The private insurance industry is ready and anxious to take on flood risk, and politicians should reform the federal program now to take advantage of this interest, according to the U.S. executive of a leading specialty insurer.
“I think there is a moment here. I think there is a moment where the right pieces are in place,” Ben Walter, president and CEO of insurer Hiscox USA, said in a recent conversation about flood risk with Wells Media. “There’s a combination of a lot of fiscal pressure and the right pieces are in place on the private side to be able to respond to the opportunity. But it takes an enormous amount of political will.”
In Walter’s view, among the factors favoring privatization now are plenty of capital in the industry, advances in risk modeling, and Washington politicians who talk about limiting the cost of government. Another is that the National Flood Insurance Program (NFIP) is currently $24 billion in debt.
“The point here is, it’s time to take the private sector involvement in flood insurance seriously and figure out what we need to do to make that happen,” Walter says.
According to the insurance executive, moving to a more private system is a political challenge because it would require policymakers to openly indicate how much of the risk should be borne by property owners and how much, if any, should be subsidized by the government.
It may also require mandating that people in flood prone areas buy insurance, he argues.
Keeping the flood insurance subsidies would be fine if in fact that is what Congress and the public want, he offers. But he questions whether that’s the case.
“The question is have we really signed up to take the risk? When Congress passed the program it was designed to be self-funding but we’re uncomfortable with what that really means,” Walter says. “I don’t have a problem with that. I still think that the private sector can more efficiently allocate that risk because we do it with hurricanes and we do it really well. We can make that choice.”
Congress returned from its August recess last week. While there are proposals and efforts to move flood insurance pricing to actuarial levels and encourage private sector involvement, there are also calls for the government to discontinue the limited role the private insurers now have under the Write Your-Own (WYO) program to write and service policies.
The Biggert-Waters Act of 2012 was an attempt by Congress to address the NFIP’s debt by eliminating certain premium subsidies and phasing-in premium increases so that prices more closely reflect the risk of flood-prone properties. However, Congress backtracked on those changes two years later after consumers protested, passing the Homeowners Flood Insurance Affordability Act (HFIAA) that rolled back key provisions of Biggert-Waters.
In a discussion with Wells Media’s Andy Simpson, Walter further discussed what he sees as the realities and the politics of flood insurance, urging policymakers to learn from earthquake and terrorism experiences and make the tough political choices needed to let privatization happen.
According to Walter, politicians can differ over whether flood is a risk that should be shared by the public or privatized. “I have a strong view that it should be privatized and that the market can efficiently respond to that, but that is a philosophical debate that we can have,” he says.
But that’s not quite what’s been going on.
“What’s unfortunate about flood is that we’ve chosen to do it, but not really do it. We haven’t done it in an actuarially sound way, where the government really is just the risk-taker of last resort.”
In his view, the current flood insurance set-up contrasts with what has been done with terrorism insurance under the the Terrorism Risk Insurance Act (TRIA), where the government truly is the risk-taker of last resort. “That’s really not what’s happened with flood because you don’t force any kind of actuarially sound rates,” he says.
The 2012 Biggert-Waters Act attempted to install more actuarially-sound pricing but it didn’t last.
“[A]s soon as people saw rate hikes in an election year, everybody backed off, and they repealed it. There is no political will to have this thing [flood insurance] be actuarially sound. That’s simply because people have a benefit and taking away a benefit from people is hard, just like cutting Social Security or cutting Medicare, or any entitlement cuts. It’s basically an entitlement,” according to Walter.
Given the political realities, he suggests any move to risk-based pricing would have to be done gradually, along some sort of glidepath. If this were to happen, he says, there would likely be two results.
“One is you will see more private sector participation and actuarially sound rates, which they are not today,” he said.
“Number two — and this is the really hidden, ugly part of this– is you’ll see less development in floodplains. Why do people build in floodplains? Because it’s subsidized. Why do people over-invest in housing? Because it’s subsidized.”
He said that in addition to real estate interests, others factors including geographic, socioeconomic and even racial politics influence how flood insurance is addressed.
