An Industry Under Water?

The 2022 hurricane season had been quiet until Hurricane Ian struck Florida on Sept. 28, 2022. With estimated insurable losses between $40 billion and $70 billion, Hurricane Ian could be one of the most expensive hurricanes in U.S. history, second only to Hurricane Katrina.

Leading up to and following Hurricane Ian, news outlets ran headlines that reported the National Flood Insurance Program (NFIP), the federal government’s flood insurance program, was losing policies. The reports of NFIP policies decreasing, and the large number of uninsured losses that are expected from Hurricane Ian, raises the following question: Why are flood insurance policies being dropped, and how can we as a nation increase the number of policies?

The truth is, the private flood insurance industry has been scooping up flood insurance policies for years. Having insurance agents, attorneys, claims adjusters, and other professionals who are familiar with the clauses of private flood policies that may differ from the NFIP is becoming more important than ever.

In October 2021, the NFIP introduced a revolutionary change to its rating methodology called Risk Rating 2.0, also dubbed “Equity In Action.” Equity in Action’s more nuanced rating approach will no longer be based on flood zones or base flood elevation, but rather employ a “graduated” rating system that evaluates factors such as distance to water, types of flood exposure, replacement cost, and other advanced elements. The NFIP noted that roughly 23% of policyholders would see a decrease in their premiums due to Risk Rating 2.0, but that 77% of policies could see an increase of some type.

Following this statement is when steep decreases in NFIP policy counts began being noticed. FEMA reported the NFIP lost 171,517 policies from August 2021 to August 2022. While there is no direct correlation in the loss of policies to the implementation to Risk Rating 2.0, the suggestion has certainly been made. In the weeks after Hurricane Ian, reports surfaced that only 18% of homeowners in Florida had flood insurance, and that Florida accounted for 48,698 of the 171,517 policies lost from the NFIP.

The Biggert-Waters Flood Insurance Reform Act of 2012 (BW-12) began the expansion of the residential private flood insurance market. Private flood insurance is flood insurance from sources other than the NFIP, such as Lloyd’s of London. Since the passage of BW-12, lending regulators have changed their rules around how to accept flood insurance for the mandatory purchase requirement (MPR). Rule changes, specifically in 2019, have further fueled the growth of private flood insurance.

While the NFIP still accounts for nearly 90% of the total flood insurance policies, private flood insurance placements have skyrocketed in recent years. Since 2018, the National Association of Insurance Commissioners (NAIC) has collected data on the number of private flood insurance policies and the direct written premiums of those policies for each state. The NFIP reports data on a month-to-month basis (at the time of writing this article, only August 2021 to August 2022 was available). The NAIC data that is used reports in calendar year on an annual basis. Therefore, NFIP data is measured from August 2021 to August 2022, and private flood is measured on an annual basis from 2020 to 2021.

Looking at the country as a whole in 2020, there were 431,323 private flood insurance policies in the United States, and in 2021, there were 561,871, which is a 130,548-policy gain, equating to an approximate 30% year-over-year increase. In August 2021, there were 4,905,419 NFIP policies written while in August 2022, there were 4,733,902, a loss of 171,517 policies, equating to an approximate 3.5% decrease year over year. A direct correlation that the policies leaving the NFIP are going directly to the private flood market cannot be made, but there is a steep increase in private flood placements with more coverage and broader policy forms—a fact not being reported in the news.

Comparing Coverages

The speed at which private flood is growing should cause excitement and concern for industry experts. Private flood insurance can offer broader coverages, different cancellation requirements, and payment flexibility. In a storm like Hurricane Ian, this can make a big difference to an insured in the event of a covered loss. For example, several private carriers offer “loss of use” as an included coverage. This coverage will give the insured reimbursement for the loss of use of their house up to the declared limit on the flood policy. The NFIP does not offer this coverage.

