— Six years after Hurricanes Katrina and Rita battered the U.S. Gulf Coast, the Eastern seaboard is bracing for a wallop from a now Category 3 Hurricane Irene. But homeowners aren't the only ones battening down the hatches; insurance companies are also taking numerous steps to make sure a strong storm season doesn't blow them away.
Unfortunately, this often comes at the expense of the very homeowners who are counting on their insurance policies to protect them from a financial disaster caused by broken windows, fallen trees and other acts of nature.
"The insurance industry does not like to have to play claims. The idea is to make a profit, so they use many different ways to avoid having to pay claims," says John Garamendi, California congressman and former insurance commissioner for that state. Although his constituents' property perils tended more towards earthquakes and wildfires, the business practices are similar, he says.
The property-casual insurance sector did see net income drop by about $1.1 billion in the first quarter of this year as compared to a year ago. But insurers are still financially sound with aggregate capital of $565 billion, according to Robert Litan, vice president of research and policy at the Kauffman Foundation.
"In the aggregate, the industry is very well capitalized, as long as we have no more than one big hurricane," he says. "The real problem is if we have a bad hurricane season with two landfalls of Category 3 or 4 each doing $30 [billion] to $40 billion in damage."
If that happens, Litan predicts some smaller insurers will probably fail, in which case homeowners would have to rely on the money available in state guarantee funds.
The recent turbulence in the stock market also has hurt insurance companies, albeit indirectly. When investors pull out of equities, they tend to park their money in so-called safe havens, such as short-term U.S. Treasuries. Unfortunately, these are insurers' preferred tool of choice for managing their money.
"The thing that's the biggest headache is there's virtually a zero interest rate on short term securities," Litan says.
Robert Hartwig, president and chief economist of the Insurance Information Institute, told CNBC in an interview Thursday that Irene is likely to be a "multibillion dollar storm," although probably not on the level of Katrina or 1992's Andrew.
Category 5 Andrew was an expensive learning experience for insurers; that year, the industry paid out more in damages than it took in from premiums, a highly atypical occurrence. Companies began quietly making changes to their policies, but many homeowners didn't notice them until 2005, when a strong hurricane season caused widespread devastation.
"They've mastered hurricanes," says Robert Hunter, director of insurance for advocacy group Consumer Federation of America. "They've mastered them basically by laying it back on the consumer, and on taxpayers by way of state pools."
In 2005, many homeowners discovered perhaps the most insidious of the new clauses insurers had begun employing: the anti-correlation causation clause.
It sounds like a mouthful and it works like this: If you have a covered claim (a hurricane sends a rouge tree branch sailing through your window) and that occurs in conjunction with an uncovered claim (your kitchen fills with a foot of water due to flooding), since floods are excluded from standard homeowners' insurance coverage — the company wouldn't pay out on the "covered" claim.
Americans filing claims after the 2005 storm season were generally shocked to learn about this clause, which CFA's Hunter says is like having "a little trap door in your policy." Instead of protecting homeowners, the clause shields insurers' assets from claims.
In the wake of 2005, companies also litigated vigorously to defend the argument that a wind-driven storm surge should be considered a flood rather than the result of wind damage. In the case of the former, the homeowner would be left holding the bag for repairs.
Most judges sided with insurers on that, but the companies didn't want to take any chances next time around, so they've been spelling out more explicitly in recent years that storm surges fall under the uncovered "flood" category.
This is but one of many additional changes insurance companies have made to homeowners' policies, and these adjustments almost always put the homeowner at a disadvantage, according to Daniel Schwarcz, associate professor at the University of Minnesota Law School.
Exploiting consumer ignorance
A recent report authored by Schwarcz found "empirical evidence that firms may be exploiting consumer ignorance to draft inefficiently one-sided contracts," according to the introduction.
Schwarcz gives a couple of examples.
"There are some carriers that have changed the nature of the water coverage so it's not provided on an all-peril basis." All-peril used to be standard language, and it meant that everything was covered except a few things that were explicitly excluded. Now, polices are more likely to have what's called "named peril" coverage, which means only damages that are specifically listed will be covered.
"They've shifted the burden onto you," Schwarcz says, since it's the homeowner's responsibility to make the case that damage occurred in the context of a covered event.
Insurers have also limited their liability for other storm-related payouts. For instance, if high winds bring down a tree on your property, insurance might only pay to remove it if it's blocking your driveway.
Homeowners have to deal with another potential problem in their policies, warns Garamendi.
"There is a constant problem of what we call underinsurance. The home is probably not insured for sufficient value to rebuild the home" if the entire structure is destroyed. Some homeowners have what are termed "cash value" policies, which means the company will pay the market value of your home.
In general, but especially in today's real estate market, that's less than the cost of rebuilding from scratch. Even people with policies that stipulate that their coverage is for rebuilding costs may find themselves short of funds if the house has to be rebuilt in compliance with stricter building codes than when it was initially constructed.
Homeowners would do well to carefully examine the fine print of their policies to see exactly what they say — if they still have policies to examine.
Insurance companies have dropped homeowners in areas not traditionally associated with major storm risks such as coastal Connecticut and other parts of the Northeast, or they've raised premiums significantly.
As a result, states often wind up stepping in and operating as a kind of last-resort insurer, a situation that both Hartwig and Litan warn is precarious. Florida's state insurance program has been criticized in the past for financial instability, although the 2011 hurricane season seems to have spared the Sunshine State thus far. Hartwig told CNBC there is current concern about North Carolina as well as Massachusetts.
Litan says indirect government support of homeowners insurance would help alleviate the headaches for homeowners left scrambling for coverage, but he acknowledges that such an entity would face the same vulnerabilities as Fannie Mae and Freddie Mac if underwriting standards weren't kept high.
Other experts, such as the Wharton School's Howard Kunreuther, have suggested making insurance policies long-term and rolling them into a homeowner's mortgage.
Without some sort of overarching solution, though, Litan offers a gloomy prediction: "Only rich people are going to be able to live on coastal areas, if anybody at all."