GPSolo Magazine - September 2006
Insuring Against the Natural Catastrophe After Katrina
Amid the rubble-piled Mississippi Gulf Coast and breached levies of New Orleans, many of Hurricane Katrina’s victims are asking, “Am I covered by insurance?” This article explains how the United States, privately and publicly, insures against natural disasters. It explores the battleground of insurance coverage disputes that have followed Katrina and provides an overview of the National Flood Insurance Program. Finally, it explores the criticisms and possible solutions with respect to the future of property insurance in areas prone to hurricanes.
The battle on private ground: The standard property policy. The most common means for insuring against the natural disaster is the standard-form property policy covering damage to tangible and intangible property. Whereas the standard property policy insures against wind damage associated with a hurricane, virtually all private insurers will take the position that their policies exclude losses caused by flooding or storm surge. Most private insurers are unwilling to underwrite and assume the risk of flood insurance because of the catastrophic nature of flooding and the inability to adequately predict flood risks. For those few private insurers willing to write policies insuring both risks, their substantial premiums are not affordable to most property owners who are prone to hurricane damage.
Flood damage following a hurricane is one of the most elusive kinds of loss to exclude. A typical homeowner’s policy excludes “loss resulting directly or indirectly from . . . water or damage caused by water-borne material,” including “flood, surface water, waves, tidal waves, overflow of a body of water, spray from these, whether or not driven by wind.” However, the same policy will cover losses caused by windstorm, including “direct loss caused by rain . . . driven through roof or wall openings made by direct action of wind, hail, or other insured peril.” History and case law support that an insured who offers any evidence that wind caused or contributed to the damage will prevail.
Since Hurricane Camille and subsequent natural disasters, insurers have modified their policies to include what are known as “anti-concurrent-causation” clauses. These clauses exclude coverage “regardless of any other cause or event that contributes concurrently or in any sequence to the loss” and form the basis for litigation filed in Mississippi and Louisiana. Some insurers have denied coverage for losses in entirety based on this exclusion without inspecting the property. The Mississippi attorney general has filed a lawsuit seeking a declaration that the “anti-concurrent- causation” clause contravenes the public policy of Mississippi, is unconscionable, ambiguous, and violates the Mississippi Consumer Protection Act. Class action lawsuits also have been filed by insureds in Louisiana claiming that to disallow coverage “would contravene the very purpose of homeowner’s policies.” Ultimately, these disputes will be resolved by the particular language of the policies, the evidence supporting each claim, and the governing state law.
Flood insurance and the NFIP. In 1968, Congress enacted the National Flood Insurance Act establishing the National Flood Insurance Program (NFIP). Although the NFIP is administered by the Federal Emergency Management Agency (FEMA), 95 private insurance company partners have contractual agreements with FEMA to sell policies and adjust claims. These participating insurers, called “write your own” companies, employ or contract with thousands of private-sector insurance agents and adjusters to perform this work.
The NFIP policyholders receive a standard flood insurance policy (SFIP), which provides coverage for “direct physical loss caused by ‘flood,’” defined as “a general and temporary condition of partial or complete inundation of two or more acres of normally dry land area of two or more properties. . . .” Losses resulting from wind or a preexisting structural weakness in a home are not covered. Further, for homeowners, there is a $250,000 statutory ceiling on coverage to the building and a $100,000 ceiling for contents coverage. Businesses may obtain up to $500,000 of coverage for structures and an additional $500,000 for contents.
The NFIP has its critics. One of the main criticisms is that flood insurance is not compulsory. Currently, homeowners are only required to buy flood insurance if they live in a flood-prone area and their mortgage is through a federally regulated or insured lender. Further, once their mortgage has been paid, they are free to allow their flood insurance to lapse. Consequently, significantly fewer than one half of the homes in New Orleans and Mississippi were insured by the NFIP. These uninsured landowners will be eligible for relief under the Disaster Relief Act without having to wade through many of the issues facing insureds who paid premiums for flood coverage. The Disaster Relief Act has been criticized as working against the NFIP as a disincentive to flood insurance.
Perhaps the harshest criticism of the NFIP is that policyholders whose homes are destroyed will rebuild in the floodplain, insure their property through the NFIP, and hope that next year’s hurricanes do not wreak the same havoc. As of March 2004, about 1 percent of 4.4 million properties insured by the NFIP were identified as repetitive loss properties—properties for which policyholders have made two or more $1,000 flood claims. About 38 percent of NFIP claim costs resulted from these repetitive loss properties. In 2004, Congress enacted the Flood Insurance Reform Act, creating a five-year pilot program to deal with these properties. Under the program, FEMA is authorized to provide financial assistance to participating states and communities to carry out mitigation activities or to purchase “severe repetitive loss properties.” Policyholders who refuse a mitigation or purchase offer are required to pay premium rates increased by 150 percent following their refusal and another 150 percent following future claims of more than $1,500.
The future: What will Alberto and William bring? There are 21 new names awaiting tropical storms in 2006, beginning with Alberto and ending with William. Katrina is expected to result in higher pricing and reduced coverage in the hardest hit areas. The market lacks sufficient capital to fund a future catastrophic event exceeding $100 billion in private insured losses. FEMA has had no choice but to borrow repeatedly from the U.S. Treasury to pay claims. The NFIP is inadequate to weather the storm for the same reason private insurers have tried to stay out of it—the cost of flood claims is disproportionate to the cost of flood insurance.
So what can be done? Any solution is likely to require the combined efforts of government, the private sector, and the individuals affected by hurricanes. Congress will consider numerous policy options ranging from tax incentives for catastrophe insurers, federal reinsurance for “mega-catastrophes,” and passing certain risks to capital markets through sale of securities. Among the policy questions are whether reinsurance and securitization are enough to maintain insurer solvency after another $100 billion catastrophe, whether future potential losses are beyond the ability of private markets to diversify natural hazard risks, and what role the federal government will play in insuring against natural disasters. In addition, state and federal legislators will be seeking the right balance between rebuilding coastal areas so vital to our nation’s economic, cultural, and recreational resources and the NFIP’s goal of sensible floodplain management.
Spencer M. Taylor is a partner at Balch & Bingham LLP in Birmingham, Alabama. He can be reached at email@example.com.
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