If it were a dam or a levee, it would have been replaced ages ago. Yet the National Flood Insurance Program (NFIP) has stayed afloat despite a regular leaking of funds since its inception in 1968. The much-needed, often-maligned program has seen a lot of action, and nearly as much inaction.
Created in 1968 to give property owners the ability to insure against flood loss, the NFIP has provided much-needed coverage for flood damage reparations for an estimated 5.6 million homes nationwide. With participation agreed upon between local communities and the federal government, the program would then establish and manage flood plain ordinances to reduce future flood risks in exchange for federally funded insurance protection that property owners could purchase. Maps were created to identify flood zones and special flood zone hazard areas (SFHAs), and the Federal Emergency Management Agency (FEMA) was put in charge of overseeing the program.
The program was set up to be self-sustaining, though during times of higher-than-average claims losses, the NFIP borrows from the U.S. Treasury. For the most part, it worked well, with any monies borrowed paid back to the Treasury with interest.
Then came Katrina. And then Rita. The losses from the 2005 storms flooded the program, causing NFIP to turn to the Treasury Department for a loan. Some $18 billion later, the NFIP has been operating in the red and struggling to find ways to repay the loan and handle the regular flow of claims.
However, $18 billion of debt is a lot to correct. According to a Congressional Budget Office (CBO) report, the changes implemented would reduce NFIP’s need to borrow by $380 million between 2012 and 2014 and result in a net income increase of $4.7 billion by 2021. But the report states that current premiums are not enough to cover expected costs, and that could result in the NFIP borrowing up to the statutory limit by 2015, which would result in no effect on direct spending for the next 10 years.
NFIP: A Brief History
Four years, 17 extensions, four expirations – that’s how often the NFIP had to be considered before Congress could find common ground and appropriate steps to modernize the program, which was last updated in 2008. Despite the numerous extensions and renewals, the program has been modified just four times prior to this year’s overhaul. In 1973, provisions were added making the purchase of flood insurance mandatory for properties designated to be in SFHAs. In 1982, the Coastal Barrier Resources Act added maps that identified various undeveloped coastal barriers and rendered them ineligible for NFIP assistance.
The National Flood Insurance Reform Act of 1994 established the community rating system, which attempted to encourage communities to surpass minimum requirements for development within flood plains. Then in 2004, the NFIP was again amended in an effort to reduce property losses on properties that have sustained repeated flood losses.
On July 6, 2012, President Obama signed the Biggert-Waters Flood Insurance Reform Act of 2012 extending the National Flood Insurance Program through September 30, 2017. Known as the Biggert-Waters Flood Insurance Reform Act of 2012, the act is more than the usual extension. It’s a much-needed overhaul of the program, which experts think can right its financial wrongs thanks to fiscal reforms that have been built into the new legislation.
Enter a whole new set of rules. For starters, the legislation extends the NFIP for five years. In the past, Congress has managed to keep the program limping along with extensions of smaller increments. In some cases, the program expired, leaving millions of policyholders with no protection.
What’s different about Biggert-Waters is, well, everything. Instead of keeping the NFIP as status quo, there are now plenty of fundamental changes – modernizations to the 44-year-old program. To be phased out are subsidies on properties with repetitive losses, which many properties were afforded, and new rules make it easier to apply for the FEMA buyout program. Under the previous program, subsidies for vacation and second homes were granted to approximately 355,000 policyholders. With the phasing out of the program, the NFIP expects to be able to reduce its borrowing needs, though by how much is still undetermined.
The new plan also allows FEMA to purchase reinsurance. “It will engage, in no way we’ve done in recent decades, the private sector in the National Flood Program,” says David Treutel, Jr., president of Treutel Insurance Agency and T&T Financial Services in Biloxi, Miss. “That’s been part of the challenge –FEMA’s been faced with the task of being reactive instead of proactive [in transferring risk].”
Also, the legislation caps annual premium increases at 20 percent, a 10-percent raise over last year’s cap. Another key change – coverage availability for multifamily properties, which were excluded under the old program. More changes include minimum deductibles for flood claims and establishing a technical mapping advisory council to handle map modernization. That’s a need Treutel says was punctuated by Katrina.
After Katrina, it was discovered that large portion of the Biloxi area was not considered to be, according to 1981 maps, in a special hazard zone. After the maps were updated, several excluded properties were then placed in the special hazard zone. “The ability to update and maintain these maps is crucial because that’s what everyone points to – building code officials, mortgage, insurance, and real estate people – to determine whether someone is in that special hazard zone,” he says.
Another requirement – a plan from the NFIP administrator that outlines how debt incurred from Hurricane Katrina will be repaid. The reforms set forth in the new plan have the Congressional Budget Office estimating a $2.7 billion increase in net income over the next ten years. Still, Congress is expecting a more aggressive plan for paying off the $18 billion still owed.
One of the more anticipated – and still undecided—portions of the legislation is how NFIP will respond to business interruption and additional living expenses coverage claims. Biggert-Waters requires the Government Accountability Office (GAO) to study how the program might respond to these coverage needs. Also, the Federal Insurance Office (FIO) is required to study natural disaster insurance issues and submit to Congress a report outlining possible legislative solutions.
