Insurance: 2017 Californian Wildfires

The disasters that have struck North America in the second half of 2017 have put unrelenting pressure on reinsurers and insurers of US Property & Casualty. The devastation caused by Hurricane Harvey, Irma and Maria are now followed by some of the most destructive Californian wildfires in the State’s history. The unprecedented severity of events in Texas, Florida and now California are prompting uncertainty as to whether insurers have sufficient reinsurance cover.

Wildfires - Cause of Loss

Moody’s most recent estimate of the total insured loss from the Californian wildfires has risen to $4.6bn, based on the number of structures now believed to have been destroyed.

The term ‘wildfires’ is potentially misleading as it suggests that the fires have arisen from natural causes. In reality, they appear to be mostly the result of human intervention, ranging from deliberate arson to discarded cigarettes and power line failures. The shortage of adjusters in the US following the recent series of catastrophe losses (or the unwillingness of hard-pressed direct carriers to incur adjusters’ fees) may result in difficulty distinguishing between different causes of loss. A fire started by an accidentally dropped cigarette or out-of-control camp fire will by its nature be an isolated incident, lacking any causal connection with other nearby fires.

The power line failures have created liability exposure for electricity companies, which in turn creates difficulty for reinsurers when aggregating property and casualty losses. Furthermore, without definite causes of loss, reinsurers will be unable to ascertain whether losses are non-elemental or elemental for the purposes of excess of loss cover based on those distinct towers.

CMS has considerable experience of arbitrating these issues in the reinsurance market following the 2007 Californian wildfires. Similar issues have arisen in Canada following the 2016 Fort McMurray fires and apply equally to the recent 2017 Iberian wildfires.

Number of Events

Further comparisons with the 2007 Californian wildfires include establishing not only the cause of the fires, but the number of different events. The wildfires are not concentrated to a particular location. By contrast, areas spanning the length of the geographically diverse Californian terrain are now ablaze, with 213,000 acres thus far having been burned. The question will arise as to whether multiple fires can be classified as a single event. In many excess of loss treaties, losses occurring within a specified number of hours – typically 168 – will be deemed to constitute a single event (the reinsured normally elects when that begins). Several of the fires have now exceeded the scope of cover under the 168 hour clauses. However, thanks to the prevailing soft market, certain reinsureds may benefit from an extension of cover to 504 hours.

Order of presentation of losses

Sometimes, the order in which losses are presented can have a direct impact on the cost of a series of disasters for cedants and reinsurers. In Teal Assurance Company Limited v. W R Berkley Insurance (Europe) Limited [2013] UKSC 57, the UK Supreme Court determined that a cedant does not have the complete freedom to present losses in any order it chooses. Typically, this is circumscribed by a Loss Date Order clause. In property treaties this will often specify date of loss order, but in casualty risks, date of settlement order may be preferred.

Accumulation of exposures

A genuine concern for insurers of North American exposures is that multiple further events combined with earlier catastrophe losses may lead to the exhaustion of reinsurance cover. Whilst none of the catastrophes has been sufficient on its own to exhaust the vertical limits of reinsurance cover, the unprecedented frequency of large loss events in 2016 may lead to the exhaustion of horizontal limits. Many cedants will be scrutinising their reinsurance wordings to determine whether further reinstatements are available.

In particular, cedants will be concerned about the potential for yet further events in the remaining two and a half months of 2017. They will also be considering whether their programmes need to be re-designed to reflect increased risk exposures in 2018 and subsequently.

For example, there is a high concentration of earthquake and fire exposures in Napa Valley, which is one of the areas worst affected by the wildfires and relatively recently was impacted by the 2014 earthquake.

Business Interruption Contingent Business Interruption Losses

Napa Valley wine producers have been affected by physical damage with business interruption. Some producers may also suffer contingent business interruption loss, even if there is no physical damage to their property. Catastrophe modelling firm RMS noted the significant uncertainty around BI losses, particularly for the wine industry, when issuing a preliminary estimate for both insured and economic losses of approximately $6bn. Coverage under certain catastrophe excess of loss treaties will be triggered by the Original Insured Market Loss. Whether or not that threshold has been exceeded may lead to the usual uncertainty (and therefore disputes), particularly where the wording does not provide for a reliable index for the loss.

The same can be said for electricity companies, who may be subject to their own first party losses due to the inevitable disruption to networks, but also third party claims by households and businesses left without power.

California as a plaintiff-friendly jurisdiction

The pressures for insurers and reinsurers are only increased further by the plaintiff-friendly juries in California. Insurers and reinsurers will encounter difficulty when navigating the complexities of these losses in a courtroom dominated by jurors who have not only been affected by this catastrophe but the multitude suffered by Californians in the past decade. Under English law, the case of Commercial Union Assurance Co Plc v NRG Victory Reinsurance Ltd [1998] C.L.C. 920 provided that the English Courts will normally treat the judgement of a court of a competent jurisdiction as decisive. However, where a settlement has been concluded following legal advice as to a likely liability due to an unfavourable judicial climate (e.g. a plaintiff friendly jury), that may create problems for a cedant when recovering from its reinsurers.

2017 may therefore come to be remembered not only for the frequency and severity of catastrophes in the USA and elsewhere, but an additional layer of complexity in determining legal liability or the losses incurred.