Catastrophe Insurance Explained: Types, Benefits, and Who Needs It

What Is Catastrophe Insurance?

Catastrophe insurance protects businesses and residences against natural disasters such as earthquakes, floods, and hurricanes and against human-made disasters such as riots or terrorist attacks. These low-probability, high-cost events are generally excluded from standard homeowners insurance policies.

Understanding How Catastrophe Insurance Operates

If you have a mortgage loan, your mortgage lender will likely require you to buy homeowners insurance. Homeowners insurance may contain certain types of coverages, but loss or damage resulting from certain types of events is typically excluded.

Perils Not Covered by Standard Homeowners Insurance

As a rule, damage, and destruction due to earth movement are typically excluded from homeowners insurance policies. These perils include:

• Landslides
• Mudslides
• Earthquakes
• Sinkholes

Also, floods usually are not covered by homeowners insurance, including floods from:

• Storms
• Typhoons
• Tsunamis
• Hurricanes

However, many homeowners policies cover only named perils, which can vary from policy to policy and by insurance company. Even an "all perils" policy may exclude some events or contain specific policy limits, resulting in inadequate coverage for a major loss, which is where catastrophe insurance can help. 

Varieties of Catastrophe Insurance Coverage

Different types of catastrophe insurance are available to cover the damage done by natural disasters and human-made events. Special catastrophe insurance is available for specific natural disasters, such as flood insurance, storm insurance for hurricanes and tornadoes, earthquake insurance, and volcano insurance.

Catastrophe insurance is also different from other types of insurance from a business standpoint. It is difficult to estimate the total potential exposure to, and cost of, an insured loss, especially since a catastrophic event often results in an extremely large number of claims being filed simultaneously. This makes it challenging for catastrophe insurance issuers to manage risk effectively. Insurers use reinsurance and retrocession to manage catastrophe risk arising from their coverage of catastrophic events.

Exploring Flood Insurance: A Catastrophe Coverage Essential

Often, the coverage you should consider buying will mostly depend on where you live. Certain geographical areas are at higher risk than others for events such as hurricanes, tornadoes, windstorms, wildfires, or floods. If you live in an area vulnerable to aquatic mishaps, such as a hurricane zone or flood plain, you may need to carry flood insurance on your residence. Flood insurance is available through the federal government's National Flood Insurance Program (NFIP).

The government runs this program because flood insurance risks are typically too high for commercial carriers. Depending on your specific circumstances and coverages, several scenarios are possible if you have flood insurance and there is a flooding event.

• If you buy flood insurance to cover your home and personal property, you'll receive compensation for the damage to your residence and your belongings.
• If you bought flood insurance only to cover your home, you wouldn't receive compensation for personal belongings.
• The NFIP requires a 30-day waiting period from the date of purchase before the flood insurance policy takes effect. Because of this, if you did not purchase your flood insurance well ahead of flood warnings, you might not get any compensation for flood damage. 

Comparing Catastrophe and Hazard Insurance

Catastrophe insurance overlaps with and is often referred to as hazard insurance. However, hazard insurance usually reflects the proverbial "acts of God" events: volcano eruptions, lightning, and tornadoes. Hazard insurance may also refer to a general homeowners policy section covering these events.

On the other hand, catastrophe insurance refers to more far-reaching coverage, applying to human-made and natural disasters. It also tends to refer to a standalone policy that is separate from regular homeowners insurance.

The Bottom Line

A homeowners insurance policy might be inadequate to cover certain natural and human-made events. Catastrophe insurance protects against natural disasters, including earthquakes and floods, but also human-made disasters such as terrorist attacks. Special catastrophe insurance policies might be needed for events like floods and earthquakes.