Quantifying Flood Risk in the United States
Jul 26, 2021
Catastrophe models have become standard tools used by insurers, reinsurers, and brokers to manage exposures, develop rates, and create and implement risk transfer strategies for extreme event risk. In recent years, advanced flood solutions have emerged and catastrophe models have evolved to aid the growing private flood insurance market in developing actuarially sound rates and risk transfer mechanisms, which are both critical components of healthy insurance markets. To confirm the robustness and reasonability of catastrophe model output, users should evaluate their ability to replicate their company’s historical loss experience as well as produce reliable estimates of industry insured loss estimates in an unbiased fashion.
In this article, we will provide an overview of the U.S. flood insurance landscape, share high-level estimates of the industry loss potential from all sources of flooding based on AIR’s models, and highlight how our solutions can be used to support the expansion of the flood insurance market.
The Flood Insurance Landscape
Flood is one of the costliest and most damaging atmospheric perils in the U.S. Floods can arise from a variety of sources: hurricane-induced precipitation; precipitation from weaker tropical systems, severe thunderstorms, extratropical storms, and other non-tropical systems; and storm surge, which is coastal flooding. Flood risk management and flood insurance are cornerstones of household, business, and community resilience.
Before we quantify the insurable and insured view of flood risk in the U.S., it is important to understand the flood insurance market landscape. Figure 1 shows how flood risk is transferred across the various public and private market entities.
The National Flood Insurance Program (NFIP), operating under the auspices of the Federal Emergency Management Agency (FEMA) since 1979, predominates when it comes to homeowners flood insurance in the U.S. Until 1979 the NFIP had operated as a public-private risk-sharing partnership from its inception in 1968, prompted by the lack of a robust private market for homeowners flood insurance. Currently homeowners can buy up to USD 250,000 for building coverage and up to USD 100,000 for contents coverage. Commercial properties can insure their buildings and contents for up to USD 500,000 each.
Private flood insurance can be provided by either admitted or non-admitted carriers, also referred to as excess and surplus lines (E&S) carriers. Admitted carriers are regulated by the states in which they operate; they typically file rates and forms in these states. E&S carriers, although approved by the individual states, are not bound by many of the same requirements as their admitted counterparts in getting their rates and forms approved by state regulators. They are also not backed by the state in cases of insolvency and they tend to have higher minimum solvency requirements when compared to admitted carriers. Insurers cede their risk to reinsurers, which helps distribute and diversify risk beyond the carriers themselves. Reinsurance continues to play an important role in shaping the private flood insurance market in the U.S. by helping insurers spread their risk and offer more capacity.
Private market residential flood policies can be broadly bucketed under the following types:
- Primary private policies with similar coverage and limits as the NFIP
- Primary private policies with broader coverage and limits than the NFIP
- Excess policies that offer additional coverage limits beyond the primary policy limits
- Endorsements adding flood coverage to standard homeowners policies
For private market commercial lines flood policies, the peril of flood is excluded in the base policy form but sublimited coverage can typically be provided through an endorsement or amendment to a policy. In addition, Difference-in-Conditions (DIC) insurance is available to provide expanded coverage for perils including flood, which are excluded on standard coverage forms.
Due to the differences we’ve highlighted between the NFIP and the private insurance markets for flood coverage, it was important within the context of our U.S. industry exposure database (IED) and resulting industry loss estimates to provide a separate view of each of these markets. This includes market-specific policy limits, deductibles, and coverages. Take-up rates, which measure the market penetration of these types of flood policies in a given area, vary widely between the NFIP and the private flood insurance markets and also must be reflected in our U.S. industry loss estimates.
The Flood Protection Gap
The lack of robust private market offerings when it comes to flood is what led to the creation of the NFIP. Despite mandatory purchase requirements for properties within the FEMA-designated Special Flood Hazard Areas (SFHA), a significant flood insurance gap exists when it comes to residential flood insurance when compared to standard fire/wind insurance policies. While local areas along the U.S. Gulf Coast and East Coast show relatively high take-up rates, the nationwide take-up rate for the NFIP—even within the SFHA—is barely above 30%. The numbers are much smaller when we look at the private insurance market for flood. The same is true when we look at small commercial risks. While the take-up rate is significantly higher for mid-market and large commercial risks, the restrictions imposed on their coverages makes their insured values much smaller in comparison to fire/wind policies.
Significant flood risk also exists outside the SFHA; AIR’s U.S. hurricane and inland flood models demonstrate this in subsequent sections of this article. Recent historical events, including the 2016 Louisiana Floods and Hurricane Harvey (2017) demonstrated the same. These areas outside the SFHA and those with outdated Flood Insurance Rate Maps (FIRMs) are equally important when evaluating flood risk. AIR has continued to publish white papers that quantify the global protection gap, including in the U.S.; the importance of closing the flood insurance gap so that property owners can quickly recover in the aftermath of these disastrous events is undeniable. The average claim payout that the NFIP made in the aftermath of the 2016 Louisiana Floods and Hurricane Harvey is approximately USD 92,000 and USD 117,000, respectively, while the average federal assistance that FEMA paid out to the uninsured from these same events was less than USD 5,000.
