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NFIP’s Failure Fuels New Risks

Revered economist Thomas Sowell once observed, “Some things are believed because they are demonstrably true, but many other things are believed simply because they have been asserted repeatedly, and repetition has been accepted as a substitute for evidence.”

Sowell’s thinking may have bearing on why taxpayers and property owners have lost hundreds of billions of dollars as Congress has attempted to manage America’s flood risk over the past 43 years. It may also explain why taxpayers and property owners will continue to lose hundreds of billions more, at least until the tragically inaccurate, but-oft repeated idea that flood insurance rates should be artificially low is replaced by what evidence-based science and common sense have revealed during the last decade.

Government-controlled programs operating in what would otherwise be the domain of private enterprise have repeatedly led to unintended market distortions and financial distress; the National Flood Insurance Program (NFIP) is a prime example. While Congress and federal administrative staff have known empirically for many years that the NFIP has, and continues to, encourage behaviors that produce upside-down outcomes on a massive scale, overcoming intrenched misperceptions has proven very difficult. Unless the NFIP raises their rates and begins giving refunds to folks who buy private market flood coverage prior to the last day of their NFIP coverage, we will continue to see varying tragic outcomes that could have easily been avoided.

Congressional hearings have illuminated numerous acute problems surrounding the NFIP, such as insolvency, contributing to increased risk of flooding across the country, and insufficient and inaccurate flood mapping, to mention just a few. During these hearings, those who testified, as well as members of Congress, identified a correlation between the NFIP’s problems and the artificially low rates they charge – a reality that would likely not be the case if the NFIP followed congressional directives to meaningfully raise rates at a reasonable pace annually. Ironically and perhaps predictably, the unintended negative outcomes generated by the NFIP continue to grow – now spreading to GSEs (government-sponsored enterprises) Fannie Mae and Freddie Mac. 

The Trouble With Fannie and Freddie

Though publicly traded companies, Fannie Mae and Freddie Mac operate under a congressional charter that provides a financial backstop from the government – one that was invoked during the financial crisis of 2008 to the tune of $187 billion, according to The Shadow Open Market Committee. Fannie Mae and Freddie Mac were designed by Congress to expand the secondary market for mortgage debt and ultimately boost homeownership among buyers from a variety of demographics. While the GSEs have succeeded in boosting homeownership, they’ve been allowed by Congress to become “too big to fail.”

A recent article in POLITICO noted that Fannie Mae and Freddie Mac hold more than 60% of the mortgages in flood-prone areas across the U.S. Because these homes are technically located outside NFIP-designated “special flood hazard areas”  but inside the actual “100-year flood plain,”  these homeowners are not required by their lenders to purchase flood insurance. As a result, Fannie Mae and Freddie Mac are exposed to potentially existential risk from the peril of flood. Only owners of properties that are within an NFIP flood zone are required to buy flood insurance. That said, their equally flood-exposed neighbors are not forced to buy flood insurance, and as a result do not.

If a significant number of these uninsured, flood-exposed homes were to be seriously damaged by a flood, the owners might not have the resources to repair their homes and may have no incentive to do so if the cost of repairs is equal to or greater than the equity they have in the home. If climate change translates to more frequent or more severe floods, the implications for Fannie and Freddie are ominous.

In their article, POLITICO observes that taxpayers could be on the hook for more than $1 trillion in home mortgages as Fannie and Freddie fail to consider climate risk when purchasing mortgages from lenders. This practice could lead the country into recession even in the absence of a crescendo of floods. More and more savvy homebuyers and lenders are now using new technology to assess the climate risk on properties before they buy a home or originate a loan. This may translate to a downward spiral in flood-prone property values across broad sections of the country. Additionally, Fannie and Freddie may see an even greater concentration of flood-prone mortgages within their portfolios.

Reforming the NFIP will be both a political and a public policy problem until the practice of offering artificially low flood insurance premiums to some and overcharging others, as well as denying policyholders the option to easily switch to competing products, is discontinued. 

