Has the flood insurance headache been solved?
While tech has revolutionized flood insurance, insurers must continue to develop better risk-mitigation and coverage solutions.
For more than half a century, flood insurance has posed a significant challenge to underwriters in the U.S. Despite the best efforts of carriers, the complexities of flood risk have led to substantial financial losses for companies that have provided flood coverage, deterring most insurers from entering the space.
Consumers have suffered as a result. Flooding is the most common and costly type of natural disaster in the U.S., causing around $5 billion in damage annually, according to federal government reporting.
And yet, millions of high- and moderate-risk homes and commercial buildings remain uninsured for flood damage.
As climate change increases flood risk across the U.S., FEMA and private insurers have turned to new technology to improve the underwriting process and create more efficient pricing plans that generate returns and protect Americans from disaster. While providers have begun to embrace these digital solutions, insurance carriers must further modernize their underwriting systems to create lower pricing for policyholders, lower loss ratios for the markets, and expanded insurance access for consumers.
History of assessing flood risk
Since the inception of flood insurance in the U.S, carriers have struggled to accurately assess flood risks, making it difficult for them to determine whether to insure or decline a risk and how to set the appropriate price for coverage. Several decades ago, these complexities led carriers to withdraw their flood offerings, leaving Americans unable to protect their property from flood damage.
In 1968, the U.S. government created the National Flood Insurance Program (NFIP) —administered by the Federal Emergency Management Agency (FEMA) — to fill the void in the marketplace. Until the last decade, the NFIP served as the only source of flood insurance for homeowners, condominium associations and commercial buildings.
However, most plans were not purchased voluntarily. The vast majority of policies were sold in response to flood insurance requirements imposed by mortgage companies on properties located in a high-risk zone on a FEMA flood map.
While FEMA flood maps were never designed to assess the risk of individual structures, the absence of more sophisticated flood modeling technology meant that the NIFP had to leverage these maps to classify individual risk. Until October 2021, the NFIP relied on a cumbersome process to calculate premiums, first identifying the applicable flood zone classification on a FEMA flood map, and then applying a confusing set of rate tables to determine the final amount the insured party owed. This system often required an elevation certificate prepared by a surveyor to identify important rating information.
Although the government’s intervention filled a pressing need in the insurance market, the NFIP failed to generate positive returns from their flood coverage. As many of the highest risk homes and buildings were constructed before a community’s first flood map, these owners were allowed to buy flood insurance without an elevation certificate and at more favorable rates that were grandfathered in. While this benefited a subset of NFIP policyholders, it led the NFIP to accumulate large losses and made it difficult for private flood insurance carriers to step in with actuarily-sound, competitive pricing.
Harnessing technology for more informed coverage
As all insurers know, a strong data platform serves as the foundation for accurate underwriting. In recent years, new technology has revolutionized the flood insurance space, allowing carriers to incorporate data and analytics that improve risk assessment capabilities.
Consider light detection and ranging (LiDAR) technology. LiDAR uses lasers to capture precise topographic data, a previously unincorporated datapoint that records the shape, elevation, and physical characteristics of the Earth’s surface. Topographical data is crucial in evaluating the flood potential of a building’s location, allowing for the identification of low-lying areas prone to flooding. Additionally, new photo-analysis technologies use third-party images to determine information about building foundation types, which can help determine a property’s erosion risk.
While NFIP flood coverage was the sole option for consumers a decade ago, private flood insurance companies now leverage digital sources of underwriting data to draft flood insurance plans more accurately than the NFIP. This has led to the creation of a robust private flood insurance marketplace, where private insurers can “cherry pick” the lowest risk homes and buildings out of the NFIP’s book of business, allowing them to offer lower premiums and often superior coverage.
Private flood insurance has developed so rapidly that the NFIP has been forced to forgo its archaic use of flood maps, elevation certificates, and rate tables for its new Risk Rating 2.0 underwriting system. While the new system allows the NFIP to more accurately and efficiently underwrite individual homes and buildings, federal law sets limits on the amount of coverage the NFIP can provide. This gives private flood markets a perpetual competitive advantage, allowing them to offer higher limits and broader coverage at a lower cost for the most desirable properties.
For example, the NFIP’s maximum limits for a single-family home stand at $250,000 of building coverage and $100,000 of contents coverage. They offer no Additional Living Expense, limited coverage for basements, and other coverage restrictions that prevent policyholders from being made whole after a substantial flood loss. In contrast, some private flood carriers offer limits up to $4 million in building coverage and up to $500,000 in contents coverage, a significant upgrade that also eliminates many of the NFIP’s coverage restrictions and, sometimes, the need for a separate excess flood insurance policy.
What’s next?
As a 20-plus year veteran of the flood insurance industry, I’ve seen firsthand that combining flood insurance with innovative technology improves coverage and pricing for consumers and insurers alike. The private flood market is now moving quickly in the right direction, and more Americans than ever have access to flood insurance.
But these recent successes do not mean that the industry has developed the necessary technology to solve the flood problem. Insurers must continue to develop and improve technological solutions to better assess risk and provide more tailored coverage to clients.
Additionally, the marketplace still needs more capacity to grow the policyholder base to create lower pricing for policyholders and lower loss ratios for the markets. Currently, there are almost six million flood insurance policies in effect, including both NFIP and private flood, and this number must quadruple before we reach the tipping point that benefits all stakeholders.
Dan Freudenthal is the National Flood Practice leader at Acrisure. These opinions are the author’s own.
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