A Flood Of Changes: The Growing Risk Of Flood Loss

August 11, 2015Articles Law360

Reprinted with permission from Law360. (c) 2015 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

Law360, New York (August 11, 2015, 10:24 AM ET) -- On April 1, 2014, the federal Homeowner Flood Insurance Affordability Act of 2014 (HFIAA) went into effect. Its purpose was to amend provisions of the Biggert­-Waters Act of 2012 (BW12), which had unintentionally triggered turmoil in the insurance and real estate markets while attempting to stave off a looming fiscal crisis confronting the National Flood Insurance Program (NFIP).

By 2012, the financial situation had grown dire for the NFIP due in part to a series of storms, including Hurricane Katrina, which drove the program into the red. After Superstorm Sandy hit the Northeast in October 2012, the deficit totaled almost $25 billion. The program’s model of subsidizing flood insurance for property owners in high-risk flood areas, coupled with the large losses that resulted from the series of catastrophic storms, left the NFIP financially at risk.

The idea behind BW­12 was simple enough: ­­ to restore the NFIP to fiscal solvency by gradually bringing flood insurance premiums up to their true actuarial risk rate in flood zones. The program was only generating approximately $4 billion per year in premiums against more than $1.5 trillion in insured properties. Some of the properties were in especially vulnerable locations and had suffered multiple flood losses over the years, but the U.S. Federal Emergency Management Agency flood maps that designated the areas at highest risk of flooding had not been updated to reflect that fact.

As a practical matter, however, BW12 severely impacted the flood insurance market nationally as rates dramatically spiked, in some cases by percentages in the hundreds or even thousands, while at the same time some properties were unexpectedly placed into new, higher ­risk flood zones despite having never been flooded. Real estate markets in some areas essentially froze as doubts about the affordability of mandatory flood insurance caused potential buyers to pause, at exactly the same time as other property owners were confronted with significant rate increases for flood insurance.

HFIAA was implemented to solve these problems by changing the process for raising premiums and making the increases more gradual. The measure phased out certain subsidies over a longer period of time and restored grandfathering provisions that BW­12 had eliminated. The law also implemented a small annual assessment of $25 on primary residences and $250 on secondary residences and businesses until full­risk rates could be achieved to help restore the NFIP’s financial solvency.

For the most part, HFIAA’s provisions (compared to BW­12) were welcomed, especially by property owners facing significant rate increases that were perceived as sudden and extreme. However, while reforms to the NFIP had historically been implemented at the federal level, for the first time individual state legislatures began exploring more local solutions.

Some states have responded by passing legislation that encourages private insurance companies to enter the market and provide flood insurance at commercially competitive rates. The emerging state legislation reflects a fundamental change in which insurance can be obtained for flood-prone properties. Often, the legislation provides property owners with more coverage choices and allows them to reduce premiums by opting out of certain coverage that may otherwise be required by the NFIP.

One of the states most impacted is Florida. Of the 5.3 million policies currently in force in the NFIP portfolio, approximately 2 million cover Florida properties, three times more than the next closest state, Texas. In fact, Florida has more NFIP policies in effect than Texas, Louisiana, New Jersey and California (the next four closest states) combined.

In the wake of BW­12, Florida lawmakers focused on encouraging private insurers to enter the market. Citing statistics indicating Floridians had paid $16 billion in NFIP premiums against $4 billion in paid claims since 1978, legislation was introduced to promote the private flood insurance market. HFIAA was passed and implemented to address BW­12 before the Florida bill could become law, but the Florida measure allowing for “customizable” flood insurance policies was eventually passed.

Senate Bill 1094 (Peril of Flood), which became law earlier this year, expands upon legislation enacted last year (Senate Bill 542), which together allow an insured and an insurance underwriter to deviate from the guidelines set out by the NFIP and negotiate deductibles and coverage terms directly, provided both parties agree to the terms. The legislation also encourages local governments to take direct action in mitigating flood damage and requires local coastal management plans to take flood risk into consideration.

