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Privatizing Flood Insurance: What Would it Take to Attract Private Carriers Into the Market?

Posted by Aditya Udai Singh, Assistant Manager, Insurance, Deloitte Services LP, on April 30, 2014

Flood insurance might represent the biggest growth opportunity for private carriers in years, but insurers are likely to be wary about taking on greater exposure in a line that historically has been difficult to write, absent changes to give them a reasonable chance of making a profit.

Indeed, the road to even partial privatization of the National Flood Insurance Program (NFIP) is fraught with many hurdles. Among them is the fact that one-in-five insured properties currently pay rates that do not adequately reflect their risk.1 In addition, there has been low uptake of the coverage, particularly among those with relatively moderate exposures, thereby skewing the risk pool towards higher-hazard properties. And many potential policyholders take a pass on flood insurance because they likely anticipate the availability of government loans or grants in a worst-case scenario.

Even though these challenges may seem daunting for carriers interested in writing flood insurance, they are not necessarily insurmountable. A few private carriers have already entered the market in certain states, such as Florida, and local legislative efforts are underway to encourage more insurers to join in, perhaps on a surplus lines basis.2

Our recent report on the potential for greater flood insurance privatization offered 10 potential scenarios for the industry and government officials to consider. They are not mutually exclusive, and many could be most effective if adopted in tandem. They range from the purchase of private reinsurance for the NFIP, to the floating of catastrophe bonds, to community rating, to bundling flood coverage with standard property policies on an opt-out basis — perhaps with the proviso that those who go without flood coverage are not eligible for government relief funds.

However, any effort to further privatize the flood insurance market is likely to falter unless carriers are given the freedom — by individual states or perhaps the federal government — to underwrite and price coverage to reflect the true cost of risk. Otherwise, we could see a repeat of the industry's experience in the Florida wind market, where many insurers exited because they felt they weren't allowed to price coverage at sufficient levels to cover potential losses.

If such rate freedom results in what's considered to be "unaffordable" coverage for some insureds, this could exacerbate the current problem with the take-up rate. However, government (federal, state or both) could cushion the blow for such policyholders while still spreading more of the risk through the private market by offering flood insurance vouchers to needy households, at least for an interim period.

In any case, we are not suggesting that flood insurance can be completely privatized anytime soon. In fact, it's likely that the federal government will have to continue to be involved — at the very least as a market of last resort for those facing the highest risks, especially with climate change trends expected to broaden and deepen flood exposures around the country. The government should also continue providing and updating national flood maps to better assess exposures, while raising the bar when it comes to mitigation and loss control. Such steps would limit the loss of life and property, as well as give insurers more confidence in writing the risk.

In the meantime, private carriers interested in writing flood insurance need to take a number of preparatory steps, including setting up their own underwriting, pricing and claims systems that leverage predictive models designed to tackle this particular exposure. They would also need to secure reinsurance, with their ability to do so likely reflecting the adequacy of the rates they can charge.

In summary, private carriers in theory have the ability to share a larger portion of risks traditionally assumed by the NFIP, and thus relieve the potential burden on taxpayers, who are currently covering the program's $30 billion of debt.3 However, while a handful of carriers may already be eager to expand in some niche flood markets, additional reforms are likely required to convince more insurers to enter the broader market in a big way.

What additional challenges do you believe the private sector faces in entering and making a profit in the flood insurance market? Read our report, "The potential for flood insurance privatization in the U.S. ­— Could carriers keep their heads above water?," and be a part of the discussion.

1FEMA Website, "Questions about the Biggert-Waters Flood Insurance Reform Act of 2012," http://www.fema.gov/media-library-data/20130726-1912-25045-9380/bw12_qa_04_2013.pdf, accessed April 9, 2014.
2"Florida senator drafts bill to encourage private flood insurance," The St. Petersburg Tribune, November 7, 2013.
3Rawle O. King, "The National Flood Insurance Program: Status and Remaining Issues for Congress," Congressional Research Service, February 6, 2013.

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