NON-CATASTROPHIC HOMEOWNERS WATER CLAIMS

NON-CATASTROPHIC HOMEOWNERS WATER CLAIMS JANUARY 2016 Citizens Prperty Insurance Crpratin

EXECUTIVE SUMMARY: AOB AND LITIGATION ARE A POCKETBOOK PROBLEM In Octber 2015, the Office f Insurance Regulatin (OIR) issued an Assignment f Benefits (AOB) Data Call t Citizens alng with Flrida s mst active private market prperty insurance cmpanies. Citizens Prperty Insurance Crpratin (Citizens) respnded t this Data Call and als prvided the results t Flrida s Insurance Cnsumer Advcate. Citizens als matched the Data Call respnse t larger, mre credible actuarial datasets t prbe deeply int the questin f the impact f AOB, and mre generally f litigatin, n nn-catastrphe claims csts and rates fr cnsumers. AOB is an agreement used by cntractrs remediating damage t secure the legal right t stand in the shes f the plicyhlder and directly access plicy benefits, withut accepting the respnsibility t perfrm the duties after a lss as required in the plicy. AOB at Citizens primarily manifests as an accelerant t water damage claims, while private insurers ften see AOB used n rf damage claims. AOB is strngly assciated with eventual litigatin f demands fr payment that exceed industry standards. While rt cause analysis is utside the scpe f this paper, the public recrd shws that cntractrs ften wrk clsely with attrneys t expand the scpe f claims and t litigate the claims, triggering Flrida s ne-way attrney s fee law that requires the insurer t pay all legal fees fr the plaintiff. Citizens has clsely mnitred water damage claim cst trends that have skyrcketed since late 2013 and almst exclusively driven actuarially sund rate increases in Suth Flrida in 2015 and 2016. With windstrm csts near all-time lws and steadily declining administrative expenses, were it nt fr these trends, rates wuld be drpping fr many mre custmers in the regin. T islate the impact f AOB and litigatin, Citizens has perfrmed mre detailed analysis f individual claim files. Key insights include the fllwing. The prevalence f AOB n water claims, particularly litigated claims, is increasing in the Tri- Cunty (Miami-Dade, Brward and Palm Beach) regin. There is evidence that this has spread arund the state in the past year. The Data Call shws that the grup f claims with AOB, whether litigated r nt, incur higher paid lsses and expenses than thse withut AOB. The Data Call als shws that average cst fr litigated claims is mre than duble that f nnlitigated claims, and the average cst fr nn-litigated claims with AOB is mre than duble that fr nn-litigated claims withut AOB. Litigated water claims drive the need fr rate increases fr nn-wind perils. Overall frequency f water claims in Tri-Cunty and arund the state began a rapid increase in late 2013 that cntinues tday. In Tri-Cunty, severity has increased as well. Frequency and severity bth drive rate hikes. There is a very strng cnnectin between the increase in litigated water claims and increases in AOB and representatin at First Ntice f Lss (FNOL). There des nt appear t be a strng crrelatin between water lss claims and the age f the hme. 1 P age

The bdy f evidence that AOB and litigatin, bth separately and tgether, are the drivers f Citizens claim csts and rate increases is indisputable. These findings primarily impact the Tri-Cunty regin, but all f Flrida is at risk. The steady increase in frequency f reprted water claims all ver Flrida, cmprising a much larger percentage f the cmpanywide reprted water claims in 2015, is trubling, and the percentage f these claims being represented at FNOL has increased significantly. Absent a reversal f these trends, nn-wind rates wuld be expected t increase annually at r near the limits impsed by the 10% glide path law fr years t cme fr mst Citizens plicyhlders. ASSIGNMENT OF BENEFITS AND LITIGATION INTERACT TO DRIVE COSTS AOB ccurs when a plicyhlder agrees with a cntractr, ften at the time f initial damage remediatin, t authrize the insurer t issue checks directly t the cntractr. The vendr prvides service t an insured and then presents Citizens with a bill. Very ften this ccurs well prir t a claim being reprted t r adjusted by Citizens. Three issues are clear regarding AOB: 1. Citizens is seeing a general uptick in the percentage f water claims that have an assignment f benefits. 2. AOB claims are cmprising a larger percentage f ttal litigated claims. 3. Average litigated AOB lsses and lss adjustment expenses (LAE) per claim are higher than litigated claims withut an assignment f benefits. Exhibit 1 displays trends in percentage f reprted water claims that had an assignment f benefits. Suth East (Tri-Cunty) had a large uptick between 2013 and 2014. Currently 2015 is slightly lwer, but this is an incmplete reprt year. The Rest (f Flrida) has been slwly and steadily increasing frm 2013 thrugh 2015. 2 P age

