Purchasing Insurance: Market Transparency and Other Important Concepts

At the Mississippi Insurance Forum we have identified two main problems with Property and Casualty insurance in the aftermath of Hurricane Katrina:

1. Unfair and predatory claims handling as demonstrated by the unrefuted fact patterns in cases like McIntosh v. State Farm where State Farm threatened to fire their own engineers who found wind damage as the primary cause of the loss rather than flooding. State Farm actually ordered additional engineering reports until they received the “answer” they requested in such cases.

2. A lack of transparency in insurance product pricing, especially in the area of reinsurance.

While we will tackle both issues its worth noting the first has already received a fair amount of press attention while the second has not been addressed in detail except at a few web sites like this one. I suspect the reason the economic concept of market transparency has received such little attention is because it is complicated to explain and understand. I endeavor with this entry to start our readership along the path to understanding these important yet basic economic principles.

First we need to start with the decision to purchase a multi-peril homeowner’s policy and examine the criteria consumers use when selecting an insurer. Think about it, how did you choose your insurance agent and insurer? Did you let your fingers do the walking or perhaps you received a referral from a friend of the agent? Or maybe we thought the ad we saw during the football game was good and we feel safe knowing the local agent in the spot showed up when the house burned down. Maybe as a first time homebuyer you got a good tip from your mortgage broker on who to use. Another good question is why did you buy the policy? Because it was it required by the bank or mortgage company? What about the policy limits, were they set to only cover paying off the mortgage because it was cheaper than insuring the total value? How many times since you first purchased the policy have you evaluated the risks you are paying to insure?

These are all very important questions. My professional experience preparing post Katrina income tax returns with casualty loss is that most people literally are asleep at the wheel when it comes to assessing the risks that may impact them in the future. In fact I submit it is basic human nature to avoid thinking about such unpleasant possible future events. The end result of burying ones head in the sand is invariably bad for the consumer once disaster strikes.

Post disaster hindsight reveals the complete inadequacy of the original criteria we used to select an insurer. For instance, the fact your local State Farm agent is a good guy (mine is for certain) is meaningless when the “good neighbor” refuses to pay for an insured risk. And all the accumulated advertising we’ve seen never prepared us for the very real possibility the good neighbor will force many of it’s customers to use the court system to collect on the policy as a matter of internal claims handling policy.

Had we used good criteria originally to purchase insurance, we would have considered variables such as recent claims handing histories of these companies in our purchase decision. I’ve had people I know off the coast tell me they are not worried about State Farm covering windstorm risks because they are “too high to flood”. Human nature then takes over for a time, refusing to believe that State Farm refused to cover obvious wind damage in Oklahoma City after an F5 tornado struck there in May 1999 or that a jury there found, “that State Farm “recklessly disregarded” its duty to deal fairly with policyholders, doing so “intentionally and with malice” through the use of biased expert opinions after the 1999 tornado.” Perhaps we decide to switch to another insurer such as Allstate only to find out their internal documents describe treating a claimant/customer with “Boxing Gloves” instead of “good hands” and their record in customer treatment in automobile insurance claims appears abysmal. In fact we find out that according to the AM Best, “In the decade after Allstate instituted the McKinsey program in 1995, the amount of money it paid out per premium dollar in car accident cases declined from about 63 cents to 47 cents”. Most importantly we find out the lack of good information the consumer has to evaluate insurers is stunning.

Insurers on the other hand know a good bit about their customers. They know your credit score for instance and will rely on a computer model to determine how your claim is handled. In a previous post on this forum I detailed how insurers spend big money on weather modeling to assess the risk they face. In short most consumers use subjective, sometimes emotional criteria to purchase insurance while insurance companies use objective criteria in how they conduct business. The gap in market knowledge between insurers and consumers is referred to in economics as Information Asymmetry, and is defined as “A situation in which one party in a transaction has more or superior information compared to another. This often happens in transactions where the seller knows more than the buyer, although the reverse can happen as well. Potentially, this could be a harmful situation because one party can take advantage of the other party’s lack of knowledge.”

