By Anthony Cappelletti
Flood risks are often considered uninsurable without some form of government intervention. Flood prone areas (i.e., those adjacent to rivers or coastlines) are most likely to be flooded, possibly repeatedly. Governments must be involved in the management of development in flood prone areas, such as minimum building standards, in order to control loss exposure. But even with effective flood plain management, there will still be flood risk and the need for insurance. Insurers often consider flood to be uninsurable for a number of reasons including: flood plain management may not be effective, the risk of widespread flooding can cause catastrophic level losses affecting many policyholders, only those in flood prone areas will demand coverage, and adequate rates in flood prone areas may not be affordable. Governments must consider that without the availability of flood insurance, those with flood losses will need to rely on post-disaster assistance funds.
In 1968, the U.S. implemented the National Flood Insurance Program (NFIP) to manage flood risks and make insurance available with the federal government as the insurer. The NFIP has a sunset clause and periodically requires reauthorization by Congress in order to continue. Congress has reauthorized the NFIP every time, but it is not without debate and modifications to the program. The current reauthorization of the NFIP is set to expire on Sept. 30 of this year.
In the coming months, Congress will be considering many potential changes to the program for the upcoming reauthorization. The program has paid out more than it received in premium revenue. Before Hurricane Katrina in 2005, the difference was modest. However, losses from Hurricane Katrina created a debt of nearly $20 billion. Since then, the NFIP has experienced other catastrophic losses that have added to the debt (e.g., Superstorm Sandy). Despite including premium surcharges to reduce the debt, the debt is now nearly $25 billion. The Biggert-Waters Flood Insurance Reform Act of 2012 was an attempt to bring financial stability to the program partly through the phasing out of premium subsidies with a move to actuarially sound rates. However, this created affordability issues almost immediately. In 2014, some of the Biggert-Waters changes were moderated with enactment of the Homeowners Flood Insurance Affordability Act.
Top 5 NFIP Loss Events
Source: Federal Emergency Management Agency
|Event||Year||NFIP Amount Paid|
|Hurricane Katrina||2005||$16.3 billion|
|Superstorm Sandy||2012||$8.4 billion|
|Hurricane Ike||2008||$2.7 billion|
|Hurricane Ivan||2004||$1.6 billion|
|Hurricane Irene||2011||$1.3 billion|
The NFIP is a federal program that, as of August 2016, had just more than 5 million policies in force. However, these policies are concentrated regionally. More than 80 percent of the NFIP policies come from 10 states. In fact, more than 70 percent of the policies arise from just six states. Florida alone has more than 35 percent of all NFIP policies with another 35 percent of NFIP policies from the following five states: Texas (12 percent), Louisiana (9 percent), California (6 percent), New Jersey (4 percent) and South Carolina (4 percent). (Source: Federal Emergency Management Agency) It will be interesting to see if regional issues influence the considerations of Congress for NFIP reauthorization.
In order to determine the best path forward for the NFIP, Congress must consider the most effective use of taxpayer dollars in ensuring that flood insurance remains available and affordable. It must consider issues such as: program debt, actuarial soundness of rates/rate subsidies, compulsory purchase of flood insurance, structure of the program, and involvement of the private sector. In order to make a sound decision, Congress needs all the facts before it. To this end, three reports were released in April of this year to give Congress the information it needs.
- The American Academy of Actuaries Flood Insurance Work Group published the monograph “The National Flood Insurance Program: Challenges and Solutions,”
- The Center for Insurance Policy and Research (CIPR) of the National Association of Insurance Commissioners (NAIC) published the study “Flood Risk and Insurance,” and
- The United States Government Accountability Office (GAO) published a Report to Congressional Addressees, “Flood Risk and Insurance: Comprehensive Reform Could Improve Solvency and Enhance Resilience.”
Each of these reports provide a wealth of information to Congress as they consider reauthorization. The Academy Monograph gives an actuarial perspective, the CIPR Study provides a regulatory perspective, and the GAO Report provides a fiscal perspective.
