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Private insurers could tip toe into flood market


Although reforms to the National Flood Insurance Program could encourage private insurers to enter the market, don't expect a tsunami of underwriters to jump in, according to a new report by Standard & Poor's Financial Services L.L.C.'s Standard & Poor's Global Ratings operation.

“As the NFIP is set to expire Sept. 30, 2017, there has been interest from policymakers and private insurers alike in the future form of flood insurance,” according to the report “Privatizing U.S. Flood Insurance: A Trickle-Down Effect, Or Opening Floodgates?” “Taking clues from ongoing reforms, we believe the future flood insurance market may end up looking very different from the current one,” said the report, released June 13

The report notes that the self-funding model instituted by the NFIP, which was created in 1968, has collapsed. Losses stemming from Hurricane Katrina in 2005 forced the NFIP to borrow from the U.S. Treasury to meet its obligations, and the program is currently about $23 billion in debt. “The NFIP was set up to be self-funded and to repay its borrowing with interest,” said the report. “But that's exceedingly difficult given that it doesn't charge actuarial rates and therefore relies on the Treasury as a backstop.”

But private insurers would face considerable difficulties to enter the market, according to S&P. For example, “flood insurance faces a higher degree of moral hazard and adverse selection problems than other forms of insurance,” said the report. “In addition, lack of robust models and accurate flood zone maps add to the underwriting complexity.”

The report also noted that modeling flood risk poses “unique” challenges

“Modeling vulnerability to floods requires granular levels of latitude and longitude,” said the report.” And unlike a hurricane model that predicts vulnerabilities by construction type, vulnerability to floods is sensitive to geographic factors such as elevation. These challenges and lack of robust historical loss analysis make modeling floods difficult. Vendor models have flood risk for coastal flooding built into their hurricane models, but inland flooding has proved more difficult to simulate. An additional variable to consider is increasingly volatile weather. Models and pricing need to incorporate this uncertainty into their calibrations.”

Despite the challenges, S&P believes that excess-surplus lines insurers along with reinsurance partners “may be willing to offer limited capacity to assume flood risk that fits within their risk/return parameters.” S&P said excess-surplus lines may be the first ones to enter the market because “they can work with flexible terms, conditions and prices.”

“At this point, we don't expect a wave of private insurers to sweep into this market but rather a trickle as insurers would enter cautiously before they become more comfortable with the risks involved,” said S&P.

“Although a few insurers have experience in flood insurance, many will have to improve their claims-handling capabilities if they want to provide flood coverage in a significant way,” said S&P. “As of now, we believe a slight increase in flood exposure wouldn't significantly affect our financial strength rating on a given company. However, if private insurers were to enter the flood insurance market aggressively without proper underwriting guidelines, models and risk tolerances/limits in place, we could take some rating action on the insurers.”