See also: Insurance Outlook for 2021

Reworking the NFIP

Congress created the NFIP as a way to shift the U.S. flood insurance market to private insurers. Unfortunately, in 1978, regulators used a loophole in the law that enabled them to remove private flood insurers from the market. This was not the original intent of Congress nor the desire of private flood insurers. Operating as what is essentially a nationalized flood insurance system, the NFIP has cost taxpayers about $1 billion per year since its inception.

What if the private market had continued to be involved in the nation’s flood insurance paradigm? I would venture to say that pricing would have at least kept up with losses. Likely, prices would have been high enough to discourage rampant building in dangerous locations. As a result, more coastal and riverine land would have been left to nature and thereby would have served to reduce the severity of flood events. And importantly, with fewer houses built in hazardous locations, we would have avoided the present-day financial risk to our nation’s economy faced by Fannie and Freddie.

When it comes to responding appropriately to climate risk, the NFIP experience has demonstrated that a government-controlled system is the wrong approach. The NFIP is now a political football, used as a favor for folks located close to sources of flooding at the expense of those located in less-flood-prone areas. This kind of unintended outcome is what often happens when the government takes over where the free market was willing to participate. Now, we are seeing manifold pernicious effects manifesting themselves in the mortgage finance market with staggering implications. 

Congress must focus on reforms that allow buyers to change flood insurance carriers at the time of their choosing and encourage the private sector to assume flood risk over the long term by assuring that the NFIP does as Congress has already instructed them to do – to raise rates to actuarially sound levels and serve as the flood insurer of last resort.

Now Comes the Flood Season

We’re entering a flood season where one-third of Americans are expected to experience flood events, after which we’re forecast to see above-average hurricane activity. With people already experiencing financial shocks from COVID-19, it is all the more important that we take steps now to prepare for flooding. 

We need three things: rapid innovation from the Federal Emergency Management Agency (FEMA), long-term authorization of the National Flood Insurance Program (NFIP) and the removal of regulatory barriers around private flood insurance.

1: Rapid FEMA Innovation

FEMA’s response to COVID-19 was swift and decisive: It extended its flood insurance premium payment grace period to 120 days (from 30). This offers homeowners breathing room and will go a long way toward ensuring homeowners maintain the protection they need while juggling other financial commitments.

The agency has also provided guidance for remote claims adjusting, which makes it possible for policyholders to have a flood loss adjusted without an adjuster physically visiting the property. This guidance lets everyone comply with social distancing directives.

These actions illustrate the agility and innovation FEMA is capable of. To ready homeowners for 2020’s flood season, we need more of this, in areas that go beyond direct responses to COVID-19.

While there are some actions FEMA can take today, the most important changes would require action from Congress.

2: Long-Term NFIP Authorization

NFIP authorization is set to expire on Sept. 30, in the midst of the 2020 hurricane season. This is incredibly dangerous. 

We’ve been lurching from short-term authorization to short-term authorization since 2017. The lack of long-term authorization creates uncertainty that could cause further financial damage to a population already reeling from record unemployment. This would happen via two mechanisms.

First, an NFIP with lapsed authorization cannot write new policies or issue renewals. This has the first-order effect of leaving millions of Americans without flood protection. Just as crucially, the lapse could also cause real estate transactions in some areas to halt, as mortgage lenders will not issue loans in these areas without proof of coverage.

For an industry already strained by COVID-19, a lapse would be disastrous.

Second, without long-term authorization, the NFIP’s ability to borrow from the Treasury is severely reduced, which could jeopardize its ability to pay claims. After a flood, homeowners with insurance might be delayed in collecting benefits they depend on to rebuild their homes. It’s hard to overstate how devastating this could be, particularly in light of current economic conditions.

See also: Need for Context in Assessing Flood Risk  

3: More Common Sense Around Private Flood Insurance

Today, homeowners with private flood insurance who decide, for one reason or another, that they want to switch to an NFIP policy aren’t considered to have had continuous coverage, which can make them ineligible for subsidized NFIP rates.

