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Flood Risk.

 

Flood Risk:  What You Don’t Know Can Hurt You.

According to the Federal Emergency Management Agency (FEMA), floods are the most common natural disasters in the United States. Since its inception in 1973, the National Flood Insurance Program (NFIP) has paid almost $40 billion in flood claims, and the losses keep mounting. In 2011 alone, damages from the Mississippi and Missouri River floods, Tropical Storm Lee, and Hurricane Irene were estimated at over $14 billion. Experts already have predicted losses of $3.53 billion for 2012.

Yet, despite the prevalence and enormity of flood, it remains one of the most frequently misunderstood property perils. Business owners who fail to address this risk properly often fall victim to unanticipated, underinsured, uninsured and often ruinous losses. It is therefore imperative that agents review flood basics with clients. The three most important elements that insureds must understand are:  CAUSATION, LOCATION AND COVERAGE.

The Causation Myth:  It Won’t Happen or It Can’t Happen Again

Flood risk is a dangerous combination of Mother Nature’s whim and environmental influences. While floods are most often associated with severe weather like hurricanes or tropical storms, they are also influenced by additional factors, such as:

  • Melting ice and snow
  • Clogged sewer drains
  • Overloaded drainage systems
  • Beach erosion
  • Dam failure
  • Unexpected or severe rain
  • Poorly constructed dams or levees
  • Land development impacting ground water absorption

Areas at high risk for flooding have been historically characterized as “100-year” or “500-year” flood plains. This is a troublesome terminology and open to misinterpretation. Many insureds wrongly assume that 100-year areas will experience severe flooding only once a century. Based on this incorrect premise, they cancel insurance or refrain from buying it.

Alas, “100-year” terminology is not and was never intended as a term of regularity, but rather a term of probability. A 100-year floodplain has 1 in 100 chance of flooding each year. As a result of this confusion, the term is now replaced by “Special Flood Hazard Areas” (‘SFHA’). This generalist moniker could prove equally challenging as it fails to underscore any notion of ongoing flood risk and is irrespective of specific flood zones.

Insureds need to appreciate that flooding is a regular occurrence, not an occasional anomaly. Floods are not a flash-in-the-pan phenomenon. Even a quick recollection of events in 2011 shows a deluge of flooding in the U.S. as well as the rest of the globe. Indeed China, Brazil, Australia and Thailand experienced some of the worst flooding in recent memory.

The Location Myth:  Even if it Does Happen, It Won’t Happen To Me

To help communities prepare for and address potential disasters, FEMA issues official maps that indicate the likelihood of flooding. Flood zones are organized with many sub-categorizations, but generally may be summed up to high risk, moderate to low risk, and undetermined areas:

High Risk Areas

 Label

 Description 

 Insurance

Zone A, AE, A1-30, AH, AO, AR, A99

High Risk Area (Special Flood Hazard Areas) Mandatory flood purchase if borrowing from federally backed lender.

Zone V, VE, V1-30

High Risk Area (Coastal) Mandatory flood purchase if borrowing from federally backed lender.Mo
Moderate to Low Risk Areas

 Label

 Description 

 Insurance

 Zone B and X (shaded); C and X (unshaded)

 Moderate

Insurance is not mandatory, but available.
Undetermined 

 Zone D

 Undetermined

Not yet studied, therefore without participation in NFIP.

One of the biggest mistakes business owners make is to assume a flood zone classification will protect them from a flood. But according to FEMA itself, more than 25 percent of paid claims arise from properties in medium or low-risk areas.

Flood insurance commonly receives consideration at the time of property purchase. This is because federally regulated lenders require insurance for properties located in Special Flood Hazard Areas. Insurance costs will necessarily be higher for properties in Zones A and V and buyers should be aware of these costs. Determinations should be done before closing so that buyers can take their premium costs into account when considering purchase prices of real estate and the impact these costs will have on their businesses in subsequent years.

It is critical that property owners do not abandon flood considerations after a loan closing. Flood plains are frequently re-evaluated to reflect evolving climate changes and man-made influences.  Failure to continually re-assess zone designations is a dangerous game. A business that exists in Zone C at the time of closing could find itself located in Zone A several years later — without having moved an inch — and as a result insurance may no longer respond because the policy has a Zone A exclusion.

