Valuing Catastrophic Loss: Hypothetical Appraisals

The hypothetical appraisal is a proven method for determining economic losses for insurance claims involving a catastrophic loss.

Valuing Catastrophic Loss: Hypothetical Appraisals

Hypothetical Appraisals

In the case of catastrophic loss due to natural or man-made causes, the best case scenario would have the insured provide a complete appraisal identifying their household contents completely and linked perfectly to their homeowner’s policy. In the usual scenario, this appraisal is out-of-date, inadequate or lost as a part of the catastrophic event. In the case of major events such as Hurricane Katrina, even appraisals kept off site may be lost. The result is too often a complicated claim process that attempts to recreate identification and value of no longer existent, covered property. When claims take a nasty turn, especially when fraud is suspected, the process becomes a very expensive case of experts and litigation. The results of these worst-case claims are rarely satisfying for either the insured or the insurer. There are proven methods for determining economic losses that can improve the chances of satisfactory resolution and sift out potential fraudulent claims, the hypothetical appraisal.

The normal professional appraisal is a two-part process, identification and valuation. The hypothetical appraisal has an additional component that must precede the usual method, feasibility. As far as the appraisal profession is concerned, hypothetical appraisal methodology was supported by the Colorado Supreme Court in 1992 (Nadeau v. Calgas, et al), and introduced into the curriculum of the American Society of Appraisers the same year. This case involved a gas explosion completely destroying a new home and all of the household contents. The importance of feasibility to the process was further supported by a case involving the Northridge earthquake where the residence remained but the contents claimed were not available for inspection. In both cases there are two common features although the first settled in favor of the property owners and the second in favor of the insurance company. One was the time and expensive of the litigation (the Northridge case was finally adjudicated in 2003) and that both required an unbiased and professional feasibility of existence analysis before any valuation could occur. Both cases could have been settled earlier and at lower cost to all parties had the hypothetic appraisal process been followed at the start of the claim, or at least the start of the claims dispute.

As we stated above, the hypothetical appraisal is a methodology recognized by both legal and professional authority. It consists of three distinct processes, feasibility, identification and valuation. The feasibility process is essential to determining an agreed upon identification of property that is no longer extant. In both of the cases discussed above (hereafter Nadeau and Northridge), the appraiser opined correctly that failing to make the feasibility case must necessarily result in a zero value for the unobserved properties being claimed. Although there might be an award based on issues other than the appraisal such as contractual minimums, the appraisal itself would list non-extant property without adequate feasibility resolution as zero value. This result is supported fully by the requirements of the Uniform Standards of Professional Appraisal Practice (USPAP) which requires a supported identification of the property appraised. The feasibility analysis can be as simple as an amicable stipulation by the parties or as complex as the procedures used in Nadeau and Northridge.

The Nadeau and Northridge cases were different in their approaches to the feasibility analyses, due mainly to the circumstances of the parties commissioning the hypothetical appraisals. In Nadeau, the appraiser used a series of interviews with the traumatized client, narrowing the options of what was extant prior to the gas explosion with photographs and prompts based on prior interviews. The interview-prompt process is similar in concept to the police sketch artist with an eye witness. The result was a description of the lost household contents accurate enough for the appraiser to make appropriate decisions on comparables. In Northridge, the insured provided an extensive description of lost property with an appraisal based on only the insured’s descriptions. Due to the extent of quantities and values claimed, appraisers for the insurer were asked to consider the veracity of the claim. The appraisers devised a two-part analysis. They attempted the interview-prompt process, seeking specifically any external evidence that may be available to support the feasibility of the claim. Since much of the lost property had been purchased overseas they sought import documentation, international shippers who might corroborate, and credit purchase documentation. Additionally, since the property was claimed to exist to support a lifestyle that included considerable entertaining, the appraisers sought names of those who may testify to having seen the property. On a second front the appraisers created a virtual representation of the physical dimensions of the claimed property using a dealer of comparable properties. This representation was based on the most compact, reasonable method of storing or shipping the claimed property. With no support from the insured on the first front, and a virtual representation of the claimed property fitting in the residence but leaving it uninhabitable, the court agreed with the insurer’s appraisers that the claimed property that was unsupported in the insured’s appraisal must be valued as zero without further corroboration. 

