Flood Insurance: A Hard Sell Despite Risks

If Hurricane Katrina — not to mention the eight other hurricanes that hit Florida and other parts of the country in 2004 and 2005 — showed America just how vulnerable and ill-prepared it was, it equally exposed the country's blind eye to the devastating effects of flood damage. At a recent exhibit in New York's Museum of Modern Art, a collection of photos taken in New Orleans's Lower Ninth Ward exposed just how ravaging a rising tide of water can be. The pictures showed house after house with layers of mud caked on the floor, sagging covers of waterlogged furniture, warped and disfigured pictures, and that brown line along the walls that marked just how high the water reached. For all visual purposes, it might as well have been a war zone.

It was only after the storms that many homeowners discovered that their homeowners' insurance policies didn't cover flood damage. Those with the money to retain high-priced lawyers found out the hard way that suing private insurers for losses due to flood was an exercise in futility. After all, the only entity selling flood insurance is the federal government, and participation in the National Flood Insurance Program is strictly voluntary. This fact is the Achilles' heel of the entire financial structure put in place to protect policyholders from damage due to hurricanes and any associated flood damage.

Given Katrina, and the numerous other storms that have caused millions of dollars in losses due to storm surge and rising water, a question of whether there should be a state or federal mandate calling for homeowners in flood zones to purchase flood coverage has been raised.

Mandate or Option?

It's ironic that while Congress continues to resist creating a national hurricane catastrophic financial safety net, it decided decades ago to take on the responsibility for covering losses due to flood damage.

Congress created the National Flood Insurance Program in 1968 as the government's response to the rising need for taxpayer-funded disaster relief due to the increased amount of damage caused by flooding. Operated by the Federal Emergency Management Agency, the government-backed coverage provides homeowners with up to $250,000 in coverage to repair their homes. The insurance program also provides up to $100,000 in contents coverage. The insurance was designed to complement the windstorm coverage offered by private carriers or state-run markets such as Citizens Property Insurance Corporation.

Since 1978, the federal flood insurance program has paid out more than $30 billion in claims. Over the past decade (1996-2005), the country's average annual flood losses have exceeded more than $2.4 billion (that's before taking into account the full amount of losses caused by Katrina). In 2005, the National Flood Insurance Program paid nearly $16 billion in flood claims, and up to 25 percent of that went to owners of flood-damaged property located outside of designated “flood prone” areas. FEMA calculates that every three dollars paid in flood insurance claims saves one dollar in disaster assistance payments.

Given the cost-benefit ratio of the flood insurance program, it would seem a no-brainer to mandate coverage in flood-prone areas. In Florida, one need not look further than the repeated damage due to storm surge along the Panhandle region to make a cogent argument in support of mandating flood coverage.

However, currently the only homeowners required to carry the coverage are those forced to by banks and other lenders who require homeowners in flood-zone areas to purchase the coverage in order to be eligible for a mortgage. By law, homeowners in flood-prone areas — such as along the coast — need to get flood coverage if they get a mortgage from a federally regulated lender. But even that mandate has holes, as witnessed in the aftermath of Katrina when many damaged homes were not covered by flood insurance.

Banks are required to enforce the rules and after Katrina, many critics blamed banks for their sometimes-lax enforcement of the flood-insurance requirement, which resulted in homeowners finding themselves without the needed coverage to repair their homes.

The Federal Deposit Insurance Corp., which regulates lenders, fined banks $297,815 last year for flood-insurance violations, an 82 percent increase from 2005. Then there is the case of homeowners buying flood coverage to secure a mortgage, only to turn around drop the policy later. “Lenders do a good job of finding out whether someone is in a flood plain, but they don't do as good of a job of tracking the coverage if you lose it,” said J. Robert Hunter, director of insurance at the Consumer Federation of America.

But while lenders and regulators have made progress over the years in requiring homeowners to buy policies, most say more must be done to get homes covered in flood zones. Despite efforts by the government, insurers, agents, and lenders to prod homeowners into buying flood policies, too many don't feel compelled to do so. And currently, beyond banking requirements, there are no legal tools for either the federal or state governments to require those living in flood zones to purchase coverage.

