Post-Katrina Turmoil: Insurance Solutions

June 2008

This ongoing saga, including several legal cases that are still in the appeals process nearly 3 years after Hurricanes Katrina and Rita, points to the need for pursuing a host of measures and ideas to reduce the likelihood of litigation and other problems for these types of losses in the future.

by Robin Olson
IRMI

Ideas to consider include better education of the consumer about the need for a separate flood policy, adding the wind peril to the flood insurance policy, adding the flood peril to the homeowners policy, improving the National Flood Insurance Program (NFIP), promoting and requiring tougher building codes in coastal regions, and reevaluating the nation's flood control and environmental protection philosophy.

Enhanced Education of Insurance Consumer

It is important to realize that floods and flash floods happen in all 50 states and frequently occur outside floodplains. Last year, one-third of all claims paid by the NFIP were for policies in low-risk communities. Unfortunately, only 1 percent of persons with property outside the floodplain procure flood insurance.

A recent National Association of Insurance Commissioners (NAIC) survey showed that 33 percent of the heads of households incorrectly believe that the homeowners policy covers flood losses. Thus, agents and insurers need to do a better job at educating consumers on this critical issue. For example, insurers should include a notice on new and renewal homeowners policies that flood losses are not covered and that coverage is available through the NFIP. One agent notifies his clients every April via a newsletter, urging them to consider flood insurance. After each newsletter, their flood insurance sales calls come in.

Adding the Wind Peril to the Flood Policy

The separation of wind coverage under the homeowners policy and flood coverage under the NFIP form creates a host of problems when hurricanes strike since both windstorm and flood damage often factor into the loss. In the aftermath of major hurricanes, a conflict of interest most certainly arises for the NFIP's Write-Your-Own (WYO) private insurers who provide the administration and claims handling of flood policies along with their own homeowners policies. Since the NFIP allows the insurer to use a single adjuster for flood and wind claims, this process can present insurers with an easy opportunity to manipulate claims in order to bill the federal government—shifting costs from the insurer to the U.S. taxpayer. Indeed, the federal regulations explicitly state that the private WYO insurers are entirely responsible for providing the proper adjustment for both claims.

This situation is one of the main reasons why the U.S. Congress is pursuing the approach of adding wind coverage to the flood insurance policy. This measure, providing consumers with all-perils coverage, would unify disparate approaches and reduce coverage gaps. One of the features of the U.S. House of Representatives' bill would be to make the rates actuarially sound—a situation that is certainly not the case in the current flood program.

But if the multi-peril policy is supposed to be actuarially sound, it could not compete with state wind pools, which are heavily subsidized. Also, legislators and regulators have almost universally chosen to sacrifice actuarially sound rating and underwriting practices and fiscal prudence for political reasons. The likelihood that the rates would be promulgated on an actuarially correct basis is limited at best.

Another concern with this idea is that the flood program is already in debt to the tune of $17 billion. With windstorm losses added to the flood program, the chances of even greater debt (which would inevitably be foisted on the taxpayers) will grow. In addition, consumers would still need to procure a homeowners policy to cover other perils such as theft, fire, and explosion along with medical payments and personal liability. At this time, though, this bill does not appear to be one that will be promulgated.

Adding the Flood Peril to the Homeowners Policy

Perhaps an overall better idea is to add the flood peril to the homeowners policy. This approach would likely result in a more efficiently run operation, when one compares the efficiencies of private insurers to the federal government. Due to its catastrophic nature, the federal government could still be the 100 percent reinsurer for flood peril itself. Or it could be set up so that the government could simply provide federal backing or a credit line over a certain magnitude event to cap the CAT exposure for insurers, similar to what is done with the terrorism peril.

Part of the problem with this approach is that it would allow consumers to opt out of the flood peril if they so desired. History suggests that consumers often forgo voluntary coverage to save money, particularly if they think the federal government will still provide financial assistance. Countries such as France, Spain, and New Zealand have avoided this problem by mandating flood coverage; the results from these programs indicate some success. This approach should be strongly considered in the United States.

Improving the NFIP Program

One of the main concerns with the NFIP is that the program is heavily subsidized by the taxpayer, particularly repetitive loss properties. This short-sighted policy, arising from powerful political interests, leads to increased building in flood and wind-prone coastal areas. The consumer does not bear the full costs of building and maintaining these properties—these are passed on to taxpayers. If the homeowner had to bear the full costs of insurance, there would be less building in vulnerable coastal areas.

