As we have seen with the Katrina and Wilma litigation, courts will enforce the anticoncurrent causation clause, standard in most all risk and wind insurance policies. Many who suffered total losses could not fully recover because they did not have adequate flood insurance. Generally, policyholders with insufficient flood coverage limits fall into three categories:

  1. Those who did not purchase flood coverage.
  2. Those who underestimated the value of full replacement cost.
  3. Those correctly estimating replacement coverage but not able to purchase the amount through National Flood.

Most fall into the second category. There is an epidemic of underinsured structures. I have no idea why the insurance industry is not pushing harder to correct this problem, but I suspect ninety percent of all properties do not have the coverage necessary to fully replace a structure following a catastrophe.

This problem was highlighted in 2004 congressional hearings following Hurricane Isabel in 2003. A number of Mid-Atlantic Congressional leaders had complaints from constituents following these storms. The claims handling problems were exacerbated by many not having sufficient National Flood Insurance limits. Those from major computerized construction cost estimating companies essentially testified that the construction costs in their database reflected new construction costs not following a catastrophe. If a catastrophe ensued, the costs could be up to forty percent higher.

When policyholders underinsure, it is an underwriting problem. The issue rarely arises because the vast majority of all losses are small–many are not even reported because of deductibles or the hassle of reporting and collecting upon small claims is financially not worth the effort. Some policyholders are even warned that they may become "undesirable" for reporting small losses–so they simply do not. So, the first lesson is that most losses are not total and the need for policy limit coverage seldom arises.

But what about co-insurance penalties that penalize policyholders for not insuring to value as I warned recently in "Coinsurance Penalties Await Policyholders Who Do Not Insure to Full Value?" A coinsurance penalty occurs when a policyholder purchases less coverage than is needed to insure to full replacement value. It exists just to prevent policyholders from gambling with the probabilities that a total loss will never happen.

Typically, the larger the loss, the greater the economic incentive for the insurer to investigate whether a coinsurance penalty applies. The second lesson is to avoid the financial catastrophe of having any significant loss not fully covered. Policyholders, agents, and insurers need to promote the idea that properly insuring to value is a significant part of underwriting. The wide-spread practice of promoting construction underwriting estimates that are insufficient to restore structures must stop. All of us in the insurance claim business see this underinsured to value phenomenon as a repeated problem—is anybody at underwriting listening?

If National Flood had doubled the residential limits to $500,000 and made commercial limits available to $1,000,000, with proper underwriting of insurance to value, many of the Hurricane Katrina total loss cases may never have been litigated. While there seems to be significant political reservation about the Federal Government competing with the private market, why not increase the coverage? The insurance industry cannot or will not underwrite at a limit that satisfies the vast majority of structures. Increased coverage would allow National Flood to insure to value on many structures and therefore, be more actuarially sound.

The uninsured flood policyholders need better education or "required" lending incentives to purchase flood coverage. Standard mortgage requirements at time of closing need to reflect the flood peril. Flood waters occur much further inland than many expect. While infrequent, inland floods can devastate, but the cost is so minimal in those areas of slight risk that it should almost be required–just ask those several miles from the Mississippi and Louisiana coasts. Flood limits should be the same as "all-risk" limits. Many coastal insureds had substantially less coverage for flood than under their all-risk policies. The third lesson is that the concept of insuring to value should be promoted in flood underwriting. Currently, that seems to be a foreign concept.

Some may wonder why I would call for higher National Flood limits and better underwriting of policies. After all, it would certainly decrease the need for my legal services. Many Katrina lawsuits in Mississippi would never have been filed if these few suggestions were followed. Many Hurricane Ike lawsuits in Galveston and the Bolivar Peninsula would not be needed either. Much of this madness can stop without a major disruption in the day to day operation of the way insurance currently works and without major political changes to National Flood, if today’s suggestion were put into practice.

So why not do it? It seems the only people to lose are the lawyers, and we have no problem with that in this case. We have plenty of other insurance coverage disputes to keep us busy.

  • shirley heflin

    I think alot of it is the consumer’s Agent’s fault. It’s their job to educate the insured on the coverage they should have – but the more coverage they try to sell, the higher the premium. Most insureds don’t won’t do pay a high premium and most Agents don’t want to lose their commission, so the coverage is minimized. Of course, this is unfortunate.

    SHIRLEY HEFLIN

  • Stephen R. Figlin, SPPA

    As usual these comments are well founded, except, the Flood “Insurance” program is not really an insurance program. It is only a Federal Benefits Program dressed up to look like insurance. It does not have the same underwriting guidelines or coverage selection of other insurance, and I believe is only a measure to recoup some dollars in the form of premium to offset other federal loan programs available after a catastrophe.

    Unfortunately, the availability of NFIP coverage relieved the traditional markets of the need to provide either “Flood” or DIC coverages, formerly available in the absence of NFIP Flood coverages. The Federal fear is they may be responsible for paying a larger amount of dollars in claims without any substantial offsetting income, and they would rather have the property owners use other programs or loans to finance the shortfall in claim value over available insurance coverage. It is also an example of the Federal Government devising a benefits program, without thinking through all of the marketplace effects or end user results.

  • John Nixon

    I don’t think carriers are unwilling to provide the Flood coverage; I just don’t see very many property owners in flood zones willing to pay an actuarially sound rate for the coverage. Even with all profit factors stripped out, the rates would need to be very high. On top of the pure loss cost, you’d need to pay for loss adjustment, underwriting expenses, and agency commissions.

    Underinsurance isn’t a foreign concept, just an unpopular topic at the negotiating table.

    In my experience, the various pools are more subject to manipulation of values. The rates are relatively fixed, so the values are the only variables to play with (other than the also popular “creativity” with the street address). Similarly, Flood, Hurricane, and Earthquake exposed properties are more prone to value manipulation because the premiums are higher.

    Personally, I’d like to see the government put more effort into improving the quality and consistency of public record data. This will help with valuations, catastrophe modeling, and marketing of exposures to carriers, reinsurers, and capital markets. We can’t hope to make good public policy decisions based on poor data. Market forces resist individual attempts improve data quality; governments are better positioned to address this issue than they are to dabble in underwriting.

    Outside of deliberate under-reporting of values, there are some common causes of underinsurance:

    3. Inadequate coverage.
    Deliverately insuring to 80% coinsurance is a poor choice, better to save premium expense with a higher deductible.

  • Ms. Hayes

    Can you please clarify, as to the ACC Clause?

    Are the courts going to keep the clause for the Ins. Companies or are the Courts going to rule it ambiguos and strike it? Is the decision still pending?

    I think your saying the courts are keeping the clause.

  • Chip Merlin

    Ms. Hayes,

    The Corban case in Mississippi is still pending and we do not know the outcome yet.

    Most Courts that have ruled on this issue have found that the clause is allowed, but the decisions all have differing interpretations of exactly what it means in a given situation.

  • Ms. Hayes

    Thank You