A closer look at FEMA's Risk Rating 2.0 reveals flaws

FEMA is calling its Risk Rating 2.0 pricing plan for flood insurance “Equity in Action.”

But is it?

Risk Rating 2.0 was intended to be a method by which the National Flood Insurance Program (NFIP) would correct the inequity built into its current underwriting and rating. The new methodology was designed to “deliver rates that are actuarially sound, equitable, easier to understand and to better reflect a property’s risk.” It was to treat taxpayers, flood insurance buyers and private flood insurers with greater fairness. It was to discourage development in flood-prone areas. And it was to do all this by simply correlating the flood insurance risk of a structure with the flood insurance premium charged against that structure.

Best of intentions

While the architects of this methodology may have had the best intentions, as currently envisioned, Risk Rating 2.0 is filled with many of the same inequities that have plagued the government-sponsored flood insurance monopoly in the U.S. for decades. It will continue to produce perverse outcomes on a panoramic scale. When FEMA was instructed by Congress to change flood insurance rates to actuarially sustainable levels in 2012, the idea was to allow pricing to dictate outcomes rather than continuing to allow well-intended rules and incentives to deliver unintended and often disastrous outcomes. A most important correction intended by Congress was the unfair burden FEMA had placed on taxpayers who have funded about 50% of all claims paid by the NFIP since inception. Equitable flood insurance pricing was also meant to fight the effects of climate change by assigning a more correct cost to structures located in flood-prone areas. Finally, more accurate rates were to deliver consumers a greater choice by stimulating a competitive, private flood insurance market.

Unfortunately, under Risk Rating 2.0, it appears the NFIP will not make much headway toward fully funding program-wide losses or discouraging building in areas impacted by climate change or opening the marketplace to more consumer choice. Taxpayers, climate realists, and agents and brokers who were hoping for a significantly more equitable government-sponsored flood insurance program will, in many instances, be disappointed by Risk Rating 2.0.

Strange but true

On the surface, Risk Rating 2.0 may seem to contain meaningful improvements over the existing rating mechanism. However, the closer you look, the more flaws materialize in its execution. What starts out as a road map to more equitable rates is impacted by so many hidden inconsistencies that it is massively inequitable.

Four examples of inequities that continue to exist or have been heightened under Risk Rating 2.0 are:

• A new artificial rate cap has been implemented. Under Risk Rating 2.0, no matter the actual risk exposure of an NFIP policyholder’s property, they will never pay more than $12,125 per year for their policy. This creates a tremendous incentive for developers to ignore climate change and continue to destroy millions of acres of habitat. This provision encourages development in the most flood-prone areas because the effective subsidy increases as the exposure to loss increases.
• Rates still do not align with risk. Regardless of how many losses a property has experienced over the past two decades, Risk Rating 2.0 will rate the structure as though it has never had a loss. That said, the artificial rate immediately increases to its actual rate with the first claim under Risk Rating 2.0. Consider a buyer who purchases a previously flooded home and is unaware of its loss history. After their first claim, their actual premium is reinstated. This untoward construct will rightfully leave such buyers feeling blindsided and betrayed by their own government. The NFIP provides no way for homebuyers to discover the flood loss history of a structure. When considered in light of both the ongoing unexpected expense, as well as the devaluation of one’s property, this rule seems both irrational and cruel.
• Rate discounts unrelated to specific risk will continue. Under Risk Rating 2.0, the NFIP’s Community Discount System will continue to provide community-wide premium reductions regardless of an individual property’s risk profile. These reductions impact more than 70% of NFIP policies and provide discounts of up to 45% to every structure in the community whether its risk profile is reduced under the Community Discount System or not. Retaining the Community Discount System continues the NFIP practice of decoupling a structure’s risk from the structure’s rate. Communities have not and will not derive the kind of results intended through the overly complex, awkward-to-implement Community Rating System. Communities will enact far more rational flood mitigation strategies when motivated by more accurate flood insurance pricing.
• There are still no refunds for many policyholders who want to trade up. Risk Rating 2.0 failed to address the fact that once an NFIP policy has been in force for more than 30 days, the NFIP will not allow a refund to a policyholder who cancels an NFIP policy and replaces it with private coverage. For agents and brokers, this is a big one. Many clients will contact their agents when they are looking for a better deal on flood insurance. Those agents will be the bearers of bad news when a client phone call or email is received outside of the 30-day window for coverage replacement. Imagine the conversation that will ensue after the insurance producer says something like, “that’s right, even though you can save hundreds or thousands of dollars by switching to a private flood insurance policy because your NFIP policy renewed over 30 days ago, the NFIP will not return one dime of your premium.”

Not the change we need

Agents and brokers looking to sell quality, comprehensive, properly priced flood insurance to their clients will see some improvement but should not expect to find fulfillment in Risk Rating 2.0. Those who want to see real change in America’s flood insurance system should call on Congress to ensure true “Equity In Action” when it comes to flood insurance and give folks their money back when they replace an NFIP policy with a private market alternative.

Craig Poulton (cpoulton@poulton.com) is chief executive officer of Salt Lake City-based Poulton Associates, LLC, which administers various catastrophe-related insurance products, including the country’s largest private flood insurance program, the Natural Catastrophe Insurance Program.

These opinions are the author’s own.

Also by this contributor:

• FHA borrowers better served by private flood insurance
• The NFIP favors the wealthy at the expense of lower income groups and taxpayers
• Recent earthquakes highlight need for disaster planning