The conflict of interest problem for the WYO insurers is a concern that needs to be addressed. The Government Accounting Office (GAO) recently reported that government auditors could not accurately assess the flood claims payments from the 2005 hurricanes. They were hampered by a lack of access to data on wind damage from insurers, negatively impacting FEMA's reinspection program. The GAO has issued a series of recommendations for FEMA and WYO insurers that should be adopted in order for FEMA to more accurately gauge the quality of adjusting of flood losses by insurers; this effort will help mitigate the conflict of interest concerns.

Flood insurance has historically suffered from low penetration rates. As mentioned, approximately 33 percent of all flood claims in the past few years have occurred outside the 100-year flood zones. Thus, more effort should be made when it comes to educating consumers on the need for flood insurance.

Furthermore, studies indicate that FEMA's flood maps are woefully out-of-date. Indeed, many of the homes in New Orleans flooded by the levee breaches were not in the 100-year flood zones. Fully updated and digitized maps are needed to more accurately assess the peril of flood for individual properties.

Maximum limits for homes under the NFIP are $250,000 for the dwelling and $100,000 for the contents. Maximum limits for commercial property are $500,000 for both the building and the contents. These limits are inadequate and need to be raised to more accurately reflect the property values of higher-end homes.

Tougher Building Codes

There is no question that improved building codes, such as what has been documented in certain coastal counties in Florida in the aftermath of Hurricane Andrew, save structures as well as lives. Some of the homes in coastal Mississippi that were built with enhanced building codes handled the 2005 hurricanes very well and in many cases remained nearly unscathed after these cataclysmic events.

The Texas Windstorm Insurance Association performed a major study after Hurricane Rita on the enhanced building codes put in place in 1998. Two issues were researched on homes in the 14 counties on the Texas coast—percent of claims reported compared to the total number of dwellings insured and average paid loss for those claims reported. Many fewer claims were reported for dwellings built to the new codes, and the average paid loss per dwelling was 40-50 percent less.

Some of the measures that homeowners and businesses can take with respect to mitigating the wind peril include the use of the following:

• Heavy-duty pilings anchoring the structure
• Wind-resistant shingles
• High-quality storm shutters
• Braces on gable ends
• Longer screws, rather than nails, on the outside of the structure such as on the roof
• Hurricane-rated garage door

Greater tax credits and subsidies for lower income residents who buy or build these types of homes should be pursued.

Reevaluate Flood Control and Environment Protection Philosophy

The U.S. Army Corps of Engineers has reported that 122 levees in the United States are at-risk and vulnerable to breaking. Many of these at-risk levees are over 100 years old, poorly designed, and built with materials that were close at hand—clay, soft soil, and sand mixed with seashells. Tree roots, shifting stones, and rodents weaken them further. The land on which they were built often subsides. Water, of course, constantly probes for weak spots; it is an inexorable force. It will assert itself whenever and wherever it can.

A standard line used by the Corps states that there are two types of levees: those that have been breached and those that will be breached. Due to funding problems and bureaucratic turf battles, many of these projects have been put on hold. The U.S. Congress needs to take steps to provide the funding for these critical projects.

In addition, a greater emphasis should be made to develop more intelligent and greener solutions to vulnerable coastal areas. The past approach to flood control has relied on dredging, bulldozing, and building ever taller walls to control nature. Instead, Corps should work with scientists, business groups, and environmental groups to develop a greener, more intelligent system that integrates traditional engineering with natural defenses like wetlands, islands, and reeds. In addition, society should only build in areas that can be adequately protected, and some wetlands should be allowed to return to their naturally unconstrained state.

Conclusion

There is obviously no consistency among the courts on this critical issue concerning the definition of flood and the interpretation of the flood exclusion and the anti-concurrent causation clause. They will continue to try to find a consistent theory on the allocation of water losses and wind losses in the Katrina-impacted regions. In the meantime, insurers should make strong efforts to clarify these exclusions in a consistent way.

Complex problems rarely can be solved with a single solution. The losses arising from Hurricanes Katrina, Rita, and Wilma in 2005 are no exception. Key areas to explore and pursue for solutions include enhanced education of consumers and business owners concerning coverage issues, merging the wind and water peril into a single policy, making vast improvements to various aspects of the NFIP, pushing enhanced building codes, and re-evaluating the U.S. Army Corps of Engineers' flood control and environment protection philosophy.

One catastrophe modeler has stated that property values in coastal areas in the United States have doubled over the last decade, and that this growth will continue. This fact alone points to the critical need to properly and quickly address this ongoing debate and corollary issues. Only a sustained and multi-pronged approach to these complex issues will result in success in the age old wind versus water debate.

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