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October 14, 2014

It has been a record eight years since the last major hurricane made landfall in the United States and this year’s hurricane season may prove to extend that record. Hurricane Sandy, in October 2012, was the most recent threat: It was a Category 2 hurricane when it hit Cuba but weakened to a post-tropical cyclone by the time it made U.S. landfall. There are many signs pointing to yet another below-normal Atlantic hurricane season. This will likely have an impact on both property insurance rates and the catastrophe bond market. However, it only takes one powerful hurricane to cause widespread damage to businesses and potential adverse effects on the insurance market. When the inevitable hurricane arrives, businesses should be mindful of the top “detours” a business interruption claim may take on the road to settlement.

Hurricane History

The 2014 Atlantic hurricane season started on June 1 and has been much less active relative to last year. In 2013 through the end of September, we had 10 named storms and two hurricanes, compared to five named storms and four hurricanes this year. Similar to last year, the National Oceanic and Atmospheric Administration (NOAA) revised its May forecast slightly downward in August. Last year shaped up to be a below-normal hurricane season and even fell below NOAA’s forecast.

NOAA predicts only a 5 percent chance of an above-normal hurricane season this year, a 25 percent chance of a near-normal season, and a 70 percent chance of a below-normal season. A normal season, based on 30 years of data, has 12 named storms, six hurricanes, and three major hurricanes. Hurricane Arthur, a Category 2 storm, made landfall in North Carolina in July as the first storm of 2014. The last major hurricane (Category 3 or above) to make U.S. landfall was Hurricane Wilma on October 24, 2005. That was over 3,263 days ago and far exceeds the previous record of approximately six years between major hurricanes, which dates back to 1900. The average number of days between major hurricanes is approximately 500, or every year-and-a-half or so.

Inputs for Another Quiet Season
We have gotten through the typical mid-September peak of the season and NOAA’s predictions for a below-normal season have, thus far, proved correct. There are several key drivers for an anticipated slow season. Cooler ocean temperatures have been a primary factor, as hurricanes have a greater propensity to form and strengthen when fueled by warm water and warm, moist air. Expected stronger wind shear is another significant factor contributing to the quiet forecast. Wind shear in the upper level of the atmosphere dismantles developing storms by dispersing heat, reducing temperature, and raising surface pressure, eliminating key components for hurricane development.

Impact on the Market
Both property insurance rates and the catastrophe (“Cat”) bond market have been impacted by the long period of calm in the United States. without a major hurricane. Property insurance rates appear to have stabilized, as reinsurance costs have declined. Even if a major hurricane were to make landfall in the United States this year, an immediate spike in rates would not be expected because, by law, insurance companies cannot raise rates in order to recover money paid out for property damage claims. However, a major hurricane could still result in rate increases because it might prompt reinsurers to raise their rates, which in turn would translate into higher costs for carriers. Another quiet hurricane season this year could even put downward pressure on rates.

The absence of major hurricanes in the United States has continued to fuel the red-hot Cat bond market. The Cat bond market is expected to issue a record $8–$9 billion in bonds this year.1 Cat bonds enable carriers to reduce their exposure to natural disasters by shifting risk to bondholders in exchange for premiums. Bondholders earn high yields on their investment in the absence of hurricanes and other disasters, but typically lose money in the face of significant Cat activity. Low yields on other fixed income securities have led institutional investors and pension funds to invest more heavily in Cat bonds, as the perceived risk-reward ratio has been favorable. That could obviously change if Cat activity picks up.

Aside from typical property damage and business interruption coverage, businesses should also consider contingent business interruption (CBI) coverage, which can protect them against lost income associated with property damage and other losses suffered by their suppliers or customers. For example, a home health business which treats patients in their homes could benefit from CBI before a major storm, as it could cover losses attributable to patients who lose their home and cancel treatment, such as many homeowners did after Superstorm Sandy. Typical property policies would only cover losses attributable to damage to the home health provider’s own property, not that of its patients. Consideration of appropriate deductibles and sublimits is just as important as procuring CBI coverage to ensure intended risk transfer. Understanding, identifying and quantifying CBI risks hidden in the complexities of a company’s supply chain is a critical component to pre-loss planning and securing proper coverage.

Despite our record stretch without a Cat 3 hurricane, it only takes one powerful storm to cause widespread losses to businesses. When the record run ends and the inevitable hurricane arrives, businesses should ensure they have adequate business interruption coverage to protect them against losses.

How to Avoid Claim "Detours" When the Inevitable Hurricane Strikes
Business interruption claims are often complex, both in terms of causation and quantum; accordingly, they often take longer and require more effort to settle than anticipated. Below are considerations for policyholders to avoid detours when formulating their business interruption claims:

Detour 1 – Sales Projections

  • Need to reflect the expected performance of the business had no loss occurred
  • Should typically comport with pre-loss budgets/forecasts and industry expectations
  • Should consider pre-loss performance
  • Should employ a normalized base period
  • Should consider the insured’s pre- and post-loss performance relative to competitors

Detour 2 – Changes in Market Conditions

  • Consider changes in macro-economic conditions attributable to the hurricane.
  • Understand the difference between potential quantum calculations as if “no hurricane occurred.” or if the “hurricane occurred but caused no physical damage to the insured.”
  • Recognize that case law on this issue varies in different jurisdictions and guidance from coverage counsel could be valuable.

Detour 3 – Planned Changes to the Insured’s Business Model

  • Can include sales / advertising campaigns, new products or product lines, and cost reduction initiatives
  • May be difficult to document if: not budgeted, lacking a historical track record, unable to be measured with specificity, or impacted by timing of the loss

Detour 4 – Non-Covered Factors Contributing to the Loss

  • Be prepared to address idle periods, uncovered causes of loss/concurrent causation and exclusions for remote or consequential losses (in which the degree of remoteness or consequentiality can cause disagreement).

Detour 5 – Make-Up Production

  • May be characterized by carrier if sales exceed expectations subsequent to restored operations
  • Can be difficult to bifurcate post-loss sales that were deferred versus those that would have occurred anyway
  • Seasonality can exacerbate the issue
  • Understand customer behavior to identify the cause of increased sales

As we continue to make history with no major hurricanes making landfall in the United States and the Cat bond market barreling on, businesses should not let down their guard because the calm will eventually cease and it just takes one major storm to cause significant widespread damage. Even though Hurricane Sandy arrived during a slow 2012 season and was only a post-tropical cyclone when it made landfall, it was the largest Atlantic hurricane on record and the second most costly in U.S. history. Businesses that invest in planning, procure adequate coverage, and consider the guidance above will be better suited to avoid detours when the time comes to file and settle a business interruption claim.

1 “Willis Expects Record Catastrophe Bond Volumes This Year,” Reuters, July 7, 2014.