Staying on top of flood zones is fiscally prudent, not only from a loss perspective but also from a cost perspective. Flood map changes are a gradual process and there is typically an interim period between a preliminary map and its final implementation. This is a good time to buy flood insurance—both through the NFIP and the commercial market—if you haven’t already done so. To help ease the transition to a high-risk zone, FEMA offers certain grandfather provisions whereby insureds may be able to qualify for discounted rates. Purchasing insurance before a zone change can help decrease the price of flood insurance when the switch is final.  However, commercial excess insurance does not afford the same cushion. In the event of an elevation of flood risks, the cost of this insurance will rise.

The Coverage Myth: The NFIP is the Final Solution

Coverage for flooding is a unique animal and insureds need to understand how it works in the insurance marketplace. Regardless of zone classification, primary and excess flood coverage is available in the excess and surplus lines market for residential and commercial consumers.

For commercial properties located in high-risk zones, flood insurance in the open market can be expensive and on occasion difficult to procure. The National Flood Insurance Program was established, in part, to address this issue and its directive is to make affordable flood insurance available to those most at risk for flood damage.

NFIP policies are available for insureds in “participating communities.” A participating community is one that establishes and enforces flood plain management ordinances that fall in line with the NFIP. Under the program, commercial businesses can be insured for up to $500,000 for building coverage and up to $500,000 for contents. Premiums will vary and begin as low as $567 for non-residential policies in moderate to low-risk areas, based on preferred rates.

Though NFIP policies are designed to be affordable, they may not be sufficient to fully cover a flood loss. It is therefore imperative that business owners do not treat the NFIP as one-size-fits-all solution. In many cases, they still serve as a deductible of sorts due to exclusions, valuations and the limited scope of the policy. NFIP policies do not provide excess limits, nor do they address many tangential risks such as business interruption. Property owners should seriously consider commercial excess policies and/or Difference in Condition (DIC) policies, particularly if the maximum limits of $500,000 will not be sufficient to reconstruct a damaged building or to reconstitute all contents. This coverage is available for purchase in the excess and surplus lines market.

The NFIP is also available for insureds in low-risk zones but it has more competition from the commercial market, which offers broader terms and conditions with minimal impact on pricing. Insureds in low-risk zones have an easier time getting flood exclusions removed, and often without considerable impact to pricing.

When considering flood insurance, do not overlook the importance of causation and its relevance to deductibles. If flood coverage under an all-risk policy is related to or caused by a named windstorm and the insured location is in a coastal area, the deductible could be in the range of two percent to five percent of total insured values, with per occurrence minimums starting at $100,000 or more. Pure flood losses, however, can carry significantly lower deductibles. While deductibles will vary depending on exposure, account size, insurer and premium, these deductibles may be as low $25,000.

Some insureds may choose not to participate in the NFIP and structure their program so as to contemplate their deductible as what NFIP coverage would have been, had they chosen to participate in the flood program. This is a fairly common strategy and one that is often more tenable for organizations with the resources to self-fund a large deductible. Others may choose flood deductible buy-backs or other open market risk transfer solutions.

Insureds should also be aware of annual aggregates. If a single flood event erodes policy limits it could leave an insured without coverage if another flood or floods occur within the policy period. This is why excess flood coverage is critical to effective risk management.

Calm Waters or a Maelstrom?

Recent flood disasters, particularly Hurricane Katrina, have placed significant pressure on the NFIP, with total debt and interest costs of over $17 billion. In late December of 2011 the U.S. Congress extended the program to May 31, 2012. It will likely be continued, despite increasing concerns over its fiscal state, but its future remains uncertain.

The commercial property market traditionally has not been manifestly influenced by the NFIP. Flood insurance in the private insurance market has always been, and will likely remain, expensive relative to other perils. Private flood insurance does not cycle through periods of advantageous or disadvantageous pricing.

However, the market is entering a new era that challenges previous climate assumptions. Recent reports indicate that sea levels are rising, which means that low-lying coastal areas may likely see more flooding. Additional studies suggest that high water levels from storms will be a more frequent fact of life this century and that the chance for significant floods will increase and possibly even double.

In the wake of this change, insurance agents must advise their insureds to stay vigilant and ensure that they understand flood basics.

Contact the Author, J.C Sparling

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