Private Flood insurers who are not yet ready to fill the US Protection Gap


Some of these system problems have been resolved – for example, flood risk models have been developed. But most problems remain.

"The private market for flood insurance is small, but the [flood protection] the gap is enormous ", confirmed Robert Muir-Wood, RMS Chief Investigator, the Newark, Calif. -based catastrophe modeling company." In the US there are currently 5.1 million households in the so-called "100-year flood zone" as defined by the Federal Emergency Management Agency (FEMA), "he added." Of those households, 65 percent do not have flood insurance, "which shows the magnitude of potential business opportunities for the insurance industry, Muir-Wood said during a panel discussion at the reinsurance Rendez-Vous de Septembre (RVS).

During hurricanes Harvey and Sandy, less than 20 percent of homes flooded had flood insurance, he said, pointing out that these catastrophes have marked the huge protection hole around the flood hazard in the US. The insurance protection gap – or underinsurance – is defined as the value of high-risk assets that are not covered by insurance when a catastrophic event occurs, whether natural or caused by man.

If you write flood cases in one of the coastal or eastern states, you will find that many of the major floods are hurricanes.

The National Association of Insurance Commissioners found that half of the US flood losses occur outside the designated high risk areas, but only 1 percent of the properties outside the defined flood areas have flood insurance, according to a report on the security gap published by Lloyd's London.

Part of the problem is that the National Flood Insurance Program (NFIP) of the government, which is managed by FEMA, dominates the flood insurance market.
Robert Muir-WoodMuir-Wood even said that 95.5-96.5 percent of the flood policy is offered by the NFIP, which means that only 3.5-4.5 percent of all residential flood policies in the US are now covered by the private market.

Muir-Wood was accompanied on the RVS panel by Karl Jones, managing director, head of Catastrophe Analytics at Willis Re. They discussed the state of the private flood insurance market and some of the possible remedies to improve growth. The panel was moderated by Ben Brookes, vice president at RMS.

Although there is still a need to develop a solid private insurance market in the United States, there is a growing interest from insurers and reinsurers, who want to diversify their books by providing cover for the risk of flooding, the panel members agreed.

In his comments, Muir-Wood began with a historical perspective of catastrophe models that were developed after Hurricane Andrew in 1992. "In the nineties, Andrew was the great poster child of what a hurricane looks like, yet we see afterwards that Andrew was actually quite unusual "he said, explaining that the storm was dominated by wind influences and had a low share of flood damage. "Over time, it has become quite clear that floods are causing a much larger share of hurricane losses," he added.

Muir-Wood pointed to events such as Hurricane Katrina in 2005, Hurricane Sandy in 2012, Hurricane Harvey in 2016 and Hurricane Florence in 2018, where floods caused significantly more than half of the economic loss. (See related article: "Hurricane Florence shows the dangers of being underinsured / uninsured, says RMS.")

"What this actually means from a modeling perspective is that we need instruments that combine and integrate the wind loss, the loss of the storm surge, the domestic flood loss and even the wave effects on offshore platforms," ​​said Muir-Wood, emphasizing that by To address these four hurricane threats, insurers may have more confidence that all of the risk is covered.

"If you write flood risk, deep inland in the United States, it does not have a strong correlation with hurricane, but if you write flood cases in one of the coastal or eastern states, you will find that many of the most important floods are hurricanes. & # 39;

As a result, an insurer must manage its book for the wind, flood and inland flooding together, he said, noting that modeling technology has only recently advanced to the point where it is able to combine all the dangers. "Earlier, [an insurer was] a bit in the dark about how to diversify the risk. "

Jones on Willis Re agreed and said that flooding has evolved from a danger without a model to a model for which models are available, largely helped by advances in computers and technology.

Both Jones and Muir-Wood confirmed that flooding is in fact a very predictable risk and that profitable risk selection is possible for insurers and reinsurers as long as they understand the models and determine the right price for the risk.

"There are more elegant ways to formulate this, but if your home is on a hill, you are not at risk, and if you are in lower areas, there is a risk of flooding," Jones said. "You can define the floodplains and you can deal with them, we have the tools and the precision to be able to identify the danger in great detail."

In addition, he added, floods in recent years are helping insurers, reinsurers and model building companies to validate the models against losses.

Moreover, the information about the risk exposure of the building is much more accurate than in the past, Jones said, pointing to detailed information about properties, recorded by insurers and brokers, which have been brought together by modeling companies.
Definable danger
Muir-Wood emphasized how flood risk is demonstrably more a definable risk than even hurricane and earthquake. He gave a technical explanation about modeling, which has to do with two kinds of uncertainty: "epistemic" uncertainty and "aleatoric" uncertainty. Epistemic uncertainty is what you do not know, while aleatory uncertainty is the fundamental arbitrariness associated with the risk, he said.

"If you think of hurricanes or earthquakes, there is actually a lot of uncertainty, because wind is a chaotic process: one house is hit by strong gusts of wind, while the next house is missed by strong wind gusts, the danger can be very variable on a small scale. , and it is not possible to model that complete variability, "continued Muir-Wood. He noted that the same applies to earthquake ground movement, which is chaotic and complicated.

"And actually flood … has a much lower level of aleatory uncertainty, a much lower level of intrinsic variability, because flood heights are quite consistent from one piece of land to the next," he explained.

