FEMA Reforming Flood Insurance Risk, Rate Structure

Since the National Flood Insurance Plan’s (NFIP) inception in 1968, additional legislation has been enacted to strengthen the program, ensure its fiscal soundness, create better maps, and tie rates closer to risk. Next year, FEMA will transform the NFIP with something called Risk Rating 2.0, a major change.

FEMA says that with Risk Rating 2.0, NFIP is leveraging industry best practices and current technology to deliver rates that are fairer, easier to understand, and better reflect a property’s unique flood risk.

That last part is code for “we lost a lot of money.”

Unsustainable NFIP Losses

NFIP continues to pay claims in excess of revenues, and borrows increasingly from the U.S. Treasury.

Last October, Michael D. Berman wrote an article titled “Flood Risk and Structural Adaptation of markets: An Outline for Action” in the Federal Reserve Board’s Community Development Innovation Review. In it, he says, “On September 22, 2017, after borrowing $5.825 billion to fund claims from Hurricanes Harvey, Irma and Maria, the NFIP had reached its maximum U.S. Treasury borrowing authority of $30.425 billion in program debt. On October 26, 2017, Congress cancelled $16 billion of NFIP debt—the first time in the history of the NFIP that has occurred. Then on November 9, 2017, the NFIP borrowed another $6.1 billion to fund additional 2017 losses, including additional losses from Hurricanes Harvey, Irma and Maria.”

Rating Flood Risk at Property Level

Berman claims, “The NFIP is clearly not properly pricing flood risk, nor is it adequately influencing prudent behavior by property owners and municipalities to sufficiently reduce or otherwise mitigate this risk…This new rating system, known as Risk Rating 2.0, is expected to include repricing of premiums based on flood risk at the property level.”

What Risk Rating 2.0 Involves

FEMA says its current risk-rating methodology has not fundamentally changed since the 1970s. It is now heavily dependent on the 1-percent-annual-chance-event (100-year floodplain).

Risk Rating 2.0 will incorporate a broader range of flood frequencies, new mapping data, and new technologies, more individual rating characteristics, such as:

• Distance to the coast or another flooding source;
• Different types of flood risk; and
• The cost to rebuild a home.

By reflecting the cost to rebuild, the new rating plan will also aim to deliver fairer rates for owners of lower-value homes.

Rates that Promote Mitigation Efforts

FEMA also plans to offer mitigation credits to help incentivize risk-reduction efforts and reduce the cost of future flood events. Risk Rating 2.0 will initially provide credits for three mitigation actions:

Installing flood openings;
Elevating onto posts, piles, and piers; and
Elevating machinery and equipment above the lowest floor.

FEMA is not yet saying how many premiums will increase or decrease, or by how much. Two things ARE clear though.

6:1 Payback on Flood Mitigation Investments

First, the old system is broken and unsustainable. Flood maps were outdated and based on data decades old in many cases. They contained many unmapped areas and the mapped areas were strongly influenced by local politicians and developers. Maps also did not reflect the effects of upstream development or more intense, frequent storms.

Second, the new system has a chance to incentivize risk-reduction. The old system encouraged people and communities to rebuild things the way they were after a disaster. We need a new system that encourages more prudent behavior.

FEMA cites a recent study by the National Institute of Building Sciences. Looking back over 23 years of data, the study found that for every dollar that the federal government invests in flood hazard mitigation, taxpayers save an average of six dollars of future disaster recovery spending.

Rebuild to Fail or Rebuild to Adapt?

The current federal flood insurance program promotes rebuilding in flood prone areas. Hopefully, the new system will promote adaptation to help mitigate increased risk.

Flood insurance rates that better reflect risk may promote more prudent behavior by developers, lending institutions, property owners, buyers, and real estate agents who will all “follow the money.”