Horn Flood Flashcards
National Flood Insurance Program (NFIP) Overview
- A federal flood insurance program administered by FEMA (Federal Emergency Management Agency)
- Main provider of primary residential flood coverage (vs. private insurance)
- Involves private insurers and all tiers of government
- Created in 1968 and participation is (mostly) voluntary
- Primary reason for existence is to fill an unmet need in marketplace – if private insurers charged actuarially sound rates, coverage would be unaffordable to high-risk insureds who need it most
Policy Goals of NFIP
AM&R
* Access: provide access to primary insurance (transfers some of the financial risk to the federal government)
* Mitigate & Reduce: mitigate & reduce flood risk through floodplain management standards
Objectives of NFIP
RASH
* Risk-based premiums
* Affordability
* Sustainability (premiums should cover claims costs & expenses)
* High participation rates
Differences between NFIP & private insurance
Social goals:
* provides coverage to high-risk customers who would not be able to obtain affordable coverage in the private market
Non-insurance goals:
* distribute flood maps (to assist with flood-risk management)
* require land use and building standards for participation in NFIP
* reduce the need for other post-flood disaster aid
* fund rebuilding after a flood (makes it easier for people to recover)
* protect lenders against mortgage defaults due to uninsured losses
FEMA, FIRMs, SFHAs
- FEMA = Federal Emergency Management Agency
- FIRMs = Flood Insurance Risk Maps
- SFHAs = Special Flood Hazard Areas
FEMA makes FIRMs
FIRMs identify SFHAs
When is purchase of flood insurance mandatory?
- for property owners in a SFHA with a federally backed mortgage
- when a mortgage lender specifically requires participation
Exceptions to risk-based NFIP rates
- pre-FIRM: properties built or improved before 12/31/1974, or before the first FIRM for their community (whichever is later)
- newly mapped: properties mapped to a SFHA on/after 4/1/2015 (if applicant obtains coverage within 12 months of map revision date)
- grandfathered: properties originally built in compliance with FIRM (even if they are subsequently mapped into a higher-priced class)
Role of Private Insurers in NFIP
- service policies (marketing selling, writing, claims management)
- share risk with FEMA
- assume full risk as primary insurer
- assume a portion of risk as a reinsurer
2 Servicing Arrangements available to private companies within NFIP
Direct Servicing Agent (DSA):
* private contractor for FEMA
* facilitates purchase of flood insurance directly from NFIP
Write-Your-Own program (WYO):
* private companies directly write and service policies themselves
* the majority of NFIP policies are currently written through WYO
Both: NFIP retains the financial risk
NFIP Risk Management Tools
Private reinsurance:
* purchase from a varied group of reinsurers with each bearing part of the risk
Capital markets:
* catastrophe bond reinsurance is facilitated by a single company
* risk is then transferred to capital market investors who purchase the bonds
* investors pay a certain percentage of the losses from a single, large scale event
Advantages for using private reinsurance for NFIP
- FEMA knows the cost of (some) of its flood risk up front instead of borrowing from the Treasury after a flood (the cost is just the cost of the reinsurance policy)
- reinsurance reduces the volatility of losses (helps manage risk)
Disadvantages for using private reinsurance for NFIP
- expected value of long-term costs is higher because reinsurers must be compensated for assuming risk (in addition to paying out claims)
- NFIP may have insufficient funds after reinsurance premiums to pay claims it retains
- NFIP may have insufficient funds after reinsurance premiums to fulfill other goals & objectives like risk mitigation, flood mapping, improving NFIP rating structures
Why do private insurers consider flood risk to be uninsurable?
- catastrophic nature of flooding
- pricing difficulties (data is highly variable from year to year, unlike auto pricing which has a stable data history)
- adverse selection (only high-risk customers would purchase flood coverage)
- affordability (risk-based pricing could lead to unaffordable rates for high-risk customers who need it the most)
Common types of private flood insurance
- commercial coverage
- secondary coverage (XS coverage above NFIP maximums, coverage for business interruption, …)
- lender-placed coverage (that’s when a bank forces a borrower to obtain coverage to protect the bank’s loan)
Issues & barriers to private flood insurance
SNAP RBC
* Subsidization by NFIP: private insurer can’t compete with taxpayer-subsidized rates
* Non-compete clause
* Accurate assessment of flood risk: don’t have credible data, but FEMA can’t release NFIP data due to 1974 Privacy Act
* Participation rates: necessary to manage & diversify portfolio; even where flood insurance is mandatory participation can be low
* Regulatory uncertainty: private coverage increases state involvement which increases compliance costs since each state may have different regulations
* Broad coverage (at least as): hard to determine since policy forms can be written differently
* Continuous coverage requirement: coverage must be continuous to retain NFIP premium subsidies; switching to private may constitute a lapse in coverage
