Flood at the Crossroads
While the federal flood insurance program remains mired in debt, changes are afoot in the private sector insurance market that point to a greater role for property/casualty insurers.
One, there is ample risk-transfer capital in the private sector — capital looking for a home.
Two, changes are occurring in modeling that are going to make this risk much more palatable for commercial insurers, provided they can get the price necessary to sustain the profitability of their portfolios.
Three, federal legislators are fine-tuning legislation to remove any ambiguity on the part of lenders that private sector policies are adequate to cover a risk that’s been held primarily by the federal government for the past 50 years.
Let’s move first to the modeling.
Tom Larsen, an Oakland, Calif.-based chief product architect for CoreLogic, reports that significant increases in computing power mean that his firm can map and model flood risk with a granularity that it could not provide previously.
“You go back to how well you can measure it,” Larsen said.
“Flood risk is very specific. One house got it and one didn’t. It’s a matter of understanding the elevations at a very granular level,” he said.
In September, CoreLogic released a flood model that provides granularity on elevations to within 10 meters. Larsen said the company is working to increase that level of detail even further.
“As a modeler we are just going to keep pushing it,” Larsen said.
CoreLogic competitor RMS is also advancing its computing and modeling capabilities, to the point where it hopes to have a cloud-based flood solution to market in late 2016 or early 2017. The product will allow insurers to upload their entire property portfolio and calculate flood exposures.
The demand from carriers is there, according to Matthew Nielsen, senior director of global government and regulatory affairs with RMS.
“The folks that are writing the large commercial risks are saying, ‘We need this yesterday,’ ” Nielsen said.
“The folks that are writing the large commercial risks are saying, ‘We need this yesterday.’ ” — Matthew Nielsen, senior director of global government and regulatory affairs, RMS
Consider that a flood model for the U.S. with resolution down to 50 meters creates a grid system with 32 billion cells. That’s a huge amount of data for a modeler to process, not to mention its clients.
Nielsen and RMS hope to spare the carriers the cost of investing in that much technology and use this cloud-based platform to show them the risks they might be inclined to write.
They also are seeing demand from carriers on how they can prevent unwanted flood risk from leaking into their portfolios.
“Because most of them don’t have any flood claims experience and they need to start somewhere,” Nielsen said.
Another area that is producing changes that should make flood risk more palatable for carriers is federal and state regulation.
Perhaps with the best intentions, the U.S. Congress passed in 2012 the Biggert-Waters Act, which was intended to make it easier for private sector carriers to write insurance coverage independent of the National Flood Insurance Program.
But industry observers say it had the opposite impact.
The act confused matters by making it less clear that a private sector policy could be used to replace a federally backed flood insurance policy.
Confused by the lack of language clarity, lenders were unwilling to accept private sector policies, which led to a chilling effect on private sector flood coverage in both commercial and personal lines.
There was also political pushback against some of the act’s other provisions, chiefly that the NFIP start charging rates that are more actuarially sound.
Politicians from states with significant flood exposures succeeded in weakening Biggert-Waters, resulting in legislation in 2014 that allowed homeowners to pass on subsidized insurance rates to purchasers when they sold their homes.
According to a report by Deloitte, the six states with the greatest number of flood claims, are — in descending order — Louisiana, Texas, New Jersey, New York, Florida and Mississippi.
Florida lawmakers have since passed a law that makes it clear that a standard policy can replace an NFIP policy. Legislation has also been launched in Washington, D.C. to clarify the intent of Biggert-Waters.
“The idea is to fix the wording in Biggert-Waters to clarify the section in that legislation that would encourage lenders to accept private flood insurance as a way to get private insurance more into the business and not discourage it,” said Don Griffin, a Chicago-based vice president with the Property Casualty Insurers Association of America (PCIAA).
As to the private sector’s capacity to provide that coverage more efficiently than the public sector, Griffin had this to say:
“We saw the insurance industry sustain $62 billion in losses after Katrina-Wilma-Rita in 2005 and pay those out without too much trouble.
“We didn’t see anybody going under as we did with [Hurricane] Andrew,” he said.
“But the national flood program paid out a little more than $20 billion and it’s been in the hole ever since,” Griffin said, referring to the National Flood Insurance Program’s current debt level of $23 billion.
“We saw the industry sustain $62 billion in losses after Katrina-Wilma-Rita in 2005 and pay those out without too much trouble.” — Don Griffin, vice president, Property Casualty Insurers Association of America
According to a Deloitte report that examined the pros and cons of more private involvement in the flood insurance marketplace, the NFIP was $20.7 billion in the red when Superstorm Sandy hit in late October of 2012.
