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To The Point

Water vs. wind: The coverage dilemma

The two-policy approach solves some problems but creates others

By Emanuel Levy

Another addition to life’s certainties—death and taxes—might be hurricanes and floods. This may sound facetious, except that the vast majority of weather scientists and worldwide climatologists have been virtually uniform in their dire predictions. Are they being taken seriously enough by government authorities and legislative bodies? It’s hard to measure how much is enough. But even if governments, industries and the public at large are primed for battle—an unlikely premise—the reversal of global warming to restore the environmental balance is decades away. Ideally it can be achieved.

As the imbalance continues to create all kinds of problems, the insurance industry is dealing with its own dilemmas. Hurricane Katrina and the other 2005 disasters sounded the wakeup call, primarily to meet coverage needs for the immediate future and beyond. Fortunately, Mother Nature magnanimously spared the country from an encore in 2006. Nevertheless, the urgent need for reforms should be vigorously pursued and the industry associations, to their credit, have stood at the forefront in sharing ideas designed to protect public interests without endangering financial integrity.

In last month’s column, I reported the recommendation made to the U.S. Senate Committee on Banking, Housing and Urban Affairs by Walter A. Bell, president of the National Association of Insurance Commissioners and commissioner of Alabama. In his April 11 testimony, he set out this challenge: “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 intent?”

Commissioner Bell emphasized that the public at large is unaware of the bifurcated nature of the policy, which separates windstorm and flood perils. He pointed to the bulletin distributed by Mississippi Insurance Commissioner George Dale immediately following Katrina, instructing insurers that the burden of proof as to whether a loss was covered fell on them and not on the policyholders. He also told them that where there was any doubt as to whether the damage was caused by flood or wind, the insurers were obligated to pay the claim.

On an emotional note, in a recent New York Times Business Section story about the Katrina wind/flood claims, a top Mississippi trial lawyer, Richard F. Scruggs, was quoted as saying that he “fought for the little guy who cannot stand up alone to big anonymous insurance companies.” The clear dilemma of the insurers is that the flood exclusion is vitiated when less than 25% of insureds in a given area purchase flood insurance but, in one way or another, have the loss attributed to wind by courts or through settlements, So, who defines “flood”?

State Farm’s decision to pay multi-millions of dollars in claims that it had initially rejected as flood losses is well known. This is another indication that it is unclear that the flood exclusion will ever hold where there is doubt, challenge, legal action or insurance regulatory intervention. While the Katrina-type windstorm/flood events may never be repeated, the issue of two separate policies needs to be considered carefully.

All-perils policy

The concept of an “all-perils” policy had already been introduced by Rep. Gene Taylor (D-Miss.) as an amendment to the National Flood Insurance Act of 1968. The original legislation brought NFIP (National Flood Insurance Program) to life because such consumer protection was deemed essential and because the private insurance industry consistently argued that such insurance was not economically feasible. According to a position paper of the National Association of Professional Insurance Agents—reported on in the March 2007 issue of its house magazine PIA Connection—Rep. Taylor’s amendment would expand the 1968 NFIP law to make available a multi-peril coverage for windstorm and flood.

PIA explained that the purpose of Taylor’s HR 920 is to overcome the bifurcated private homeowners policy limited to windstorm and the NFIP flood coverage. The legislation is in line with Commissioner Bell’s proposal, except that it would put the combined coverage under the auspices of the NFIP. In addition, the bill contains a twist. PIA indicates that for the bill to become effective, it would be necessary for a “community” to adopt the program and agree to abide by building standards, evidently devised by NFIP. PIA points to another provision that gives policyholders the option to buy the combined form or buy the separate coverages. The provision is intended to ensure actuarially sound rates.

That proposal puts the NFIP in competition with the private insurance business because it now offers an element of the homeowners policy along with its flood insurance product. This new hybrid would be sold by insurance agents because that’s how flood insurance is sold under the “Write Your Own” program. Independent insurance agents sell 95% of NFIP policies, so they would be offering their insureds the NFIP multi-peril policy, its separate policies or the private insurance company’s homeowners policy. Now, if the insured could make sense out of the offer and choose the NFIP multi-peril policy and also buy a homeowners policy, he or she would have two windstorm policies. Or the insured could choose the multi-peril policy with windstorm coverage, thus avoiding duplication by not buying a multi-coverage homeowners policy. What agent would want to be in such a sure-fire E&O trap? And who would be liable for a windstorm claim—NFIP or the private insurer? In its commentary, PIA sees such a situation posing “tremendous unintended consequences.” PIA has it right

A wide-ranging bill on flood insurance reform is now awaiting further consideration in the House of Representatives. It was introduced by Rep. Barney Frank (D-Mass.), chairman of the House Committee on Financial Services, and Rep. Judy Biggert (R-Ill.), ranking member of the House Financial Services Subcommittee on Housing and Community Opportunity. The bill expands the kinds of coverage that would be available in the NFIP portfolio and also deals with financial issues.

