A Turning Tide?

Guest Blog: Jane Warring, senior counsel, Clyde & Co. U.S. LLP

A few weeks’ back I attended my first Exceedance. If you go to a new conference, you are never entirely sure what to expect. Suffice it to say though, it was like no industry event I have ever attended — and in a good way.

For one, I seemed to be the only lawyer in the village, which made a pleasant change. And they know how to party, the “EP” knocks the socks off your average “corporate reception”.

Above all, though, I was blown away by the sessions. I have spent almost 15 years litigating first-party property/coverage disputes at both the trial and appellate levels. So, I know a thing or two about the interplay between exposure, risk and coverage. But Exceedance was a whole new level of learning: information-rich content, transparent discussions, engaged delegates and high-quality speakers.

Like many attendees, I filed a trip report on my return to the office. I wanted to make sure my colleagues who lead our resilience work benefited from my learnings. This got me thinking. What were some of the top takeaways from #Exceedance18?

At the top of the list is the momentum towards risk-based pricing for flood insurance — and the impact it will have on homeowners, businesses, insurers and taxpayers.

Pricing Flood Risk Accurately

In case you do not know, the Federal Emergency Management Agency (FEMA) is redesigning its approach to rating risk in the National Flood Insurance Program (NFIP). This is not new news, FEMA went on record in April 2016, citing “the in-versus-out problem” (of crude, 1-in-100 year flood zone boundaries), and the desire to ensure that NFIP rates “accurately reflect the flood risk.”

This initiative, known as “Risk Rating 2.0”, is not just FEMA updating its flood maps. It is far more fundamental than that. Indeed, some commentators are characterizing it as a significant overhaul — an overhaul which, in turn, has the potential to transform how we think about risk and resilience in the United States.

Working with leading cat models, Risk Rating 2.0 seeks to make NFIP premiums more precise and more granular than ever before. The result: policies which are more transparent, more accurate, and fairer.

What will this mean for NFIP policyholders? Well, some will see their rates go up, and some will see them go down. Whether your premium goes up or down will have a lot to do — quite correctly — with the market value of your property and the height of the hazard it faces.

Right now, flood insurance is heavily subsidized by taxpayers. We should therefore expect the premiums of luxury, beachfront condos to increase. Conversely, insurance on more modest homes in less affluent and less flood-prone communities ought to become more affordable.

Regulation Makes Things Possible, But Models Make Markets

But there is a wider landscape to consider. NFIP was — and still is — a response to private market failure. The broader hope underpinning Risk Rating 2.0 is that more accurate NFIP premiums will stimulate greater participation by private flood insurers.

The consensus, it seems, is that NFIP policies, taken in aggregate, are underpriced. That rates do not accurately reflect the risk does not just lead to a billion-dollar, Federal Government bailout; it also makes it difficult for the private market to compete. Simply put, private insurers cannot match the rates offered by NFIP policies.

In addition to NFIP competition, private insurers tend to cite three other impediments to entering the market: regulatory hurdles, insufficient risk understanding, and a lack of demand. But each of these barriers seems to be eroding.

In November 2017, the House passed a HB2874. Among other things, the bill mandates that FEMA allows a company to sell private flood insurance and provide data related to NFIP risks and premiums, including community-level data, through a publicly available data system. The bill is currently with the Senate. Other measures, including House Bill 1422 (aka the “Private Flood Insurance Market Development Act of 2017”) are indicative of a general, bipartisan agenda to move toward privatizing this market. In short, there are signs that the regulatory shackles may soon loosen.

Access to good flood risk analytics is also improving. RMS has long-since been recognized as the view of flood risk globally. Indeed, research undertaken by the Federal Government in 2017 determined that 92 percent of the private market covering U.S. exposures uses RMS models. So, when RMS releases its highly anticipated U.S. Inland Flood Model to the market, private insurers may finally have the confidence they need to build larger flood portfolios, opening up an unprecedented supply of hungry and informed risk capital.

But supply is only ever one part of the equation. The demand-side issues still need to be addressed.

Ultimately, if the product (including its positioning, packaging and pricing) is right, then it should sell. And in some parts of the country, pent-up demand already exists. A private insurance market, heartened by helpful regulation, motivated by the removal of state-backed subsidies and armed with the necessary models, may now find itself encouraged to tackle the demand issue head on.

And with good reason. The average insured is much more likely to experience a flood loss than a fire loss. Yet everyone is insured for fire, and not for flood. In fact, current assessments suggest that only 15 percent of homeowners have flood insurance. Worse still, as many as half of homeowners in the 100-year flood plain are uninsured — and most do not even know it.

As Daniel Stander from RMS says, drawing lines on a map was probably the worst thing FEMA ever did. After all, a quarter of flood losses occur outside of NFIP’s insurance-required zones.

Re-educating policyholders of their flood risk is an important step toward closing the protection gap. In an environment where insureds are open to insuring emerging risks, like cyber and medical marijuana, it is worth reminding policyholders that flood is the most underinsured, high-frequency risk in the United States. Thankfully, the tide may finally be turning.