Each report includes an overview of the insurability of flood and the history of the NFIP while also providing suggestions with respect to the reauthorization of the NFIP. However, each report includes material unique to each perspective. For example:
- the Academy monograph includes a section on Actuarial Standards, Principles, Soundness,
- the CIPR study includes a section on State Insurance Regulator Views on Flood Risk and Insurance, and
- the GAO report emphasizes efforts to reduce federal fiscal exposure and improve risk mitigation.
I encourage all who are interested in the future of the NFIP to read these reports. It should be noted that all three reports support the view that the NFIP must find a way to get the private-sector involved in the insurance risk-taking role as opposed to just being administrative support for the program.
It remains to be seen if there is a willingness for Congress to consider major changes to the program at this time that would increase the role of the private sector.
|"Although the NFIP has generally priced its policies at levels inadequate to cover losses from major catastrophes, with coverage in the high risk areas often sold at below market levels, the take-up rate remains at a low 50 percent in the NFIP flood zones and far less outside these zones. With the recent experience showing flood risk is not limited to NFIP-designated flood zones, but in reality it extends to most, if not all, geographic regions. Expanding coverage is critical as floods are more widespread and happen with increasing frequency."— CIPR study, April 2017|
In its deliberations for program reauthorization, Congress must consider all of the NFIP’s activities in order to weigh the costs and benefits of the program. The NFIP is not limited to the supply of flood insurance in the U.S., it also produces flood mappings, develops land use strategies with communities, and contributes to the development of building codes.
The GAO report outlines the following six areas to consider with respect to comprehensive flood insurance reform:
- Outstanding debt
- Premium rates
- Consumer participation
- Barriers to private-sector involvement
- NFIP flood resilience efforts
FEMA’s $24.6 billion outstanding debt, as of March 2017, represents a significant financial obligation for the program and making principal and interest payments on that debt has tied up funds that might otherwise have been used for program operations.
NFIP premiums do not reflect the full risk of loss, which increases the federal fiscal exposure created by the program, obscures that exposure from Congress and taxpayers, contributes to policyholder misperception of flood risk … and discourages private insurers from selling flood insurance. ...
Industry and non-industry stakeholders with whom we spoke said that rate increases associated with the transition to full-risk premium rates can raise affordability concerns for some policyholders and create a risk that fewer consumers would purchase flood insurance.
Increasing consumer participation could help ensure more consumers would be better protected from the financial risk of flooding.
According to industry and non-industry stakeholders with whom we spoke, NFIP’s subsidized premium rates remain the primary barrier to private-sector involvement in flood insurance.
NFIP flood resilience efforts include mitigation, mapping, and floodplain management through community participation. Based on our analysis of the policy goals we identified, supporting these activities could address the policy goal of enhancing resilience by ensuring flood risk was identified through mapping and reduced through mitigation and floodplain management. Any reforms related to NFIP flood resilience efforts will have potential implications for issues such as premium rates, consumer participation, and private-sector involvement in flood insurance.
For each of these six areas the GAO report considers potential reforms for Congress to consider and the implications for the potential reforms. For example, in regard to the outstanding debt, the GAO report notes that “Congress could eliminate FEMA’s debt to Treasury.” One of the implications of this would be to allow the NFIP to allocate “funds currently used for principal and interest payments and reallocate them for other purposes such as building a reserve fund or financing program operations.” The report then goes on to state that “eliminating the debt without addressing an underlying cause of the debt—insufficient premium rates—would keep in place an unsustainable system.”
In its conclusion, the Academy monograph suggests a number of issues that Congress consider with respect to the reauthorization of the NFIP. The following is a sample of some of the suggestions presented:
- Take-up rates in “low-risk” areas.
- The non-insurance activities of the NFIP.
- The NFIP’s interaction with other federal budget functions.
- Changing hazard over time (e.g., rising sea levels).
- The impact of technology on what is possible to underwrite in the private market.
- The challenges of state regulation for private insurers.
- State-level solutions to property insurance market challenges.
