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Now Insurers Are Threatened by Hurricane Sandy

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It may sound like a game of semantics, but whether superstorm Sandy is called a hurricane or "just" a nor'easter is literally a billion-dollar question for the insurance industry: Hurricane Sandy could save them from having to pay out billions in claims.

A rose by any other name
Barreling up the east coast and hooking left before slamming into the New Jersey shoreline, Sandy had sustained winds above 80 mph, which in typical weatherman parlance would be a hurricane. But if you ask the National Weather Service what it was that blew apart homes, businesses, and lives with catastrophic effect, they'll tell you it was a post-tropical cyclone, and the difference isn't trifling.

When a storm is anything but an official hurricane, a homeowner's typical deductible -- usually $500 or $1000 -- will kick in before Allstate (NYSE: ALL  ) , AIG (NYSE: AIG  ) , or State Farm start paying out claims. But when a storm is classified as a hurricane, a special deductible kicks in, which can be anywhere between 1% and 5% of the value of the property damaged, limiting the amount insurers pay.

Considering estimates are that the storm caused between $10 billion and $20 billion worth of damage, the different designation could mean Travelers (NYSE: TRV  ) , Chubb (NYSE: CB  ) , and others will have to pay as much as 50% more than they otherwise would. No doubt reinsurers like Berkshire Hathaway's (NYSE: BRK-B  ) General Re are watching the debate closely.

The Tropic of Cancer
The National Weather Service's Hurricane Center changed Sandy's classification an hour before it made landfall, even though at the time, it had maximum sustained winds of 85 mph. When it did slam into Atlantic City at 8 p.m. on Oct. 29, Sandy was blowing a gale of 80 mph, but the NWS said it "had lost its tropical characteristics" and so it was really a post-tropical depression.

Although it seems like weatherman geek-speak, part of the reason for the change was the other major storm raging across the U.S. at the same time. The typical winter storm collided with Sandy and brought cold air into the arms on the west side even as it dragged warmer ocean air up the east side -- very much like the storm in George Clooney's movie "The Perfect Storm."

But there were other characteristics that made it more of a winter nor'easter than a tropical hurricane, including its bizarre east to west movement. Also, hurricanes don't typically make snow, but Sandy dumped a foot of it in a raging blizzard in West Virginia days before it hit New Jersey. It's no understatement to say that weather forecasters had never seen a storm like this.

I'm from the government. I'm here to help.
Naturally, politicians are flexing their muscles, warning insurers not to try to impose the hurricane deductible on homeowners, but it's just camera-hogging bluster as insurers already say they'll pay all legitimate claims.

Of course, while that's the public posture of Markel (NYSE: MKL  ) , Allstate, and Nationwide, their trade associations are saying something a little different. The National Association of Mutual Insurance Companies says if you ask those still living in tents, "they will tell you it was a hurricane." The trade groups may appeal the designation. Maybe, but insurers usually don't rely upon a layman's definition to decide whether they'll pay claims.

While higher premiums are a sure outcome, it also raises the question of whether many homeowners should be allowed to rebuild at all.

Tearing down to build up again
If we're going to socialize the costs of storm damage -- and by that I mean spreading the cost over taxpayers through government orchestrated relief efforts -- then we ought to limit encroachment in areas where the likelihood for damage is great. The continuing cycle of build-destroy-rebuild-destroy really needs to end.

Whatever superstorm Sandy is ultimately classified as, it will certainly be a record-breaker, but it may have the beneficial effect of getting people to finally discuss whether we should be carrying the burden of bailing out those who choose to live in hurricane -- or post-tropical depression -- prone areas.

Not smelling so sweet
After bringing the financial world to its knees, most investors are wary about owning a stake in AIG today. Hurricane Sandy didn't help. The Motley Fool will help you sort fact from fiction to determine whether AIG is a buy at today's prices in its premium analyst report on the company. Just click here now for instant access.

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