The Magazine

Reaping the Whirlwind

Mississippi's insurance problem is everybody's.

Mar 26, 2007, Vol. 12, No. 27 • By ELI LEHRER
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The Broussards' situation was typical of homeowners' complaints. Faced with an entirely destroyed house, the Broussards filed a claim. State Farm said that flooding--explicitly excluded from its policies--had caused the damage and provided expert testimony in court to back this up. The Broussards claimed their home collapsed because of wind damage that State Farm should have covered. The problem is, there's almost no way to know what caused the damage. Senter based his ruling on the common law principle that courts should resolve insurance-contract ambiguities in favor of the insured. A proposed class action settlement that soon followed seems likely to get both federal and state approval: Under it State Farm and other insurers will likely have to pay billions in claims that they never expected to.

In the long term, this situation is untenable. Faced with the risk of similar payouts, State Farm and other large insurers will have little choice but to continue their pullback. Attorney General Hood has proposed following the lead of Florida, New Jersey, and a handful of other states and forcing State Farm to sell home owners' policies if it sells any other type of policy in the state. Even he, however, calls this a "temporary, short-term fix to stabilize the situation." Barbour has pooh-poohed the idea, and it seems unlikely to move forward.

Legislation to bail out Mississippi's wind pool may offer a fix only until the next major storm. "Mississippi is the freckle on the end of the tail of the dog," says Larry Cox, director of the University of Mississippi's insurance program. "We just aren't big enough to support [a wind-insurance program]. In the long term, it needs to be multi state." Cox argues that an all-South wind insurance pool might work, and Mississippi insurance commissioner George Dale has expressed interest in the idea. Tom Quaka, the president of Mississippi-only Brierfield Insurance, fears that even an improved Mississippi wind pool "will need some more changes after the next big storm." Even a multistate wind pool might eventually need a bailout.

Thus, an all-government solution looms. Rep. Gene Taylor, a Democratic congressman from Mississippi, has started pushing a bill to create federal "multi-peril" insurance, adding wind storms to the federal flood program. For all intents and purposes, this would displace a massive part of the private homeowners' insurance market everywhere. Although it has little chance of moving forward at the moment, the bill has attracted an ideologically mixed set of sponsors including extreme liberal Maxine Waters of California and Republican rising star Bobby Jindal of Louisiana.

A Congressional Research Service report has sharp criticism of Taylor's proposal. In particular, CRS insurance analyst Rawle King observes that a new federal insurance program would displace private wind insurance even in places where such coverage "is cheap and plentiful" and would impose an enormous unfunded mandate on taxpayers. King points out that Congress would be tempted to keep yearly premiums low and then ramp up "emergency" spending to bail out the program after disasters.

But proponents of an increased federal role raise a valid point: In true catastrophes like Hurricane Katrina, it's nearly impossible to determine exactly what caused damage. In areas with small numbers of insurers, supposedly "independent" adjusters do most of their work for a single company, creating a potential conflict of interest. The very existence of government flood and wind pools creates a moral hazard: Under the current system, it's possible for insurance companies to collect premiums for "safer" coverage while sticking taxpayers with the serious bills.

The alternatives to an ever-larger government role involve difficult choices. Over 20 percent of the properties currently in the federal flood insurance program could not be built today with ordinary financing and insurance. At least in Mississippi, the same goes for many properties in the state wind insurance pool. A rational market would likely demand unaffordable yearly premiums for these "nonconforming" properties. Unless lenders and local governments do more to encourage flood insurance purchase, furthermore, premiums would likely rise sharply in a private market even for safer but still flood- and wind-prone properties.

Hazard mitigation efforts--ranging from razing houses to purchasing flood prone land and transforming it to parks--offer some hope of saving nonconforming properties. Letting insurance companies apply for federal charters like those offered to banks could also lead to a more healthy spreading of risk, more regulatory competition, and, thus, lower long-term rates for "conforming" but still flood-prone properties.