Recovering From Disaster: Essential Financial Steps

Recovering from a catastrophe like Hurricane Katrina  entails far more than sorting out financial matters, but dealing with such practicalities is a vital first step for survivors, as they reconstruct their lives. The following information will help advisors assist clients to take the proper financial steps in Katrina's wake—and it will detail precautions that all clients can take to prepare for the unexpected.

Financial recovery in the aftermath of Katrina or any disaster involves accessing resources in the following order:

Insurance

The first thing Katrina victims must do is check their homeowners' or renters' insurance policies to find out if their losses are covered by insurance. Most homeowners' insurance policies cover hurricanes—but not floods.

In many cases in New Orleans, it will not be very clear whether damage was caused by winds or floods, so some people will have a major challenge just determining whether insurance comes into play or not.

Because most private insurance policies don't cover floods, special flood insurance is offered through the National Flood Insurance Program (NFIP), which is run by the Federal Emergency Management Agency (FEMA). Unfortunately, only about 40% of New Orleans homeowners carried such insurance.

Those who did will face policy limits of $250,000 to rebuild damaged properties, and up to $100,000 to replace contents. In addition to checking policy limits, clients will need to determine if their policies offer replacement value or actual cash value. Under the NFIP, personal property is always valued at actual cash value, which means things like carpeting and appliances will be reimbursed for considerably less than it would cost to replace them.

Incidentally, most homeowners' insurance policies also do not cover earthquakes. Clients in earthquake-prone areas might take this opportunity to consider purchasing earthquake insurance. California residents can get such insurance through the California Earthquake Authority, a private-public partnership set up to ensure that every resident of the state has access to earthquake insurance.

A.M. Best says all rated insurance companies should be able to meet their commitments despite the projected magnitude of the potential losses in the aftermath of Katrina. FEMA's flood insurance program will likely run short, but it can seek additional funds from the U.S. Treasury. Here's what clients should do when filing a claim.

FEMA assistance

Clients with insufficient insurance coverage may be able to get help from FEMA, which provides assistance in presidentially declared disaster areas through emergency grants and loans offered through the Small Business Administration. The FEMA booklet "Help After a Disaster" provides an overview of the Individuals and Households Program.

The program is not designed to restore damaged property to its condition before the disaster. FEMA's main purpose is to prevent hardship by providing temporary housing and sufficient repairs to make damaged homes safe, sanitary, and functional, as well as to provide necessary clothing and household items.

To apply for FEMA assistance, clients should call 800-621-3362 and have the following information available:

FEMA says that within 10 days an inspector will visit the property to assess the damage. Clients who are eligible for help will receive a check from the U.S. Treasury or a transfer of funds to their bank account. They may also be referred to the Small Business Administration for help from the SBA Disaster Assistance Program.

When an area is declared a disaster by the president, the SBA posts a declaration and fact sheet on its website. You can check the fact sheets for Louisiana, Mississippi, and Alabama to find out exactly which areas were affected and the details on the types of loans available.

The filing deadline for applications for physical damage to homes, personal property, and businesses is Oct. 28, 2005. The filing deadline for applications for economic injury (for small businesses in need of working capital to assist them through the disaster recovery period) is May 29, 2006. The SBA tries to make a decision on each complete application within 7 to 21 days.

Clients need not wait for their insurance settlements to apply for an SBA loan; they can apply for the full amount of the loss (within the limits) and assign the insurance check to the SBA. Minimum monthly payments vary depending on the borrower's circumstances; the first payment is generally not due until five months after the date of the loan.

Loan interest rates depend on whether the borrower has access to credit elsewhere. If so, the rate is 5.375% on home loans and 6.557% on business loans. If the borrower does not have credit available elsewhere, the rate is 2.687% on home loans and 4% on business loans.

Home loan amounts are limited by SBA regulations to $200,000 to repair/replace real estate and $40,000 to repair/replace personal property. The actual amount of each loan, up to these maximums, is limited to the verified uninsured disaster loss. Loans over $10,000 have to be secured. Business loans are limited to $1.5 million for real estate, machinery and equipment, inventory, and other physical losses. Economic injury disaster loans are limited to $1.5 million or the actual economic injury as calculated by SBA, if less.

Tax relief

The IRS has established a special toll-free telephone number for Hurricane Katrina victims who have tax questions. They can call (866) 562-5227 on weekdays between 7 a.m. and 10 p.m. Central Time to get questions answered, receive free copies of tax return transcripts, and receive Disaster Tax Loss Kits.

The IRS has extended filing and payment deadlines for people in the affected areas to Oct. 31, 2005. This applies to estimated payments normally due Sept. 15 and to the second extension for filing 2004 returns. The disaster designation is "Hurricane Katrina" and should be marked prominently on the tax form. See these IRS FAQs for more information on Katrina tax relief.

Clients with uninsured losses may get some economic relief by taking the casualty loss deduction on Schedule A of their income tax return. Normally, casualty losses are deducted in the year they occurred, but in the case of presidentially declared disasters, taxpayers have the option of deducting them on the previous year's return in order to receive their refund faster.

Since most clients have already filed for 2004, they would need to file an amended return by Oct. 31, 2005, if they choose this option. Clients and their tax advisors should calculate the casualty loss deduction for both years to determine which year they should take it. Even though the actual loss would be the same, the deduction may be different because the loss is reduced by 10% of the client's adjusted gross income, which could be different from year to year.

Casualty losses are reported on Form 4684. Here are the steps in determining the loss.

IRS Publication 547, "Casualties, Disasters, and Thefts," provides details on claiming casualty losses and features several examples. Also, this tip sheet offers guidelines for claiming losses from a hurricane.

Looking ahead

The victims of Katrina and other disasters face the challenge of a lifetime as they cope with their losses and rebuild their lives. Once again, this is a wake-up call to all of us to get our affairs in order and be ready for the unexpected.