FLOOD REFORM–Icing on the Cake!

This post may not sit well with some of my industry friends–Write Your Own (WYO) carriers and their agents ensconced in the current National Flood Insurance Program (NFIP) approach as prescribed by federal law.

But…those taking umbrage may find comfort knowing that, like all my other good idea’s, this one will be totally ignored by anyone in a position to implement it.

This is particularly true since the most recent federal reforms are generally viewed as the best we can expect.   You can read a summary of those reforms and see a section-by-section analysis here.  For a quick summary on the flood peril and how the Federal Government got involved, see NOTE #1 below.

Despite the recent reforms, flood deficits (See NOTE #2 below) will continue due mostly to the phenomenon called “adverse selection.” Those who buy flood insurance will continue to be 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 whose taxes fund FEMA and other emergency relief programs.

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.

It’s an actuarial nonsequitur exacerbated by realtors, bankers and yes, even some insurance professionals, who tell home buyers (the ones the NFIP wants to insure the most) that they don’t need flood insurance “because you’re not in a flood zone!”  

In fact, we all live in a flood zone, just not always in a SFHA, where flood coverage is required by most mortgages.

So… without requiring people to pay based on their exposure and without force placing coverage, how can we fix this?

I propose that all property insurance policies include Federal flood coverage automatically. In essence all insurer’s would become WYO’s by attaching an endorsement that reads similar to the NFIP Flood policy. Claims and administration would be handled similar to the WYO program. The Fed would still pay the carrier for processing and the carrier would still pay the agent a commission. (See NOTE #3 below)

BUT, there are two important kickers…

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 the government stops competing with itself–spending millions to sell Flood insurance but providing millions more in federal relief to those who don’t buy it.

Second,  federal tax exempt status for property residual markets such as Citizens should be tied to requiring wind policyholders to purchase federal flood insurance, regardless of location. For property residual markets, like Florida’s Citizens, the claims process would be simplified monumentally and the legal problems that besieged the Louisiana Citizens after Katrina would be non-existent.  In Florida it would also help keep policies from going in Citizens front door while providing a needed coverage and reducing loss payouts from wind.

My guess is that millions more home buyers would have flood insurance on their homes under this plan. Moreover, 25% of them would be those who would need the coverage someday but are located outside of SFHA’s.  The majority would be those who are very unlikely to ever file a claim and would spend relatively little on the premium, but…would have peace of mind knowing they are covered if something unfortunate and very unlikely occurred.

Nationally, when coupled with recent reforms, NFIP adverse selection is reduced considerably, if not altogether, under this plan.  Revenues to NFIP 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.

Heck, who knows how many more might buy flood coverage and how much doing so would increase NFIP’s claims paying potential? And…how much could coffers grow if millions of dollars no longer needed to be spent on television ads? Again, this won’t solve all the problems, but…it’s a politically sensitive way to get at the root of many of them. (See NOTE #4 below)

The recent flood reforms are helpful steps, but…this would be the icing on the cake!

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NOTE #1: In the early part of the last century, insurer’s 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.

NOTE #2: 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. In Florida, it’s 2 million policyholders pay $10 billion more in premiums than the amount of claims paid out over 30 years but they also saw only one year when their annual claims exceeded premiums. Compare that to, Illinois with 48,000 policies but nine (9) high-loss years – the seventh highest number overall.

NOTE #3: 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.

NOTE #4: Four years, 17 extensions, four expirations – that’s how often the NFIP had to be restarted before Congress decided to update the program. The last time 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. See 2012 reforms here.

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