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To The Point Quo vadis homeowners flood insurance? NAIC president calls for all-risk homeowners policy that includes flood By Emanuel Levy In testimony offered to the U.S. Senate Committee on Banking, Housing, and Urban Affairs on April 11, Walter A. Bell, president of the National Association of Insurance Commissioners, made a recommendation that no one whom I have come across has had the temerity to suggest. I was going to propose the same concept in my column, but then the testimony came into my possession. So, I must step aside and report how Commissioner Bell presented it to the Senate committee. Bell is calling for an “all-perils” homeowners policy that would really give insureds the all-encompassing coverage so many mistakenly think they already have. If that is the intent, one thing it would do is provide an E&O shield to agents and brokers against any after-the-fact allegations that they failed to tell the customer about coverages. There is a whole body of case law about E&O and the subject is often covered in textbooks, lectures, and courtrooms. Liability is often hard to define, and past events usually are based on memory or imagination; therefore, everyone will agree that it is best not to be faced with challenges or courtroom proceedings. In essence, it seems clear that Bell, who is also the insurance commissioner of Alabama, is calling for an end to federal flood insurance and the incorporation of the flood hazard into an all-inclusive policy. He described his idea as “a single policy for a single, risk-based premium where the only natural catastrophe-related exclusions are dictated by the consumer.” He said this serves the best interest of consumers, maximizes personal responsibility, and eliminates confusion over what is and is not covered. This appears to mean that the customer would be presented with all of the catastrophe coverages as well as the right to opt out. The subject of the Senate committee hearing was the availability of property/casualty coverage in coastal areas. Bell provided a large-scale view of the problem. “In coastal areas where catastrophic risk is perceived to be higher, we typically see greater fluctuations in availability and affordability than in other areas. The problem with this perception is that it focuses on what happened last, rather than on what could happen next. We must not overlook the possibility of a large-scale natural disaster that has little to do with coastlines. The threat of natural disasters on a massive scale exists in virtually all states.” The NAIC president sought to give the legislators a more balanced view of the entire underwriting picture, noting that despite record catastrophic losses, “the industry is enjoying record profits.” He emphasized that the crisis of 2005 affected only coastal regions of the Gulf states, where the insurance market “is in crisis.” As examples of the variations, he noted that in Alabama, only the two coastal counties of its 67 had insurance challenges; Mississippi, with 6 out of 82 counties and Louisiana, “which took the brunt of Katrina, experienced trouble in the 24 coastal parishes of its 62 total parishes.” In those parishes, he said, insurance costs are “skyrocketing,” building has come to a standstill, and mortgage defaults are on the rise.” He also pointed to South Carolina, where, even though many very positive modernizations have been put in place, some admitted carriers, following Katrina, sought rate increases of as much as 100% to 200%, and they added deductibles as a means of decreasing coverage. In the case of one condominium development, Bell reported, the premium increased from $126,000 to $879,000 and took five insurers to provide coverage. Bell said that insurers cited “risk concentration” as the motivation for their actions. After all, the policies include the legend somewhere in the verbiage, or in a letter accompanying the policy, that advises that there is no coverage for flood. But Bell said in his testimony that the policyholders do not always get the message because the distinction is not clear and the buyer just wants to be reimbursed for losses to his or her property. Commissioner Bell also referred to the anti-concurrent cause language in the standard property insurance policy that—as most everyone is aware— results from the need to exclude coverage for flood damages. The National Flood Insurance Program (NFIP), of course, has run parallel with private industry for a long time. But without private insurers, brokers and agents, NFIP would be a shadow with few purchasers. Clearly, the public has been generally well-served by this bifurcated system with the government collecting the premiums and paying the claims for flood loss, but with insurance industry input. It has also established the rules and the rates. However, as Commissioner Bell emphasized in his testimony, Katrina’s magnitude created a new game, because, for the first time, there was no clear defining line between flood and water. He pointed out to the Senate hearing that the flood exclusion in the insurance policies was not sufficient to draw a line that put coverage on one side and the exclusion on the other. He cited the bulletin put out by Mississippi Commissioner George Dale that instructed insurers that they must bear the “burden of proof” as to whether the damages were caused by flood or wind, despite the fact that there was water, water everywhere. Under legal principle, doubt is always construed against the maker of the contract. In these instances, it’s the insurance companies’ contract. What is not in doubt is that the major homeowners insurers on Gulf properties have been giving up the battle over coverage questions even though they may believe without question that the extensive damages in Mississippi and Louisiana were caused by flooding. Anyone