Debate over NFIP Reforms Likely to Extend into 2019A new short-term extension through December 21 leaves the National Flood Insurance Program (NFIP) in limbo as Congress grapples with a lengthy to-do list in advance of the holidays.  NFIP, the biggest source of flood coverage in the U.S., has been reauthorized through a set of short-term extensions in the last year as lawmakers debate the prospect of reforms to the program. NFIP has struggled to remain solvent in the wake of costly hurricanes, but lawmakers have not yet reached a consensus on how to make the program more sustainable.

In the face of the most recent extension, FEMA published a statement calling the short-term reauthorization “an opportunity for Congress to take bold steps to reduce the complexity of the program and strengthen the NFIP’s financial framework so that the program can continue helping individuals and communities take the critical step of securing flood insurance.” We have previously written about FEMA’s own changes to the program, including steps to loosen restrictions on private insurers selling NFIP policies, as well as purchasing reinsurance for the program. Congress will have to determine the viability of other changes, such as proposals to make rates correspond more accurately to risk and funding for mitigation of flood-prone areas.

The short-term extension through December 21 puts NFIP reauthorization on the same timetable as other significant legislative deadlines, including the expiration of a continuing resolution to fund the government. Should Congress pass another extension for NFIP without making changes to the program, the 116th Congress will take up the debate with several changes to the key players in the negotiations. Most notably, current House of Representatives Financial Services Committee chair Jeb Hensarling will be succeeded by incoming chair Maxine Waters.  Waters co-authored a reform act in 2012 that would have significantly curbed government subsidies to premiums, but in recent years has advocated a more cautious approach to rate increases.

National Flood Insurance Program Shows Continued Promise--and Limitations--for Businesses Recovering from Hurricane LossFollowing record-setting levels of rainfall in the Carolinas from Hurricane Florence, businesses both in and outside of affected areas will likely be reviewing their flood coverage to assess how it will respond to adverse weather events. Although private flood insurance is on the rise, the National Flood Insurance Program (NFIP) remains by far the biggest source of flood coverage in the U.S.

NFIP was created in 1968 to address the problem of disaster relief costs and is administered by a department of the Federal Emergency Management Agency (FEMA). For participating communities, NFIP makes federally subsidized flood insurance available in special flood hazard areas. NFIP policies can be purchased directly from the government or from private carriers through the “Write Your Own” program.

Commercial policyholders under NFIP can obtain coverage for up to $500K for a building, and up to an additional $500K for certain types of personal property. These are single peril policies – they only cover direct physical damage caused by flood up to the property’s cash value. Notably, NFIP does not provide business interruption coverage for lost profits due to a shutdown of an insured’s operations. These limitations highlight the need for excess flood insurance coverage, as many businesses will need more than $500K in commercial property coverage; coverage for business interruption arising from flood; and coverage for the full replacement cost of lost property, rather than just cash value.

We have previously written about NFIP’s efforts to remain solvent in the face of multibillion-dollar flood insurance losses over the last 15 years. Last year, Congress passed a bill to forgive $16 billion owed by NFIP to the U.S. Treasury in order to ensure the program remains solvent. The program is currently authorized through November 30, 2018, as a result of seven temporary extensions by Congress over the last year. These steps by Congress reflect bipartisan support for a program that provides an important role in disaster recovery, but consensus has not yet developed around new long-term legislative reforms. This year, FEMA has introduced several changes to the program intended to manage its exposure, including loosening restrictions on private policies in the Write Your Own program, reducing compensation for private insurers who sell NFIP policies, and purchase of reinsurance for the program. We will continue to monitor the effect of these changes, as well as new initiatives and their impact on policyholders.

Coverage for Cannabis? How Cannabis’s Legal Limbo Affects Property Insurance PoliciesA recent federal court of appeals’ decision raises interesting questions for all policyholders, particularly commercial and residential landlords with tenants that grow, possess, and/or distribute cannabis, even where it is legal to do so under state law.