In today’s flood insurance landscape, where private products are increasingly available and robust, this policy no longer makes sense. But FEMA seems unable to update it without authorization from Congress.

It is incumbent upon Congress, therefore, to update eligibility guidelines so that Americans who have maintained continuous insurance coverage are eligible for subsidized NFIP rates. Without those subsidies, cash-strapped homeowners might opt to forgo flood insurance altogether, meaning that, in the event of a storm, they become wholly dependent on emergency FEMA resources rather than benefits from a policy specifically designed to help them recover and rebuild.

To Prepare for 2020’s Flood Season, We Need Support From Lawmakers

Much flood preparation happens at the individual homeowner level.

But we can’t expect collective, nationwide resilience to flood events without innovation from FEMA, and we can’t achieve that without decisive action from Congress. We need long-term NFIP authorization to ensure that homeowners have coverage when waters rise and regulations that acknowledge the validity of private flood insurance to ensure NFIP subsidy access to homeowners returning to NFIP policies.

Without both, we risk augmenting financial distress for both individual homeowners and the larger economy, neither of which we can afford right now.

Micro-Censusing: Future of Flood

The ability to micro-census – that is, to gather granular data about individual homes and businesses and use it to inform underwriting – will lead to the biggest changes in flood insurance since the launch of the National Flood Insurance Program (NFIP) in 1968.

Most visible among these changes will be the transformation of NFIP policies and the rise of private flood insurance, which micro-censusing makes possible (read: potentially profitable at scale) for the first time. Here, I’ll examine the rise of micro-censusing in insurance; its likely applications in the flood market; and the potential impact on NFIP and private products, the agents selling them; and the Americans they’ll protect.

The Rise of Micro-Censusing and Its Applications in the Flood Market

In the last two decades, innovation in the insurance industry has been powered by better data. Data collection from smart devices is changing how health and auto insurers price policies, and data from services like Google Maps is changing how underwriters assess business insurance applications.

In homeowner’s insurance, providers are pulling publicly available, address-specific data – from roof type to proximity to a fire hydrant – and feeding it to algorithms to assess risks.

All of these can be considered examples of micro-censusing because they use data at the individual rather than demographic level to determine risk, which makes for much more accurate assessments.

Now that readily available tech makes micro-censusing possible and practical, it’s become wildly popular. With micro-census data, insurance providers can price policies more accurately and manage risk far better than was historically possible.

This is a boon for markets like flood, where existing risk models are often outdated. Micro-censusing makes it possible to assess risk on a property-by-property basis in something close to real time. 

In practice, this means, for example, that the houses on the lower-lying part of a street, where water tends to pool during heavy rainstorms, could receive vastly different quotes from those at the top of a modest hill, where puddles typically don’t form. Homeowners at both locations would receive more precise quotes.

Risk Rating 2.0: How NFIP Is Leading the Way

FEMA is redesigning its flood insurance products, thanks in part to micro-censusing breakthroughs. In October 2021, the NFIP plans to roll out Risk Rating 2.0, an all-new rating methodology.

While not many details about Risk Rating 2.0 are public, the update is expected to change NFIP policies in a few fundamental ways. 

First, micro-censusing capabilities are expected to introduce property-specific risk assessment capabilities, which will make way for flood insurance policies that are tailored to each household.

The new rating engine is also expected to help agents accurately price and sell policies. More rating clarity will help policyholders better understand their property’s flood risk and how that risk is captured in their cost of insurance.

Perhaps most importantly, NFIP’s rating characteristics under Risk Rating 2.0 include the cost to rebuild a home, which means that NFIP will aim to give more affordable quotes to owners of lower-value homes. In other words, the system will be able to provide fairer policies to all homeowners.

See also: Flood Insurance: Are the Storm Clouds Lifting?  

The Impact of Micro-Censusing on Private Insurance

In addition to changing the way the NFIP rates policies, micro-censusing technology is also drawing private insurers to enter the flood market. The new availability of data means they can now more confidently assess and underwrite risks around the country. 