Exhibit 1 AOB claims cmprise a steadily increasing percentage f the ttal litigated claims. Table 1 belw includes litigated water claims in Suth East Flrida nly. It demnstrates that bth litigatin and AOB drive higher claims csts, bth separately and tgether. Table 1 Reprted Litigated Water Claims in Suth East Flrida as f 9/30/2015 Reprt Year* % f Claims Litigated with AOB Lss Severity ALAE Severity AOB Nn-AOB AOB Nn-AOB 2012 9.6% $26,580 $22,116 $16,514 $7,339 2013 14.9% $26,411 $24,222 $13,401 $6,278 2014 29.3% $29,594 $25,331 $8,993 $5,910 2015** 46.9% $31,987 $23,776 $6,437 $6,350 * Undevelped Reprt Year inf. It is expected the mst recent years will increase. ** Incmplete and immature Reprt Year Cncerning Table 1, Citizens nly began t track AOB claims systematically in 2014. There may be additinal AOB claims in reprt years 2012 and 2013 that were nt identified as such. Hwever, even if the percentages fr 2012 and 2013 are slightly understated, there is n indicatin that the 2012 and 2013 levels are clse t the 2014 and 2015 levels. This has been verified by manually reviewing randmly sampled claims files. At this pint in time we can nly identify AOB claims that went int litigatin unless a manual review f a sample is perfrmed, as was the case fr the OIR Data Call. The manual data mining cntinues as a 3 P age

jint effrt amng Claims, Actuarial, and Crprate Analytics; underlying text files that include the claims adjusters ntes may help identify ther AOB claims. DATA CALL SHOWS AOB DRIVES NON-LITIGATED AND LITIGATED CLAIM COSTS The Data Call fcused n clsed claims nly, f water lsses resulting frm rf r pipe damages. At the time f the respnse, Citizens did nt cllect AOB status and vendr details fr claims ther than claims in litigatin ver the past tw years. T imprve the effectiveness f ur respnse, we manually reviewed a statistically valid randm sample f nn-litigated claims t capture the incidence f clsed claims with AOB. The litigated and nn-litigated data sets were prvided in the respnse, with the caveats abut the scpe f the sample. Since the data call, Citizens has been able t identify additinal claims that wuld qualify, but such claims d nt include the detail necessary t reprt a full recrd t the OIR fr example, attrney name(s), AOB vendr, public adjuster name. Table 2 n the next page cmpares the data submitted t the OIR by litigatin status, AOB status, and regin. Nn-litigated claims with AOB cst 74% mre n average than claims withut AOB in Tri-Cunty and 116% mre utside Tri-Cunty. While the paid lss severity was higher fr litigated claims with AOB than thse withut AOB, the differences were nt as steep as fr the nn-litigated claims. Litigated claims in the Suth East regin are apprximately 50% mre expensive n average than elsewhere regardless f AOB. Separately, litigated claims are 182% mre expensive n average statewide than nn-litigated claims. Table 2 Litigated and Sampled Nn-Litigated Clsed Claims with AOB Assignment f Benefits Clsed NON-LITIGATED CLAIMS SAMPLE Lss/ALAE Severity* Clsed LITIGATED CLAIMS Lss/ALAE Severity** Statewide Suth East Rest Statewide Suth East Rest Y $15,822 $16,152 $14,718 $37,677 $38,544 $26,099 N $8,507 $9,280 $6,807 $30,526 $31,083 $19,804 Ttal $11,677 $12,450 $9,658 $32,882 $33,506 $22,380 *Based n randm sample f 983 claims reprted in 2015 **Based n claims reprted in 2014 & 2015 as f 9-30-2015 Nte: Data in ther parts f this dcument is nt based n the same data set as used in the OIR data call, as the larger actuarial data set includes a lnger perid f time and pen and clsed claims. WATER LOSSES DRIVE ALL OTHER PERILS RATE INCREASES Citizens prjected a 95.2% lss and LAE rati (t premium) fr 2016 fr All Other Perils (AOP) 1 lsses, based n rates in effect in 2015. This means that fr every dllar f AOP premium earned fr AOP 1 Citizens makes rates separately fr Fire, Liability, Sinkhle, Hurricane, Other Wind, and All Other Perils. 4 P age

