The Emerging Tort Storm
Is climate change the next mass tort? A growing number of experts predict it could be, particularly after the ambiguity of a recent large case settlement opened the door for potential mass litigation.
The insurance implications could also be significant, and corporations that might be contributing to climate change should plan now how to mitigate these exposures.
Environmental damage caused by climate change could be “the next mass tort” if future litigators are able to demonstrate a link between environmental damages and greenhouse gas emissions by large corporations, wrote actuary Jill Mysliwiec in a recent Milliman Inc. report, The Cost of Climate Change: Will Companies Pay in Court?
Mysliwiec pointed to the 2011 U.S. Supreme Court case of American Electric Power, which pitted five large-scale private electric power companies emitting greenhouse gases against the City of New York and eight additional states.
In an 8-0 decision, the Supreme Court held that corporations cannot be sued for greenhouse gas emissions under federal common law, primarily because the Clean Air Act delegates the management of carbon dioxide and other greenhouse gas emissions to the Environmental Protection Agency.
“While the AEP case may not have specifically created a path to indemnification, the fact that it didn’t rule out any possible future litigation efforts speaks volumes,” Mysliwiec wrote. “The ruling may be an indication that such potential efforts may in fact be successful in the future.”
Since a major obstacle in litigation has been demonstrating a cause and effect relationship between damages and emissions, and in identifying a specific defendant, future groups of plaintiffs and defendants might be lumped in a single mass tort litigation case, she wrote.
Such plaintiffs could be armed by each defendant’s public disclosures of their greenhouse gas emissions, now required by the EPA.
“If documentation exists proving that a corporation was aware of its harmful operations, avoiding the consequences becomes more difficult,” she wrote.
“As was the case with tobacco and asbestos, we likely will not know whether climate change will be the next mega-tort for many years.” —Warren A. Koshofer, partner, Michelman & Robinson LLP
Warren A. Koshofer, a partner in the Los Angeles office of Michelman & Robinson LLP, said that there are significant hurdles to obtaining coverage for climate change litigation under standard commercial general liability policies, as highlighted by the Virginia Supreme Court decision in AES Corp. v. Steadfast.
“The occurrence hurdle is one that is not readily susceptible to negotiation when new CGL policies are being obtained,” Koshofer said. “The two exclusions can, however, be the subject of negotiations with the insurer.”
Given the current state of climate change litigation, where plaintiffs are having extreme difficulty overcoming the standing and political question doctrines and otherwise establishing claims against emitters of greenhouse gases, the real goal for an insured is to avoid the insurer being relieved of their duty to defend, which is broader than their duty to indemnify, he said.
Separating the duty to defend from the indemnity provisions of the CGL policy is one potential avenue an insured can explore — whether through negotiated sub-limits or the procurement of a stand-alone defense cost policy.
“As was the case with tobacco and asbestos, we likely will not know whether climate change will be the next mega-tort for many years,” Koshofer said.
“While it certainly is following the early pattern of tobacco and asbestos, a key difference is the injuries alleged in climate change cases thus far have been more focused on property damage than the significant bodily injuries that ultimately fueled the plaintiff’s bar to refine and target tobacco and asbestos related cases.”
Lindene E. Patton, chief climate product officer of Zurich Insurance Group in Schaumburg, Ill., who co-authored a book titled Climate Change and Insurance, said that plaintiffs are now experimenting in the tort liability area, as well as claims of statutory violations or noncompliance.
But so far, that litigation is largely at the procedural stage and “not a whole lot beyond that.”
Still, underwriters should consider looking for appropriate risk management practices from clients that could be potentially exposed to such litigation — whether that is greenhouse gas emitters or professional service providers, such as engineers or consultants who do work involving greenhouse gas or adaptation to climate change, Patton said.
For example, she said, engineers need to understand that the law is now examining whether “conduct evaluating and managing climate-related risks not only should consider historical exposures, but also projected exposures in the future. If an engineer is going to deliver a product to customer who declines to address future exposures expected by climate scientists, then engineers need to explain to their clients the range of potential impacts based on the expert advice.”
There might be dispute about which science to apply. And if a loss occurs, litigation might lead to the ultimate determination of who was right and who was wrong, Patton said. However, underwriters might have to pay for defense expenses, even if the carriers ultimately have no indemnity expenses. This will be true for professional liability policies as well as general liability policies, to the extent they are triggered.
“People who believe that they have followed the law and received a permit to build or have purchased a property may wake up one day with their property blown away or underwater, with no mechanism to get relief, and they may look elsewhere for compensation,” she said. “This appears to be what we’re seeing in some cases of climate change litigation.”
Mysliwiec suggested that companies mitigate potential exposures by forming partnerships with governmental entities to develop a means for funds to be pooled and set aside for damages.
Companies, either individually or as a group, should also take a proactive approach to provide funds to cover losses, “in an effort to appeal to consumers,” she wrote.
In addition, insurers should develop a means to provide the funds for these losses, potentially through the use of catastrophe models.
