Covering Katrina—Doing "The Right Thing"
December 2005
What's to happen to insureds who have suffered
extensive mold damage from Katrina but whose federal insurance coverage has
been negated or seriously threatened by the "failure to inspect and maintain
the insured property" exclusion when government officials barred their access?
by George
L. Head, Ph.D.
American Institute
for CPCU
The Society
of Risk Management Consultants (SRMC) is an association of small, independent,
risk management consultants who are either self-employed or work directly for
a self-employed consultant. Member-for-member (they number less than 200), the
SRMC is one of most intelligent and creative risk management groups anywhere.
As an educator rather than a consultant, I am proud to have been an honorary
SRMC member for a good number of years.
Many SRMC members join in group-wide Internet chats ("strings") from which
all members can learn. Here are some anonymous excerpts from a recent string
among three members who had some concerns about the ethical aspects of insurance
claims handling for damage caused by hurricane Katrina. Included in their Internet
string are some provisions from the National Flood Insurance Program (NFIP)
policy that was widely in force when Katrina struck—provisions which I quote
from this string because I believe we should all be alert to these ethical concerns.
"Who Cares? Just Pay It!"
The excerpts, the exact words of these consultants to one another [with some
clarifications in brackets and their comments somewhat reordered for clarity]
are provided in the box below.
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A young New Orleans couple owns a 180-year-old,
2-story, beautifully restored home in a flooded area. The flood waters
in their house were about 8-feet deep, causing extensive damage on the
first floor. The first-floor upper walls (12-foot ceilings), ceilings,
and upstairs area were untouched by flood waters. The house is located
in a prohibited area and only recently has the couple been allowed access
to their house after 6 weeks of hot, humid New Orleans weather. Damage
on the first floor is severe. In addition, mold has migrated well beyond
the standing water levels into the second floor and throughout the house.
An adjuster for [the nongovernmental insurer that insures this house],
[who is] apparently also the claims administrator in New Orleans for
the NFIP told the couple that the migration of mold to the upper parts
of the house isn't covered. The NFIP policies do exclude [damage from]
mold caused by neglect of the insured (see below), but this insured
has been denied access by force of law until this week.
Section V, Exclusion D.4.b(3) of the
NFIP flood policy provides in pertinent part: Coverage is excluded for
water, moisture, mildew, or mold damage caused by the policyholder's
failure to inspect and maintain the insured property after the flood
waters recede ... We do not insure for [meaning "against"] direct physical
loss caused directly or indirectly by any of the following: … Failure
to inspect and maintain the property after a flood recedes.
Since the mold in this New Orleans
couple's house [the SRMC consultants' discussion continues] is a result
of the standing water and heat incubation in every flooded home, this
position [stated in this exclusion] would result in $0 [valid] insured
claims from the hurricane and the flood that followed. This is just
wrong. This is a case where the NFIP and the [homeowners] insurers need
to waive their policy terms and do the right thing. They can call the
payments whatever they want—good business, a donation, a voluntary payment—who
cares? For the good of the public, just pay it.
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Why We Should Care
I believe that, ethically, we really do need to care—we can't "just pay it."
We can't "just pay" all those with flood insurance because "just paying" ignores
some ethical issues about (1) whether and how to bypass the "failure to inspect
and maintain" exclusion in the case of Katrina without jeopardizing other exclusions
in property insurance policies in the future; (2) how much to pay; and (3) recognizing
the interests of others, such as the owners of the insurance company and insureds
in other flood-prone regions of the country.
We must care because we, as risk management professionals applying the risk
financing tool of insurance in the truly catastrophic situation which Katrina
and her 2005 forerunners and successors created, are ethically bound to try
our utmost to "do the right thing."
