Renewed Scrutiny for Flood Insurance

As the 2021 hurricane season roars on, flooding has become pervasive.

In addition to the damage of the storms themselves, secondary effects such as torrential rains, storm surge and river overflow are causing increasing damage farther inland.

As of this writing, the Federal Emergency Management Agency (FEMA) has made five major flood disaster declarations for 2021. The agency also reports that 99% of U.S. counties were impacted by a flooding event between 1996 and 2019.

At the same time, FEMA estimates more than 95% of residences do not carry a flood insurance policy, leaving entire households and communities financially vulnerable to floods, a FEMA spokesperson tells Leader’s Edge.

The industry has been concerned about the flood insurance gap for a while now, with various efforts undertaken to try to increase flood coverage, particularly among personal lines. But flood coverage poses some fundamental challenges. Among the most pressing: the stagnant flood zone mapping used by the National Flood Insurance Program, the regulatory hurdles of a state-run insurance system, a lack of trust in the models that predict risk, and consumer education about flood risk.

Patty Templeton-Jones, president of Florida-based Wright Flood, describes the flood insurance gap as “quite large,” but she says many homeowners are caught off guard in floods because they are not aware of their individual flood risk. “Hurricane Ida is the most recent example of that, and the coverage and news about that storm may have educated some people about their potential risk,” Templeton-Jones says. “Advancements in technology, flood modeling and the use of flood-resistant materials are all things that can help close that gap.”

Stakeholders are working to whittle away at these barriers to flood protection. And several new initiatives may bring together the right products and the right education to begin to narrow the flood insurance gap.

Risk Rating 2.0

The National Flood Insurance Program (NFIP), administered by FEMA, provides nearly $1.3 trillion in coverage against flooding for more than five million policyholders. The program offers a Write-Your-Own option in which private insurance companies sell and service NFIP plans. The Insurance Information Institute reports that, in 2019, 88% of NFIP policies were held in the WYO program.

But many have long criticized the program for its low insurance limits and poor flood zone mapping. According to FEMA, since the 1970s, rates have been predominantly based on relatively static measurements that don’t consider changing flood risk.

But FEMA is responding, introducing the long-awaited Risk Rating 2.0, which, according to the agency, gives FEMA the “capability and tools to address rating disparities by incorporating more flood risk variables. These include flood frequency, multiple flood types—river overflow, storm surge, coastal erosion and heavy rainfall—and distance to a water source along with property characteristics such as elevation and the cost to rebuild.” FEMA is incorporating private sector data sets, catastrophe models, and evolving actuarial science into its revised rating system.

Beginning Oct. 1, new policies became subject to the new pricing methodology, and existing policyholders will be able to take advantage of immediate decreases in their premiums. “This is the fair thing to do,” FEMA says. Starting April 1, 2022, renewals of the remaining existing flood insurance policies will be written to the new plan. “That means this group of existing policyholders will have an additional six months to prepare for any rate adjustments,” FEMA says.

Templeton-Jones says Wright Flood has been working diligently to enact all the changes necessitated by Risk Rating 2.0. “As we head into the next phase of renewals, we’re doing everything possible to make the transition easy for our agency partners to obtain the additional rating elements that will be needed on renewals,” she says. “As with any change—with continued use—our clients will find the process user friendly, and quoting will become simpler for them with less documentation needed. We’ve organized many webinars for our agents and then allowed those who were unable to attend to view them on-demand. I’m confident that has been just another step in the process of streamlining these changes for our agents.”

It’s too early, Templeton-Jones says, to predict with assurance how pricing will be affected under the new system, though she’s confident that FEMA is more directly tying premiums to a property owner’s individual flood risk. “Several factors are now being considered under Risk Rating 2.0 that are routinely taken into consideration in other lines of property insurance,” she says. “FEMA does have a glidepath in place as part of the program that places a limit on the amount that annual premiums can increase for renewals.”

