FLOOD…A Carrot & A Stick!

Every once in a long while I’ll write about Flood insurance–subsequent, usually, to either a flood of great proportion or another government attempt to fund an existing or potential deficit.  This time, Harvey in Texas and Irma rapidly approaching from the Atlantic, provide impetus on both fronts.

Please forgive a little self-plagiarizing of previous blogs, but… there’s history some haven’t heard, too many have forgotten and no one seems to have learned from. And, there’s an idea I often share at these times that bears revisiting.

The idea–the crux of which is obvious, the details not so much–won’t sit well with some of my industry friends.  Write Your Own (WYO) carriers, new private flood writers and their agents may not be able to see above the trees.  Perhaps they’ll find solace knowing that, like all my other good ideas this one, too, will be entirely ignored by public officials positioned to implement it.

[See NOTE #1 below for documents and history on flood insurance, including Biggert-Waters, 2012 and a summary of the changes in 2014–Homeowners Flood Insurance Affordability Act (HFIAA)]

I should clarify the idea’s origin. The crux comes from all those who understand how insurance works.  It’s that obvious. Only the plan of implementation is unique and, who knows, I may have stolen parts of that too.

Any reform of NFIP, unless it succinctly addresses the phenomenon of “adverse selection”, will continue to require backup from other tax paid sources.  Currently those who buy flood insurance are those most likely to need it.  Worse, and typical of government run programs everywhere, those who should pay more are subsidized by those who should pay less or, as with NFIP deficits…by taxpayers who don’t buy it at all but who support FEMA and other emergency relief programs.

According to Andrew Simpson writing for the Insurance Journal, a Congressional Budget Office (CBO) analysis reveals that “…under the NFIP’s current structure, policyholders living in inland counties are subsidizing policyholders in coastal counties, particularly in southeastern and Gulf Coast States.”  (See Note#2 below)

Worse, by continuing to provide subsidized rates to residents of Special Flood Hazard Areas (SFHA’s) while simultaneously making those areas the only ones where flood insurance is mandatory, the Fed merely doubles down on the problem–creating more and more adverse risks that desperately need, indeed are required to purchase, coverage.

This actuarial nonsequitur explodes when realtors, bankers and yes, even some insurance professionals, allow “low flood risk” home buyers (the ones the NFIP needs to insure more of) to think they don’t need flood insurance because they’re “…not in a flood zone!”  

As insurance professionals we all know, everybody lives in a flood zone, just not always in a zone where coverage is required on mortgaged homes.  So, without requiring people to pay based on their exposure–which is price prohibitive–and without force placing coverage–a political non-starter–how can adverse selection be addressed?  How can those allowed not to buy flood insurance begin making a better choice?

First, I propose that all residential property insurance policies, regardless of location, include Federal flood coverage automatically. In essence, all property insurers would become WYO’s via an endorsement that reads similar to the NFIP Flood policy. Claims and administration would be handled like the WYO program as well. The Fed would still pay the carrier for processing and the carrier would still pay the agent a commission.  

BUT, there are two important kickers; one political, the other not so much.  One a carrot.  The other a stick.

First, all policyholders, except those in SFHA’s can reject the endorsement by signing a waiver stating they don’t want it and forfeiting any right to allege differently after a loss.  This includes barring the receipt of FEMA funds or other government assistance related to flood damage.  In this way, government stops competing with itself–spending millions to sell Flood insurance but providing millions more in federal relief to the millions who choose not to purchase it.

Second, federal tax-exempt status for property residual markets such as Citizens in Florida or Louisiana or TWIA in Texas, should be tied to requiring wind policyholders to purchase federal flood insurance–regardless of location or whether they have a mortgage.  And, with no ability to reject it!

Including FAIR plans, there are some 35 residual property markets across the country (See drop down box at PIPSO) and, though I don’t know the total number of wind policies they insure, I do know it’s substantial, particularly the Gulf Coast and states along the eastern seaboard.

For property residual markets like Florida and Louisiana, the claims process would be monumentally simplified, saving on loss adjustment expense.   And, the legal problems that besieged Louisiana’s Citizens and its’ policyholders after Katrina would entirely fade.

