December 6, 2021

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Bailing out the National Flood Insurance Program

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“If it can rain where you live, it can flood where you live,” is an expression well-known to meteorologists and the insurance industry, among others. A recent study by the Insurance Information Institute found that about 90 percent of all natural disasters in the United States involve flooding. Just one inch of floodwater can cause up to $25,000 in damage.

Most homeowner’s and renter’s insurance policies do not cover flood damage. Flood insurance is a separate policy that can cover buildings, the contents in a building, or both. However, flooding as a risk exposure violates the characteristics that make up an insurable risk. Generally, exposure units in a flood are not independent of each other, resulting in the potential for a catastrophic loss. Adverse selection is also problematic because owners of property with a higher probability of flooding are more likely to seek protection.

Because of the insurability issue, the National Flood Insurance Program was created in 1968. The NFIP offers flood insurance to property owners, renters and businesses, which helps them recover after floodwaters recede. To determine if a house you own, are renting, or thinking of buying is in a flood zone, you can enter the address at the Federal Emergency Management Agency Flood Map Service Center website.

Flood insurance covers losses directly caused by flooding. If a sewer backup is not caused directly by flooding, the damage is not covered. Flood insurance can be purchased from agents or brokers who represent private insurers. The FEMA website has a tool to find participating insurance providers by state. Contact your insurance agent for more information.

Some reasons not to rely on the federal government to bail out flood victims include the fact that federal disaster assistance comes in two forms: a loan, which must be paid back with interest, or a FEMA disaster grant, which is about $5,000 on average per household. In comparison, the average flood insurance claim in 2018 was more than $40,000.

FEMA is currently in the middle of a major overhaul of the National Flood Insurance Program and is expected to increase premiums in high-risk flood zones anywhere from 379% to as much as 1,216%. The Insurance Journal reports that the federal flood program has lost more than $36 billion since its inception by Congress 53 years ago. Inadequate premiums and a series of major hurricanes over the last 16 years have contributed significantly to this deficit.

While FEMA has not publicly shared how its new “Risk Rating 2.0” overhaul will impact individual premiums, there have been simulation studies by the nonprofit research group, First Street Foundation. First Street’s attempt to duplicate FEMA’s approach is based on the best available information, so these are just estimates.

A tool at their web site gives projected changes in premiums by ZIP code. As an example, ZIP code 88011 was entered. There are 10,090 homes/structures in this ZIP code, 2.7% of which are at risk of damage from a 100-year flood event. Premiums could increase by nearly 7%, as the average annual loss for these properties is $555, which is greater than the estimated NFIP premium of $519. The impact in this example is not nearly as drastic as it’s expected to be in low-level coastal areas.

Perhaps our local monsoon season is a good time to evaluate whether you should have flood insurance coverage.

J. Tim Query, PhD, CPA, ARM, is the Mountain States Insurance Group endowed chair at  New Mexico State University. Learn more at http://business.nmsu.edu/insurance.

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