In future posts we will further examine the concepts of Asymmetric information and how it translates into premium pricing, especially in reinsurance.


Home for Christmas…only in dreams

Since Christmas 2004, many of the people of Katrina Ground Zero have been home for Christmasonly in their dreams.

All do dream. Whatever they called “home” – humble or grand, rented or owned, is gone. Some 14,000 are celebrating yet another Christmas in a travel trailer. Others are sharing space in another family’s home. Many of those able to find temporary housing found little more than a roof over their head.

The emotional and financial toll is staggering and there is no Santa Clause delivering a Gulf Coast version of Miracle on 34 Street for those caught in the crossfire of the “insurance war” or the logjam in Congress over HB3121.

As they have done since Katrina, the people of Ground Zero continue to give to others at Christmas – even when all they have to give is themselves.

Although most had been “slabbed” by Katrina, the remaining members of the Coast Choral – about one-third the number before the storm – gathered to sing their annual concert that first Christmas. Yet unable to replace the music and other items lost to Katrina by Christmas 2007, they continue to bring “Joy to the World of Ground Zero.

In the spirit of Christmas, please remember the people of Ground Zero who will be home for Christmas…only in dreams.


Good Editorial in Todays Clarion Ledger

Here is a well reasoned opinion on the impact of the current legal mess and it’s impact on coast residents seeking justice.

“Katrina lawsuits: Coast residents want justice

The Clarion-Ledger

For Mississippi Hurricane Katrina victims, hope for recovery from the storm took a sickening turn with the charges lodged against attorney Dickie Scruggs.

State Farm Fire and Casualty Co. is seeking to have attorneys with Scruggs’ “Katrina Litigation Group” representing policyholders thrown off a key case because the insurer claims the lawyers have behaved unethically.

Scruggs withdrew from most of his firm’s Katrina cases after his indictment on charges he tried to bribe a judge for a favorable ruling in a dispute over legal fees.

The newly formed group, which includes members of Scruggs’ legal team, is now handling hundreds of cases on behalf of Coast policyholders in “wind vs. water” disputes, alleging the insurer failed to honor claims.

State Farm claims that Scruggs and members of his team have committed “highly unethical acts,” such as illicitly obtaining internal claims records, and have “irreparably perverted the litigation process.”

Scruggs’ indictment has muddied the water for policyholders. The more cases are delayed, the longer the recovery can take – if homeowners don’t just give up or move away. About 14,902 families still are in temporary housing units in Mississippi.

In clarionledger.com’s Forums, under Katrina-related issues, Mississippi Insurance Forum, readers commiserate. Says one: “‘Ain’t life grand?’ For some people, maybe, but nothing’s grand for the people on the Coast that were ‘slabbed’ by Katrina, ‘stabbed’ by their ‘good neighbor,’ and forced to live out a horror story that even Hitchcock would find frightening.

“Life’s not going to be grand for anyone in our state until we get to the bottom of this mess … Unfortunately it’s going to take a long time – longer, I fear, that folks with valid claims can hold on.”

Mississippians have the “want to” for rebuilding. The legal disputes need to be resolved.”

Wind: “Breaking News”

If you missed Sop’s post last Friday, scroll down and take a look and look at the pictures he took after Katrina. Pay particular attention to picture number three. Note his question – How is it that the majority of the houses on this street stood while three houses in close proximity of one another were reduced to rubble?- and his answer – a tornado or mini-tornado – evidenced by the damage to nearby trees.

Some claim there were no tornadoes documented in Katrina as the storm hit and passed over the coastal counties.

Could this be a case where there are two sides of the story and both are true? Let’s visit the University of Illinois at Urbana-Champaign, take a look at a hurricane, and see what we can find out.

Hurricanes initiate from an area of thunderstorms. Once these thunderstorms become a hurricane, an “eye” is located near the center and surrounded by an “eye wall” containing the most damaging wind and intense rain. Tornadoes [are] found within the eye wall and in the spiral bands outside.


