  First, Crumlish's requirement for statistical evidence was not a universal requirement. PICD at 25. More significant was the "catchall" exception added to § 27-501 which established a "standard approved by the Commissioner that is based on factors that adversely affect the losses or expenses of the insurer under its approved rating plan and for which statistical validation is unavailable or is unduly burdensome." PICD at 25.

"That is what the Commissioner did in this case."  PICD at 25.  In other words, the Commissioner found Allstate's evidence met its burden of demonstrating that its use of modeling as the basis to stop writing policies in certain areas was reasonably related to its business and economic purposes and was not discriminatory. 

The dissent would have adopted the Crumlish dicta and required Allstate to offer statistical evidence concerning the landfall of destructive hurricanes in Maryland. PICD, dissent at 5.  Such an assessment was either to be based on the historical record (an impossibility as no hurricane had ever made landfall in Maryland) or "climate science" (which one would think would include modeling).  PICD, dissent at 9, 10.  According to the dissent, all Allstate provided was a computation of the "relative risk" of a hurricane landfall in Maryland as once in 25,000 years based on the worst 5% of hurricanes that made landfall in North Carolina, Virginia, and Delaware.  Allstate justified its decision based on hypothetical hurricanes, i.e., a model.  PICD, dissent at 7.

The Court properly rejected this distinction.  The use of probabilistic catastrophe risk modeling came of age following the destruction caused by Hurricane Andrew in South Florida in 1992. As stated by modeler RMS in its 2008 A Guide to Catastrophe Modeling (p6):  "It became clear that a probabilistic approach to loss analysis was the most appropriate way to manage catastrophe risk. Hurricane Andrew illustrated that the actuarial approach to managing catastrophe risk was insufficient; a more sophisticated modeling approach was needed."  Another modeling firm, EQECat, put it this way:  "The main concern for all users is the uncertainties in the models. Some time ago, the only way to estimate a probable loss was to trust few statistical studies of past losses from some historical events and or on the experience of the underwriter. The uncertainty in these models was quite large as confirmed once a new event [such as Hurricane Andrew] took place. The main problem is that there is not enough historical data, and the standard actuarial techniques of loss estimation are inappropriate for catastrophe losses." 

One of the purposes of catastrophe modeling is to assist the user (often an insurer) in avoiding the alliteratively named "risk of ruin."  If all the industry is using a tool that can minimize the risk of run, it would ill-behoove a court to take away that tool.  In Allstate the Maryland Court of Appeals agreed. 

Nevertheless, if one is looking for guidance on how modeling will be received in the courts, there is one significant question left unresolved by this decision:  how will competing models be treated?  PCID's expert seems to have been completely out of his league. Whatever his actuarial credentials, if the issue is modeling then a modeling expert is needed. And at the very least the AIR model was subject to challenge. In a review published just this month, Assessing US Hurricane Risk: Do the Models Make Sense?, AIR takes on its competition, RMS, and states:  "with this latest round of updates, we [modelers] find ourselves more divergent in our views of risk than ever." (p5)  As one example of this divergence, "Catastrophe modeling companies have vastly different views on what influence sea surface temperatures (SSTs) in the Atlantic Ocean have on U.S. hurricane landfall risk." (p12).  If AIR is correct, perhaps application of the RMS model would have altered the list of excluded zip codes. More fundamentally, does the uncertainty established by competing models (and that is inherent in modeling) impose an unavoidable and unacceptable arbitrariness in application?  That is for another day.  For the moment, modeling companies and those who use them likely will proceed full speed ahead.

Post scriptum - Climate change seems to have been a subject not to be discussed.  As noted by the dissent, if Allstate was worried about the science of climate change, it didn't bring it up.  Nevertheless, the dissent did bring it up and asserted that meteorological change occasioned by climate change could be a legitimate basis for Allstate's decision.  The modeling firms think otherwise. Eqecat's CEO Bill Keogh has stated because of the uncertainty associated with climate change's effect on hurricanes, " it has no role in catastrophe risk modeling."

Peoples Insurance Counsel Division v Allstate Insurance Company.pdf (78.07 kb)

This is the last of three parts concerning Ceres’ recently released Climate Risk Disclosures by Insurers:  Evaluating Insurer Responses to the NAIC Climate Disclosure Survey.   We already have looked at the first two Recommendations to Regulators.  Today we finish with number 3:  more clarity in disclosure expectations.  Id. at 51. 

It is always easier to make apples-to-apples comparisons when everyone is speaking the same language.  Uniform and detailed disclosure requirements would help achieve that goal.  However, the down side of specifying what will be disclosed is that it assumes the specifier knows all that needs to be identified.  The scariest part of climate change is that we probably do not yet know how all the changes will interact.  Correlated risk is a prime example. 

