National Flood Insurance Program’s Radical Alternative

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by Christopher J. Boggs, CPCU, ARM, ALCM

Nationwide Mutual Insurance Company may have landed on the outer edges of a radical solution to the problems with the current NFIP program when, in June 2008, the company lobbied congress to allow it to sell flood insurance as part of their homeowners’ package. Even though the plan was “unprecedented” according to some in congress, it did not go far enough to fix the problem. Click here to read the article highlighting some of their plans.

Going Further. One idea without a clear author, but which has been bantered around is that every property policy should include flood coverage as part of the property package. This includes all homeowners’ policies, commercial property policies, lessors’ risk only policies – any policy insuring a structure. Further, the coverage will be provided by the insurance carrier writing the property policy.

Here is where the afore mentioned Nationwide plan and this idea diverge. The premiums will not track current NFIP premiums and will, in fact, be lower; the NFIP will not be the insurer, but will assume the role of a trustee and a reinsurer; and every property owner will have coverage.

Before reacting, read the following “skeleton” of the modus operandi, the objections and the supposed benefits of this plan.

How It Works

As stated previously, every property policy will include flood coverage as part of the coverage form. Policyholders will pay an additional premium for the coverage and the property carrier will settle all losses and pay claims regardless of the cause (wind, flood or whatever); and there will be no option to exclude the coverage. Building and contents coverage matching the limits provided by the property policy will be provided subject to the maximum limits available (same as the current NFIP maximums).

Premiums (not rates) for the flood coverage will be charged based on the exposure. Property owners within special flood hazard areas will pay a higher premium than those outside of special flood hazard areas. A surcharge would be made on property owner’s policies whose property is not in compliance with current flood plain management requirements (this would mean the end of some parts of the grandfather laws and the heavily subsidized pre-FIRM rates). Further, property in SFHA’s would have separate rates based on the zone. “V” zone rates would be higher than “A” zone rates due to the increased damageability risk.

This plan will continue to use the maximum limits specified by the NFIP so residential property premiums will be lower than non-residential, multi-family and condominium property premiums. Premiums may break down as follows (subject to review):

Residential Property (1 to 4 Family Dwellings):
• SFHA (“A” Zone): $150
• SFHA (“V” Zone): $200
• SFHA (non-compliant): $300
• Non-SFHA: $40

Non-residential and Multi-Family (more than 4 families) Properties:
• SFHA (“A” Zone): $200
• SFHA (“V” Zone): $300
• SFHA (non-compliant): $500
• Non-SFHA: $100

Premium Calculation: Calculating the annual premium generated by the institution of such a plan requires just a couple estimations and assumptions. The sample calculation below is based on the following known data and assumptions.
• According to the US Census Bureau, there are 125 million residential dwellings in the US. We’ll assume that there are half as many non-residential and multi-family structures developing 62.5 million of these structures (total number of structures 187.5 million).
• There are currently 5.55 million flood policies written by NFIP. A best-guess estimate would be that 75 percent of the properties are in special flood hazard areas.
• Of the 5.5 million, nearly 4 million are residential properties.
• Properties in “A” zones and “V” zones will be split evenly for this example.
• The example ignores the “non-compliance” issue.

Based on the above premiums and data, this calculation would yield an annual premium of just over $11.8 billion (remember the current program brings in $2.85 billion) as follows:

Residential Property:
• SFHA (“A” Zone): (4 million * 75%)/2= 1,500,000 * $150= $225,000,000
• SFHA (“V” Zone): (4 million * 75%)/2= 1,500,000 * $200 = $300,000,000
• Non-SFHA: 122 million * $40 = $4,880,000,000

Non-residential and Multi-Family Property:
• SFHA (“A” Zone): (1.55 million*75%)/2= 583,000 *$200 = $116,600,000
• SFHA (“V” Zone): (1.5 million*75%)/2 = 583,000 * $300 = $174,900,000
• Non-SFHA: $100: 61.33 million * $100 = $6,133,400,000

According to the 2006 Congressional Research Service report, the average annual flood losses have doubled to $6 billion from the previous annual average of $3 billion. Instituting the above plan will develop the necessary premiums to pay for average annual losses; leaving an ample amount of reserves to pay for losses in atypical years (like 2005). With annual premiums near $12 billion and losses plus operational costs at $6 billion annually, nearly $6 billion can be placed in reserve each year. In a relatively short amount of time, there will be enough in the program to drastically lower the premiums for all property owners ($100 billion reserve should be adequate).

The Federal Government’s Role

For such a program to work, the Federal Government will be required to assume a different role from that to which it is accustomed; a dual role of trustee and reinsurer.

Trustee. Premiums assignable to the flood coverage will pass through to the Federal Government. Insurance carriers settle the losses and are indemnified by NFIP for flood losses out of the premiums sent to the NFIP by that carrier. A type of “joint loss agreement,” like those used between property carriers and equipment breakdown insurers, will be utilized stipulating that the insured gets paid for the loss (no question of wind vs. water) and any debate regarding the cause of the damage will be decided between the insurance carrier and NFIP without the insured having to wait three years to get paid or fight a court battle.

The term “trustee” is used because these premiums could not be touched for any other purpose or use by the Federal Government. Premiums are to be set aside solely to pay flood losses, any NFIP administrative costs and to develop reserves. Any other use of these funds would violate the position as trustee since this is not tax income, but rather premiums paid to purchase, albeit forced, flood coverage.

