Fighting social inflation in Florida

After Florida’s lawmakers moved to restrict assignment of benefits abuses, Hiscox Re’s Chair of North America – Ross Nottingham and Hiscox USA’s Head of Legal and Government Affairs – David Schonbrun, look at the new legislation and its potential impact on the reinsurance industry.

The enactment of House Bill 7065 in May 2019 by Florida’s state legislature might sound innocuous, but it’s the latest legislative broadside aimed at tackling the social inflation of insurance claims particularly noticeable in recent years following the growth of Assignment of Benefits (AOB) claims.

According to the Insurance Information Institute (III), AOB lawsuits increased by 94% in five years from 79,000 cases in 2013, to 153,000 in 2018. Consequently, claims costs have risen for insurers following big, catastrophe losses, which in turn have fed through to reinsurance programmes not priced to take into account significant abuse and fraud factors.

With the 2019 Atlantic hurricane season well underway, the reinsurance market waits in anticipation to see what tangible impact the new legislation will have. It’s hoped that the legislation will prove effective at reducing the frequency and severity of AOB claims, but some reinsurers are proactively addressing their own catastrophe models and underwriting criteria to factor in fraud.

 No pain, all gain for litigants

The practice of AOB – where a policyholder agrees to a contract with a third party, such as a building contractor or auto windscreen repairer, to fix damage to their house or car and then bill the insurer directly – started out as an efficient way for a policyholder to get their problem fixed without having to go through the claims process with their insurer. Unfortunately, repair costs have been inflated by third parties, who rush to court often before insurers are able to properly investigate the claims, represented by attorneys whose fees will be paid by the insurers if the plaintiffs prevail. The cost to settle AOB claims have increased due to Florida’s one-way attorney’s fee provision, with little financial risk to the plaintiff. This has fed through into the homeowners’ insurance market which, according to the Florida Office of Insurance Regulation, saw the frequency of water claims in the two and a half years to the middle of June 2017 increase by 44.1% and the severity up by 17.6%.

The more recent hurricane activity has further exacerbated the problem with extensive loss creep post Irma – III figures showed there were 16,521 AOB lawsuits in 2018 (to the 9 November).[i] In the 12-18 months since Irma, there has been clear evidence of third-party adjusters, attorneys and other third parties canvassing homeowners to represent their claims to insurers to get a higher pay-out than that originally agreed after the initial damage assessment. In many instances, homeowners are using light damage to a roof to try and get their entire structure replaced under their insurance policy in lieu of what would have been a standard maintenance matter.

Model miss for reinsurers

For reinsurers, AOB losses have proved problematic because most haven’t factored social inflation into their pricing. Given the industry uses vendor models to help price their risks, most will impose their own views and load the models as appropriate making some allowance for model miss. But for Hurricane Irma, and given the absence of any allowance for AOB abuses, the model miss was anywhere from 10% to 150%.

Legislators to the rescue?

So will the new law deliver some salvation for insurers and reinsurers? It’s still too early to draw firm conclusions, but the provision to level the playing field when it comes to awarding  attorney fees could mean that, if an AOB assignee refuses a pre-suit offer to settle a dispute, they may be liable for all of  the insurance company’s attorneys’ fees and costs incurred during litigation, depending on the final level of the award.

There is also a requirement for attorneys to give insurers a 10-day notice period before filing suit, which will give carriers a chance to resolve the claim by demanding the use of the appraisal process, rather than by going to court, or an examination under oath to learn more about the claim. In addition, there is an incentive for insurers to make sure they inspect the damaged property or authorise repairs within seven days, or else risk waiving their right to an award of attorney’s fees. Insurers may also offer policies excluding AOB rights outright, provided the premium is less than that for an unrestricted policy.

Some industry figures suggest that these changes could lead to a double-digit reduction in the percentage of losses, but it is likely that plaintiffs’ lawyers will be working hard to find a way to overcome some of the new obstacles put up by the law. From a procedural perspective, the changes are likely to be effective, but, if there is one vulnerability in the law, it could be the perceived interference when it comes to a policyholder’s contractual rights. Will, for example, attorneys argue that prohibiting a policyholder from entering into an assignment – even if they chose that option – be seen as unconstitutional? Such a challenge is likely.

Charge more

It will take time to understand the new law’s impact and, in the meantime, the reinsurance community will be taking action in current and future renewals to prevent AOB inflicting larger than expected losses from a future catastrophe event. Charging more to cover the risk is an option that some reinsurers have already taken as underwriters look to build in social inflation uplift factors. 2019’s renewals have already seen the market moving as much as 8% to 35% per program, or up to 70% for specific layers. In addition, reinsurers will vote with the line size they are prepared to put down; allocating more capacity to those cedants they think are proactively tackling the problem at the source by adding additional clauses to their homeowners’ policies for example or reducing in the areas most prone – such as Florida’s tri-counties.

With the cost of AOB abuses ultimately carried by policyholders, the new law is to be welcomed as a first step in the fight against social inflation, but it will also take a concerted effort by the (re)insurance community to ensure the incentives and options for vexatious legal claims are further reduced.  And with Dorian skirting the coast of Florida at the time of writing, it looks like this could be the new legislation’s first big test.   

Find out more about our property reinsurance team and their product offering here.