IRMI describes “correlated risk profiles” as those “that move in concert when affected by the same set of stimuli.”  Insurers run from correlated risk and the Ceres report rightly poses a troubling concern in that regard:  “If … climate change has the potential to introduce correlated risks across previously uncorrelated assets and to drive market values in ways that cannot be predicted from historical trends, the insurance industry may be poorly positioned to meet its investment objectives.”  Climate Risk Disclosures at 39.  According to the report, few companies recognize the potential for correlated losses across their business.  Id. at 43.  And the ones that do say no more than that climate change will increase insured losses and may negatively impact the businesses in which insurers invest.  Id.   We don‘t think that this is news to those who did not specifically mention correlated risks in their submissions. 

What we take from all this is that no one yet knows in a meaningful way where the climate change correlated risks lie.  Or they are keeping mum (see our first posting on the Ceres report concerning competitive advantage).  So the question for a regulator is the following:  Is one better off with answers that are less-constrained and potentially more revealing, or is more specificity in the guidance more helpful?  If one is a regulator who knows all the questions that should be asked, one should opt for more specificity.  But if one does not, then one might support providing unstructured disclosure opportunities.

The Ceres report, of course, is not all about recommendations, but we have gone on for too long to delve further.  Before we close, however, we did want to address the need for stronger research.

The Corporate Liability section attracted our particular focus, as climate change liability suits and their insurance have been a central feature of the blog.  Those of us following this subject drop the names of the three liability damages suits, Comer, General Motors and Kivalina, and the insurance suit, Steadfast, like they were business cards. 

The statement that got our dander up was this:  "Since the first suits were filed in 2003, their numbers have rapidly proliferated—more than 120 suits were filed in 2010 alone, nearly two-thirds of them in the U.S."  Id. at 11.  This is an accurate paraphrase of its source, a sentence in a short article published by the Geneva Association.   The problem is that the source, at best, is misleading.  While there may have been 120 climate change suits filed in 2010, as demonstrated by the comprehensive set of charts kept by the Climate Change group at Arnold & Porter LLP there were none filed that were seeking damages under common law theories.   Those suits continued to be the three:  Comer, GM and Kivalina.

We will be the first in line to agree that the insurance industry should be concerned about climate change liability suits.  But that concern has not yet had to focus on 120 climate change liability suits, because they have not been filed yet.

That being said, the Ceres report brings to the fore statements by representatives of a multi-trillion dollar industry that is in the eye of the climate change storm.  Those statements otherwise might languish in some regulator’s dark bottom drawer.  The report is a valuable resource; we look forward to next year’s reprise.

This morning the Virginia Supreme Court decided the first climate change liability insurance coverage case:   The AES Corp. v. Steadfast Ins. Co., Record No. 100764 (attached). It held that there was no covered “occurrence” and that therefore the trial court properly dismissed the insured’s claim for coverage.

Followers of this blog are well familiar with Steadfast and the underlying Kivalina case.  For those new to this subject, this coverage case arose out of the climate change nuisance damages case, Native Village of Kivalina v. ExxonMobil Corp., CV 08-1138 SBA (N.D. Cal.), in which claimants asserted that defendants' greenhouse gas emissions resulted in warmer winters, which lead to melting of sea ice and erosion of the shoreline around their community to the point that their village was set to fall into the sea.  They brought suit against oil and gas companies, electric utilities and a coal company, seeking damages for an alleged nuisance.  In Steadfast one of the Kivalina defendants’ insurers (Steadfast), after first defending under a reservation of rights, brought a declaratory judgment action against its insured (electric utility AES), seeking to avoid coverage under its general liability policies.  Shortly thereafter Steadfast filed a motion for summary judgment asserting that there was no occurrence, and that coverage was barred by the loss-in-progress and pollution exclusions.

AES initially prevailed and defeated Steadfast’s motion.  AES then moved for summary judgment on the duty to defend and Steadfast cross-moved.  This time Steadfast gained victory.  The trial court issued a very brief opinion holding:  “Steadfast has no duty to defend AES in connection with the underlying Kivalina litigation because no 'occurrence' as defined in the policies has been alleged in the underlying Complaint.”  AES appealed.

In most jurisdictions, including Virginia, an “eight corners” rule is applied:  “only the allegations in the complaint and the provisions of the insurance policy are to be considered in deciding whether there is a duty on the part of the insurer to defend and indemnify the insured.”  Opinion at 7 (citations omitted).  Coverage under the Steadfast policies hinged on whether there was an occurrence, specifically defined to mean “an accident, including continuous or repeated exposure to substantially the same general harmful condition.”  In Virginia the terms “occurrence” and “accident” are synonymous and an “accident” is commonly understood to mean “an event which creates an effect which is not the natural or probable consequence of the means employed and is not intended, designed, or reasonably anticipated.”  Id. at 9.

There was no dispute that AES intentionally released carbon dioxide as part of the combustion process at its power plants.  But intentional acts do not preclude coverage:  “[W]hen the alleged injury results from an unforeseen cause that is out of the ordinary expectations of a reasonable person, the injury may be covered by an occurrence policy provision.”  Id. at 10 (citing 20 Eric M. Holmes, Appleman on Insurance 2d § 129.2(I)(5) (2002 & Supp. 2009)).  However, “If a result is the natural and probable consequence of an insured’s intentional act, it is not an accident” and coverage will be barred.  Id. at 9. 

