Horn2020.Flood

Question 1

National Flood Insurance Program (NFIP) Overview

Answer 1

• A federal flood insurance program administered by FEMA (Federal Emergency Management Agency)
• Main provider of primary residential flood coverage (vs. private insurance)
• Involves private insurers and all tiers of government
• Created in 1968 and participation is (mostly) voluntary
• Primary reason for existence is to fill an unmet need in marketplace – if private insurers charged actuarially sound rates, coverage would be unaffordable to high-risk insureds who need it most

Question 2

Policy Goals of NFIP

Answer 2

AM&R

• Access: provide access to primary insurance (transfers some of the financial risk to the federal government)
• Mitigate & Reduce: mitigate & reduce flood risk through floodplain management standards

Question 3

Objectives of NFIP

Answer 3

RASH

• Risk-based premiums
• Affordability
• Sustainability (premiums should cover claims costs & expenses)
• High participation rates

Question 4

Differences between NFIP & private insurance

Answer 4

Social goals:
* provides coverage to high-risk customers who would not be able to obtain affordable coverage in the private market

Non-insurance goals:
* distribute flood maps (to assist with flood-risk management)
* require land use and building standards for participation in NFIP
* reduce the need for other post-flood disaster aid
* fund rebuilding after a flood (makes it easier for people to recover)
* protect lenders against mortgage defaults due to uninsured losses

Question 5

FEMA, FIRMs, SFHAs

Answer 5

• FEMA = Federal Emergency Management Agency
• FIRMs = Flood Insurance Risk Maps
• SFHAs = Special Flood Hazard Areas

FEMA makes FIRMs
FIRMs identify SFHAs

Question 6

When is purchase of flood insurance mandatory?

Answer 6

• for property owners in a SFHA with a federally backed mortgage
• when a mortgage lender specifically requires participation

Question 7

Exceptions to risk-based NFIP rates

Answer 7

• pre-FIRM: properties built or improved before 12/31/1974, or before the first FIRM for their community (whichever is later)
• newly mapped: properties mapped to a SFHA on/after 4/1/2015 (if applicant obtains coverage within 12 months of map revision date)
• grandfathered: properties originally built in compliance with FIRM (even if they are subsequently mapped into a higher-priced class)

Question 8

Role of Private Insurers in NFIP

Answer 8

• service policies (marketing selling, writing, claims management)
• share risk with FEMA
• assume full risk as primary insurer
• assume a portion of risk as a reinsurer

Question 9

2 Servicing Arrangements available to private companies within NFIP

Answer 9

Direct Servicing Agent (DSA):
* private contractor for FEMA
* facilitates purchase of flood insurance directly from NFIP

Write-Your-Own program (WYO):
* private companies directly write and service policies themselves
* the majority of NFIP policies are currently written through WYO

Both: NFIP retains the financial risk

Question 10

NFIP Risk Management Tools

Answer 10

Private reinsurance:
* purchase from a varied group of reinsurers with each bearing part of the risk

Capital markets:
* catastrophe bond reinsurance is facilitated by a single company
* risk is then transferred to capital market investors who purchase the bonds
* investors pay a certain percentage of the losses from a single, large scale event

Question 11

Advantages for using private reinsurance for NFIP

Answer 11

• FEMA knows the cost of (some) of its flood risk up front instead of borrowing from the Treasury after a flood (the cost is just the cost of the reinsurance policy)
• reinsurance reduces the volatility of losses (helps manage risk)

Question 12

Disadvantages for using private reinsurance for NFIP

Answer 12

• expected value of long-term costs is higher because reinsurers must be compensated for assuming risk (in addition to paying out claims)
• NFIP may have insufficient funds after reinsurance premiums to pay claims it retains
• NFIP may have insufficient funds after reinsurance premiums to fulfill other goals & objectives like risk mitigation, flood mapping, improving NFIP rating structures

Question 13

Why do private insurers consider flood risk to be uninsurable?

Answer 13

• catastrophic nature of flooding
• pricing difficulties (data is highly variable from year to year, unlike auto pricing which has a stable data history)
• adverse selection (only high-risk customers would purchase flood coverage)
• affordability (risk-based pricing could lead to unaffordable rates for high-risk customers who need it the most)

Question 14

Common types of private flood insurance

Answer 14

• commercial coverage
• secondary coverage (XS coverage above NFIP maximums, coverage for business interruption, …)
• lender-placed coverage (that’s when a bank forces a borrower to obtain coverage to protect the bank’s loan)

Question 15

Issues & barriers to private flood insurance

Answer 15

SNAP RBC
* Subsidization by NFIP: private insurer can’t compete with taxpayer-subsidized rates
* N
* Accurate assessment of flood risk: don’t have credible data, but FEMA can’t release NFIP data due to 1974 Privacy Act
* Participation rates: necessary to manage & diversify portfolio; even where flood insurance is mandatory participation can be low
* Regulatory uncertainty: private coverage increases state involvement which increases compliance costs since each state may have different regulations
* Broad coverage (at least as): hard to determine since policy forms can be written differently
* Continuous coverage requirement: coverage must be continuous to retain NFIP premium subsidies; switching to private may constitute a lapse in coverage

Question 16

How to address issues & barriers to private flood insurance

Answer 16

• replace “at least as broad” with “comply with state regulations” (easier to determine)
• pass a federal law stating that private flood insurance counts when assessing whether coverage has been continuous
• reform NFIP rate structure so that prices match what a private insurer would charge (FEMA redesigned risk-rating system: Risk Rating 2.0)
• don’t change anything: state level authority may be better in the long-term because it encourages state-specific solutions
• remove personally identifiable information from NFIP data then make data public (or release only aggregate data)
• expand mandatory purchase requirement (require all SFHA properties to buy flood insurance, not just those with federally-backed mortgage)

Question 17

Potential effects of increased private sector involvement in flood insurance

Answer 17

• more choice (higher limits, expanded coverages like business interruption and living expenses, shorter waiting periods before policy becomes effective)
• lower prices (lower-risk, non-subsidized NFIP customers may be charged lower rates by private insurers)
• variable protections (consumer protections for private policies are enforced at the state level and may vary considerably from state to state)
• adverse selection (private companies may cherry-pick profitable, low-risk policies from NFIP, leaving NFIP with underpriced high-risk policies and weakening its future ability to pay claims)
• impaired flood mapping & floodplain management (NFIP pays for flood mapping and floodplain management with policy fees so a significant decrease in NFIP policies could weaken NFIP’s ability to perform these functions