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.
National Flood Insurance Act of 1968 creates National Flood Insurance Program.
Flood Disaster Protection Act of 1973 mandates flood insurance purchase in Special Flood Hazard Zones.
Government launches Write-Your-Own insurance program, where private insurers and producers market and service NFIP policies in an effort to encourage participation in the program. The federal government remains the NFIP underwriter.
Hurricane Katrina and others plunge NFIP into billions of dollars of debt.
Superstorm Sandy continues to add to NFIP’s growing debt. Biggert-Waters Flood Insurance Reform Act becomes law, requiring, among other things, that premiums better reflect the risk insured.
Homeowners Flood Insurance Affordability Act of 2014 delays implementation of some Biggert-Waters reforms and repeals others.
NFIP makes its first purchase of private reinsurance to bolster the program.
NFIP’s debt has ballooned to more than $24 billion. Congress begins debate over reforming and reauthorizing NFIP, which is set to expire Sept. 30. In late August, Hurricane Harvey devastates Houston and other areas along the Texas Gulf Coast, and Hurricane Irma slams Florida in September, ensuring NFIP’s deficit will grow.
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.”
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.
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.
Entitlement means flood insurance will be difficult to change.
Virtually everybody agrees the National Flood Insurance Program is broken. After all, the program is about $24 billion in debt, courtesy of a series of natural disasters starting with 2005’s Hurricane Katrina and exacerbated by years of actuarially inadequate rates propped up by subsidized premiums.
Yet consensus on reform has proven quite hard to achieve, as have congressional reauthorizations of the program. A few years ago, there was even an attempt to expand the already debt-ridden program to include windstorm coverage. As opponents of the proposed expansion pointed out, the private insurance market already provided windstorm coverage, albeit at a price some policyholders might balk at.
The failure to come to terms with reform has led to brief lapses in the program, which didn’t do any wonders for the real estate market, as federally backed loans in flood-prone areas must be backed by NFIP coverage. A significant reform in 2012, which among other things opened the way for actuarially based rating, was partially rolled back two years later after NFIP policyholders facing meaningful rate hikes let their members of Congress know their displeasure.
Why is reform so difficult?
One reason is that the reform debate is philosophical as well as economic, says Joel Kopperud, The Council’s vice president of government affairs.
“This debate falls into the philosophical debate of what the role of the federal government is,” he says. “Some are focused on budget issues and actuarial soundness; others are focused on making sure Americans are covered.”
Another reason is that the debate over the scope and cost of the program doesn’t break down neatly along party lines, says Frank Nutter, president of the Reinsurance Association of America. Instead, regional issues come into play, which is hardly surprising given more than half of the policies are issued in three states—Florida, Louisiana and Texas. “You get strong support from Democrats and Republicans [in coastal states] for continuing a program that has subsidies built into it.”
Don Griffin, vice president of personal lines for the Property Casualty Insurers Association of America, agrees NFIP is “more a coastal and riverine issue.” He says many of the areas that have lots of subsidies are in populous states.
“Subsidized insurance for those who live in flood-prone areas—including wealthy property and business owners—should be viewed as entitlements that have been around just about as long as Medicare and Medicaid,” 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.
“As the current healthcare debate and debacle illustrate, once an entitlement genie is out of the bottle, it’s almost impossible to get it back in.”
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.
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.”
When it comes to catastrophe loss estimates from events like Hurricanes Harvey and Irma, odds are insurers and others will have to wait quite a while before the true cost of the event is known.
Catastrophe models generated a wide range of estimates of insured damage in the immediate aftermath of Harvey, all of which are sure to be revised and revised again. While the models often differed, all indicated Harvey’s toll would fall considerably short of those caused by the three costliest hurricanes in recent U.S. history.
The Insurance Information Institute, citing research conducted by Property Claim Services, a Verisk Analytics business, puts 2005’s Hurricane Katrina at the top of the list, with $49.79 billion in insured damage in 2016 dollars. The next costliest, 1992’s Hurricane Andrew, caused less than half as much, with $24.48 billion in insured damage in 2016 dollars, while 2012’s Superstorm Sandy came in at $19.86 billion.
The highest initial insured-damage estimate for Hurricane Harvey came from Karen Clark & Co., which put total insured loss—not including losses covered by the National Flood Insurance Program—at roughly $15 billion. This included about $2.5 billion in wind damage, $500 million in storm surge and more than $12 billion in inland flooding in Texas and Louisiana.
Modeler AIR Worldwide estimated insured losses—again excluding properties covered by NFIP—would exceed $10 billion, with $3 billion stemming from wind and storm surge. But the insured losses amount to only a fraction of total property losses, which AIR estimates could hit the $65 billion to $75 billion range.
CoreLogic, another modeler, estimated private insurers would sustain less than $500 million in insured flood losses, while wind losses would range in the $1 billion to $2 billion range. Uninsured flood loss could reach $27 billion.
Damage to private and commercial automobiles as a result of Harvey is expected to be relatively high. A spokesman for the Insurance Council of Texas said insurers faced an estimated $2 billion in losses from private automobiles and an additional $1 billion from commercial auto, including mobile homes and trailers.
One critical question is how big a loss the nation’s largest flood insurer—the federal government’s NFIP—will ultimately take. The program was already more than $24 billion in debt when Harvey struck. The program enjoys—if that is the right word given the potential losses—a virtual monopoly on residential property flood insurance and underwrites commercial properties as well. Yet both CoreLogic and modeler Risk Management Services provide remarkably similar answers, with CoreLogic estimating losses of $6 billion to $7 billion and RMS estimating $7 billion to $10 billion. As of mid-September, NFIP had not released its own estimate.
RBC Capital Markets issued an analysis that looks at the historical pattern of loss estimates from catastrophes in general since the terrorist attack on 9/11. “They start a little too low, then they seesaw to being a little too high and often end up towards the higher end of the gap in between,” RBC says.
The company uses as an example the course 9/11 loss estimates took. Initial loss estimates were in the $10 billion to $20 billion range, but “conventional wisdom quickly adopted $50 billion as the going rate.” The final tally was closer to $30 billion. Estimates for Hurricane Katrina followed a similar pattern.
“In our experience, this is the ‘normal’ reaction—to favor the high end of the range until information crystallizes,” says RBC. “As one client commented, ‘taking the over’ on loss estimates has always been the safe play.”
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 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 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