Insurance Information Institute President Dr. Robert Hartwig said that it is time for the federal government to step forward and change this. He said every hurricane season, the same lesson is learned: without flood coverage, there is a significant hole in the financial needs to rebuilding after a storm. “We've tried the carrots for a long time,” he said. “It's time to try the stick.”

From Hartwig's point of view, if the government can mandate automobile drivers to buy auto insurance and companies to carry workers' compensation insurance, it can also require homeowners living in flood zones to buy flood coverage. How to accomplish this is easy, he says. If a homeowner living in a flood zone refuses to purchase coverage, they must sign a waiver that makes them ineligible for federal disaster aid in the event of a major storm.

Until that becomes law, Hartwig said, the minority of people in flood zones will have flood coverage and those without coverage will have their expenses paid for by the rest of the taxpayers in the form of federal disaster aid payments. “People say, 'I don't buy flood insurance because floods are such an extremely rare event.' They don't understand that's the whole purpose of having insurance,” he said.

Florida's Experience

Citizens Property Insurance Corporation formerly required all policyholders located in flood zones to purchase the federally-backed flood insurance. However, the legislature later lifted the mandate in a political move to help show taxpayers that they were trying to reduce insurance costs. Then it appeared that maybe private insurers were indeed on the hook for losses due to flood.

In Mierzwa v. Florida Windstorm Underwriting Association (877 So. 2d 744), a homeowner sustained both wind and flood damage but was only covered by a wind policy issued by FWUA. Under a local ordinance, the house was deemed a total loss. The homeowner then sued FWUA, saying that the company should be responsible for paying the full face value of the policy, which effectively ended the insurer's ability to apportion the damages. The Fourth District interpreted the state's value policy law so that in the insurers were on the hook regardless of the specific perils and uncovered items listed in the policy.

A recent Florida Supreme Court ruling reversed Mierzwa by stating that the state's value policy law only covered damages under a policy, regardless of the total damages sustained by a homeowner. Specifically, the court's ruling codified that private insurers issuing wind-only policies in coastal areas are responsible for damages due to wind and not flood damages caused by storm surge or flooding. As stated by the court, “The intent of this subsection is not to deprive an insurer of any proper defense under the policy, to create new or additional coverage under the policy, or to require an insurer to pay for a loss caused by a peril other than the covered peril.” Further the law goes on the read, “When a loss was caused in part by a covered policy and in part by an uncovered peril, the insurer's liability under this section shall be limited to the amount of the loss by the covered peril.”

Citizens spokesman Rocky Scott said the company would like its policyholders to have flood coverage, but the recent court ruling made the issue moot because the insurer is no longer on the hook for any flood costs. The company does ask policyholders to sign a waiver if they chose to not have flood coverage while living in a flood zone. But given the court's findings, Scott acknowledged, “Today, it doesn't affect us one way or the other if they have a flood policy or not.”

The Florida Insurance Council doesn't have a position on the issue, but spokesman Sam Miller said such a requirement could help take the pressure off property insurers. Miller notes that nearly 40 percent of five million people holding federal flood policies are in Florida. But it should be noted that the state has more coastline than any other. “We do a fairly good job of encouraging customers to buy it,” he said. “But people don't want to buy flood due to the cost of the premiums.”

“Everyone ought to have flood insurance, if they live in a flood zone or not,” said Scott Johnson, executive vice president of the Florida Association of Insurance Agents. “But knowing they should have it is not enough for many people to buy it.”

Johnson bought a flood policy for the first time himself this year for his home in Tallahassee. He said the hurricanes of the past few years influenced his decision, along with adding a new patio in his backyard. He said the $300 he spent gives him peace of mind should a freak storm hit. Johnson said property owners are wrong to skimp on flood coverage, thinking they are saving money by not buying a policy. “It's like going to sleep in the park to save on rent,” he said.