Insurance Coverage Lessons From Katrina: Insurance Companies Should Be Protecting Policyholders, Not Insurance Companies

Originally published in The Metropolitan Counsel (January 2013)

Much of the Northeast was not fully prepared for Superstorm Sandy, and its effects will linger for some time. But one industry largely headquartered in the Northeast had been preparing for the storm for years: the insurance industry.

Since Hurricane Andrew in 1992, the insurance industry has been taking steps to reduce its exposure to catastrophe losses – ironic, considering that insurance companies are supposedly in the business of insuring them. As a result, insurance companies made record profits in the immediate aftermath of Hurricane Katrina and in recent years have kept enormous surpluses, despite 9/11 and the overall economic landscape.1

The ultimate lesson from Katrina accordingly is simple. The time has come for consumers, courts and state regulators to stop insurance companies from protecting themselves from catastrophe losses. It is time for them to start protecting their policyholders instead.

Two Views Of The World

To put coverage issues into perspective, one must view the world through an insurance company lens. To most of us, a hurricane is a singular event – a swirling shape, with an eye in the center. Not so, however, for the insurance industry. Insurance companies see a hurricane as a series of unrelated events – wind, rain, high water, waves, storm surges and so on.

The same applies to the hurricane's consequences. To the "untrained" eye, the flooding of cities, the power failures that render businesses inoperative and the evacuation orders all are caused by the storm. To the insurance industry, however, each is a separate loss that might or might not be covered.

There is a reason for the insurance industry to draw such distinctions. By parsing storms into multiple parts, it becomes easier to deny all or part of a claim. But the entire system is confusing to policyholders. Somehow, it turns the insurance policies they thought would cover their losses into denial letters when they make claims.

What Does Your Policy Say?

Insurance policies are drafted by insurance companies. The insurance companies define the key terms (i.e., "flood"), draft the exclusions and even include draconian language that purports to eviscerate coverage in certain circumstances. The insurance companies then interpret the provisions that they drafted, leaving the policyholders with the relatively undesirable option of arguing against a fait accompli.

Property insurance policies generally fall into two types: (1) "all risks," that cover "all risks of direct physical loss or damage," except those specifically excluded;2 and (2) "named perils," that cover damage or loss caused by listed perils (i.e., fire, wind, hail or vandalism) but also contain exclusions, including for weather conditions.3

A typical commercial policy covers buildings and structures, personal property inside or on them and personal property that is nearby or in a vehicle.4 Coverage then is modified by a section called "Covered Causes of Loss": "We insure for direct physical loss to the covered property caused by windstorm or hail unless the loss is excluded in the Exclusions." The most important section for purposes of this article sets forth the exclusions:

The following exclusions apply to loss to covered property:

Flood. "We will not pay for loss or damage caused by or resulting from flood, surface water, ..."5 Power Failure. "We will not pay for loss or damage resulting from the failure of power or other utility service ... [unless] ... on the described premises if caused by windstorm or hail." Rain. "We will not pay for loss or damage caused by or resulting from rain, whether driven by wind or not unless wind or hail...