The Court summarized the rule it would apply:

Thus, resolution of the issue of whether Kivalina’s Complaint alleges an occurrence covered by the policies turns on whether the Complaint can be construed as alleging that Kivalina’s injuries, at least in the alternative, resulted from unforeseen consequences that a reasonable person would not have expected to result from AES’s deliberate act of emitting carbon dioxide and greenhouse gases.  Id. at 10-11.

Notwithstanding that the Kivalina plaintiffs specifically alleged negligence, and that AES adduced evidence that the Kivalina plaintiffs were arguing on appeal before the Ninth Circuit that their claim sounded in negligence, the Court followed strict adherence to the eight-corners rule:

Kivalina plainly alleges that AES intentionally released carbon dioxide into the atmosphere as a regular part of its energy-producing activities. Kivalina also alleges that there is a clear scientific consensus that the natural and probable consequence of such emissions is global warming and damages such as Kivalina suffered. Whether or not AES’s intentional act constitutes negligence, the natural and probable consequence of that intentional act is not an accident under Virginia law.  Id. at 12.

Further, “[e]ven if AES were negligent and did not intend to cause the damage that occurred, the gravamen of Kivalina’s nuisance claim is that the damages it sustained were the natural and probable consequences of AES’s intentional emissions.”  Id. at 13.  In sum, “If an insured knew or should have known that certain results would follow from his acts or omissions, there is no 'occurrence' within the meaning of a comprehensive general liability policy.”  Thus, the trial court was affirmed.

As noted at the outset, this is the first skirmish of what is certain to be a protracted battle between insurers and insureds.  There are 50 other jurisdictions (including the District of Columbia) and this is only one issue based on one complaint and one insurer's policy language.  There is a long way to go before we will have clarity here.

Post scriptum:  Many will recall that Steadfast argued in its papers and before the Court that the pollution exclusion also barred coverage; AES responded that it had not been properly raised.  The Court did not even address the subject, apparently feeling that it was enough to cite to AES's grounds for appeal, which did not include the pollution exclusion.  So even in Virginia, there are still coverage battles to be fought.

AES Corp. v. Steadfast Ins. Co., No. 100764, slip op. (Va. Sept. 16, 2011).pdf (64.69 kb)

We wrote yesterday to introduce Ceres’ report on the disclosure of climate risks by insurers and considered its first Recommendation to Regulators concerning mandatory and public disclosures.  We address today the second recommendation in Climate Risk Disclosures by Insurers:  Evaluating Insurer Responses to the NAIC Climate Disclosure Survey.    Ceres’ second recommendation is to "[c]reate shared resources around the implications of climate trends on enterprise risk management."  Id. at 51.  In other words, more research should be made available concerning investment risks and opportunities, correlated risks, loss modeling, the potential for loss of health and life, and customer resilience (ability to resist extreme events).  Id. 

Taking modeling by way of example, Ceres discusses modeling thoroughly in Part 2 and the discussion is thought-provoking.  Several insurers are conducting climate change modeling internally.  For the rest, they rely on third-party vendors, which invokes much criticism from Ceres.  "The majority of insurers that report using catastrophe models describe them in terms that suggest their company does not have a clear understanding of how the models can or cannot be used to anticipate changing risk.  Most of the industry relies on third-party catastrophe risk models that only marginally integrate changing extreme weather."  Id. at 6.  "[I]nsurers relying entirely on third-party models may be severely unequipped to adjust pricing to incorporate emerging climate risks." Id. at 31.  "Insurers' disclosures suggest that the majority of insurers may be setting pricing based on flawed assumptions of how the industry's loss models incorporate changing climate trends."  Id. at 32.

Ceres lauds those companies that can do it in-house.  But specialization and economies of scale are fundamental drivers of the market.  Were every insurer to bring modeling inside, undoubtedly there would be some new insights not presently uncovered.  But there would also be insurers who got the models grievously wrong and, in most cases, the resources spent on modeling would be more cost-effectively spent on other items necessary to delivering products or services.

To be sure, reliance on EQECAT, AIR Worldwide and RMS as the sources for all climate change modeling has its flaws.  One need only think back a few years to where another triumvirate dispensing financial ratings (allegedly) misled sophisticated investors around the globe.  But in a world of constrained resources, or even an unconstrained one, third-party modelers are necessary and beneficial. 

Further, a disadvantage to society from in-house modeling is that the insights developed from proprietary work may remain just that:  proprietary.  Ceres acknowledges "it is ... possible that asymmetrical information can be used by individual companies to secure a competitive edge against their peers."  Id. at 38.  Indeed, "larger insurers more readily recognize the inherent limitations of current catastrophe models in light of changing climate than do their smaller competitors or clients.  These players have a clear competitive advantage in deploying resources to build the latest climate science into their pricing models."  Id. at 37.  Third-party vendors, on the other hand, spread their best products across many insurers, in effect sharing their best research (but only to those willing to pay for it). 

