Hurricane Katrina: Insurance

http://web.mit.edu/12.000/www/m2010/finalwebsite/katrina/insurance.html

Insurance Policy

General Home Insurance

      According to the Insurance Information Institute, homeowners insurance provides financial protection against disasters. Homeowners insurance generally covers many areas including the house, its contents, and personal liability claims against policyholder and other members of the household. The coverage that each person wants to get depends on their needs and priorities and the insurance premiums depend on the coverage each individual chooses. An insurance premium is the amount paid or to be paid by the policyholder for coverage under the contract, usually in periodic installments (Dictionary, 2006).  Each household's insurance premiums is also weighted on the square footage of the house, building costs, construction materials and features, crime rate in the neighborhoods, probabilities of disasters and distance of the closest fire hydrant or fire station, and the conditions of plumbing, heating, and electrical system (Insurance Information Institute). Generally, the homeowners insurance covers from disasters such as “windstorm, hail, fire, lightening, theft, aircraft, vehicles, smoke, vandalism, malicious

mischief, explosion, breakage of glass, explosion and riot or civil commotion.” (California Department of Insurance, 2004). Most home insurance generally does not cover flood, earthquakes, or maintenance related damages. There are three basic types of home insurance policies:

1.      HO-2 or the Basic Home Insurance Policy which covers the value of the home, personal liability protection and theft. The Basic Home Insurance Policy is usually required by the mortgage companies to purchase.

2.      HO-3 or the Comprehensive Home Insurance Policy is the policy that most people have and it covers most of what a general home insurance should cover such as fire, lightening, theft, wind, water (not flooding) and etc.

3.      HO-8 or the Special Home Insurance Policy is highly recommended and usually used by the homes prone to certain natural disasters (although even this plan does not cover flood insurance or earthquake insurance). (The Different Types of Home             Insurance, September 21, 2006)

These are the most common types of homeowners insurance, but each of these
different types of coverage also have about three subdivisions on which homeowners can choose their limits.

1.      Actual Cash Value is the type of limit in which the homeowners will get reimbursed with the fair market value (amount house would sell for with no outside pressure).

2.      Replacement Cost Value Policy is the type of limit in which homeowners can rebuild their homes without any deduction (the insurance money might still not cover for all the money it might take to rebuild but they will reimbursed for most part of it) but they will not be funded for improvements on their homes to keep up with the building codes.

3.      Guaranteed or Extended Replacement Cost is the type of limit in which homeowners will be reimbursed fully to rebuild their home even if it exceeds policy limits, although they still will not be funded for improving their homes to new building codes. (Spend on Life, November 13, 2006)

    According to Insurance Focused, the first option of the actual cash value option generally cost twenty five percent less than the replacement cost value policy and the replacement cost value on AVERAGE cost about $400 to $1000. Although there is extensive home insurance provided by various private insurance companies like State Farm, they still do not provide for flood insurance and according to FEMA, floods are the number one natural hazards in the United States.

National Flood Insurance Plan (NFIP)
 

    Thus, to cover the damages caused by floods, the United States Federal government created the National Flood Insurance Policy under the National Flood Insurance Act of 1968. National Flood Insurance Plan defines flooding as the general and temporary condition of partial or complete inundation of normally dry land areas for the overflow of inland or tidal waters or from the unusual and rapid accumulation or runoff of surface waters from any source. The premiums for flood insurance are assessed by criteria similar to that of general home insurance. On average, NFIP's premiums cost about $370.00 per year. However, there are many factors, when followed, can help reduce this rate (National Flood Insurance Guide, 2006). Updating homes to newest building codes and giving each home the best possible protection against flooding can cause the cost of the NFIP to decrease. Furthermore, if the home owner's community participates in the Community Rating System, and the community follows the measures to decrease the possibility of damages caused by flood, then the flood insurance for homeowners in that community will decrease by 5% to 45%. Home owners can obtain NFIP either directly through FEMA or with the Write Your Own programs through private insurance companies. In the WYO program, homeowners basically buy their flood insurance from their insurance agency whose flood insurance is backed by the NFIP. Although the NFIP is not mandatory in all areas, it is still strongly recommended and urged by FEMA for everyone, even those not living in high risk areas to buy this policy. When the homes are backed by the federal loans, then the government determines if the home is in the Special Flood Hazard Area. If the home is determined by the government to be in such an area, then NFIP is made mandatory and must be purchased within forty five days of notification. Also, when the government provides assistance to rebuild homes after a nationally declared flood disaster, it can make purchase of NFIP mandatory after the assessment of the area. Thus far, 19000 communities participate in the NFIP program and NFIP provides up to the $250,000 of building coverage and $100,000 of content coverage (National Flood Insurance Guide, 2006).

