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The National Flood Insurance Program's new pricing methodology raises premiums for most of its 5 million policy holders, creating a huge opportunity for insurance companies to grow the fledgling private flood insurance market.
It's still uncertain, however, if the new rating system - called NFIP Risk Rating 2.0 - will undergo changes under political and public pressure to lower caps on rate increases and maintain affordable premiums for high-risk properties.
Proponents of NFIP Risk Rating 2.0 say its new pricing will increase private competition, which creates more choices for consumers and could eventually attract more buyers. The residential flood insurance market has about $4 billion in written premium, but the actuarial firm Milliman estimates the total flood market at $37 billion to $47 billion.
Private carriers can offer broader coverage and higher limits than the NFIP, which tops out at $250,000. Many private flood insurers are also confident they can offer lower prices for a variety of risks, not just those overpriced by NFIP's old, clumsy rating methodology.
"It's the best thing that ever happened to the private flood market," said Florida state Sen. Jeff Brandes. "It's going to raise prices dramatically and make private flood more attractive."
Based on conversations with actuaries and insurers, Brandes estimates that 85% of Florida properties can receive lower cost coverage in the private market. "The only question is capacity," he said. "There just isn't enough capacity to handle that level. Insurers are very selective about the amount of capacity they place into any specific ZIP code."
Today's private flood market is small but growing. In 2020, 189 private carriers wrote flood insurance, compared with just 45 in 2016, according to Milliman.
The NFIP's leap in sophistication could also lead some carriers to reassess their competitiveness in the market, specifically those that target the best risks with the same coverage at slightly lower prices, according to Nancy Watkins, Milliman principal and consulting actuary.
Those products also rely on flood risk maps from the Federal Emergency Management Agency’s (FEMA)-which manages NFIP, "even though there were known limitations that made most observers believe that they didn't accurately reflect the risk," she said. Risk Rating 2.0 could make those private programs obsolete.
Insurance companies that already used property-specific data and catastrophe models to price flood policies should find new market opportunities and fewer regulatory barriers in states seeking alternatives to NFIP 2.0, Watkins said, and even those with outdated products can benefit from their own data and experience in the market. Insurers that have stayed on the sidelines will also benefit when FEMA makes public massive amounts of flood data as part of the new risk rating program, she said.
Better public data is "a public service to the companies that want to understand flood risk better," she said. She added that FEMA's growing use of catastrophe models on a wide scale across millions of properties will help the models evolve more quickly, become more reliable, and gain acceptance with more regulators.
Risk Rating 2.0 is the first fundamental change to how the NFIP calculates premiums in the program's 53-year history, with a goal of making its rates actuarially sound and reducing the program's $20 billion deficit. It abandons the use of flood zones that place many dissimilar properties into groups that receive a similar price, and instead adopts modem tools like catastrophe modeling and the property-specific data used by private carriers for more precise pricing. Risk Rating 2.0 also considers a wider range of flood frequencies, geographical variables - such as the distance to water and the type and size of nearest bodies of water and the elevation of the property relative to the flooding source, according to the Congressional Research Service.
The new rating methodology went into effect for all new NFIP policies written as of Oct. 1. The remaining policies are subject to the new rating program with renewals as of April 1, 2022.
The federal government launched the NFIP in 1968 to fill the market need at a time when private carriers, lacking the ability to adequately assess and measure risk, viewed flood as an uninsurable peril.
As technology to measure risk improved, the NFIP's low rates remained a barrier to insurers launching flood products. The conventional wisdom held that it wasn't worth investing in the market if products with actuarially sound rates couldn't compete against NFIP's artificially low prices. But if carriers view the NFIP as a rational competitor that charges rates that reflect the risk, Watkins said, that fear subsides.
Private carriers only began entering the admitted flood insurance market following the NFIP's last attempt at reform - the Biggert-Waters Flood Insurance Reform Act of 2012. Even though some provisions were rolled back two years later in response to a political outcry, the effort signaled to the industry that the NFIP would ultimately bring its rates more in line with actuarially sound views of risk, Watkins said. Vendors and reinsurers began developing inland flood catastrophe models and upgrading storm surge catastrophe models. The act also sought to remove one of the major barriers to private flood insurance: the unwillingness of banks to accept private policies as protection for federally backed loans in flood risk areas. Rules adopted by banking regulators in early 2019 required mortgage lenders to accept qualifying private flood policies in addition to NFIP policies.
Armed with catastrophe models, insurers began targeting the best risks with better pricing and higher limits. Private flood products became even more sophisticated in recent years with specific data about a property's characteristics.
"What we're seeing now is a wave of very granular pricing that may have been developed based on catastrophe models, but it doesn't require using a catastrophe model at point of quote," Watkins said. "Those kinds of rating plans are much more consistent with what state regulators expect to see when they're approving [filings]."
Melissa Burt DeVriese, president of Security First Insurance Co. in Florida, said private insurers can use that granular data to offer better prices and more comprehensive coverage for many NFIP policyholders, not just the most overpriced.
