9/24/2005

Read the Fine Print

As everyone knows, Hurricane Katrina caused property damage that has never been witnessed before in America. One would assume that insurance companies would really be in a state of panic with all of the claims that have or will arise by homeowners. However, this article suggests that this is most likely not the case. This is the case because very few homeowners are covered for flood damage beyond an optional Federal $250,000 policy that is available by the government. In most cases the insurance policy states that the homeowner is covered for rain and wind damage. The problem is that most of the damage is caused by flooding even though the rain and wind are the perils of the situation. As the article states, insurance companies may be able to escape 15 billion in payouts based on this wording in their policies and prior contract law outcomes. With this knowledge, it is nice to know that the premiums being paid by millions of homeowners are safe earning interest in the insurance companies investments.

1 comment:

Dr. Tufte said...

Wow - why are you folks majoring in business if you've been so deeply sucked in to anti-business hyteria?

Think about it: if insurance companies were making so much money, whose share price would be going through the roof? What sort of stocks would they be advising you to buy on the TV?

While I'm at it - big oil isn't a problem either.

I do think there is an issue here, but floods are not insured by private companies for a good reason.

Insurance works by spreading risk. Damage from things like wind is easy to cover because there might be a lot of damage in one yard (where the tree fell) and not much in the next (where the tree didn't fall). Floods are not like that. If there is a flood virtually all property in the vicinity would be severely affected. This makes risk sharing almost impossible.

The way you should interpret the absence of private flood insurance is that the price they would have to charge for it is so high that no one would buy it.

The government does provide flood insurance, and they finance by pooling the risk in New Orleans (which always floods) with that of the desert southwest (where it almost never does). That's a system that encourages people to take too much risk.

Again, speaking from experience of living in New Orleans, here are some thoughts. First, it is not possible to get out of flood insurance if you finance a mortgage through a bank or other private lending agency. Those financiers know it is essential. Everyone who got out of flood insurance did it buy paying off their loan, borrowing from relatives, or inheriting. It was their choice in those cases not to insure. Secondly, I had two serious weather related problems in New Orleans (flood and hail), and I am fantastically pleased with the amount of money and cooperation I got from my company each time. Third, the culture in Louisiana is congentally underinsured. I'm not sure why this is, but it is a fact.