New Orleans: Risky business for insurance

Fortune Magazine -- Silver-haired and 62, Jim Donelon has never worked so hard. The New Orleans-born lawyer and politician has suddenly become a traveling salesman of sorts. His pitch: "Come sell insurance in New Orleans."

In recent weeks, the Louisiana state insurance commissioner has traveled to Columbia, S.C., to meet the chief executive of Companion Property & Casualty Group, to Seattle to call on the board of the National Association of Mutual Insurance Companies, and to London, where he spoke to insurers at Lloyd's.

Jim Donelon, in the Ninth Ward, concedes "There is a lot to overcome" to persuade insurers to do business in Louisiana.

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"When I talk to executives, I share some positives about the business environment. The levees are being rebuilt," Donelon says. "And more importantly, with our Napoleonic Code [which does not impose punitive damages], we are a much less intimidating litigation environment than our neighboring states. I tell the companies they can fill the vacuum, step in, and take advantage of the opportunity for profit that hard markets present."

It's not an easy sell. Of the $40.6 billion in losses associated with Hurricane Katrina, insurers paid $25.3 billion to Louisiana policyholders. And that doesn't include up to $3 billion in losses associated with the energy industry. No wonder insurers are not racing to come back.

The state's political culture doesn't inspire confidence either. Three of Donelon's four predecessors were sentenced to prison for malfeasance. And Napoleonic Code or not, Orleans Parish has long been fertile territory for litigation.

But Donelon, a Republican elected in late 2005, is a man on a mission. He believes that introducing more choice and greater price competition to the insurance market is key to reviving the city and erasing the image of the Big Easy as a dystopian Venice.

The problem is not what many people think. More than 99 percent of Katrina-related claims in Louisiana have been resolved, and insurance is widely available.

Unlike in other coastal states, insurers haven't stopped doing business in Louisiana altogether. They can't. A 1992 law makes it difficult for a company to cancel a policy if a customer and an insurer have been doing business for three or more years.

So while insurance providers are still doing business, they are responding to the perception of higher risks by offering fewer new policies and placing greater restrictions on existing coverage. All of this, of course, comes at higher prices.

Since Katrina struck two years ago, major insurers such as Allstate (Charts, Fortune 500) and State Farm have been hedging their risks in Louisiana, especially along the Gulf Coast. Those companies have raised rates by as much as 50 percent in New Orleans. They have also removed wind and hail protections from new and existing policies.

State Farm, which has 32 percent of the homeowners' market in the state, says the average premium on a $100,000 wood construction New Orleans home has risen almost 30 percent since Katrina, to $2,162 a year.

"Our actuaries measure the cost of the promises we make to homeowners. And what they're telling us is that the cost of doing business in Louisiana - and other places along the Gulf Coast and Eastern Seaboard - is going up," says State Farm spokesman Dick Luedke.

Allstate, the No. 2 insurer in the state (21 percent of the market), is doing much the same thing. The company began aggressively cutting its risks in 18 southern Louisiana parishes late last year, reducing coverage and raising premiums - a trend that is likely to continue.

Allstate is also not renewing policies that provide landlords with coverage for single and multifamily rental properties. To balance out the rate increases across the state, Allstate reduced rates in safer areas as much as 11 percent.

So while pre-Katrina homeowners can generally get insurance, coverage is more expensive and more complicated. A typical homeowner in New Orleans, for example, has to contract with the federal National Flood Insurance Program for flood damage, the state-owned Louisiana Citizens Property Insurance Corp. for wind, and private insurers for the rest.

As for newcomers, private insurers are not bound to cover them, and most are not willing to. Those consumers have to go to the insurer of last resort, Louisiana Citizens. These market realities are hurting efforts to rebuild, which is why housing and small business have not recovered to pre-Katrina levels.

Convinced that fixing insurance will go a long way toward healing the state, Donelon put together a package of proposals designed to attract and retain insurers. Last month the Louisiana state legislature passed nearly all of them.

