The Coming Insurance Crisis in the Gulf

One of the first big shots was fired at the insurance companies today in the wake of Hurricane Katrina:

U.S. Sen. Trent Lott is suing his insurance company over his beachfront Pascagoula home, which was leveled by Hurricane Katrina.

The law office of Lott's brother-in-law, high-profile plaintiff's Richard "Dickie" Scruggs, filed the federal lawsuit Thursday on behalf of Lott and his wife against State Farm.

The case is part of an ongoing wind-versus-water-damage showdown between insurance companies and thousands of storm victims. The issue is whether a wind-driven storm surge is the same as flooding. The companies contend they shouldn't have to pay for water damage for those who did not have flood policies.

"Today I have joined in a lawsuit against my longtime insurance company because it will not honor my policy, nor those of thousands of other south Mississippians, for coverage against wind damage due to Hurricane Katrina," said Lott, R-Miss. "There is no credible argument that there was no wind damage to my home in Pascagoula."

The whole big argument comes down to what is wind damage and what is flood damage. Homeowner's policies routinely exclude flood damage (water from outside coming in), though most will cover interior floods due to sewer back-ups or broken plumbing. Most policies also cover wind damage, though often with higher deductibles in hurricane areas. The tricky part is how to adjust a claim when the damage is caused by wind-driven water, as in the case of a storm surge.

Had Sen. Lott had a federal flood policy, that damage would have been paid by the flood policy and not his homeowner's policy. I would guess he was probably in a designated flood plain, and had he had a mortgage on the house, would have probably had to have a flood policy to satisfy the bank. Without that flood policy, coverage is subject to interpretation, and right now it looks like State Farm is interpreting the storm surge as flood damage and therefore not covered.

The real risk when this is all said and done is that if companies are forced to pay for damage resulting from causes of loss that they specifically excluded and for which they did not receive premium payments, those companies, should they be able to remain in business, will likely flee the state leaving homeowners with few if any insurance options. The companies that remain will be forced to jack up their prices in order to protect against future disasters, and insurance may become unaffordable for the lower income households. The next thing you know the State or Federal taxpayers will end up with the bill.