Prior to the storms, the NFIP was already $25 billion in debt.

But as high as the payouts, and the additional debt burden for NFIP, will be, those figures pale in comparison to the hundreds of billions of dollars of estimated property damage caused by the string of storms. That only a small fraction of the damage will be covered by insurance payouts speaks to one of the fundamental problems with the current approach to disaster financing: the coverage gap and low take-up of flood insurance in hurricane- and flood-prone places like Florida, Texas and Puerto Rico. For example, only about 20% of residential property owners in Houston had flood insurance coverage when Harvey hit in late August, while only 2% of residential property owners in Puerto Rico had flood insurance coverage when Maria struck the island three weeks later, according to Carolyn Kousky, director of policy research and engagement for the Wharton Risk Center at the University of Pennsylvania in Philadelphia.

The storm season of 2017 “certainly reinforced a lot of issues that have been building [with disaster risk financing in general and NFIP in particular],” says Kousky. “The NFIP was never designed to cover disasters like the ones we've experienced in 2017.”

The string of storms appears also to have supplied new momentum to efforts to find a sustainable disaster risk financing strategy in the U.S. Any effective solution, Kousky suggests, likely will involve government agencies at multiple levels, as well as private insurers. It also needs to address the vulnerabilities of all the parties by distributing risk and incenting participation by insurers as well as residential and commercial property owners, adds Anthony Cappelletti, FSA, FCIA, FCAS, staff fellow, general insurance, for the Society of Actuaries.

What's clear is the current NFIP-reliant system is inadequate. Given the escalating flood risk due to climate change, flood insurance in particular “can't be offered [privately] at a price people are willing to pay,” says Kousky. By default, the financing burden thus has fallen on NFIP, a federal program that, due to heavily discounted rates that don't reflect risk, is woefully in debt and challenged to pay off claims, especially in high-loss years like 2017.

Some type of public-private collaboration might provide the most viable pathway to a sustainable disaster risk financing solution, according to Kousky and Cappelletti. But as Cappelletti notes, “Finding the right [risk-sharing] balance between government and private industry isn't simple.”

Experts report that only about 20% of residential property owners had flood insurance coverage in Houston, seen here, when Harvey hit in late August. (Photo: AP Images)

Existing public-private programs instituted in the U.S. and elsewhere to finance disaster risk might already be illuminating the pathway to a solution. One is the U.S. Terrorism Risk Insurance Act (TRIA) program. Instituted in 2002, TRIA established a public-private partnership between the federal government, private insurers and commercial enterprises. For their part, insurers must offer terrorism insurance to commercial policyholders. For assuming that risk, Uncle Sam provides insurers with a free up-front $100 billion backstop in the event of a terrorist attack on U.S. soil. As a result, commercial entities gain affordable coverage (at a cost of 2 to 6 percent of property premiums) for a risk that otherwise was largely considered uninsurable. Still, the program remains untested for large-scale losses.

Other success stories can be found outside the U.S., with programs such as the World Bank's Disaster Risk Financing and Insurance Program, which provides a financial safety net to sovereign disaster risk financing programs in various countries. Those programs use a layered approach to distributing risk, employing a combination of retention instruments (emergency reserves, contingency budgets, etc.), budget reallocation mechanisms, contingent credit lines and risk transfer mechanisms involving reinsurance and capital markets for the highest risk layers.

What elements might a disaster risk financing scheme in the U.S. include?

Kousky and Cappelletti offer six possibilities:

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         1. On the supply side, make insuring flood risk more palatable to private insurance companies, which as things stand today are “just not going to take on that risk,” Kousky observes. A program in which federally backstopped reinsurance kicks in at a certain loss threshold could help build a business case for private insurers to involve themselves in financing disaster risk, suggests Cappelletti. “That kind of system can work.”
         2. On the demand side, emphasize educating consumers about risk and the need for flood insurance coverage, and combine that with requirements compelling consumers to purchase coverage. Such a requirement could be coupled with subsidies to help low-income families afford coverage, suggests Kousky. Compulsory coverage would bolster sagging take-up rates in disaster-prone areas, she notes. According to reports, the total number of federal flood insurance policies nationally has declined 10% over the last five years.
         3. At the federal level, perhaps in the context of the debate over NFIP reauthorization, phasing out the discount rates that contribute to NFIP's debt problem in favor of risk-based rates.
         4. Invest more in proactive loss-reduction and risk-mitigation measures, including low-interest loan programs and incentives for homeowners, as well as programs to require or incent local and state agencies in hurricane- and flood-prone areas to strengthen oversight of new development, and to create a stronger linkage between disaster risk and the siting of new infrastructure.
         5. Establish a federal aid program to provide financial assistance to disaster victims.
         6. Equip general insurance actuaries with the skills and tools to help insurers price and manage disaster risk. As one of the world's foremost actuarial education organizations, the Society of Actuaries is augmenting its General Insurance Track to better prepare actuaries for the challenges that disaster risk presents, emphasizing hands-on predictive modeling analytics and training and other advanced tools of the trade. Cappelletti says “actuarial education involves basic education, continuing education and work experience. All three pieces are necessary to prepare actuaries for dealing with disaster risk. The SOA is adding more predictive modeling analytics coverage to its general insurance basic education and continuing education offerings. The SOA's education system requirements include actual problem solving using predictive analytics tools that goes beyond what can be included in typical exams.”

In the wake of the havoc-filled 2017 hurricane season, the imperative to find a coherent, sustainable approach to financing disaster risk in the U.S. has never been clearer. But doing so won't be easy, concedes Kousky. “All the stakeholders will need to be involved, and the federal government has to take the lead in risk-mitigation and in providing a backstop.” The NFIP reauthorization process in Washington, D.C., likely will reveal much about Uncle Sam's inclination to do so.