Matt Junge, head of property solutions in the United States and Canada for Swiss Re, calls Risk Rating 2.0 “a positive improvement in the overall flood space.” Swiss Re also has a new flood offering aimed at the flood insurance gap. “A lot of people ask, ‘Is it going to create more competition between the NFIP and the private market?’” Junge says of Risk Rating 2.0. “I think that getting people thinking about flood and thinking about their individual risks or their individual properties, whether it’s the private market or the NFIP, is important for the flood insurance industry overall. And getting more people covered for flood is what we’re after. We want to make progress on closing that production gap, not competing private market versus NFIP. That’s really where our focus is.”

FEMA is of the same mind as Junge: “We believe there is room for both the NFIP and the private market to grow,” the agency’s rep says.

And while the private market has been growing, it’s not without its own challenges.

Regulatory Hurdles

Restrictions within the NFIP as well as state regulatory challenges have hampered carriers’ ability and willingness to get into the flood market. According to a July 2018 report from Wharton Risk Management and Decisions Processes Center, “We estimate that private flood insurance accounts for roughly 3.5 to 4.5 percent of all primary residential flood policies currently purchased.”

For its part, FEMA has worked over the last few years to loosen NFIP restrictions on carriers operating within the program and to enable other products to come to market. In 2018, the NFIP ended the long-standing restriction prohibiting flood insurance companies participating in the NFIP—the Write-Your-Own companies—from selling their own flood insurance policies. And in 2019, five federal regulatory agencies issued a joint final rule to implement provisions of the Biggert-Waters Flood Insurance Reform Act of 2012, requiring regulated institutions to accept certain private flood insurance policies in addition to National Flood Insurance Program policies.

Lenders’ refusal to accept private policies as satisfaction of mandatory flood purchase requirements for homes in certain flood zones has been cited in the past as a major challenge to boosting sales of private market policies.

The Wharton report also notes that private market growth to date has largely been driven by the interest of global reinsurers in covering more U.S. flood risk. Swiss Re is one of those.

The reinsurer entered the flood space with a fully customized solution in 2017, Junge says. But even after introducing the product, Swiss Re found it wasn’t really addressing the gap. “What we found is that there’s still a need for just really affordable flood insurance for low-risk homes, low risk as defined by being in a FEMA zone X,” Junge says, referring to flood hazard areas lying between those elevations with a one-in-100-year flood risk and a one-in-500-year flood risk.

“The Illinois Department of Natural Resources did a study and found that 90% of urban flooding happened outside of a high-risk flood zone,” he says. “NFIP statistics are often cited to say at least a third of NFIP flood claims come from low-risk flood zones. And that number is probably understated because a lot of people that are low risk don’t buy an NFIP policy. So what we said is there is a need for a product and, at the same time, maybe that need for a product is not something that’s really complex and fully customized.”

He’s referring to the need for simplicity, which Swiss Re is addressing in several ways. One of them is simplifying the regulatory process for carriers so they will sell the product. “Everybody has a desire to have a flood product,” Junge says. “But states aren’t sure exactly how they’re going to approve that flood product on an admitted basis. And it differs by state.”

Among other challenges, Junge says, states are grappling with the use of cat models, which clarify what should be covered in a policy. “The state regulators don’t have a lot of experience looking at flood insurance products and saying, ‘What’s our opinion on this? Can we approve this?’” Junge says.

For carriers, he says, the risk is that they would put work into developing a product and then have state regulators reject it. To address that regulatory uncertainty, Swiss Re partnered with consulting and actuarial firm Milliman, which has an open advisory and rating organization, Milliman Appleseed, which is licensed to submit loss costs, rating factors and risk scores with state insurance regulators.

“So what we’re doing is taking that work on with Milliman and filing it in their Appleseed Advisory Organization,” Junge says. “Then we know that our product is approved and ready for use in the states that we’re filing in, especially. So a company comes in and can quickly adopt a product.”

Validating the Model

Junge says the biggest barrier from a state’s perspective may be the use of a cat model for rates. “If you’re a regulator, you want to have the most transparent product for your state,” he says. “And there’s a lot that goes into understanding cat models.

“Many states are open to the use of cat models because they just want that insurance provided in their state. But some states would also say, ‘Well, I’m not really sure what assumptions are made within that cat model. Can you tell me how you validate it? What data goes into it? How are you making sure that you’re not discriminating?’ Basically, how are you following the most important rules of insurance rate setting, per state.”