- The need for clarity around NFIP funding sources for it to compute actuarially sound rates.
- The likelihood of adverse selection from private-sector competition.
- Depopulation of the NFIP will affect its ability to repay public debt.
The Academy monograph also makes the following interesting observations:
- The NFIP’s mission has evolved over time. Changes in the law have led to some conflicting mandates, particularly between reducing Treasury’s exposure to the need for lending to cover program deficits while encouraging widespread participation by keeping premiums affordable and offering subsidies to certain classes of policyholders.
- Various stakeholders interviewed by the work group offered several clear directions for potential changes to the NFIP. One area strongly supported involved finding ways to increase flood coverage in areas perceived to be “low risk.” Doing so would address problems of uninsured losses arising from events like the recent flooding in Louisiana, while potentially improving the system’s overall financial position by increasing revenue and spread of risk.
- The current distinction of the 1-in-100-year flood zones for mandatory coverage has led consumers to believe erroneously that they do not have significant flood risk when they are not required to purchase flood insurance. It is politically and logistically infeasible to require mandatory flood insurance coverage for all property owners, or even to significantly expand the existing mandatory footprint. However, increasing consumers’ awareness and educating them about their flood risk can potentially increase take-up in areas outside the mandatory coverage areas.
The CIPR study also includes a number of suggestions for public policymakers to consider with respect to flood insurance in the U.S. The following is a sample of some of the suggestions presented in the conclusion of the CIPR study:
- Develop better understanding of population exposure and total risk mitigation strategies for accurate modeling of losses at both risk and portfolio levels.
- Require mandates to make sure people purchase flood insurance.
- Offer community flood insurance where a local government or quasi-governmental entity purchases flood insurance on behalf of all its residents.
- Flood insurance premiums should in principle reflect risk.
- Provide assistance to high-risk area residents through a means-tested program distinct from risk-based pricing.
- Improve NFIP mapping using state-of-the-art technology for better risk information.
- Include flood in every standard homeowners insurance policy.
- Allow private insurers flexibility in charging risk-based insurance premiums for flood insurance.
- Bring together insurers, reinsurers and insurance-linked security (ILS) market participants to link flood risk to the capital markets to increase capacity.
- Look to how flood insurance is provided and regulated in other developed countries.
Be sure to read the June/July of The Actuary as it will include a GI themed article, “Extreme Measures: How the design of the Florida “Cat Fund” Fairly and Efficiently Provides Funding for Catastrophic Hurricane Losses in the State,” by Rade Musulin and Jack Nicholson. Rade Musulin, MAAA, ACAS is vice president, Casualty of the American Academy of Actuaries, and CEO of FBAlliance Insurance. He was one of the authors of the Academy monograph. Jack Nicholson, Ph.D., CLU, CPCU, was the chief operating officer of the Florida Hurricane Catastrophe Fund (FHCF) from 1994 until early 2016. This article provides another perspective as to how the provision of insurance for catastrophic losses can be managed in a partnership with the private sector and the government. While the FHCP and the NFIP cover different perils (i.e., wind for the FHCP, and flood for the NFIP), losses for both programs have been generated by the same event (e.g., Hurricane Matthew in 2016). The structure and functioning of the FHCF could be a source of inspiration for those looking at potential changes to the NFIP. The FHCF is an example of government supporting the private sector to provide insurance for difficult-to-insure exposures. For hurricane exposures in Florida, private-sector insurers provide the insurance while the FHCF acts as a low-cost reinsurance facility to the private-sector insurance industry. It is possible that the FHCF model could work for the NFIP.
|"It is worth noting the implications of the non-reauthorization of NFIP would extend far and wide beyond the confines of the insurance market, impacting mortgage lenders and the housing market with serious repercussions for the U.S. economy as a whole, handicapping its continuing growth."— CIPR study, April 2017|
Anthony Cappelletti, FSA, FCIA, FCAS, is a staff fellow for the SOA. He can be contacted at firstname.lastname@example.org.