Trigger Happy?

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It’s hard to escape the raft of articles in the press ‘guesstimating’ the losses created by hurricanes Harvey, Irma and Maria but, as we know from the past, there are often significant differences between the initial estimates and the final total. For Harvey, in particular, there are very divergent views – some saying as much as $35 billion and some saying as low as $10 billion. Interestingly, PCS’ initial estimate has come in at $15.9 billion (but this excludes the sizeable losses that will be covered by the NFIP).

Past experience has taught us to be wary of:

  • The trigger mechanism – do the parties understand exactly when and how the contract will respond? For a more in-depth review of trigger issues, please see our legal guide, here.
  • The index – is the chosen index suitable for the insured exposure? Some indices only cover specific territories (e.g. PERILS only reports losses in Europe) and/or specific perils (e.g. PCS covers natural catastrophes but excludes most types of flood).
  • The reporting threshold, period, and frequency of revisions. Some indices report quarterly (until the estimate remains constant) whereas others may only report once (which could give rise to issues where the industry loss deteriorates significantly after the index has reported). It is common for contracts to include a defined reporting period (usually 36 months), providing a long-stop date by which the size of the loss will be fixed for the purposes of the contract.

Indeed, this last point has proven in the past to create an opportunity to commute certain contracts early. For example, if an initial loss estimate falls slightly below a trigger point, but a further estimate is expected within the reporting period, there may be a window of opportunity to negotiate a commutation rather than anxiously await the ‘all or nothing’ outcome of the revised estimate. Hurricane Sandy (in 2012) was a good example of where many companies awaited revised loss estimates from PCS with some trepidation, hopeful that the estimate would breach the $20 billion mark which triggered many contracts – only to find that the PCS final estimate was $18.75 billion.

Prior US litigation (please see our articles on the Mariah Re dispute: here and here) has also put reporting indices and modelling agencies under the spotlight. Given that significant sums can turn on what these agencies report, it is vital that their methodology and reporting can stand up to scrutiny.

It is too early to predict how the issues in the market will play out, and no doubt the coming weeks will prove decisive in parties’ evaluating their exposures and protections.

Kiran Soar
Lorraine Fernandes