Tag Archives: firms

Harvey Hammers Home NFIP Issue

The economic devastation and human suffering that Hurricane Harvey inflicted on vast numbers of people will sorely test the National Flood Insurance Program (NFIP) as it comes up for renewal, with the NFIP lapsing if Congress and the president fail to act by the end of the month. Some in the federal government, state regulators, industry experts and this economist favor solutions encouraging private sector participation in flood insurance markets. Near-term, the most likely and wisest course seems to be a short extension allowing the Federal Emergency Management Agency (FEMA) and NFIP to focus on settling claims while politicians and policy experts develop longer-term solutions.

With the U.S. Government Accountability Office (GAO) reporting the NFIP was $24.6 billion in debt before Hurricane Harvey, many in government and elsewhere feel significant reforms are needed. Other knocks against the NFIP as currently constituted include its reliance on allegedly inaccurate and out-of-date flood insurance rate maps (FIRMS), its failure to charge actuarially appropriate premiums and policy limits too low to provide adequate insurance protection. Some also contend that the NFIP encourages excessive risk taking and poor land use by providing subsidized insurance coverage for properties that repeatedly get flooded out, effectively divorcing those who choose to reside in flood prone locations from the consequences of their decisions.

Uncertainty about the exact extent of the devastation caused by Harvey will persist for some time, as the huge number of properties damaged by the storm, difficult conditions and continuing lack of access to some of the hardest-hit areas all add to the time necessary to assess losses. Further complicating efforts to understand the magnitude of the losses caused by Harvey, published reports often fail to clearly distinguish between economic losses, insured losses covered by private carriers and insured losses covered by the NFIP. Nonetheless, it appears Hurricane Harvey may exhaust the NFIP’s financial capacity, causing the program to go still deeper in debt.

See also: Harvey: First Big Test for Insurtech  

The NFIP purchased private reinsurance covering 26% of its losses between $4 billion and $8 billion, but Fitch Ratings believes losses from Hurricane Harvey could consume the NFIP’s $1.04 billion in reinsurance protection.

As Congress and the president ponder the way forward, the options available to them include several that would facilitate development of private markets for flood insurance akin to the private markets for homeowners insurance. Key elements of such solutions include measures clarifying mortgage lenders’ ability to use flood coverage underwritten by private carriers to satisfy insurance requirements imposed by Fannie Mae and Freddie Mac.

The development of private markets for flood insurance will also require that the NFIP adopt actuarially sound pricing. Simply put, private carriers that must cover their costs and earn an adequate rate of return on capital would be at a tremendous disadvantage competing against taxpayer-subsidized coverage from the NFIP. And it would certainly help if carriers currently participating in the NFIP’s WYO Program were allowed to also offer alternative coverage. Currently, the WYO Program includes a non-compete clause that precludes carriers from offering alternative standalone flood insurance.

The constituencies supporting increased private sector involvement in flood insurance markets include the National Association of Insurance Commissioners, the Property Casualty Insurers Association of America, the National Association of Mutual Insurance Companies and the American Insurance Association, which have all come out in favor of the Flood Insurance Market Parity and Modernization Act passed unanimously by the House in 2016.

Thinking more broadly, there may be no need for the federal government to participate directly in the flood insurance business. Mechanisms akin to state FAIR and Beach Plans could serve as insurers of last resort for property owners unable to obtain coverage from private carriers. Or, we could transition from the NFIP as it exists today to a new NFIP modeled on the Terrorism Risk and Insurance Program (TRIP) introduced after the terrorists destroyed the World Trade Center on Sept. 11, 2001. Under that program, insurers must offer terrorism coverage, with policyholders then free to accept or decline. If insured losses from a terrorist attack exceed specified triggers, the federal government provides reinsurance protection, and insurers subsequently reimburse the federal government.

Thinking still more broadly, there may be no need for the federal government to participate in the flood insurance business at all. With trillions of dollars flowing through global capital markets, catastrophe bonds and other insurance-linked securities could enable insurers and reinsurers to obtain all of the capacity necessary to cover flood risk without any federal reinsurance backstop.

See also: Time to Mandate Flood Insurance?  

An ideal solution would enable one policy to provide coverage for both wind losses and flood losses. As long as those losses are covered by separate policies, policyholders and insurers will remain burdened with having to distinguish wind losses from flood losses— a frequently contentious and often expensive undertaking that adds to the time necessary to settle claims.

In any case, private sector insurers and reinsurers now have access to data and sophisticated flood models that enable them to price and underwrite flood risk intelligently. And developments such as the new commercial flood insurance program recently introduced by ISO and Verisk Analytics set the stage for greater participation in flood insurance markets by ever greater numbers of insurers, as will the corresponding personal property flood insurance program they plan to roll out later this year. With state regulators and insurers aligned, it seems all that’s necessary to unleash the power of private markets is action on the part of Congress and the president. Why not send them a postcard?

Flood Risk: Question Is Where, Not When

Over the past year, flood insurance has become more apparent in the media and trade publications. Normally, only catastrophic events (i.e. hurricanes) capture so much attention, but the combination of some massive floods and the continued progress of private flood legislation has started conversations that are overdue. Both the nature of these storms and floods, and their impact on property owners are getting close attention, and that is welcome because it is changing the way people think about underwriting flood insurance.

Recently,  Jeri Xu of Swiss Re published an article that illustrates such a change of perception. She offers a very useful way to think of the rain events (what NOAA calls 1-in-a-thousand-year rain storms) that have caused some of the most serious recent floods (i.e. 2016 Texas, West Virginia, Maryland and Louisiana). Because these types of flood-causing storms are localized at the county-level (roughly speaking), and there are about 3,000 counties in the country, it is not unreasonable to expect three flood-causing thousand-year rain storms every year. With this insight, Xu has transformed the extremely rare to the commonplace and reconciled the headlines with the stats.

See also: How to Make Flood Insurance Affordable  

A bit of caution is needed when comparing rain events with flood events – for the sake of this argument, let’s assume a millennial downpour does result in flooding (it is not a stretch to say so).

Xu and the headlines are teaching us to stop wondering when a serious flood is going to happen – it is way more important to understand where the damage will be when the serious flood does happen.

The accepted and common way to guess where the flooding will occur is the 100-year floodplain on FEMA’s FIRMs. However, according to this article from David Bull, 85% of the losses in Baton Rouge and Lafayette were outside the 100-year flood plain and uninsured. Clearly, the FIRMs do not help underwriters (or homeowners) understand flood risk (neither where, nor when). Indeed, the FIRMs were never intended for that, as they are rate maps, not risk maps.

Instead, underwriters need information that will help them understand the likelihood of a specific property flooding when there is flooding, because the flood is coming, somewhere.

This approach is comparable to how wind (and, lately, storm surge) is underwritten. Karen Clark & Co. has taken such an approach for hurricane: The software assumes an event (the firm calls them characteristic events, or CEs) and then calculates the expected loss results based on that CE happening. There is good reason for this: Underwriters should assume a handful of hurricanes will land on the coast in a given year, just as they should assume a handful of significant inland flood events should happen annually. Working with that logic makes it less important to wonder when something will happen.

See also: Is Flood Map Due for a Big Data Make-Over?  

It has long been written about how flood losses occur beyond flood zones. Looking at flood risk by where, not when, is an effective way for underwriters to manage their business while considering this fact. More importantly, it is a view of risk that supports the creation of insurance products that can help narrow the protection gap in the U.S., because it is unacceptable to have 85% of damaged homes (in Louisiana of all places) without flood coverage.