Flood: It’s Not Just a Coastal Problem

With both inland and coastal communities increasingly experiencing flood damage, the Federal Emergency Management Agency is working to increase risk and pricing transparency in flood coverage and close the large flood insurance gap in America. This is the first in our three-part series on those efforts, the private market response, and how to get to risk prevention. —Editor

If it rains, it can flood. That stark reality has been driven home in the last few years as hurricane-related rainfalls smashed records and inundated communities from Houston to New York City. Homes and businesses from coast to coast suffered extensive inland flooding, and swollen rivers breached levees and left farmlands and communities across the Midwest immersed in huge amounts of standing water.

Sadly, those affected by these floods had more in common than the agony caused by the weather events: very few of them had flood insurance to help with repair, rebuilding and other expenses associated with the disaster.

Flood is one of the country’s largest risks, yet only 5.1 million homes and businesses have flood insurance though more than 40 million should. Among industry experts, this is known as the flood gap. Why, when the industry is well capitalized to take on this risk, does such a gap exist?

Our research shows that flood risk is misunderstood. Consumers lack awareness of their coverage, and outdated maps underestimate the risk, making it a challenge for insurers to properly price and underwrite policies. The flood market is desperate for some transparency and clarity.

The National Flood Insurance Program (NFIP) has been the dominant provider of residential and commercial flood insurance for more than 50 years—it is estimated the program writes 84% of the flood premium in the country. And now the program is working on a new risk-assessment method that it hopes will drive that risk transparency and thus bring more consumers and private insurers into the market.

“This is a story about suffering and loss that we have seen often and unfortunately will see again,” says David Maurstad, deputy associate administrator for insurance and mitigation at the Federal Emergency Management Agency and chief executive of the National Flood Insurance Program. “We need to do more to close the insurance gap. I believe we are at a critical crossroad, and the demand for change is now.”

But is it enough?

Risk Transparency

Most flood policies are sold to homeowners and businesses that are required to purchase flood insurance to qualify for a federally insured mortgage loan. These properties are primarily beachfront and coastal locations classified by FEMA (which administers NFIP coverage) as being in a Special Flood Hazard Area (SFHA), which signifies the highest risk of flooding. But there is growing concern that the SFHA designation no longer reflects the reality of flood risk and results in a perception among consumers that their properties are safe when in fact they are not.

“Because the SFHA boundary is central to NFIP mapping, it may create a false belief that flood risk changes abruptly at the boundary and that properties outside the SFHA are safe and do not need flood insurance,” says Diane Horn, an analyst and flood specialist for the Congressional Research Service. Yet Horn says about 20% of flood insurance claims are for properties outside the flood hazard areas—“and all 50 states,” she says, “have experienced floods in the last five years.”

In addition, there is increasing evidence that so-called secondary perils are equal to or greater than the risk of flood to non-coastal properties. These perils are defined as either independent, small to midsize events, such as drought and wildfires, or secondary effects of a primary peril, such as torrential rains or surge-induced flooding.

An April 2019 study by Swiss Re estimated natural catastrophe losses across the United States in 2017 and 2018 reached $219 billion, the highest ever for a two-year period, and secondary perils were a large part of that total.

The study found losses from secondary perils “have been rising due to rapid development in areas exposed to severe weather conditions. We expect this trend to continue given ongoing urbanisation, growth in concentration of assets in exposed areas, and long-term climate change projections.”

The study also noted: “Explanations for under-insurance include lack of consumer risk awareness, a poor understanding of the catastrophe cover available, and hesitation on the side of the industry to provide cover where risk assessment is uncertain.”

According to a report by Wright Flood, the largest provider of NFIP policies under its Write Your Own program, “Flooding is a natural disaster that strikes everywhere across the nation, and the risk is real for both inland and coastal locations. In fact, some estimate that inland flooding causes more property damage annually than any other disaster. The reality is, flooding is so widespread an issue that 98 percent of counties in the United States have experienced a flooding disaster. Despite this shocking revelation, nearly 88 percent of homes and businesses are not covered with flood insurance.”

