Congressional Research Service: 'Private Flood Insurance & National Flood Insurance Program' (Part 2 of 2)
(Continued from Part 1 of 2)
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Private Flood Insurance Outside the NFIP: Issues and Barriers
One of the reasons that
Currently, the private flood insurance market most commonly provides commercial coverage, secondary coverage above the NFIP maximums, or coverage in the lender-placed market./51 The 2018 premiums for private flood insurance as reported to the
Currently few private insurers compete with the NFIP in the primary residential flood insurance market. One illustration of this is that the NAIC only began systematically collecting separate data on private flood insurance in 2016.
As discussed in the following sections, private insurers have identified a number of potential barriers to more widespread private sector involvement in providing flood insurance. Increasing private insurance may present a number of issues for the NFIP and for consumers.
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48
49 Adverse selection is the phenomenon whereby persons with a higher than average probability of loss seek greater insurance coverage than those with less risk. See
50 See GAO,
51 The lender-placed or forced-place market is where lenders can force-place flood insurance on properties that are out of compliance with the mandatory purchase requirement.
52 The NAIC is an organization of the state regulators of insurance and, among other things, collects the data that the regulators require to be reported by insurance companies.
53 Statistics provided by the
54
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Flood Insurance Coverage "at Least as Broad as" the NFIP
In BW-12,
The responsible federal agencies/57 issued two separate Notices of Proposed Rulemaking (NPRM) on the question, the first in October 2013,/58 and the second in November 2016./59 On
* "allows institutions to rely on an insurer's written assurances in a private flood insurance policy stating the criteria are met; [and]
* clarifies that institutions may, under certain conditions, accept private flood insurance policies that do not meet the Biggert-Waters Act criteria."/61
This second point may seem unusual, because BW-12 included a specific definition of private flood insurance, while the agencies indicate that the rule allows acceptance of private flood insurance that does not meet this statutory definition. In creating the exception that allows private flood insurance that does not follow the statutory definition of "private flood insurance," the agencies relied on the usage of the more general term "flood insurance" in 42 U.S.C. 4012a(b)(1)(A) combined with the perceived congressional intent to promote private insurance in BW-12./62
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55 42 U.S.C Sec.4012a(b).
56
57
58
59
60
61
62 For the complete agency rationale, see the section entitled "Discretionary Acceptance" in
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The rule took effect on
In the 115th
Continuous Coverage
An associated issue is that of continuous coverage, which is required for property owners to retain any subsidies or cross-subsidies in their NFIP premium rates. Under existing law, if an NFIP policyholder allows their policy to lapse, any subsidy that they currently receive would be eliminated immediately./64 Unless legislation specifically allows private flood insurance to count for continuous coverage, a borrower may be reluctant to purchase private insurance if doing so means they would lose their subsidy should they later decide to return to NFIP coverage.
In the 115th
The "Non-Compete" Clause
Before FY2019, the Write Your Own carriers, private insurers who sell and service NFIP policies, were restricted in their ability to sell flood insurance policies on their own behalf while also participating as a WYO, due to a "non-compete" clause contained in the standard NFIP contracts./65 These contracts governing the WYO companies' participation in the NFIP restricted the WYO carriers from selling their own standalone private flood products./66 A non-compete clause would require WYO companies to decide whether to offer private flood insurance policies in their own right or to act as WYO carriers, thus potentially limiting the size of the private flood market.
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63 See, for example, Sinnock, Bonnie, "Banks Claim Victory in New Private Flood Insurance Rule," American Banker,
64 As required by Sec.100205(a)(1)(B) of BW-12 (P.L. 112-141, 126 Stat. 917), only for NFIP policies that lapsed in coverage as a result of the deliberate choice of the policyholder.
65 Details of the FY2021 WYO company arrangements are available at https://www.fema.gov/sites/default/files/202010/fema_fy-21-wyo-financial-subsidy-arrangement_october-2020.pdf.
66 GAO,
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In the 115th
The CBO cost estimate of H.R. 2874/68 considered the impact of eliminating the WYO companies' non-compete agreement. CBO estimated that, over the 2017-2027 period, holders of about 690,000 properties that, under existing law, would have been purchased under the NFIP would instead choose to buy private flood insurance to cover those properties if H.R. 2874 were enacted.
CBO did not expect any property owners who are subsidized by the NFIP to be among those leaving the program./69 CBO estimated that eliminating the non-compete clause and making NFIP data publically available would lead to an increase in spending of
NFIP Subsidized Rates
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67 Nonresidential properties, severe repetitive loss properties, business properties, or any property that has incurred flood-related damage in which the cumulative amount of payments equaled or exceeded the fair market value of the property.
68
69 Ibid., p. 9.
70 Ibid., p. 5.
71
72
73
74 GAO,
75
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In order to make the flood insurance market attractive, private insurers would want to be able to charge premium rates that reflect the full estimated risk of potential flood losses while still allowing the companies to make a profit. A reformed NFIP rate structure could have the effect of encouraging more private insurers to enter the primary flood market because NFIP full-risk based rates would be closer to the rates that private insurers would likely charge; however, this could lead to higher rates for households.