The implications of this are significant: With private insurers entering the market, there’s sure to be an increase in available products, which means greater opportunity for Americans to protect their homes and greater opportunity for agents to grow their books and better serve their customers. 

Greater product availability will also put less strain on federal disaster funds. Today, 20% of all NFIP claims come from properties that aren’t in high-risk areas. Those properties receive a third of all federal disaster assistance for flooding, in part because they’re not required to carry flood insurance.

In other words, the impact of micro-censusing (and other technology) on flood insurance can’t really be overstated, especially in an era where FEMA’s official position is “anywhere it can rain, it can flood.”

See also: 5 FAQs on Private Flood Insurance  

Micro-Censusing Will Bring Macro Changes to America’s Flood Insurance

Today, the typical homeowner faces a 10% chance of fire loss over the course of a 30-year mortgage, but a 30% chance of flood loss. Still, 85% of homeowners have fire insurance and just 15% have flood insurance. These are clear indicators that flood insurance in America needs a makeover.

Micro-censusing has the power to spark dramatic change in the industry. The granular data it provides will lead to the entry of more private insurers and the improvement of NFIP policies, which will increase agents’ ability to find appropriate coverage for their customers. Overall, this will mean better flood protection for at-risk Americans.

5 FAQs on Private Flood Insurance

With headlines about catastrophic and historic storms driving increased interest in flood insurance, the emerging private flood insurance market – an alternative to coverage through the National Flood Insurance Program (NFIP) – is increasingly attractive to homeowners. As realtors guide their clients through the home buying process, here is some basic information that clients need to know about this new option:

Q: What is private flood insurance, and what does it cover?

A: Private flood insurance is a risk management tool backed by global capital markets that provides financial protection for buildings and personal property damaged by floods, helping families, communities and businesses to recover from these devastating events.

Q: What are the differences between an NFIP and private policy?

A: There are two primary differences between an NFIP and private policy: regulatory authority and source of capital.

The biggest misconception with private flood insurance is that the NFIP is regulated and that private isn’t. Private flood insurance is heavily regulated and falls under the jurisdiction of state insurance regulators – just like homeowners, hurricane and auto insurance. While these state-based insurance regulations are separate from the federal regime that regulates the NFIP, the level of consumer protection and oversight is comparable.

The second difference is who’s bearing the risk of loss. With an NFIP policy, FEMA holds all program risk, with U.S. taxpayers serving as the ultimate backstop. With private flood insurance, independent insurance companies bear the risk of loss. As a result, these companies cannot accept any risk in any location and must be more discerning with respect to underwriting, coverage and price. While private insurers cannot be all things to all people, this disciplined and thoughtful approach means these insurers can deliver a sustainable and valuable product to homeowners.

See also: Here Is How to Make Flood Insurance Work  

Q: How can a private policy work in tandem with an NFIP policy?

A: A private policy can act as either an alternative or a complement to an NFIP policy. Private policies equip agents with customizable options that can cater to individual homeowners’ needs, allowing insurance agents to craft solutions that ultimately protect more people from floods.

Private policies can also complement an NFIP policy. If you have a policy through the NFIP, you can purchase private insurance to increase the limits of your coverage. Private insurance is also available to expand coverage, such as adding protection for contents in a basement or the expense to clean out a swimming pool.

Q: Who qualifies for private flood insurance, and how does it work?

A: The NFIP is essentially a one-size-fits-all policy available to almost every person in all geographies. However, homeowners aren’t all the same. That’s the beauty of private insurance programs – they’re different programs offering different value propositions to different people, like high-net-worth homeowners or renters.

Q: What is/isn’t covered by a homeowner’s policy when it comes to a flood?

A: Generally speaking, most homeowners’ policies exclude flood losses completely. A homeowners’ policy may cover water damage from broken pipes or sump pumps, but most exclude loss from inundation, whether resulting from swollen rivers, storm surge or intense rainfall.

The flood insurance industry is rapidly changing, and there are new opportunities coming online every day. Every realtor should take time to understand these new options. In most situations, the home is the family’s most valuable investment. Wherever it rains, it can flood, so take time to consider solutions that can protect these treasured investments from catastrophe.

