Excerpt: Profits of Denial by Steve Hochfelsen
Nothing Like a Good Neighbor
Hurricane Katrina pummeled the Gulf Coast in August 2005. The monster Category 5 storm caused $125 billion in damage, killed more than 1,800 people, and devastated the City of New Orleans and parts of Mississippi. For those of us who had spent many celebratory days enjoying the New Orleans culture and frivolity, the scene was devastating. Yet not as devastating as it was to those who lived there. Their homes and businesses were flooded, overrun with disease, vermin, and death. In its wake, the powerful hurricane left another nightmare for property owners to contend with: A long and arduous road to recovery.
The destruction was nothing short of apocalyptic. The storm sustained 125 mph winds. It tore off roofs, shattered windows, ripped homes down to their foundations. It pulled off the membrane covering New Orleans’ football stadium, the Superdome, and swept cars off of the highway. Levees burst, rapidly rising floodwaters washed away homes and businesses, drowned people, and spread disease.
Those who remained in the city were in utter despair. Rescue personnel took many days to get there as some residents suffered and died. The raw devastation was laid out on TV screens all over the world. They showed rescuers traversing the streets in boats, passing doors with spray-painted symbols, which indicated how many bodies were left in each home.
The death and destruction were not the only problems faced by those affected by Katrina. Insurance companies, unwilling to shell out tens of billions of dollars in damages all at once, were dragging their feet on providing coverage. The claims process was slow and painstaking for many property owners. Sometimes multiple insurance adjusters were called in to examine a structure. Often, damage that appeared to be entirely or almost entirely caused by wind would be classified as flood damage. Why? The answer is simple: flood damage is excluded from most homeowners’ policies. By finding that flood was the cause of the damage instead of wind, insurers were able to reduce or deny payments for coverage.
Flood vs. Wind
Flood protection in the United States is mostly provided by the government-run National Flood Insurance Program, paid for by the taxpayers. Standard homeowners’ policies available on the private market generally exclude any damage from floodwaters. The government program, administered by the Federal Emergency Management Agency, is supposed to fill the gap. The coverage is underwritten by private insurers, but it is subsidized to some extent by the government. In that way, it can be made available to property owners at more convenient rates.
“Flood” is narrowly defined by legal statutes governing insurance coverage. It refers to the inundation of rising waters or the overflow of streams, rivers, or other bodies or water; or from tidal surges, abnormally high tidal water, tidal waves, tsunamis, hurricanes, or other severe deluge. Floods can also be defined as a “general and temporary condition of partial or complete inundation of two or more acres of normally dry land area or of two or more properties” from the overflow of inland or tidal water, from mud-flow, rapid accumulation of runoff, or the collapse of land along the shoreline.
Not everyone has flood insurance. If you have a mortgage and live in a so-called flood zone, as specified by FEMA, there’s a good chance your lender requires you to have it. However, if you don’t live in a specified flood zone, or if you live in one and don’t have a mortgage, you may not have purchased it.
Katrina victims who had flood insurance found themselves in a bureaucratic nightmare as private insurers sought to avoid paying claims and stick the government program with the tab. It was even worse for those who had no flood coverage at all. When insurance companies sought to wriggle out of paying, this type of victims were often left with nothing.
In Louisiana alone, at least 6,600 lawsuits were filed by Katrina victims against their insurers, the New York Times reported in 2007. One victim had extensive damage to his home’s floors caused by rain after high winds tore a ventilator off from the roof, leaving a huge hole. His insurer labeled his property as “flood damaged,” even though the rising floodwaters had not touched it. Numerous property owners, whose insurers offered only modest payouts that were far from enough to rebuild, were forced to abandon their homes and move elsewhere.
Insurers said they paid $11 billion for damages in Louisiana, but the National Flood Insurance Program covered more than $13 billion. Billions of dollars worth of damages were just not covered. The frustration and despair of victims who struggled to put their lives back together continued for years. Insurance companies systematically stonewalled clients and denied any wrongdoing.
The Rigsby Revelations
Kerri Rigsby and her sister Cori used to work as claims adjusters for an independent adjustment firm called E.A. Renfroe. Following Katrina, they were sent to Gulfport, Mississippi, to work on the State Farm Insurance Company Catastrophe team and analyze damage to policyholders’ properties.
They discovered vast devastation, caused mostly by Katrina’s high sustained winds. They also knew that, although there had been extensive media coverage of flooding related to the storm, the coverage was confined to a relatively small portion of the affected area – namely New Orleans and other low-lying areas in Louisiana and Mississippi.