In the 115th
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76 For a discussion of the rates at which NFIP subsidies can be phased out, see the section on Pricing and Premium Rate Structure in CRS Report R44593, Introduction to the National Flood Insurance Program (NFIP), by
77 Non-primary residences, nonresidential properties, severe repetitive loss properties, properties with substantial cumulative damage, and properties with substantial damage or improvement after
78 For additional information on Risk Rating 2.0, see CRS Report R45999, National Flood Insurance Program: The Current Rating Structure and Risk Rating 2.0, by
79 42 U.S.C. Sec.4015(e).
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Regulatory Uncertainty
As addressed above, the rules on the acceptance of private insurance for the mandatory purchase requirement, and whether or not private flood insurance would count for continuous coverage, have had a significant impact on the market potential for private insurers./80 Another driver of private sector concern is regulatory uncertainty at the state level. The role of state regulators would increase in a flood insurance market with increased private sector involvement, which could increase the burden of oversight. The involvement of 56 state and territorial insurance regulators is likely to add complexity and additional costs for insurers, lenders, or property owners./81 For example, some private insurers cited the intervention of state regulators in controlling rates for wind insurance in
Ability to Assess Flood Risk Accurately
Many insurers view the lack of access to NFIP data on flood losses and claims as a barrier to more private companies offering flood insurance. It is argued that increasing access to past NFIP claims data would allow private insurance companies to better estimate future losses and price flood insurance premiums, and ultimately to determine which properties they might be willing to insure./84 However,
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80 See FEMA, National Flood Insurance Program Report to
81 Ibid., p. 63.
82 Ibid., p. 105.
83 Ibid., p. 41.
84
85 P.L. 93-579, 5 U.S.C. Sec.552a, as amended.
86 See, for example, GAO,
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Adequate Consumer Participation
Insurers need sufficient consumer participation to manage and diversify their risk exposure. Many private insurers have expressed the view that broader participation in the flood insurance market would be necessary to address adverse selection and maintain a sufficiently large risk pool./87 A long-standing objective of the NFIP has been to increase purchases of flood insurance policies, and this objective was the motivation for introducing the mandatory purchase requirement.
Despite the mandatory purchase requirement, not all covered mortgages carry the insurance as dictated, and no up-to-date data on national compliance rates with the mandatory purchase requirement are available. A 2006 study commissioned by
The mandatory purchase requirement could potentially be expanded to more (or all) mortgage loans made by federally regulated lending institutions for properties in communities participating in the NFIP./90 Another possible option would be to require all properties within the SFHA to have flood insurance, not just those with federally backed mortgages./91 Consumer participation could also be increased if the federal government were to mandate that homeowners' insurance policies include flood coverage or require all homeowners to purchase flood insurance./92 All four 115th
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87 GAO,
88
89
90 NFIP, Report to
91
92 GAO,
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In the 116th
Potential Effects of Increased Private Sector Involvement in the Flood Market
Increased Consumer Choice
Current NFIP policies offer a relatively limited array of coverages, particularly compared to what is available in private markets for similar insurance against perils other than floods. Private insurance companies could potentially compete with the NFIP by offering coverage not available under the NFIP, such as business interruption insurance, living expenses while a property is being repaired, basement coverage, coverage of other structures on a property, and/or by offering policies with coverage limits higher than the NFIP. The NFIP currently also has a 30-day waiting period in almost all cases before the insurance coverage goes into effect,/94 whereas private insurance companies may have a shorter waiting period. Private companies could also offer flood coverage as an add-on to a standard homeowners' policy, which could eliminate the current problem of distinguishing between flood damage (which is covered by the NFIP) and wind damage (which is often covered by standard homeowners' insurance). Unlike the NFIP, private flood insurance companies may also issue a policy without necessarily requiring elevation certificates, perhaps by using new technology to measure the elevation of individual structures.
Since some properties receive lower NFIP rates due to cross subsidies from other NFIP policyholders, it seems likely that some of the non-subsidized NFIP policyholders would be able to obtain less expensive flood insurance from private insurers. Private insurers may also be able to offer premiums more closely tied to individual risks than the NFIP currently does, which would provide lower premiums for some policyholders. Quantifying the potential savings for some policyholders from private insurance is, however, difficult, as the amount and extent of cross-subsidization within the NFIP is not fully known. One example of an attempt to provide estimates of NFIP versus private insurance is a modeling exercise carried out by two private companies, Milliman and KatRisk, which looked at premiums for single-family homes in
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93 The 500-year floodplain is defined by
94 See FEMA, Flood Insurance Manual, Before You Start, Revised
95
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Variable Consumer Protections
The consumer protections associated with private policies are likely to be enforced at a state level and will therefore be variable; some states may offer a higher level of protection than others. Because private insurers are free to accept or reject potential policyholders as necessary in order to manage their risk portfolio, private insurers may not necessarily renew a policy. A private flood insurance policy might be less expensive than an NFIP policy, but it might also offer less extensive coverage, which a policyholder may not realize until they make a claim following a flood. Unlike the NFIP, the language in private flood insurance policies is not standardized and has not yet been tested in court in the same way as, for example, homeowners' insurance. Thus there may be greater variability in claims outcomes for consumers in the early years of private flood insurance penetration.