may agree with them by viewing the oceans of water—anyone, that is, except the unfortunate residents who had no flood insurance, their lawyers, regulators, legislators and judges, some of whom saw the insurers as scoundrels of last resort. The class action suits brought against State Farm did not definitively settle the question of wind vs. flood because insurers, primarily State Farm, agreed to settlements. In a Mississippi case, Federal District Court Judge L.T. Senter Jr. ruling from the bench, acknowledged that the evidence was “overwhelming that the storm surge was sufficient in force and duration to destroy the dwelling or to remove the debris of the property if the home had collapsed before the surge.” Under such circumstances, it makes sense to turn the homeowners policy into an all coverage instrument. At least there would be premium income to offset claims and there would be no need to try to distinguish the source of claims. It is absolutely true that the resistance by insurers to cover flood claims was always valid; however, as Katrina has demonstrated, the policy exclusion does not always mean what it says. The question must now be answered, what came first, what really caused the damage? And what about simultaneous damages? And as climatologists predict so ominously, storms of this nature are in our future, so who wants to face such risk odds without a good hand? Perhaps Commissioner Bell’s challenge needs to be considered: “Why shouldn’t we offer consumers an all-perils policy that covers wind and water and eliminates the need for this provision [the exclusion] along with any possible distortion or manipulation of the intent.” In his presentation to the Senate committee, Commissioner Bell took up the issue of “intent,” asserting that there had been serious allegations that some companies or adjusters had wrongly denied claims while misconstruing the exclusion provision. On the other hand, as late as mid-April 2007, a major law firm representing large numbers of claimants (Scruggs Katrina Group), charged that an e-mail trail showed that State Farm not only provided Forensic Analysis & Engineering Corp., its engineering survey firm, with a suggested format for reports, but that the format contained language suggesting that water surge, not wind, was a cause of the damage. According to the Scruggs document, State Farm went so far as to threaten to reject Forensic reports that suggested damage causes other than flood. The extent of the damage on the Mississippi Gulf Coast has been reported numerous times, but one recently cited in a blog (RiskProf) is about as stark as one can get. It reported that of the 171,000 dwellings in the area, Katrina destroyed more than 65,100, and severely damaged more than 38,000—over 60%. But another disturbing element is that only 8,500 owners of all this vulnerable property carried flood insurance, and perhaps the only reason they did was that their mortgage bank required it. If the number is right, it’s a sad commentary on the distribution of this vital coverage, particularly on coastal exposures. And this is particularly disturbing: The blog asserts that for the most part, coverage was not promoted because “they are not profitable products for agents or companies.” In addition, the blog notes that coverage limits are too low (capped at $250,000) to provide for property replacement. No comprehensive approach According to Commissioner Bell, the current system lacks a comprehensive approach to managing the devastating effects of catastrophic natural disasters because it is in itself ineffective. He said it also discourages personal responsibility and risk avoidance by relying too heavily on the federal government. He pointed to the $110 billion fund currently set up by the federal government to facilitate recovery and rebuilding. Bell said the fiscal burden falls on the American taxpaying public and is ineffective and not risk-based, so that it provides little legacy that guarantees relief for the next natural catastrophe, regardless of where it strikes. He said: “Although I believe this committee should consider all reasonable options, it is important to stress that the solution to handling natural catastrophes and assuring a stable insurance market does not begin or end necessarily with a massive federal program.” Bell added that congressional powers directly and indirectly affect state insurance markets, and he cited specifically the loan conditions put on federal mortgages, the tax treatment of insurance company reserves, economic incentives for individuals to retrofit their homes, improved building codes, and even upgrading the nation’s infrastructure. He said these are all areas that Congress can address in order to “positively impact the insurance marketplace.” That’s a lot of items on the congressional plate in the face of other national and international demands and political realities, but they deserve attention to protect public safety and fiscal integrity. And Bell added some more as concomitant to his development of all-perils insurance coverage. Uppermost is planning for disaster response to save life and property. He cited studies that make it clear that such advanced planning is not in place and asserted that NAIC has endorsed disaster planning as a top priority and maintains a disaster-preparedness manual for use by all states. As to the all-perils policy, it may take a lot of doing, and there is little doubt that it will raise industry hackles. Yet the industry should take a sharp look at the proposal and debate it before sending it to the dustbin. Getting the government out of the insurance business by substituting a viable alternative may be the way to go. The NAIC suggestion undoubtedly has bugs, but some fresh ideas’ spray may put them to flight. * The author |
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