First Hurricane Harvey dumped unprecedented amounts of rain on Texas, causing massive flooding along the coast and in the Houston metro area. Then Hurricane Irma cut an unprecedented swath of destruction from one end of Florida to the next, causing flooding across and beyond state boundaries.
Federal flood insurance suffers from actuarial/rate dislocation.
Private insurers are not into repetitive-flooding risks.
Will Harvey and Irma force Congress to reform NFIP or mire us further in flood insurance dystopia?
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In between, Congress stuck with National Flood Insurance Program precedent and kicked the can down the road once again, giving it three more months on life support.
Insurers are known for coverage innovation. There’s insurance for everything, right? Except for the one area that, especially now, seems conspicuously absent—flood insurance for high-hazard areas.
Whereas countries such as the United Kingdom rely on private insurers to underwrite flood insurance, albeit with government backing, in the United States, Uncle Sam is the underwriter—in the form of NFIP.
That isn’t because insurers don’t want to underwrite flood insurance—they’re almost always looking for new opportunities. Part of the problem is that NFIP actively discourages private insurers from getting into the market. The result has been a debt-ridden public operation that seems to receive public attention only in the wake of catastrophes or when it periodically comes up for reauthorization, as is the case this year. With the program already about $24 billion in debt—a deficit that’s sure to swell as claims from Hurricanes Harvey and Irma are paid—expanded private participation in flood insurance is certain to draw renewed consideration.
The Council supports long-term reauthorization accompanied by reform, including expansion of the private role in the flood insurance market.
“We absolutely believe in a greater private role,” says Joel Kopperud, The Council’s vice president of government affairs. “The challenge is the private market needs access to NFIP data to truly function—it’s important that the private market has access to data that only the Federal Emergency Management Agency has.” FEMA oversees NFIP.
Kopperud says everyone involved in the debate should be concerned about increasing uptake of flood insurance. “It ought not to be partisan—people need to purchase insurance,” he says. “The goal should be expanding the market and broadening the base regardless of whether it’s public or private.”
The challenge is the private market needs access to NFIP data to truly function—it’s important that the private market has access to data that only the Federal Emergency Management Agency has.Tweet
NFIP provides federally backed insurance in communities that agree to enforce floodplain management plans that meet federal requirements. Flood insurance is required for owners of property in high-risk areas if they have a mortgage from a federally regulated or insured lender.
Somewhat ironically, NFIP came into existence nearly 50 years ago because private insurers said they could not underwrite flood insurance, partly because they found the risk too unpredictable and they lacked the modeling capabilities to better understand it. But technological advances and other factors, not the least of which is a mountain of capital, have whetted their appetite, provided they can generate an adequate return.
NFIP doesn’t work like traditional private insurance. Policyholder premiums are based on the experience of properties within the larger flood risk zones, which are defined by floodplain maps. A constant criticism of the program has been that the federal floodplain maps often don’t reflect reality, because they’re out of date. The program involves subsidies and premium levels that don’t accurately reflect exposure. It even pays for rebuilding properties in areas that contend with repeated serious flooding.
A series of catastrophes—notably 2005’s Hurricane Katrina—plunged NFIP deeply into debt, which now totals more than $24 billion. At press time, claims stemming from Hurricane Harvey were still being tallied, and estimates of Irma hadn’t even begun. The program appears almost certain to overrun its $30 billion borrowing limit.
The debt burden led Congress to approve major reforms in the Biggert-Waters Flood Insurance Reform Act of 2012, reforms that included allowing the program to charge risk-based premiums, removing discounts to some policies that were not actuarially sound, and eliminating “grandfathering” of older, lower rates. The act also included language that signaled Congress’s desire to open the flood insurance market to surplus lines insurers. Apparently the language wasn’t strong enough, however, as some lenders have still refused to accept policies from surplus lines insurers, saying the language doesn’t specifically say private insurance can be accepted as an alternative to NFIP coverage.
The reforms took another blow after outcry from some lawmakers (particularly those in coastal areas), the public and others led to the Homeowners Insurance Affordability Act of 2014. Among other things, this act reinstated grandfathering of the older, lower rates and repealed some of the rate increases.