Bypassing an Exclusion under Extraordinary Circumstances
The "failure to maintain and inspect the property after the flood waters
recede" exclusion in the NFIP policy could strongly support insurers' denial
of all mold claims in New Orleans and anywhere else that the government barred
insureds from doing what the policy requires them to do if they are going to
have valid mold-damage claims following Katrina. But denying all Katrina-related
mold claims would (1) be "just plain wrong" ethically in the eyes of very perceptive
risk management consultants; (2) greatly increase the claims-related litigation
that Katrina and other hurricanes are already spawning; and (3) cast property
insurers in a mean-spirited, niggardly light in the eyes of the public, the
courts, regulators, and Congress for enriching themselves at insureds' expense
by refusing to pay claims that, when these insurance policies were issued, everyone
understood would be honored. As IRMI Editor Jack Gibson said here in October,
in a more general context [see IRMI Update 122]:
- It is important for insurers to deny coverage for claims that are outside
the scope and intent of their policies [as first worked out by agents/brokers,
their clients, and underwriters]. However, to try to weasel out of coverage
for a loss that everyone thought would be covered when the policy was written
simply is not right.
So, if it would not be good business for insurers to simply walk away from
policyholders who have substantial Katrina mold losses without even a heart-felt
"Sorry about all this," what can these insurers do to side-step an apparently
pertinent exclusion while also keeping this or similar exclusions alive for
future hurricanes, for which the exclusion may be eminently proper?
I see two credible approaches to temporarily side-stepping the "protect …
after the flood waters recede" exclusion in the extraordinary situation that
Katrina created while still being able to revive this or a similar exclusion
the next time a hurricane strikes. Both of these approaches change the nature
of the insurance contract and enable the insurer to "do the right thing" as
its senior management believes it ethically should.
The first approach is a variation of the common law contract doctrine of
impossibility. This doctrine holds that a party to a contract is not obligated
to do the physically or legally impossible. The insurance concept of force majeure, or an overwhelming, usually
unexpected, physical force that changes the basic nature of an insured loss
exposure, is an application of the doctrine of impossibility. Here, the force majeure would be the intervention
of federal authorities to prevent Katrina-ravaged property owners from returning
in order to protect their property. This intervention would excuse insureds
from their property-protection duties, which also excuse insurers from paying
mold claims—but, most importantly from an ethical perspective, would free insurers
to do the right thing in Katrina's moldy
wake. (More on that in a moment.)
The second approach to validly waiving the "failure to protect … after the
flood waters recede" exclusion would be for the federal officials in charge
of the NFIP to admit that the policy which they and others drafted before this
most recent hurricane was not perfect. In particular, when they wrote the "failure
to protect" exclusion, they had in mind barring coverage for those insureds
who were negligent in failing to try to protect their properties after the flood.
They had no idea that authorities would intervene as they did, without precedent,
after Katrina's waters receded, thereby preventing insureds from safeguarding
their properties.
Had these policy drafters imagined such intervention, NFIP officials could
now say, the drafters clearly would have rephrased the exclusion to (1) excuse
insureds from the duty to protect their properties if prevented by valid legal
authority, and (2) relieve insurers from paying flood related mold claims. Here
again, insurers would be freed from their policy obligations, but just in the
extraordinary circumstances following Katrina (but not all severe natural disasters),
to do what their senior executives deemed to be the ethically proper thing.
How Much To Pay
In a given real case—such as that of the young New Orleans couple above—we
could well have trouble deciding how to compute the amount we should pay this
couple, as well as every other similarly-situated insured. For example, if we
were to agree that NFIP insurers are ethically bound to pay something to every
insured homeowner whose home was totally destroyed this year's Gulf Coast hurricanes,
should the payment be (1) the face amount of each homeowner's policy, which
is administratively easy to determine but probably overpays the underinsured;
(2) the amount of the loss that each insured homeowner can document, which may
be very little if the documentation disappeared in the flood; or (3) an equal
amount, on the basis that the real loss was to the entire community of insureds,
and equal payments treat all insureds equally?
If some (but not all) insureds received disaster relief for the flood damage
to their property, should the value of each insured's disaster relief be deducted
from that insured's insurance recovery? Or again, if two insured homeowners
each have their equally-valued homes destroyed by Katrina's flood waters, and
if both of these homeowners are just now making their first flood insurance
claim after each has lived in his or her current house for 30 years, should
it make a difference that one homeowner has insured against flood for 10 years
while the other just bought his first flood insurance in August of this year?
