Flood Insurance: Not a Cut and Dried Proposition

From Superstorm Sandy to disasters in Florida, California, and even Japan, floods are the most common and widespread of all natural disasters. Many communities have experienced a flood at some point—after spring rains, heavy thunderstorms, hurricanes, or winter snowmelts. Surprisingly, you do not have to live by a river, lake, or ocean to be affected; 20% to 25% of all flood claims happen to clients living in low- to moderate-risk areas.

Examined from another angle, if your client’s house is on a 100-year flood plain, a 1% chance of flooding each year does not seem too bad. On the other hand, if this same client has a 30-year mortgage, he or she might want to know that the probability of damage from a 100-year flooding event during the 30-year lifetime of the mortgage is 25%.

Ensuring that your clients have the proper insurance in place to help recoup the costs associated with rebuilding or repairing a home or replacing personal property not only softens the financial impact, but is also likely to accelerate the emotional healing that often comes with such losses. However, did you know that basic homeowner’s insurance does not cover damage caused by flooding?

The intent of this article is not to make you an expert on flood insurance, but rather to provide information and insight to develop a basic understanding of the risk and the insurance options available, so you will be comfortable discussing the topic with your clients.

Flood and Risk
The National Flood Insurance Program (NFIP) defines a flood as “a general and temporary condition of partial or complete inundation of two or more acres of normally dry land area, or of two or more properties (at least one of which is your property) from an overflow of inland or tidal waters, unusual and rapid accumulation or runoff of surface waters from any source, or a mudflow.” The definition also includes “the collapse or subsidence of land along the shore of a lake or similar body of water, as a result of erosion or undermining caused by waves or currents of water exceeding anticipated cyclical levels that result in a flood."

Several homeowners insurance companies that primarily focus on high-value homes also offer flood insurance and have slightly broader definitions.

The Federal Emergency Management Administration (FEMA) conducts flood insurance studies to determine a community’s flood risk. FEMA uses data, such as river flow, storm tides, hydrologic or hydraulic analyses, and rainfall, to create flood hazard maps that outline a community’s flood risk areas. The resulting Flood Insurance Rate Map (FIRM) delineates the special hazard areas and the risk premium zones applicable to the community.

Floodplains and areas subject to coastal storm surge are shown as high-risk areas or Special Flood Hazard Areas (SFHAs). Areas outside the SFHAs are referred to as low- or moderate-risk and are designated as B, C, or X zones. However, areas directly outside the SFHAs may also find considerable risk. The location of your client’s home, relative to the hazard area, will determine what kind of flood coverage is available and its cost.

Financial Protection through NFIP
Many clients mistakenly believe that a homeowners or renters policy covers the damage to their home and personal belongings caused by a flood. This is a common misconception that can have devastating consequences. Most homeowners or renters policies specifically exclude damage caused by floods, and most private insurers will not write flood policies, saying that they are too risky. As a result, the federal government offers flood coverage through the NFIP, run by FEMA.

Another common misconception you may hear is, “I can’t buy flood insurance because I don’t live in a flood plain.” Almost everyone can purchase flood insurance, regardless of whether they live in a high-risk flood zone. The NFIP offers flood coverage through Write Your Own (WYO) insurance companies, as well as the NFIP servicing agent. Your client’s insurance adviser likely has a relationship with a WYO company or one of the few private homeowners companies that now offer flood insurance. The adviser should be able to facilitate placement of the coverage.

Because there is typically a 30-day waiting period before any new or modified flood insurance policy can go into effect, planners should counsel clients not to wait until a storm is barreling up the coast to try to purchase coverage. Exceptions to the 30-day waiting period are limited to insurance required in connection with a loan, insurance purchased within 13 months of a map revision (1-day waiting period), and wildfire.

The average flood insurance policy costs $600 per year. Premiums vary depending on the amount and type of coverage being purchased, location and flood zone, and the design and age of your client’s home. Preferred Risk Policy (PRP) premiums are the lowest premiums available through the NFIP, with building and contents coverage each starting at $129 per year.

NFIP Flood Policies
This section provides an overview of the two types of NFIP flood policies, preferred and high risk, what they cover, and their limitations.

Preferred Risk Policy
The NFIP PRP offers multiple coverage combinations for buildings and contents (or contents-only for renters) and for eligible properties that are located in moderate- to low-risk flood areas.

Maximum residential coverage limits are available as follows:

It is important to note that the NFIP does not package together building and contents coverage, as is the case with the standard homeowners policy; clients need to purchase these coverages separately.

Deductibles will apply separately to building and contents coverages. As with automobile or homeowners insurance, choosing a higher deductible will lower the premium clients pay, but will also reduce their claim payment. Choosing the deductible amount is an important decision and should be made by your clients in consultation with an insurance adviser.

High-Risk Policy
High-risk flood areas are shown on a Flood Hazard Boundary Map or a FIRM as A, D, or V zones.

If your client’s home is in one of these areas and he or she obtained a mortgage through a federally regulated or insured lender, the client is required to purchase a flood insurance policy. Dwelling coverage types mirror those available to PRPs, as does the requirement to purchase structure and contents separately and the subsequently mentioned limitations.

Costs vary depending on the amount and type of coverage being purchased, location and flood zone, and the design and age of your client’s home. For homes in high-risk areas that are built after the first FIRM was drawn for that community, the elevation of the building, in relation to the base flood elevation, will also be a factor in the cost.