We wrote yesterday of the need to recognize that intellectual capital is a business asset and criticizing a goal of making climate change disclosures public available.  We think those comments apply likewise to the sharing of resources.

Nevertheless, Ceres does great work in raising the bar for third-party vendors.  By pointing out to insurer-users that they may not be getting what they really need from the modeling firms, we expect the modelers will have to go out and address Ceres’ criticisms.  For example, insurers are exposed if (as Ceres asserts) "few insured perils are modeled by insurers, leaving the possibility for climate-affected perils to be underpriced."  Id. at 35.  More specifically, "recent years have demonstrated that climate change may be driving up aggregated losses from smaller events, including perils such as floods, snowstorms and hailstorms, in ways that erode insurer profitability."  Id.

Tomorrow we conclude our review with a look at Ceres’ third recommendation as well as sharing some concerns about research.

Ceres released last week the first analysis of the insurer climate change disclosures submitted to state regulators pursuant to the National Association of Insurance Commissioners rule.  The report is eye-opening.  The authors have combed through the disclosures of 88 insurance companies and offer thoughtful insights on, for example, investment practices, management structure and modeling.  Those seeking to advance their bottom line will find nuggets of information directly related to competitive advantage.  In this post, we outline the report and discuss its first recommendation regarding mandatory and public disclosures.  In subsequent posts we will address Ceres’ second and third recommendations.

The report’s title is dry and daunting:  Climate Risk Disclosures by Insurers:  Evaluating Insurer Responses to the NAIC Climate Disclosure Survey.   Fortunately, it does not live up to the ominous desiccation foretold by the title.  We know from the get-go where this is going:  "This report documents this powerful industry's sluggish and uneven response to the ever-increasing ripples from global climate change, which could undermine both its own financial viability and the stability of the larger global economy."  Id. at 3.

For those to whom Ceres and NAIC are unfamiliar, the former is a non-governmental organization composed of a coalition of investors, environmental organizations and other public interest groups, whose mission is to “integrat[e] sustainability into day-to-day business practices for the health of the planet and its people.”  The latter is the National Association of Insurance Commissioners, which in 2009 approved mandatory requirements for climate change disclosures for insurance companies, because "[a]s regulators, we are concerned about how climate change will impact the financial health of the insurance sector and the availability and affordability of insurance for consumers.  This disclosure standard will give regulators the information we need to better understand these risks."    NAIC later revised its requirements to make disclosure voluntary.

Ceres's work is based on the 2010 disclosures of 88 US insurers filed in six states (mandatory:  New York, California, Pennsylvania; voluntary:  New Jersey, Oregon, Washington).  The report is set up in three parts.  Part 1 describes climate change risk and the need for disclosure.  "The changing climate will profoundly alter insurers' business landscape, affecting the industry's ability to price physical perils, creating potentially vast new liabilities and threatening the performance of insurers' vast investment portfolios." Climate Risk Disclosures at 9. 

Part 2 is the meaty analysis of the report and addresses the following topics:

Risk Perception and Management Structure
Risk Exposure and Management
Financial Effects
Loss Modeling
Investments
Emissions Management
External Engagement

Its goal is to set out “risk perceptions and management practices for handling climate change across the American insurance industry.”  Id. at 17.  While often couched in possibilities, the analysis raises numerous interesting issues.

Part 3 is the Recommendations to Regulators.  There are three and we focus there.  First, Ceres recommends “implement[ing] mandatory disclosure annually, and mak[ing] survey responses publicly available."  Id. at 50.  We take no position on whether NAIC should require climate change disclosures and would be interested to read NAIC’s own evaluation of the disclosures and how they advance the goals of insurance regulators.  As for public disclosure, while we are perhaps more interested than most in these types of things, we are acutely sensitive to the issue of competitive advantage.  There will be winners and losers in the insurance industry as a result of climate change.  The winners will be those who, among other things, recognize correlated risks first, have more accurate models, and innovate better.  Requiring companies to give away their proprietary information may lead them not to generate it in the first place.

And items leading to competitive advantage are all over the NAIC submissions.

Harleysville Insurance Company reports that “over time the Company has witnessed the traditional tornado alley expand causing increased losses further east and toward the southeastern states." Id. at 24.

"[A] handful of insurers discuss the ways their approach to establishing reserves, reinsurance coverage or capital market transfers have been adapted to reflect changing risk statistics or future scenarios where historic statistics do not illuminate future risk."  Id. at 32.

Allianz is “developing products and services geared to address climate change, ... leveraging climate change research, and contributing to related public policy development."  Id. at 19.

There are a lot of things that make a business succeed.  Intellectual capital is one of them.  Just as we would not expect businesses to give out greenbacks to passersby, why should their green ideas be treated differently? 

Tomorrow we will look at Ceres’ second recommendation concerning shared resources.