Adverse Selection
Private sector competition might increase the financial exposure and volatility of the NFIP, as private markets will likely seek out policies that offer the greatest likelihood of profit. In the most extreme case, the private market may "cherry-pick" (i.e., adversely select against the NFIP) the profitable, lower-risk NFIP policies that are "overpriced" either due to cross-subsidization or imprecise flood insurance rate structures, particularly when there is pricing inefficiency in favor of the customer./96 This could leave the NFIP with a higher density of actuarially unsound policies that are being directly subsidized or benefiting from cross-subsidization. Because the NFIP cannot refuse to write a policy, those properties that are considered "undesirable" by private insurers are likely to remain in the NFIP portfolio - private insurers will not compete against the NFIP for policies that are inadequately priced from their perspective./97 Private insurers, as profit-seeking entities, are unlikely independently to price flood insurance policies in a way that ensures affordable premiums as a purposeful goal, although some private policies could be less expensive than NFIP policies. It is likely that the NFIP would be left with a higher proportion of subsidized policies, which may become less viable in a competitive market./98
The extent of such "cherry picking" is uncertain with some arguing that it would have little effect./99 However, evidence from the
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96
97
98
99 See, for example,
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This gave them a competitive advantage, as they could choose to select the more profitable lower-risk business. One driver for change therefore was that Flood Re would include these new entrants and force them to contribute by charging their clients for the cross-subsidy for Flood Re, leveling the playing field between the private insurers./100 A significant increase in private flood insurance policies that "depopulates" the NFIP may also undermine the NFIP's ability to generate revenue, reducing the amount of past borrowing that can be repaid or extending the time required to repay the debt. If the number of NFIP policies decreases, it would likely become increasingly difficult for the remaining NFIP policyholders to subsidize policies, raising prices for the non-subsidized policyholders and thus accelerating the move to private insurance. In the long term the program could be left as a "residual market" for subsidized or high-risk properties. Residual market mechanisms are used in areas such as auto insurance, where consumers may be required to purchase insurance, but higher risk individuals may be unable to purchase it from regular insurers. The exact form of residual market mechanisms varies in different states and for different types of insurance, but they typically require some form of outside support either from the government or from insurers themselves.
In the 115th
Issues for NFIP Flood Mapping and Floodplain Management
If the number of NFIP policyholders were to decrease significantly, it might also be difficult to support the NFIP's functions of reducing flood risk through flood mapping and floodplain management./101 NFIP flood mapping is currently funded in two ways, through (1) annual discretionary appropriations; and (2) discretionary spending authority from offsetting money collected from the Federal Policy
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100
101 For a further discussion of the NFIP's floodplain management and mapping functions, see CRS Report R46095, The National Flood Insurance Program: Selected Issues and Legislation in the 116th
102 For an additional explanation of NFIP funding, including the funding for mapping, see CRS Report R44593, Introduction to the National Flood Insurance Program (NFIP), by
103 42 U.S.C. Sec.4014(a)(1)(B)(iii).
104 Email correspondence from FEMA Congressional Affairs staff,
105
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Enforcement of floodplain management standards could be more challenging within a private flood insurance system, as the current system makes the availability of NFIP insurance in a community contingent on the implementation of floodplain management standards. For example, the
Concluding Comments
The policy debate surrounding NFIP and private insurance has evolved over time. The discussion in 2012 was framed in the context of privatization of the NFIP and actions that might be taken to create conditions for private sector involvement. One of the primary interests of
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106
107 Ibid.
108
109 Ibid., p. 108.
110 Ibid., p. 2.
111 Ibid., p. 52.
112
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In fact, private sector flood risk analytics and modeling have improved significantly before any sizable entry of private insurers into the market. Another argument was that, in contrast to the NFIP, which cannot diversify its portfolio of flood risk by insuring unrelated risks, the insurance industry can diversify catastrophic risks with uncorrelated or less correlated risks from other perils, other geographic regions, non-catastrophic risks, or risks from unrelated lines of business./113
Currently the discussion is more focused on sharing risk and increasing penetration rates, with the recognition that neither the NFIP nor the private sector is likely to be able to write all of the policies needed to cover all of the flood risk in
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113 Ibid., p. 51.
114 Ibid., pp. 82-84.
115 The requirement in Sec.28 of HFIAA (P.L. 113-89, 128 Stat. 1033) that the Administrator "clearly communicate full flood risk determinations to individual property owners regardless of whether their premium rates are full actuarial rates."
116 For a full discussion of NFIP subsidies and cross-subsidies, see the section on Pricing and Premium Rate Structure in CRS Report R44593, Introduction to the National Flood Insurance Program (NFIP), by
117
118
119
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The report is posted at: https://crsreports.congress.gov/product/pdf/R/R45242
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Congressional Research Service: 'Private Flood Insurance & National Flood Insurance Program' (Part 1 of 2)
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