In an effort to narrow the flood gap and encourage more individuals and businesses to buy flood insurance, FEMA has launched an initiative called “Moon Shot” intended to double participation in NFIP. A key part of that initiative is a revision of the much-criticized FEMA flood zone mapping system, in place since the 1970s, that categorizes properties in zones based on their location and perceived risk and that sets flood insurance premiums accordingly.

The revision of risk assessment methods is called Risk Rating 2.0. It combines state-of-the-art technology, such as risk modeling techniques now used by private insurers and reinsurers, with sophisticated mapping information and other data to better reflect the actual risk of an individual property. New NFIP property rates calculated under the initiative are to be announced next April and take effect in October 2020.

“Risk rating 2.0 will help customers better understand their flood risk and provide them with more accurate rates based on their unique risk,” FEMA said in an explanation of the new system. “This will include determining a customer’s flood risk by incorporating multiple, logical rating characteristics—like different types of flood, the distance a building is from the coast or another water source, or the cost to rebuild a home.”

FEMA hopes the new rating system will encourage more people to buy flood insurance, and flood experts agree the new system definitely will help close the gap by creating a considerably fairer system for setting premiums. For example, Property X, on the inland edge of a Special Flood Hazard Area, now pays the same premium as one on the waterfront, and the premium on a similar house just across the street from Property X but out of the hazard area often is substantially lower.

Changes in Latitude, Changes in Attitude

Industry stakeholders generally agree this is a step in the right direction.  

“This new approach is likely to be fairer and more equitable and intends to better communicate risk through insurance rates,” says Laura Lightbody, project director of flood-prepared communities for the Pew Charitable Trusts. “If the program is seen and better understoodas a fairer program that more closely reflects actual risk of the policyholder, you could see more uptick in policies because of the transparency of the program.”

Other risk-management experts, although supportive of Risk Rating 2.0, say it will take more than just a change in how premiums are calculated to significantly increase the number of insureds and close the flood gap. They say consumers must first recognize that virtually no structure, home or business is safe from a flood.

“I would say some may be—if I sit on top of a mountain, maybe,” says Lisa Lindsay, executive director of the Private Risk Management Association, a nonprofit educational organization.

Timothy McCoy, managing director of Insurmark/Floodwatch, an Aon subsidiary, says those who find themselves in low-hazard areas and qualify for preferred-risk policies should pay the annual premium of $300 to $400. “In my mind, buy it, put the policy in the file cabinet, and you don’t have to worry about it,” McCoy says. “You can sleep well at night.”

Also, experts say, there needs to be an understanding that flood is the same sort of risk as fire and other perils and it, too, should be covered by insurance. Traditional homeowners policies now exclude flood coverage, and unless brokers and agents point that out, many insureds do not realize they don’t have flood coverage.

Failure to have coverage in place can be a costly mistake. The average NFIP insurance claim is around $43,000, and the average flood premium is $700. Wright Flood notes businesses also  should consider potential major financial loss from flood.

“For businesses, this could be the difference of re-opening or closing your doors for good,” the company said in a white paper on the need for flood coverage. “Forty percent of small businesses that experience flooding never re-open.”

Individuals and businesses without a flood insurance policy have no financial assistance available except for a relatively small federal grant from FEMA, and that depends on whether their loss is in an area covered by a federal disaster declaration.

A July 2018 Wharton study titled “Can a Growing Private Flood Insurance Market Close the Coverage Gap?” noted, “What’s clear is that many families who underrate the risk of flooding can suffer enormous losses. For example, after Hurricane Harvey in 2017, the average residential insurance payout was $120,000 while those without insurance received an average grant of just $4,300 from FEMA.”

Perhaps most important of all in closing the gap is the need for a major change in attitude toward flood coverage, specifically a recognition that just because a property is in an area where flood insurance is not required does not mean it is not necessary.

“Everybody lives in a flood zone, as evidenced by the recent flooding in the last few years,” said one risk manager whose company serves as a third-party administrator for Write Your Own insurers. “There has been a huge amount of damage in low to moderate risk zones where maybe 15% of the people have flood insurance.”

