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Excess flood

Flood coverage limits are often too low for most property owners

By Michael J. Moody, MBA, ARM

One of the most complex coverage areas for some agents is in the flood insurance area. And since Super Storm Sandy, things have only gotten more problematic. At this point, flood insurance is front and center when it comes to difficult coverage areas. Not only are flood claims typically some of the most contentious claims, but the inconsistencies of the reauthorization of funds from Congress have only exacerbated the issue. Since it is now critical to make certain that all property owners are made aware of the risks involved with flood, this article is designed to provide an overview of the critical points.

Flood insurance basics

The National Flood Insurance Program (NFIP) was created by Congress in 1968, to provide affordable coverage that was not available within the conventional market. In establishing the program, Congress was attempting to solve two specific on-going problems. The first was to provide property owners with an opportunity to purchase hard-to-obtain, cost-effective coverage. Second, they were also trying to encourage communities to implement and enforce measures to reduce future flood risk in high-risk areas.

Most of the people who live in high-risk flood zones can easily see the need for flood coverage. What surprises people, however, is when they find out that everyone lives in a flood zone. Flood zones, as determined by the Army Corp of Engineers, are assigned throughout the United States and cover every area, even though many are considered low-risk flood areas. While flood coverage is strongly recommended for all property owners, if the property is located in a high-risk zone and it has been purchased through a federally regulated lender, flood insurance must be obtained by the property owner.

With flood insurance, one of the most important issues is what qualifies as a flood? According to the NFIP, "A flood is defined as a general and temporary condition of partial or complete inundation of normally dry land areas." NFIP states that "it can be caused by overflow of inland or tidal waters, the unusual and rapid accumulation or runoff of surface waters from any source, or mudflows caused by flooding." This definition is sufficiently broad to consider many types of water damage situations.

Coverage limits are $250,000 for residential buildings and $100,000 for contents located within the structure. Nonresidential or commercial buildings have a $500,000 limit on the structure, and a $500,000 limit for contents. Replacement cost coverage is offered only for single-family dwellings that are considered to be the insured's principal residence. Standard deductibles on these policies vary from $500 to $750. One key point that is frequently forgotten is that there is a 30-day waiting period for all flood programs; thus, it's important to secure coverage prior to any last-minute loss potentials. The only exception to this is if the initial purchase of flood insurance is in connection with the making, increasing, extending, or renewing of a home loan; there is no waiting period. Coverage becomes effective at the time of the loan, provided the application and payment of premium are made at or prior to loan closing.

Excess flood coverage

Since the primary limits of coverage available from the NFIP may not be adequate for the needs of all property owners, there is a viable excess flood insurance market for those home and business owners who need higher limits. However, due in large part to the results of Sandy, the excess flood market is changing dramatically.

Unlike the federal NFIP program, excess carriers can change the rates and terms of coverage whenever they feel it is necessary. "While it is still too early to see major changes in terms and conditions, we are beginning to see increases in rate and reductions in limits available," points out Connie Masella, managing director of brokerage property, Markel Corporation.

For the most part, the excess market is made up of both Lloyd's companies and a number of domestic carriers. However, the rating of the primary/NFIP coverage is done in a completely different way than is the excess flood program, according to Patrick Small, vice president, Wells Fargo Special Risk, Inc. Small says that the NFIP program is unique because "the rating mechanism and methodology are the same regardless of the carrier." The national flood program has authorized about 125 insurers to provide this federal coverage on their paper. However, he points out, "The coverage is 100% reinsured by the federal government."

This approach is in sharp contrast to the rates for excess coverage, as carriers enter and exit the market based on risk appetite or business opportunity that can change as the carrier sees fit.

While the rates under the NFIP program have provided excellent value to most insureds, especially those in the high-risk zones, there has been one major obstacle. That issue revolves around obtaining the authority to add more funds to the program; currently it has become a more troublesome issue for the federal program.

"Whether or not the federal government will fund the primary layer of coverage is an ongoing issue," says Masella. This is further complicated, notes Small, because the majority of Lloyd's forms are following form coverage documents and, as such, there is no drop-down feature. The reauthorization of the NFIP has become a major issue for the continuation of the coverage as it is currently structured, and there are several initiatives within the reauthorization to make the NFIP flood program more financially sound.

While there a number of difficult aspects associated with the NFIP, both Small and Masella agree that education of both the agent/broker and the insured are of critical importance. They believe that one of the most important aspects of their jobs as wholesalers and insurers has to do with educating the agents about the need for the coverage. Flood risks that are located in high-risk areas are pretty easy to see and the need is easily observable, notes Small. But it is the properties in the low- to moderate-risk zones that also have an exposure to flood. And, he notes, the agent often has some misunderstanding regarding the need for coverage in the lower risk areas. Regardless of how flood-prone an area may appear to be, Masella says, agents and brokers should be recommending flood coverage. She indicates that rates for low-risk areas will be reflected in the premiums charged.

Many lessons were learned as a result of Super Storm Sandy. One of the things that may come out of all this, says Masella, is changes in basic building design. Many of the commercial claims involve the loss of expensive equipment and machinery that was located in the basements of some structures.

Small states that hospitals are a good case in point. Several large facilities in New York had these types of issues when their basements flooded. They lost expensive MRIs, CAT scans and other types of machinery, as well as most of the central electrical equipment. Masella notes that similar problems occurred with Hurricane Ike when it hit Houston several years ago.

"While it is still too early to see major changes in terms and conditions, we are begining to see increases in rate and reductions in limits available (for excess flood coverage)." Connie Masella, Managing Director of Brokerage Property Market Corporation

Conclusion

Due to a number of factors, not the least of which is the long-term effects of Sandy, Small suggests that provisions within the reauthorization, if agreed and executed, will provide for a longer-term and more stable insuring mechanism. New guidelines, he says, will be instituted with reauthorization as the programs become more actuarially sound. However, the major effect of this activity will be that property owners located in high-risk flood zones will begin to see meaningful increases. Small suggests that even though this will likely occur over several years, rate increases for this group may be in the range of 20% to 25% per year.

Agents and brokers must spend more time educating their clients, according to Small—first to the reality of the flood market today and then keeping them apprised of changes that will likely be forthcoming in the next several years. Masella points out that educating your client base is one of the only ways to make your agency stand out when marketing the NFIP-type products. Accordingly, she indicates that keeping them informed will help you sell more flood coverage and possibly avoid any E&O claims later. Educating the consumer is extremely important. "I would always encourage agents and brokers to have the insured make the decision of whether or not to buy the coverage, rather than just not offer it at all," Masella says.

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