We thought last January, when the Supreme Court denied a writ of mandamus, that the long saga of Ned Comer through the courts had finally come to an end.  We were wrong.  At the end of May, the case, Comer, et al. v. Murphy's Oil USA, et al. (attached), was refiled in the Southern District of Mississippi.  Although predating the Supreme Court's June decision in American Electric Power v. Connecticut, one could be excused for concluding that it was filed afterward as it relegates federal common law to a sentence and instead is all about state law causes of action.

But before we get into the resurgent Comer, we thought we would point out a June paper published by the Geneva Association, an insurance industry think tank.  One of the industries most affected by climate change is insurance. In Why Insurers Should Focus on Climate Risk Issues, Chief Climate Product Officer, Lindene Patton, outlines some of the risks and opportunities she perceives.   Her perspective is particularly worth considering as her employer, Zurich Financial Services, faces climate change issues across a broad spectrum of activities. (Ms. Patton notes, however, that the positions in the paper are hers alone.)

Ms. Patton's views are insightful:  "society at large appears increasingly underinsured for the impacts of climate change at the time of its greatest need."  And they are ominous:  "Unless global societal risk management of climate change improves, the mismatch between the loss exposure and monies needed to cover economic loss associated with climate change-related severe weather events and other impacts will only become more extreme."  The solution she calls for is for insurance companies to take the lead to overcome the current "governance gap with respect to climate change policy."  Even without leadership, important social decisions can be made if the right price signals (i.e., premiums) are sent. Such signals can lead to "cogent risk management decision-taking" and assist in the spreading and management of climate change risks. An example of such price signals from an earlier period are the fire proofing of much of America as the result of the insurance industry's support of fire codes and the underwriting to go with them.

The alternative to leadership in the marketplace is what Ms. Patton refers to as the frictional costs of litigation. In some cases those costs can be trivial, such as occurred with Y2K. In other cases, the outcomes can be devastating -- think asbestos and tobacco, on which insurers have paid, by some estimates, $150 billion and $750 billion respectively.

Driving litigation in the climate change sphere is the relatively unknown fact of "a trend of decreasing percentage of insured loss when calculated as a percentage of damages from extreme weather events on an annualized basis."  Stated more simply, those harmed by hurricanes are not insured or are underinsured and the path to being made whole lies with a judge, not with an adjuster.

The litigation path is not set out in black and white. Yet. But there are areas that may be fruitful for plaintiffs. Ms. Patton identifies SEC disclosure rules, fractional allocation (market share) schemes, and de minimus liability regimes as potential routes for "activist judges to find liability associated with" greenhouse gas emissions.  Regardless of the theory du jour, the ongoing injuries and displacement caused by climate change "may ultimately end up over a number of years in dedicated, repeated efforts by plaintiffs to find a legal theory that 'sticks' as happened in tobacco or asbestos."

Which brings us back to Ned Comer and his protean and unvanquishable litigation.  All remember Hurricane Katrina; most will recall the lawsuit filed 20 days after Katrina made landfall.  In various iterations it sued insurance companies, mortgage lenders, oil companies, electric utilities, coal companies, and chemical companies; it alleged against all of the greenhouse-gas-emitting defendants responsibility for Katrina's "unprecedented" ferocity.  Its appellate travails are legend.  Following dismissal in the district court, and reinstatement by a Fifth Circuit panel, that decision was vacated when the Fifth Circuit accepted the case for en banc argument, and then dismissed the case when its quorum dissolved.  The petition for mandamus did not avail and everyone thought the case was gone.

Everyone, that is, except Ned Comer's lawyers.  On May 27, 2011 Comer v. Murphy Oil USA, Inc. was re-filed.  It is a monstrous class action lawsuit with over 90 named corporate defendants - a crowd even larger than the earlier iterations of the case.  Like a Who's Who of particular industries, it alleges against classes of oil companies, utilities and coal companies, and chemical companies claims in three counts of public and private nuisance, trespass and negligence. But it also includes, almost as afterthoughts, a strict liability claim (¶ 36) and a conspiracy claim (¶ 41).  It concludes with a count for a declaratory judgment that federal law does not preempt state law claims.

Ms. Patton's frictional costs are here in vast numbers.  As is her recognition that it is injury rather than an interest in climate change policy that provides the litigation incentive:  "Plaintiffs do not ask this Court to regulate greenhouse gas emissions or change national policy regarding climate change. Instead, Plaintiffs seek legal redress for the damages caused by these Defendants."  (¶ 11).

Those damages are broad. 

"[Plaintiffs'] homes and property were destroyed by Katrina's destructive winds and storm surge, which effects were increased in frequency and intensity by Defendants' emissions of greenhouse gases." (¶ 18) 

"Plaintiffs' property also is damage[d] by sea level rise as a result of submersion and/or increased exposure to hurricanes. (¶ 19)

"Plaintiffs' insurance premiums for their coastal Mississippi property have risen dramatically, and the resale values of their homes and property values have plummeted."  (¶ 20)

The insurance premium allegation is thought-provoking.  Plaintiffs recognize that proving a particular defendant caused Hurricane Katrina will be difficult. Pleading in the alternative, they assert that the Defendants' greenhouse gas emissions "put Plaintiffs' property at greater risk of flood and storm damage, and dramatically increase Plaintiffs' insurance costs." (¶ 37) They link insurance company efforts to price climate change risk to increased premiums (Ms. Patton's risk-based price signals), and, because those "insurance costs attributable to global warming are distinct and quantifiable", they assert they are entitled to recovery. (¶¶ 38-40)  This theory of damages based on increased risk, rather than actual harm, bears watching.

