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To the Point Water, water everywhere Reforms may be needed, but the NFIP should remain in place By Emanuel Levy Federal flood insurance came on the scene in 1968 with the enactment by Congress of the National Flood Insurance Act (NFIA). It was conceived as a replacement for the government’s practice of providing disaster relief to those suffering losses from flood damage. For many years property/casualty executives had considered the possibility of coverage being provided by the private sector, but they ultimately concluded that it could not be done without endangering the industry’s financial structure. History has shown the wisdom of that decision. I recall attending a meeting of the board of directors of one of the major trade associations sometime in the 1950s, witnessing first hand the adamant rejection of the concept. The federal government has been in the disaster relief business for 200 years, going back to 1803 and the passage of an act to provide assistance to a town in New Hampshire that had been devastated by a fire. Over the next 100 years, the government responded more than 100 times via one-time congressional enactments to a variety of natural disasters, including earthquakes and floods. According to a recent history prepared by the Federal Emergency Management Agency (FEMA), by the 1930s the federal relief system had become a fixture, and formal mechanisms were introduced to share the burden. For example, the Reconstruction Finance Corporation (RFC), an agency that grew out of the Great Depression of the 1930s, was given the authority to make loans for repair and rebuilding of public facilities following a variety of disasters. Similar funding actions followed, including the Flood Control Act, which called for enhancement of the authority of the Army Corps of Engineers to implement flood control projects. FEMA describes these responses as “piecemeal” and problematic but notes that they led to legislation mandating greater cooperation among federal agencies under presidential coordination. Federal involvement, the FEMA history points out, increased as a result of the disasters of the 1960s and early 1970s, bringing about the creation of the Federal Disaster Assistance Administration within the Department of Housing and Urban Development (HUD). The 1968 flood act offered home owners, renters and business owners the opportunity to purchase insurance. This did not come without strings. The act mandated that communities adopt and enforce flood plain management measures as a prerequisite for insurance eligibility. In addition, NFIA sets 10 different flood hazard rate zones based on the level of risk in each zone. The zones are tied to a mythical “100-year flood,” which means a flood elevation that has a 1% chance of being equaled or exceeded each year. (It does not mean a flood that occurs only once every 100 years.) In most of the flood zones, property owners are required to purchase federal flood insurance, but owners may seek removal from the floodplain by showing that their structure is on land that is not subject to flooding by the “100-year flood.” The hurricanes of 2005, however, may make the whole zone system obsolete. Lessons from Katrina In the wake of Hurricane Katrina, the floodwaters that inundated huge swaths of New Orleans, destroying whole communities and disrupting countless lives, brought home the reality of flooding to everyone in the country. It may induce a rush to get coverage and demonstrate to those who eschew flood insurance that the homeowners policy really does not cover flood damage. Mississippi Attorney General Jim Hood wasted no time in mounting a challenge to the flood exclusion in the homeowners policy. Hood filed a class action suit on September 15 2005, against some major insurers. He is asking the court to require the insurers to pay for flood damage under homeowners policies, alleging that the standard exclusions are ambiguous and that, in any event, damages were caused by the hurricane winds. In addition, a class action suit has been brought against AIG over claims for damage caused by Katrina. This action was filed by a New York City-based public interest organization, Americans for Insurance Reform, on behalf of residents of New Orleans and environs whose homeowners policies were issued by the Louisiana FAIR Plan, managed by AIG through its subsidiary, Audubon. There are an estimated 400,000 insureds in the class, and the suit alleges that AIG failed to come to their assistance. Flood insurance facts According to a statement submitted to the House of Representatives Housing and Community Opportunity subcommittee in April 2003 by the National Association of Realtors (NAR), there were 4.4 million flood insurance policies in force representing $623 billion in coverage providing “over 90% of all flood insurance nationwide and close to 100% of flood insurance coverage for individually owned properties and small to medium-sized commercial properties.” In its testimony, the realtors’ association reported 91 insurers provided flood insurance either under the Write Your Own (WYO) program or through direct sales. NAR told the subcommittee that in fiscal year 2002, the National Flood Insurance Program generated $1.4 billion in written premium, with average coverage of $142,204 and an average payout of $24,551. Since 1969, the National Flood Insurance Program has paid some $12.7 billion for flood insurance and related claims. This year’s disasters will increase that figure to unknown heights. NAR also cited NFIP problems, including the costly impact of repetitive property loss from flood. It reported findings that 45,000 insured properties nationwide have incurred two or more flood losses over a 10-year period, at a cost to the program of over $200 million a year. NAR said that the top 10,000 structures alone cost the program $65 million a year. NAR pointed to the “serious economic harm” that repetitive losses do to NFIP because they drive up premiums for all other policyholders “by allowing the entire system to rest upon an unsustainable actuarial foundation.” NAR said that properties with repetitive claims should be paying their fair share