Plugging the Hole in the U.S. Flood Market: How Risk Modelers Can Help to De-Risk the NFIP
The National Flood Insurance Program (NFIP) has long been the dominant player in the U.S. flood insurance market, providing subsidized flood insurance based on actuarially unsound rates for millions of property owners, in turn discouraging the private market.
Until now, this status quo has remained unchallenged, resulting in the NFIP accruing debt to the tune of $23 billion. The federal government accepts the situation is unsustainable and is intent on cutting back the program, however this will leave millions of property owners without flood cover.
The journey to de-risk the NFIP requires a major overhaul of the program, needing cooperation between the Federal Emergency Management Agency (FEMA), which manages the NFIP, state and federal legislators, insurers, and risk modeling firms.
Plugging the coverage gap and enabling homeowners to access continued cover requires private insurers to enter the market with attractively priced insurance products. But there are barriers to entry: consumers are accustomed to paying capped premiums and private insurers need sophisticated flood risk management tools to help them understand the risk and price it competitively.
Companies eager to grow their flood portfolio are being enticed into the market by the availability of new flood maps, data products and models that more comprehensively capture flood risk beyond existing FEMA products. The suite of new products, being developed by modeling firms, will help companies to differentiate pricing, understand flood accumulations, visualize catastrophic flood events and diversify risks.
New Risk Models in the Private Market
Studies show that private flood insurance can be more affordable than the NFIP, particularly in less risky portions of select flood zones. Flood is a high-gradient risk, however, and in order to make this pricing differentiation, flood models and hazard data products must be able to resolve down to the individual property level. This degree of high-resolution modeling requires tremendous computing power and advances in software design, which is only recently possible due to advances in technology.
To effectively manage the risk requires knowledge beyond a location’s inclusion in the 1-in-100 or 1-in-500 year flood zone. Model vendors, such as RMS, are addressing this need by creating hazard maps that show not only the 1-in-100 year floods, as FEMA does, but different return periods and also the severity metrics (i.e. depth) associated with those floods.
Portfolio management also demands a deeper understanding of the corresponding frequency, hazard, and severity of potential flood events, and requires the ability to capture correlations across catchments and river basins throughout the country. The pipeline of new flood risk products being released by modeling companies, particularly the probabilistic flood models, will arm companies with the ability to understand the impact of flood hazard and severity on exposures at risk.
The flood models also provide full exceedance probability analysis, enabling companies to dissect flood risk in the same way they do today with earthquake, wind and severe convective storm hazards. This will also enable companies to understand how to diversify a portfolio beyond a company’s current geography, something models are well suited to quantify.
Even with an influx of more sophisticated flood models and maps to help open up the private insurance market, there are several challenges that need to be addressed.
Reforming the NFIP
The private market needs a baseline of actuarially sound rates to work from. The obvious move for the NFIP would be to raise its pricing to sustainable levels, and position itself as the insurer of last resort. A move like this would enable private insurers to set rates that will cover the risk they are writing, avoiding the huge debts that accrued by the NFIP.
However, the NFIP’s current portfolio of 5.6 million policies covering $1.3 trillion in exposure makes depopulation no small task. Congress attempted to do this via the Biggert-Waters Flood Insurance Reform of 2012. The resulting rate increases that were experienced by policyholders over such a short timeframe unfortunately angered many voters and impeded progress.
In response, two years after Biggert-Waters, new legislation under the Homeowner Flood Insurance Affordability Act (HFIAA) of 2014 was introduced to delay and cap the annual price increases. The 2014 act didn’t completely reverse the rate changes introduced as a result of Biggert-Waters, but it delayed the move to actuarially sound rates.
In some states, such as Mississippi, the affordability of flood insurance is such a contentious issue that legislation to repeal Biggert-Waters is now being considered.
Alongside federal initiatives, individual states are also attempting to nurture the private market. In Florida, for example, the legislature tasked the Florida Commission on Hurricane Loss Projection Methodology to develop flood standards, establishing that insurers can submit rates based on state-approved probabilistic flood models beginning in 2019. This echoes Florida’s policy for encouraging private firms to provide hurricane insurance.
Claims Data, Alternative Flood Maps
Even with the more progressive rate increases, however, encouraging private insurers to enter the market with realistic pricing requires them to have access to historical claims data, which is critical for accurate risk modeling.
In addition to private flood insurance feasibility studies, FEMA is working with the insurance industry and risk modelers to facilitate the release of high-resolution historical claims information from the NFIP. This is an extremely important initiative since FEMA has the most historical claims data for flood in the U.S., which will be needed by companies to validate and calibrate their flood modeling.
Risk modelers are also developing alternative flood maps to overcome the limitations of the FEMA Flood Insurance Rate Maps (FIRMs), the primary source of U.S. flood zone and hazard information.
While FEMA invests heavily in producing the FIRMs to inform flood policy rating for the NFIP, the maps provide only one view of flood risk and their consistency from region-to-region is often questioned since they are not produced using standardized modeling methodologies across flood basins.
To add another wrinkle, the FIRMS are often subject to local community review, resulting in appeals being submitted to redraw the inundation boundaries, adding in a human-influence factor that is very apparent at high resolution.
Another issue with the maps is the binary nature of the flood zones – you are either in a flood plain or not. While this is helpful in underwriting, it does not provide sufficient input to the portfolio management or risk transfer process. To effectively assess flooding severity, insurers need return-period flood depths in addition to the inundation that is provided in the FEMA maps.
The market for U.S. flood insurance offers an ocean of untapped opportunity for private insurers, which until now has remained out of reach for most companies. The continuing regulatory reforms combined with access to more sophisticated modeling and data products from modeling firms will help to create a friendlier landscape for the private market and help increase their confidence to embrace the growth opportunity.