High water mark: insurers are scrutinizing the National Flood Insurance Program after the worst flooding in decades.
At the center of the industry's speculation is proposed legislation in Congress intended to revamp the federal flood program into a comprehensive catastrophe assistance program. The one thing everyone seems to agree on is that the federal flood program needs work.
The NFIP was launched in 1968 to help homeowners survive flood disasters, the most common form of natural catastrophe in the United States, according to the Federal Emergency Management Administration. Managed by FEMA's Mitigation Division, the program's purpose was to discourage building in flood-prone areas, thus preventing further high losses and federal payouts. Some 95 private insurance companies currently sell NFIP flood polices under the "Write Your Own" program, both directly and through agents and brokers.
Yet a surprisingly low take-up rate, paired with severe hurricane seasons in 2004 and 2005, has brought flood reform back to the table. Only about haft of all homeowners living in the nation's most flood-prone areas buy flood insurance, according to a study by the nonprofit organization Rand Corp. The NFIP was last amended in 2004.
The NFIP is bankrupt. Last year's storm season generated a higher dollar amount of claims in one year than the program has seen in its 37-year history. Congress already has extended the program's borrowing authority three times since Hurricane Katrina, from $1.5 billion to $20.8 billion, to pay outstanding claims. Now members of the House Financial Services Committee and Senate Banking Committee are struggling to save the flood program, with recommendations for reform coming from virtually every corner of the insurance industry.
Perhaps no one agrees more that the NFIP needs help than its current overseer, Mitigation Division Director and Federal Insurance Administrator David Maurstad, whose experience since taking the helm in 2004 has been admittedly, "baptism by fire." Language surrounding repetitive loss properties needs to be updated, as some $40 million in authorized funds promised in the 2004 NFIP reform bill for this purpose did not materialize until last fall, he said.
"We're in the process now of developing the rules to implement that program, to target severe repetitive loss properties," Maurstad said. Currently, a repetitive loss property is defined as experiencing two events that incurred losses of at least $5,000, or a loss at the value of the structure or the policy limits. Other improvements Maurstad and the NFIP recommend:
* Eliminate subsidies on grandfathered properties.
* Raise the cap from 10% to 15% on the amount of premium increase Congress allows for the program.
* Strengthen the mandatory purchase requirements for federally regulated lending institutions to insure the value of the structure, not just the outstanding loan balance.
* Require more frequent reviews of lenders' portfolios so policyholders who don't comply with NFIP mandates incur stiffer penalties.
* Schedule new flood policies to take effect after 15 days; half the present 30-day waiting period.
* Increase the current flood plain requirement, which represents a 1-in-100-year flood level, to a 1-in-500-year flood level.
The Independent Insurance Agents and Brokers of America, which represents some 300,000 insurance agents and brokers nationwide, would like to see the addition of optional business interruption coverage at actuarial prices, said Charles Symington, the group's senior vice president for government affairs and federal relations.
"We saw it as a glaring weakness," Symington said. IIABA, also known as the Big I, has received feedback from Gulf Coast consumers who lost businesses last year. "It was one of our biggest issues, hands down."
Big I agents also have gotten feedback from insurers, who've said they want additional living expenses added to the flood program. Symington called optional BI coverage and ALE coverage "two of the major coverage gaps" of the NFIP.
Several Big I reform recommendations are included in the House and Senate versions of the proposed Flood Insurance Reform and Modernization Act of 2006, Symington said. And while both versions include a temporary rate increase, the Senate's version takes a "more aggressive approach" on eliminating subsidies in the program. The House's proposal is to slowly phase out subsidies for vacation homes, second homes and commercial establishments; the Senate's version adds repetitive loss subsidization.
"It would phase it out quicker, but it doesn't include the modernization of coverages that the House does," Symington said.
J. Robert Hunter, director of insurance for the Consumer Federation of America, said he's not convinced that the original tenets of the flood program have been met. A former federal insurance administrator and Texas insurance commissioner, Hunter administered the NFIP from 1974 to 1978.
"The original deal with Congress was, in exchange for paying for maps and subsidies for the old houses (which are by now 30 years old at least), the taxpayer would gain by having safer construction in the future," Hunter said. "The taxpayer part of the quid pro quo has not been delivered."
