The National Flood Insurance Program and the State of the Market NAIC CIPR Event The Future of Flood Insurance April 10, 2017 Robert W. Klein, Ph.D. Georgia State University

Overview The growing threat of floods in the U.S. History and evolution of the NFIP Recent reform legislation Key elements of the program Flood insurance statistics Issues and challenges facing the NFIP Enhancing the role of the private sector in flood insurance.

The Growing Threat of Floods in the U.S. The incidence of damaging floods has been increasing significantly over the last several decades. More and more communities face substantial flood risk and flood losses have been rising. Contributing factors: Increasingly volatile weather Compromised flood plains Erosion Economic development in flood-prone areas

Rising Flood Losses in the U.S.

History and Evolution of the NFIP In 1968, the National Flood Insurance Act established the National Flood Insurance Program (NFIP) to: Address the lack of availability of flood insurance in the private market; Reduce the demand for federal disaster assistance for uninsured flood losses; and Integrate flood insurance with floodplain management. Subsequent legislation established the mandatory purchase requirement, the Write-Your-Own (WYO) program, and the Community Rating System (CRS) and addressed the problem of repetitive loss properties. In 2005, Hurricane Katrina resulted in $16B in flood losses paid and a $16B loan from the Treasury. Subsequent investigations stressed the need for further program reforms.

Biggert-Waters Flood Insurance Reform Act In 2012, the Biggert-Waters Flood Insurance Reform Act was passed to institute a number of reforms to restore the NFIP’s fiscal solvency, including: A phase out of pre-FIRM and grandfathered rates (annual increases to be capped at 25%); Requiring premium adjustments for any property to accurately reflect its risk – any increase in premium to be phased in over a 5-year period at a rate of 20% annually; Requiring FEMA to use actuarial principles in determining rates and to consider catastrophic loss years in the calculation of the average historical loss year; Requiring FEMA to establish a reserve fund to fund catastrophic losses funded by a 5% surcharge on most properties; and Reinsurance and privatization initiatives.

Homeowners Flood Insurance Affordability Act In 2014, the Homeowners Flood Insurance Affordability Act was passed which limited or rescinded some of the rate increases that would have been implemented under Biggert-Waters. Its provisions include: Limiting annual rate increases on subsidized properties to 18% with some exceptions; Reinstatement of grandfathering; Subsidies are now funded by a $25 surcharge on homeowners flood policies and a $250 surcharge on nonresidential and secondary properties; and Requiring FEMA to commission studies on flood insurance affordability and community-based flood insurance.

Eligibility and Coverages To be eligible for flood insurance, a property must be located in a community that participates in the NFIP. Coverages Replacement cost or actual cash value coverage Deductibles

Flood Mapping, Zones and Pricing Flood insurance pricing starts with Flood Insurance Rate Maps (FIRMs) which indicate a given area’s vulnerability to floods and designated by its flood zone. Special Flood Hazard Areas (SFHA) are areas where the annual probability of a flood is 1% or greater (e.g., Zones A and V); areas designated as having moderate flood risk have an annual probability of flooding ranging from >1% to 0.2% (Zones C and X (shaded)); areas designated as having minimal flood risk have a probability of flooding less than 0.2% (Zones C and X (un-shaded)). A rate per $100 of coverage is used to determine a base premium for a given property which reflects its zone & other factors including its structural characteristics, occupancy, contents and elevation. The premium for a given property is further adjusted by several factors to account for policy limits, loss adjustment expenses, the policy deductible, underinsurance, other expenses, and contingency provisions for the A and V zones in Special Flood Hazard Areas (SFHAs).

Subsidies and Grandfathering Properties built before FEMA had mapped flood risk in their community receive a subsidy that can result in a premium substantially below what they would otherwise be charged – these are known as pre-FIRM properties. These subsidies are being phased out with annual rate increases of 5%-18% with some exceptions. Certain properties may receive a 25% annual rate increase, e.g., business properties, secondary homes, substantially damaged/improved properties & repetitive loss properties. Grandfathering – properties that were built to code and are subsequently mapped into a higher risk zone will not receive a rate increase with one exception. Properties moving into a SFHA receive a subsidized premium the first year and annual rate increases of 5%-18% after the first year.