Each of these potential answers to "how much to pay" to each NFIP policyholder
is an indemnity-centered response, focused on returning insureds to their pre-Katrina
physical and financial positions. Another set of answers could step beyond New
Orleans and the Gulf states to consider how the money that these policyholders
paid for flood insurance could help them restore their lives and futures either
as they were before Katrina or as they would choose them to be long after Katrina.
In the special case of Katrina, perhaps what should be restored is not so much
properties and incomes as realistic potentials for future prosperity. (More
on this in a moment.)
Recognizing Everyone's Interests
In deciding how to treat those particular NFIP insureds who have suffered
extensive mold damage from Katrina but whose coverage has been negated or seriously
threatened by the "failure to inspect and maintain the insured property" exclusion
when government officials barred their access, it is wise to ponder at least
briefly the nature of insurance.
Very broadly, insurance is one type of enterprise through which several groups
of constituents contractually share or shift specified risks. In the case of
Katrina mold losses, some of the major constituent groups (other than Katrina
flood victims) are: (1) NFIP insureds in flood-prone areas far from the Gulf
of Mexico; (2) the owners of the private insurers, both stock and mutual insurers,
that administer (with federal financial backing) the NFIP; and (3) federal taxpayers
and bondholders, who provide the back-up funding for the private insurers administering
the NFIP in situations where the insurance program is not financially self-sufficient.
While these three (and perhaps other constituencies, did not suffer as severely
as did Katrina's direct flood and mold victims, the interests of these other
groups should be kept in mind. In rushing to respond to the immediate plight
of the victims of this flood, we should not so overlook or burden these other
constituents that the entire NFIP is endangered, perhaps rendered unable to
respond to future disasters like Katrina. Even more immediately, we should not
focus on the particularly heart-rending losses of some of Katrina's victims
that the NFIP becomes financially unable to provide reasonable compensation
to others who suffered less spectacular, but just as real, flood and mold losses.
Everyone's interests, both present and future, should have at least some ethical
weight in defining "the right thing" to do for those whom Katrina struck.
My Own View of "The Right Thing"
My personal response for ethically doing the right thing after Katrina, and
for being better prepared the next time an unprecedented storm of any sort brings
catastrophic flood waters, has three elements.
The first is so obvious that it almost certainly will be done, retrospectively
if necessary, even for Katrina's victims: Increase the federal back-up funding
for the private insurers that administer the NFIP.
My second element is to rewrite the "failure to inspect and maintain" exclusion
in the NFIP policy so that the exclusion applies only if, when the flood waters
recede, the policyholder or someone acting on the policyholder's behalf, is
physically and legally able to take such action as may be appropriate. The spirit
of the present exclusion, barring coverage for those who willfully or with gross
negligence do not protect their property when flood waters recede, should remain.
Others more skilled than I in drafting precise policy language can find better
words to embrace this basic idea. For Katrina's victims, who have to live under
the present, poorly drafted language, I believe the federal authorities in charge
of the NFIP should order this exclusion ignored for Katrina's losses, except
where the insured was willfully or grossly negligent.
Third, because no one can compose words that will always apply meaningfully
to every future flood that will be called "unprecedented" or somehow "beyond
the scope of what we intended to insure," I would give each NFIP insured an
"investment option" in addition to the insurance coverage that the present NFIP
policy provides. Call the present indemnity-centered coverage the "insurance
option" under the NFIP.
In contrast, I suggest what might be called an "investment option" under
the NFIP policy—an option that would convert an insurance policy into an investment
instrument. This investment option would let any NFIP insured who suffers a
severe flood or mold loss "get his or her money back" with interest earned at
a federally determined rate, without having to document the precise extent of
the loss and without having to use this "money back" to rebuild or build a similar
structure anywhere. The insured who had paid more for higher limits of coverage
for a longer period would get more than the insured who had been minimally insured
for only a short time—but everyone would get something, even if their house
was completely gone, to rebuild their lives wherever they wished. I recognize
that this investment option could lead to some "adverse selection" during the
claims process, but it is better than having insurers labeled, perhaps quite
accurately, as "weaseling out" of coverage that everyone, especially regulators,
expected they would provide.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.