Why Flood Should be a Covered Cause of Loss in Property Insurance

By | July 5, 2021

There’s something fun about contemplating flood insurance while the ground outside the office is so saturated that it’s like walking on sponges. No. We aren’t having a flood event and even if we were, there’s a good chance that most property policies around us would exclude it and an even better chance that no one near me has a flood policy on their property.

That last thought is exactly why property insurers (whether commercial property or homeowners) should include flood as a covered cause of loss.

If you were to look at the ISO HO 00 03 05 11 Homeowners 3 – Special Form, or the ISO CP 10 30 09 17 Causes of Loss – Special Form, you would see this exclusion. (This isn’t all of it, and they’re not identical but really close, so let’s work with it.)

Water – This means: Flood, surface water, waves, including tidal wave and tsunami, tides, tidal water, overflow of any body of water, or spray from any of these, all whether or not driven by wind, including storm surge;…

I would recommend that some carrier, especially a well-capitalized Florida carrier, get brave enough to modify their water exclusion to make flood a covered cause of loss. I’m not suggesting that a carrier should make it an available option. Add it to the policy. Cover flood similar to the way other causes of loss are covered.

Flood can be underwritten against. In 1968 when the National Flood Insurance Program was created, there was data that helped the new agency to assess the flood risk for areas around the country, but that data was limited in scope, accuracy and detail.

Over 50 years later, there are terabytes of data available to assess the risk of flooding in any given location.

Today, we can look up the Special Hazard Flood Zone (SHFZ) for any location in the United States (except for those communities that don’t participate). FEMA has loaded its FIRMs (Flood Insurance Rate Maps) to its site, and anyone can look up an address to determine its location in relation to any flood zones.

That’s not enough information to really underwrite a location for its flood potential. If one looks at the DFIRM (Digital FIRM), there’s more to see than just the flood zones. That map can be compared with other aerial imagery. This comparison would allow the underwriter to determine how close a location is to a body of water and would show the underwriter what kind of building has been going on in the area.

New building, whether it’s putting up more buildings or making paved surfaces, changes the dynamics of where the water will go next.

There’s another map that can be considered, and that’s the topographical map. The more vertical distance there is between an insured location and a body of water, the less likely it will be that the water will rise enough to impact the building.

There is also more than 50 years of weather data to consider. We can find out how much rain a location gets and how many times that location might have flooded in some way over the years.

This sounds like a lot of information to try to gather, but this is a time when gathering data and making it tell a story is big business. You don’t honestly believe that there is no one out there that isn’t using all of this data to tell a flood story, do you?

By-peril rating provides a way to rate for flood. More carriers today in more states are filing by-peril rating for property in both the homeowners and commercial property markets. By peril rating allows the carrier to split up the premium by certain named perils, such as fire, wind, flood, etc.

By using a by-peril rating system, the insured can accurately price the flood peril and note the impact on the insured’s final premium.

How would it work? Take the replacement cost of what’s actually at risk of flooding, which is to say that if you have a commercial building that is 20 stories tall, only the first floor or two is likely to flood. The entire building might be at risk, but that’s not the situation here.

Now, use the fire rate (or wind if you like) for that building, multiply it by a modifier based on the true flood risk for the location. The true flood risk of that location includes the Special Hazard Flood Zone (SHFZ), the number of flood events that have occurred in the last 10 years to 20 years, the distance to any body of water, the size of that body of water, the altitude difference between the location and that body of water, and probably something else that I’m not thinking about.

This is a good place to remind you that I’m not an actuary, but I do have an idea or two about what should go into a rate modifier and what makes for a sound rate.

By using several data points, a reasonable rate for flood can be created for every location, which then should generate the appropriate premium for the risk.

Yes, that means that those who have a higher risk will pay more, but isn’t that one of the principles on which insurance operates?

Someone already knows how to write it into a policy. In a perfect world, you could simply amend the water exclusions to remove references to flood, but it’s not that simple. It’s a good thing ISO and insurance companies have been writing their own flood endorsements for a few years.

One solution could be to amend the water exclusion to provide coverage for a flood. This could be done by removing words, such as flood, surface water or overflow of any body of water. Another option might be to add an exception to the exclusion for defined floods.

While we are looking at potential policy considerations, this is a good place for a carrier to use a different deductible. They could add a flood deductible if the location is in a higher risk area. The deductible could be similar to the hurricane deductible in Florida, which is often written with a percentage of the replacement cost of the property.

Catastrophic risks are already being insured. The ideally insurable risk is a risk where there are a large number of similar exposure units. This allows us to predict the actual potential loss costs of an individual risk. The loss must be accidental, unintentional, measurable and calculable. The ideally insurable risk also shouldn’t be catastrophic.

This means that the risk must not be subject to a particular loss where a large number of similar risks are subjected to the same loss. That’s like saying that we shouldn’t insure against a hurricane because an entire city might be subjected to the same hurricane. As you already know, we do insure against hurricane and other catastrophic losses. Flood is no different.

This is possible in part because not every location is at risk of every possible catastrophic event. A company might have some locations that are at risk while the rest are not. Several insurance companies wrote the buildings that were impacted by Hurricane Michael, and not all of the buildings that were written by any of those companies were impacted. The same is true of flood.

A carrier that chooses to add flood as a covered cause of loss for all of its policies is doing something that is perfectly sound in the insurance world. It is spreading the risk to a large enough group of buildings so the risk for any one is relatively small, even if flood has the potential to be a catastrophic event.

Flood was a covered cause of loss before insurance companies decided that it was too risky after some flood events in the early 20th century. It’s 100 years later, and it’s time for flood to be a covered cause of loss in most cases. We will allow for some companies that write the extremely risky location to exclude flood, but only if there is a robust residual market in that state.

Topics Profit Loss Flood Property

About Patrick Wraight

Patrick Wraight, CIC, CRM, AU, is director of Insurance Journal's Academy of Insurance. He can be reached at pwraight@ijacademy.com.

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