“Captive” Reinsurer. If the amount of flood losses suffered by an insurance carrier in any one year exceeds the amount of premium forwarded (passed through) to the NFIP by that insurer, the additional losses would be paid from the pool of funds collected from all carriers. Thus the term “captive” reinsurer; the NFIP is not reinsuring the losses, they are acting as a captive manager paying the losses and assigning a percentage to each carrier; a win for the insurance carrier, the insured and the tax payer. In essence, each insurance carrier will be reinsuring each other for flood with a federal backstop if needed.

The NFIP would continue to have the authority to borrow in the event another 2005-type year occurs before adequate reserves are amassed. But under this plan, the annual premium plus the reserves would be enough to cover the $17.6 billion loss after only 18 months to two years of operation. If this plan is made effective July 1, 2009, and based on the assumptive factors above, the plan would have built reserves plus premium near $24 billion by July 1, 2011; even with $6 billion in flood losses paid in both 2009 and 2010 (which would probably not be the case).

Additionally, the implementation of this program would remove the need to cancel NFIP’s $18 billion debt to the American taxpayer (another unnecessary bailout). It would take several years to pay back and the time necessary to build up the reserves would be lengthened, but the $18 billion debt could be paid back in six years under this type of plan. Assuming that annual premiums are around $12 billion (as calculated above) and annual losses are $6 billion, $3 billion could be set aside for reserves and operating costs and $3 billion could be used to retire the debt.

Lastly, expenses to run the NFIP should be greatly reduced. There will no longer be a need for a Write Your Own (WYO) program so those administrative expenses should disappear; there will no longer be a need for the NFIP to print and issue policies or renewal reminders; no need to maintain a premium collection system or have any adjustment expenses (just to name a few costs that can go away). The NFIP under this type of plan can run very lean as it becomes a trustee payer of funds with very few other duties related to the flood insurance coverage. In fact (there is no basis for the figure, just an estimate) operating expenses should be less than 5 percent of the collected premiums. The NFIP should be able to comfortably operate on $592 million annually with such limited duties.


The next post will complete the conversation on this alternative to the National Flood Insurance Program. Objections to and benefits of this alternate program will be presented.

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  • October 20, 2008 at 2:42 pm
    Jeri Williams says:

    This idea may be actuarially sound, but it strikes me as unfair to the vast majority of property owners who will never need flood insurance, as they will simply be subsidizing the cost for those who do.

    According to FEMA, flooding is the most common natural disaster in the country; however, that does not imply that every property has the same risk. In fact, according to FEMA’s own maps, the majority of properties have very little flood risk, so why force them to buy flood insurance?

    One of the key problems with the NFIP is that it is constantly under attack by policiticans trying to placate their constituents who do not want to be required to purchase flood insurance or to comply with FEMA’s floodplain management regulations. It seems that every time FEMA tries to do the right thing, whether it be updating flood maps to identify high risk areas or requiring that significantly damaged structures – whether they be levys or canals or buildings – be brought up to current floodplain management standards, they are met by an uproar from people (voters) who don’t want to pay the cost of living in a high flood risk area. Often, due to the efforts of some senator or representative, FEMA is forced to back down.

    Until control of this program can be taken away from politicians and it can be made to work according to basic insurance principles (the way a well run private insurance program would), it cannot be expected to be profitable.

  • October 21, 2008 at 10:16 am
    Andrea Rohrer says:

    This is the best solution to insuring flood that I’ve heard. It uses the very basis of insurance – the law of large numbers – in an actuarily sound risk-sharing plan.

    Simple to administrate, policyholders would have to deal with only one company in the event of a claim. Including flood insurance on Property policies eliminates the burden of having to prove cause of loss. Presently, if FEMA lacks the funds to pay catastrophic claims we, as taxpayers, help pay for damages.

    This plan is a streamlined solution to the present cumbersome and often confusing flood coverage provided through the National Flood Insurance Program.

  • October 21, 2008 at 12:43 pm
    JOE ROLLINS says:

    Jeri Williams correctly identified the two problems with the grand solution proposed whic are participants outside the flood plain areas and political intervention to prevent true costs from being realized by those incurring the costs. With regard to getting those not in a flood plain to participate, this group represents over 90% of the residential premium shown in the example. This seems like another “spread the wealth” opportunity some to subsidize others based on the government’s help. I believe the grand solution needs some additional research focusing on having those who potentially benefit pay their own way.

  • October 22, 2008 at 6:11 pm
    Kelli O\'Dea says:

    Aside from the obvious flaws pointed out by other readers, the math just doesn’t work quite as conveniently as stated in the article. Remember, if only a fraction of properties have flood insurance, then only a fraction of the losses are contained in the $18 billion debt the author refers to. His assumption appears to be that the only flood losses in 2005 were those that were covered by flood insurance. At least those are the only ones he offsets with his premium computation. So, the actual flood losses that would be covered, if everyone had flood coverage, would be 3, 4 or 5 times higher. And it’s not just the Katrina losses that would be higher but all the flooding events across the country would generate much, much higher loss dollars that might just eventually outstrip the dollars that are accrued as premium. Everyone always makes the same mistake when talking abou this same tired model. They talk about all the premium it would generate and forget to ratchet up the loss dollars.

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