Florida’s innovative, two ­pronged approach essentially broadens the available insurance options for property owners in covered areas while simultaneously restricting, or even eliminating, flood insurance in flood­prone areas. Whether it will ultimately prove as effective as hoped remains to be seen, but it is inarguably intended to be tailored to the economic and geographic realities of the state.

In Massachusetts, then Governor Deval Patrick signed a bill into law last year that banned mortgage lenders from requiring homeowners to insure the contents of their homes, prohibited creditors from requiring borrowers to purchase flood insurance policies with coverage terms in excess of the balance of their mortgages and prohibited the sale of flood insurance policies with deductibles of less than $5,000. The straightforward regulatory approach reflects the determination of lawmakers to limit the impact many state residents felt with the passage of BW­12 and that continued to persist despite HFIAA’s reforms and the reinstituted grandfathering provisions.

In neighboring Connecticut, where the coast was heavily impacted by both Hurricane Irene and Superstorm Sandy, reducing risk in order to lower flood insurance premiums has taken on a particularly high degree of urgency. Much of the housing stock near the water is older, and among the property owners who carry flood insurance, approximately 45 percent benefit from a subsidized rate ­­ about twice the national average. These property owners will experience accelerating rate increases in accordance with HFIAA. To complicate matters further, Superstorm Sandy hit as FEMA was undertaking the process of remapping the flood zones on the Connecticut coast and many properties were suddenly classified as being in a flood zone or moved from a lower­ risk zone to a higher one.

A growing number of Connecticut property owners have opted to manage their risk by elevating their homes. The federal Hazard Mitigation Grant Program, administered through Connecticut’s Emergency Management and Homeland Security office, will pay 75 percent of the cost of raising a house above the “100 ­year” flood level FEMA uses in classifying flood zones. To incentivize homeowners to mitigate risk, Connecticut has implemented the “Shore Up Connecticut” program, which offers low ­interest loans to cover the costs not paid by the grant.

Even more recently, in June 2015, the Pennsylvania legislature introduced its own flood legislation, the Flood Insurance Premium Assistance Task Force Act. Pennsylvania is one of the most flood-prone states in the nation, with about 86,000 miles of waterways. If enacted, the Pennsylvania legislation will establish a task force charged with reviewing and analyzing the laws and procedures regarding the administration of flood insurance. Within six months of the effective date, the task force is expected to issue a final report recommending the following:

1. Potential programs that provide premium discounts

2. Potential programs that create incentives for local governments to undertake or continue flood mitigation efforts

3. Implementation of changes in state statutes and practices, policies and procedures relating to the administration of flood insurance

The creation of the task force is just the latest in a series of efforts by the Pennsylvania legislature to minimize the impact of rising flood insurance premiums on property owners. Earlier this year, the legislature introduced House Bill 1029, the Flood Insurance Premium Assistance Program Act. The legislation proposes a program that will provide eligible homeowners with a 15 percent flood insurance premium subsidy designed to encourage the purchase of flood insurance.

In the meantime, the Pennsylvania Insurance Commissioner has urged legislators to support federal legislation that would allow private flood insurance policies to satisfy the NFIP requirements. The federal legislation at issue would redefine the legal definition of private flood insurance as a policy issued by a private insurance company provided the insurance is compliant with state laws and regulations. The federal legislation would also authorize the states to regulate private flood insurance, as they do with respect to other insurance.

It remains unclear whether the recent flurry of state legislation will gain traction in other states. However, there is no doubt that most states recognize that the changing insurance environment and the growing risks of flood loss require a solution. Florida opted for an innovative free market approach. Massachusetts chose to regulate rates and restrict the range of policy provisions. Connecticut put its emphasis on mitigating risk. Pennsylvania has taken initial steps through the creation of a task force to identify the issues and devise solutions. All four approaches have their merits and their own unique costs. However, for insurers and property owners alike, it is evident that only a comprehensive method of addressing flood risk and the fiscal solvency of the NFIP will ultimately prove satisfactory. Cooperation between the federal and state governments, increasing reliance on and implementation of risk mitigation, and more responsible action at the local level will no doubt produce a healthier and more stable flood insurance market in the future.

Reprinted with permission from Law360. (c) 2015 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.