Federal Emergency Management Agency (FEMA)

    Governor Kathleen Blanco declared a State of Emergency on August 26, 2005 and requested disaster relief funds from federal government on the 28th. President Bush then declared Sate of Emergency on the 28th and thereby giving federal assistance. On August 29th, President Bush declared Hurricane Katrina as a major disaster and by September 8th, $52 billion in aid was assigned in aid to the victims of Hurricane Katrina by the Congress (Kunreuther, 2006). Overall, the victims of Hurricane Katrina were left helplessly while the federal and state government played the blame game. FEMA waited two days after the storm hit to activate a national response plan. Michael Chertoff, secretary of Homeland Security claims that he did not know that the levees will be over topped or breached until the morning of the damage. However, Chertoff claims that he kept asking Brown, who was not trained to take on the role of director of FEMA, if FEMA was all set and Brown claimed they had what they needed to respond to hurricanes (CNN, 2006). However, once the hurricane blew over, and victims of Katrina still were not helped, Brown was removed as head on September 9th, and he resigned on 12th. However, Brown also claims that it was not FEMA's job to evacuate the residents, it was the governor's and state's job to do so and FEMA's help cannot be provided until the state declares its need for help. (Stone, 2005)

Insurance Ambiguities 
Ambiguities and Problems with Insurance
    The sheer magnitude of the damage caused by Katrina-related events has led to difficulty in determining the cause of building destruction. The ambiguities in homeowner’s insurance policies have led to multiple lawsuits. The typical homeowner’s insurance policy, HO-3 policy, is for broad risk and covers everything except for specifically stated exclusions such as flooding. Although water damage is explicitly defined as “flood, surface water, waves, tidal water, overflow of a body of water, or spray from any of these, whether or not driven by wind; and water or water-borne material which backs up through sewers or drains,” the leveling of homes has led to the inability to differentiate between wind-related damage, which is covered by homeowner’s insurance, and flood related damage, which is only covered by the optional National Flood Insurance Program, or NFIP.
 

Court Cases/Legal Atmosphere

    In the case Leonard v. Nationwide Mutual Insurance Co., the court ruled in favor of the insurance company citing the damage to the plaintiff’s residence as “attributable to the incursion of water.” This court case applies to thousands of Nationwide Mutual Insurance policyholders also affected by Hurricane Katrina.
   The complexities inherent in insurance policies and the lack of transparency of insurance companies contributed to the large volume of Katrina-related lawsuits clogging the Louisiana courts. Specifically in the Leonard v. Nationwide Mutual Insurance Co. case, the attorney for the plaintiff claimed the references to windstorms and hurricanes led the client to believe hurricane damage would be covered.  
    Richard Scruggs filed a suit for 669 State Farm policyholders claiming the reports issued by State Farm were biased. (Kunzelman, 2006) According to Richard, State Farm reassigned its adjustors who designated wind as a factor and generated a generic report that blanketed all damages as “storm surge” based. In State Farm’s homeowner’s policy, storm surge is included in the definition of flood water and therefore is not covered. State Farm defended the validity of its assessment and stood by its story of the storm surge serving as the reason for the damage.
  The burden of determining the cause of destruction lies with the insurance company, and if the damage is determined to be water-based, then “they must clearly demonstrate the cause of the loss,” according to the Insurance Commissioner of Mississippi on September 7, 2005. (Goldberg, 2005, 4) 
    Although insurance companies have been bombarded with class action law suits concerning competing water and wind damage claims, the buzz in the current legal atmosphere surrounds two major cases, namely Mierzwa v. Florida Windstorm Underwriting Association and the battle between Mississippi Attorney General Jim Hood and a consortium of insurance companies including Mississippi Farm Bureau Insurance, State Farm Fire and Casualty Company, and Allstate Property and Casualty Insurance Company. In the Mierzwa case, the court ruled the defendant insurance company owed the full amount of the policy in a “total loss” situation including the damage caused by flooding, which is excluded from the homeowner’s policy. This decision had a huge impact on the insurance carriers because they essentially became responsible for an externality specifically excluded from their contract. Mississippi Attorney General Jim Hood added to this momentum when he won the case declaring “certain provisions” in the insurance contracts “void and unenforceable because of consumer’s reasonable expectations.” (Wilson, 2005, 2)
   The legislative atmosphere post-Katrina favors policyholders, and this relationship is demonstrated by Louisiana’s Rule 23. Rule 23 “suspends the right of any insurer to cancel or nonrenew any personal residential, commercial residential or commercial property insurance policy covering a dwelling, residential property or commercial property located in Louisiana that sustained damage as a result of Hurricane Katrina or its aftermath, or Hurricane Rita or its aftermath.” “Rule 23 provides sufficient time for the Louisiana Citizens Property Insurance Corporation to prepare insurance products that provide adequate property insurance to Louisiana citizens subsequent to Hurricane Katrina and Hurricane Rita.” (Wooley, 2005, 2) 

