The Paradox of Flood Insurance Coverage

Whether you are an attorney, an insurance agent, adjuster or broker, or an individual insured, when dealing with claims under flood insurance policies, you may be surprised to discover that many things you think you know are wrong, and, particularly for insureds, many things you think you don’t know, you are deemed to know. This is a paradox of flood insurance coverage.

In this litigious day and age, lawsuits alleging breach of the insurance policies, bad faith, unfair claims handling, unfair settlement practices or negligence by an insurance agent are so common that they are not considered particularly unique or as requiring specialized knowledge by most attorneys practicing in the area of insurance defense. But, until recently, the amount of litigation involving claims under flood insurance policies was fairly insignificant, particularly compared to litigation involving general liability and non-flood related property insurance.

However, the widespread flooding recently experienced in the United States beginning with Hurricane Katrina in 2005 through Hurricane Ike in 2008 led to a relative explosion of litigation in which recovery under flood insurance policies or the alleged negligence of insurance agents in procuring or failing to procure flood insurance was a central issue. As a result, attorneys, insurers, insureds and the courts have confronted issues unique and peculiar to flood insurance claims which had not been fully addressed in the past or which were not widely understood.

Two of the more significant issues addressed in the flood insurance related litigation are whether all claims related to recovery under flood insurance policies – including claims against insurance agents – are preempted by federal law or whether they are otherwise subject to limitations imposed by federal law. The number of opinions issued since 2005 addressing these two issues illustrates the uncertainty in the answer to these questions. While the judicial decisions have since begun to reach a consensus, the application of that consensus to individual cases still requires some fleshing out.

Government as Primary Insurer

What makes a flood insurance policy unique from homeowners or commercial property insurance policies is that flood insurance is underwritten by the federal government. In 1968, Congress enacted the National Flood Insurance Act (NFIA) as a means to provide affordable flood insurance to the general public because premiums charged by private insurers had risen dramatically following significant flood losses from hurricanes and other catastrophes. As a result of the NFIA, the U.S. government became the primary insurer against damage from flooding.

The U.S. flood insurance program is administered by the Federal Emergency Management Association (FEMA). As administrator of the program, FEMA promulgated the Standard Flood Insurance Policy (SFIP) through regulations published in the Code of Federal Regulations. FEMA regulations also set the terms of the SFIP, its rate structure and premium costs.

The SFIPs are issued to the public either directly by FEMA or through private insurers operating as “Write Your Own” (WYO) companies. WYO companies issue the SFIPs in their own names and handle the adjustment, settlement, payment and defense of all claims arising under the flood insurance policies, but the policies remain underwritten by the U.S. government and claims are paid out of the U.S. Treasury.

Preemption of Flood Insurance Claims

Following Hurricanes Katrina and Rita, many of the thousands of lawsuits filed by insureds included claims asserting various state law causes of action for bad faith claims handling and adjustment of flood insurance claims, and also claims for misrepresentation or negligence by insurance agents in connection with the procurement or failure to procure flood insurance. Accordingly, a predicate issue which the courts had to decide was whether these state law claims were preempted by federal law.

Because Louisiana, Mississippi and Texas incurred some of the most significant flooding due to hurricanes in the past few years, the Federal Fifth Circuit Court of Appeals and the Federal District Courts within that circuit have issued a number of opinions addressing the issue of federal preemption. In the 1993 case of Spence v. Omaha Indemnity Insurance Co., the Fifth Circuit held that federal common law governed claims under flood insurance policies, but state law provided the statute of limitations for misrepresentation claims brought against the WYO companies that issued SFIPs. [Spence v. Omaha Indemnity Ins. Co., 996 F.2d 793, 796 (5th Cir. 1993)]

Subsequent courts interpreted Spence as holding that the SFIP and FEMA regulations did not preempt state law tort claims against WYO companies.