According to Treutel, who is also Flood Insurance Task Force chairman at Independent Insurance Agents & Brokers of America (IIABA) and chairman of the Flood Insurance Producers National Committee, most of the important components of the NFIP have been changed. And those changes were long in coming – since Katrina. “It’s been over a decade since we’ve looked at the values in the amounts of coverage we provide,” he says. “One of the problems I saw as an independent agent after Katrina was no matter how well you tried to buy insurance, you could never get the amount you needed.” He points to business interruption coverage and additional living expenses exclusions as examples.
Treutel says the current legislation should help in addressing the Katrina-incurred debt. There will be more effort, he says, to be more actuarially sound in terms of the ratings structure. “We have to have a means of keeping the program financially stable,” he says. “We now have a good blueprint.”
Another change: flood insurance requirements for lenders. Thanks to the Coastal Barrier Act, some communities were carved out as areas that are not part of nor are they able to obtain national flood insurance. They were forced into the private market, Treutel says. However, many lenders weren’t able to use that as a viable alternative under NFIP rules. Under Title 2, that’s changed. “Title Two requires lenders to accept non-NFIP-backed coverage provided by a private insurer provided that coverage meets all NFIP requirements,” says Treutel.
Wind v. Water
One of the most intriguing changes taking place under the new legislation is the inclusion of an amendment that will help determine water and wind damage claims much faster and with more accuracy. Introduced by Senator Roger Wicker (R-Miss.), the Consumer Option for an Alternative System to Allocate Losses (COASTAL) Act is now an amendment to the NFIP and will help determine whether a claim is the result of water or wind damage.
Under the Act, officials will use data from the National Oceanic and Atmospheric Administration (NOAA) and the Federal Emergency Management Agency (FEMA) to accurately assess the cause of water damage following a hurricane. The engineering formulas, which are to be developed by FEMA, will apply to total-loss, “slab” properties in which the building is completely destroyed. The goal is to ensure that wind damage claims aren’t inadvertently routed to the NFIP coverage.
States are already responding to the changes. For example, Vermont is now urging local governments to adopt zoning bylaws that restrict development in flood-prone areas. Vermont officials state that FEMA maps are just overviews of conditions and are not giving the clearest picture of the changes in the river movements. They’ve even named the changes — “fluvial erosion hazard areas.” State officials are now partnering with municipal governments to create more accurate maps.
Write Your Own
So what about private insurance? In 1983, the NFIP brought the insurance industry back into the flood insurance business with the introduction of the Write Your Own (WYO) program. Under the program, which is governed by NFIP rules, participating P/C insurers write and service the NFIP standard flood insurance policy under their own names. NFIP provides the insurers with expense allowances for policy writing and claims processing, and the NFIP absorbs all underwriting losses. One of the goals of the program is to give insurers experience in handling flood insurance business, and also to improve the overall distribution of policies.
To date, over 80 private insurers sell and service NFIP policies. For their troubles, they will now receive an expense allowance equal to 30 percent of premium. Agents receive 15 percent commission, and the NFIP picks up 13 percent of company expenses and 2 percent of state premium tax.
However, despite the desire of NFIP to transfer some of the business to the private market, the opposite is also happening. A few insurers began jumping ship after 2008, when those 17 extensions and lack of any real change discouraged some insurers. Most notably, State Farm dropped its participation in the program, at which time it was administering 829,273 policies . At the time, the company cited extensions and expirations, as well as procedural changes that forced too much of its resources to the program as reasons.
The loss of some insurers notwithstanding, John Prible doesn’t believe the WYO program will change much at all. There will be some consumers who see their premiums rise, including owners of repetitive loss or subsidized properties. Agents will see a fair commission. Also, the program distribution system should remain unchanged, and there might be a slight positive. “The companies will finally feel a bit of stability in that there’s a five-year extension,” says Prible, vice president of federal government affairs for IIABA.
Tim Gallagher, director of commercial lines for RJF Agencies, a Marsh McLennan Agency company in Minneapolis, says the private commercial market has been experiencing significant rate increases and a reduction in capacity. One $5 million policy he’s trying to place at the moment had a premium last year of $30,000. This year, he’s expecting the total to come in at $90,000.
That’s because the private market still retains the right to turn down business. Given the changes to the program, though favorable to private insurers, Gallagher believes they’ll proceed cautiously. “Private insurers are going to look at things from a blanket basis of all the flood business they write, but also on an individual basis more closely than the NFIP would.”
He’s confident that the changes made are good ones, but he adds a caveat: “If the program were starting with a zero balance today, moving forward those changes look to put the program in a much better financial situation,” he says. “However we still have this issue of $18 billion owed to the Treasury. Whether we’ve done enough to offset that and create stability moving forward is the $64,000 question.”
Perhaps a larger question looming is just how ready is the private market to take over the flood insurance market? That question is about to be answered. Prible says the new law has provisions written in for the market to conduct a study on the privatization of flood insurance. But it won’t happen without a study, he says. And, ideally, he says everyone including the NFIP would like to see the private market take on more of the risk.
However, Prible says, it’s critical to avoid blindly assuming the private market can handle it. “Before we start transferring the risk onto the private market, we need to make sure the market will be there to assume that risk and not walk away from consumers because they can’t accurately and actuarially rate the risk,” he adds.
Maybe it’s viable, but time and studies will tell. “While we prefer the private market to be engaged in flood insurance and to be the ultimate bearers of the risk, the most important thing is that consumers have flood insurance and that it is available across the country,” says Prible.
Widmer is a Philadelphia-area freelance writer and editor who specializes in risk management and insurance issues.