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Flood insurance protection: Challenges for small business, FEMA and NFIP

Updated: Jun 6, 2020

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Recently, Business Insurance highlighted a white paper sponsored by ACE Insured concerning flood insurance (“Innovations in Flood Insurance Protections” by Jeremiah Konz). 

An excerpt:

In the aftermath of Superstorm Sandy, many corporate risk managers whose organizations had experienced a flood loss from the hurricane were distressed by their inability to acquire adequate limits of insurance to absorb future flood losses that might occur during the remainder of the policy period. They had few places to turn for this additional insurance and peace of mind. The catastrophic losses of Superstorm Sandy forced many carriers to drive a hard bargain, either declining to provide additional capacity or reinstating the limits of existing policies at much higher cost, stricter coverage terms and conditions and substantial increases in client self-insured risk retentions or deductibles.

The paper discusses the unfortunate, but not surprising, response by the private insurance industry to flood losses suffered by small businesses from Hurricane Sandy.  Its response – raising rates and restricting coverage and renewals – is not new but generally has been limited to windstorm insurance in coastal areas.

I recall a similar reaction many years ago following coastal storms when some insurers stripped the flood hazard from their commercial policies on condominium buildings along the East and Gulf Coast. This caused a near-panic among mortgage banking companies with mortgages in buildings in the affected areas.

The result was that FEMA developed its own stand-alone flood policies for condo associations (both buildings and individual unit owners when the associations either refused to purchase an association policy, or the refused to purchase sufficient insurance). The industry has never fully returned to that market resulting in FEMA policies covering tens of thousands of condo buildings and 1+ million units representing about 20% of their total policy base.

When it comes to small businesses structures, only about 4% of NFIP policies cover small business structures. Why? Because Congress never wanted to provide more than very limited coverage amounts for truly “small” businesses, although in recent times such coverage limits have been increased to $500k for building and contents each.

Flood coverage for such structures of greater insurable value has typically been sold by private flood insurers  requiring the insured to purchase the NFIP policy as primary, which they use as their deductible, with their coverage being considered excess coverage.  That means those insurers are not at risk for that first-dollar coverage, which lowers their risk and therefore cost.

When small business structures are damaged or destroyed, they are subject to NFIP’s regulations for rebuilding.  After Hurricane Sandy, those buildings will have to be either elevated or flood-proofed to or above the 100-year flood level on FEMA’s NFIP maps, regardless of whether they were covered by NFIP insurance or whether the cause of the loss was a flood. Those are mitigation requirements for community eligibility participation in the NFIP, which brings with it the availability of such flood insurance coverage.

Because of this, if the insurance carriers automatically reinstated initial pre-Sandy limits of coverage post Sandy for their private coverage, they would not be at risk for destroyed buildings (no insurable value) until they were rebuilt.

When a structure insured under the NFIP is damaged or destroyed, the NFIP insurance coverage amounts on that policy remain in effect following the loss to the structure.  But the effective amount of coverage for such a policy would be reduced by the amount of the damage until such damage is repaired. FEMA doesn’t take any specific action to change the coverage amount following damage or loss to the insured structure. It simply uses the policy language, which defines insurable value.

Part of the industry’s reaction, as mentioned in the paper, may also be driven by the re-insurance industry. Few private insurance carriers providing primary property insurance to their clients retain much of the coverage within their companies following their writing their policies. In order to diversify their risk, they typically cede or sell of large portions of the coverage in each policy to re-insurers and pay them a commensurate portion of the premium.

In years when there are large events such as Sandy or Katrina or there are many large events throughout the world resulting in record losses, the re-insurance companies often experience restrictions in their capacity.  That forces primary domestic carriers to cut back their business, raise rates or both.

Owners of small business properties are in a difficult position regarding flood coverage since the NFIP only provides limited coverage and the private industry seems to want to limit the maximum amount of coverage it may choose to offer. Large businesses with high value structures typically have little difficulty in obtaining the coverage they want and/or need because such buildings are engineered thereby typically being safer with only a small percent of the value of the building at risk from flooding.

D&A follows these issues and is in a position to help any small business property owner or group of property owners with the specifics of the NFIP.

Joe Coughlin Senior Advisor

Joe spent more than 30 years with FEMA and also served as the National Flood Insurance Program’s principle liaison to the real estate, mortgage lending, insurance and condominium industries.


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