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NFIP’s new pricing structure should be celebrated

Widespread flooding in the US Midwest has once again highlighted the inadequacy of the Federal Emergency Management Agency’s (Fema) pricing methodology for the National Flood Insurance Program (NFIP). However, recent news that Fema wants to reform how it assesses what to charge should be celebrated.

The extent to which the (re)insurance industry will be impacted by the record-breaking inundations remains unclear, although AccuWeather said on Friday that total damages and economic losses from the catastrophe will amount to $12.5bn.

That estimate, AccuWeather explained, is based on its analysis of any damage that has already been inflicted as well as that caused by additional flooding and the lingering health effects resulting from flooding and diseases caused by standing water.

As we reported last week, the reinsurance industry is keeping a close eye on developments in the Midwest over fears that Fema’s excess of loss contract will be triggered. That will occur if the NFIP is hit with claims of more than $4bn from the flood.

As of 31 January this year, the NFIP provided $11.6bn of coverage across 57,000 policies in the five states that have been hit hardest: Iowa, Missouri, Nebraska, South Dakota and Wisconsin.

Questions have long been asked about the rating methodology used by Fema to assess the premiums charged to NFIP policyholders. The NFIP’s detractors have argued that the pricing for the coverage is completely wrong and not actuarially sound, hence why the program regularly finds itself with significant deficits in the wake of major events. Indeed, the NFIP was into the red by some $30bn in mid-2017.

That rating inadequacy was brought home starkly while researching Fema’s potential exposure to NFIP claims. Having made a Freedom of Information request, I was startled to see that just $56mn of premiums were paid to secure that $11.6bn of NFIP coverage. That works out at a rate on line of almost 0.005 percent.

Okay, so not each one of those 57,000 policies will be right in the middle of a flood plain. However, it is important to remember that any home with a mortgage backed by Fannie Mae or Freddie Mac – and that is most of them in the US – within a Special Flood Hazard Area (SFHA) must have flood insurance in place. So it is more than reasonable to surmise that those 57,000 policies are protecting residences that have a higher-than-normal flood exposure.

I am not an actuary – far from it – but it makes very little sense to me that flood insurance is being offered with average rates as low as 0.005%. The startling thing to remember is that figure is the median – some policies will be offered with terms even lower than that.

Which brings me back to the welcome news that the NFIP’s pricing is to be overhauled. There is no doubt that some serious work needs to be done to change the way flood insurance is charged by Fema.

Under the new Risk Rating 2.0, the amount homeowners must pay for NFIP coverage will depend on how prone their property is to flooding. Previously, NFIP pricing was largely determined by whether or not a property was situated on a 100-year floodplain.

It is bizarre that’s not currently the case, but obviously the Federal government has now realised it can no longer keep paying out to repair people’s houses from the taxpayer’s pocket as has happened in the past.

To the outside observer, the introduction of the new pricing policy makes a lot of sense, but those who have houses in flood plains are likely to be in for a nasty shock when they see the cost of their new actuarially sound coverage when the new methodology is introduced in October 2020.

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