However, a tornado’s circulation is present on the ground either as a funnel–shaped cloud or a swirling cloud of dust and debris. In other words, evidence of a tornado will be a damaged area somewhat circular in shape.

The damage Sop pointed out was linear. Nonetheless, it was very real and distinctly different from other wind damage – exactly the type of damage caused by what is called a plough wind.

Plough winds belong to a family of strong, straight-line downburst winds found in thunderstorms. When they strike the ground the air spreads horizontally in a burst of wind, much like water pouring from a tap and striking the sink below.

Plough winds can blow continuously but the damage is usually confined to an area less than 3 km [or approximately 2 miles] across. They are more common than tornadoes and have the power of a twister but the damage pattern looks different – a starburst or more commonly a straight line.

How could the linear pattern of damage in Sop’s picture be the result of anything other than plough winds from the thunderstorms that formed hurricane Katrina?

Ask Sop who paid. “I personally know of at least one such resident who was only paid on their flood policy instead of their private wind policy. That’s right ladies and gents, the bill was on you, the taxpayers.”

Insurance Weather Modeling – Others Have Questions Too

Last week I posted a couple of different links to stories on the use of weather modeling in setting insurance rates. I shared some questions that are stuck in my mind on the reliability of the long range forecast. Given the magnitude of coastal insurance rate increases since Katrina struck, the issue of whether consumers of insurance are being treated fairly on price and the use of weather modeling to justify drastic price increases was addressed last week as well in the Boston Globe.

HOME INSURANCE rates are skyrocketing on Cape Cod, the islands, and in other coastal areas. Driving the increases are concerns by insurers that a major hurricane could wreak the kind of devastation that hurricanes have brought to other parts of the country. Some companies have simply stopped insuring in shore areas, forcing homeowners into the state’s FAIR Plan, the insurer of last resort.

But Massachusetts need not simply accept this price spiral, because the state has options for making insurance more affordable. One is for state officials to take a closer look at the models of hurricane devastation that insurers use to justify their higher rates.

Companies hold these “black box” models closely, but a legislative commission recommended earlier this month that state officials seek access to them. The panel called for a new “independent public entity” to study the reliability of the models. Two members – state Senator Robert O’Leary of Barnstable and state Representative Eric Turkington of Falmouth – went further, calling for the state to create its own model or require that any private model be open to review by the attorney general. Such efforts make sense; rates for a product that homeowners have little choice but to buy ought to be based on defensible criteria.”

Merlin Law Blog

Folks, this Cowboy has been letting the totality of this mess sink in and then I read this comment on David Rossmiller’s blog that appears to sum things up well:

“For those scoring at home:
1.Maria Brown blew the whistle and sued Nutt & McAlister of SKG, alleging sexual harassment, hostile work environment, and mentions N&Ms failure to turn over records to Judge Acker.
2. Scruggs and Bartimus, Frickleton, Robertson & Groney have filed suit against State Farm, Nationwide, Allstate, USAA, and several engineering firms for overbilling the federal government for Hurricane Katrina damage.
3. Jones, Funderburg have sued Dickie Scruggs, Don Barrett, Scruggs law firm, Barrett law office, Nutt & McAlister, and Lovelace law firm over payment of disputed funds. Jones and Funderburg have asked to court to take control of SKG assets.
4. United States of America v. Dickie Scruggs, Zach Scruggs, Sidney Backstrom, Tim Balducci, and Steve Patterson for attempting to bribe Judge Henry Lackey.
5. Balducci blew the whistle against Scruggs & Co, and pleads guilty to bribing Judge Lackey.
6. Jim Hood, AG, sued State Farm for breach of the settlement agreement.
7. State Farm sued Jim Hood, AG for breach of the settlement agreement.
8. State Farm sued to disqualify Dickie Scruggs from Katrina cases.
9. E.A. Renfroe & Co sues whistleblowers Cori and Kerri Rigsby for violating the Alabama Trade Secrets Act and breaching confidentiality agreements.
10. Judge Acker appoints special prosecutors to prosecute Dickie Scruggs with criminal contempt related to the E.A. Renfroe suit against the Rigsby sisters.”