However, effective Dec. 31, 2000, FEMA amended the SFIP to provide that “all disputes arising from the handling of any claim under the [flood insurance] policy are governed exclusively by the flood insurance regulations issued by FEMA, the National Flood Insurance Act of 1968 as amended (42 U.S.C. §4001, et seq.) and Federal Common Law.” [44 C.F.R. Pt. 61, App. A(1) art. 9 (2001)]

Subsequently, the Fifth Circuit issued an opinion clarifying that Spence did not hold that none of the available state law claims against WYO companies were preempted by federal law, but only that extracontractual state law claims against WYO companies were not preempted. But, for cases filed after the Dec. 31, 2000, effective date of FEMA’s amendment to the SFIP, the Fifth Circuit held that all state law tort claims, including extracontractual claims, arising out of claims handling by a WYO company under a flood insurance policy were preempted by federal law. [Richmond Printing, L.L.C. v. Director Federal Emergency Management Agency, 72 Fed. App. X. 92 (5th Cir. 2003); Gallup v. Omaha Property & Casualty Ins. Co., 434 F.3d 341 (5th Fir. 2005).]

Since these pronouncements by the Fifth Circuit, courts have drawn a distinction between state law causes of action arising from claims handling of flood insurance and those arising out of procurement of flood insurance coverage, holding that the former are preempted but the latter are not.

One court has noted that “procurement” cases, which are not preempted, “include claims that the insurance agent failed to procure coverage having been asked to do so, or where the agent failed to increase the coverage over time, where the agent failed to recommend flood coverage, and where the coverage had lapsed and the agent had failed to inform the plaintiff of the loss of coverage.” [Valerie v. Fidelity & Deposit Co. of Maryland, 2007 WL 2446100, n. 4 (W.D. La. 2007)]

What the Right Hand Giveth, the Left Hand Taketh Away

Although these rulings permit state law causes of action to be brought against insurance agents or WYO companies in connection with their procurement of or failure to procure flood insurance policies, at the same time, many courts have issued rulings suggesting that it will be impossible to prevail on most procurement related causes of action.

Specifically, most procurement claims allege misrepresentations by the insurance agent or the WYO company about an insured’s need for flood insurance or the amount of flood insurance coverage available. The Fifth Circuit has held that insureds have a duty to read and understand the terms of their SFIP, and, even if they do not have a copy of the SFIP, they are charged with constructive knowledge of the terms of the SFIP because it is published in the Code of Federal Regulations. This knowledge is imputed to the insured “regardless of actual knowledge of what is in the regulations or of the hardship resulting from innocent ignorant.” [Richmond Printing, L.L.C. v. Director of Federal Emergency Management Agency, 72 Fed. App. X. 92 (5th Cir. 2003)]

As a result, numerous district courts in the Fifth Circuit have concluded that even if an insurance agent or WYO company makes a representation that is contrary to the provisions of the SFIP as contained in the Code of Federal Regulations, it is unreasonable as a matter of law for the insured to rely on such representation, notwithstanding that the insured may look to the insurance agent as an expert or how confusing the regulations may be.

At least one district court outside of the Fifth Circuit has suggested that while constructive knowledge of the SFIP may prevent an insured from asserting misrepresentation as the basis of a contract or estoppel claim against the U.S. government, it should not apply in the context of whether an insured’s reliance on the misrepresentation was reasonable for purposes of a misrepresentation claim against the insurance agent or WYO company themselves. [Padalino v. Standard Fire Ins. Co., 2008 WL 4630585 (E.D. Pa. 2008)]

However, thus far, courts in the Fifth Circuit do not appear inclined to follow this view.

Robert Redfearn, Jr. (Redfearnjr@spsr-law.com) is a partner in Simon, Peragine, Smith & Redfearn, a regional law firm with offices in New Orleans, La., and Mississippi.

Editor’s Note: The above is an edited version of an article that originally appeared in the Feb. 23, 2009, edition of Insurance Journal – South Central Region.