A recent headline declared: Pennsylvania Governor signs Bill Stemming Flood Insurance Costs Into Law. It’s another example of governments’ hard work to ameliorate the costs that individual property owners must pay to insure against their local catastrophe hazard.
Whether it’s hurricanes in Florida, earthquakes in California, or windstorms in Texas, hope springs eternal that the actual cost of natural events can somehow be distributed more equitably.
For flood catastrophes – and floods can indeed be catastrophic – the overarching program is Federal. The National Flood Insurance Program, or NFIP, offers minimum coverage at subsidized rates (while continuing to add to its enormous debt, which reached $20.5 billion in 2022). Formed in the 1960s, the NFIP has had six decades to ensure every building in America has adequate flood insurance.
Since it hasn’t met this goal, states are also getting into the flood insurance business. In Florida, the state-backed Citizens Insurance Company will now oblige all its property policyholders with premises valued at $600,000 or more to buy its flood insurance. It can and does sell this coverage at prices below commercial market rates because Citizens has an automatic loss-recovery mechanism. Under State law, the company must levy assessments on most Florida policyholders if it accumulates a deficit in the wake of a particularly devastating run of weather. There’s a guarantee of financial stability for sure!
Who’s at risk?
The number of US homes located in in 100-year flood zones is not known with certainty. Estimates range between 13 million and 41 million. But the real number of homes at risk of flood is greater. At reThought, we understand that anywhere it rains it can flood, so in fact almost any house could suffer a flood-damage loss.
Despite subsidies which reduce the up-front price of government-backed flood insurance programs, the take-up of coverage is woeful. In November 2023 the NFIP had only 4.7 million policies in force, and Citizens in Florida will have about 1.2 million by the end of the year. That’s a total of just 5.9 million. Even after adding the homes insured in the private market to the protected total, a huge number of households in the high-risk category would simply have to bear the potentially crippling cost of a flood.
Nationwide, less than a third of homes in the highest risk areas have flood coverage, according to the Wharton School. The share that’s insured is dramatically lower in zones perceived to be safer, but they too can flood. Just ask the homeowners in Vermont, Massachusetts, and Pennsylvania who felt invulnerable until this past year, but have since learned otherwise. Almost every building is at risk, albeit with wide variations in probability.
Is risk perception part of the take-up problem? A comparison with homeowners fire insurance may help find the answer. Housefires, and even houses, may be counted in many different ways, but based on 353,500 fires reported across 144 million residences, the probability of a fire at an individual house during any year is less than 0.3%.
This probability could be roughly comparable to the flood risk of an individual home located outside a specified flood zone (the risk is higher in a FEMA-demarcated “A” zone, where by definition it’s 1%). The total cost of fires and floods is broadly similar too. Fires cost about $8.8 billion in 2021; floods cost $7.0 billion in that year.
In the absence of a fiduciary obligation to buy insurance (like a mortgage), would homeowners go without fire insurance, since it is such a low risk? Or, knowing that floods are about as likely as house fires, and typically cost similar amounts, would they decide they had to have flood coverage? Consider flying. Which is more dangerous: the airline trip or driving to the airport? Which activity scares people more, despite the data?
Even for educated owners who consider buying flood insurance, the cost can be a breaking factor. For one insurance broker seeking coverage, someone adept in the market and aware of the risk, the premium for a $200,000 policy was $7,000. That’s not attractive, no matter what the risk.
As with all insurance, broad take-up is the best solution to reduced premium cost: spread the risk cost. Wharton School hosted a workshop about five years ago which tried to identify ways to increase the take-up of flood insurance. The resulting report is pessimistic at best, and raises more obstacles to change than it proposes solutions. We at reThought sympathize.
One problem is that homeowners are hardly ever made aware of the flood risk at their doorstep, especially when they buy a new property. Sellers, builders, and realtors all have obvious incentives to ignore the issue.
This is an area where government intervention is beginning to work. After years of political struggle, New Jersey, New York, and now North & South Carolina have recently modified real estate transfer requirements to include disclosure of flood exposure. Yet many states – including seven that lie along America’s coast – have yet to act. According to The National Resource Defense Council, eighteen states have no disclosure requirements, and the measures in six others are inadequate.
A second obstacle to the disclosure of flood risk is that the market value of properties may go down if the flood risk is known. Since market values drive assessment values, lower valuations may lead to increasing tax rates. Ouch!
What can be done? Wharton offered several solutions that might produce an efficient risk finance environment. In the meantime, from the perspective of this risk and insurance consultant, the following actions are essential:
- Know the real risk. If the property is in a FEMA flood zone, it is obvious. But it may be even worse: downstream culverts or bridges can become obstructed, causing waters to back up and rendering any flood zoning irrelevant. Consider uphill exposure as well as to what might come down and change the normal flow of water. If you live on a hillside, but not at the very top, you’re exposed. Indeed, intense local rainfall may flood your building. Even on level ground or small slopes, the water flows away only so fast, and perhaps not fast enough. reThought Flood’s proprietary risk assessment technologies help understand the true flood risk of any structure.
- Defend as well as possible. Seal foundation penetrations, install waste-line backflow valving, obtain barriers for entrances below grade, protect utilities, and … lots more can be done, but that’s a good start.
- Request flood insurance quotes from your broker or agent. Ask for an NFIP price as well as a commercial market quote (you may want both, to get proper coverage), and consider deductibles higher than you may have thought about before. Some coverage after a large loss is better than none, and premiums may be very much lower.
Finally, we should consider Pennsylvania’s solution. The headline quoted at the top of this article claims that the state has stemmed flood insurance costs by law. Unfortunately, though, the headline slightly overeggs the pudding. The Governor has simply formed a panel to study the issue. But perhaps they will actually come up with new insights into an old problem which is getting worse every year, as flooding gets worse. Hope springs eternal!
Ed Haas joined reThought Insurance in October 2019 as property risk and CAT modeling consultant. Ed was formerly with Marsh Risk Consulting for over twenty years as Senior VP, with a focus on natural hazard modeling for flood, wind, earthquake, and other perils. Work included managing data for modeiing, interpreting results, and applying them to insurance and risk management programs. The work included site assessments at a wide variety of unique properties throughout the US and internationally. Ed was the Risk Consulting leader in the Marsh Real Estate Practice and served as lead risk advisor to the largest clients. Responsibilities included insurance program design in regard to selection of limits and deductibles, as well as designing and managing appropriate risk control programs. Specification for new construction with regard to CAT perils was a key contribution to these clients, Ed’s career started with FM Global, and has held P&C broker’s and professional engineer licenses.