Except this post really sums up nothing about the real insurance issues or insurance law. Notice folks the implied threats against the Rigsby sisters, who by all accounts have had no involvement with the allegations against Scruggs. Most of what makes the so called insurance blogs these days is either old news, or half the story as Mr. Rossmiller himself pointed out in an rare moment of balanced commentary.

Well folks, here on the Mississippi Insurance Forum you’ll get just insurance talk; straight talk in fact, the kind that even a Cowboy can understand without a bunch of frue-frilly legal double talk. That’s probably why this Cowboy-farmer enjoys reading Mr. Chip Merlin’s insurance law blog. While the talking heads sit in places like New York City and Portland Oregon ole Chip was over New Orleans way at the Fifth Circuit Court of Appeals listening to the actual arguments. He presents an analysis of the recent Broussard arguments that you won’t find anywhere else and he makes it understandable. I highly recommend it.

In his reply to me there he summed up why you can’t trust a carpetbagger with this issue. Like in most cases it’s what these talking heads don’t tell you that matters most. Remember folks, State Farm threatened the engineers with termination because they found 2 instances of wind rather than flood in over 90 reports. Whadda you think the “boxing glove” hands people would do to a lawyer that doesn’t tote the company line?

“Claims Dumping” – A Primer

There is an informal brotherhood of those slabbed and/or destroyed. Among that brotherhood all know at least one person whose house was destroyed by wind but was only paid their flood coverage (if they had it). We are not professionally trained licensed engineers but in some cases the cause was most evident, such as in the picture of this house in Lakeshore which was also flooded but not subjected to wave action.

This is a picture of the house across the street also smashed and flooded. The window in the house was removed by the owner as they salvaged some of their contents from the interior. In both cases the contents of these houses stayed with the house instead of being swept from it like so many others.

This picture finishes the story, notice the house down the street left standing. All the homes on the street were built within a year or so of each other by the same builder. Also notice the hole in the roof of the house down the street that stood. How is it that the majority of the houses on this street stood while three houses in close proximity of one another were reduced to rubble? A tornado or mini tornado is the cause. There was a line of snapped trees that lined up perfectly with the woods across the field from the destroyed houses on this street and through to the woods on the other side. I personally know of at least one such resident who was only paid on their flood policy instead of their private wind policy. That’s right ladies and gents, the bill was on you, the taxpayers.

The Right Side of Hurricane Katrina

The right side of a hurricane is the wrong side to be on.

You could take that sailor’s warning to the bank after Katrina – if there had been one after Katrina.

The weather wizards say “ground zero” is where the eye of a hurricane makes landfall.

Katrina’s eye passed just to the right of the Louisiana-Mississippi state line in Hancock County, Mississippi. We’re the orange spot on the map.

Of course, it didn’t take the wisdom of a wizard for any of us to figure out we were “ground zero”. All we had to do was take a look around and see nothing – “zero” – on the “ground” escaped Katrina’s wrath.

There’s still more nothing than something down here, rebuilding is stalled in the court, the economy is heading further south, and some are starting to wondering if we haven’t hit “Ground Zero for Hope”.

The right side of an insurance claim is the wrong side on after a hurricane.

When you purchase a homeowner’s policy with hurricane coverage, you expect the insurance provider to know what a hurricane is and what it does. If they don’t, you’d sure expect them to look it up and not make it up. Nonetheless, make it up appears to be exactly what some did.

All 82 Mississippi counties were included in the disaster declaration and 60% (49) were eligible for full federal disaster assistance. The insurance folks north of the Coast didn’t seem to have a problem understanding that water damage is covered if the wind blows a hole in your roof and water gets in your house.

Most of us didn’t even have a roof after Katrina blew through here. You would think, then, it wouldn’t be hard for the ones they sent down here to figure that water damage was done before the surge followed Katrina inland. Actually, it appears they did figure it out – probably right about the time they started trying to figure out ways to get by without paying when all that Katrina left behind was a slab.

The wrong side of a hurricane to be on is the one it takes a lawyer to make right.

