Risky business, reforming America’s flood insurance model
Founded in 1968, the insurer has relied on flawed methodologies for decades to determine risk and set insurance premiums. This served to incentivize construction in flood-prone areas, and it virtually subsidized many rich homeowners’ policies. Given all of this, it should come as no surprise that the NFIP currently owes over $20 billion to the U.S. Treasury, even after Congress cancelled $16 billion of the NFIP’s debt.
Despite not being a household name, the NFIP and its shortcomings impact many Americans. Most houses and businesses with government-backed mortgages in flood-prone areas are required to have flood insurance—driving business to the government-run insurer. The NFIP boasts around 5 million policyholders—nearly 90,000 of whom are here in Georgia and pay an average annual premium of nearly $700.
Recognizing the NFIP’s flaws, FEMA administrators have crafted a plan to revamp the NFIP’s rating methodology to better represent risk and help it draft better-informed flood insurance policies. Indeed, they recently announced the release of “Risk Rating 2.0: Equity in Action,” which hopefully represents a shift in the NFIP’s direction.
“Since the 1970s, rates have been predominantly based on relatively static measurements,” the NFIP website reads, “emphasizing a property’s elevation within a zone on a Flood Insurance Rate Map (FIRM).” The problem with this timeworn strategy is manifold. There are other, credible variables that predict the likelihood of a flood and its intensity, and FEMA’s maps are problematic. Many of them are “badly out-of-date.” In fact, in 2017, a Homeland Security report stated, “more than half of the [maps] either required a re-study or have not yet been assessed through the validation process.”
The result is that NFIP insurance premiums don’t adequately represent risk, which runs contrary to the private insurance market’s best practices, but the NFIP’s problematic model will soon change. As part of the NFIP’s Risk Rating 2.0, the insurer will begin considering additional, actuarially credible variables when determining risk and setting premiums.
“These include flood frequency, multiple flood types—river overflow, storm surge, coastal erosion and heavy rainfall—and distance to a water source along with property characteristics such as elevation and the cost to rebuild,” according to FEMA’s announcement.
To do this, annual flood insurance premiums must be adjusted to account for a more holistic approach to calculating actual risk. Under this new paradigm, 24 percent of Georgia’s NFIP policyholders will see a rate reduction, premiums will increase from $0-120 a year for 69 percent and the remainder will have to pay around $120-240 more a year for flood insurance.
While many people will certainly grumble at the thought of premium increases, the truth is that it’s absolutely necessary for many properties. For years, the NFIP has been entirely unsustainable—racking up debt and issuing policies that make little sense—and its hands have been partially tied by Congress. It even imposed a statutory limit on annual rate increases.
The result is a program of dubious solvency. To date, taxpayers at large have been on the hook for some of the NFIP’s debt, many insurance policies have been unfairly cross-subsidized and premiums don’t accurately represent risk. Risk Rating 2.0 looks to make improvements and put the NFIP on better financial footing.
While these reforms are a start, they won’t resolve all of the NFIP’s woes. Indeed, a continued focus on updating their flood maps is critically important, and they ought to examine methods for addressing repetitive risk properties. After all, if the NFIP continues to insure and rebuild properties that are damaged with high frequency, then that only encourages people to build in high risk areas. What’s more, the statutory cap on annual premium increases virtually guarantees that some policies will not match certain properties’ higher risk profiles.
In an ideal world, the government wouldn’t be in the business of writing flood insurance policies; the private market would. However, we don’t live in a perfect world, and the NFIP promises to exist in some form or another for the foreseeable future. Given this, it is vital to ensure that it operates less like a bureaucratic government agency and more like a sustainable private insurer. Risk Rating 2.0 appears to be a small step in the right direction.