Finding a solution to the US flood insurance challenge

Matthew Nielsen of Moody’s RMS highlights the need to encourage flood insurance take-up in the US.

Representatives from the Federal Emergency Management Agency (Fema), US insurers, flood plain managers, regulators, catastrophe modellers, and other experts recently gathered in Washington DC to discuss a weather peril that has the potential to affect every postal code in the United States: flood.

At the National Flood Conference, the pressing nature of flood risk was reinforced using statistics ranging from the 37 individual billion-dollar events that have occurred since 1980, to the $850 billion given out in flood assistance and aid since 2000.

Examining the take-up rate for flood insurance in the US, this remains small with only 4.7 million National Flood Insurance Program (NFIP) policies in force in June 2023, a figure that has shrunk by almost one million in the last five years. In the same period, just 420,000 private residential policies were written.

These numbers highlight the importance of expanding flood insurance coverage, whether via the NFIP or private policies, and of ensuring that homeowners are covered when the waters begin to rise.

Achieving higher flood insurance take-up

While there is strong agreement that increasing flood insurance coverage is a top priority, there are differing opinions as to how to achieve higher take-up.

Typically, a first suggestion revolves around educating policyholders through a more complete view of homeowners’ risk.

Many at the conference agreed that the typical policy language used is too detailed and too specific for the average home buyer to fully comprehend.

Agents typically fall back on the mandatory flood purchase requirement and will convince homeowners that because they are not in a flood zone, they do not need insurance.

Some agents even convince their clients to drop flood coverage after the first few years of their mortgage, noting that the lenders rarely notice the lapse in coverage.

Other ideas focus more on regulations, and one popular idea involves mandating the inclusion of flood coverage within a standard homeowner’s policy.

In December 2022, the Florida legislature took a first step in creating a flood insurance purchase requirement for participants in Citizens, their state-run insurance agency.

Coverage issues arising from Hurricane Ian in 2022 led Florida legislators to create a phased plan to roll out the requirement for flood coverage in the state’s insurance pool, starting with the most expensive properties in 2024 and, by 2027, expanding to all properties covered by Citizens.

While these requirements only apply to a subset of their 1.3 million policies in force (approximately 27 percent are in a Special Flood Hazard Area), this requirement may be a crucial step for expanding the flood insurance pool.

Switch opt-in to opt-out

Another suggestion to boost take-up focuses more on the psychology of buying an insurance policy. Instead of offering homeowners the chance to opt into flood coverage, the paradigm can be flipped to require them to opt out.

This would start with the policyholder being quoted their full-risk rate, which includes the optional coverages that they may need to fully protect their property. They will then have the option to remove coverage by signing an acknowledgement that they are waiving their right to protect certain aspects of their property.

While this approach would require that all insurers quote for policies in the same way, it also provides a compromise by asserting necessary coverage while not mandating expenses that some homeowners can’t afford.

Rewarding homeowner flood mitigation measures

With many different routes available to promote greater insurance coverage, for each pathway, the need to accurately reflect the risk of each location will be paramount.

Home protection and hardening measures are necessary components to increase resilience and keep insurance rates affordable. Reflecting these mitigation credits at the point of underwriting will then help to provide a building-specific risk rating.

While the NFIP is still rolling these rating features into the new methodology, the credits for these measures are not provided to the underwriting agents. Not knowing how much of a return they will get from their rates makes it difficult for homeowners to make the decision to harden their homes.

However, private carriers have the advantage of using catastrophe models that agents can quote in terms of discounts. Homeowners can then use these quotes to create a cost/benefit analysis for updating or improving their homes and subsequently lowering their insurance rates.

Using modelling to quantify homeowner flood risk

Catastrophe models can provide estimates of risk that can differentiate between various construction types, occupancies, build codes, mitigation features, and other detailed criteria.

Insurers have used these models to develop credits for home hardening and resiliency efforts that reduce risk, and these can then be used to pass discounts along to policyholders to reflect the upgrades they have made to their properties.

Mitigation and resiliency are the main tools that the insured must use to keep their rates affordable and their property well-defended.

The journey to building adequate flood insurance take-up is still taking shape, and there are millions of unprotected properties that are exposed to the ravages of flood. The silver lining is that the insurance industry, regulators, Fema, and floodplain managers are all focused on finding a solution to this problem.

Will the purchase requirement set to be implemented by Citizens in Florida offer the blueprint for the future, or will we need to collectively think of new and innovative ways to convince policyholders to protect themselves?

No matter which path the industry chooses to follow, catastrophe models will continue to be a valuable resource in quantifying and communicating risk for a peril that can affect anyone, anywhere.