How the NFIP, Insurance Law and Climate Change Could Cause the Perfect Storm
By ANDREW K. GORDON, a partner in the Trial Practice Group in the San Francisco office of law firm Duane Morris, and JESS R. BOOTH, an associate in the Trial Practice Group in San Francisco
Now that the new U.S. Congress has convened, among the many difficult decisions on its already-full plate will be the fate of the National Flood Insurance Program. After nearly 40 years of relatively stable existence, the NFIP finds itself nearly $18 billion in debt as a result of flood damage claims arising from hurricanes Katrina, Rita and Wilma and more recently, Ike and Gustav.But current case law and climate change are conspiring to create the perfect storm.
In deciding how to fix the NFIP, Congress should consider that recent appellate decisions pertaining to post-Katrina insurance coverage disputes have seemingly ended the "wind versus water" debate as it pertains to homeowner's liability policies, confirming the NFIP as the only source for flood damage insurance in communities where private insurers do not provide it.
A forward-thinking plan for providing flood insurance is all the more vital because storm events such as Katrina may become more frequent as a result of global climate change.
THE EXISTING BANKRUPT SYSTEM
Congress passed the National Flood Insurance Act in 1968 to provide flood insurance in government-approved areas where it was not available through private insurers and to decrease federal disaster relief outlays by encouraging people to purchase flood insurance at a reduced rate.
Today, the NFIP insures 5.4 million homeowners, renters and business owners and generates approximately $2.3 billion in premiums. Since 1994, the NFIP has provided maximum limits of $250,000 for eligible residential properties and $500,000 for eligible commercial properties.
In the wake of hurricanes Katrina, Rita, and Wilma, the NFIP saw an unprecedented spike in flood claims that greatly exceeded the NFIP's premium revenues and reserves.Claims from these three 2005 hurricanes alone total some $20.7 billion, more than double what the NFIP paid out in the prior 37 years. NFIP-related payouts for 2008's Ike and Gustav could be as high as $3 billion to $6 billion.
THE LEGAL STORM
Homeowners filed thousands of lawsuits after Hurricane Katrina once their homeowners insurers denied coverage for damage that the insurers characterized as water damageMany property owners argued that their homes were destroyed as a result of a storm surge (i.e., a wall of water propelled by the wind), not flooding. Property insurers denied such claims, relying on the anti-concurrent clause provisions in policies, which preclude coverage for a loss where an excluded cause of loss (such as flooding) was a "but for" cause of the damage.
Legal battles ensued, and while some homeowners won their cases, they were less successful in the appellate courts. Several post-Katrina appellate decisions may have ended the so-called wind versus water debate.
For example, in Leonard v. Nationwide, the federal Fifth Circuit Court of Appeals held that most of the damage to the homeowner's property was not the result of covered wind damage, but rather by water damage as a result of a storm surge.In doing so, the Court expressly stated the ACC provision unambiguously excluded coverage for water damage even if another peril contributed concurrently or in any sequence to cause the loss, and that the only damage covered under the policy was damage caused exclusively by wind.
Another Fifth Circuit case, In re Katrina Canal Breaches Litigation, and a case from the Louisiana Supreme Court, Sher v. Lafayette, relied on the flood exclusion to defeat attempts to obtain coverage under property policies.
These decisions make it more difficult for a property owner to recover under the typical property policy for losses caused by hurricanes.It should come as no surprise then when homeowners and commercial real estate owners from high hurricane zones apply for NFIP flood insurance in higher numbers.
Proposals to reform the NFIP must contemplate this influx of prospective insureds, as well as the sobering predictions about global climate change.According to the U.S. Government Accountability Office, significant hurricanes will increase in frequency and severity, leading to additional future losses on the scale of hurricanes Ike or Katrina.
THE NFIP OPTIONS
Legislators and some insurers have offered a variety of proposals for reforming the NFIP.
For example, Rep. Maxine Waters, D-Calif., proposed legislation that would forgive the NFIP's debt and expand the scope of coverage offered by the NFIP to include wind coverage.
While increasing the exposure of the NFIP does not appear to be a sound idea at first, if the NFIP offered multi-peril coverage, it could collect increased premiums. This could cushion the adverse effects from future catastrophic storm events and offset some of the NFIP debt forgiveness.
However, in expanding its scope, lawmakers must ensure that the NFIP would have the ability to pay for claims.
Nationwide Mutual Insurance Co. has proposed offering a multiperil homeowners policy that would provide coverage for both wind and water damage and would be reinsured by the NFIP.Under this proposal, flood coverage premiums would be comparable to those provided by the NFIP, but higher limits would be available.
Notably, this would minimize the likelihood of further coverage litigation involving the wind versus water dispute.If accepted by the insurance industry and Congress, it could be adopted by other private insurers, while also reducing the burden on taxpayers to periodically financially rescue the NFIP.
Congress faces no easy task in deciding how to reform the NFIP.Major hurricanes and floods are here to stay, and the availability of affordable flood insurance is a necessity.While weighing the options, Congress should be urged to take the long view and enact a comprehensive plan.Otherwise, the "perfect storm" of heavily taxpayer-subsidized insurance coverage, insufficient coverage or no coverage will result.
March 3, 2009
Copyright 2009© LRP Publications