And…in addition to reducing the number of policies going into Citizens while providing a needed coverage, this piece of the puzzle would reduce deficit potentials on the most deserving—those who were responsible enough to buy flood coverage without a carrot (subsidized premium) or the stick (signed rejection of federal assistance).

My guess?   Millions more would buy flood insurance. Moreover, approximately 25% of them would be those in need but who are located outside of SFHA’s—like many in Houston.  A majority would be those who are unlikely to ever file a claim but whose coverage would be dirt-cheap—$450 a year maybe.  Like everyone else who buys flood coverage, they would have peace of mind knowing they’re protected when the next 1,000-year happening turns unexpectedly in their direction.

Federal flood revenues would dramatically increase, lowering the chance for a deficit while forcing all homeowners to realize they are in “flood zones” and need to buy flood coverage.

And…how much could coffers grow if millions of federal dollars no longer needed to be spent on television ads promoting federal flood coverage?

I must admit that the recent involvement of private carriers in providing flood coverage “might” have an impact on all this.  But, no one can credibly predict what that impact will be.  (See NOTE #3 below)

I’ll give it a go.

No matter what happens with private flood, private carriers will always require two things: sound underwriting and pricing flexibility.  It remains to be seen how many consumers will find affordable coverage under this scenario.

It also remains to be seen what the fed will do with those the private market can’t or won’t insure.  If the fed chooses to continue only mandating coverage for those in harms way, while states continue promoting coastal development, the deficits will continue to grow regardless of anything the private market does.


NOTE #1:

  • In the early part of the last century, insurers learned the hard way each and every time the Mighty Mississippi overflowed that flood was a commercially uninsurable peril.  Some forty years later in 1968 the Fed got involved.  Much like earth movement, war and riot, the peril of flood violates too many of the principles we learned in Insurance-101. It’s uninsurable in the traditional commercial sense because flood events are usually catastrophic, impacting wide geographic areas and large numbers of risks.  Engineer’s will also tell you, it’s a peril that defies reasonable attempts to mitigate–water always finds a way into any structure they say.  It teems with moral hazard–even promoting unmitigated construction, in flood prone areas.  And… it results in an actuarial premium often considered unaffordable.
  • The NFIP has often borrowed from the U.S. Treasury but, it traditionally paid back with interest. Then came Katrina and Rita and the Treasury Department had to loan it $18 billion.
  • Over 80 private WYO insurers sell and service NFIP policies for an expense allowance equal to 30 percent of premium. Agents receive commissions ranging from 10% to 22% more or less as determined by the company. It’s likely that both the carrier and agent would receive less under my proposal–carriers because the Fed will recognize they are doing less under this arrangement; agents, because the carrier will try and make it up by cutting agents’ commissions.
  • Four years, 17 extensions, four expirations – that’s how often the NFIP had to be restarted before Congress decided to update the program in 2012 and again in 2014. The time previous to that was 2008. Despite all the extensions and renewals, the program has been modified just four times prior to the 2012 overhaul. In 1973, provisions were added making the purchase of flood insurance mandatory for properties designated to be in SFHAs. In 1982, the Coastal Barrier Resources Act added maps that identified various undeveloped coastal barriers and rendered them ineligible for NFIP assistance. You can read a summary of the 2012 Biggert-Waters flood reforms and a section-by-section analysis here.  You can see a summary of the 2014 Homeowners Flood Insurance Affordability Act (HFIAA)  here.

NOTE #2: The CBO also shows NFIP is currently on its way to a $1.4 billion shortfall even without Harvey and Irma and whatever else may be left of the 2017 hurricane season.  For more on NFIP’s current deficit situation read “Why Federal Flood Program Is Sinking Further Into Debt: CBO Report”, written by Andrew Simpson for the Insurance Journal.

NOTE #3:  The Insurance Journal published another piece by Suzanne Barlyn  regarding private flood   and it’s potential for success in Florida.  It cites OIR data showing nearly 30 insurers are offering various types of flood coverage including units of American International Group Inc, Chubb Ltd. Progressive Corp. and HCI Group Inc.

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