Another example of how private flood insurance can benefit an insured is with increased cost of compliance (ICC) coverage. ICC coverage is used to elevate, demolish, move, or flood-proof a building if it becomes substantially damaged. “Substantially damaged” usually means any building that has received damage of more than 50% of its pre-damaged value.

Local communities are required by building codes and FEMA to elevate substantially damaged buildings to bring them into code with floodplain requirements. Many private flood carriers, unlike the NFIP, allow the ICC coverage found in flood policies to go above the maximum limits the building is insured for. For example, if a home has a private flood policy in place and is insured for $250,000, the policy will most likely have at least $30,000 of ICC included in the policy form. In a loss where the building is substantially damaged, the building owner would receive up to $250,000 for the loss, plus the $30,000 for the ICC for a total claim of $280,000. However, while the NFIP offers $30,000 of ICC coverage, that limit is included within the $250,000. Therefore, with the NFIP, if a single-family home with $250,000 building coverage is substantially damaged, the insured receives a maximum settlement of $250,000 and no more. This highlights how private flood insurance is creating opportunity for the market, but challenges for agents, adjusters, lawyers, and others as they maneuver the various private flood insurance coverages and forms.

While private flood offers more coverages and creates more opportunity for the market, there is still a benefit to having NFIP flood insurance. Beyond the fact that the NFIP is federally backed, the program shows its value in the way it operates during a claim, especially in storms like Hurricane Ian. One example of this is in the NFIP’s reformation of coverage. Reformation of coverage is seen by some as a negative, taking coverage away if the insured has failed to pay premiums. In reality, reformation of coverage as implemented by the NFIP gives the insured the benefit of the doubt when an issue is found at the time of a claim.

For example, an insured has a policy for 10 years, written as an elevated building with a crawlspace. When Hurricane Ian strikes, the insured files a claim. The adjuster finds that the building does not have a crawlspace, but rather a basement. This would cause the policy to have an increase in the premium. Since premium has already been paid, the amount of coverage will be reduced to the amount of premium that has been paid for the policy. However, the NFIP allows the insured to provide the increase in premium within 30 days of the date the premium deficiency was discovered. If paid in the proper amount of time, the NFIP will increase coverage to the originally requested amount and pay the claim based on the coverage requested.

Prior Losses

Hurricane Ian has highlighted how important it is to be insured against the peril of flood, and how important it is to disclose prior claims. Whether a risk is being placed with the NFIP or with a private flood insurer, it is critical to ask the insured to disclose any prior flood losses for the history of the property. The NFIP does not publicly disclose claims history, as there are significant rules and laws around the disclosure of claims, and the current owner of the building is the only person that can receive a full detailed claims history from FEMA.

Private flood companies vary on how they handle prior claims, which is why disclosure of prior claims is critical to ensure claims are paid out to the amount of the covered loss within the policy limits. There is no national claims database for private flood companies to access flood claims data. The only real way to know of a prior claim is if it is disclosed by the insured. In fact, after Hurricane Ian, some private flood applications have a question that asks if there were any prior-Ian losses specifically.

Some private flood companies are fine with prior losses, depending on the size of the loss, when and how it occurred, and what was damaged. However, if, for example, a loss was not disclosed when the policy was issued, and the building experienced another loss, eventually in the claims process the prior loss would most likely be discovered. It is not without precedent that a private flood carrier would deny the claim due to material misrepresentation.

It is too soon to know Hurricane Ian’s long-term impacts on the flood insurance market, but there are already some signs of what lies ahead. At the time of this writing, the NFIP has received close to 50,000 claims and is issuing advanced loss payments, while Lloyd’s syndicates are already discussing rate increases on new business and renewals. Policies written with the NFIP through Risk Rating 2.0 will also increase after Hurricane Ian losses.

Despite increases in premiums, much like after major flooding events in the past, Hurricane Ian’s most immediate and evident short-term impact will be an increase in flood policies from those previously uninsured. As our nation experiences more frequent and more severe flooding events, understanding flood coverages and programs, as well as the importance of disclosing all prior claims, can help insureds be better protected.