“It would be advantageous to all parties involved for a proactive solution to be explored, in an effort to avoid the high costs of defense and litigation that may come from a less assertive approach,” Mysliwiec wrote.
“This uncertainty and our society’s current state could be creating an ideal situation for the next mass tort of our generation. The money to pay for the damages will have to come from somewhere and it remains to be seen just where that deep pocket may be hiding.”
Coping with Cancellations
Airlines typically can offset revenue losses for cancellations due to bad weather either by saving on fuel and salary costs or rerouting passengers on other flights, but this year’s revenue losses from the worst winter storm season in years might be too much for traditional measures.
At least one broker said the time may be right for airlines to consider crafting custom insurance programs to account for such devastating seasons.
For a good part of the country, including many parts of the Southeast, snow and ice storms have wreaked havoc on flight cancellations, with a mid-February storm being the worst of all. On Feb. 13, a snowstorm from Virginia to Maine caused airlines to scrub 7,561 U.S. flights, more than the 7,400 cancelled flights due to Hurricane Sandy, according to MasFlight, industry data tracker based in Bethesda, Md.
Roughly 100,000 flights have been canceled since Dec. 1, MasFlight said.
Just United, alone, the world’s second-largest airline, reported that it had cancelled 22,500 flights in January and February, 2014, according to Bloomberg. The airline’s completed regional flights was 87.1 percent, which was “an extraordinarily low level,” and almost 9 percentage points below its mainline operations, it reported.
And another potentially heavy snowfall was forecast for last weekend, from California to New England.
The sheer amount of cancellations this winter are likely straining airlines’ bottom lines, said Katie Connell, a spokeswoman for Airlines for America, a trade group for major U.S. airline companies.
“The airline industry’s fixed costs are high, therefore the majority of operating costs will still be incurred by airlines, even for canceled flights,” Connell wrote in an email. “If a flight is canceled due to weather, the only significant cost that the airline avoids is fuel; otherwise, it must still pay ownership costs for aircraft and ground equipment, maintenance costs and overhead and most crew costs. Extended storms and other sources of irregular operations are clear reminders of the industry’s operational and financial vulnerability to factors outside its control.”
Bob Mann, an independent airline analyst and consultant who is principal of R.W. Mann & Co. Inc. in Port Washington, N.Y., said that two-thirds of costs — fuel and labor — are short-term variable costs, but that fixed charges are “unfortunately incurred.” Airlines just typically absorb those costs.
“I am not aware of any airline that has considered taking out business interruption insurance for weather-related disruptions; it is simply a part of the business,” Mann said.
Chuck Cederroth, managing director at Aon Risk Solutions’ aviation practice, said carriers would probably not want to insure airlines against cancellations because airlines have control over whether a flight will be canceled, particularly if they don’t want to risk being fined up to $27,500 for each passenger by the Federal Aviation Administration when passengers are stuck on a tarmac for hours.
“How could an insurance product work when the insured is the one who controls the trigger?” Cederroth asked. “I think it would be a product that insurance companies would probably have a hard time providing.”
But Brad Meinhardt, U.S. aviation practice leader, for Arthur J. Gallagher & Co., said now may be the best time for airlines — and insurance carriers — to think about crafting a specialized insurance program to cover fluke years like this one.
“I would be stunned if this subject hasn’t made its way up into the C-suites of major and mid-sized airlines,” Meinhardt said. “When these events happen, people tend to look over their shoulder and ask if there is a solution for such events.”
Airlines often hedge losses from unknown variables such as varying fuel costs or interest rate fluctuations using derivatives, but those tools may not be enough for severe winters such as this year’s, he said. While products like business interruption insurance may not be used for airlines, they could look at weather-related insurance products that have very specific triggers.
For example, airlines could designate a period of time for such a “tough winter policy,” say from the period of November to March, in which they can manage cancellations due to 10 days of heavy snowfall, Meinhardt said. That amount could be designated their retention in such a policy, and anything in excess of the designated snowfall days could be a defined benefit that a carrier could pay if the policy is triggered. Possibly, the trigger would be inches of snowfall. “Custom solutions are the idea,” he said.
“Airlines are not likely buying any of these types of products now, but I think there’s probably some thinking along those lines right now as many might have to take losses as write-downs on their quarterly earnings and hope this doesn’t happen again,” he said. “There probably needs to be one airline making a trailblazing action on an insurance or derivative product — something that gets people talking about how to hedge against those losses in the future.”
Beware of Medical Hyper-Inflation!
Historically, medical inflation rates nationwide have been fairly consistent. However, data is now showing that medical inflation is not a “one size fits all” phenomenon, with hyperinflation spikes occurring in some locations…but not others.
This geographical conundrum means hyperinflation can occur as narrowly as two hospitals having dramatically different charges on the same street in Anytown, USA. So, uncovering these anomalies is akin to finding the proverbial needle in a haystack.
