The Intelligent Quarterly from the publishers of The Insurance Insider

Summer 2018

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History repeating

Ted Bunker

Even before Hurricane Harvey dumped over four feet of rain over Houston and inundated America's fifth-largest metropolitan area, Washington policymakers knew the insurance system set up to help Texans deal with such events was broken.

But Harvey underlined that assessment in bold red type.

The National Flood Insurance Program (NFIP), run by the Federal Emergency Management Agency (Fema), was already drowning in debt from earlier hurricanes because it was never set up to deal with catastrophes on the scale of Hurricane Katrina, Superstorm Sandy or this year's Harvey.

The programme was established in the Great Society era of the 1960s to provide flood cover where private insurers feared to tread, mainly along low-lying shores and riverbanks. It was not set up, however, to provide a catastrophe fund.

Because NFIP rates aim to meet the needs of insureds during an average year, its finances were easily overwhelmed by flood losses in New Orleans during Hurricane Katrina and from metro New York and New Jersey following Sandy.

The latter two storms alone left the programme owing over $20bn to the US Treasury, and flooding in Louisiana from heavy rains last year raised it past $25bn - bring losses ever closer to the approximately $30bn cap on the NFIP's borrowing capacity.

With depictions of Harvey's devastation fresh in their memories, Washington lawmakers - prodded by President Donald Trump - cancelled $16bn in NFIP debt.

But that only cleared some headroom to cover an estimated $11bn loss from Harvey, not to mention claims from hurricanes Irma and Maria.

At the same time, Congress resisted taking what had, as recently as last year, been regarded an uncontroversial step to let more private carriers into a flood market nearly monopolised by the NFIP and its subsidised rates.

As part of its debt cancellation request, the Trump administration asked lawmakers to change the rules and let private flood cover suffice when a property or business in a designated flood hazard area had a federally backed loan. The Senate balked.

Barriers to entry
While that same step won unanimous support in the House of Representatives last year, passing without a single vote against it as analysts applauded the move, dozens of House members opposed it this year.

In the Senate, Louisiana Republican Bill Cassidy had the provision stripped from hurricane relief legislation in September. The Senate blocked the step again last month as it cancelled roughly half of the agency's Treasury debt.

Democrats and a few coastal state Republicans have argued against the market-opening step, characterising it as a threat that would undermine the NFIP's finances by letting private carriers strip away less risky insureds from its nearly 5 million policyholders, leaving it with less revenue to cover costs such as rate subsidies.

According to Pew Trusts analyst Laura Lightbody, some opponents insisted on a companion measure requiring private carriers that write the business to support funds set up for flood mitigation work or for claims from repetitive loss properties - those with two or more NFIP claims.

Supporters of opening the market have argued that getting more private carriers to write flood cover will be hard enough without adding costs, as new entrants would have to compete with the below-market rates often offered by the NFIP, as well as shouldering substantial risks.

Flood is the most common and expensive natural disaster in the US, according to the Insurance Information Institute. Last year produced 15 natural disasters that cost $1bn or more, including a record number involving inland flooding, the Union of Concerned Scientists has reported, citing federal data.

Backers of reforms cite the wide and apparently growing gap between insured and at-risk properties as reason enough to end a policy that virtually requires a large portion of the market to buy NFIP cover. And it is a void many insurers see as an attractive opportunity, under the right conditions.

"The gap in flood insurance protection represents up to a $40bn potential new market for private insurers," Guy Carpenter executives said in a recent commentary.

The flood risk gap
CoreLogic, a real estate data and analytics company, published a report in December showing how wide the gap can be between areas where NFIP cover is required on homes and businesses with federally backed loans, and areas at moderate-to-high risk of flooding but which lie outside Fema flood hazard areas.

Click to open The map shows the ratio of NFIP policies in force versus the number of properties at moderate-to-high risk of flooding in each US state, but which lie outside Fema flood hazard areas (expressed as a percentage).

In total, Fema said there were over 4.9 million NFIP policies in force at the end of September. CoreLogic has estimated that around 29.4 million properties with moderate-to-high flood risk lie outside Fema-designated flood hazard zones, where there is no legal or regulatory mandate that requires NFIP coverage.

Presumably, therefore, a significant proportion of those 29.4 million properties lack flood coverage, which is typically excluded in homeowners' insurance.

Following Superstorm Sandy, statistics showed that 80 percent of residents in affected areas lacked flood cover for their homes, according to TransRe flood leader Elizabeth Geary.

Getting more property owners to buy flood cover is regarded as a vital prerequisite to repairing a market that the government, whatever its intent, has long skewed through intervention, analysts say.