After evaluating wrecked homes and determining that they had been destroyed by hurricane-force winds, engineering firms were often called in to re-assess the damage. Following their scrutiny, the firms, including Forensic Analysis Engineering Corporation, Haag Engineering, Structures Group, Jade Engineering, and Rimkus Consulting Group inexplicably changed the assessed cause of damage. Suddenly, wind-related damage was classified as water-related. Suspiciously, the engineering companies also worked for USAA, Nationwide Insurance Company, and Allstate, among others.
The firms provided “forensic analysis for insurance agencies for the purpose of categorizing damages as being one type (wind) over another (water),” the Rigsby sisters said in a whistleblower lawsuit filed in federal court in Mississippi. They alleged that the firms provided “materially false engineering reports at the request of State Farm Mutual Insurance for the bold purpose of convincing FEMA to pay property damage claims out of flood insurance rather than hurricane or homeowners insurance,” according to the complaint. This pattern of deception, coming at the expense of both the taxpayers and the policyholders, outraged Kerri and Cori.
Storm surge, or water pushed toward the shore by the hurricane-force winds, can cause extensive flooding by making water levels rise by 15 feet or more. It inundated the coastline when the storm’s eye makes landfall. Powerful winds, however, typically arrive more than seven hours before the surge. The Rigsbys discovered that engineering reports were commissioned by State Farm to say the opposite: that the surge had reached shore before the winds, a conclusion "contrary to science and all normative models of hurricanes in the past 100 years."
“State Farm’s view was that it was better to pay $1,500 for an engineering report if it would save them up to $350,000 on a homeowners claim,” the Rigsby sisters alleged.
The whistleblowers said the company also “directed its employee adjusters and independent contractors to show flood damage whenever and wherever there was any amount of water damage, and to adjust the claim as flood insurance rather than hurricane insurance even though the primary mechanism for damage was wind, not flood waters.”
State Farm allegedly “insisted that adjusters ‘hit limits’ when adjusting flood claims,” to maximize the amount of damage that would be pawned off on the government.
“By employing engineering reports that reallocated losses to ‘flood’ instead of homeowners, State Farm, Nationwide, and other insurers essentially pushed off their responsibility to pay claims onto the federal government,” the Rigsbys said in their complaint.
The sisters disclosed their information to the U.S. Attorney for the State of Mississippi, providing detailed personal accounts of fraudulent conduct. They also gathered additional evidence of fraud by accessing State Farm’s files, showing that the insurer had engaged in crimes including wire fraud and mail fraud, submitted false claims, and destroyed evidence of legitimate engineering reports. The Rigsbys notified State Farm that they had turned over materials to law enforcement officials.
Then the retaliation and intimidation began. Once State Farm was aware the Rigsbys had disclosed its appalling conduct to the Feds, the lawyers were called in. State Farm asked the whistleblowers to discuss matters with its attorneys. The Rigsbys refused and went on vacation. When they returned, State Farm locked them out of the facility where they had been working, had them escorted out by security, and told them they would not be allowed back in the building, according to their complaint.
Their employer, E.A. Renfroe, fired and sued the Rigsbys, seeking to enjoin the use of the documents and asking that they be returned to State Farm. E.A. Renfroe won its request for an injunction, but it was too late. The documents were already in the hands of the Department of Justice. The Rigsbys no longer had any materials to return. Despite knowing this, the adjustment firm sought to hold the Rigsbys in contempt for failing to hand back the materials.
While State Farm and the adjustment contractor won the battle, the Rigsbys, federal and local governments, and policyholders ultimately won the war. The court found that State Farm had committed fraud against the government. The U.S. Supreme Court eventually upheld the ruling. While the case, focusing on just one home in Biloxi, Mississippi, only included a $750,000 award and about $3 million in attorneys’ fees, the monetary impact of the decision proved to be much higher. The court’s findings opened the door for a $522 million lawsuit by the state of Mississippi against the insurer.
Insurance companies sell peace of mind. In exchange for premiums, they are supposed to provide financial assistance in the event of a disaster. Their slogans reiterate this notion. “Nationwide is on your side,” the insurer proclaims in its commercials. “You’re in good hands with Allstate,” a spokesman for this insurer will say, typically in a reassuring voice. And almost everyone knows the motto for State Farm: “Like a good neighbor, State Farm is there.”
