Hurricane Sandy Sets the Stage for Insurance Battles

NEW YORK ( TheStreet) -- The pain following Hurricane Sandy is just beginning as millions of policyholders discover their insurance will not cover a majority of the damage done by the storm.

Most of the destruction from the super storm has been caused not by hurricane winds, but by severe flooding from the tidal surge.

But traditional homeowner policies do not cover floods. Flood insurance needs to be purchased separately from the government's National Flood Insurance Program.

This may come as a rude shock to victims of the disaster, as it did years ago to the victims of the devastating Hurricane Katrina.

At the time, hundreds of policyowners dragged insurance carriers to court, arguing that their policy covered damage caused by wind and that the damage to their homes from the catastophic flood was really nothing more than that caused by "wind-driven rain."

Unfortunately, the law came firmly on the side of the carriers. Courts ruled that so long as the damage is caused by flooding, whether by wind or not, insurers were not liable.

Despite the experience of Katrina and numerous examples of widespread devastation caused by floods, less than 15% of homeowners nationwide have taken up flood insurance, according to industry data.

And as the disaster victims in the NorthEast, where flood insurance is rarer still, wake up to the fact that they are not going to get much from their insurer after paying a rich premium, they are going to try the same argument in court again.

"It is an ongoing saga," says insurance lawyer Frank Darras, who has worked extensively on litigation scenarios following Katrina. "If you are a homeowner, you are going to argue that you have damage caused by wind and wind-driven rain. If you are the carrier, you are going to say the damage was caused by flood, tidal surge or a hurricane, which requires hurricane coverage."

"Anytime you get a big surge combined with wind the big question is what caused the damage," says Bob Freitag of AmeriClaims. As a public adjuster, Freitag works with individuals and businessowners to get the largest settlement possible from the insurance carrier following a fire, flood or other disaster.

While the wind versus water is sure to be a contentious issue given the widespread damage, Freitag isn't sure the debate will be as stormy as it was post Katrina.

"We had much higher winds with Katrina, nothing was left. What you are seeing in New York and New Jersey is not quite the same. Water did not come as far and the winds were not that high."

Others also believe that homeowners won't have much luck winning the" wind-carried water" argument. "Five years ago, you did not have this many video cameras. You see a big wall of water flooding the city and there is nothing left in its wake. It is very difficult to argue it wasn't a tidal surge," says Darras.

Carriers could emerge the winners in the wake of the crisis. While estimates of total damages range between $15 billion to $20 billion, most of the insurers are likely to find the losses manageable. "

The three carriers with the largest property & casualty underwriting business in New York State are all publicly traded: Berkshire Hathaway ( BRK-B) ith a 7.9% of direct premiums written in 2011, followed by Allstate ( ALL) with a market share of 7.7%, and The Travelers Companies ( TRV) with a 6.3% share.

For the Northeast, Liberty Mutual had the highest 2011 market share, with 9.65% of direct premiums written during 2011, followed by Travelers, with a 7.08% market share.

All the major disasters since Katrina have taught the carriers some valuable lessons. Insurers have strengthened and solidified their exclusions from the policy and protected their exposure in standard policies.

"These policies are as clear as mud," says Darras.

Freitag too has his doubts about the effectiveness of the argument.

At first, he was a little perturbed by the decision of some states to waive the hurricane deductible on the grounds that the hurricane has been downgraded to a post-tropical cyclone before it made landfall in New York.

"At first I was encouraged by the waiver of the deductibe,: says Freitag. " But now I wonder if we are going to see insurance companies get out of paying some of the wind damage on that argument?"

Thomas J. Crowley, chairman of the Independent Insurance Agents and Brokers Association expects that there could be "massive appeals" to governors of the affected states to intervene. Perhaps there could be class-action lawsuits that gained favor in Mississippi after Katrina.

But Crowley thinks homeowners will lose the battle. "Bottomline, you are in a low-lying area, and are near the water, you got to get flood insurance," he said.

Experts lament the lack of flood insurance which they argue is very affordable. Flood insurance with the NFIP costs less than $600 a year and gets you coverage of $250,000 for the house. In low-risk areas, the cost could be as low as $129 according to the NFIP website.

Not too high a price to pay, considering that there is a 26% chance of flooding damage in a 30-year mortgage period in high-risk areas, according to the website. Moreover, a 6 inch flood of water can cause damage equivalent of more than $20,000 in a house of $1,000 square feet.

As the program's website points out, disaster relief isn't as easy as it seems. Most relief comes in the form of a loan repayable with interest.

Darras suggests those whose homes have not been completely wiped out by the flood to carefully word their claims.

"I would not use the loaded word "flood"- I would say water damage," he advises. "Trees around my property fell and covered my drains. Or debris from the wind damage broke my pipes. I sure would make that argument rather than say water creeped in, crawled in or flooded my house.

A lot of people make the mistake, saying 'all of a sudden I was in 6 inches of water'. That water came in because of something. Words make all the difference."

-- Written by Shanthi Bharatwaj in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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