If I’m looking to diversify some risk and not have the reputational issues that have come with being a WYO, the biggest stumbling block is the mandatory purchase requirement—you have to buy a flood policy if you have a federally based mortgage and are in the floodplain. And the way the law reads, it needs to be an NFIP policy.Tweet
Reform once again received a boost as Congress considered a series of bills earlier this year, including the Repeatedly Flooded Communities Preparation Act, which would ensure community accountability for areas repetitively damaged by floods; the Flood Insurance Market Parity and Modernization Act, which spells out that flood insurance policies written by private insurers must satisfy the mandatory purchase requirement; and the Taxpayer Exposure Mitigation Act, which would repeal the mandatory flood insurance coverage requirement for properties located in flood hazard areas and provide for greater transfer of risk under NFIP to private capital and reinsurance markets.
Neither the House nor the Senate, however, voted on these bills before the September 8 temporary NFIP reauthorization, which came as part of a congressional continuing resolution that also raised the debt limit, funded the U.S. government until Dec. 8, and authorized emergency funding for hurricane disaster relief.
Private Insurance Proponents
Private insurers have become increasingly interested in participating in the overall flood insurance market beyond the role some have accepted as “Write-Your-Own” companies that service NFIP policies but leave the underwriting to NFIP.
Don Griffin, vice president of personal lines at the Property Casualty Insurers Association of America (PCI), notes that some insurers left the Write-Your-Own (WYO) program because of the reputational problems it presented as policyholders complained about claims handling in the wake of Katrina and other storms.
“If I’m looking to diversify some risk and not have the reputational issues that have come with being a WYO, the biggest stumbling block is the mandatory purchase requirement—you have to buy a flood policy if you have a federally based mortgage and are in the floodplain. And the way the law reads, it needs to be an NFIP policy,” he says.
That lack of choice has led risk managers to also support a larger private role in the market. The Risk & Insurance Management Society supports reauthorization of the program.
We believe that policies purchased on the surplus lines market will satisfy lender requirements. That’s our top priority in reform after long-term reauthorization.Tweet
Watt Companies, a commercial real estate firm in California, owns and manages assets invested in office buildings and shopping centers with numerous locations in flood zones.
“We have full flood coverage with the exception of these high-risk zones. These are high deductibles, and there’s really nothing we can get out there other than NFIP. The problem is that our lenders require us to purchase NFIP—it's not NFIP or equivalent,” says Mark Humphreys, Watt Companies’ vice president of litigation and risk management and a member of RIMS’s external affairs committee.
“I would like to see a larger role for private insurers, and I think it’s possible. It’s not going to be a quick process. I can’t see privatization happening overnight. There has to be some way to lead people and lead the lending community into it,” he says.
Joel Kopperud agrees. “We believe that policies purchased on the surplus lines market will satisfy lender requirements. That’s our top priority in reform after long-term reauthorization,” he says.
Support for greater private participation in flood insurance spans the political spectrum.
As might be expected, the free-market R Street Institute is among the many pro-business advocates of a greater private market, as R Street’s R.J. Lehmann and Steve Ellis of Taxpayers for Common Sense wrote in a letter to the House Financial Services Committee earlier this year.
“Because the National Flood Insurance Program historically has charged subsidized or otherwise distorted rates for coverage, it has failed to convey accurate information to property owners and developers about the true risks they face, which can have and has had disastrous consequences,” they wrote. “We do not believe encouraging private insurance would result in ‘cherry-picking’ of only the lowest-risk properties. Shrinking an already broken and unsustainable program can only benefit taxpayers.”
And support came from an unexpected source in a letter to the Senate Banking Committee. Longtime industry critic Bob Hunter, director of insurance for the Consumer Federation of America, wrote that the CFA “strongly supports Congress taking steps during this reauthorization process to allow private insurers to assume a significant amount of flood risk.” The support came, of course, with a caveat. “However, involving the private insurance market on flood insurance requires careful planning since some proposals we have seen would expose consumers to extremely unfair practices and expose taxpayers to more risk…. Any increase in the role of private insurers must be accompanied with robust consumer protections.”
