Last week, we started a conversation about flood coverage. If you missed last week’s blog, go back and read it now. We’ll wait for you. To sum up last week’s blog, I believe that the standard market could cover flood because there is plenty of data available to rate for the peril of flood and there are plenty of carriers already writing flood. This week, I would like to focus on reasons why I believe that the standard market should make flood a covered peril.
Transparency alert! Before we go any further, I have a disclaimer. I am for common sense regulation. I am for logical mandates of financial responsibility. I am intrigued by New Hampshire’s solution to mandated auto insurance. (hint, they don’t have a mandate) I am not a proponent (in general) of government mandated insurance programs. I am not a fan of the NFIP. I think that there are better solutions possible in the private market or at the state government level. Yeah, I do like state level regulation of insurance (and state level residual markets), so there’s that, too.
There is plenty of data to tell us that the NFIP is not sustainable long term. I am also not a proponent of letting people go without insurance if they are not able to self-insure. NFIP was established in 1968 with the passing of the National Flood Insurance Act in response to massive losses after the Mississippi river flooded in the 1960’s. Since then, they have written policies, collected premium and paid losses all under the banner of protecting people from loss by flood. There are several problems, but let’s focus on just a few.
If you think insurance companies are slow to innovate, let me introduce you to the federal government. As the current president is finding out, things don’t change quickly in federal programs, nor do they change easily. Therefore, when an issue is discovered in a program, like it is underfunded or over-burdened, it is hard to fix that issue. The issues that exist with the NFIP have either existed since it was conceived or they were created by legislators trying to fix one problem.
The NFIP is over $24 billion in debt today. Without getting political, do we really think that a federal program can dig itself out of debt? How many more losses can this system sustain without collapsing in on itself? All it will take is another storm, like Super Storm Sandy to make landfall in an area that is heavily covered by the NFIP for it to go deeper in debt. Without considerable help from the Federal government, NFIP will eventually collapse under its own weight of debt.
There is plenty of capacity to move to state residual markets. State run residual markets are not perfect, however when you break the exposure down to the state level, and create a robust standard market, it seems possible that the individual state residual markets can pick up the slack. The residual markets were created for this sort of risk. They exist to write those risks that the standard market is unable or unwilling to write.
Let’s pick a state (Indiana) to use as an example. Indiana establishes the Indiana Flood Insurance Corporation. They offer flood insurance for insureds who need homeowners’ or commercial property insurance but are unable to obtain insurance in the voluntary market. IFIC is an insurance company, just like any other admitted market. It’s rates, rules and forms are approved by the Insurance Commissioner.
It is run by insurance professionals and it is very conservative in its underwriting. It’s not looking for an underwriting ‘profit’ for profit’s sake. It’s looking for underwriting profit to create and sustain policyholder surplus. While it builds its book of business and surplus, it makes reinsurance treaties (or finds other non-traditional catastrophe financing)
Here’s how it works:
- Applicants must show that they tried to get insurance.
- Applicants must show a declination because the carrier cannot write flood in that location according to their normal underwriting requirements, or a homeowners’ (commercial property) declarations page showing that flood is excluded.
- Applications are underwritten and priced for the policy requested.
- The IFIC writes coverage for flood for each property at actuarially verifiable rates.
There is plenty of capacity in the E&S market. By relieving the standard market of the need to cover risks that they don’t want (for solid underwriting reasons) the market builds itself. Over time, as the market proves itself, the E&S players will enter the market. Let’s be real. E&S underwriters don’t just write risks because it makes everyone happy. They write risks because it makes sense to their bottom line. It’s possible that once the flood insurance market starts to act more like the rest of the insurance world, the E&S markets will pay attention and get involved.
As more standard market players enter the market and the E&S market heats up, the true residual market will come into focus at the state level. When the market starts to act the way it should, more and more policies will leave the NFIP and then all is left is for the NFIP to run off policies and pay its debts. To be honest, if NFIP stops writing policies, the Congress will likely write off the debt.
As we approach the renewal of the NFIP (yes, it will be renewed for probably 10 years) let’s take this renewal term to move flood into the standard market and let the NFIP die of natural causes. What do you think on the topic? Should there be a standard market solution to flood? Should NFIP be renewed?
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