Swiss Re feels confident in its ability to provide a smoother regulatory path. “Those are things we are actually able to explain,” Junge says. “So we can talk to a regulator about the data to use, the data that comes out, how we validate it, why we are confident in it.

“That one thing is the most important thing to us as to why we can offer a flood product. It’s the advancements in technology and cat models that allow us to evaluate individual properties and provide insurance. To offer a flood product, you must be able to evaluate that risk and then price that risk. If you’re just able to evaluate it, but you don’t know how to price it, it’s not good enough. So the tools to evaluate the price are important.”

One of the tools, Junge says, is a better understanding of how water flows. Another is better mapping technology, which includes mapping small pieces of land with satellite and lidar (light detection and ranging), a remote sensing method that uses light in the form of a pulsed laser to measure ranges to the earth to generate precise, three-dimensional information about the shape of the earth and its surface characteristics. By inputting those maps into the cat model, along with increased knowledge of flooding and water flow, the model can ask better questions.

“It’s going to say, ‘Well, what do I know about how a home reacts when it gets wet?’” Junge says. “What’s the vulnerability of that home? And then what are realistic events that could occur given the tributaries of water, given the terrain and all that, what realistic events can occur?

“And that’s how we come up with a price. There’s a lot of great mapping technology out there where folks can see what their risk is, and that’s a really important step, then you have to go one step further and say, ‘OK, I know what my risk is. But let’s talk about how we actually put a price range for that,’ and that’s where the cat model comes in.”

Education All Around

Both Junge and FEMA agree that a large part of ultimately reducing the flood insurance gap is educating the various stakeholders, including carriers, brokers, and insureds.

“This is something we’ve put a lot of time into,” Junge says. “What we’ve learned is we have to work with our insurance company partners to educate them on why we think that flood is a peril that’s worthy of offering insurance on and help remove barriers for them to enter the flood space. We are focused on lower risk because it’s less customizable. We want to enter the space where there’s a big gap, where we know losses occur, where people aren’t thinking about their risks. We enable insurance companies to get into the flood business quicker, and then they can focus their energy on actually educating consumers on why they should buy the product. I’m not afraid about saying that selling it is still a challenge. Just because you start offering a flood product does not mean that people will automatically start buying it.

“One insurance company I was talking with said, ‘Will somebody buy a flood policy, or do I have to sell it?’ The answer is you have to sell it. And then selling it is really the education process of the consumer.”

Swiss Re has used a behavioral economics team to evaluate what would make it easier for people to understand their flood risk. Junge notes they have worked to reframe the conversation away from flood zone risk and more toward probability of flood loss over the life of a mortgage, for example.

Templeton-Jones says she considers the education of property owners “vitally important” in overcoming the flood insurance gap. Wright Flood maintains a website—www.wrightfloodadvice.org—that offers up-to-date information and answers to frequently asked questions. “We always try to help inform agents and clients about the risks of flooding, changes to coverage and any other information that will educate them about flood coverage,” she says.

Junge emphasizes ensuring agents know how easy it can be to get a private market quote. “If folks have only worked with NFIP quotes in the past, they might be surprised at how easy it is to get a quote from the private market,” Junge says. “You might not even need much more data or any more data than what’s already being collected.”

FEMA is also working to ensure agents and brokers selling NFIP policies are trained on Risk Rating 2.0 changes.

“A primary goal of Risk Rating 2.0 is simplifying the NFIP so more people can easily engage with us. With that in mind, we’re focused on increasing activity from the broker community throughout the entire United States and territories. Beginning in June, FEMA began offering training to ensure the broker community was educated on the upcoming changes. FEMA has also made this training available to the carriers to support their efforts to build their own training on Risk Rating 2.0,” FEMA’s spokesperson says.

“Risk Rating 2.0 will significantly improve our ability to communicate flood risk by allowing us to communicate the full risk premium to every policyholder for the first time. This is an important step to helping consumers understand their flood risk. With that said, the NFIP is committed to continuing to expand our nation’s understanding of flood risk,” the agency says.