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Rising Waters: Navigating the Future of Flood Risk and Insurance

December 6, 2024 | 1 minutes reading time | By Cristian deRitis and Firas Saleh

Floods in the U.S. have increased in severity, frequency and volatility. How is this impacting homeowners, insurers, lenders and asset managers with skin in the game, and what steps can risk managers take to mitigate this threat?

The increasing prevalence of floods across the United States presents a complex and urgent challenge, not only for homeowners but also for insurers, lenders and their risk managers. As climate change progresses and compounds with urbanization and overall changes in land use and land cover, the frequency and severity of these natural disasters also increase, affecting communities nationwide.

A staggering 99% of counties in the U.S. have experienced flooding within the last two decades, demonstrating the widespread nature of this threat and highlighting the importance of investing in both physical measures and flood insurance to mitigate overall risk.

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Let’s now examine the present flood risk situation and strategies for managing it.

The Rise (and Fall) of National Flood Insurance

Over the last 50 years, floods have become more frequent across the U.S., impacting communities in various ways. Even areas that historically have not experienced much flooding are increasingly exposed. Shifts in weather patterns are particularly challenging for residents in these areas, as they are ill-equipped to deal with rising flood waters.

The National Flood Insurance Program (NFIP), managed by the Federal Emergency Management Agency (FEMA), is critical in flood risk management. Established in 1968, the program offers single-family homeowners coverage of up to $250,000 for structures and up to $100,000 for contents. It provides approximately 90% of all flood insurance, with 4.7 million active policies totaling $1.28 trillion in coverage. (The private market provides the remaining 10% of flood policies.)

Recent hurricanes highlight the NFIP's crucial role in providing financial relief after floods. FEMA reported more than 72,000 NFIP claims following hurricanes Debby, Helene and Milton in Florida, while 2022’s Hurricane Ian resulted in 47,000 claims and approximately $4.5 billion in payouts.

firas-salehFiras Saleh

The sharp rise in claims in recent years has forced the NFIP to incur roughly $20 billion in debt. With an average interest rate of 3%, the NFIP must cover over $600 million in annual debt service payments, on top of new claims from homeowners. 

A key contributor to the NFIP’s precarious financial position is the fact that the program has consistently undercharged for flood risk insurance. The NFIP's dependence on outdated flood maps and risk assessments, notably the "100-year flood" standard, significantly impairs its ability to deliver adequate protection. This antiquated approach, combined with a decline in policyholders and the program's financial instability, highlights the urgent necessity for reform.

To address this shortfall, FEMA implemented a program called Risk Rating 2.0 in 2021 to assess flood risk more accurately on a per-house basis. While Risk Rating 2.0 aims to align insurance premiums with their actuarial fair values, it presents significant affordability challenges to existing and first-time homebuyers. While an 18% cap on annual premium increases cushions the impact on household budgets, many homeowners won’t reach their full premium levels before 2030.

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Further contributing to NFIP’s financial woes, the program has witnessed a notable decline in the number of policies since 2009, decreasing from approximately 5.7 million to 4.7 million. This reduction can be attributed to several factors, including increased premium costs and property owners' growing perception that their flood risk is minimal due to outdated flood risk maps.

What’s more, since the end of Fiscal Year 2017, the NFIP has experienced 31 short-term congressional reauthorizations, contributing to the program's instability through temporary extensions.

The most recent extension came at the end of September, with the NFIP authorized until December 20, 2024. Unless Congress reauthorizes or amends the program before this date, it will no longer be able to provide new flood insurance contracts.

Although existing contracts will remain valid until their one-year policy term expires, the inability to secure flood insurance would cause home sales to plummet. Moreover, the authority of the NFIP to borrow funds from the Treasury would significantly decrease (from $30.425 billion to just $1 billion) without reauthorization, putting homeowners at risk should another natural disaster strike occur. 

Managing Flood Risk

The increased severity, frequency and volatility of flood events (not just in the U.S., but globally) illustrate the complexity of flood risks and the need for adaptive management strategies. Flood risk management strategies are therefore critical for individual property owners, businesses and lenders.

By prioritizing flood risk mitigation, stakeholders can protect assets, reduce losses and enhance community resilience. This approach includes implementing physical measures, such as infrastructure improvements, and taking financial precautions, such as securing adequate insurance coverage.

The prevailing uncertainty and the material aftermath of recent hurricanes highlight the critical need for flood insurance. While the number of NFIP policies has declined, private flood insurance has experienced significant growth.

According to data from the National Association of Insurance Commissioners (NAIC), direct written premiums in the private sector have increased notably, from $735 million in 2020 to an estimated $1.432 billion in 2023. This rapid expansion in private flood insurance is attributed to risk assessment technologies and modeling advancements, enabling private insurers to offer more comprehensive and customized coverage. 

