It is already apparent that one of the most heavily litigated issues to arise out of the 2005 hurricane season will be cause of loss, particularly as it relates to flood exclusions in homeowners and other form policies and flood sublimits in more sophisticated commercial policies.
This litigation includes the lawsuit filed by Mississippi Attorney General Jim Hood, seeking to avoid enforcement of flood exclusions in homeowner's policies. It also includes litigation in Louisiana seeking to determine that much of the contended "flood" damage was actually caused by improper engineering and construction of levees or negligent damage to wetlands, reducing flood protection for New Orleans. Separately, individual policyholders with substantial claims have, or soon will, file lawsuits to determine the scope of first-party coverage for their 2005 hurricane losses. In the final analysis, all of this litigation is driven by one factor: inadequate or unclear insurance coverage, particularly as it relates to flood insurance.
Risk managers need to understand the precise parameters of their insurance coverage for flood and consider how both National Flood Insurance Program (NFIP) coverage and commercial coverage will respond in the event of different types of disaster. This article focuses on two issues arising under NFIP policies: The draconian effect of missing policy deadlines for filing a proof of loss and the lack of "bad faith" remedy to protect against claims handling abuses.
The Loss Notice Conundrum
The first place to start with flood insurance in flood and hurricane-prone areas is the NFIP, a statutorily mandated program which provides federal flood insurance protection for properties in certain flood zones. The NFIP is administered by the Federal Emergency Management Agency (FEMA) under the National Flood Insurance Act. The terms of standard flood insurance policies are dictated by FEMA, and payments on claims arising under such policies are ultimately paid by the federal treasury. Insurers writing standard flood insurance policies under the NFIP are called "write your own insurers." All losses and all administrative expenses they incur are paid by the NFIP, and ultimately the money comes out of the federal budget.
NFIP policies are, of course, very useful, particularly where other flood insurance is not available. In addition to providing stand-alone flood coverage, they can act as primary flood coverage for commercial risks and allow a standard commercial property policy to provide excess flood coverage. This makes flood coverage from standard markets (as opposed to NFIP coverage) both cheaper and more readily available.
However, policyholders must be aware of several key issues. First, as with other types of property policies, standard flood insurance policies require the insureds to file a proof of loss within 60 days. However, unlike proof of loss requirements under standard policies, courts strictly enforce the 60-day requirement and hold that failure timely to file a proof of loss complying with the regulatory requirements is a valid basis for denying a claim under federal flood policy. See, e.g., Wright v. Allstate Ins., 415 F.3d 384 (5th Cir. 2005).
In contrast, under standard commercial policies, almost every state requires an insurer to prove prejudice before being allowed to avoid coverage because the insured failed timely to file a sufficient proof of loss. Indeed, in the case of NFIP policies, even if the insured relies on statements by a write your own insurer's adjuster indicating that the proof of loss requirement will not be strictly enforced, failure to comply with that requirement may lead to forfeiture of coverage. Wright, 415 F.3d at 388 (citing Dawkins v. Witt, 318 F.3d 606 (4th Cir. 2003)).
The circumstances in Wright are truly egregious. After Tropical Storm Allison struck Houston in 2001, Dr. Wright filed a claim under his standard flood insurance policy, issued through Allstate. The Allstate adjuster calculated covered damage at $12,580.04. Dr. Wright's public adjuster estimated the loss, after deducting damage unrelated to flood, at $125,840.23. The public adjuster and Allstate's adjuster were not able to agree on the amount of loss and Dr. Wright refused to sign Allstate's proposed proof of loss. Instead, he submitted his own proof of loss which did not include all of the information required by FEMA regulations.
Allstate, not its outside adjuster, responded by stating "We are accepting this proof in compliance with the policy conditions concerning the filing of a Proof of Loss." The letter expressly reserved all other rights and defenses available under the policy. The public adjuster sent three letters to Allstate trying to initiate settlement negotiations. Allstate's response, received only after the deadline for filing a proof of loss had passed, rejected Dr. Wright's claim on the grounds that he failed to cooperate as required by the terms and conditions of the policy and failed to file an adequate proof of loss within the proper time. Dr. Wright filed suit, and the district court eventually determined that Allstate was equitably estopped from denying the claim based on the failure to timely file a proper proof of loss.
The U.S. Court of Appeals for the Fifth Circuit reversed, finding that, because NFIP insurance proceeds are funded by the federal treasury, equitable estoppel is generally not available. Indeed, citing U.S. Supreme Court precedent, the Fifth Circuit held that: "Where federal funds are implicated, the person seeking those funds is obligated to familiarize themselves with the legal requirements for receipt of such funds." Because the policy terms were dictated by FEMA, they could not be waived or modified by Allstate. Therefore, the Allstate employee was not authorized to waive the requirement that a proof of loss be timely filed with certain specific information, and Dr. Wright's claim was barred.
No Bad Faith Remedy
Federal flood insurance presents another significant problem. Write your own insurers are not subject to bad faith liability under state law. Thus, in Wright, the court specifically held that state law tort claims arising from claims adjustment activities, i.e., bad faith claims handling, were preempted by the National Flood Insurance Act. Following precedent from the Third and Sixth Circuits, C.E.R. 1988, Inc. v. Aetna Cas. & Surety, 386 F.3d 263 (3rd Cir. 2004); Gibson v. American Bankers, 269 F.3d 943 (6th Cir. 2002), the Fifth Circuit held in Wright that the NFIP was conceived to achieve national policies, and the federal government participates extensively both financially and in a supervisory capacity. The Fifth Circuit noted with approval the Third Circuit's statement that a central purpose of the NFIP was to reduce financial pressures on federal flood relief efforts and that state law tort claims against write your own insurers increase the cost to the federal government and reduced the efficiency of the program.
The Fifth Circuit also looked to FEMA regulations which amended the language of the standard flood insurance policy to state: "This policy and all disputes arising from the handling of any claim under the policy are governed exclusively by the flood insurance regulations issued by FEMA, the National Flood Insurance Act of 1968….and federal common law." 415 F.3d at 390 (ellipses in original). The court noted that this policy language might provide a separate and sufficient basis for preemption.
Interestingly, the Fifth Circuit remanded for determination of why the district court had denied Dr. Wright's motion to amend his complaint to add federal common law claims for fraud and negligent misrepresentation. That holding left open the possibility of federal common law bad faith claims. The viability of such claims is, however, open to some question. In Scritchfield v. Mutual of Omaha Ins., 341 F. Supp. 2d 675 (E.D. Tex. 2004), the court was faced with the question of whether insurance bad faith claims are available under federal common law in the context of federal flood insurance. After analyzing the National Flood Insurance Act, the court decided that there is nothing in the statute indicating that Congress intended to create private tort actions under the statute.
The court noted that the Act does permit policyholders to sue for breach of contract if they are dissatisfied with the amount of claim payments, but there is nothing in the legislative history suggesting a statutory cause of action for negligence or consequential damages. In accordance with this analysis, the court held that there was no federal common law right to bad faith. Therefore, to the extent federal flood insurance is available and purchased, write your own insurers have a virtual cart blanche to handle claims any way they see fit, usually to the detriment of the policyholder.
While NFIP coverage can be an important part of an insurance program for businesses operating in flood and hurricane-prone areas, policyholders should take careful note of all policy terms and conditions. Such terms and conditions should be carefully followed. Failure to do so can lead to forfeiture of coverage.
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