Flood Zones

Flood zones and associated flood risk 

    Flood Plains refer to the areas around bodies of water that have a tendency for flooding. These areas are usually flat and have fertile land, thus making the land an ideal place to build upon in terms of agriculture and city development. Water is easily accessible in terms of transportation and for use in the city and farmlands. Thus, disregarding the danger and risk associated with these high-risk areas, these flood plains have been developed. But the government regulates these areas through the National Flood Insurance Program, or NFIP, by mapping these areas in terms of different criteria, such as flood data collected over the years and elevation contours. The NFIP uses these maps and data to assign insurance rates in areas that fall in to these flood plains.
    The way communities that fall into these high-risk areas are regulated is based on incentives given by the NFIP to these communities. NFIP uses the Community Rating System, or the CRS, as a way to encourage communities to do their best to protect themselves by classifying them based on whether they follow their certain regulations and lower them accordingly. There are 18 activities that the communities have to follow and these fall in to four categories: (i) Public Information, (ii) Mapping and Regulations, (iii) Flood Damage Reduction, and (iv) Flood Preparedness. After the communities have been assessed they are assigned a class from 1 to 10, 1 being the highest rating. If a community falls in the Class 1 category they may receive up to a 45% premium discount in their insurance rates, whereas a Class 9 rating would receive up to a 5% discount (a Class 10 community is a community that does not participate in the NFIP program). (FEMA, 2006)
    New Orleans has been divided into several flood zones, ranging from areas with low flood risk and areas with high risk. These zones classifications are assigned letters and areas with specific letter zones must complete different requirements. The FEMA zones that are prevalent in New Orleans are Zones B, V19, V16, A0-A8, A10, A13, and A14. Areas that are classified as Zone B areas are not required to have flood insurance. Areas that are classified as Zone A areas have to carry flood insurance because they have a high risk of flooding. The higher the number next to the letter (such as A6 or A10) signifies a higher risk of flooding. Areas that are classified as Zone V are coastal areas with a high risk of flooding and must also carry flood insurance. Again the higher the number next to the letter the higher the risk of flooding is in the area. 
  The majority of the other areas show a rating that requires flood insurance according to the NFIP, showing the magnitude of the problem that flooding presents in this area. (City of New Orleans, 2006)

Percentage of people that had NFIP and/or other types of insurance  

    A major problem faced by many citizens after the all the destruction and horror of Hurricane Katrina was the prospect of picking up the pieces of their lives and rebuilding. This led to the problem of dealing with the costs of rebuilding, which in turn led to insurance problems.  According to estimates made soon after Katrina, the costs of uninsured losses have reached the $100 Billion mark, while costs of reimbursing people with insurance reached $34 Billion. (Baade, 2005)

Building Codes

  Pre-Hurricane Katrina building codes for flood protection were virtually non-existent in New Orleans. Protection against hurricanes was never a priority for New Orleans residents. While there are no statistics for how many residents individually furnished their homes, we can assume most homes were not wind and flood protected since most of the residents have an “It will not happen to me” attitude (Kunreuther, 2006. 2). Hurricane protection was not a priority segment of the government responsible for New Orleans either. The state of Louisiana did not create any building codes nor did it require local governments to enforce or develop local building plans. The city itself has also never created any building codes to minimize flood damage (Burby, 2006. 8).  
    The only building code required for lower lying areas of New Orleans was created by the Federal Emergency Management Agency (FEMA). The code required flood insurance and a base flood elevation (BFE) for certain areas of the city (Lambert Advisory, 2006. 3).
    The white sections labeled B represent higher elevation areas in New Orleans where flood insurance and base flood is not required The BFE for low lying areas was last updated in 1984. The advisory BFE required all residential homes to raise their buildings 1.5 feet above the home’s nearest sidewalk, patio slab, or deck (Lambert Advisory, 2006. 9).   Because B zones were protected by levees and have higher elevation, they have less than “1% chance of flood a year” (FEMA, 2006. par.12). As a result, FEMA did not require these areas to be protected. Buildings built before 1984 were also unprotected since the FEMA’s BFE applied the “grandfather” rule. So, only homes that were hugely renovated or built after 1984 had to follow FEMA’s Base Flood Elevation Advisory.