Last month Congress once again failed to fund the National Flood Insurance Program (NFIP) and subsequently let the program lapse for 30 days placing thousands of businesses and homeowners at risk. Congress finally authorized funding for NFIP on July 1, but only through September 30. Property owners in coastal regions will be in serious peril if Congress plays political football with the NFIP program again in September at the height of hurricane activity.

What would happen to property damaged by a hurricane during a period when Congress allowed the NFIP to lapse?

Commercial property owners and homeowners with property insurance in place would have coverage for damage caused by wind; however, there would be no coverage for damage caused by tidal surge and flooding. Tidal surge usually causes more damage than wind; therefore, the majority of property damage in our area would be uninsured.

Traditionally, most of the businesses failing to resume operations after a hurricane are those that did not purchase flood insurance. If Congress fails to extend the NFIP this fall, even those businesses and individuals in flood zones who purchased flood insurance separately from the NFIP would be in peril, as such policies typically maintain deductibles equal to the limits of insurance available under the NFIP program.

The above situations are a worst case scenario. In the event of a hurricane strike, the Federal government would most likely pass legislation retroactively reviving the NFIP thereby making coverage available to those who had previously purchased flood insurance. However, the speed with which this political back-pedaling would occur would undoubtedly be too late for many businesses and homeowners. The lack of immediate funding for businesses and homeowners to make repairs and rebuild would wreak havoc on the local economy.

Would excess flood insurance pay claims if the NFIP is not operating?

It depends. Some excess flood policies require underlying coverage to be enforce at the time of damage. In such cases, claims would most likely be denied. If excess flood policies were to respond to a claim, they would cover only those losses in excess of the primary policy limits available under NFIP ($500,000 per building and $250,000 for personal property on commercial properties).

Would private insurance become available if the NFIP were not revived by Congress?

It is highly unlikely that the federal government will allow the NFIP to be dissolved. It was created in 1968 due to the lack of availability and affordability of flood coverage from the private sector. If private insurance companies were to begin offering flood insurance as a primary coverage, most property owners would find the new premiums too costly and the terms too restrictive.

Insurance experts have stated for years that the rates charged by the NFIP were not actuarially sound. Major storms during the past decade – - Ike, Wilma, Katrina, Dennis, Ivan, etc. – - have taken their toll on the program’s financial stability, thus validating opinions that the government’s insurance model was underfunded and unsustainable. According to an independent, nonpartisan think tank, Resources for the Future, the NFIP debt as of January 2009 was over $19 billion and NFIP is struggling to make its debt payments at the program’s current premium levels.

Will Congress Create a Long-Term Solution for NFIP?

In addition to solving problems associated with inadequate capital, one of the issues delaying a long-term solution for the NFIP is the question whether to include funding for wind damage. Given the current debt position of the NFIP, a proposal to add wind coverage may not be the most practical or sensible solution. However, concerns over wind coverage were heightened following Hurricane Katrina when some insurers used “anti-concurrent causation” policy language to deny coverage for wind damage to homes that simultaneously sustained water damage. Many insurance professionals are against the wind inclusion as they believe a free market competitive system is a better option for policyholders.

A potential yet controversial answer to the funding problem includes elimination of “discounted policies” that impair the NFIP’s ability to build catastrophe reserves. As with any solution that allows for reserve building, safeguards would need to be implemented to prevent Congress from “raiding” the surplus funds to pay for other, non-related costs. Other ideas presented by independent parties include the issuance of catastrophe bonds as well as the purchase of reinsurance by the NFIP in the commercial market. Alternatively, some suggest the NFIP could become a reinsurance program to commercial/residential insurers, with flood coverage mandated on all homeowner policies and the NFIP providing catastrophe protection to insurers

Conclusion

While many thoughtful ideas have been developed, a long-term solution to NFIP funding does not appear to be on the horizon any time soon. However, a major storm will arise if Congress fails to extend the NFIP during the height of hurricane season. The lack of coverage and slow legislative response will undoubtedly spell disaster for many businesses and homeowners if a hurricane strikes while the NFIP is insolvent. Contact your Congressman now to let them know your livelihood depends on timely extension of the NFIP program this September.

This notice is provided as information only and should not be considered a legal opinion. If you have questions about this Client Advisory, please contact Seacrest Partners at 912-544-1900.