Pennies From Heaven

Why Katrina won't flood insurance companies.

By Daniel Gross
Posted Tuesday, Sept. 6, 2005, at 5:10 PM ET

http://www.slate.com/id/2125758/

Swamped by disaster claims?
Amid the continuing scenes of devastation in the Gulf Coast region, there's hope that the economic cost will be relatively low in the long-term. Last Friday, Treasury Secretary John Snow spoke optimistically about the economy's prospects. In the New York Times today, Simon Romero reported on the gold-rush mentality in Houston, with rising demand for everything from office space to oil-rig services. Stock analysts expect companies like Home Depot to see a surge in business.

The bullish case rests on the notion that money will flood into the Gulf Coast region from private companies and individuals who are rebuilding their properties, from charities, from the federal government, and from insurance companies, just as it has after previous catastrophes. But despite insurance companies' large role in helping to reconstruct New Orleans and its environs, Katrina is unlikely to wreak devastation on insurers' balance sheets, or on their stocks.

In fact, all things considered, big insurers like St. Paul Travelers and Allstate have weathered the most devastating hurricane in the nation's history quite well. (Here's a chart of St. Paul's, Allstate, and the S&P 500 over the last five days.) Why? While they may suffer, they're clearly not going to bear the lion's share of the rebuilding costs. The consulting firm Risk Management Solutions projected Katrina and its aftermath would cause some $100 billion in economic losses. But RMS estimates that insurers' losses will be only a fraction of that, between $20 to $35 billion.

That's a big chunk of change, and it's likely to be a record. Assuming the estimates are correct, Katrina could leave in her destructive wake larger insured losses than Sept. 11 ($20.1 billion) and Hurricane Andrew ($20.5 billion), according to Fitch Ratings analyst Donald Thorpe. But most large insurance companies are highly adaptable risk-spreading machines. As a rule, many buy reinsurance—in effect, they buy insurance on the insurance policies they sell. That offloads much of the repayment risk onto the shoulders of other companies. Insurers also move swiftly to recoup losses. In the weeks after Sept. 11, insurers jacked up premiums on policies that insured buildings against terrorism attacks. After the rash of corporate scandals, directors and officers insurance—the insurance that companies and individuals buy to indemnify top executives and directors against lawsuits—likewise went through the roof. The insurers that sustain heavy losses in Mississippi and Louisiana will respond by increasing rates for customers there—or for customers around the country, if need be. As a result, when big hits come, forward-looking stockholders generally rest easy that heavy losses sustained in one area won't recur to the same degree in the next quarter.

And although insurance companies like Allstate and its rivals project a customer-friendly image, portraying their adjustors and agents as first-responders in times of need, it's no secret that insurers are not eager to pay out on claims. Anybody who has made a home insurance claim or has health insurance knows that there are caveats, like deductibles and exclusions, embedded in insurance policies. The Wall Street Journal noted that after Hurricane Andrew, "Florida homeowners now pay steep deductibles for hurricanes—often 3% or more of a home's insured value." Another key: Most home insurance policies don't cover floods, just wind damage.

Since 1968, the federal government has offered flood insurance to homeowners in vulnerable areas. But here, again, the insured—especially those who reside in expensive beachfront communities—won't recover anything near the total of what was lost. The policies cover up to $250,000 for a home and $100,000 in personal property. They exclude outdoor property like septic systems and swimming pools, living expenses like temporary housing, or losses from business interruption. In other words, the federal government is not going to pay to rebuild the porch on Trent Lott's destroyed home in Mississippi.

And in cases where they are explicitly on the hook, insurance companies can be counted on to resist—even in the most emotion-laden cases. After 9/11, when Larry Silverstein, who owned the lease on the Twin Towers, tried to collect on his insurance policy, insurers argued that the two attacks were a single event, thus capping the amount Silverstein could receive. Silverstein took them to court, and last December convinced a jury that the two plane crashes were two distinct events.

Something similar may be shaping up here. In its report, RMS noted that the destruction is tied to two distinct events: 1) Hurricane Katrina; and 2) "the Great New Orleans Flood which has resulted from failure of the levee systems that protect New Orleans." Expect plenty of insurers to argue that they'll be happy to pay for property damaged by the hurricane, but not for both the hurricane and the flooding, if individuals or businesses lacked flood insurance. According to RMS, "at least 50% of total economic loss is expected to come from flooding in New Orleans." Needless to say, the vast majority of those who have lost businesses and residences in the past week don't have Larry Silverstein's ability to litigate.

There's another big difference between the recent floods and 9/11 that may limit the insurance industry's contributions to the rebuilding effort. On 9/11, many of those who suffered the largest economic losses were Fortune 500 companies, which carried lots of insurance. Given the socioeconomic conditions of the affected area in New Orleans, it's also likely that most affected residents were underinsured, and that many lacked insurance altogether.

Of course, the victims of Katrina won't be relying entirely on insurance funds. The Chronicle of Philanthropy last Friday reported that American companies, foundations, and individuals have already kicked in $404 million. The federal government has approved $10.5 billion for relief. And there's sure to be more from both sources.

Those are significant sums, to be sure. But it still leaves a gaping hole. The insurance coverage, the federal relief, and the private efforts will likely add up to less than $50 billion—or about half the total damage. Yes, there's plenty of reason to be optimistic that the national economy will bounce back from the blow it took last week. But as New Orleans begins the long process of drying out, we should also wonder where most of the funds to reconstruct the Gulf Coast are going to come from.