Uninsured Flood Losses Spur Killer Suits

Katrina exposes shortcomings in federal coverage, putting insurers on the spot

Hurricane Katrina was the worst catastrophe ever to hit the U.S. insurance industry, which is why the massive storm and its powerful sisters—Rita and Wilma—earned the number-one ranking in this year’s NU Top 10. However, the hurricanes could end up being far more damaging over the long term if resulting legal challenges to standard flood exclusions are successful.

Mississippi Attorney General Jim Hood shocked the industry by filing a state lawsuit to force carriers to cover all Katrina-related water damages. The Sept. 15 filing alleges that traditional homeowner policy flood exclusions do not apply because of the storm surge created by the hurricane.

The suit was prompted in part by the fact that a large number of policyholders who saw their homes severely damaged or destroyed in the storm had not bought additional coverage available through the National Flood Insurance Program, leaving them exposed for their hurricane losses.

Industry officials warned that if successful, the suit could cost insurers tens of billions more on top of the $34.4 billion in covered Katrina losses conceded by the industry, while inviting copycat suits by those seeking restitution for flood damages in prior hurricanes.

Last month, Mr. Hood put less-than-subtle pressure on the industry to settle his suit. While insisting “this is not a scheme to extort money,” he warned that insurers would face a flood of single-plaintiff suits in front of hostile Mississippi juries if they refused to come to terms with him. “Insurers would get hammered in individual suits,” he predicted ominously.

Insurers were quick to respond, insisting they have no intention of surrendering to Mr. Hood and paying claims for flood damages they do not owe. The Property Casualty Insurers Association of America said the industry would “not be bullied into covering claims that are not covered,” while the American Insurance Association added that “no amount of hoping, or wishing, or threats” would prevent insurers from defending their contractual obligations.

In addition, agents could face errors and omissions suits for failing to adequately inform policyholders about their flood exposure and urging them to take the NFIP coverage, unless they got a waiver signed from buyers who chose to pass or are able to document their due diligence another way.

Meanwhile, federal lawmakers coped with attacks on the shortcomings of the NFIP, which lacked adequate funding to cover Katrina claims even though thousands of impacted homeowners didn’t bother buying the supplemental coverage. The government had to raise the program’s borrowing authority more than fivefold.

A number of grand solutions were debated, but state and federal lawmakers were at odds. Among the proposals were calls for states to establish uniform claims resolution regulations, as well as join together to create a risk-sharing pool.

House Democrats introduced legislation that would give Katrina and Rita victims the chance to buy “retroactive” NFIP coverage. Others called on the government to charge actuarially-sound rates for flood coverage and to require private insurers to have “skin in the game” by covering at least part of the risk. Some suggested eliminating the NFIP and instead creating a public-private partnership to cover flood and other disaster risks, backed perhaps by federal reinsurance.

#5: Industry Titan Toppled