The reinsurers and the modeling companies have improved their risk analysis capability, such as with catastrophe modeling related to flood, so they have more confidence in understanding what the risk is.Tweet
But Is It Profitable?
Despite the interest in and support for private insurance in the flood market, uptake has been limited, and there are multiple reasons why—beyond the ambiguous language in the Biggert-Waters Act. Much of it comes down to determining whether this can actually be a profitable market.
“The largest obstacle in recent years…[is] the fact that private insurers must compete against a government-subsidized entity that does not charge rates that are actuarially sound,” says Robert Hartwig, co-director of the Center for Risk and Uncertainty Management at the University of South Carolina’s Darla Moore School of Business in Columbia.
And charging those same low rates wouldn’t help. In fact, concern that state regulators will too heavily regulate premium pricing has also steered private insurers away, says Jim Auden, managing director with Fitch Ratings in Chicago. Hartwig agrees. He says there is fear that any new flood product would be subject to rate suppression by state regulators, potentially rendering it a perpetual money loser. Under such circumstances, “this is not a business in which an insurer would be willing to allocate much, if any, capital,” he says.
Auden also notes that people outside flood-prone areas aren’t willing to buy the product. “If you’re only selling to the folks who inevitably would be flooded out, you couldn’t make a profit.”
Then there’s the lack of data. According to Ken Evans, senior vice president and chief risk officer of Willis Towers Watson’s Loan Protector Insurance Services, NFIP has closely held its premium and loss ratio information. Because private insurers haven’t had access to the information, they haven’t been able to determine whether the market would be profitable.
Even with these barriers, however, it is important to note that private reinsurers have become involved with NFIP recently and their ability to use data has played a role in this. The program initially ceded some risk to private reinsurance in October 2016 and then transferred a larger book of business to 25 reinsurers earlier this year.
“Reinsurers have a robust capital position, and they’ve been looking for new areas of growth. Government programs such as the flood insurance program offer them that opportunity,” says Frank Nutter, president of the Reinsurance Association of America. He says flood is a diversifying risk so reinsurers have an opportunity to write more than windstorm or earthquake, for example.
The reality is…you’re never going to have a private market that’s interested in insuring repetitive flood areas. To what degree do you mitigate flooding? That’s a question Congress will have to answer.Tweet
“The reinsurers and the modeling companies have improved their risk analysis capability, such as with catastrophe modeling related to flood, so they have more confidence in understanding what the risk is,” Nutter says.
Flood Is Growing
Despite increasing support for greater private participation in the flood insurance marketplace, observers agree that NFIP isn’t likely to disappear any time soon.
The program needs to be reauthorized on a long-term basis to encourage the development of a private solution, says the PCI’s Griffin. “We want to see the program continue, we need a long-term reauthorization, companies need to know where they can go.” A long-term reauthorization is “a market stabilization signal to the industry because it says we’re going to stay the course.”
“I believe there will continue to be a need for NFIP for the foreseeable future, particularly for homeowners in high-hazard flood zones,” says Martha Bane, managing director of the property practice at Arthur J. Gallagher in Glendale, California. “There will be continued pressure to offer subsidized rates that don’t adequately cover long-term losses and expenses for private insurers, so the private flood market could be somewhat limited.”
Evans takes a similar stance. “The reality is…you’re never going to have a private market that’s interested in insuring repetitive flood areas,” he says. “To what degree do you mitigate flooding? That’s a question Congress will have to answer.”
The largest obstacle in recent years…[is] the fact that private insurers must compete against a government-subsidized entity that does not charge rates that are actuarially sound.Tweet
The flood peril isn’t going away, and in fact it may be growing, notes Evans. “We’re seeing more everyday occurrences than we have in the past. Is it climate change? Is it Mother Nature taking a different path? More and more, everyday flooding is happening. Brokers are finding more people are becoming more aware of flooding—it’s no longer just coastal areas affected.
“If a broker has more choices, the broker will be able to use these choices to better serve the consumer,” he says. “But no matter how you cut it, flood is very difficult and convoluted to understand, because it’s not the same as hazard insurance. Flood has nuances that are particular to flood insurance.”
Hofmann is a contributing writer. Markahofmann1952@gmail.com