Circuit Courts Affirm Strict Construction of Flood Insurance Policies

Two recent circuit court decisions affirmed that national flood insurance policies are to be strictly construed and are not subject to the flexible standards applied to private insurance policies.

The National Flood Insurance Program (NFIP) was created because the private insurance marketplace could not adequately provide flood insurance to homeowners. The program is federally subsidized and is administered by the Federal Emergency Management Agency (FEMA).

Under the program, property owners may obtain flood insurance either directly through FEMA or through the Write-Your-Own (WYO) Program, which utilizes private insurers to issue and administer the federally-backed flood insurance policies. Whether obtaining a policy through FEMA or through a WYO company, insureds are uniformly issued the Standard Flood Insurance Policy (SFIP), which is prescribed by law. The Code of Federal Regulations provides the exact language in the SFIP. Courts have generally been unwilling to treat the SFIP the same as private insurance policies.

Earlier this year, the Second Circuit Court of Appeals rejected an argument that the SFIP must be interpreted like any private insurance contract. Jacobson v. Metro. Prop. & Cas. Ins. Co., 672 F.3d 171 (2d. Cir. 2012). Instead, the court held that the policy is to be strictly construed according to its terms because it is a federal insurance policy implicating federal funds and is subject to federal regulations.

In Jacobson, an insured’s property was damaged by a flood. His claim was initially denied and he argued that this denial constituted a repudiation which relieved him of complying with the policy’s proof-of-loss requirements. The insured argued that the SFIP should be interpreted like any private insurance contract, thereby allowing a liberal interpretation of the proof-of-loss requirement. Indeed, the Fourth Circuit has stated, “Under federal common law, the federal courts draw upon standard principles of insurance law to resolve disputes over coverage in an SFIP.” Studio Frames, Ltd. v. Std. Fire Ins. Co., 483 F.3d 239 (4th Cir. 2007).

The court in Jacobson recognized that when interpreting private insurance policies, courts may invoke certain principles “on behalf of an innocent insured in order to accomplish the design of an insurance policy,” but further said that when federal funds are implicated under a government policy, the legal requirements control and the insured must strictly comply with those requirements, even if such strict compliance creates an inequitable result.

The court explained that such a harsh interpretation is justified because the NFIP is federally subsidized and offers consumers a flood policy that would be “virtually impossible to purchase in the marketplace.” According to the court, “Where federal funds are implicated, the person seeking those funds is obligated to familiarize himself with the legal requirements for receipt of such funds.”

Because the NFIP is a government program, courts treat the SFIP less as a private insurance contract and more as an extension of federal regulation. Therefore, the requirements set forth by the government supersede many of the arguments that insureds typically avail themselves of when dealing with private insurers.

Using this reasoning, the court in Jacobson denied the insured’s claim because he did not strictly comply with the proof-of-loss requirements.

A strict construction was also applied in the recent case of McGair v. American Bankers Insurance Company of Florida, No. 11-2179 (1st Cir. Sep. 4, 2012). In McGair, the insured argued that the declarations page of the policy, issued by a WYO company, conflicted with the provisions of the SFIP and created an ambiguity. The specific terms of the SFIP limited coverage for flood damage to a basement to certain items. However, the declarations page stated more generally that the policy covered all the contents of the home located both “in the basement and above.” The insured contended that standard insurance law principles should apply and that the ambiguity should be interpreted in his favor.

Without addressing whether an ambiguity actually existed, the court determined that there can be no ambiguity because the terms of the SFIP are federally prescribed and therefore control over the declarations page. The court conceded that ambiguities within the terms of the SFIP would be resolved according to common law principles, but refused to allow the declarations page to change the terms of the SFIP. “General insurance law principles applicable to interpretation of ambiguities must give way in light of the prescription by federal regulation of the terms of the SFIP… there is no need to resolve any supposed inconsistency between the SFIP and Declarations Page. The terms of the SFIP control.”

While both holdings are rather specific–McGair standing for the proposition that a declarations page cannot create ambiguity in the SFIP; and Jacobson determining that an insured must strictly comply with the proof-of-loss requirements in the SFIP—both decisions reinforce the courts’ inflexible attitude towards federally-backed flood insurance policies. As much as insureds may entreat the court to interpret the SFIP liberally in their favor, the courts have not, and likely will not, relax their strict standards.

Flood insurance policies are not equivalent to standard private policies. They are unique policies subject to federal rules and regulations and are not afforded the same flexibility that courts often lend to private insurance contracts.

Courts enforce this strict construction for three main reasons.First, the SFIP is not a contract issued by a private company but is backed by the federal government and is guided by federal law and regulation. Because the SFIP is grounded in federal regulation, it demands strict adherence. Second, federal courts seek uniformity in decisions involving the NFIP and strict standards of construction facilitate that uniformity. Third, because the program is backed by federal funds, courts are compelled to protect taxpayer dollars by demanding strict compliance with the SFIP.

As noted in Jacobson, “Requiring the [insured] to turn square corners when dealing the Treasury does not reflect a callous outlook. It merely expresses the duty of all courts to observe the conditions defined by Congress for charging the public treasury.”

Courts may “draw upon standard principles of insurance law” when interpreting flood insurance policies but, as demonstrated by the First Circuit and the Second Circuit, they will not apply those principles blindly and will always defer to the stated principles in federal law and accompanying regulations.