Hunter suggests that Congress hold off raising maximum coverage limits of the NFIP until the mandatory coverage requirements of the program are better enforced.
"I'm not for that until we're sure that mitigation works," Hunter said. "I want less coverage to put a building up wisely. I don't think taxpayers should subsidize rich people building houses in those places."
Don Griffin, vice president of personal lines for the Property Casualty Insurers Association of America, a trade group representing more than 100 member companies that write more than 40% of the P/C business nationwide, said there has been safer new construction around the nation, but the NFIP as written encourages the opposite.
"The program has some inherent conflicts by allowing coverage for buildings that existed before the program map process was finished" Griffin said. "Even under newer construction, what communities have to do is demonstrate that they've done something to try to mitigate the damage."
And that has unintentionally encouraged development of areas that perhaps should not be developed, giving some people the impression that, "if I can build a building right on the coast and elevate it so that it theoretically doesn't flood, and it's outside the flood zone, then I can go ahead and build that building," Griffin said.
But it doesn't mean the building will not incur loss. "There's an economic struggle within the states as well as the country: You don't want to suppress development, but by the same token, you have to build safer buildings," Griffin said. "I think people all agree we need to be better land-use managers, as well as charge appropriate premiums and make the product more like what's offered in the private market."
Requirements and Incentives
Once flood maps are developed for a community and the base flood level is determined, all new structures within NFIP communities have to be constructed at base elevation or higher, which is higher than the 1% annual chance of flooding, Maurstad said. Such measures by communities across the country have saved some $1.1 billion in estimated insurance claims every year.
And those are minimum federal requirements, Maurstad added. Through its Community Rating System, the NFIP offers incentives for participating communities to go beyond the program's minimum requirements. "A little over 1,000 communities do that, representing about 75% of our policy base," he said.
He is skeptical about such reform proposals as additional living expenses, automatic contents insurance and business interruption; even at an actuarially based rate, none may be the right thing to do at this time, Maurstad said.
"My concern is the number of folks that may end up selecting those coverages, and whether we have greater adverse selection than already exists with the flood program. And, whether we can charge enough premium in the early years, when the policies will go into effect, to take care of the losses that would occur in the same period of time," Maurstad said. "We're not close-minded about it. We need to look at what the effects are, try to set the extension where we can actuarially make it fiscally sound."
Some observers would like to make flood coverage mandatory across the board, while others in the industry don't think any type of insurance coverage should be mandatory, said Robert Hartwig, chief economist for the Insurance Information Institute. "But then when they aren't covered, they demand tremendous resources from the government," he explained. "And that winds up as deficit Finance. People 25 years from now will still be paying for the Katrina damages."
A Combination Approach
Some would like to combine wind and flood insurance. An example is the all-perils policy recommended by a National Association of Insurance Commissioners' subcommittee. "The problem with that is, the Montanas and Oklahomas are probably going to have to pay a little bit more for homeowners insurance for the privilege of my folks being able to live in Biloxi or Bay St. Louis, and I'm not sure they'll be willing to do that," Mississippi Insurance Commissioner George Dale said.
Hartwig of III disagrees with pooling flood and wind insurance, saying they are distinct risks that need to be rated separately. "While there are some proponents of an all-risks policy, there are problems with that in the sense that it gets back to the issue of rate suppression. Insurers do not want to write flood coverage until they can write a rate that is actuarially sound, to generate a reasonable profit," he said.
Maine Insurance Superintendent Alessandro Iuppa, who is NAIC president, said the commissioners' group is hoping to get the NFIP to partner with the states on nonbinding mediation programs. Florida was successful with that approach after the hurricanes in 2004, but there is resistance, particularly with the Southeastern states, he said.
"That is something our members have said repeatedly they don't want," PCI's Griffin said. The group is part of the "Write Your Own" flood insurance coalition. "One of the other key goals for the WYO companies is to preserve federal jurisdiction over the program."
Flood reforms that PCI favors are an increase in the availability of educational materials on flood insurance; easier policy rating for agents; a single, higher deductible with options and surcharges; and a change in disaster assistance procedures, so that those with flood insurance are paid ahead of those without.