Called the Flood Insurance Reform and Modernization Act of 2007, the bill has a catchy acronym—FIRM. It is bipartisan and multi-sponsored. Its insurance features include phasing out the subsidized rates currently afforded vacation and second homes, making business owners eligible (optional) for business interruption coverage, and updating maximum coverage limits for residential and non-residential properties as well as additional living expense coverage. Also available on an optional basis are benefits for contents replacement and finished basements. The bill also gives NFIP an increase in borrowing authority of $21.5 billion.

Combined policy challenges

But what about Commissioner Bell’s proposed phase-out of NFIP and the substitution of a homeowners policy including both windstorm and flood coverages as a means of ending the Katrina dilemma of water vs. wind? The challenge is historic and real. Is flood insurance a risk that private industry can assume? It’s a dollars and “sense” question, as it always has been. Commissioner Bell sought to demonstrate to the Senate committee the reality of the cost of disasters to the country. He called the present policy “inefficient,” asserting that it fails to use “the efficiency and risk-based structure of the insurance market.”

One of the industry’s objections to including flood insurance in homeowners policies is that insureds in low-risk areas do not want to pay premiums for high-risk disaster areas. But Commissioner Bell refuted that argument, pointing out that currently there is a reliance on federal payments for large-scale disasters. The funds for these federal payments, he said, do not come from some magical treasure chest, but instead come from the American taxpayer. Bell included with his testimony estimates compiled by the Florida Office of Insurance Regulation showing the federal tax burden, by state, of the federal Katrina allocation of $110 billion. He said the analysis highlights “one important truth about the consequences of large-scale national disasters—they are a national issue rather than local or regional problems.”

Alluding to his central theme of the comprehensive insurance policy, Commissioner Bell told the Senate hearing that while Congress should consider all reasonable options, “It is important to stress that the solution to handling natural catastrophes and ensuring a stable insurance market does not begin and end necessarily with a massive federal program.” He said constitutional powers of taxation and interstate commerce powers directly and indirectly affect state insurance markets. He pointed specifically to loan conditions put on federal mortgages, and the tax treatment of insurance company reserves.

Insurance or mitigation?

But a significant involvement of the federal government eschews the insurance aspect for flood. Bell pointed to economic incentives for individuals to retrofit their homes as well as the upgrading of the nation’s infrastructure. It might be summed up by revising the definition of the NFIP acronym by dropping the “I” and substituting an “M” for “mitigation,” an essential ingredient for preserving property and lives in disasters, which may become even more pervasive and destructive in the not too distant future.

There is so much to engage government, with emphasis on the National Flood Program and the Federal Emergency Management Administration and all of its agencies to combat storm devastation, including dams and levees all over the country; conduct disaster preparation to minimize damage, organize evacuations, plan for emergency medical teams, provide temporary housing, monitor flood plain housing and industry, map the100-year floodplains and the like, to prevent the recurrence of a New Orleans-style debacle. Commissioner Bell’s comprehensive testimony to the Senate deserves widespread attention on the part of everyone involved in the flood insurance issue and in disaster mitigation.

My interview with insurance association executives turned up some interesting observations. There was almost universal reluctance to end the National Flood Insurance Program on the long-held grounds that insuring the flood peril is no more economically feasible for private insurers today than it was in the past. But there was also a willingness to be shown how new approaches might work.

No one, however, thought it would be easy.

Here’s a statement that was sent to me by the Independent Insurance Agents & Brokers of America (IIABA): “The Big ‘I’ will support any reasonable proposals that will increase the availability and affordability of insurance in disaster-prone areas. Some in Congress have indicated they would like to explore the creation of an ‘all-perils’ policy. We continue to study this approach and its impact on the private insurance market and the consumers that we are here to serve.” *


While the Katrina-type windstorm/flood events may never be repeated, the issue of two separate policies needs to be considered carefully.