By Donald S. Malecki, CPCU

In last month's column, one of the messages was that both producers and insurers have an opportunity to capitalize on the flood insurance market even though it is governmentally controlled. However, both producers and insurers must realize that, while the Federal Insurance Administration enjoys immunity, they do not.

A recent case involving the plight of a flood insurance policyholder raises some additional points to consider involving not only the mechanics of the National Flood Insurance Program, but other timely subjects, such as direct bill or contact between insurers and their policyholders and important, related insurance developments.

The case that triggers this multi-faceted subject is Zinsel Company, Inc. v. J. Everett Eaves, Inc., 749 So.2d 798, (Ct. of App. of Louisiana 1999), a dispute between a flood insurance policyholder and its agent. After nearly 30 years of service, the agency relationship was terminated at renewal, except for the flood policy which did not have the same expiration as the other policies.

The coverage through this agency was handled under the "Write Your Own" Program by Omaha Property and Casualty Company [hereinafter, the insurer]. When this insurance first became available in the 1970s, the maximum limits available to businesses were $100,000 for buildings and $100,000 for contents.

Sometime in the 1980s, Congress raised these limits to $200,000 for buildings and $200,000 for contents, which were purchased by the insured. These were the limits of the flood policy at the time the insured moved its other insurance portfolio from the other agent. In late 1994, Congress again raised the limits of flood coverage, effective in 1995, to $500,000 for buildings and $500,000 for contents.

In response to this change, the insurer sent out a mailing to all of its insureds who were carrying the then maximum flood insurance advising them of the increase in limits. It also sent this list to its agents. The agent made the decision to rely on the insurer's letter as being sufficient notice of the increased maximums, but with the idea that the subject of increased limits would be raised at renewal.

Unfortunately, the insured sustained a flood loss, which would have been fully covered had the higher limits been purchased. The claims adjuster queried the insured's comptroller as to why the insured had not purchased the higher limits that were available. When the insured asked its agent about this, the agent produced the insurer's notice. The insured attested that this was the first time it had seen the notice.

The insured sued its agent, alleging that it had breached its duty to a client in not making sure that the insured was aware of the increased flood limits and giving the client an opportunity to purchase this extra coverage. It also was alleged that the agent was derelict in not informing the insured of the availability of "difference in conditions" or DIC coverage.

The agent was absolved of any blame in this case. The court held that the agent's alleged failure to advise the insured to procure a DIC policy did not damage the insured (for reasons discussed subsequently). It also held that the agent did not breach a duty to inform the insured of an increase in flood limits.

DIC coverage scope

A DIC policy, briefly, was originally called a "gap filler," because it provides coverage against all risks of loss and was written over a property policy that limited its causes of loss to named perils. The idea was that losses from the named perils were more likely to happen and that causes of loss covered by the DIC policy--flood or earthquake, for example--would be less likely but nonetheless catastrophic enough that it was a good idea to have this policy in place. Thus, the DIC policy not only provided coverage not otherwise available, but also excess limits for losses covered by the primary property policy.

As it has become more common for property forms to provide coverage on an all-risks perils basis, the need for DIC coverage as gap filler has decreased. However, it is still a useful tool to single out excess coverage for certain specified losses, such as those due to transit or property exposures in foreign lands, and business interruption resulting from floods. Considering that the National Flood Insurance Program does not offer business interruption coverage, DIC could be an alternative.

For the most part, however, the DIC policy is not as broad or as useful as it once was. It has gone the same route as the umbrella liability policy, which has been described as being "leaky." The problem with the DIC policy is that it is virtually impossible to determine what it might cover, subject to a high deductible, in excess of what coverage is available under a primary property policy. One actually has to formulate loss situations and then search the policy for a possible answer as to coverage.

In the above noted case against the agent, the insured argued that if the agent had recommended the purchase of a DIC policy, the flood loss would have been avoided. The fallacy of this argument is that, while the DIC policy can be written excess of flood coverage available from the National Flood Insurance Program, the insured must first purchase the maximum available limits from the program before the DIC policy is triggered.

Recall that the insured had purchased limits of only $200,000 for buildings and $200,000 for contents, when, at time of the flood, the maximum available limits were $500,000 for buildings and $500,000 for contents. Thus, if this insured had purchased a DIC policy, it still would not have paid the loss.

It is uncertain what the nature of the insured's business was, but some property insurers have long offered flood insurance in excess of the maximum limits available from the governmental program. The problem is that not as many insurers have offered this coverage as business owners would have wished.

New ISO form

Perhaps the shortage of an insurance market for excess flood coverage may change in December of this year when the Insurance Services Office makes effective its Flood Coverage Endorsement (CP 10 65). ISO intends to offer this endorsement as excess coverage where insurance must be purchased from the National Flood Insurance Program, or as primary where this governmental program does not apply.

Among some of this endorsement's features are the following:

* While coverage under the National Flood Insurance Program is on an actual cash value basis, coverage under this endorsement will follow the particular valuation applicable to the ISO policy; that is, actual cash value, replacement cost, or functional replacement value.

* An option is provided for coverage on a "no co-insurance" basis, thus enabling insureds to purchase flood insurance at full limits applicable to other causes of loss, or for sub-limits.

* Coverage is subject to an annual aggregate. With flexibility of the endorsement, the aggregate can be in the same amount as the single occurrence of flood limit, or the aggregate can be a multiple thereof.

* The flood loss that occurs before or within 72 hours after the inception date of this endorsement is not covered.

* The policy's Ordinance or Law exclusion applies to coverage under this flood endorsement, unless Ordinance or Law coverage has been purchased.

* This newly proposed endorsement also does not cover the cost of restoring or remediating land.

Other points to consider

In the above noted case, the agent who succeeded in writing the other coverages testified against the agent who had written the flood insurance. It is not clear to what extent this agent testified against the other one. However, it makes good risk management sense not to do this, no matter how hard attorneys try to persuade you to do otherwise.

A major problem is that the basic charge of testimony may go beyond what a testifying agent intends. This testimony, furthermore, creates a paper trail and can come back and "nip" the testifying agent who may one day be sued for some alleged error or omission. There are some known instances where this actually has happened.

The point about the direct mail notice by the insurer also is important. More and more insurers are going directly to policyholders for more than simply obtaining the payment of premium. If these notices generated by insurers are recognized as being sufficient and there is no reason not to maintain otherwise, agents may be less vulnerable to errors and omissions losses.

Currently, policyholders generally do not hesitate to sue their own insurance agents when coverage is lacking or coverage is denied. Many policyholders (and their attorneys) view insurance agents as "easy pickings." It remains to be seen whether policyholders will take that same approach with insurers that choose to go direct. *

The author

Donald S. Malecki, CPCU, is chairman of Donald S. Malecki & Associates, Inc. He is chairman of the Senior Resource Section of the CPCU Society, serves on the Examination Committee of the American Institute for CPCU, and is an active member of the Society of Risk Management Consultants.