One of the big unknowns is whether "a reasonable number" of policyholders will take up federal flood insurance, Hartwig said. While U.S. media coverage of flood insurance has risen some 200% to 300% since Hurricane Katrina, the number of new flood policies sold rose just 6% nationally, he said.
When "otherwise intelligent, wealthy people turn it down, that causes me to be somewhat skeptical: We'll never get the majority of people that need to take up NFIP," Hartwig said.
It is difficult to get homeowners outside high-risk zones to consider flood insurance. "Part of it is that 25% of our losses happen outside the high-risk area," Maurstad said. "Does that high-risk area need to be larger? The most prudent approach at this point is to study the feasibility and implications of expanding that mandatory purchase requirement."
Strengthening enforcement of mandatory purchase requirements would not only provide flood insurance to people who need it, but as the policy base expands, the premium would expand as well, Hunter said: "It would allow us to have more revenue on hand to pay these catastrophic losses."
Another problem is the "very high" lapse rate. "Very often, between 10% and 13% of policyholders will lapse on an annual basis ... I'm not sure what kind of incentives there are at the NFIP to keep these customers," Hartwig said
Rising rates are hampering flood insurance sales in Massachusetts, said insurance department spokesman Chris Goetcheus. Massachusetts has 44,700 homeowners covered through the NFIP; six years ago, coverage for $100,000 cost about $300; the average yearly cost for building and contents flood coverage today is $790, he said.
"We rank 18th in the nation in terms of coverage for flood insurance," Goetcheus said. "It's not bad, but we're a very wet region."
The NAIC has three recommendations for improving the federal flood program, Iuppa said:
* Update the flood-plain maps
* Offer nonbinding mediation
* Increase the appeal of flood insurance.
"When I was running the program, my rule was every three years you update the map, and even at that, I was saying we're going to be behind," Hunter said. "There's going to be development that forces the water up, like sitting in a bathtub: You put more houses in, and up goes the water. Now they're behind 20 years."
"I was a little surprised that people were, after this event, coming to the conclusion that our maps were outdated," Maurstad said. The NFIP is in the third year of a five-year map modification program, for which Congress had allocated $200 million annually. Each state provides the program with its priorities for new maps.
"On August 29, we were within two-to-three months of having new preliminary maps for the [Gulf Coast] communities to start the appeal and adoption process on," Maurstad said. "We were working on it."
Currently, some 40% of the nation's population has modernized digital flood maps available.
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* The National Flood Insurance Program is bankrupt and needs reform.
* Only about half of all homeowners living in the most flood-prone areas buy flood insurance, and the annual lapse rate is above 10%.
* Congress is considering reform measures that would phase out subsidies for vacation homes, second homes and commercial establishments.
While many insurers, agents and brokers are contemplating the merits and potential mishaps of privatizing flood insurance, one company is doing something about it. The Chubb Group of Insurance Cos. in Warren, N.J., began writing primary flood insurance policies in March.
"Only 14% of people who have homeowners coverage are buying flood, and the need is much greater than that." noted Peter Spicer, Chubb's personal insurance new product manager. "There is a market for it, and it s interesting."
The product is geared toward Chubb's affluent homeowners policyholders and covers flood losses from the first dollar of damage tip to $15 million. It's now available in Arizona, Colorado, Illinois, Idaho, Indiana, Michigan and Utah. The company expects to have 15 states in the program by year-end, and tip to 30 by the end of 2007.
Chubb's primary flood product has an automatic limit of $7,500 of additional living expense, and gives customers the ability to purchase up to $100,000 of additional living expense coverage, Spicer said. The National Flood Insurance Program does not currently offer ALE. Chubb's product also addresses real property in basements, which the NFIP does not.
"We moved away from broader coverage in basements because the losses associated with that would overwhelm the amount of premiums that we could charge for it," said David Maurstad, mitigation division director and federal insurance administrator for the NFIP Besides. "We want to encourage people to have their properties above their base flood level. If we offer it, it will encourage people to build at or below the base elevation."
Were the entire industry to start privatizing flood insurance, the NFIP would become even more of an insurer of last resort, which could cause greater financial stress on the program, he said.
"But besides that, we welcome people to come," Maurstad said. "The more people who have flood insurance, the better protected our country will be."