Ms. Patton concludes, "the AEP case only addresses nuisance cases and does not address broader theories under tort liability law.  A verdict for the defendants on the nuisance issue may not arrest the flow of cases and associated defence costs.  The plaintiffs bar may still continue to file demands and claims for other types of tort damages."  We would go further. With apologies to Atlanta, Comer Resurgens demonstrates that the conditional "may" is being replaced by the declarative "will."

20110527 Comer v. Murphy's Oil (re-filed) Complaint.PDF (796.31 kb)

On the eve of hurricane season, we ponder what would happen if an irresistible force met an immovable object.  To make this concrete, we consider the effect of a Hurricane Katrina-like storm impacting Florida's property insurance program, the centerpiece of which is the actuarially unsound, tax-exempt, non-profit corporation, and insurer of last resort, Citizens' Property Insurance Corporation.

The Atlantic hurricane season begins tomorrow. The forecasters at the University of Colorado Hurricane Center predict 16 named storms.  Historically, that is an above average crop. Their methodology is not controversial. After gathering oceanic and atmospheric data - such as sea surface temperature, atmospheric pressure, and wind shear -  in February and March, they then compared those conditions to the historical record and identified the previous seasons that had similar conditions.  All but one (2006) had an above average hurricane season. The distinguishing feature for the exception was that it did not have neutral or La Niña conditions in the Pacific (i.e., El Niño dominated).  The effect of that is to minimize the wind shear in the upper atmosphere, which permits hurricanes to build.   

How does an increased hurricane incidence translate to landfalls in the United States?  The forecasters predict an increased probability of landfall.  Of particular note is the ominous comment:  “Except for the very destructive hurricane seasons of 2004-2005, United States coastal residents have experienced no other major landfalling hurricanes since 1999. This recent 9 of 11-year period without any major landfall events should not be expected to continue.” 

And what would happen should that probability become reality?

One place with a particularly bad outcome may be Florida.  The largest property insurer in the state is Citizens' with over 1.3 million policies insuring $462 billion worth of property.  That is approximately 18 percent of the residential market.  Citizens' estimates that its exposure for a once-a-century storm is $23.4 billion. It has reserves and potential reinsurance of $11.75 billion. That leaves a gap of $11.65 billion.  (For reference, a NOAA report based on inflation-adjusted dollars puts Hurricane Andrew's cost at over $43 billion; the 2004 quartet of Charley, Frances, Ivan and Jeanne cost over $45 billion.) 

How can this be?  An analysis done in support of HB 1243 in the Florida House of Representatives gives some insight:

Citizens' premiums are less than those charged by private insurers - If the premium in the private market for comparable coverage is 15% or more than Citizens' would charge, Citizens' coverage is available to a homeowner. 

Citizens' portfolio of risks are not low-budget - If the value of the property is up to $1 million, or $2 million in designated windstorm areas, Citizens' coverage is available to a homeowner.

Citizens' insureds can (and do) shop their other coverages in the private market - In designated windstorm areas, property owners can buy non-wind coverage from private insurers and windstorm coverage from Citizens'.

Citizens' rates are not actuarially sound - Citizens rates are required to be actuarially sound but were frozen at 2005 levels for all of 2007, 2008 and 2009. Rate increases are capped.

Citizens is not required to be solvent - Citizens does not have to meet the solvency requirements of traditional insurers.

If this sounds like a recipe for disaster, many in Florida recognize it as such.  Companion bills to reform Citizens' were introduced in the Florida Legislature this spring.  HB 1243 and SB 1714 had the support of an "unlikely coalition" of industry, environmental groups, tax watchdogs and free market advocates.  Notwithstanding this diverse support, and the documented flaws in the current program, both bills died at the end of the legislative session.  Citizens' form and operations may be immovable given political realities.

Florida will lurch into tomorrow's hurricane season keeping its fingers crossed and hoping that this year's cyclonic trajectories all steer clear of the Sunshine State.  If that hope is not borne out, then the irresistible force of 150 m.p.h. winds may demonstrate that immovable political realities are not.

We were interviewed by Business Insurance last week after the Virginia Supreme Court heard argument in AES Corp. v. Steadfast Insurance Co. The topic du jour:  what would be the effect of the U.S. Supreme Court's decision in American Electric Power v Connecticut. Obviously, an insurance readership would very much like to know if carbon dioxide liability was something they needed to continue to worry about. Much of the blogosphere has concluded that the justices didn't give much credence to the public nuisance theories of the plaintiffs (we reserve judgment on that conclusion - there were some pretty tough questions posed to the appellants too). If that is so, then carbon dioxide liability is something like Y2K, right?

