Flooding is the most common and costly natural disaster in the United States, causing billions in economic losses each year. According to the National Flood Insurance Program (NFIP), 90 percent of all natural disasters in the United States involve flooding.
There is no coverage for flooding in standard homeowners or renters policies or in most commercial property insurance policies. Coverage is available in a separate policy from the National Flood Insurance Program (NFIP) and from a few private insurers.
The National Flood Insurance Program: Before Congress passed the National Flood Insurance Act in 1968, the national response to flood disasters had been to build dams, levees and other structures to hold back flood waters, a policy that may have encouraged building in flood zones.
The National Flood Insurance Act created the National Flood Insurance Program (NFIP), which was designed to stem the rising cost of taxpayer funded relief for flood victims and the increasing amount of damage caused by floods. The NFIP has three components: to provide flood insurance, floodplain management and flood hazard mapping. Federal flood insurance is only available where local governments have adopted adequate floodplain management regulations for their floodplain areas as set out by NFIP. More than 20,000 communities across the country participate in the program. NFIP coverage is also available outside of the high-hazard areas.
The law was amended in 1969 to provide coverage for mud flows and again in 1973. Until then, the purchase of flood insurance had been voluntary, with only about one million policies in force. The 1973 amendment put constraints on the use of federal funds in high-risk floodplains, a measure that was expected to lead to almost universal flood coverage in these zones. The law prohibits lenders that are federally regulated, supervised or insured by federal agencies from lending money on a property in a floodplain when a community is participating in the NFIP, unless the property is covered by flood insurance. The requirement for flood insurance also applies to buildings that receive financial assistance from federal agencies such as the Veterans Administration. However, because the initial mortgage on the property is frequently sold by the originating bank to another entity, enforcement of this law has been poor.
Legislation was enacted in 1994 to tighten enforcement. Regulators can now fine banks that consistently fail to enforce the law, and lenders can purchase flood insurance on behalf of homeowners who fail to buy it themselves, then bill them for coverage. The law includes a provision that denies federal disaster aid to people who have been flooded twice and have failed to purchase insurance after the first flood.
Buildings constructed in a floodplain after a community has met regulations must conform to elevation requirements. When repair, reconstruction or improvement to an older building equals or exceeds 50 percent of its market value, the structure must be updated to conform to current building codes. A 2007 NFIP study on the benefits of elevating buildings showed that due to significantly lower premiums, homeowners can usually recover the higher construction costs in less than five years for homes built in a “velocity” zone, where the structure is likely to be subject to wave damage, and in five to 15 years in a standard flood zone. The Federal Emergency Management Agency (FEMA) estimates that buildings constructed to NFIP standards suffer about 80 percent less damage annually that those not built in compliance.
How it works: The NFIP is administered by FEMA, part of the Department of Homeland Security. Flood insurance was initially only available through insurance agents who dealt directly with the federal program. The direct policy program has been supplemented since 1983 with a private/public cooperative arrangement, known as "Write Your Own," through which a pool of insurance companies issue policies and adjust flood claims on behalf of the federal government under their own names, charging the same premium as the direct program. Participating insurers receive an expense allowance for policies written and claims processed. The federal government retains responsibility for underwriting losses. Today, most policies are issued through the Write-Your-Own program but some non-federally backed coverage is available from the private market.
The NFIP is expected to be self-supporting in an average loss year, as reflected in past experience. In an extraordinary year, as Hurricane Katrina demonstrated, losses can greatly exceed premiums, leaving the NFIP with a huge debt to the U.S. Treasury that it is unlikely to pay back. Hurricane Katrina losses and the percentage of flood damage that was uninsured led to calls for a revamping of the entire flood program.
Flood adjusters must be trained and certified to work on NFIP claims. NFIP general adjusters typically re-examine a sample of flood settlements. Insurers that fail to meet NFIP requirements must correct problems; otherwise they can be dropped from the program.
