Another damaging surge slows rebuilding – "demand surge" calculation left homeowners shortchanged

The Sun Herald reports on a Biloxi attorney’s claim homeowners have been shortchanged in the settlement of Katrina insurance claims.

At least two major insurance companies have shortchanged homeowners covered for inflation on their Hurricane Katrina losses, said a Biloxi attorney who advises policyholders to make sure they are fully compensated under the inflation provision.

“Nationwide and State Farm have been misrepresenting the amount of coverage they owe Mississippians with total losses from Katrina,” Christopher C. Van Cleave said. “We’re not talking about small money. We’re talking substantial amounts.”

He said the companies have used the date of the loss – Aug. 29, 2005 – to calculate payments for inflation owed to policyholders who bought the optional coverage. That would be fine for those paid shortly after the storm, but many left with only slabs waited a year or more for insurance money because both Nationwide and State Farm initially denied coverage for wind damage when storm surge was involved in total losses.

What Van Cleave is talking about is known as demand surge in the insurance industry.

Demand surge refers to price inflation for scarce construction materials, labor and services following a significant disaster. The more widespread the damage, the greater the price for the rebuilding resources.

Demand surge costs are influenced by the inability to have resources simultaneously available when damage is widespread, said David Lalonde, senior vp in the Toronto office of catastrophe modeler AIR Worldwide Corp.

According to a recent article in Business Insurance, the industry is aware of the problem and changed the model used to project demand surge – whether the new model factors in the length of time between the event and settlement was not mentioned. However, the need for a new model surfaced after the 2004 and 2005

Pre-2004 catastrophe models allowed insurers to estimate their exposure to demand surge losses, but only on single events, said John DeMartini, a principal at Towers Perrin in Stamford, Conn…

Then four very significant events struck Florida in 2004, making it the first time one state experienced that many hurricanes during a single season since 1886 in Texas, according to the U.S. National Climatic Data Center.

The Florida storms compounded demand pressure on finite building materials, supplies and contractors. Then in October 2005, Hurricane Wilma battered Florida again while building contractors were already in short supply because of the 2004 storms.

“The frequency of events is what really caught everybody off-guard,” Mr. DeMartini said.

Obviously, so, and Katrina and other storms in 2005 even moreso; but, these events also caught policy holders off guard as well.

Because of previous models’ limitations in estimating demand surge exposures, some insurers found they hadn’t purchased sufficient reinsurance when the hurricanes of 2004 and 2005 hit, Mr. DeMartini said.

Claims settlement delays and disputes also arose with insureds because of discrepancies between contractors’ repair quotes and claims adjusters’ assumptions about reasonable settlement amounts.

Mind you, the industry still recorded record profits in those years. Policyholders took the loss and many are still unable to rebuild because demand surge has continued to drive up the Coast and other factors such as new construction requirements increase the distance between the amount of a settlement and the cost of rebuilding.

That brings us back to Van Cleve and Judge Senter’s ruling in a Nationwide case the inflation index on the anniversary date of the policy, rather than the date of the loss, should be used to calculate the payments.

“The difference is not inconsequential,” L.T. Senter wrote. “According to the plaintiffs, the difference can be as much as 15 percent or as little as 3 percent of the coverages to which this inflation provision applies.”

State Farm spokesman Fraser Engerman said the company believes its policy is clear that the date of the loss is used to calculate the inflation payment.

The policy may be clear; however, the introduction of a new model makes it clear the calculation used to determine the inflation payment didn’t accurately predict the demand surge – data that supports both Van Cleve’s position and Senter’s ruling – policy holders were short-changed.

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