The feasibility analysis provides an additional benefit for both professional compliance and courtroom credibility, the benefit of appraiser objectivity. In Nadeau the appraiser documented the interview process as a forensic investigation, like the police sketch artist. In Northridge, the insurer’s appraisers proceeded with a stated premise of proving the possibility of the claimed property’s existence. In Nadeau, a reasonable and supportable claim was made possible by the process. In Northridge no claim was allowed on millions of dollars worth of property that couldn’t possibly have existed as claimed. Not every claim in the wake of personal or widespread disaster requires “CSI-like” reconstructions, and not every insured is going to falsely claim millions in household property. It is certain that in every claim including “hypothetical” property the appraisal must include a feasibility of existence statement or the results of a feasibility analysis. The appraisal profession and courts require it and the claims process is made stronger and fairer by its early incorporation.

---

About the Author:

Terry Ray King has been a full time, professional personal property appraiser since 1983, when he joined J. M. King Appraisals (later Connoisseur Appraisers). Since that time he has attained national prominence as an appraisal practitioner and educator. Mr. King is currently president of Paladin Inc., a Colorado corporation with offices in Denver and San Francisco engaged in personal property appraisal practice, education and publication.

During the 1980’s, Mr. King attained prominence as the senior appraiser for court-related projects at Connoisseur Appraisers in Denver. He also achieved senior accreditation from the American Society of Appraisers in Residential Contents and Antiques and Decorative Arts during this period (He tested for the ASA Fine Art credential in 1997). During the 1990’s, Mr. King contributed to the appraisal profession as chairman of many international committees of the American Society of Appraisers including the Personal Property and Personal Property Education Committees, and Search For Shelter, ASA’s only pro bono committee, a joint project with the American Bar Association and the American Institute of Architects. From 1990 through 1996, Mr. King taught thousands of hours of professional appraisal courses for ASA and The George Washington University Fine and Decorative Arts Appraisal Program in Washington, DC.

Since 1997, Mr. King has devoted most of his time revisiting personal property curricula, most of which hasn’t been revised since the early 1990’s. He began work in 1998 on The Appraisal of Fine Art and Material Culture for Divorce (due in late 2005). He has also completely revised appraisal report writing and approaches to premium values based on his work in Townes v. Commissioner of the Internal Revenue Service. The resulting report format is more readable for the court, and more clearly addresses the underlying valuation process and compliance requirements. The format has been tested by other appraisers and Mr. King successfully in divorce cases in Chicago and St. Louis during 2004 and 2005. These cases showed that the sources of value data can be better presented than previous report writing processes offered and introduced a distinct procedure for qualifying and quantifying premium value for organized collections of fine art and material culture. During this period, Mr. King refrained from taking private clients and concentrated on consulting to other professional appraisers throughout the United States.

In 2005, Mr. King formed Paladin Inc., returning to full time practice based in the Denver and San Francisco areas. During the first half of 2005, Mr. King has appraised approximately $10M in fine art and material culture ranging from antiquities to 20th century collectibles primarily in divorce. In July, 2005, Paladin Inc. was pleased to add Theresa Graf-King to appraise personal property for insurance scheduling. Ms. King comes to Paladin Inc. with prior appraisal experience at Connoisseur Appraisers and Ian D. Gardenswartz and Associates, P. C., of Denver.

Article Contributed by: Mr. Terry Ray King
Paladin Inc – Fine Art & Material Culture Valuation
Denver ~ San Francisco
1265 Teller Street
Lakewood, CO 80214
theresa_king8@hotmail.com