Unfortunately, we fear that is not the case. The concerns over Y2K reached their zenith at 1159 on December 31, 1999. By 1201 on January 1, 2000 most everyone had slapped each other on the back and moved on. Story over. Concerns over carbon dioxide liability are unlikely to have that sharp crest.  If a decision favorable to carbon dioxide emitters is issued by the Supreme Court, that will only mean that federal common law nuisance claims cannot move forward. It says nothing about state law nuisance claims, nor new theories that have not yet been tested, nor even thought up. We strongly believe that carbon dioxide liability suits will be with us for a while yet. Our reason:  climate change is ongoing and those whose interests are harmed will look for succor. So theories of liability will be spun and suits will be brought.  And such suits will require a defense.
 
All of which leads us back to AES v. Steadfast.  The Virginia Supreme Court will render a decision on one state's law on likely only one issue. Indeed, at oral argument, Steadfast's counsel conceded the result would be different in other jurisdictions. Thus, insureds concerned about carbon dioxide liability should be paying attention to choice of law rules, and to the range of issues where choice of law matters.

Let's look at just the two issues in dispute in AES, the application of the pollution exclusion and the meaning of occurrence. The Wisconsin Supreme Court has already ruled that exhaled carbon dioxide is not a "pollutant" and numerous jurisdictions have held that a so-called "absolute" pollution exclusion is not absolute.  Donaldson v. Urban Land Interests, Inc., 564 N.W.2d 728, 730 (Wis. 1997); Am. States Ins. Co. v. Koloms, 687 N.E.2d 72 (Ill. 1997) (carbon monoxide); W. Am. Ins. Co. v. Tufco Flooring E., Inc., 409 S.E.2d 692 (N.C. Ct. App. 1991) (floor sealant); Cont’l Cas. Co. v. Rapid-Am. Corp., 593 N.Y.S.2d 966 (1993) (asbestos); Keggi v. Northbrook Prop. & Cas. Ins. Co., 13 P.3d 785 (Ariz. Ct. App. 2000) (bacteria).   As for occurrence, in many jurisdictions there is no question that an occurrence is determined by looking at the intentionality of the injury from the subjective standpoint of the insured, rather than the reasonably foreseeable standard argued by the insurer in AES. Compare Ohio Cas. V. Henderson, 939 P.2d 1337 (Ariz. 1997); Am. Family Mut. Ins. Co. v. Pacchetti, 808 S.W.2d 369 (Mo. 1991) with Brief of Appellee, AES Corp. v. Steadfast Ins. Co., No. 100764 (Va. Sup. Ct. Oct 8, 2010).  Accordingly, it would be extremely shortsighted for insureds to assume every jurisdiction is like every other. 

Potential carbon dioxide liability defendants should take two steps going forward. They should ascertain what state's law will be applied on the liability contract they are purchasing today and how that law is likely to address the carbon dioxide liability coverage questions. And they should be asking the same questions for past occurrence-based policies. 

And of course, if the oracles and seers who have channeled the Supreme Court turn out to be wrong, the need for coverage and the answers to these questions will manifest themselves much sooner.

Brief of Appellee, AES Corp. v. Steadfast Ins. Co..pdf (182.69 kb)     

"Catastrophic risk is different." So concludes an important opinion out of the Maryland Court of Special Appeals filed earlier this month.  In the case of first impression, People's Insurance Counsel Division v. Allstate Insurance Company, the court affirmed the primacy of models and business judgment in the writing of insurance, and further recognized that there is a "gaping difference between ordinary insurance risk and catastrophe risk."

The case stems from the decision way back in 2006 by Allstate to advise the Maryland Insurance Administration (MIA) that it did not intend to write any new property policies in certain Maryland counties subject to heightened hurricane risk. As distilled by the court: "certain coastal areas bordering the Atlantic Ocean and the Chesapeake Bay presented an unusually high risk of loss in the event of a catastrophic hurricane. As a result, [Allstate] decided that it was no longer in Allstate's best economic interest to continue to write new property insurance policies in those areas."

The MIA concluded that Allstate' business decision was properly made on "an obective basis and [was] neither arbitrary nor unreasonable." However, the state's public advocate, in the guise of the People's Insurance Counsel Division, concluded differently. Following a trip to Maryland's highest court, which confirmed the Division had standing to challenge the MIA's decision, the Division argued that Allstate's determination not to write property policies in certain geographic areas was arbitrary and unreasonable in contravention of Maryland Insurance Article § 19-107. Further, the Division argued that because Allstate had not shown that a hurricane would strike Maryland and that its rates were insufficient to carry that loss, the decision violated § 27-501.

Section 19-107

To determine whether it wanted to undertake the risk of hurricanes along the Eastern Seaboard, Allstate retained Applied Insurance Research (AIR) to model the areas of the state and region that were catastrophe-prone, and those that were not.  It concluded that some or all of certain Maryland counties were at a substantially heightened risk of higher levels of hurricane damage than other areas. The model was explained:  "What it did, in order to get down to the zip codes, statistical level, generated the next year 100,000 times. That is, it's doing simulations of the next year, 100,000 times. And what they do in order to do that is they look at the last 100 years of meteorological data to try to come up with a probability of various hurricane strikes."