Security First began offering Swiss Re's flood product to its existing homeowners policyholders as an endorsement in 2018, and about 10% have elected to buy it. She said the publicity about flood insurance generated by Risk Rating 2.0 should help increase demand. Publicity can also help dispel the notion that homeowners only need flood insurance if they are in a high-risk flood zone and their mortgage lender requires it.
Dan Alpay, flood line underwriter for His- cox's surplus lines flood policy, FloodPlus, said that closer alignment between NFIP and private carrier rates will also improve the public's over- all trust in flood insurance products.
"You can have two neighbors who have a slightly different elevation with very, very different premiums quoted," he said. "And when they talk to each other, then they think the whole private market is all over the place, but then in reality, it's just more granular."
Milliman launched a private flood product called Bungalow that uses property-specific data for exact pricing. Using its new rating advisory organization, Appleseed, Milliman has also filed Swiss Re's flood product in several states.
Private flood policies will likely have greater appeal for homeowners facing NFIP rate increases, as well as those who want more coverage than the program's $250,000 limit.
With the new rating system, premiums will increase $10 or less per month for 66% of NFIP policyholders. About 7% will see an increase between $10 and $20, and 4% will see a monthly increase of more than $20, according to FEMA estimates. Monthly premiums will decrease an average $86 for about 23% of NFIP policyholders.
In Florida, NFIP's largest market with about 1.73 mil- lion policies, prices increase rise for about 80% of policy- holders. Premiums will rise for about 86% of the 768,537 policies in Texas, the next big- gest market. In Louisiana, the third largest NFIP state with 495,923 policies and the biggest beneficiary of its claims payouts - 80% of policyholders will pay more.
All increases are capped at 18% annually. But critics of the new rating system point out that 18% increases on an annual basis will cause a homeowner 's premium to nearly double every four years. In addition to the monthly burden on the homeowner, prohibitively expensive flood insurance can hurt property values and render some real estate essentially worthless.
A notoriously tiny percentage of homeowners buy flood insurance. For one thing, many aren't aware that traditional homeowners insurance policies don't cover floods. For another, lenders require flood coverage as a condition of a federally backed mortgage only for properties located in FEMA-designated "special flood hazard zones," despite the flood risk faced by millions of properties outside those zones.
Only 30% of homes in the highest-risk areas have flood coverage, according to the Risk Management and Decision Processes Center of the Wharton School at the University of Pennsylvania. And FEMA reports that more than 20% of flood claims come from outside of high-risk flood zones. Hurricane Harvey in 2017 provided a potent example: An estimated 80% of Texas flood victims lacked flood insurance.
Homeowners who stick with the NFIP still often require excess flood coverage, given the program's low coverage limits and the likelihood that a flood claim will result in a total loss.
"Most people have no concept of when they have a big storm in Florida and they get hit by a storm surge, that if their home gets pushed off of its foundation by the storm, that's not a home-owner insurance claim, that's a flood claim," Brandes said. "They think that their home might be worth a million bucks, but they only have $250,000 dollars in coverage because they didn't buy excess flood."
The fear that Biggert-Waters would lead to prohibitively expensive flood insurance and damage real estate values prompted Brandes to sponsor a 2017 law in Florida that eased regulatory barriers for admitted market private flood carriers. It spurred the growth of the largest number of private flood carriers of any state.
NFIP 2.0 could lead to more states taking similar action. Using the Florida law as a model, Louisiana lawmakers passed legislation in June that temporarily replaces the usual requirement that rates and forms receive prior approval with a file-and-use system for private flood.
Louisiana is "very dependent on the NFIP, but we're also very much interested in stimulating a private flood insurance marketplace that, yes, has the potential of rendering the NFIP a residual market or market of last resort," said Louisiana Insurance Commissioner Jim Donelon. "But, frankly, with the continued threat of raising rates to the point of rendering thousands of policies in our market unaffordable, we are trying to find alternatives to the FEMA-sponsored Nation- al Flood Insurance Program as well."
The Congressional Budget Office projects that an estimated 900,000 NFIP policyholders, or about 20%, will drop NFIP coverage as a result of Risk Rating 2.0.
Two Louisiana U.S. senators, Republicans Bill Cassidy and John Kennedy, are part of a bipartisan group of lawmakers introducing legislation this month that would, among other reforms, limit annual premium hikes to 9% instead of 18%. They also called on FEMA to delay implementation of Risk Rating 2.0. The legislation would reauthorize the NFIP for five years when it expires Dec. 3, instead of relying on short-term funding measures as it has since Sept. 30, 2017.
Private insurance companies interviewed for this story believe by moving private and public flood insurance rates in closer alignment, Risk Rating 2.0 would, over time, help increase the overall take-up rate for flood insurance as more consumers become aware of their need for coverage and more carriers see opportunity and enter the space.
"It's the boldest step in the right direction to help consumers in this country, it's like nothing I've ever seen," said insurance consultant Lisa Miller, a former deputy insurance commissioner in Florida. "It may be painful for some, but the long-term effect of what FEMA is trying to do is transformational."