This article was republished with permission from Insurance Day.
by Matthew Foote, head of exposure management at ArgoGlobal
For more than half a century the National Flood Insurance Program (NFIP) has held a monopoly on the U.S. flood insurance market. The program, which was designed as a self-funding model, has paid out far more in claims that it has absorbed in premium, resulting in an approximately $23 billion debt to the U.S. Treasury.
With the NFIP set to expire in September 2017 and its future structure under review by the U.S. Congress, there is a clear opportunity for private insurers to enter the market. Considering the NFIP collects on average $3.3 billion in premium each year, this represents a significant opportunity for property/casualty insurers. However, for the private market to succeed, insurers and legislators will need to address the challenges which have stymied the NFIP.
Globally, flood is an extremely challenging and increasingly costly risk. Nearly one third of the $200 billion losses caused by natural disasters in 2016 related to flooding of some kind. The U.S. is no exception, with flooding affecting all regions from various sources.
Inland flooding events have caused significant losses in the recent past and research1 suggests the frequency and severity of these types of floods are expected to increase in the future, but with regional variations of impact. Storm surge, the primary cause of U.S. coastal flooding, is expected to rise in line both with forecast sea level change and predicted changes to frequency of severe surges2, 3. Social and economic factors, such as the demographic shift in population and wealth towards more coastal exposed locations, have also led to increasing losses to our industry.
The complex and interdependent nature of flooding has hindered the development of flood catastrophe models with the same levels of confidence earthquake and windstorm have provided in recent years. Flood therefore remains a difficult risk to quantify.
While the NFIP was designed to ensure all U.S. homeowners had access to affordable flood insurance, the state of the program at present is evidence reform is needed. Big losses, such as the $16.3 billion paid in claims from Hurricane Katrina, have pushed the NFIP into the debt position it now finds itself in and the $2.3 billion payout4, 5 from last year’s Louisiana floods could indicate a worrying increase in future non-hurricane losses, potentially in areas not traditionally considered to be at highest risk.
The NFIP’s administrator, the Federal Emergency Management Agency (FEMA), has recently taken some steps to mitigate the financial burden through catastrophe excess-of-loss reinsurance placement. However, this does not address the other, fundamental issues which affect NFIP’s effectiveness and sustainability, including not investing reserves to create additional income, not charging actuarial rates and the consequent skewing of the perceived risk.
There is growing demand from legislators and private citizens for a broader private- public partnership to bolster the existing program. The Biggert-Waters Flood Insurance Reform Act of 2012, which mandated study of further privatization of the NFIP, and the Flood Insurance Market Parity and Modernization Act of 2017, which provides states with more flexibility to individually regulate private flood insurance and removes problematic regulations, have both supported increased involvement from the private market.
This week the U.S. Senate will debate a bipartisan bill that would reauthorize the NFIP for 10 years. The bill stipulates an annual cession of risk to reinsurers or the capital markets, directs more funds to mitigation efforts and removes barriers to the entrance of private insurers into the market.
Accurately assessing risk
Legislative reforms such as these are essential, but insurers still face other challenges. In particular, they will need to develop significantly more advanced models if they are to make this risk profitable while ensuring cover is affordable. The NFIP, as a non-profit organization, has been able to rely on the U.S. Treasury; insurers will not have this luxury and will need to be fully confident the risk is correctly reflected in their pricing and capital models.
Addressing these challenges is vital for the creation of a successful public-private partnership. Several models have been proposed, which include; partial privatization, the NFIP purchasing reinsurance from the private market, a flood insurance pool and more. A credible model which provides a balance of the risk carried by the public and private market is essential.
The implementation of better risk management measures will also help. Ultimately, to be successful, insurers must continue to build more accurate and high-definition models, which take climate change into consideration, so policies can be priced effectively.
U.S. flood can be a clear opportunity for the insurance market. However, we must tread carefully and work with the NFIP to create a strong private-public partnership, supported by analytics and modeling that is fit for purpose.