Quantifying the Risk from All Sources of Flooding
Considering the frequency and severity of floods in the United States and the losses they can cause, managing just part of your flood risk is not optimal. High-resolution, physically based catastrophe models that realistically simulate both hurricane and non-hurricane precipitation, as well as storm surge, allow insurers not only to underwrite, price, manage, and transfer flood risk but also to expand into new markets profitably and cover the flood insurance gap. The AIR Hurricane Model for the United States and the AIR Inland Flood Model for the United States simulate both hurricane and non-hurricane precipitation realistically and together offer the industry a unified and comprehensive view of flood risk from all precipitation events, as well as storm surge, to help insurers truly own their U.S. flood risk.
To add hurricane-induced flooding to the AIR Hurricane Model for the United States, each of the hurricane tracks required unique and realistic spatio-temporal precipitation patterns to be mapped onto them. Using machine learning and big data, we employed a hybrid numerical/stochastic approach that is both physically based and computationally feasible. The hydrodynamic storm surge module accounts for spatial and temporal tidal variability, complex coastal geometry, and localized changes in elevation. The destructive impact of storm surge—which includes property inundation, damage from the force of moving water, debris collision, and sedimentation—can affect residential and commercial exposures from the immediate coast to miles inland. The pluvial component of the AIR Inland Flood Model for the United States provides granularity in the modeling of intense precipitation events, offering insight into which properties were flooded by ponding, excess flow from ephemeral streams, or from overflowing rivers—three sources of precipitation-driven flooding that are not spatially uniform across a landscape and do not always appear on traditional flood maps.
These state-of-the-art models account for the unique circumstances across the country that contribute to flood risk, providing insurers with a highly detailed, physically based, probabilistic approach for underwriting and managing this complex risk. The capabilities of the precipitation-induced flood vulnerability framework underscore the importance of having detailed location-level exposure information, such as type of foundation, first floor elevation, compliance with FEMA guidelines, and year built. Comprehensive and granular data will go a long way toward helping companies assess and manage their flood risk, producing more robust results at the individual and portfolio level.
AIR estimates the insurable ground-up aggregate average annual loss (AAL) from all sources of flooding in the U.S. to be around USD 38.5 billion. However, the insured AAL including losses covered by both the NFIP and the private flood market is around USD 10 billion, leaving approximately USD 28.5 billion, or almost 75% of the overall risk, uninsured. Figure 3 shows this breakdown across residential, commercial, and automobiles lines combined as well as separately across residential and commercial lines. In addition to illustrating the significant protection gap, these exhibits also reveal other interesting information.
- Non-hurricane precipitation-induced flooding is the driver of AAL when we look at the insurable market, with an almost 60% contribution to the AAL across all sources of flooding
- Non-hurricane precipitation-induced flooding drives the AAL for the private flood market in terms of contribution to the insured AAL, with a 55% contribution; this is expected, given that the private flood market tends to operate outside FEMA’s SFHA where precipitation-induced flood tends to be the driver of risk
- Storm surge drives the AAL for the NFIP with a 52% contribution, with the remainder coming from precipitation-induced flooding from both hurricanes and non-hurricanes; this is expected, given the heavy coastal concentration of the NFIP portfolio where storm surge tends to be the risk driver
- The contribution across perils from the residential private flood market is low in comparison to the NFIP, given that the NFIP remains the largest provider of coverage in the high-risk areas—the AAL covered by the private market is just 10% of that covered by the NFIP; conversely, the contribution across perils from the commercial private flood market is higher in comparison to the NFIP—the AAL covered by the private market is 2.5 times that covered by the NFIP
Risk Outside the FEMA-Specified SFHA
We can break this down further to estimates within and outside the FEMA-specified SFHA for the NFIP portfolio across all supported lines (residential and commercial). Given the relatively heavy exposure concentration in the SFHA within the NFIP’s portfolio, it is expected that the contribution of flood risk is high within the SFHA. Storm surge is the primary driver of risk within the SFHA, with contributions exceeding 65%. Outside the SFHA, it is almost a 50-50 contribution from precipitation-induced flooding from both hurricanes and non-hurricanes vs. storm surge.