After that storm, the NFIP had to borrow another $9.7 billion from the U.S. Treasury to pay claims, according to the Deloitte report. That left it more than $30 billion in the red.
One obstacle for the private sector that Griffin and others point to is the issue of rate. The federal government has no cost of capital, compared to the private sector insurance industry. So its rates aren’t actuarially sound, from the point of view of a private sector underwriter.
But CoreLogic’s Larsen points out that there is a significant chunk of claims that FEMA pays out that don’t fall within its 100-year flood maps. There is an opportunity there for private insurers, Larsen said.
“I think the opportunity for writing flood isn’t just relying on regulatory changes,” Larsen said.
The National Flood Insurance Program was created as a public-private partnership by Congress in 1968. Currently, according to information provided by the PCIAA, 80 of the approximately 1,300 active personal and commercial lines insurers in the U.S. act as Write Your Own, or WYO, partners to the program.
These carriers assist the program by marketing the coverage and providing claims management services, in effect acting as third-party administrators.
The PCIAA also reports that the number of carriers helping to administer the program is declining, as is the number of NFIP policies that are in force. From a peak of around 5.6 million policies in force post-Katrina, the NFIP now has about 5.2 million policies in force and that number continues to decline, according to the PCIAA.
There’s an opportunity here for the private sector, according to John Dickson, president of Advanced Insurance Coverges, a subsidiary of National Flood Services, which manages three million flood policies and $2.3 billion of flood insurance premium annually.
In July 2014, Aon bought National Flood Services to “expand its flood solutions to reach a larger client base with this growing sector,” according to Aon Affinity President and CEO Bill Vit.
Major brokerages Brown & Brown and Marsh have also purchased flood businesses within the past year.
“From our perspective, FEMA is driving private markets to the business of flood insurance by means of the surcharges and assessments that FEMA is applying to policies,” Dickson said.
“FEMA is unabashed in what their mission is,” he said. “Their mission is to shrink the NFIP program to allow more private markets to enter this space to more effectively insure home and business owners,” he said.
In an industry awash in capital, expanded flood coverage looks like a logical place to put that capital to use, Dickson said.
“This is one of the last insurance areas that is untapped from a private underwriting standpoint,” Dickson said.
“That’s what’s exciting — we believe companies that come into this space today with the most thoughtful business plans and disciplined allocation of capital are going to be poised for very long-term success,” Dickson said.
Perhaps the key obstacle for carriers and their partners to attaining the success Dickson envisions is the issue of rate.
As the PCIAA’s Griffin pointed out, the federal program, unlike the private sector, has no cost of capital and isn’t required to reserve or buy reinsurance.
Thus the premiums it charges are far less than what the private sector would require to be profitable as a first-dollar insurer.
“The risk is there, the rate isn’t,” said Brady Kelley, executive director of the National Association of Professional Surplus Lines Offices, an industry trade group that represents surplus lines carriers.
Surplus lines carriers currently write insurance in layers above that offered by the NFIP. Kelley and his group are continuing to work to make sure that any tweaks to federal legislation on flood coverage don’t unwittingly put limits on the involvement of surplus lines carriers in flood coverage, which has been substantial and ongoing.
“The risk is there, the rate isn’t.” — Brady Kelley, executive director, National Association of Professional Surplus Lines Offices
The Government Accountability Office echoed Kelley’s sentiment in a January 2014 report, stating private sector carriers won’t write more flood risk without the freedom to charge adequate, risk-based premiums.
The Deloitte report outlined several options for a more viable partnership between the government and the private sector.
One, which it calls the “Crop Insurance Model,” would have private carriers writing more first-dollar coverage and reinsuring catastrophic levels of loss with the federal government.
The second, which Deloitte calls the “Reinsurance Model,” would involve the NFIP spreading its flood risk through the purchase of reinsurance from the private sector.
The aforementioned Biggert-Waters Act authorized that approach.
Another model categorized by Deloitte as “The Pooling Model” would set up a flood insurance pool, similar to the California Earthquake Authority, where participating insurers could sell flood insurance bundled with standard homeowners’ policies.
Mandatory coverage, requiring every homeowner to purchase flood insurance, would spread the risk even further and create such a large pool of participants that it would allow carriers to keep premiums at affordable rates, the Deloitte study authors reasoned.
Such a mandate would likely face a substantial amount of political opposition.
More granular modeling, coupled with robust risk mitigation and portfolio management, might very well support statements like that in the Deloitte report, which said flood insurance coverage “likely represents the largest potential growth opportunity in the property and casualty market.”