The House's Flood Insurance Reform and Modernization Act of 2006, H.R. 4973, calls for the following additions and changes to the National Flood Insurance Program:
* Participation by FEMA in nonbinding mediation of insurance claims resulting from a flood.
* A permanent increase in FEMA's borrowing authority from $18.5 billion to $20.8 billion,
* A study by the comptroller general to review mandatory purchase requirements for the natural 100-year flood plain and for homeowners with nonfederal loans.
* Phasing in of actuarial rates on vacation homes, second homes and nonresidential properties subsidized by the program.
* An increase in the amount FEMA can raise rates, from 10% to 15%.
* An increase in the 1994 maximum coverage limits.
* Coverage for additional living expenses, basement improvements, business interruption and replacement cost of contents.
* Requiring that lenders provide notice of the availability of flood insurance to all homeowners, as well as notice of the ability to escrow for flood insurance.
* A reduction in the waiting period for effective date of policies from 30 days to 15 days.
* An increase in penalties for noncompliance.
* An extension of the Severe Repetitive Loss pilot program.
The Senate's Flood Insurance Reform and Modernization Act of 2006, approved on May 25, calls for the following additions and changes to the National Flood Insurance Program:
* Participation by the NFIP in state nonbinding mediation claims.
* Elimination of obligations owed to the U.S. Treasury by NFIP for the 2005 hurricane season.
* Creation of a reserve fund of up to 1% of all risk exposure in force.
* Studies by the Government Accountability Office on the "Write Your Own" program, the effects expanding flood coverage may have on the private insurance market, and allowing homeowners from nonparticipating communities to purchase flood insurance through the NFIP.
* The phasing in of actuarial rates on nonprimary residences, severe repetitive loss properties and business properties, and any property that has exceeded its fair market value, or requires improvement to more than 30% of its fair market value.
* An increase in the amount FEMA can raise rates for nonsubsidized properties, from 10% to 15%.
* Creation of a new Technical Mapping Advisory Council.
* Requiring the NFIP to map the 500-yeer flood plain and areas of residual risk (properties behind man-made structures, such as levees and dams) along with the 100-year flood plain.
* Alerting homeowners outside high-risk zones to the availability of flood insurance, and that payments can be placed into an escrow account.
* By year-end 2008, mandatory purchase requirements would include properties with state-backed mortgage loans.
* An increase in penalties for noncompliance.
Flood Insurance By the Numbers
Average premium for a yearly flood insurance policy.
Percentage of all flood claims filed yearly that come from low- to moderate-risk areas.
Number of flood insurance policies in force nationwide.
Percentage of homeowners living in the most flood-prone areas who buy federal flood insurance when it's not required.
Percentage of Americans living outside flood zones who buy federal flood insurance, even though they also are at risk.
Percentage of homeowners in coastal flooding areas who purchase flood insurance.
Percentage of homeowners in areas subject only to river flooding who purchase flood insurance.
Source: FEMA, Federal Flood Insurance Program, RAND Corp.
Top 10 Flood Claim States 2004 Three of the Top 10 U.S. states receiving large claims payments from the National Flood Insurance Program during the 2004 hurricane season do not have an ocean border. Payments to Payments to Residential Commercial State Total Properties Properties Florida $810,160,181 $752,878,524 $57,281,657 Pennsylvania $175,527,943 $118,480,766 $57,047,177 Alabama $171,840,648 $151,021,481 $20,819,168 West Virginia $64,828,894 $49,088,141 $15,740,753 Texas $46,489,344 $40,839,795 $5,649,549 North Carolina $29,176,548 $13,974,496 $15,202,052 Ohio $24,897,597 $13,999,636 $10,897,961 Georgia $21,032,927 $21,032,927 $1,099,008 New Jersey $17,437,544 $16,426,791 $1,010,753 Virginia $13,819,318 $9,536,445 $4,282,873 Source: FEMA National Flood Insurance Program
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|Title Annotation:||Property/Casualty: National Flood Insurance; Federal Emergency Management Administration|
|Comment:||High water mark: insurers are scrutinizing the National Flood Insurance Program after the worst flooding in decades.(Property/Casualty: National Flood Insurance)(Federal Emergency Management Administration)|
|Author:||Cavanaugh, Bonnie Brewer|
|Date:||Jul 1, 2006|
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