When we look at the risk profile of the private market within and outside the SFHA, storm surge once again dominates the profile within the SFHA. Figure 5 shows the breakdown of precipitation-induced flood alone within and outside the FEMA-defined SFHA for the private flood market across all supported lines (residential, commercial, and automobiles). Storm surge is purposely excluded to explore how precipitation-induced flood breaks down within and outside the SFHA. As shown in Figure 5, the contribution of precipitation-induced flood is almost 50-50, with the risk outside the SFHA being slightly more than that within the SFHA. When we look at the relative contribution between hurricanes and non-hurricanes, non-hurricanes significantly dominate the risk profile with precipitation-induced flooding from non-hurricanes contributing more than 75% to the overall precipitation-induced flood risk.
Growth Opportunities for the (Re)Insurance Market with Verisk’s Suite of Flood Risk Solutions
Our analysis of how losses break down across these dimensions reveal a number of opportunities for the (re)insurance market. First, the sheer size of the protection gap highlights the substantial growth opportunity that exists in the private (re)insurance market. This can drive premium growth for carriers and expand the manner in which they can serve their customers and fulfill their promise of providing financial protection to individuals and corporations whose assets are at risk. In a challenging era for growth in premiums, from the analyses presented in this article, it is clear that flood has significant growth potential. Estimates from Verisk’s “Sizing the Personal Flood Insurance Market” indicate a potential USD 41.6 billion in personal flood premium—including properties already covered, primarily by the NFIP—for owner-occupied residences in the 48 contiguous U.S. states.
The growth opportunity is particularly large for residential and small commercial lines of business, where more than 85% of the exposed value remains uninsured. This opportunity exists both within and outside the SFHA, given the low utilization of the NFIP even within the SFHAs—despite mandatory purchase requirements and the fact that more than 50% of the risk from precipitation-induced flooding occurs outside of the SFHAs.
Private flood insurance is no longer a distant prospect. Tools such as Verisk’s suite of extreme event models and WaterLine™, an underwriting solution, which cover all sources of flood risk in the U.S., are vital to the existence and expansion of a healthy flood insurance marketplace. WaterLine is a flood hazard scoring tool, developed using many of the same inputs as the extreme event models described in this paper. Verisk’s tools enable (re)insurers to sustainably underwrite, price, manage, and transfer risk. With all the variations in causes of flood—and how that breakdown can change drastically for different portfolios and regions—it’s important for carriers writing flood to have a comprehensive view of flood risk for their books from the point of underwriting through to portfolio management and risk transfer. Verisk’s suite of flood risk solutions provides that comprehensive view:
- Underwriting/Risk Selection—Risk selection should be tailored to the specific nature of the flood hazard at a given location. WaterLine provides high-resolution flood risk scores that account for all sources of flooding and provide detailed breakouts of those scores between the three major sources of flooding at a high resolution.
- Pricing—It’s crucial that pricing reflect the risk from all sources of flood risk to ensure that you avoid adverse selection for policies subject to a flood hazard that you’re not pricing for. AIR’s U.S. hurricane and U.S. inland flood models can provide you with expected losses across all sources of flood, which can be used to develop a comprehensive flood rating plan such as ISO®’s personal and commercial lines flood programs. Our models can also be invoked at the point of sale for more detailed pricing of E&S lines.
- Accumulation Management—When considering the accumulation of risk presented by a flood portfolio, it’s important to look at both individual occurrences, as well as the aggregation of events within a year:
- Occurrence—As shown in Figure 2, the flood market is still dwarfed by the standard homeowners and commercial lines insurance market. As a result, Atlantic hurricanes represent the single largest occurrence accumulations for the global reinsurance market. Ensuring that storm surge and precipitation-induced flooding from hurricanes are included in the same occurrence as the wind losses allows the (re)insurance industry to understand the potential for flood losses to contribute to those hurricane events using AIR’s hurricane model, which already has wide adoption across the insurance value chain for wind.
- Aggregation—In addition to single occurrences, it’s important to understand the aggregation of risk throughout the year from multiple events to ensure your portfolio remains profitable in the face of variable conditions. Prior precipitation from hurricanes can exacerbate flooding from non-hurricane precipitation, and vice versa, meaning that there is significant correlation between the two. The AIR Hurricane Model for the United States and the AIR Inland Flood Model for the United States share a common underlying precipitation catalog to ensure that antecedent precipitation is appropriately captured in both models, and those correlations can be preserved and accounted for in building your portfolio.
- Risk Transfer—In addition to the models themselves, the industry loss estimates that we have developed across these various dimensions, including for the private market, can facilitate the evolution of risk transfer mechanisms beyond traditional indemnity-based covers, such as industry loss warranties (ILWs), industry index triggering securities, and retrocessional placements.
Our solutions including industry loss estimates offer risk quantification capabilities that provide utility across the full insurance value chain, from the underwriting of original risk through to the placement of retrocessional and capital markets covers. We look forward to supporting our clients and the market at large in capitalizing on this opportunity and helping make homeowners and business owners and, more broadly, the communities we live and work in more resilient.