In those 100,000 simulations AIR concluded that there would be eight hurricane strikes that would cause half a billion dollars in damage in Maryland alone. Because Allstate insured a substantial number of properties in these risky areas, it made the "business judgment that further growth at this time could jeopardize [its] anticipated long-term strength." The court quoted the Commissioner in holding that Allstate complied with the law:  "I conclude that Allstate's geographic designation of Hurricane Bands 4-6 had adequate factual support and, therefore, was not arbitrary or unreasonable. Allstate's hurricane bands were developed based on objective and reasonable factors, including modeled hurricane loss data, proximity to water and geographic contiguity. Through its use of the hurricane models, Allstate developed [Average Damage Ratios] ADRs at a zip code level. The higher the ADR, the higher the potential damage the area in the band is likely to sustain in the event of a catastrophic storm."

Section 27-501

This section of the Insurance Article forbids an insurer from refusing a "particular insurance risk or class of risk" for "any arbitrary, capricious or unfairly discriminatory reason." The court first held that a decision to stop doing business did not address a particular individual or group of individuals; therefore, because Allstate's decision was "broad-based", section 27-501 simply did not apply.

But even if it did, the modeling demonstrated that the decision was not unfairly discriminatory, arbitrary or capricious. The Division asserted that ""Allstate was legally required to show the probability of a catastrophic hurricane striking Maryland in order to justify its no-write decision."  The court was dismissive and characterized the Division's contention as "unreal". The issue faced by Allstate was very plain, syllogistic in fact: 

THE ENTIRE EASTERN SEABOARD OF THE UNITED STATES IS AT RISK FROM HURRICANES.
MARYLAND IS PART OF THE EASTERN SEABOARD OF THE UNITED STATES.
THEREFORE, MARYLAND IS AT RISK FROM HURRICANES (capitals in original). 

The court then went on to enumerate the details that the model considered such as historical hurricane reports, weather databases, and property values.  It came down firmly on the value of the model:  "Allstate's use of the AIR Hurricane Model V7.0 cranked out, zip code by zip code, predictive statistical data for 100,000 model years.  We are hard-pressed to understand exactly what more the Division could want."

As to the Division's last argument (that prior Court of Special Appeals precedent required Allstate to demonstrate that its rate plan was insufficient to cover catastrophe losses) the court was scathing. Referring to the Division's argument as "fantasy analysis," it demonstrated that the precedent on which the Division relied suffered from a fundamental error in its understanding of the source materials and, as it "was wrong in 1987, ..., as it most assuredly was, it is still wrong 24 years later."

The court concluded its analysis with a discussion of catastrophe risk.  It pointed out that for the usual risk, say fire or car accidents, insurers diversify their risk by taking on more insureds.  Where a catastrophic risk is present, however, taking on more insureds increases the risk to the insurer, rather than decreases the risk, because if the catastrophe strikes, all of the insureds will make a claim.  It concluded that catastrophic risk was "unique" and that case law that focused on individual insureds was completely irrelevant.

People's Insurance Counsel is significant at a number of levels for those following climate change insurance issues.  First, the modeling data and results were unchallenged.  There are three dominant modeling companies (AIR, EqeCat and Risk Management Solutions) so the Division was not stymied here because Allstate's modeler had a lock on the market. More likely, it was recognized that while a different model might preserve coverage for a few zip codes, the models would not reach fundamentally different outcomes.  If the goal was to ensure that Allstate (and by extension all other insurance companies) could not abandon the front lines of hurricane risk, no model would show that Worcester County (on the ocean) would have a similar risk as Garrett County (at the headwaters of the Potomac). Businesses should take note.  In most businesses, profit is made at the margins.  Employing models to ascertain where the weather-related risks change their character could yield real monetary benefit - as Allstate demonstrated by giving up underwriting in only parts of some counties.  

Second, AIR looked at historical weather records. It made no predictions about the future more severe weather called for in climate change models. This reluctance to face the future is not unique to insurance companies.  The Federal Emergency Management Agency takes the same approach in its analysis of flood plains.  We have written elsewhere concerning the head-in-the-sand mentality that afflicts many that are subject to altered climate change risks.  Catastrophe modeling is no different.  We await the case that tests the insurer's ability to rely not on what has happened in the past, but on what is predicted for the future.

Third, there is (at the moment anyway) a great belief in the efficiency of the market in identifying the appropriate path for society.  The insurance markets are taking steps to halt the migration to the shore by determining not to insure it.  It remains to be seen whether governments will abide by those business decisions or force dislocations onto the market in order to preserve continued growth in hurricane-prone areas.  Maryland, for the moment, appears to be one state that is allowing the insurance market to shape the future of the shore.  As we have blogged before, other states (notably Florida), are not so laissez-faire.