Muddy waters: Flood insurance in period of flux

No matter how you slice it, insurance is a complicated topic and flood insurance is no exception.

Further muddying the picture are changes to the coverage that protects homes and businesses from rising water.

Conventional flood insurance is currently backed by the federal government through the National Flood Insurance Program, which was created in 1968 to ensure funds are on hand to cover flood-related losses. The program, known as NFIP, is funded through a combination of congressional appropriations, premiums, fees and surcharges.

Today the owner of any property located in a flood zone is required to purchase flood insurance if the mortgage comes from a federally regulated lending institution, according to Rob Thompson, assistant vice president/public entity practice leader with Lancaster-based insurance agency EHD.

The federal program sets rates and handles claims like an insurance company, Thompson said.

In some cases, though, insurance can be purchased from a private insurer, Thompson. The insurer sets rates using the federal program’s methodology, issues the policy and adjust claims.

“However, they cede all of the financial risk to the NFIP,” he said. “In return the private insurance company is paid a nominal fee or commission.”

Thompson says there is talk of phasing out the NFIP, which is set to expire on May 31 – unless Congress reauthorizes it.

“In recent years as the expiration dates approached Congress has reauthorized the program,” he says. “At this time there is no way to guess at what Congress may do.”

A financial hole

The sticking point for the program is its deficit, which dates back to 2004.

Up until then, premiums coming into the NFIP covered all the losses, according to Alexander Zarnas, a partner with Bethlehem-based Lehigh Valley Insurance Brokers.

“However after Hurricane Katrina and Sandy, the NFIP had to borrow money from the U.S. Treasury to cover the losses,” he said, noting that they run into the tens of millions of dollars. “It’s not sustainable unless Mother Nature changes her hurricane patterns, or the NFIP starts charging people what they should be paying based off their risk.”

He said NFIP’s low premiums essentially subsidize people who live in flood-prone areas and continue to rebuild after a loss.

A 2012 law required people to start paying the true cost for flood insurance, Zarnas added, but it was overturned 2014. “I think any logical government should see this money pit and address it,” he said.

The good news is that the private market is growing and becoming more competitive, which means there are options for business owners in need of flood insurance, according to both Zarnas and Thompson, as long as their mortgage company allows for the purchase of private flood insurance.

In fact, private flood insurance now provides coverage for about 15 percent of the flood insurance market, according to the NFIP’s January 2018 report.

Zarnas said: “The private market is typically almost half the cost of the NFIP and (private policies) include some great coverage enhancements. It’s especially relevant in the Lehigh Valley market because as a whole, we don’t have a ton of properties in hazardous flood zones so the private market is good to us.”

More options, flexibility

Michael Smale, a partner with TW Cooper Insurance based in Coopersburg, said that the coverage enhancements found in the private market could really be attractive to a business owner.

“It is possible to get income protection or loss of rents coverage on the private forms, which is not available for the personal or commercial flood programs through the NFIP,” Smale said.

Private insurers also offer more options for replacement costs, meaning they will cover what it costs to replace lost property, as opposed to actual cash value, which accounts for depreciation and is typically lower, Smale said.

“Also, the private sector has more flexibility in the amount of insurance they will write on any given risk, whereas the national flood program as a ‘maximum’ amount of coverage,” he added.

In addition, the private sector has shown more flexibility in underwriting, pricing and other requirements, Smale says.

The flexibility can help businesses with a property that is in more than one flood zone, for example. The zones are determined using flood maps from the Federal Emergency Management Agency.

The NFIP charges a premium based on the highest flood zone within a property, even if the office or home is in another zone on the same property. A private insurer would write a policy based on the risk of flood waters rising to the structure, Smale said.

Know the risks

Even with the potential advantages of private flood coverage, Thompson said, it’s important to remember that private flood insurance carriers may have disadvantages.

“Private flood insurers can cancel your coverage or raise rates according to their policy terms, whereas the NFIP policies are guaranteed to renew each year,” he says.

According to Zarnas, there is another downside. “If a massive weather event happens, it’s possible a private company could fail. With the NFIP, you have the United States of America backing it,” he said.

But, Zarnas adds that there is a way alleviate concerns about a private carrier’s ability to adequately respond to disaster claims.

“You can mitigate that risk by understanding the insurance company who’s backing the policy,” he said. “I write policies that are on Lloyds of London paper so if they fail, it’s mostly likely the end of the world at that point anyway … I say that tongue-in-cheek, but the takeaway should be the importance of understanding your carrier and trusting your agent.”

Smale said it also comes down to an agent’s due diligence when vetting a private insurance company.

“In addition to claims-paying strength, how well have they responded to other catastrophic loss situations in the past that are typically covered by regular property and casualty insurance?” he said.