Insurance 101

Here are a few key definitions and concepts which might help those new to the insurance forum more rapidly understand the nature of the insurance problems our society faces. I will add more as time allows and hopefully we might combine them with other concepts.

What is Insurance?

One definition of insurance is a system to make large financial losses more affordable by pooling the risks of many individuals and business entities and transferring them to an insurance provider for a premium. More basically insurance is the process of the assumption of risk from one party to another for a fee.

The key to understanding insurance is the concept of risk assumption. In insurance terms risk is the chance of loss of that which is insured.

For the purposes of this web site the main type of insurance studied is property/casualty in general and catastrophe insurance (CAT) in particular. ISO defines a catastrophe as an event that causes $25 million or more in insured property losses and affects a significant number of property/casualty policyholders and insurers.

What is the role of insurance providers?

Insurance providers core function in society is that of helping to manage risk. Insurance plays a vital role in helping individuals and businesses prepare for and recover from the potentially devastating effects of a disaster such as a catastrophic hurricane or earthquake.

Insurance providers help society pre-pay for their risk needs. Catastrophic insurance providers have a special role in helping entire communities pre-pay for their disaster needs. Because their losses are more volatile the property/casualty insurers invest largely in high-quality liquid securities, which can be sold quickly to pay claims resulting from a major hurricane, earthquake or man-made disaster such as a terrorist attack.

Who are the leading providers?

Data from the National Association of Insurance Commissioners (NAIC) identifies the 10 leading writers of non-governmental property/casualty insurance by direct premiums written during the 2006 calendar year.

NAIC percentages were based on the U.S. total including territories before reinsurance transactions, excluding state funds.

  1. State Farm Group 10.0%
  2. American International Group 7.6%
  3. Zurich Insurance Group 5.6%
  4. Allstate Insurance Group 5.6%
  5. Travelers Group 4.4&
  6. Liberty Mutual Insurance Group 3.7%
  7. Nationwide Group 3.2%
  8. Berkshire Hathaway Insurance Group 3.1%
  9. Progressive Group 2.9%
  10. Hartford Fire & Casualty Group 2.4%

It should be noted the federal government is considered by many CEO’s of insurance and individuals as the insurer of last resort. The federal government is also the sole insurance provider for basic flood coverage in the United States.

How’s the Weather – Model?

Today we begin with the weather forecast but not just any weather forecast mind you. First off is this story from Reuters which proclaims our property and casualty insurance rates in the US will remain high due to the massive hurricane that is surely coming to destroy us all. As a result, the article concludes our P&C rates will continue to increase. So proclaims the popular press which by the way has never met a scientific story on global warming and Hurricanes they failed to butcher.

So what’s so complicated about the long range weather forecast? Easy, these high priced models that are periodically publicly released (and butchered) aren’t really worth the paper Reuters wrote the story upon:

One big problem is that catastrophe models are not reliable predictors of when or where a monster hurricane is going to strike, according to Karen Clark, vice chair of AIR Worldwide, one of the leading modeling firms.

“A model is just that—a model. It is still based on many simplifying assumptions, with a high degree of uncertainty,” she said. “It can tell you, given where you have your insureds, what the maximum probable loss would be should a storm of a certain strength hit a certain area, but the question of frequency is more vexing.”

However, she noted that “while there is no consensus at all on climate change and the frequency of hurricane landfalls, most scientists agree that when storms do hit these days, their intensity is likely to be greater and will cause more damage.”

So here, in the National P&C Underwriter, an insurance industry trade publication, we discover a deeper truth about these climate models and as borne out by the last two Hurricane seasons which have also come complete with prediction of coastal doom; namely that weather models are notoriously unreliable predictors of when or where a windstorm may strike.

This basic fact does not stop insurers, especially those in reinsurance from paying big bucks for weather forecasting as most have their own in house forecasting units like this one. We submit that despite the limitations of weather modeling there has to be good reason the insurance industry keeps such a close eye on the weather. However, insurance seems to be one business that profits handily even when they completely miss on the extended forecast like these past two years.