Fire and Volcanic Fury
There is nothing neighborly about defrauding government programs and policyholders, and refusing to pay for damages when a hurricane strikes. Nor is there anything “good” about the “hands” that reach up to slap policyholders in the face when it is time to pay a claim. Although egregious, the actions by State Farm and other insurers to minimize their payouts from Katrina are hardly unusual. An entire branch of litigation is devoted to handling instances of bad faith by insurers. These involve insurance companies attempting to wriggle out of providing promised coverage, sometimes by construing ambiguities in language against the policyholder, using sleight of hand to assess property values, or relying on trumped-up engineering reports.
Bad faith occurs all the time, including–sadly–after virtually every major disaster. In 2017 and 2018, for instance, large wildfires raged uncontrollably for weeks in California, incinerating whole neighborhoods. In December 2018, a group of homeowners in Santa Rosa, California, looked to AAA affiliate CSAA for payouts, with disappointing results. The homeowners filed a lawsuit, alleging the insurer systematically provided far too little coverage to rebuild homes in the event of a disaster.
One of the victims, Larry Spanier, was caught by a rude surprise when he discovered his policy capped damages at $1.1 million. His home would have cost more than twice that, at $2.3 million, to rebuild according to the lawsuit. CSAA estimated total rebuilding costs at just $1.3 million.
Part of the problem was a change that had been tucked into policies in 2016, which put homeowners on the hook to a greater extent for large claims, according to the lawsuit. The insurer failed to inform policyholders that it was making that revision. Before the change, CSAA had promised to provide 100 percent of the replacement cost of the dwelling, as estimated by the insurer itself. After the change, the onus was put on policyholders to alert the insurer to how much coverage they would need each year based on current construction costs.
Homeowners complained that these changes were “buried,” and were intended to reduce the total amount the insurer would have to pay in the event of a total loss. As of March 2019, the case was still pending.
The tactic of underpaying after wildfires is well known. In 2005, more than 70 homeowners sued another AAA affiliate, USAA, and State Farm for similarly failing to provide enough to cover rebuilding costs after fires raged through nearly 85,000 acres in a community northeast of Tucson, Arizona. Instead of paying the true cost of reconstruction, which was around $200 per square foot, insurers sought to pay only approximately $90 per square foot, according to the Arizona Daily Sun.
While insurers blamed policyholders, saying they had failed to secure adequate insurance, homeowners alleged that their agents had talked them out of buying more generous coverage. The result was that almost 85 percent of homes in the area were underinsured, according to the policyholders.
After a recent eruption of the Kilauea volcano in Hawaii, numerous homes were damaged and destroyed by lava flow and related fires. Lava, molten rock spewed by volcanoes, can reach temperatures as high as 2,200 degrees Fahrenheit. Insurance providers denied coverage for some of the homes, citing a specific lava exclusion. Homeowners filed lawsuits alleging that the insurance companies and insurance agencies purposely steered homeowners away from comprehensive policies offered by a state program that included lava coverage. Instead, they allege, they were duped into taking policies from the private insurance market that excluded damage from lava flow.
Slapped with breach of contract and bad faith claims, insurance provider Lloyd’s of London capitulated and promised to waive the lava exclusion after the company was sued in a Hawaii state court.
Giving to The Wealthy
Bad faith often impacts wealthy policyholders with expensive luxury homes, for which insurance companies might prefer not to pay. Clearly such actions are violations of the law, but wealthy policyholders tend to have the resources to cover the shortfalls. For people at the lower end of the income spectrum, such actions can be absolutely devastating.
Federal disaster assistance tends to favor the wealthy over lower-income people in the event of disasters, providing higher amounts of relief in the form of low-interest loans, significant tax refunds, and more. According to a 2019 investigation by NPR, people with lower incomes are usually left with much lower amounts of assistance, such as a rental subsidy and limited tax refunds, which makes it much more difficult for them to get back on their feet.
After deadly floods, a woman living in Houston, whose home was wrecked, received barely enough in assistance to keep her family fed. She was forced to live in the spare room of a relative’s home, with her children, a long commute away from her job, until she was eventually evicted because of her struggles to pay rent. When she was finally able to secure another shelter, she had no furniture and was forced to sleep on a disaster-assistance cot for years afterward. This is precisely the kind of nightmarish scenario insurance is supposed to prevent.
When insurance companies fail to pay what they owe, bills go unpaid, people struggle to find a place to live, to replace their belongings, and to secure basic necessities. The mere act of survival can become an exhausting exertion. In short, bad faith by an insurance company can profoundly harm vulnerable families as they endure some of the most terrible ordeals in their lives.