What's in a typical policy: Flood insurance covers direct physical losses by flood and losses resulting from flood-related erosion caused by heavy or prolonged rain, coastal storm surge, snow melt, blocked storm drainage systems, levee dam failure or other similar causes. To be considered a flood, waters must cover at least two acres or affect two properties. Homes are covered for up to $250,000 on a replacement cost basis and the contents for up to $100,000 on an actual cash value basis. Replacement cost coverage pays to rebuild the structure as it was before the damage. Actual cash value is replacement cost minus the depreciation in value that occurs over time. (Excess flood insurance is available in all risk zones from some private insurers for NFIP policyholders who want additional coverage or where the homeowner’s community does not participate in the NFIP.) Coverage for the contents of basements is limited. Coverage limits for commercial property are $500,000 for the structure and another $500,000 for its contents.
To prevent people from putting off the purchase of coverage until waters are rising and flooding is inevitable, policyholders must wait 30 days before their policy takes effect. In 1993, 7,800 policies purchased at the last minute resulted in $48 million in claims against only $625,000 in premiums.
Flood Risk: As with other types of insurance, rates for flood insurance are based on the degree of risk. FEMA assesses flood risk for all the participating communities, resulting in the publication of thousands of individual flood rate maps. High-risk areas are known as Special Flood Hazard Areas or SFHAs.
Flood plain maps are redrawn periodically, removing some properties previously designated as high hazard and adding new ones. New technology enables flood mitigation programs to more accurately pinpoint areas vulnerable to flooding. As development in and around flood plains increases, run off patterns can change, causing flooding in areas that were formerly not considered high risk and vice versa.
People tend to underestimate the risk of flooding. The highest-risk areas (Zone A) have an annual flood risk of 1 percent and a 26 percent chance of flooding over the lifetime of a 30-year mortgage, compared with a 9 percent risk of fire over the same period. In addition, people who live in areas adjacent to high-risk zones may still be exposed to floods on occasion. Since the inception of the federal program, some 25 to 30 percent of all paid losses were for damage in areas not officially designated at the time of loss as SFHAs. NFIP coverage is available outside high-risk zones at a lower premium.
NFIP risk rating reform: On March 18, 2019 the Trump administration announced plans to reform the NFIP with a shift to fully risk based pricing of flood insurance. FEMA said the program would begin to assess properties individually, using several variables such as hurricane rainfall, coastal surges and proximity to bodies of water, rather than applying a single formula for an entire flood zone. FEMA’s current system calculates rates based on whether a home falls in a designated flood zone, and since higher-valued properties are more likely to hit the $250,000 insurance cap, lower-value homes are paying proportionately more than higher-value homes. The reformed system would change that as well as potentially drive more flood risk into private reinsurance and risk markets. FEMA will implement the new system on October 1, 2021.
In 2012 the Biggert-Waters Flood Insurance Reform Act was passed in an attempt to make the federal flood insurance program more financially self-sufficient by eliminating rate subsidies that many property owners in high-risk areas receive.
But in March 2014 Congress rescinded many of the rate increases called for by the Biggert-Waters Act. The new law reduced some rate increases already implemented, prevented some future increases and put a surcharge on all policyholders. The measure also authorized funds for the National Academy of Sciences to complete an affordability study.
The 2014 law prevents any policyholder from seeing an annual rate increase exceeding 18 percent. It calls on the flood program’s administrator, the Federal Emergency Management Agency (FEMA), to “strive” to prevent coverage from costing more than 1 percent of the amount covered. In other words, if the policy offered $100,000 of coverage, the premium would not exceed $1,000.
The 18 percent cap will result in refunds in some cases. Refunds began in October 2014. FEMA has a fact sheet on who is eligible for refunds.
The law also reinstates a practice known as grandfathering, meaning that properties re-categorized as being at a higher risk of flooding under FEMA’s revised maps would not be subject to large increases.
It also ends a provision in Biggert-Waters that removed a subsidy once a home was sold. People who purchased homes after Biggert-Waters became law will receive a refund. Many lawmakers in coastal states were concerned that the higher cost of flood insurance would have a negative impact on the real estate industry. The subsidy will now be covered by a $25 surcharge on homeowners flood policies and a $250 surcharge on insurance for nonresidential properties and secondary (vacation) homes.
According to data from FEMA, most current flood insurance policyholders (81 percent, or 4.5 million) pay rates based on the true risk of flood damage and so were not affected by Biggert-Waters or the subsequent rollback. Properties most affected by the rate hikes were in high-risk flood zones; were built before communities adopted their first Flood Insurance Rate Map; were second homes; or are second homes that have not been elevated. Others affected include businesses and those who live in homes that have been repeatedly flooded.