NFIP Flood Policy Coverage and Limitations

  • Most losses are settled on an actual cash value basis when the claim will be settled based on the cost to replace an insured item of property at the time of loss, thereby lowering the value of physical depreciation. The exception is building coverage, in which homes will be paid on a replacement cost basis, when required occupancy and insurance to value criteria are met. 
  • Additional living expenses incur for your clients when they are forced to move out of their home due to a flood, a situation not covered by the flood policy.
  • Separate policies should be secured for each other structure (pool house or detached garage, for example), if coverage is desired.
  • Increased Cost of Compliance (ICC) coverage provides up to $30,000 of the cost to elevate, demolish, or relocate a home. If a community declares your client’s home "substantially damaged" or "repetitively damaged" by a flood, the community will require the homeowner to bring the home up to current community standards. The total amount of an ICC and structure claim cannot exceed $250,000, the maximum limit for building property coverages.
  • After Superstorm Sandy, New Jersey is requiring homeowners to elevate or meet new construction standards if their house is located in a flood zone that was declared substantially damaged by the local floodplain administrator.
  • Coverage is limited in basements and does not cover most personal property, such as clothing, electronic equipment, kitchen supplies, and furniture. Other items not covered include paneling, bookcases, window treatments, carpeting, area carpets, and other floor coverings, such as tile. A basement is defined as any area of the building, including any sunken room or sunken portion of a room, having its floor below ground level (subgrade) on all sides.
  • Although it is beyond the scope of this article, you and your clients should also be aware that, depending on the flood zone and when the home was built, coverage limitations also exist for areas below the lowest elevated floor, including crawlspaces.

Legislative Update
The Biggert-Waters Flood Insurance Reform Act of 2012 required FEMA to take immediate action to eliminate a variety of existing flood insurance subsidies and made several changes to how FEMA operates.

Effective January 1, 2013, flood insurance policy rates for some older, nonprimary residences (lived in for less than 80% of the year) in special flood hazard areas that received subsidized rates based on their pre-FIRM status, will increase by 25% a year until they reflect the full-risk rate. A pre-FIRM building is one that was built before the community’s first flood map became effective and has not been substantially damaged or improved. 

Other subsidies will also be phased out. Allowing an existing policy to lapse could be costly; a new application will be required at the full-risk rates. You and your clients need to be diligent of the expiration date and paying the premium in a timely manner.

Private Insurers
In addition to coverage available through the NFIP, some insurers offer enhanced flood protection. You may want to advise your clients with high-value homes to purchase the extra protection provided by enhanced flood coverage or excess flood insurance.

Enhanced Flood Coverage
Enhanced flood protection policies generally provide broader coverage with more favorable loss settlement terms compared to the NFIP policy. Coverage features may include the following:

  • Costs to comply with any law or ordinance requiring that you repair, rebuild, elevate, flood-proof, or demolish your home after a covered flood loss
  • Additional living expenses, including costs incurred to reside elsewhere while your home is being repaired or rebuilt
  • Increased coverage for loss avoidance expenses, including, for example, sandbags, labor, and contents removal
  • Coverage for finished basement areas
  • Stabilization, evacuation, or replacement of land
  • Higher limits for fine collectibles, jewelry, antiques, and furs

Excess Flood Insurance
Excess flood insurance provides coverage for your home and contents above the maximum amount available through the NFIP policy.

A Final Word
Flood insurance is anything but cut and dried; in fact, it may be an unmet need in your clients’ personal insurance program. Engage a licensed and trusted insurance adviser to collaborate with you. His or her expertise about the NFIP and alternative flood insurance options can help you protect your clients’ physical assets and net worth.

About The Author

Bob Donnelly, senior vice president with Marsh in Boston, serves as a personal risk manager for high net worth individuals and families. He delivers tailored risk management solutions that protect the wealth and physical assets of his clients, while freeing them of the administrative burdens associated with policy issuance and billing. Contact him at robert.j.donnelly@marsh.com.

AICPA Insurance Resources
If you liked this article by Bob Donnelly, then be sure to review his previous article for Planner, “What You Need to Know About Your Client’s Homeowners Policy,” in the March/April 2012 issue.

During the past several years, the AICPA’s PFP Section presented a number of conference sessions, webcasts, and articles on risk management, including topics on insurance and related planning tools. Here are links to these resources:

  • Visit the section’s risk management webcast archive for a complete list of online education. In addition, the self-study CPE course, Fundamentals of Insurance Planning, covering the basics of insurance planning, is available for purchase at a discounted rate for PFP members. Note that this course is part of the PFS exam’s in-depth education, and includes a textbook with CPE materials, a supplement, and optional study aids.
  • Several insurance-related sessions were held at last January’s Advanced PFP Conference, including “Opportunities and Pitfalls with Today's Life Insurance Products,” and “Property & Casualty Insurance: Identifying Risk in the Family Household.” If you missed either of sessions, recordings and presentation materials are available in the AICPA’s online library. Registered attendees for either of these sessions have complimentary access when they log in through the website (see instructions to access). Those who did not attend can create an account to purchase audio recordings and presentation materials.
  • Planner has covered the much-discussed issue of long-term care insurance; recently, Michael Kitces, MSFS, MTAX, CFP®, CLU, ChFC, wrote “Big Changes Are Underway in the Long-Term Care Insurance Marketplace” for the January/February 2013 issue. On January 31, 2013, Kitces presented “Latest Trends & Developments in Long-Term Care Insurance.” The webcast recording and presentation materials are available in the PFP Webcast Library. There is also a podcast, “Recent Trends and Developments in the Long-Term Care Insurance Marketplace” available, as well as two articles you can download on the long-term care landscape from The Kitces Report: The Changing Marketplace for Long-Term Care Insurance and The Rising Popularity of Hybrid Long-Term Care Policies.