of the premium. NAR also took issue with what it contended were inaccuracies in the floodplain maps, resulting in mandating insurance for some who did not fit into the category while exposing others to flood risk because they were mistakenly not listed within the floodplain and thus did not buy coverage. Nevertheless, NAR said, “by providing affordable flood insurance that is unavailable in the private market, the NFIP helps our citizens achieve the American dream of home ownership.” Floods are not rare As was vividly demonstrated this year, floods are not a rare phenomenon. FEMA reported that between 1994 and 2004, the average flood loss was $867 million per year, and in 2003 flood loss payout by NFIP was $601 million. Nor are floods specific to certain geographic areas; according to FEMA, they occur in all 50 states, and few property owners are immune. Interestingly, of all claims paid under NFIP policies, roughly 25% are for losses in low- to moderate-risk communities. Home owners or property owners who may see flood insurance as an expense they would rather not incur might have a different view if they knew that in so-called high-risk areas, a house has a 26% chance of being damaged by flood during the course of a 30-year mortgage, compared with a 9% chance of damage by fire. Of course, most mortgage lenders require home owners who live in a flood zone to buy flood coverage in addition to homeowners. Flood vs. water damage What exactly is flood damage as contrasted, for example, with water damage? FEMA has a definition that was evidently adopted in connection with flood insurance. It is: “a general and temporary condition of complete inundation of two or more acres of normally dry land area or two or more properties (at least one of which is your property) from overflow of inland or tidal waters from unusual and rapid accumulation of runoff of surface waters from any source, or from mud flow.” The source of the quote is the FEMA document on “Home Hazards, Flood.” A report issued on October 18, 2005, by the Government Accountability Office (GAO) charges that FEMA has neglected to fully implement the reforms that Congress called for last year requiring better education for insurance agents and the public. FEMA has challenged the findings. Independent agents became intricately tied to the flood insurance program in 1983 when the NFIP started the Write Your Own (WYO) system of distribution. The government wisely concluded that the insurance industry had a major stake in making flood coverage available, as well as the know-how and the distribution system to get protection to the widest segment of the public, without having the responsibility for paying claims. Property/casualty insurers were empowered to write and service standard flood insurance policies either in their own names or on a direct basis, receiving an expense allowance from NFIP. There are currently about 100 insurers in the WYO program with an estimated 100,000 producers involved in distribution. Trade groups weigh in Flood insurance continues to be a significant focus of the national independent agents’ associations. In April 2003, testifying at the same hearing as the National Association of Realtors, Fletcher Willey, appearing on behalf of the Independent Insurance Agents and Brokers of America, urged the continuation and strengthening of NFIP. Willey, then chairman of the association’s Flood Insurance Task Force, praised the WYO program, stating that it operates well and does not need revision. What does need correction, he stated, is the premium structure, which does not produce sufficient revenue to build up reserves to cover long-term expected losses. Willey’s observation has proved insightful, with Katrina and its sister hurricanes racking up claims payments to an amount not yet fully known. Like NAR, Willey cited the dilemma of the repetitive loss. He offered the subcommittee five suggested principles for the reform of NFIP, including the strengthening of building regulations and better management of floodplains. He noted the greater incidence of loss to older properties, with emphasis on the impact of repetitive loss. He also emphasized the need to tighten regulations on new construction. Willey also called for greater compliance with mandatory flood insurance purchase regulations; the provision of additional resources to NFIP for mitigation; and more public information about floods, including mandatory disclosure of flood losses in property transfers by the creation of an accessible electronic database. Coincident with the 2005 hurri-canes, the National Association of Professional Insurance Agents (PIA National) on October 18, 2005, filed five preliminary recommendations with the House-Senate committee holding hearings on NFIP. PIA suggests an increase in maximum property insurance limits; a system of automatic coverage for contents in non-commercial properties; adding or coordinating flood coverage for commercial policies in the area of business interruption insurance; the separation of insurance under NFIP from post-disaster government assistance; and continued multi-year authorization of the flood program by Congress for its various authorities. The PIA memorandum said the organization believes that NFIP is “the appropriate structure for insuring flood losses,” but added that going forward, Congress may consider a comprehensive, coordinated natural disaster catastrophe program. As everyone knows, a high degree of criticism was leveled at the federal government, and specifically FEMA, as Katrina devastated New Orleans and the Gulf Coast. The state governors and New Orleans city officials were not spared. In terms of insurance, however, carriers immediately began to adjust losses, albeit under trying conditions. It will be very difficult to separate flood insurance losses and homeowners insurance losses in view of the condition of properties, but independent agents will play a key role in the unfolding drama concerning settlements. It is far too early at this writing to make any predictions about the outcome. In any event, one thing is certain: The insurance mechanism will be there. * The author |
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