While it may sound strange, in many ways the people in and around Rockport, Texas, whose homes were destroyed by the strong winds that accompanied Hurricane Harvey at landfall, are the lucky ones. Although they may have lost their homes and many of their possessions, almost all of these people (more than 90%, according to AIR’s Industry Exposure Database) have homeowner’s insurance that protects against wind damage, and can expect to recover much of what they lost from private insurance companies.
It is the people who suffered from Harvey’s other major peril—the devastating flooding—who are in far worse shape.
Few Purchase Flood Insurance
Obtaining flood insurance has been a challenge since the 1920s, when large losses from the Great Mississippi flood drove private insurers to exclude flood as part of a standard home owner’s policy. Since then, the National Flood Insurance Program (NFIP), established in 1968 by the government to fill the gap, has been virtually the only provider of residential home flood insurance in the U.S. However, NFIP policies are only compulsory for homeowners with federally backed mortgages whose homes are located in Special Flood Hazard Areas (aka Flood Zones). For other homeowners, flood insurance is not required, and many see it as an unnecessary expense with little upside.
It is estimated that less than 20% of homeowners affected by Harvey’s flood carry flood insurance. Recoveries for these individuals, however, are limited by the NFIP’s strict terms. NFIP policies have limits of USD 250,000 for homes (excluding basements), and USD 100,000 for contents. When determining the value of what was lost, they use Actual Cash Value (which rapidly depreciates assets with age) and do not take into account the replacement value of those possessions. Finally, they provide no recovery from the loss of use of your home in the event of a flood, something the residents of the greater Houston area could surely benefit from in Harvey’s wake.
The NFIP Under Water
Even with low take-up rates and these strict policy conditions, the NFIP is still facing a massive financial shortfall. After accruing a small but steady surplus year over year from 1968 to 2005, the NFIP took a USD 17 billion hit at the hands of Katrina and Wilma. In 2012, Sandy added another USD 9 billion in losses, leaving the NFIP in debt by more than USD 24.6 billion. Harvey will undoubtedly add several billion more.
This year, the NFIP obtained just over USD 1 billion in reinsurance from a consortium of large reinsurers to cover roughly 25% of losses between USD 4 billion and USD 8 billion. This is the first time the NFIP had turned to the private reinsurance market to obtain this sort of coverage, and it appears very likely that this layer will be exhausted as a result of this event. If so, it would cause the NFIP to butt up against its USD 30 billion debt ceiling. Once that limit is reached, the NFIP would need an Act of Congress to raise it further so it could continue to pay out additional claims.
Finding a Way Forward
The NFIP is up for reauthorization on September 30 of this year. It is unclear exactly how Congress will proceed at this point, but a short term (perhaps three month) reauthorization seems the most likely bet to avoid any disruption in paying out claims relating to Harvey. Long-term reform of the program would seem to be inevitable, as the current situation is clearly unsustainable; that will likely have to wait until the current crisis passes to even receive serious discussion.
One solution could potentially be to free homeowners to seek flood insurance from the private market by loosening the requirement that those with federally insured mortgages must carry flood insurance from the NFIP.1 If insurance is provided by the private market at actuarially sound rates, we may finally see a shift in people’s behavior when building (or rebuilding) in high-risk, flood-prone areas. Economic realities make it clear that this disregard of an ever-present and growing risk cannot continue.
1 The law requires that mortgage holders must have flood policies with ‘similar terms’ to the NFIP, which the banks have interpreted to mean ‘identical policy conditions’. This interpretation has made it challenging for private companies to compete with the NFIP.