These advancements are not only increasing the accessibility of flood insurance to a wider range of homeowners but also fostering competition, which can result in more affordable premiums and innovative coverage solutions. As private insurers broaden their presence, they play a crucial role in raising awareness about flood risk and the importance of insurance. This, in turn, can decrease the number of uninsured properties, increase mutualization and diversification, and enhance overall national resilience against flood events. 

Risk managers must treat flood risk with utmost seriousness to safeguard their companies' physical assets, including manufacturing facilities, warehouses and offices. Moreover, they must consider secondary and tertiary effects if their suppliers, or their suppliers’ suppliers, are located in flood-prone areas.

While insurance can provide compensation for incurred losses, it is more advantageous to prevent such losses altogether. This may involve relocating facilities to regions less susceptible to climatic events or reinforcing existing infrastructures against flooding through drainage systems and pumps. Adopting flood control structures and other structural elements can effectively channel water to runoff ponds and reservoirs, minimizing water pooling.

Flood risk is also a concern for lenders and asset managers with exposure to households and businesses with real estate assets. Mortgage lenders can no longer depend solely on government flood maps and insurance to mitigate their loss exposures.

Lenders increasingly use detailed property databases, including elevation and slope measures and satellite imagery, to evaluate potential loss exposure under various flooding scenarios. Creditors, meanwhile, need to routinely verify that the owners of mortgaged properties maintain their insurance coverage and that changes to policies aimed at reducing annual premiums – such as higher deductibles and caps on coverage – would not inadvertently lead to increased credit risk if borrowers were to abandon their properties after a natural disaster.

Managing Misconceptions

Several misconceptions about flood risk and insurance exist, hindering the ability of individual homeowners and communities to build up resilience. Correcting these myths is critical to closing the insurance gap and providing better protection against floods. There are three fundamental misconceptions:

First, many homeowners mistakenly think they are safe from floods if they live outside a federally declared flood zone. The lack of flood insurance requirements from the government and mortgage companies can create a false sense of security – but this is inaccurate, as recent hurricanes have demonstrated.

The second misconception is that homeowners cannot get insurance outside federally declared flood zones. Many believe insurance is simply unavailable if it isn’t required, even if they wish to supplement their existing property insurance. This myth can leave homeowners overly exposed to flood risk. The reality is that private insurers do offer coverage in most areas, though homeowners may need to seek it out.

The third misconception is that homeowners with flood insurance are fully protected in the event of a hurricane, rainstorm or other flooding incident. While government insurance offers some coverage, it may be insufficient, given the caps on coverage and increasing reconstruction costs. Homeowners with higher-value properties may discover they are significantly underinsured in the event of a flood.

Parting Thoughts

Recent hurricanes and the rising volume of claims have highlighted the NFIP's limitations. The program's debt and the associated financial pressures indicate the need for a more sustainable approach to flood insurance. At the same time, the growing private flood insurance market, supported by advancements in risk assessment technology, provides an alternative.

These developments are making flood insurance accessible to a wider range of homeowners and encouraging competition, which may result in more affordable premiums. As private insurers extend their services, they play a critical role in increasing awareness about flood risk and the importance of insurance, potentially reducing the number of uninsured properties and improving resilience against flood events. 

As the flood insurance landscape evolves, enhanced transparency in real estate transactions concerning flood risk is a positive development. This trend toward greater disclosure at the time of sale assists in adjusting property values to reflect flood risk accurately and encourages proactive measures to reduce vulnerability. Indeed, educating buyers about potential risks to a property is crucial in addressing underinsurance.

Real estate prices are and will continue to be adjusted in response to these disclosures and the rising cost of insurance. These modifications send a strong market signal regarding the necessity to both mitigate and adapt to increasing flood risk by relocating properties out of high-risk areas and by fortifying regions that are currently low risk but may become high risk as weather patterns change.

Cristian deRitis is Managing Director and Deputy Chief Economist at Moody's Analytics. As the head of econometric model research and development, he specializes in analyzing current and future economic conditions, scenario design, consumer credit markets and housing. In addition to his published research, Cristian is a co-host of the popular Inside Economics Podcast. He can be reached at cristian.deritis@moodys.com.

Firas Saleh is Director of Model Product Management at Moody’s Insurance Solutions. He oversees the North America flood and wildfire modeling solutions. His role involves a close collaboration with stakeholders and various cross-functional teams within Moody’s, focusing on defining and executing the strategic vision and roadmap for the flood and wildfire perils. He can be reached at firas.saleh@moodys.com

Topics: Modeling

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