Community Rating System (CRS) The CRS was implemented in 1990 to encourage communities to improve their floodplain management beyond the minimum NFIP requirements. Communities that participate in the CRS receive a class rating from 9 to 1 (1 being the best). Based on their community’s class rating, properties receive a discount on their flood insurance premium, e.g., properties in an SFHA receive a 5% discount for a Class 9 rating, a 10% discount for a Class 8 rating, etc. More than 68% of all flood insurance policies are written in CRS communities.

Mandatory Purchase Requirement Certain property owners in SFHAs are “required” to purchase and maintain flood insurance. Three categories of property owners are required to purchase flood insurance: Owners who obtain loans from federally regulated lending institutions that are secured by improved real estate or a manufactured home; Owners whose loans are secured by improved real estate or manufactured homes and have been purchased by Fannie Mae or Freddie Mac; and Owners who receive federal financial assistance for acquisition or construction purposes in communities that participate in the NFIP. Lending institutions are responsible for enforcing the mandatory purchase requirement.

Buying Flood Insurance Property owners can purchase flood insurance in the following ways: Purchasing it directly from the NFIP through an insurance agent; Purchasing it through a WYO insurance company; or Purchasing it on the private market (not underwritten by the NFIP) WYO Program The WYO program was established in an effort to expand the sale of flood insurance. There are approximately 70 insurance companies that are authorized to sell & service policies on behalf of the NFIP. WYO companies receive an expense allowance, incentive bonuses, and reimbursement of their claims adjustment expenses.

Flood Insurance Statistics (NFIP) Program Summary 5.0 million policies (1/31/2017) $1.2 trillion insurance in force (1/31/2017) $3.5 billion insurance premiums earned (2015) $24.6 billion debt to the Treasury (March 2017)

Flood Insurance Policies in Force by Calendar Year: 1978-2016 Source: FEMA

Total Coverage in Force by Calendar Year: 1978-2016 Source: FEMA

Losses and Premiums Paid by Calendar Year: 1978-2015 Source: FEMA

Issues and Challenges Pricing High cost of flood insurance for some property owners; affordability Program deficits and debt Low take-up rates for flood insurance Flood risk assessment & flood zone mapping Suboptimal flood risk mitigation Repetitive loss properties Claims adjustment

NFIP Debt: Fiscal Years 1981-2016 NFIP Debt to Treasury was $24.6B as of March 2017

Enhancing the Role of the Private Sector in Flood Insurance: Motivation, Challenges, State of the Market Motivation Reduce the fiscal burden on the NFIP? Reduce the price of flood insurance for policyholders? Allow private insurers to innovate w.r.t. policy design, risk assessment, pricing, etc. Challenges Lack of access to NFIP data to assist private insurers in risk assessment and pricing. No flood maps for some areas? Under-pricing of some properties by the NFIP State of the Market for Private Flood Insurance An increasing number of private insurers are offering flood coverage but, currently, this market is still relatively small. Private insurers are offering lower premiums for properties that are overpriced by the NFIP in low and moderate risk areas.

Enhancing the Role of the Private Sector in Flood Insurance: Public Policy Issues How will private flood insurance affect the achievement of public policy objectives for flood risk management? Will funding for flood mapping and flood plain management be compromised? Will the coverage offered by private flood insurers be adequate? Should surplus lines insurers be allowed to offer flood insurance to residential property owners? Are state insurance regulators properly motivated and positioned to regulate private flood insurance? Should lending institutions and GSEs be allowed to determine what constitutes adequate coverage to cover the collateral on home mortgages and meet the mandatory purchase requirement. Will private flood insurance improve or hurt the NFIP’s fiscal situation?

Enhancing the Role of the Private Sector in Flood Insurance: Prospects Significantly increasing the sale of private flood insurance could have several benefits, such as: Encouraging innovation in policy design, risk assessment, and pricing, thereby … Reducing the cost and price of flood insurance for some property owners which in turn could … Resulting in more properties covered by flood insurance. At the same time, the issues I and others have raised need to be addressed to ensure that private flood insurance promotes the goal of good flood risk management rather than undermining it.