“We do have to accept that there is a socioeconomic and therefore, likely even, and on the uglier side, a racial component to this because outside of on the water in Florida, low lying areas tend to be less expensive and therefore more populated by minorities or those who are socio-economically disadvantaged,” he said.
He maintains that turning over the flood program to private insurers promises to reduce the politics.
“[P]rivatizing the flood program would be much, much better because the insurance industry does this for a living. It’s not politicized. It’s actuarial,” he says. “It’s us trying to get a reasonable return on our money, whereas you know that flood maps are a political animal because of who gets a subsidy and who doesn’t.”
He says there are several reasons he thinks now is the time to consider privatization.
“First of all, obviously, you have an era of fiscal discipline in Washington. You have some people in power who are professing that. We’ll see if they execute on it, but they’re professing it, number one,” the Hiscox executive says.
Number two is the record levels of capital in the global insurance and reinsurance industry. “There’s a lot of money out there to take the risk and absorb the transition. It would be a hard thing to transition the program immediately after one of the biggest floods we’ve ever seen. It’s at a time when there’s calm and there’s a good amount of capital built up in the industry. It’s a good time to do it.”
Also, he said there are now very sophisticated modeling and risk transfer options.
“They’re much more advanced. We can really control what our aggregates are. If you can control your aggregates and there’s enough capital in the industry, that’s when you want to make a transition happen,” he says.
He said a privatized system could include a role for government and even for certain subsidies as has been done with health insurance under the Affordable Care Act.
“My point is the thing should be administered by the private sector and actuarially sound rates should be set by the private sector. In my view as much risk as possible should be pushed to the private sector because we’re prepared to take it,” he says, adding the government needs to decide how much of the risk it would retain.
There are three areas in particular where he thinks the private sector could do a better job than the government: “I think pricing, modeling, and claims administration. I think having the best insurers in the world administer claims rather than FEMA administering the claims is a better thing.”
He acknowledges there is a major challenge trying to get more people to buy flood insurance while simultaneously moving the premiums to risk-based levels. He points to the way earthquake insurance is handled as the way to not do it:
“Here’s what I’ve never understood. I’m coming out and saying, ‘I don’t get this.’ If you live on the beach in Florida and you borrow money to buy your house, the bank and/or Fannie and Freddie, whoever’s taking the risk, will require you to carry hurricane insurance on that property. Because if a hurricane blows it over, they have no collateral left, right?
“In California, you can buy a house on the San Andreas Fault and the bank and/or Fannie and Freddie does not require you to have earthquake insurance. I don’t get that. What’s interesting is, with the NFIP, the government is explicitly taking a risk and just not charging enough for it, right? In California and in other earthquake zones what’s going on is the government’s taking the risk. It’s just that nobody admits it.”
The answer, he believes, is to require flood insurance.
“I think you should have to carry it. Frankly, the reason that earthquake insurance doesn’t work is it’s the same challenges that were in the private individual health insurance marketplace before Obamacare. If not everyone has to have it, then it’s adversely selective. If everyone participates, there’s a market. If only certain people participate selectively there’s no insurance market”
But is this even doable politically? Wouldn’t that be like raising taxes?
“That’s exactly what it’s like. You’re a hundred percent right.”
But he said the reality is that taxpayers pay for it now “but they don’t blame politicians for the fact that they do. Let’s be honest about what this is. That really is the challenge.”
He said the reason that not many private insurers are in the flood insurance market now is because private carriers can’t compete with the subsidized rates under the NFIP.
“It’s cheaper to get it through the NFIP than it is to charge what you’d have to charge to make any money on it,” he says.
That’s not the only obstacle to private sector entry. The other is political uncertainty. Insurers are worried they will be forced to underwrite at an actuarial loss because it’s politically popular to do so. “Unless you have assurances that that’s not the case, that will keep people out of the market,” Walter stresses.
He said he thinks private industry is “desperate to put capital to work” and would do so in the flood arena if restrictions were lifted. But he’s not holding his breath.
“I’m not optimistic about the government creating the right conditions for private sector involvement,” he concludes. “I’m very optimistic about the private sector getting involved if those restrictions could be taken off.”
If that were to happen, Hiscox is ready to dive in.
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