Given all the controversy about wind versus flood coverage following Hurricane Katrina, I invited Bob Hunter, director of insurance at the Consumer Federation of America, to lay out his arguments for why he believes there is an inherent conflict of interest when insurers must settle both types of claims--one type they cover and one they do not. Mr. Hunter is well acquainted with the program, having dealt with the problem first hand as a former federal insurance administrator. Read what he has to say and let me know what you think of his suggested reforms.
Flood Program Must End
Insurer Conflicts Of Interest
BY J. ROBERT HUNTER
There has always been an inherent conflict of interest in private insurance companies settling claims for the National Flood Insurance Program. It has also been difficult to define fair compensation for privately provided services for the NFIP in a manner that is consistent with the federal government’s duty to make sure costs are minimized for the benefit of taxpayers who subsidize the program.
Because of serious problems with both claims and fees, private insurers were removed from the NFIP in the 1970s. (Click here for a brief history of these issues.)
Awareness of these earlier problems is important because it shows the issues plaguing the NFIP today are endemic and long-lasting—not unique to the aftermath of Hurricane Katrina.
In the 1980s, President Ronald Reagan allowed insurers back into the NFIP through the “Write Your Own” program, where private insurers sell federal flood insurance along with private homeowners and business property coverage.
Hurricane Katrina exposed the severe conflict questions that arise when a private insurer settles both wind and flood claims. The conflict is obvious—each dollar the adjuster finds to be caused by wind comes out of the insurer’s pocket, while each dollar found to be flood comes out of the taxpayer’s pocket.
Worse, the insurer gets fees for settling the flood insurance claim that go up as the size of the payout goes up. The temptation for insurers to determine greater flood damage than is justified—and less wind damage—is great.
Lawsuits abound. In one, a WYO insurer allegedly paid flood insurance dollars even though no floodwaters entered the building. Other suits allege hundreds of claims were mishandled to the insurer’s benefit.
The best proof that WYO insurers are more worried about their own interests than that of the taxpayers is many WYO carriers adopted the anti-concurrent-causation clause in homeowners policies.
The blatantly anti-consumer clause works like this: If an insured wind claim happens, and at about the same time a flood claim occurs, the wind coverage is voided and the insurer pays nothing for wind (but will pay the flood claim). Insurers claim the legal right to revoke wind coverage because flood damage occurs, even for distinguishable flood damage occurring hours after the wind damage happened.
The use of the ACC clause by WYO insurers exposes taxpayers to huge potential liabilities not anticipated under flood rates, by making it more likely the NFIP will end up paying for at least some wind damage.
Other conflict questions have arisen after Hurricane Katrina.
WYO insurers get paid fees for handling flood insurance policies and claims—fees that appear to be excessive.
NFIP pays insurers an expense load based on the average costs for underwriting, policy writing and advertising, as well as taxes and general expenses in five property lines. Right now, that average is about 16 percent. To this is added a 15 percent commission allowance, paid to insurers regardless of whether an agent or broker receives a commission. A 1 percent “addition” is also paid (2 percent if the WYO insurer meets production goals).
On top of that, the insurer is reimbursed for allocated claims adjustment expenses (such as attorney and adjuster fees) and receives 3.3 percent of the amount of claims for unallocated claims adjustment expenses.
Overall, the overhead for the WYO companies approaches 40 percent, which is outlandishly high for insurers merely adding flood coverage to a homeowners policy.
REFORM PROPOSALS
There are several actions Congress can take to improve this situation, such as:
• Study whether going back to a direct program administered by a competitively bid contractor would save money.
• Eliminate conflict-of-interest questions, in part, perhaps, by bifurcating claims from policy service—using a contractor to do the claims and WYO insurers to service and sell flood insurance policies.
• Bring competition to bear in setting fees—perhaps by having competitive bids for regions of the country, or allowing insurers to discount the expense portion of the premium. This would allow insurers to compete for flood insurance market share by cutting fees.
• Require FEMA to advertise which insurers offer the lowest costs to help consumers shop and encourage other WYO companies to cut flood fees and premiums.
• Consider removing Computer Sciences Corp. as the contractor, data collector and auditor of the WYO Program. CSC is a major supplier of services to insurance companies, and this appears to be another conflict of interest that needs to be rectified.
• Set a standard for participation as a WYO company that forbids an insurer from using a policy clause like ACC that has the effect of shifting privately insured claims into the NFIP.
• Require a WYO company to use the best deal it has for its own costs when paying flood insurance—for example, no more charging the NFIP more for materials than the insurer is paying for wind damage.
Comments (5)
Bob Hunter needs to do less 'blasting' and more 'cogitating'. His misunderstanding of the anti-concurrent-causation clause causes him to arrive at terrible conclusions.
Mr. Hunter addresses the conflict when one insurer handles both the flood and the non-flood adjustment. He says "each dollar the adjuster finds caused by wind..." These are key words.
In every adjustment caused by 'mixed perils' it is the duty of the adjuster to separate the damages. Always has been, always will be. It is when the adjuster is pressured or corrupt that the system goes awry.
Mr. Hunter doesn't like that the NFIP fees are on a sliding scale (the bigger the loss, the higher the fee). Come on, Bob, let's get real. That's the way things work.
As for the anti-concurrent clause, Mr. Hunter goes on to say, "The blatantly anti-consumer clause works like this: If an insured...." What follows is a typical example of what happens when an ill-informed bureaucrat pontificates. Wrong conclusions are reached and specious cures are proposed.
1.) Appoint a contractor to oversee the program. (Been there, done that, it didn't work then, won't work now).
