Excess flood insurance — when the federal plan isn’t sufficient

By | August 7, 2006

The lessons learned from Katrina and Rita and predictions of a future with bigger and stronger storms highlight more than ever the importance of flood insurance, even in locations where it was previously thought unnecessary.

The National Flood Insurance Program provides residential structure coverage up to $250,000 limit, $100,000 for contents and $500,000 for commercial structures. The U.S. House of Representatives recently passed H.R. 4973, which would increase the NFIP’s borrowing authority and raise residential limits to $335,000 for structures, $135,000 for contents, and $670,000 for commercial buildings. The bill has been moved to the Senate for consideration.

Nationally, the average price of new houses sold in May 2006 was $294,300, more than $44,000 above the current NFIP $250,000 limit, according to the U.S. Department of Housing and Urban Development. The many homes and businesses that exceed the NFIP limits must go the “excess” flood insurance market to secure sufficient protection from flooding. Insurance carriers that provide excess flood coverage do so on a voluntary basis; they write it when and where they want.

The costs of excess flood coverage varies depending on the risk of flood and the replacement value of the property. Estimated average premiums for a residential policy with a $1 million replacement cost would be about $1,000 annually according to industry experts.

Not always available
Though federal flood insurance is available to virtually everyone in the U.S., excess flood is not. Many carriers don’t write it in certain areas–notably in those hardest hit by Hurricane Katrina in coastal Louisiana and some parts of New Orleans where it is needed most. It can be impossible to find in many of those areas according to Louisiana Surplus Line Association President Ricky Jenkins.

“Before Hurricane Katrina, rates were somewhat competitive, they were actually sliding downward. But since then rates have gone up substantially and you can’t buy coverage in many areas–at all,” Jenkins said. “Levees that have failed have not yet been rebuilt. Why would a company want to subject themselves to that?”

According to Jenkins, more companies across the country are going to be very careful writing business inside any protective levee system.

“The feeling is–the only people that know of potential breaches or failures are in the federal government. And they are not making that information public to the citizens and the insurance industry,” Jenkins said. “They knew exactly where the breaches were going to happen in New Orleans. But, did they tell us and the citizens that built next to it? Probably not.”

Beyond the Mississippi Delta
In Hawaii earlier this year, the Kaloko Reservoir on Kauai’i’s North Shore breached, spilling 300 million gallons of water over a 100-yard swath of Kuhio High-way. Seven people were killed while sleeping in their beds after being swept by raging water.

State law requires private dam owners to provide maintenance, though the state land department is responsible for their inspections. But State Department of Land and Natural Resources Chairperson and Land Director Peter Young admitted there was no record the state ever inspected the Kaloko Reservoir.

Following the breach, Hawaii Gov. Linda Lingle ordered an inspection of all reservoirs and dams statewide. After the state released the inspection reports for all 54 of Kaua’i’s dams and reservoirs, officials were quick to say there is no imminent danger of another failure, even though the reports found faults with every dam. Of the 54 dams inspected, 24 were classified by the DLNR and Kauai Civil Defense as “high hazard.”

California’s levees are suspect as well and remain vulnerable. The City of Sacramento, the surrounding areas like Marysville and Rancho Cordova and the Sacramento-San Joaquin Delta face some of the greatest flood danger in the nation, according to U.S. Senator Dianne Feinstein (D-Calif.). She recently announced the fiscal year 2006 Supplemental Appropriations bill was approved by a U.S. Senate-House Conference Committee to provide $30.4 million to accelerate critical levee repairs and flood control projects in the Sacramento region.

The bill includes $23.3 million for Sacramento River bank protection projects and $7.1 million for levee improvements for South Sacramento streams.

“An earthquake or a major storm in Sacramento would be disastrous–one-third of the city would be quickly inundated with as much as forty feet of feet of water because of a levee break.” Feinstein said in a statement on her Web site.

“A major earthquake in Sacramento or the Bay Delta is a nightmare scenario for California,” Feinstein maintained. “The earthquake damage would be bad enough. But if it were to weaken the levees, it would cause terrible flooding, kill thousands of people, jeopardize the drinking water for 23 million people, and cost billions.”

But steps toward remediation seem to be restrained by a lot of finger pointing and confusion over who’s responsible for footing the bill. With some of the levees funded with federal money, and others by state or local and regional authorities, the financial responsibility appears to be divided.

The federal government has set standards for levees in California and across the U.S., but in many cases it provides no financial support to meet them.

Media reports indicate local and regional governments in California may actually want to attract more building into flood plain areas to promote economic growth, thereby exacerbating the problem.

Citizens of South Florida are facing similar concerns with regard to Lake Okeechobee. The South Florida Water Management District had a team of specialists evaluate the integrity of the levee system surrounding the lake. They warned that if it bore the brunt of a Category 4 hurricane or higher, the levee could give way, causing severe flooding, extensive property damage and a high loss of lives.