In Connecticut, thousands of homeowners are struggling with a sudden eruption of massive networks of cracks throughout the foundations of their homes. The culprit was a concrete company which poured foundations 20 or 30 years ago throughout the state. The aggregate they used contained pyrrhotite, which is prone to swelling and cracking, often to the point of causing buildings to collapse. The problem could easily cost billions of dollars in damages, with each repair in the range of $200,000 or more. Insurers have so far largely denied coverage, alleging that the problems fall under exclusions related to foundations and construction defects. Dozens of related bad faith lawsuits have been filed across the state.
Chinese drywall, which contained toxic substances from gypsum mined in the Shandong Province, China, wreaked havoc throughout Florida and other Southern states in the run-up to the 2008 real estate crisis. During the housing boom, construction materials in the U.S. were in short supply, and builders eagerly imported tons of Chinese-mined drywall, using it to quickly construct subdivisions and shopping centers. But there was a cost. The drywall was found to contain substances that were harmful to people’s health, turned jewelry black, and corroded appliances.
One of the victims of the toxic drywall was Wendy Senior. A Dominican-born sales representative, Senior moved into a nearly-finished Lennar Corp. subdivision in the Miami area with her eight-year-old son. She appreciated the community feel of the subdivision, with its neat red-tiled roofs on each Mediterranean-style home. She paid $320,590 for a house and persuaded her mother and sister to move in down the street.
Shortly after the move, Wendy noticed her house had a caustic chemical odor. A Lennar representative assured her it was only “new-house smell,” and would eventually go away. But it didn’t. Not only did it continue, but a litany of other problems popped up. She and her family members began developing nosebleeds and coughs. Electric outlets corroded and air conditioners broke repeatedly. The homeowners’ association finally pointed out the problem in a notice: there was Chinese drywall.
As with many other construction-related disasters, insurers fought their policyholders over the drywall problems. Courts noted that many policies contain exclusions for construction defects. Other exclusions that sometimes came into play included those for deterioration, wear-and-tear, and the release of harmful pollutants. Meanwhile, the cost of replacing the drywall could be in the tens of thousands of dollars or more, putting many homeowners in financial jeopardy.
This book explores the topic of bad faith by insurers, how and why it arises, and how policyholders can fight it. It begins with a history of the insurance industry, an overview of how greed infiltrated and warped the system, the development of bad faith practices and how government agencies and consumer advocates have sought to combat it. It delves into the insurance litigation landscape, what typically happens when you sue your insurer in court, or when your insurer sues you, and the current state of the law. I will also tell you what you can do to guard yourself against becoming a victim of bad faith.
No matter what government officials do, there will always be attempts by insurers to get around the laws, and to give the short-shrift to policyholders. Throughout the history of the insurance industry, the same tricks have been used time and time again, sometimes with a little variation, sometimes with a little reinvention.
Armed with powerful armies of lawyers, and with trained actuaries on their side, insurance companies are a formidable opponent in courtrooms. Often, when they act in bad faith and deny claims, they know they’re in the wrong–they’re just playing the odds. And they know that, in many cases, due to the cost and perturbation of litigation, they aren’t likely to be challenged.
Insurance companies have also been known to try to rig the legal system in their favor. As an example, we turn again to State Farm. In the early 2000s, the insurer lost a $1 billion case over allegations that it had refused to pay for parts for covered automobiles that needed repair work. Rather than take its lumps and move on, the insurer decided to seek to have the judgment overturned–by stacking the Illinois Supreme Court in its favor.
The company allegedly installed a friendly judge that was up for election by influencing the US Chamber of Commerce and the Illinois Justice League, among other organizations. Thus, they steered the candidacy of Lloyd Karmeier. State Farm also directed as much as $4 million in donations to his campaign.
After Karmeier won the election and began hearing cases on the state supreme court, he voted to vacate the $1 billion judgment involving the auto parts customers. The plaintiffs later filed a civil racketeering lawsuit against State Farm, claiming that it had illegally engaged in a quid-pro-quo arrangement with the judge. While it denied those allegations, and maintained it did nothing wrong, State Farm agreed to pay $250 million to settle the case.
Karmeier continues to sit on the Illinois Supreme Court. He became its chief justice in 2016. A lawyer for the policyholders acknowledged that while a quid-pro-quo arrangement is illegal, there is no law currently barring insurance companies from seeking to influence the makeup of judicial benches.
While the system seems to be rigged to favor insurers, knowledge about what constitutes bad faith can make all the difference. I hope this book will help policyholders reclaim some of that knowledge.