2.) Bifurcate claims. (Good idea, but back to the same question, who should handle the NFIP claims? A contractor? Been there, done that, It didn't work then, won't work now).
3.) Having competetive bids for different parts of the country. (Looks like WYO is here to stay--even with all of its evils.)
4.) Cut fees (great idea!)
5.) Remove Computer Sciences Corp. because "CSC is a major supplier of services to insurance companies". (Since when does that disqualify anyone and who do you suggest replace them?)
6.) Forbid WYO insurers from using the anti-concurrent causation clause. (No! No! No! The ACC clause is a valuable and NECESSARY clause when PROPERLY INTERPRETED).
7.) No more charging the NFIP more for materials than the insurer is paying for wind damage. (Great idea. As a matter of fact, any company or individual who does that opens themselves to questions of integrity or criminality.)
In summary, the adjuster decides whether it is wind or water damage. The adjuster decides which company pays what amount. If they can't do that properly, fire them. In some cases arrest them. A lot of this perceived 'conflict' would come to a screeching halt!
Posted by James P. Reilly | August 11, 2007 1:51 PM
Posted on August 11, 2007 13:51
Mr. Hunter is right on the mark. This is never going to stop until the politicians stop letting the industry write the legislation.
But lobbyists have made inroads into both the Republican and Democratic parties, such that reform is unlikely. That is unless the industry doesn't stop such blatant abuse of the system.
Posted by Tim Tango | August 11, 2007 3:16 PM
Posted on August 11, 2007 15:16
Unfortunately, the suggestions of Mr. Hunter and the response from Mr. Reilly are simply nibbling at the fringes of a systemic issue, which is that the industry needs an all-perils policy, with a percentage of wind and flood loss being covered by the federal government IF the loss is as a result of a named catastrophe, as determined by an independent panel established for that purpose.
This approach eliminates structural conflict, provides a vehicle for needed coverage to property owners, enables insurance companies to equitably price coverage, protects them from excessive losses, and spreads the "excess" aggregate risk more tranparently across the total taxpayer base, which is where it ultimatly ends up anyway.
In addition, this approach is non-disruptive to the insurance industry, non-threatening to the political arena, and certainly offers a needed benefit to the consumer.
Posted by Edward Kalbaugh | August 13, 2007 5:18 PM
Posted on August 13, 2007 17:18
Re: Mr. Reilly's comments:
1. There is no question some insurers pushed as much of a claim off on NFIP as they could get away with. In cases involving storm surge and other wind-driven flood, it's always going to be difficult to absolutely separate the damage caused by each, but clearly some pushed as much off on NFIP as they possible could, to save themselves money on the wind claim.
2. The anti-concurrent-causation clause is one of the most despicable things I've ever seen the insurance industry do in my 38 years in the business. And how did 48 out of 50 state insurance departments approve it?
If they are voiding the wind coverage if there is flooding, why doesn't the clause also say we'll give you back all your windstorm premium if we invoke this clause? (Not a serious suggestion, by the way.)
And what of those who don't purchase flood because they aren't in a designated flood plain (the only reason 99.99 percent of people buy it)? Is their windstorm coverage voided when wind and surge gets them (current flood maps and zone definitions do not contemplate flooding from surge, only resulting from falling water)?
How do you stop this? Difficult. It's often just a judgment call and different people will have different judgments on the same situation.
But, if there is a pattern of overemphasizing the flood portion, then we need sanctions. This will involve a long and involved process after the losses, but clearly is needed.
3. Bifurcated claims settlement: We have already seen how bad an idea that is, each adjuster trying to push as much off the loss on to the other, when it's often a matter of opinion only.
Solution: Flood becomes another peril in the property policy, with that peril reinsured back to the NFIP. Get rid of concurrent causation.
Remember, the most important point is to be fair to the insured. Everyone forgets this minor point.
The field adjuster settles the entire claim with the insured, with no hassle over allocation to peril (NFIP limits, etc. will need to be increased to make this work, or we get Trent Lott underinsuring for flood, again, then screaming that he's been cheated).
Someone else, sitting in a cozy air-conditioned office away from the damaged area, reviews the single adjuster's evidence and suggestions, and determines the peril allocation, with the company and NFIP overlooking to make sure it's as fair as is possible.
4. What does Computer Science's administering the program have to do with it? Does someone think they, because of their expertise at administering, are mishandling and "maladjusting" the claims? How, exactly?
5. There needs to be some real teeth put into NFIP, so that taxpayers are not subsidizing people building in areas prone to flood. Quite simply, if a building is already in a recognized flood plain with frequency (every 50 years?), we'll pay for it once. After that, they are on their own.
5. Flood zones need to be re-defined to take into account flooding from storm surge.
6. Limit for flood should equal limit for wind, fire, etc. That'll slow Trent Lott and others of his kind who don't insure to value for flood, then want the rest of us to make them whole.
Mr. Reilly needs to look at reality more closely.
Posted by Bill Lockhart | August 13, 2007 5:50 PM
Posted on August 13, 2007 17:50
Has Mr. Hunter reviewed the fee schedules for 2005 and the emergency claim expediting order by NFIP, which limited the fees for the carriers and claim handlers, before making comments that there was financial incentive by carriers to move the damages to flood?
I can assure you the wind fee schedule for any carrier would have far exceeded the fees in this NFIP order:
http://bsa.nfipstat.com/wyobull/w-05054.pdf
Deborah Moroy, AIC, IIA
www.dimechimes.wordpress.com
Posted by D.K. Moroy | August 14, 2007 7:48 AM
Posted on August 14, 2007 07:48