Could Flood Insurance Go Private?

The reinsurance industry is eyeing the National Flood Insurance Program (NFIP) as an attractive risk. But that might say more about the reinsurance industry’s interest in exposure diversification than the health of the Federal Emergency Management Agency’s (FEMA) program.

High reinsurance surplus capacity is leading the industry to diversify risk by peril and region, says Frank Nutter, president of the Reinsurance Association of America. Besides weather-related risk, reinsurers would likely increase coverage for terrorism risk and have an interest in federally backed mortgages if Freddie Mac and Fannie Mae are privatized.

The national flood program has several challenges. Started in 1968 with the goal of providing affordable flood coverage, the program covers small risks and generates $3.5 billion in annual premiums while having about $1.2 trillion in policy exposure.

Affordability and rate adequacy, however, are diametrically opposed goals for the program. According to one published report, NFIP provides coverage at half the true cost of the risk, and, in high-risk areas, it’s just one third of the true cost.

The Biggert-Waters Flood Insurance Reform Act of 2012 requires rate increases that fully follow accepted actuarial practices. That goal can take several years given the continual efforts by legislators to extend subsidies and deadlines for more appropriate rate increases.

While insurers are not legally barred from offering this kind of coverage, it is not a niche in which private insurers see potential, says Stuart Mathewson, co-chairman of the American Academy of Actuaries’ extreme events committee.

Besides being unable to collect enough to cover its losses, there are also not enough American property owners buying coverage. The uptake rate is horrendous. Just 13% of those surveyed living in flood zones say they have coverage. Why so few? Some deny the need. Some assume flooding is covered by their private property insurance.

Lack of coverage meant unnecessary suffering after Superstorm Sandy flooded parts of Manhattan and its boroughs. Fewer than 5% of those New York City residents had coverage through NFIP, according to a report published last November by Resources for the Future. Maps contained in the report show that flood coverage penetration rates were woefully low on the shorelines of New York, New Jersey and Connecticut.

New York Mayor Michael Bloomberg has issued warnings about the city’s increased vulnerability to flooding. According to the New York City Panel on Climate Change, sea levels around Manhattan will rise four to eight inches by the 2020s. The Bloomberg administration estimates that by the 2050s more than 800,000 city residents will live in the 100-year flood plain—more than twice the current number, based on FEMA’s new flood maps.

And the debt of the flood program continues to rise. The program currently owes the U.S. Treasury $24 billion. Due to growing losses from Sandy, Congress approved an extension of borrowing authority to $30 billion. Sandy has cost the program $7.7 billion so far.

Natural disasters are becoming more expensive. Just one major CAT event like Sandy could crash the flood program’s debt ceiling. Biggert-Waters mandates payoff to the U.S. Treasury within 10 years.

Signed into law by President Obama just two months before Sandy, Biggert-Waters also requires reports from the Federal Insurance Office, the General Accountability Office and FEMA to look at different approaches to turn the insurance private. FEMA is required to obtain reinsurance proposals to transfer a portion of the risk, but this has not yet happened.

Advocates of reinsuring some of NFIP’s coverage say doing so could reduce the taxpayer burden.

Despite its challenges, the flood insurance program looks good to the reinsurance market. “The NFIP already has substantial risk that would be attractive to reinsurance,” says Bryon Ehrhart, chairman of Aon Benfield’s investment banking group.