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 Other knocks against the NFIP as currently constituted include its reliance on allegedly inaccurate and out-of-date flood insurance rate maps (FIRMS), its failure to charge actuarially appropriate premiums and policy limits too low to provide adequate insurance protection.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.
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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.
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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?