expsure, 95.2 cents wuld g twards paying lss and LAE. This des nt leave enugh t cver the nn-lss expenses. In rder t cver all expenses assciated with these perils (such as agent s cmmissin and general verhead), the lss and LAE rati needs t be 80.4%. The difference drives the indicated rate hike fr HO-3 AOP f 17.2% fr 2016. (The established rate increases were lwer primarily due t the glide path law.) Imprtantly, this 17.2% rate need is nt unifrm thrughut the state and was much higher in Tri-Cunty. Additinally, alarming trends began t emerge in the supprting data. In the data set ending at year-end 2014 that was used fr the 2016 rate request, Citizens saw a steady and steep increase in the frequency and severity f AOP claims. The frequency has increased by 34% and the severity has increased by 15% ver this time. These trends are trubling and if they cntinue unabated int 2016 and beynd, the actuarially sund premium rates required by Flrida law will cntinue t increase. A further breakdwn f the data illustrates the drivers. Water claims cmprise the bulk f reprted AOP claims, abut 75% f all claims ver the last five years. Excluding water lsses frm AOP yields the frequency trends in Exhibit 2 n the fllwing page. Exhibit 2 WATER LOSSES: A TALE OF TWO REGIONS Examining water claims separately, between 2010 and 2014, frequency has increased by 45% and severity has increased by 43%, freshadwing large rate increases if trends cntinue. 5 P age

These lss trends are nt unifrm acrss the state. Exhibit 3 shws that Tri-Cunty has experienced a 42% increase in frequency and the Rest f the state has seen a 65% increase in frequency between calendar years 2010 and 2014. Exhibit 3 Nte: Frequency is calculated as the number f claims clsed in the perid divided by the number f earned huse years in the perid. Accrding t the data in Exhibit 4, Tri-Cunty has experienced a 74% increase in severity between 2010 and 2014 while the Rest actually shws a 23% decrease in severity. The ptential fr verall csts t explde is alarming because the Rest f state verall frequency rate is nly rughly a third f the frequency in Suth East Flrida at this time. 6 P age

Exhibit 4 Suth East Flrida has cmprised rughly 50% f all earned water expsures in the last five years. During that same perid Suth East Flrida has cmprised rughly 85% f all incurred water lsses. The rest f the state, which als cmprises arund 50% f all earned water expsures, cmprised nly 15% f all incurred water lsses. Water claims in Suth East Flrida drve the +17.2% rate indicatin fr AOP. This was a statewide average. If we had filed separately fr the Suth East regin, the rate need wuld have been +30% while the Rest f state wuld have indicated rate reductins. This is evident in Map 1 n the next page. 7 P age

Map 1 Hmewners Average Paid Water Lss per Plicy Calendar Year Data 10/1/2009 9/30/14 LITIGATED WATER LOSSES IN TRI-COUNTY DRIVE OVERALL RATE NEEDS When further examining water lsses in Suth East Flrida, the steady and steep increase in the number f claims being litigated is apparent. Bth the lss and LAE severities are cnsiderably higher fr litigated claims. Table 3 prvides details n a reprt year basis. Table 3 Reprted Water Claims in Suth East Flrida as f 9/30/2015 Reprt Year* % f Claims Litigated Lss Severity ALAE Severity Litigated Nn-litigated Litigated Nn-litigated 2010 15.8% $19,972 $8,256 $7,450 $700 2011 18.3% $21,673 $8,889 $8,695 $874 2012 21.1% $22,544 $8,239 $8,219 $1,050 2013 29.6% $24,547 $8,741 $7,337 $1,106 2014 38.4% $26,580 $9,099 $6,813 $1,050 2015** 21.2% $27,631 $9,028 $6,391 $868 * Undevelped Reprt Year inf. It is expected the mst recent years will increase. ** Incmplete and immature Reprt Year 8 P age