“We as an industry—risk managers and professionals—need to do a better job educating people about flood risk,” Lindsay says. “People are now celebrating that banks that mortgage their house are not forcing them to have flood insurance. People look at what the bank says, and they are not really clear on the true effects of climate change, so they x-out of that flood insurance policy.”

A Congressional Budget Office report found that many households that are required to buy flood insurance do not do so and many households that buy policies do not keep them. “Our estimate is that roughly 25 percent of the households and businesses that buy flood insurance policies drop them within a year of purchase,” the report says. “Some researchers suggest that households’ failure to buy or maintain flood insurance results in part from mortgage lenders’ failure to enforce the requirement.”

Private Market Uptake?

FEMA is also counting on Risk Rating 2.0 to help close the gap by encouraging more private insurers to enter the market once it is easier to determine the actual risk a property faces.

“FEMA wants to double coverage for policies by 2023, and that is supposed to happen with a combination of NFIP and private insurance,” says Nancy Watkins, a principal and consulting actuary with Milliman. “They want the private market to step up. The gap between coverage and non-coverage is huge. I don’t think there is an appetite in our country for the feds to cover every single loss. It is best for consumers to have a reliable government source that they can understand and also have options from a number of private companies vying for their business.”

“FEMA is very engaged with agents to try to make it easy for them to look at a specific property, a specific address, and see that FEMA’s analysis says this property has this sort of risk,” says Frank Nutter, president of the Reinsurance Association of America. “Individual agents will be able to have that information and go to markets and say, ‘Here is this property…and this is what it gets in FEMA’s new risk rating system.’ It will be very meaningful.”

Mike Brown, the flood director for IAS Claims Services in Dallas, says the new rating, combined with expanded markets for private carriers, will help reduce the flood gap. “I think at least 50% is going to be under private coverage,” Brown says. “I think the private carriers are going to be able to offer insureds different types of packages at different costs and provide more logical coverage too.”

Yet even with Risk Rating 2.0 and better technology that more accurately assesses the actual risk a property faces, closing the flood gap for residential properties and small commercial properties will be a challenge. The flood gap is smaller for large commercial properties because they usually have flood insurance as part of their total insurance package. But small companies tend to be as price-sensitive as residential property owners and also resist adding flood coverage if it is not required.

“Everybody—agents, companies, FEMA and private markets—have all been trying to write additional policies, but it is going to be a heavy lift,” says Patricia Templeton-Jones, president of Wright National Flood Insurance Services.

Flood coverage is complicated, and it is not the same as traditional household insurance. For example, the NFIP policies carry two deductibles—one for structures and one for contents—as opposed to the single deductible in a standard homeowners policy. Also, the policies contain various coverage exclusions that are hard for producers to explain and customers to understand.

FEMA does send out notifications and summaries of coverage. “But let’s face it,” says Templeton-Jones, “how many people read their insurance policy?”

Tim Russell, of the Russell Agency, in Fairfield, Connecticut, says agents and brokers may be familiar with the policy form they sell but not with the NFIP claims manual, which contains the aforementioned exclusions, such as limited coverage of finished basements or ground-level enclosures and even the type of countertops eligible for coverage.

“That is why the Flood Insurance Producers National Committee asked FEMA to develop a continuing education class for agents on the claims manual,” Russell says. “FEMA has developed the course, and it will be introduced soon. Making agents more aware of the claims manual should help them give more complete advice to their customers.”

Another reason for confusion over coverage, agents and brokers say, is that most homeowners who are required to buy flood insurance are making that purchase at the same time they are dealing with countless other issues related to purchasing a new home.

“There is a lot going through a customer’s head when they are buying insurance,” Heidrick says. “I usually have 20 minutes to talk about coverages, so how deep can you get in 20 minutes? And then the flood might happen eight years later, so how much of that do you remember?”

Patricia Lambert, a lawyer at PK Law who has been involved with flood issues for 20 years, says it’s more than good business practice for agents and brokers to offer and explain the flood coverage that is available to their customers. If they do not recommend flood coverage or detail the coverage provisions, they may end up liable in the event that customer suffers a flood loss.