The trick to creating a more viable (and largely private) market is getting more property owners to pick up the coverage, and one way to accomplish that involves helping them recognise their flood risk. Disasters like Harvey raise awareness significantly. The Council of Insurance Agents & Brokers said its third quarter 2017 member survey showed a 64 percent increase in demand for flood coverage and a 59 percent jump in flood-related claims.

Raising awareness
Analysts see some good coming from these impacts.

"We're hoping that once people recognise their true flood risk, there's a greater take-up rate," Geary says.

When the door to private carriers has been pushed open, they have entered. In Florida, where state lawmakers passed legislation to ease lender concerns about flood coverage requirements in 2014, there are now some 16 companies writing the risk, Geary said in a recent interview.

The state also has the largest number of NFIP policies in force, at 1.73 million, Fema data shows.

But getting Congress to take a similar step has proven increasingly difficult, as recent actions in the nation's capital show.

Veteran lobbyist Alan Rubin is a principal in law firm Blank Rome's government relations practice who has been working on disaster preparedness and recovery financing for decades. He notes that attention to the subject often heats up following a catastrophe. "Then it's hurry up and wait," he says.

Rubin adds that when it comes to issues like mitigation to prevent or minimise flood damage: "The question is, are we willing to spend the money - and then find a way to get back the money?"

"It's absolutely doable," he continues. "It is all about the political will."

But government is often reactive rather than proactive, which means resources flow into recovery efforts first and then into mitigation after destructive events like Harvey, Irma and Maria.

Rubin notes that often as disasters recede into history and recovery progresses, efforts on preventive mitigation lose steam.

As a result, he says: "We're not doing the things we need to do."

The dynamics from a political perspective are not difficult to grasp.

"It's very hard - and it's understandable," Rubin says. "It's very hard to get legislation when the danger isn't imminent."

Analysts also agree that once government bestows a benefit, such as guaranteed flood insurance at discounted rates, it can be very difficult to get lawmakers to take it away, especially if it involves a real cost or hardship.

Political sensitivities
But the need for change has become glaringly obvious. A Pew study found that about 1 percent of the properties covered by NFIP policies - approximately 150,000 - have accounted for as much as 30 percent of the programme's losses since the 1970s.

Repetitive loss properties accounted for $12.5bn in NFIP losses before this year's hurricanes, the nonpartisan non-profit organisation says. It cites as an example the $663,000 the NFIP paid out on claims for a Mississippi home with a $69,000 market value that had flooded 34 times over 32 years.

Pew estimates that the NFIP has paid out more in claims than the property is worth on 10 percent of all repeat-loss properties. The bulk of these properties are located in Florida, Louisiana and Texas - the top three states in terms of NFIP policies in force - and New Jersey and New York.

Texas, New York and Florida rank among the largest states by population and between them have 108 representatives in the House and 10 Senators - roughly 25 percent of the House and 10 percent of the Senate.

While lawmakers from the five states may not be much influenced by the plight of repetitive loss property owners, the breakdown helps illustrate why changing the NFIP can be so politically difficult.

A reform package passed by the House, largely along party lines but with defections on both sides, contains several mitigation measures aimed at easing the costs of repetitive loss properties.

The measure would phase out rate subsidies, mandate a $5,000 minimum deductible and allow the NFIP to withhold coverage if the owner refuses a mitigation offer. The measure would also bar properties where claims payments have exceeded three times the structure's replacement value from eligibility for NFIP coverage.

Opponents have cited provisions like these as fatal flaws in the legislation, which has not moved forward in the Senate.

In the White House, President Trump has thrown his support behind the House reform measure. But the issue has taken a backseat to efforts to provide disaster relief and pass a sweeping tax reform bill, which the president has urged lawmakers to send over before Christmas. As a result, most observers expect another extension of the NFIP's authorisation to keep it going into 2018, but without any reforms.

Reforming the NFIP
A $44bn disaster relief bill remains pending in Congress and could provide a vehicle for a further NFIP extension. That measure includes $12bn in flood risk mitigation funds to be distributed through community development block grants rather than by the NFIP. Alternatively, the issue could be attached to another measure, called a continuing resolution, to extend overall government spending authority and keep all federal departments open and operating. The last NFIP extension, for two weeks, was included in such a bill.

When it comes to the multifaceted issue of NFIP reform, analysts and observers agree that overhauling the broken system will come down to mustering the political will to fix it. And that will depend on the leaders of both parties, as well as the president.

"It's really a matter of leadership to get something done," Pew's Lightbody says.

After this year's HIM losses are added to the tally, Blank Rome's Rubin says the NFIP's debt may be nearing $40bn, which may serve to keep the focus on addressing the programme's flaws.

Fixing it is critical, he suggests: "If we continue to make the same mistakes, the problems are just going to repeat, over and over."

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This article was published as part of issue Winter 2017

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