September 28, 2005

Retroactive Insurance: Homeowner's Dream and Actuary's Nightmare?

There are a lot of solutions floating around with all the debris from Katrina and Rita. Here's one: take all the people without flood insurance whose homes were destroyed and offer them retroactive coverage. They pay ten year's worth of retroactive premiums (paid for out of the settlement) and they collect up to the policy maximum of $250,000. They use this money (minus the retro premiums) to rebuild their homes. These homeowners also agree to continue to pay for flood insurance as long as they own the property. (In my cynic's eye, I can see a flurry of sales to third parties, voiding the indefinite commitment to secure flood insurance in the future. After all, hurricanes don't strike twice in the same place, do they?)

This is a pretty strange notion: buying insurance after you already know you need it. I can hear my actuary friends saying, "Hey, wait a minute. You can't do that!" Well, these are special circumstances, so maybe you can. The problem is, someone has to provide the capital, so that communities can rebuild.

AM Best addresses the fallout from the move in Mississippi to require insurance companies to cover flood damage, the language of the homeowner's policies be damned. "Any sort of move in this direction is an affront to the constitution and sets a horrendous precedent," says Bob Hartwig, chief economist with the Insurance Information Institute. "You cannot have a capitalist economy where contracts are ignored."

Louisiana's insurance commissioner, J Robert Woooley, also thinks that the Mississippi approach is a bad idea. If a law compelled coverage where the contract voids it, there would be a rush of "first one to the door" claims. "If you don't get there first, you're going to get nothing..." Because your insurance company might just crumble under the pressure of these unanticipated payouts.

No Sympathy for Insurers
Famed litigant Richard Scruggs (we've met him before, we'll see him again) has no sympathy for the insurers. "If an insurance company or two has to go broke, I'm sorry. I'd rather see an insurance company go broke than the tens of thousands of my friends and neighbors in Mississippi, Alabama and Louisiana go bankrupt." (Perhaps it does not occur to Scruggs that some of his neighbors might work for insurance companies!) The stakes are enormous -- not just in this particular instance, but in any foreseeable circumstance where public need is perceived to supercede the language of a contract.

The aftermath of the two hurricanes is an unprecedented catastrophe. The scale of the damage raises new and largely unresolved questions of liability. And as in so many of our recent blogs, one of the most compelling questions is relatively simple: "Who pays?" A simple question with no clear response. It's likely to be years before we know the answer.

Special thanks to blogger Martin Grace at riskprof.com, who has been tracking this ongoing saga.

| 1 Comment

1 Comment

Actually, "retroactive insurance" might appeal to your actuary friend. Its mostly used in sophisticated commercial contexts, when a major disaster has struck and the insurer on the hook is short of reinsurance and/or surplus. Reinsurers with deep pockets can and do accept a hefty premium to retroactively insure the loss, figuring that they can make some money off of the "float" during the time required to adjust the loss.

Another variation on the same theme is the little-understood "finite insurance," by which a risk bearer transfers a book of business or a big loss or exposure to another, along with a big chunk of cash (perhaps equal to the forecast liability). By doing so, the ceding company may be able to record "reinsurance recoverable" and clear its books of the extraordinary loss, converting an income sheet embarassment into a balance sheet haircut.

Some publicly held insurers have even been accused of using "finite insurance" to pump up earnings at the expense of financial soundness.

For more about "finite insurance," recently highlighted by Atty. Gen. Spitzer and others in their investigations of AIG and others, there's a backgrounder I tapped out about a year ago at: http://www.dougsimpson.com/blog/archives/000351.html

DKS

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This page contains a single entry by Jon Coppelman published on September 28, 2005 2:10 PM.

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