The National Flood Insurance Program, now 50 years old, compensated for coverage not available in the private market. Private insurers did not have reliable ways of measuring flood risk but technological advances now allow insurers to underwrite risk more accurately and make sounder actuarial decisions. In 2019 federal regulators allowed mortgage lenders to accept private homeowners flood insurance if the policies abide by regulatory definitions. Also allowed are private insurance policies that do not meet regulations if insurers provide adequate protection according to general safety and soundness requirements. The effect is likely to impact homeowners in states where most of the nation’s flood insurance policies are held.
In 2019 net premiums written for private flood insurance totaled $287.2 million, down 46.9 percent from $540.9 million in 2018, according to NAIC data compiled by S&P Global Market Intelligence. Premiums in 2019 were impacted by the largest writer of private flood insurance, FM Global, reclassifying private flood insurance into allied lines. When 2018 net premiums written are restated to exclude premiums from FM Global, they totaled $307.9 million. On the restated basis, net premiums written for 2019, at $287.2 million, were down at the much lower rate of 6.7 percent. Direct premiums written (which are before reinsurance transactions) for private flood insurance totaled $522.6 million in 2019, up 45 percent from $360.1 million in 2018, excluding FM Global’s 2018 private flood premiums. There were 41 private companies writing flood insurance in 2019, compared with 32 in 2018. The number of companies also excludes FM Global.
AM Best says the increase in private carriers improves competition and helps spread the economic risk that comes from flooding. Private carriers can also offer higher coverage than FEMA’s National Flood Insurance Program policies, currently capped at $250,000 for residential buildings and $500,000 for non-residential buildings.
Disaster resilience refers to the ability of communities to prepare for, recover from, and adapt to adverse events.
Some of the best practices for community flood resilience recommended by the Environmental Protection Agency include: a comprehensive disaster recovery plan; green infrastructure techniques; land conservation in river corridors; restoring wetland vegetation; discouraging development in frequent flood areas; adapting flood resistant building codes; and coordinating with neighboring jurisdictions to implement a watershed-wide approach to storm-water management.
Urban planners and engineers around the world are developing innovative flood solutions such as amphibious housing, porous roads and sidewalks, and use of satellite data for more frequent flood alarms.
A 2017 National Institute of Building Sciences study found that for every dollar invested in riverine flood mitigation the return was $7 in cost savings.
The system in the United States is unique in that for the most part the government underwrites the coverage and private insurers act as administrators bearing no actual flood risk.
In other developed countries, there are two basic methods of providing flood insurance. Under the first, the optional system, insurers extend their standard policy to include supplemental coverage for flood damage on payment of additional premium. The coverage tends to be expensive because only those most likely to be flooded, and therefore to file claims, purchase it, a situation known in the insurance industry as adverse selection. Among the countries with optional coverage are Germany and Italy.
The other method is “bundling.” Under this system, flood coverage is combined with coverage for other perils such as fire and windstorm, thus spreading the risk of flood losses across a large geographical area and greatly increasing the percentage of the population covered for flood damage. Countries that have adopted this method include the United Kingdom, Spain and Japan. In addition, in some countries such as France and Spain there are government compensation programs for major disasters, including flooding, that take effect when the cost of a disaster reaches a certain level.
In 2014 the United Kingdom launched Flood Re, a not-for-profit reinsurance organization to take on flood risks that primary insurers do not want. If an insurer calculates that the flood risk of a particular policy exceeds the flood premium, it will cede that risk to Flood Re. The insurer will pay the claim, then seek reimbursement from Flood Re. In all likelihood, Flood Re’s losses and expenses will exceed its premium. Additional funding will come from a levy raised from insurers by market share.
Federal Emergency Management Agency,"Homeowner Flood Insurance Affordability Act: Overview," March 2014
Center for Insurance Policy and Research, National Association of Insurance Commissioners."Homeowner Flood Insurance Affordability Act of 2014: Section by Section Summary," March 2014
United States Government Accounting Office, "Flood Insurance. Comprehensive Reform Could Improve Solvency and Enhance Resilience," April 2017
American Academy of Actuaries, "The National Flood Insurance Program: Challenges and Solutions," April 2017
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