He said that this means that flood models have to do with mainly epistemic uncertainty, for which information is needed in three areas to effectively model floods:

  • Height data of the property.
  • The existence of flood defenses.
  • Information about what happens in that house under the ground floor, that is, the house has a basement? If so, what is the basement used for? Is it occupied? Is it full of expensive artwork or something valuable?

By obtaining this data, flood risk modeling can become more accurate than modeling with hurricane winds or earthquake loss, confirmed Muir-Wood. "We are in a better position to really be able to quantify the flood risk, and an insurer can write that company with confidence."

So, if flooding is so insurable risk, why is the penetration so low?

Muir-Wood said that the slow growth of the private flood insurance market in the US is mainly due to the existence of the NFIP. Jones agreed by saying that the US government offers "subsidized, cheaper insurance".

"The National Flood Insurance Program's assessment schedules have not been sufficient to build up sufficient reserves to pay losses, so the scheme had to borrow more than $ 30 billion from the government to pay Katrina's claims. , Sandy, from the flooding in Louisiana in 2016 and Harvey in 2017, "added Muir-Wood.

Coverage by NFIP is a major challenge for the private market, because if insurers have to compete with NFIP tariffs, there are only certain niches in which a company can operate. "That's why the private market is currently so small in the US." He continued.

Such a niche is available because the NFIP only offers coverage up to $ 250,000, "so if you want to buy more, you have to go to the private market to buy cover," Muir-Wood said.

Insurers also provide coverage beyond the defined 100-year flood plains, where it is easier to find modeled risk prices that are lower than the price of the flood risk costs of the NFIP, he said.

The NFIP has indicated that it intends to switch to risk-based pricing, which is made possible for the first time because of the new modeling capabilities. However, Muir-Wood said that such action would likely cause protests in people living in high-risk areas such as South Florida.

"Until the price of the NFIP actually reflects the risk, it will be very difficult for insurers to go against it," he continued.

Jones predicted that consumer demand will be driven when people feel that the government's safety net is diminishing. Governments will look for support from the private sector to develop insurance solutions, he noted. "If you see a situation where that is under pressure, you will see a natural opportunity in the market."
How to increase penetration
The Lloyd & # 39; s report on the insurance protection gap noted that in the countries where flood risks are automatically included in insurance policies for households and businesses, the penetration rate is generally higher. "In the United Kingdom, for example, residential property insurance withdrawals are more than 90 percent, while for home contents (for which a flood insurance is not required by mortgage lenders), insurance penetration can fall to just 44 percent," said the Lloyd's report entitled "A world at risk – closing the insurance gap."

The penetration rate is also high in other countries where the flood risk is included in the standard coverage, such as France and New Zealand, according to the report. On the other hand, in countries where flood coverage is optional, such as Portugal and the US, insurance penetration is generally much lower, as it went on.

In the US, flood insurance is only required by banks when you take out a mortgage if you are in a designated flood area & # 39; lives, according to Lloyd & # 39; s. In recent years, however, areas that have not been classified as endangered have been hit hard by flooding, demonstrating "the need for new analysis and risk mapping", the report said.

"In the United Kingdom, Flood Re (established in 2016) is not primarily" state-backed ", but the risks are merged with all insurers offering flood policy, & # 39; the Lloyd & # 39; s report. "In an extreme case, the government would intervene as the last deposit. The UK also strives to implement a technical solution for floods, as many countries do, "added the report.

In his comments to the RVS, Jones noted that the United Kingdom committed itself in 2039 to risk-based pricing for its Flood Re program. In addition, any building built in 2009 can not be included in the program, so it is disheartening to build houses in places where there is a potential flood risk. "So, the UK is starting to join forces that affect the market."
Mandatory flood insurance?
Brookes, vice president at RMS, the moderator of the panel, asked Muir-Wood and Jones if they think there are ways in which flood insurance can be made mandatory or required as part of a mortgage.

"In the US, if you take out a mortgage, you need to take out flood insurance if you are in the so-called 100-year flood zone, but a year after you have taken out a mortgage, your mortgage is likely to go to Fannie Mae or Freddie. Mac has gone to be packaged in mortgage-backed security, "said Muir-Wood. As a result, the bank that gave the mortgage is no longer interested in whether the property is protected by a flood insurance policy, "and so the expiry rate for flood insurance is about 25 percent a year," he said.

There is actually no mechanism to ensure that flooding insurance persists over time, he noted.

If the property is only one meter off the 100-year flood zone, insurance is not required "although your flood risk is pretty much the same," Muir-Wood said.

"In California you have a ridiculous situation where, if you take out a mortgage, you must have flood insurance, but you do not have to have an earthquake insurance, so most people are not worried about earthquake insurance," Muir-Wood continued.

Policy makers could actually take away freedom not to have coverage and to oblige people to buy it, he suggested. Another option would be to change the design of the policy, he confirmed, pointing to the example of Japan, where real estate insurance products for fire, wind and floods are offered that are related to the life of the mortgage.

"Another reason for underinsurance against flooding is the prevalence of unfavorable selection in this market," according to the Lloyd's report, which explains that people who buy flood insurance are those who know they are at the greatest risk, thus the price goes up and inclusion in coverage is reduced.

"It is also true that many homeowners believe that their property is secured by their fixed home insurance policy, which is rarely the case," he continued. "Awareness raising is an important initiative to promote insurance acceptance."

A version of this article appeared for the first time in the sister version of Insurance Journal, Carrier Management.