October 2005

Katrina's Liability Implications

Hurricane Katrina was an unprecedented natural disaster on American soil. Even beyond the tragic loss of life, the economic and political fallout has been huge. One little-noticed consequence is the coming battle in the courts over what could be at least $15 billion: will insurance companies find themselves liable under homeowners’ policies to cover Katrina losses, or will the courts enforce the policies’ flood exclusion clauses against thousands of people who lost their homes? The Mississippi attorney general has filed suit to retroactively hold these flood exclusion clauses unenforceable; the plaintiffs’ bar seeks recovery under interpretations of the “valued policy law.” Are these suits tenable? What are the implications for the liability system and the insurance system? On October 3, 2005, AEI hosted a panel discussion to address these and other questions in the aftermath of the damage wrought by Hurricane Katrina.

Robert W. Klein
Georgia State University, Department of Risk Management and Insurance

Hurricane Katrina created a high-stakes liability game with many players that will take years to complete. With property losses estimated at $170 billion, more than half of which was uninsured, there is immense political pressure to compensate people from sources other than existing policies. This may mean a government bail out or inappropriately finding insurance companies liable for coverage that they had not contracted. In either case, our society sends the message that we will not hold people to the consequences of their decisions. Critics who argue that insurance companies are flush with money to pay such claims are incorrect, as homeowner’s insurance is not a profitable business for the industry, and misguided, as they fundamentally misunderstand the nature of contractual, voluntary insurance.

Joanne Doroshow
Center for Justice and Democracy, Americans for Insurance Reform

Americans for Insurance Reform has received many complaints about the behavior of insurance companies after Katrina, including accounts of insurance companies refusing to pay out transitional living expenses components that are vitally needed during this difficult time. Many people did not buy flood insurance because they were misled or confused about the coverage provided by their homeowner’s policy. Insurance companies that claim that any flooding exempts them from paying claims are factually and legally wrong, since winds certainly played a major part in the destruction. It is well-settled law that when causation is ambiguous, the policyholder should receive the benefit of the doubt. We need states to pass moratoria on policy cancellations and non-renewals, as well as price increases, to protect consumers. The industry had adequate models before this storm, will continue to have robust resources even after it, needs no protection, and should be reprimanded for its poor moral conduct in the wake of this storm.

Adam Scales
Washington and Lee University School of Law

As typical consumers have become less able to understand the increasingly complex contracts with their insurance providers, insurance law has come to resemble products liability law more closely than the law of contracts. While this poses the danger of undermining insurance companies’ ability to do business, it is generally a positive development because it protects consumers, whom the Government Accountability Office has concluded are understandably confused when it comes to their insurance purchases. Most homeowners are unable to act as sophisticated, discriminating consumers of insurance, and instead buy the cheapest policy available and assume they are covered. Because of this deficiency, and because government is likely to address problems ex post, there is good reason for government to look out for consumers’ interests. Insurance companies should distinguish pure flood losses and withholding payments in those cases, but should be force to pay in ambiguous cases.

Martin Grace
Georgia State University, Department of Risk Management and Insurance

The language of flood exclusions in homeowners’ policies has evolved to the point of least ambiguity, explicitly excluding all water-related damages from coverage. If such exclusions are ignored by the courts, then there is no reason for anyone to buy flood insurance. Insurance actuaries derive their prices from the language that actually exists in policies, not for expectations of having that language ignored. Suffering a loss does not give people extra rights, and if we do not stop “tortifying” contract law, the insurance industry may become impracticable. The most likely scenario if Louisiana and Mississippi courts ignore flood exclusions will be short-run availability problems, adverse pricing consequences, and bankruptcies among smaller companies, as well as possible long-term consequences for other segments of the insurance industry. Legislative proposals to allow people to purchase flood insurance ex post, while seemingly absurd, might have a chance if they required back-purchases of sufficient years and locked people into future policies indefinitely.

AEI research assistant Philip Wallach prepared this summary.