The insurance industry long has inculcated the belief that, in the policyholder’s time of need, the insurer will be a steadfast source of protection, compensation, and prompt relief. Over the past couple of months, close to a quarter million policyholders have turned to their (federally backed) flood insurers and filed claims under flood-insurance policies for losses from Katrina, Rita and Wilma. There are nearly 100 insurance companies whose write-your-own (WYO) flood-insurance policies are backed by FEMA, and FEMA – amazingly, alarmingly – has told those insurers to stop paying claims.
The way the WYO (or “Part B”) program is meant to work is that the insurance companies that participate collect premiums and hold that money for the purpose of paying claims. FEMA in turn provides letters of credit on behalf of the private insurers to pay claims in excess of the premiums collected and also provides reinsurance. But FEMA’s coffers now are bare.
Typically, an insurance company that has contractual privity with the policyholder cannot refuse to pay simply because its reinsurer is insolvent. It is the insurance company that typically assumes the risk of the reinsurer’s insolvency, not the policyholder. Yet, according to press accounts, private insurers may not pay flood-policy claims precisely to avoid being put in the position of stepping in when the federal government fails to perform.
Insurers issuing WYO flood policies are treated as fiscal agents of the United States, 42 U.S.C. 4071(a)(1), and the policies they issue are treated more as conduits for obtaining and disbursing federal funds than as ordinary private contracts. See generally Federal Crop Ins. Corp. v. Merrill, 332 US. 380, 385-86 (1947). As a consequence, most courts hold that claims against the “private” insurance companies writing the federally backed flood policies effectively are clothed in the sovereign immunity of the United States and that federal law governs all issues relating to the administration of these policies (and preempts state law). The federalization of this insurance program has a number of profound implications on the rights of policyholders under federally backed flood policies.
First, and perhaps most pertinent given this latest move by FEMA to authorize not paying valid claims until Congress appropriates more funding, policyholders are not able to recover interest on the amounts due but delayed. In Studio Frames Ltd. v. Standard Fire Ins. Co., 2005 WL 2977803 (M.D. N.C. Oct. 26, 2005), the court held that interest on delayed payments under flood policies was barred under the “traditional” no-interest rule, which requires that the United States separately waive its sovereign immunity for interest claims. While waiver can be express or (to some degree) implied, the court found Congress has not consented to paying interest for the FEMA backed policies; the court also refused to find an implicit waiver from the government’s entry into the flood-insurance business. And the no-interest rule applied whether one considered the claim to be against FEMA itself or against the Write-Your-Own carrier.
Second, the insurance companies handling these claims are immune from first-party bad-faith suits. In Wright v. Allstate Ins. Co. (5th Cir. June 28, 2005), the Fifth Circuit joined other circuits in holding that bad-faith and unfair-practices claims were preempted by federal law and that there was no independent federal bad-faith claim. Moreover, to the extent that state-law provides that the insurance company must pay the prevailing policyholder’s attorneys’ fees if the policyholder is compelled to file suit to collect, those claims too are preempted. Accordingly, while under other insurance policies insureds are able to get interest, attorneys’ fees, and bad-faith damages if their insurer refuses to pay because a reinsurer is out of money, flood-insurance-program policyholders have no such remedies.
What about suing FEMA directly for, e.g., misrepresentation of the promise that insurance benefits would be promptly and fully paid or for tortious interference with the policyholder’s contract with the WYO insurance companies? It would appear that that avenue, too, is closed off under the Federal Tort Claims Act, 28 U.S.C. §§ 1346(b), 2671-2680. See generally Muiz-Rivera v. United States (1st Cir. 2003) The FTCA effects a waiver of sovereign immunity to bring suit against the United States and its agencies, but there is an exception to the waiver (i.e., suit is barred) for “[a]ny claim arising out of . . . misrepresentation, deceit, or interference with contract rights.” 28 U.S.C. § 2680(h).
Accordingly, there does not appear to be any judicially enforced (i) incentive on FEMA to pay claims promptly when due, (ii) directive to ensure that the private insurance companies perform promptly, or (iii) sanction to prevent the private insurers from engaging in bad faith. The check on FEMA’s power or abuses – or those of its partners in the WYO program – is political. That check, however, is not the same as one that says “pay to the order of,” which is what the residents of the Gulf States with valid claims are looking for.