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NFIP lapse during government shutdown highlighted insurance gaps

Posted On: Jan. 30, 2018 7:39 AM CST

The National Flood Insurance Program received a reprieve when it was retroactively reauthorized last week as part of a resolution to reopen the federal government, but even the brief lapse highlighted the significant consequences for risk managers of the program’s expiration.

The NFIP’s ability to provide new flood insurance contracts expires when the program lapses while contracts entered into before the expiration continue until the end of their policy term of one year, according to the Federal Emergency Management Agency. In addition, the NFIP’s authority to borrow funds from the U.S. Treasury shrinks to $1 billion from $30.4 billion.

“When a lapse occurs, the NFIP is basically frozen in time,” said John Dickson, president of NFS Edge Insurance Agency Inc., an affiliate of Aon National Flood Services, in Kalispell, Montana. 

Mark Humphreys, vice president of litigation and risk management for real estate developer Watt Cos. in Santa Monica, California, and vice chair of the Risk & Insurance Management Society Inc.’s external affairs committee, said his company reviewed its NFIP policies in place prior to the lapse and was fortunate that the first scheduled expiration was a couple of months away.

“I was prepared — and still have to be prepared if there’s a lapse — to investigate alternative ways of getting coverage, and it’s really not available,” he said. “One of the things I learned is that there’s just nothing that can satisfy the loan covenants that we have, particularly on our commercial assets. Our loan covenants specifically require National Flood Insurance Program coverage where we have buildings in high-risk flood zones. It was going to be a real problem.”

“It would create needless chaos to have a sudden lapse in NFIP coverage,” he added.

The lapse led the U.S. Department of Homeland Security to reissue guidance to NFIP Write Your Own insurance companies, servicing agents and vendors about how to handle it, including a ban keeping these insurers from issuing policies for new business or requests to increase or add coverage during the lapse. In addition, WYO companies are not allowed to issue renewal notices during the lapse, according to the department’s guidance. 

“It’s a rare situation, but it’s not something the Write Your Owns haven’t gone through in the past,” said Janet Bordonaro, flood underwriting manager for Flood Advantage Partners, a member of managing general underwriter and wholesale broker Advanced E&S Group, based in Bonita Springs, Florida. When lapses occur, “it puts the real estate market on hold,” with buyers unable to close on home purchases, she said.

“The Write Your Owns do a really good job of putting everybody in a timeline,” she continued. “As soon as the lapse is resolved, in accordance to triage, they will issue (policies) as quickly as they can. But it puts a tremendous burden on the Write Your Owns to do that.”

Write Your Own insurers are property/casualty insurers participating in a program to sell NFIP plans on behalf of the federal flood program in exchange for compensation currently set at a 30.9% reimbursement rate, although legislative proposals could reduce that to 27.9%.

During a lapse, FEMA still has authority to ensure the payment of valid claims with available funds, but if those funds are depleted, claims must wait until sufficient premium dollars are received or Congress appropriates supplemental funds to pay claims or increases the borrowing limit.

Prior to the most recent lapse, the NFIP lapsed four times between 2008 and 2012 — lapses that ranged from one day to a month. Congress has generally reauthorized the NFIP retroactively when it has lapsed, as it did after the recent lapse, but the market disruption can be significant for some buyers, experts say.

For example, Mr. Dickson said one of the agents his company works with had a client scheduled to close on a property on Jan. 22, but the NFIP policy was unavailable so they tapped the NFS Edge EZ Flood private policy to cover the risk and close on the property, he said.

One upside of this month’s NFIP lapse was that it occurred mostly on a weekend, meaning the most recent lapse had limited impact on closings, experts say.

“Thank goodness it was a very short lapse because the longer the lapse, the more people are affected,” said Tim Russell, president of the Washington-based National Association of Professional Insurance Agents.

But in the event of a longer lapse, the private market can more easily facilitate closings than in the past, some experts say.

“The appetite of the private market will be surprisingly robust,” said Craig Poulton, CEO of Salt Lake City-based Poulton Associates, the underwriting manager and administrator of private flood insurer Natural Catastrophe Insurance Program, adding that his company prepares to receive two to three times the number of submissions on its website during NFIP lapses. “We just have to stay ready.”

However, both residential and commercial property owners are required to purchase flood insurance if their properties are in a Special Flood Hazard Area. Several NFIP reform proposals introduced over the past year have included language featured in the Flood Insurance Market Parity and Modernization Act, a bipartisan bill that clarifies that people who buy private flood insurance should receive the same treatment as those who purchase it through the National Flood Insurance Program if they’re trying to obtain federally backed mortgages that require flood insurance.

The Biggert-Waters Flood Insurance Reform Act of 2012 intended to allow this type of activity, but lenders and their regulators have sometimes questioned the validity of private insurance to cover the risk and disallowed private policies to be used to meet this requirement.

“Most people would be able to buy a private market flood insurance to meet the requirements of the loan,” Mr. Russell said. But “the private market isn’t everywhere.”

“Bluntly, we really didn’t find anything that would have been financially viable,” Mr. Humphreys said. “Our company would have been naked for that portion of our coverage. Our commercial flood insurance does cover us, but for those high-flood zones we have extraordinarily high deductibles that our lenders require we fill with NFIP coverage. And there’s really nothing in the private market that would fill that gap, and we didn’t see any sign that any private insurer was rushing in to fill that gap.