One measure abolished the Louisiana Insurance Rating Commission, an independent body of six government-appointed officials who pass judgment on insurance rate changes of more than 10 percent.

The insurance commissioner will now make that call; the idea is that it will be easier for insurers to increase rates. The centerpiece of Donelon's legislative package is an incentive program that offers $100 million in matching grants to companies that insure homes in riskier coastal parishes.

Twenty-five percent of the new policies have to come off the books of Louisiana Citizens; the state does not want to be a big player in the insurance business. The reforms offer something for consumers too, with a new office of Consumer Advocacy to handle complaints.

As a whole, the package, which passed with overwhelming support, is designed to lure back scared investors. The message: You can make money here. We want you. Few would disagree with offering incentives to insurers to do business in vulnerable areas.

Still, the proposals have sparked controversy. Former members of the Insurance Rating Commission say that the new consumer office won't be independent and therefore will not be a champion of homeowners and small businesses. Other critics contend that the Donelon plan is too generous, particularly with the incentive grants.

"When you hand money to the insurance companies," says J. Robert Hunter, director of insurance at the Consumer Federation of America, "it really never works its way down to savings for the policyholders."

Donelon counters that if the new insurance laws work as intended, insurers will want to come back to New Orleans, and competition will drive down prices further and more permanently than regulation.

"The best part of it is that it's only $100 million," he says. "Compared with the Florida fix, it's much less expensive and has a chance to positively affect the affordability and availability of property insurance."

In effect, Louisiana is taking the opposite tack to the one that Florida took after Hurricane Andrew in 1992. Florida, Donelon believes, scared off the industry by passing restrictive consumer protections.

The resulting exodus of insurers meant millions of homeowners sought policies from the state-funded insurer, Citizens Property Insurance Corp., created by the Florida legislature. Citizens is now Florida's largest home insurer. In 2006 the state legislature had to spend $715 million bailing out the fund.

"We're not going to do what Florida did," says Donelon. "We had to come up with incentives to hold the market together."

Politics aside - not that that is really possible in Louisiana - neither Donelon nor the legislature can do much about the biggest problem. New Orleans, which sits an average of six feet below sea level, is slowly dropping into the Mississippi Delta sediment, a fact acknowledged by the Army Corps of Engineers and others who have reviewed land surveys.

Says Robert Hartwig, chief economist at the Insurance Information Institute: "New Orleans is the most vulnerable city in America. Despite the best-laid plans, ultimately Mother Nature is going to have her way."

Indeed, some of the city's most vulnerable neighborhoods are sinking at the alarming rate of an inch per year. The wetlands around New Orleans, a network of marshes and tributaries that once served as protection from the invading Gulf of Mexico, are rapidly eroding.

Sea levels are rising too. As if that weren't enough, recent weather patterns suggest a ten-year period of more frequent and more severe hurricanes in the gulf.

"These factors all serve to increase the storm-surge flood hazard faced by New Orleans," is the warning in a recent report by Risk Management Solutions (RMS), a catastrophe-modeling firm whose research the U.S. insurance industry depends on.

As for the levees, they won't do much to mitigate the increasing flood risk - even after they are fortified. Why? Because they're sinking too.

"It's all sort of going down together," says RMS senior researcher Patricia Grossi. For RMS's clients in the insurance industry, New Orleans is a no-win investment. Donelon rejects this worst-case scenario.

"We don't have a choice in whether to continue to support this city," he says, "any more than Americans have the option to protect the city of San Francisco sitting on the worst fault in the Western Hemisphere. New Orleans is a gateway for oil and gas, and provides a quarter of all seafood consumed in the U.S. - not to mention the cultural heritage. Any serious discussion about abandoning New Orleans would be rapidly dismissed."

Insurance officials are keeping their opinions of the measures quiet, but the industry's actions are speaking loudly. Though the new legislation goes into effect in January, so far none of the insurers Donelon is courting has committed to doing business in New Orleans.