GCN Exclusive Report

Breaking The Bank

Flood Exclusions Aside, Insurers Are Still Awash In Katrina Claims.  It May Be Time To Rethink Our Present Shared Risk Model For Catastrophic Homeowner Insurance.

Part One

By Mark Proulx and Perry Hicks- Special to GCN

One needs only to review the new FEMA Advisory Base Flood Elevation Maps to realize the magnitude of utter destruction. In Hancock County, storm surge inundated miles inland to such a depth that the flooding has been described as literal seas with high waves pulverizing homes until they were reduced to little more than sticks.

The unprecedented loss of structures has displaced in Mississippi alone an estimated 500,000 people. Out of work and without a standing residence, these thousands of Mississippians are finding themselves in a nightmare of obligation to mortgages for homes that are now literally nothing more than a concrete slab. At the same time, they have to financially meet the everyday needs of their displaced situation.

The flood insurance issue is so out of hand regarding Katrina that even Mississippi Senator Trent Lott has filed suit against State Farm over his difficulties from the loss of his home in Pascagoula.

What is desperately needed is capital to begin the process of rebuilding so these thousands upon thousands of displaced survivors can resume their lives. Everyone hopes a federal infusion capital will be forthcoming. Part of the problem is with Congress, part is with the White House, part is with the scale of the disaster, and part of it is with the insurance industry business model.

Federal Relief vs. Insurance Reimbursement

Within three weeks following Katrina’s landfall, the federal government had authorized as much aid as it had for the 9/11 terror attacks, 2004’s four hurricanes, and 1992’s Hurricane Andrew combined! In a nutshell, Katrina aid will dwarf that was given following all other natural disasters. As of October 13, 2005, FEMA’s data shows nationwide more than 1.19 million households have received hurricane disaster assistance totaling more than $3.53 billion. More than 416,000 applications for Transitional Housing Assistance have been approved totaling $982 million. 429,324 people visited 97 Disaster Recovery Centers (DRC) across the Gulf Coast.

However, the Federal government is not alone in having financial responsibility for disaster relief. While Congress may ultimately authorize an additional $150 - $200 billion in Katrina relief- which surprisingly will be about $400,000 for each of the 500,000 displaced families- it is insurance companies that policy holders expect to pay the major part of reconstruction. This expectation may be misplaced in that insurance companies are currently projected to pay only about $40 billion.

That’s right. Insurance companies are projected to pay out only less than 20% of the Federal Government’s financial burden. However, this is not an unusually low number. So far in 2005, US catastrophic losses were a record 14.3% of net premiums earned in 2005 and were 4.3 times the 1984-2004 average of 3.3%.

(Insurance Information Institute estimate of 14.3% for 2005 based estimated 2005 DPE of $418.8B and estimated insured CAT losses of $60B. Sources: ISO, A.M. Best, Swiss Re Economic Research & Consulting; Insurance Information Institute.)

Despite this low number, insurance companies are claiming they can’t continue to do business in high-risk Gulf states. After Hurricane Andrew, reinsurance dried up in the state and there was a mass exodus of insurance companies from Florida. Cliff Gallant, equity analyst at Keefe, Bruyette & Woods said while the insurance industry is $70 or $80 billion stronger than it was after Sept. 11 and can withstand another major storm like Hurricane Rita, if there are more catastrophic storms to come this hurricane season and going forward, the industry may find itself in a cash crunch. Insurance industry data, however, suggests that there is, in fact, sufficient capacity exists to pay all of Katrina, Rita & Wilma claims.

Number of Katrina claims filed this year:

LA 900,000 claims

MS 490,000 claims

AL 123,000 claims

FL 110,000 claims

TN 8,400 claims

Total 1,631,400  

According to A.M. Best, ISO, and the Insurance Information Institute, insurance companies have a surplus capacity of cash to settle claims valued at $412.5B or 45% above its 2002 trough and 22% above its mid-1999 peak. “Surplus” is a measure of underwriting capacity, analogous to “Owners Equity” or “Net Worth” in non-insurance company parlance.

Other industry claims that paying out on Rita/Katrina will bankrupt insurance companies may also be overstated. Thus far, Katrina appears to have claimed just 1 corporate victim-Rosemont Reinsurance Ltd- which is expected to go into liquidation.

The facts are that from 1993 – 2002, the major reasons for insurance company insolvencies have been:

  • Deficient Loss Reserves (51%),
  • Unidentified (17%),
  • Rapid Growth (10%)
  • Discounted Operations (8%)
  • Catastrophic Losses actually account for only about 3% of all insurer insolvencies.

Much of the caterwauling about possible insurance company bankruptcies could be taken as ploy to convince Washington to underwrite the entire Rita/Katrina event- while the insurance companies pocket the premiums, of course. Then again, from 2000 to 2004, there were fewer US insurers able to command a A++ or A+ rating.

The present insurance business model is to keep the industry regulated at the state level following the insurance industry practice of dividing the insured into small groups. In this way, risk appears to be not spread widely thus enabling insurance companies to charge higher premiums. This also helps to keep competition out.

However, insurance profits are not kept within the individual states but are collected at the corporate level. The industry directly benefits from this risk division and could arguably be one of the reasons for the fantastic profits insurance companies enjoy. Division simply allows insurance companies to charge more for coverage because individuals may be told they belong to a high risk group.

So, the big question for any home owner is: Why buy insurance if your expectation is for for insurers to do all in their power NOT pay you and you know the amount you will be forced to settle for won’t be nearly enough?

In Part Two we will make the case for changing the way insurance is regulated.