The verall increase in litigatin is related t an increase in the number f claims that are first being reprted with representatin (either an attrney and/r a public adjuster), which is in turn related t the use f AOB. REPRESENTATION AT FIRST NOTICE OF LOSS: A SIGNAL OF LITIGATION TO COME Anther bservable trend is the percentage f claims that are first reprted with an attrney and/r a public adjuster representing the insured. A custmer is encuraged by its insurer t reprt a claim directly, but attrneys and public adjusters advertise and slicit heavily t becme invlved prir t ntificatin f the insurer. Citizens sees a clear upward trend in the number f claims that have representatin at FNOL. These claims are very likely t end up in litigatin. Table 4 displays the percentage f claims reprted with representatin at FNOL. Three pints are clear. First, a very large percentage f water claims in Suth East Flrida are histrically and currently represented at FNOL, especially relative t the Rest f the state. Secnd, that percentage has increased significantly frm 2014 thru 9/30/2015. And third, we see a significant initial representatin n litigated claims in 2015 fr the Rest f Flrida. This culd be anther indicatin that the phenmenn driving this issue in Suth East Flrida is spreading t ther parts f the state. Additinal validatin f the data is underway t ensure that we are interpreting this accurately. Table 4 Table 5 % f Claims Reprted with Representatin at FNOL % f Claims in Litigatin that were reprted with Representatin Reprt Suth Rest f Reprt Suth Rest f Statewide Statewide Year East State Year East State 2014 31.9% 39.3% 3.0% 2014 65.5% 66.4% 27.0% 2015 45.6% 56.0% 5.5% 2015* 88.6% 90.0% 27.3% Table 5 displays the percentage f litigated claims fr reprt year 2015 that were reprted with representatin at FNOL. This is a rather disturbing trend that supprts anecdtal evidence that initial representatin and AOB are tls that set the stage fr litigatin that was always intended. WATER LOSSES: IS AGE OF HOME THE REAL DRIVER? Age f hme is a cnsideratin in water lss analysis, due t the life expectancy f certain types f pipes. Many lder hmes were built using galvanized piping which is a steel pipe cvered with a layer f zinc in rder t prtect it. Over time, the zinc erdes frm the piping, causing the pipes t deterirate frm the inside. This causes a wide array f prblems such as slw water pressure and stpped up faucets and tilets. As the pipes crrde they becme filled with sediment which blcks water flw. Old galvanized pipes make all pipes susceptible t leaks. Sme lder hmes have pipes made frm cncrete r cast irn and bth are prblematic. 9 P age

Exhibit 4 prvides the distributin f plicies infrce as f Nvember 30, 2015. In bth Suth East Flrida and the rest f the state, the median Citizens hme is between 41-50 years ld, with hmes 41 years and lder cmprising 56% and 53% f the ppulatin, respectively. Exhibit 4 Hmewners Plicy Cunt by Year Built Range and Lcatin Regin Data as f 11/30/15 The year built distributin has shifted slightly ver time. Based n infrce data as f December 31, 2014, the Suth East Flrida and the rest f the state regins cntain hmes 41 years and lder at rates f 55% and 52%, respectively. The shift is driven by an aggressive deppulatin f Citizens by private market insurers since 2013. On the fllwing page, Map 2 prvides a view f the distributin f Citizens custmers by year built fr the majrity f the state. One earned huse years is equivalent t ne hme insured fr ne full year and represents a measure f the expsure. It is evident that Tampa Bay regin (Hillsbrugh and Pinellas) and Suth East Flrida have a relatively large vlume f hmes fr all three year built ranges. 10 P age

Map 2 Hmewners Earned Huse Years by Year Built Calendar Year Data 10/1/2009 9/30/14 Year Built Befre 1960 Year Built 1960 1980 Year Built After 1980 Reviewing water lss claims by age f hme prvides insight int whether Tri-Cunty claim activity is anmalus due t a unique prfile f aged hmes. Exhibit 5 prvides claims frequency by year built fr water lsses. With the exceptin f hmes built after 1999, the Suth East regin incurs 6% t 8% claim frequency acrss all age ranges, whereas the Rest f state hvers between 1% and 2% frequency. The key result is that histrical frequency trends are rather cnsistent acrss the year built ranges fr bth regins. 11 P age

Exhibit 5 Nn-Catastrphe Water Claim Frequency* by Year Built (Calendar Years 2009-2013) *Frequency is determined by taking the number f calendar year claims divided by calendar year earned huse years. Interestingly, when the paid water lsses per annual plicy is pltted in a map similar t Map 2, it becmes bvius that Suth East Flrida stands ut as having much higher water lss csts. Accrding t Map 3, higher paid water lsses per plicy are a feature f the Tri-Cunty regin acrss all age ranges. In shrt, there is little evidence t indicate that a large number f hmes reaching a critical age is a driver f claim activity r csts specifically in Suth Flrida. Map 3 Hmewners Paid Water Lss per Plicy by Year Built Calendar Year Data 10/1/2009 9/30/14 Year Built Befre 1960 Year Built 1960 1980 Year Built After 1980 12 P age