See also: Emerging Market for Flood Insurance  

This article is provided for general informational purposes only and is not intended to provide individualized business, insurance or legal advice. You should discuss your individual circumstances thoroughly with your legal and other advisers before taking any action with regard to the subject matter of this article. Only the relevant insurance policy provides actual terms, coverages, amounts, conditions and exclusions for an insured.

Here Is How to Make Flood Insurance Work

The National Flood Insurance Program (NFIP) needs to change. It was $30 billion in debt last year (though Congress forgave $16 billion of that), its flood maps are woefully outdated and its incentives are out of whack – while the riskiest homes it insures make up just 2% of premiums, they account for 25% of claims.

In recent months, Congress has extended the program (and occasionally let it lapse) without making any meaningful reforms – a strategy that has proven woefully inadequate to the problems the NFIP faces. This month presents yet another deadline: Unless Congress renews the NFIP by tomorrow, it will lapse. This is a golden opportunity to modernize a program that is not adequate for the new realities of severe weather.

We’ve faced this opportunity before, and various stakeholders have offered solutions. One common chorus is to encourage private insurers to get in the game to fix the NFIP. I’d like to modify that proposal slightly: Privatize flood insurance, and make everyone get it.

If this sounds philosophically similar to what the Affordable Care Act tried to do for health insurance, that’s because it is. We all agree that health insurance premiums won’t come down if only sick people buy it. Encouraging everyone to buy health insurance makes sense because everyone – even the healthiest among us – faces risk. Anyone, after all, can get hit by a bus.

Today, the same is true of flooding. After last year’s hurricane season, FEMA’s official position became “anywhere it can rain, it can flood.” In other words: All of us could benefit from flood insurance.

See also: Emerging Market for Flood Insurance  

Of course, there are several major differences between the health and flood insurance landscapes.

First, while nutrition and medical research are improving our tools for staying healthy, our collective flood exposure is growing. There are three major culprits:

  1. Human nature. We like living near water, which means living in high-risk areas. As long as people will buy or rent homes near the water, developers will build them.
  2. The current regulatory environment provides incentives for development without providing incentives for management of flood risks – we saw the results of this all too clearly when Harvey hit Houston last year, and we saw it again this hurricane season with Florence and Michael.
  3. Extreme weather is the new normal. Four of the five most damaging (and expensive) hurricanes of all time have happened since 2012. The most expensive was in 2005. This is not a fluke.

The second important difference between flood insurance and health insurance is that the American people are already paying for flood insurance. The NFIP is a taxpayer-subsidized program, but only taxpayers with an active policy enjoy protection in the event of a flood. Privatized universal coverage would not greatly affect the number of people currently paying for flood insurance, but it would significantly increase the number of people who enjoy the benefits of coverage because payments would be tied to actual policies.

The third difference is that our current system for flood insurance encourages behavior by homeowners, developers and local leaders that works against everyone’s long-term interest. For example, the NFIP currently has updated flood maps for some communities that show an increased number of homes at risk for floods. But residents have, in some cases, successfully lobbied for delays in the effective date of those maps because, as soon as they become effective, home values will drop and residents will have to start buying flood insurance.

In other words, skewed incentives are pushing people to act against their best financial interest and against the interests of other taxpayers. Privately run flood insurers would mean no reelection pressures to falsify flood maps (which local politicians currently face), and homeowners for whom flood insurance is mandatory would have no incentive to avoid it.

See also: Future of Flood Insurance  

Beyond all this, though, privatization makes sense for other reasons. Private insurers would find ways to provide incentives for relocation rather than rebuilding in areas that flood repeatedly. They would prioritize the data analysis necessary to make flood maps that are both accurate and predictive. And they would likely lend their lobbying weight to reforming development and environmental regulations that contribute to our growing flood exposure.

This amounts to a significant change in how we think about flood insurance in the U.S., but our risk of flooding has changed significantly in recent years. Anything short of a drastic overhaul will mean the NFIP just ends up further underwater.