If You Build It, Will They Come? The Emerging Market for Private Flood Insurance

March 18, 2014

You'd have to be living under a rock not to know that the NFIPis $24 billion under water and that the Biggert-Waters Flood Insurance Reform Act of 2012, intended to make the program more financially stable, has been gutted. The Biggert-Waters could require the NFIP to increase rates significantly for some older properties in high-risk areas. The resulting outcry has led to proposals to delay or eliminate many of the increases.

An increase in rates to reflect true flood risk should make this market attractive to insurers once again, and sure enough, this seems to be the case. A recent article by Leslie Scism in the Wall Street Journal talks about this evolution, and identifies some of the insurers beginning to offer the coverage.

As a young and eager Risk and Insurance student at the University of Connecticut, my professor, the esteemed Dr. Joseph Fields, told me "The only people that buy flood insurance are the ones that are going to have a loss so the private market won't sell it, which is why it is only sold by the government."

With apologies to Dr. Fields, this may all be changing. It seems that the traditional barriers to the development of a private flood insurance market in the U.S. are slowly coming down. It's all about appetite for risk, available information on exposure and the ability to handle catastrophic loss.

The federal government's appetite for risk may be decreasing-which is not surprising given the current NFIP deficit. Inevitably, this will manifest itself in raising rates until they are actuarially sound.

At the same time, private insurers are looking for new areas of premium growth and additional services they can provide to their customers. With the subsidized flood rates possibly going away, opportunities exist for a competing private insurance solution. Reinsurers also may have an increased interest in flood risk given the current challenges of the traditional reinsurance market caused by the proliferation of cat bonds covering the hurricane and earthquake perils, and the associated influx of new investor capital.

Insurers and reinsurers need to get comfortable with assessing exposure to flood losses and will need tools to help them quantify the risk. The insurance industry is far better able to manage the risk today than it was in the 1960s when the government stepped in. Improved flood maps, satellite imagery, and other tools are available today. A significant addition to this arsenal will be the AIR U.S. Inland Flood Model being released this summer.

Rates will likely rise, but the key question is how far-and what will determine that decision: the real risk or political expediency? The key issue, of course, is the affordability of flood insurance for the people with property prone to flooding. If the government opts to continue subsidizing flood insurance, then amass entry of the private-sector into this multibillion-dollar business would likely be stymied; but if it doesn't, can the insurance industry offer coverage at a price that homeowners at risk are willing to pay? A growing number of insurers seem to think that they can.

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