Mississippi politicians use Hurricane Katrina to blow insurers away

Posted by Marc Hodak on March 29, 2007 under Unintended consequences | Comments are off for this article

Given the ongoing insurance issues related to Katrina, Mississippi seems like a good place to visit in search of that twilight zone we like to call “the land of unintended consequences.”

After Hurricane Katrina devastated the Gulf coast in 2005, another storm engulfed the insurers. Apparently, they were refusing to pay hurricane victims for flood damage. Why would they do such a callous thing? Because flood damage is excluded from coverage by property and casualty insurers. In other words, insurers never promised to pay for flooding, and never collected premiums to compensate them for such coverage.

Nevertheless, politicians and lawyers in Mississippi, acting as “defenders of the people,” pressured the insurance companies into paying more than they contractually owed. These defenders said they were watching out for the welfare of their constituents. Yet, the main effect of going the extra mile to squeeze out the extra payments was to substantially reduce their constituents’ welfare by chasing away some of the biggest insurers in the state, and leaving their people with fewer insurers charging higher rates.

The two horsemen of the Katrina apocalypse were wind and water. Wind damage is typically covered by property insurance. Water damage, including flooding, isn’t. One might consider that a watertight argument for limiting what insurers pay out, but it can be tricky after a Hurricane to clearly distinguish one kind of damage from another. A lot of negotiation and some litigation ensue in the difficult job of sorting this out. However, homes that were washed away or literally cleaned out were out of luck.

So, after Katrina, the next disaster written up in all the papers was about how little compensation many of the hurricane victims received relative to their losses. People in distress often don’t care about contracts, or consider them a trifle in seeking to redress an unfair situation, and many such people tried to sue for flood damage anyway. Supported by politicians and the press, there were a number of settlements offered despite the high likelihood that the damage was from water, not wind. Joe Nocera of the NYT is no friend of the insurance companies. Yet he wrote, “In Mississippi, the insurance contract has been largely tossed aside by the power of litigation, and the belief that the insurance companies, especially State Farm, should pay up no matter what the cause of the damage.”

Nevertheless, this effort to extort non-contractual damages from the insurers has had very uneven results in the courts. So, the disappointed people turned to their representatives, who quickly anointed themselves the white knights in the struggle of the needy against the greedy. The insurance companies had plenty of money to pay these unfortunate folks, they reasoned. As usual in such battles, the anointed were bound to win while the disappointed would surely lose. Political crusaders, like all white knights, get good press whatever the outcome. In pursuing the bad-guy insurers, however, the people would either come up far short of what they felt they “needed” or “deserved” or, worse yet, they would win by collecting from the insurers far more than those businesses had bargained for (actuarially), then watch those businesses leave. Mississippi’s people suffered a little of both.

Seeing where the wind was blowing, many insurance companies decided to pull up stakes. Given how difficult it became to distinguish damage by wind versus water in hurricane prone areas, many insurers have simply refused to continue covering damage by either. When Mississippi threatened to prevent the insurers from excluding wind damage, Allstate decided to stop writing homeowners insurance there altogether. Said Allstate: “We’re not being good stewards of our investors’ capital or our policyholders’ surplus if we keep doing business where we can’t make money.”

Senator Schumer of New York, another state where Allstate has stopped writing coverage for wind as well as water, calls that insurer, “the poster child for terrible corporate citizenship.” Schumer wants Allstate to serve his people, and is upset that they won’t. He is appealing to a sort of communal claim that his people have on Allstate’s services to demand that the insurer write new coverage without raising their premiums. But even politicians can’t force a company to lose money, not for lack of power to do so, but because they know that after a certain point they will destroy the very economic engine they are trying to harness for the good of their constituents.

Insurers and insured should generally be able to come to agreement about what will be covered for how much, like buyers and sellers of other services. When they can’t come to such an agreement, either because the company can’t make money at a rate they must charge, or because the ultimate payout may be highly uncertain due to legal considerations well beyond their control, then the insurer will not write policies. When politicians create those conditions because of their intent to help the people, the policy ends up hurting the people instead.