In fact, experts say producers should not only inform their customers that optional flood coverage is available and provide a price quote for it, they also should document the customer’s decision if they refuse to purchase flood coverage.

Marsh, for example, does just that. “Marsh offers NFIP to every single client, regardless of whether it is lender required or not,” says Patrice Collingwood, a practice leader and senior vice president at the brokerage. “There is no difference between commercial and personal policies. If you don’t offer it and if there is a loss, that’s when agencies get sued. We even have a form if the client decides not to buy it. We get them to sign off on not getting coverage.”

Lambert says agents and brokers also should follow up and offer flood coverage to existing policyholders. “The risks of the 1970s are not the same as the risks now,” she says.

NFIP’s Baggage

Other issues involving FEMA and NFIP also need to be addressed if the flood gap is to be closed. First of all, Congress has not passed a permanent reauthorization for the National Flood Insurance Program for two years and instead has relied on a series of short-term extensions to keep the program going. The latest extension was scheduled to expire at the end of September. The House Financial Services Committee has approved a five-year reauthorization, but it is doubtful a permanent extension can pass both the House and Senate in time to avoid another short-term extension. The program also is still about $20 billion in debt due to disaster assistance payouts, even after $16 billion in debt was forgiven last year. A number of flood experts have questioned the logic of a government program being charged interest on a debt to the government. They are urging the current debt also be forgiven and transferred to taxpayers rather than paying it back through higher premiums for NFIP policyholders. The debt payment plan is also likely to be a topic of discussion in the extension debate.

Another issue that comes into play as FEMA seeks to expand private flood insurance coverage to help close the flood gap is competitive pricing. A number of subsidies in NFIP keep premiums for older policies below an actuarially sound rate. One of the subsidy programs is called Pre-FIRM, which keeps a property’s flood insurance premium the same as it was before FEMA’s first Flood Insurance Rate Map was published for the property, generally around the mid 1970s. Then there is “grandfathering,” which keeps a property’s premium the same as it was even if it is moved into a new, more expensive and more dangerous flood zone.

A Congressional Research Service study updated in April 2019 estimates that, as of 2016, 16% of NFIP policyholders—roughly 817,000 in all—had Pre-FIRM subsidies that kept their rates lower than their actual risk. The study estimated that 10% to 20% of all NFIP policyholders also had lower premiums because they were “grandfathered” within the program. In 2012, an NFIP reauthorization attempted to charge properties under both programs actuarially sound rates, but the increase those policyholders faced was so significant and the outcry so loud that Congress backed off and instead settled for only a slight, gradual increase in rates.

The National Flood Insurance Program also continues to insure properties subject to repetitive losses even if no improvements are made to protect against future flooding. Those subsidies and policies have some wondering if the program can survive.

“My concern about the NFIP is there are a lot of cross-subsidies built into the program,” says Christopher Heidrick, of Heidrick & Company Insurance and Risk Management Services. “No private company is going to insure a structure that floods repeatedly. No private company would accept that, but NFIP does. You can say it is a social good, but the cost of taking care of severe repetitive loss properties, in my opinion, shouldn’t be borne by other property owners in NFIP; it should be borne by all taxpayers. You also have grandfathering. If they don’t find another way to fund that, NFIP will be full of properties that are priced before their loss cost.”

Mark Nies, underwriting manager at Insurmark, says the National Flood Insurance Program should serve as the “insurer of last resort” for the most high-risk properties. “The federal program should probably peel away from being all things for all people and be the insurer of last resort and let the private insurers fill the void and charge the appropriate rate,” Nies says. “NFIP is not run like an insurance program, which doesn’t help their profitability and help taxpayers. They should refocus, recalibrate and be the insurer of last resort. Take those risks that nobody wants to touch and let private industry take the remaining 80%.”

“Risk Rating 2.0 is an attempt to keep it going,” McCoy says, “but insurance companies are in business to make money, and the way the NFIP is doing it now, no insurance company would do it that way. I think there will always be a need for the NFIP, but it just must be different than it looks now.”