“In recent years, workers’ compensation saw claim frequency decline, while severity rates went up. This basically means that increased job safety has offset increased medical costs,” explained Jason Beans, CEO of Rising Medical Solutions, a national medical cost management firm. “So, whenever a client’s average cost-per-claim went up, it was almost always caused by catastrophic, outlier-type claims.”
But beginning in 2013 and extending into 2014, Beans said, things changed. “I’ve never seen anything like it in my 20-plus years in this industry.”
“Our analytics made it very clear that small pockets around the country are experiencing what could only be described as medical cost hyperinflation. The big spikes in some clients’ claim costs were driven by a broader rise in medical costs, rather than catastrophic claims or severity issues.”
– Jason Beans, CEO, Rising Medical Solutions
Data dive uncovers surprising findings
On a national level, most experts describe medical costs increasing at a moderate annual rate. But, as often is the case, sometimes a macro perspective glosses over a very different situation at a more micro level.
“Our analytics made it very clear that small pockets around the country are experiencing what could only be described as medical cost hyperinflation,” explained Beans. “The big spikes in some clients’ claim costs were driven by a broader rise in medical costs, rather than catastrophic claims or severity issues.”
This conclusion is supported by several key data patterns:
- Geographic dependency: While many payers operate at the national level, only relatively small, geographically clustered claims showed steep cost increases.
- Median cost per claim: The median cost per claim, not just the average, increased greatly within these geographic clusters.
- Hospital associated care: Some clusters saw a large increase in the rates and/or the number of services provided by hospital systems, including their broad array of affiliate locations.
- Provider rates: Other clusters saw the same hospital/non-hospital based treatment ratios as prior years, but there was a material rate increase for all provider types across the board.
- Utilization increases: Some clusters also experienced a larger number of services being performed per claim.
One of the most severe examples of hyperinflation came from a large Florida metropolitan area which experienced a combined 47 percent workers’ compensation healthcare inflation rate. Not only was there a dramatic increase in the charge per hospital bill, but utilization was also way up and there was a shift to more services being performed in a costlier hospital system setting.
“The growth of costs in this Florida market stood in stark contrast to neighboring areas where most of our clients’ claim costs were coming down or at least had flat-lined,” Beans said.
An Arizona metropolitan area, on the other hand, experienced a different root cause for their hyperinflation. Regardless of provider type, rates have significantly increased over the past year. For example, one hospital system showed dramatic increases in both charge master rates and utilization. “Even with aggressive discounting, the projected customer impact in 2014 will be an increase of $773,850 from this provider alone,” said Beans.
ACA: Unintended consequences?
So what is going on? According to Beans, a potential driver of these cost spikes could be unintended consequences of the Affordable Care Act (ACA).
First, the ACA may be a contributing factor in recent provider consolidation. While healthcare industry consolidation is not new, the ACA can prompt increased merger and acquisition efforts as hospitals seek to improve financials and healthcare delivery by forming Accountable Care Organizations (ACO). ACOs, the theory goes, can take better advantage of value-based fee arrangements in existing and new markets.
“As hospital systems grow by acquisition, more patients are being brought under hospital pricing structures – which are significantly more expensive than similar services at smaller facilities such as independent ambulatory surgery centers and doctors’ offices,” Beans said.
Unfortunately, there is little evidence that post-consolidation healthcare systems have become more efficient, only more expensive. For example, a recent PwC study reported that hospital IT infrastructure consolidation alone is projected to add 2 percent to hospital costs in 2015.
Another potential ACA consequence is group health insurers may have less incentive to keep medical costs down. An ACA provision requires that 85% of premium in the large group market must be spent on medical care and provider incentive programs, leaving 15% of premium to be allocated towards administration, sales and subsequent profits. “Fifteen percent of $5000 in medical charges is a lot less than 15% of $10,000,” said Beans. “This really limits a group health carrier’s incentive to lower medical costs.”
How do increased group health rates relate to workers’ comp? In some markets, a group health carrier may use its group health rates for their work comp network so any rate increase impacts both business types.
In the end, medical inflation is inconsistent at best, with varying levels driven by differing factors in different locations – a true “needle in the haystack” challenge.
What to do?
Managing these emerging cost threats, whether you have the capabilities internally or utilize a partner, means having the tools to pinpoint hyperinflation and make adjustments. Beans said potential solutions for payers include:
- Using data analytics: Data availability is at an all-time high. Utilizing analytical tools to spot problem areas is critical for executing cost saving strategies quickly.
- Moving services out of hospital systems: Programs that direct care away from the hospital setting can substantially reduce costs. For example, Rising’s surgical care program utilizes ambulatory service centers to provide predictable, bundled case rates to payers.
- Negotiating with providers: Working directly with providers to negotiate bill reductions and prompt payment arrangements is effective in some markets.
- Underwriting with a micro-focus: For carriers, it is vital that underwriters identify where these pockets of hyperinflation are so they can adjust rates to keep pace with inflation.
“This trend needs to be closely watched,” Beans said. “In the meantime, we will continue to use data to help payers of medical services be smarter shoppers.”