Lake Okeechobee’s levees were built to withstand a Cat 3 hurricane after it overflowed in 1928, killing about 2000 people. Now there are reports of several sections of the levees needing major repair. If one of these sections were to give way or the lake overflowed, some believe it would be possible to see another New Orleans-type disaster in Florida.

Officials with the U.S. Army Corps of Engineers said they are aware of the problems and have them under control.

The water district panel’s report suggested lowering the lake by two feet to create holding capacity in anticipation of a strong hurricane. The Corps, however, has decided not to abide by the report’s recommendations. “The contents of the report did not contain any great revelations,” Steve Duba, chief of engineering for the Corps office in Jacksonville told the Desoto Sun Herald.

He recognized the levees were not in optimum shape, but said engineers work diligently to make sure residents near the lake are safe from flooding. “We’ve been managing this thing since 1930, and we haven’t had any problem with it,” Duba said.

A flood of E&O lawsuits
A number of excess flood related lawsuits have been filed against insurance agents in the wake of last year’s hurricane season. A typical suit involves couple from New Orleans, whohave more than $1 million in uninsured home losses from Hurricane Katrina. They sued, claiming the agent did not tell them they could have bought additional coverage.

Though their home was worth $1.4 million, they had only the NFIP standard $250,000 limit on the property and $100,000 in contents coverage. The suit alleges the couple was told that the coverage they secured was all that was available, and that they didn’t discover they could have purchased excess coverage until after Katrina sent a four-foot water surge through their home, destroying 80 percent of it and $500,000 in personal property.

“We are seeing an awful lot of these claims being made,” said Chuck Morgan, an agent errors and omissions attorney with Seale, Smith, Zuber & Barnette in Baton Rouge, La. “I just walked in the door this afternoon from picking up another one at an agency here in Baton Rouge–another Katrina claim.”

He expects a steady increase of these types of claims to continue to the end of August and the one-year anniversary of Katrina. He said these claims are to some degree driven by insurers denying coverage. “When the insurer denies coverage, then of course the client turns around and goes after the insurance agent,” said Morgan.

Assertions of “my agent didn’t tell me that I could get this” arising out of the Katrina and Rita disasters continue to flood in, according to industry officials.

Morgan said what it really gets down to is a question of economics.

“People don’t want to pay for the most expensive thing they can buy. Then, when something happens, they wish they had the most expensive thing they could have bought,” he added.

Managing the E&O risk
“I represent agents and I don’t want to make any of them mad. But I am sure there are situations where agents fail to offer these somewhat unusual coverages, like excess flood. In those instances, you have a problem. … Those are hard to defend. The only way that I can see to protect yourself is to try and use as many ‘paper trails’ to back up what you offered to a client and what they said they wanted. Make that client confirm what he wants,” Morgan said.

He said as is the case with most coverages, “99 percent of the time a client comes in and says, ‘I want coverage that will either, number one, satisfy the bank if it is a homeowners coverage and/or business. Or two, the best I can get for the cheapest amount of money.'”

The problem then becomes the cost of tacking on extras to the basic coverage. “About nine times out of 10 they want the cheapest thing they can get,” Morgan said.

‘Price no object’
From an errors and omissions standpoint, an agent must protect himself from what can happen when coverage is put into effect and a claim comes along that wasn’t covered under basic coverage limits. Suddenly agents are faced with the dilemma of their client saying, “Price was no object, I would have been willing to pay anything. I wanted the Cadillac of the fleet. I wanted full coverage,” whatever that means, Morgan said.

He urges agents to protect themselves by documenting what their clients said they wanted, agreed to pay for and agreed to order.

One of the easiest things for agent to do, Morgan said, is for them to make sure clients sign the application. “If the application doesn’t include business interruption, or whatever, then you at least have a signed piece of paper by the client saying, ‘this is what I want,'” he said.

Second, and perhaps better, is for agents to use what is known as a “coverage checklist” published by insurance organizations and agent organizations. The homeowners checklist, for example, would have a box to check if the client wanted flood insurance; one to check if they wanted excess flood coverage, etc. If they were to say they didn’t want those coverages, they would have to check a box indicating that. “At the end, have them sign it. Now there are two pieces of paper,” Morgan said.

“And when they say, ‘Ooh, I wanted excess flood, the Cadillac of the fleet,’ you can say, ‘Oh no you didn’t. This is what you signed saying this is what you wanted,'” he explained.

He said such a case will most often go to trial despite having the signed application and signed checklist because the client is going to say, “Oh yeah, I signed that, but I didn’t understand what I was signing.” So be it, Morgan said, but at least the case will try with the agent holding two pieces of paper that the client signed. “And juries are pretty hard on folks who have signed something,” he noted. “If there is something that somebody signed, they’re pretty much going to hold them to what they signed.”

Agents’ attorneys would like to have these sort of documents in their arsenal if they have to go to court to defend against E&O claims. “It at least gives your E&O attorney the ability to make the argument that the client understood what coverages he was requesting and what coverages he was not requesting,” Morgan said.

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Insurance Journal West August 7, 2006
August 7, 2006
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