In K.V.G. Properties, Inc. v. Westfield Ins. Co., decided by the United States Court of Appeals for the Sixth Circuit on August 21, 2018, KVG claimed coverage for losses caused by its commercial tenant’s use of KVG’s property for cannabis cultivation. In connection with its cannabis business, the tenant removed walls, cut holes in the roof, altered ductwork and damaged HVAC systems, which ultimately cost around $500,000 to repair. KVG claimed that its loss was covered under its Building and Personal Property Coverage Form (the “BPP Policy”). However, Westfield denied the claim, arguing that the loss was not covered under the BPP Policy due to an exclusion that provided that Westfield would not pay “for loss or damage caused by [any] [d]ishonest or criminal act by [KVG], any of [its] partners, members, officers, managers, employees . . ., directors, trustees, authorized representatives or anyone to whom [KVG] entrust[s] the property for any purpose” (the “Dishonest or Criminal Acts Exclusion”).

Given the litigants’ positions, the court was forced to address the question of whether the cannabis-cultivating tenants committed a “criminal act” within the meaning of the policy. The court began by noting that, while growing cannabis is a crime under federal law, it is protected by Michigan law under certain conditions. The court also noted that “[u]nder different circumstances, KVG might have a strong federalism argument in favor of coverage.” The court went so far as to say it would “hesitate before reading a Michigan insurance policy to bar coverage for a ‘criminal act’ when Michigan law confers criminal and civil immunity for the conduct at issue.” The court ultimately punted on this difficult federalism issue, though, holding instead that the evidence was such that no reasonable jury could find that KVG’s tenant complied with Michigan law. In reaching this conclusion, the court cited KVG’s pleading in a summary eviction proceeding against the tenant where KVG stated that the tenant “illegally grew cannabis.” The court also noted that federal agents, who at the time were subject to U.S. Attorney General Guidance stating that they should not prioritize individuals whose actions are in compliance with existing state laws, raided the premises. This raid, the court reasoned, confirmed that the tenants were not acting in compliance with Michigan law.

This case has multiple interesting implications for insureds. First, policyholders that have extensive and expensive insurance packages (and, consequently, some ability to negotiate policy terms) could attempt to negotiate a more definitive exclusion to obtain more certainty as to whether losses caused by things such as cannabis use and cultivation are covered.

Secondly, policyholders and their counsel should note that the inconsistency between state and federal law as to cannabis’s legality lends itself nicely to an argument that the Dishonest or Criminal Acts Exclusion (and other similar exclusions) is ambiguous in this context. It is a maxim of coverage law that ambiguous provisions in insurance policies should be construed in favor of coverage, and this ambiguity could give policyholders an avenue to pursue traditionally excluded coverage. To this end, this tension between federal law and certain state laws could almost “read out” the Dishonest or Criminal Acts Exclusion for cannabis-related losses under the theory that the legality of cannabis cultivation is always ambiguous in states where medical and/or recreational cannabis cultivation and use are legal. Brokers acting for insureds might bargain for a more specific exclusion that makes it clear the Dishonest or Criminal Acts Exclusion does not apply to cannabis cultivation or use, or policyholder’s brokers might opt for keeping this more ambiguous exclusion rather than being forced to accept an exclusion specifying that coverage is not provided for losses caused by acts that are illegal under state or federal law, in order to leave open the possibility of arguing for coverage based on the exclusion’s ambiguity.

Lastly, insureds and their lawyers should be mindful of the arguments they make in related proceedings. While it was likely in KVG’s best interest to have its tenant—who was causing losses to the rented property—evicted, its argument that the tenant should be evicted for its illegal cannabis operation ultimately worked to prevent KVG from obtaining coverage for its losses. Policyholders should, to the extent possible, litigate any related issues with an eye toward preserving (or at least not foreclosing) coverage for their losses.