Steve Helber/AP Photo
Oceanfront homes in Rodanthe, North Carolina, in the wake of Hurricane Florence, September 2018
National Flood Insurance Program (NFIP) rates taking effect today are supposed to close the historic gap between risk exposure and premiums. That will mean lowering premiums for some homes that have long been overcharged, while ending subsidies for coastal McMansions in risky areas and making rates more accurately convey danger.
The Federal Emergency Management Agency (FEMA), which runs the NFIP, has nicknamed Risk Rating 2.0, the new rate system, “equity in action.” With this update, the agency has sought to convey the impression that it is finally playing hardball, staring down pleas by lawmakers in coastal states who have long begged to slow-walk the changes.
But it could take as long as 20 years before those accurate rates are actually charged.
And even with these new changes, the program will remain insolvent. In fact, NFIP is actually expecting to lose revenue under Risk Rating 2.0, becoming less fiscally sound in the short term, program head David Maurstad acknowledged in a press call last week.
That undermines the media blitz about impending spikes in premiums, and runs counter to FEMA’s claim that it will make rates fully match risk exposure.
The problem with NFIP’s deepening insolvency isn’t that we should worship at the altar of a balanced budget (Congress has bailed out the program multiple times). And FEMA’s stated goal of making markets accurately signal risk won’t be enough on its own. Pricing poor people out of unsafe places is a blunt and regressive device. Apparently recognizing this, the agency has underscored equity.
Instead, the worry is that underpriced flood insurance continues to buttress dangerous land use.
NFIP is expecting to lose revenue under Risk Rating 2.0, becoming less fiscally sound in the short term.
The new rates are a step in the right direction. Still, like much of the action needed on climate change, the change falls so far short of what’s needed that it risks having a politically dampening effect, creating the appearance of action while in practice just putting off an eventual reckoning around rebuilding in flood zones.
“The fact that we’ve seen such resistance to even this baby step doesn’t bode well for doing the bigger things,” said Benjamin Keys, a professor of finance and real estate at Wharton.
HIGHER STICKER PRICES for flood insurance will apply to some properties starting today, though premium increases for existing policyholders will start kicking in on April 1, 2022.
But Congress prevents FEMA from hiking rates more than 18 percent each year. That “glide path” to paying full rates, capping the annual increase, means that it could take up to two decades before the most stubborn 10 percent of homes—those with the most underpriced policies—catch up to paying new premiums.
Notably, rates are already increasing in the status quo. The new system doesn’t dramatically change that fact, so much as it shifts the burden around, making rates more closely approximate properties’ individual risk profiles.
Under the current model, rates are hiked at an average of $8 per month. Under the new methodology, two-thirds of policyholders nationwide will still see increases averaging less than $10 per month. Another 23 percent of policyholders will see immediate decreases averaging $86 per month.
Media reports have focused on the small segment of policyholders, around 1 in 10, who will see increases greater than $10 per month.
But, partly since about a million policyholders will actually see their rates decrease, NFIP is expecting to lose revenue under Risk Rating 2.0 in the short term. And even in the long term, once higher-risk properties begin paying their share, the program is not expected to be self-sustaining.
Asked about NFIP’s continued insolvency on the press call, FEMA’s Maurstad pivoted to equity: “Because we’re a government program, we’re able to take an action that a private insurance company wouldn’t do, and that’s decrease premiums for those that have been overpaying for so long.”
It’s an admirable sentiment, but the update leaves in place major inequities.
Examining rate changes, geoscientists at UC Davis found that “rolling out these changes under the banner of ‘Equity’ is disingenuous.”
Malibu will see the steepest rate discount of any ZIP code in California, while denser South L.A. will see rate increases, they found. Rate changes are meant to reflect not only socioeconomic equity but risk exposure, so this could make some sense. But even accounting for those other metrics, the rate changes remain puzzling: Low-lying coastal areas of San Francisco are set for premium decreases.
Higher rates could push people to skip insurance rather than prodding them to move or make their homes safer.
Discussion of flood risk typically centers on the Gulf Coast, particularly on Florida, where exposure is off the charts. But neighborhoods with the biggest gap between premium rates and risk are nearly all on the West Coast, according to data from First Street Foundation, a nonprofit research group studying climate risk.
Overall, the UC Davis researchers said, FEMA has been guarded about how flood, climate, and engineering risks are reflected in its new rates, too. As a result, they concluded, “a lot of Risk Rating 2.0 is a black box.”
ANY ENFORCEMENT MECHANISM is also missing from the new system. There’s no effort to increase compliance with the widely flouted requirement for exposed homes with federally backed mortgages to purchase insurance.
“Risk Rating 2.0 does not have a mechanism for enforcing or increasing compliance or enrollment,” a FEMA spokesperson confirmed, adding that “FEMA encourages all citizens to purchase flood insurance policies to protect the life they’ve built.”
It’s one of the most serious oversights, since higher rates could push people to skip insurance rather than prodding them to move or make their homes safer.
In fact, that consideration has made actuaries for FEMA wary of incorporating too much long-run climate risk.
“Overpricing the risk, the downside is, fewer people buy insurance. They just check out and say, it’s not affordable, I can’t do it. And doing nothing is the worst thing,” Tom Larsen, an actuary who helped develop FEMA’s new risk rating system, told the Prospect.
Although the new program is more individualized, assessing property-by-property risk, it keeps in place FEMA’s 100-year flood zones, or Special Flood Hazard Areas (SFHAs), as the basis for whether homeowners with federally backed mortgages are required to buy flood insurance.
But substantial risk exists outside of those zones. Predicting total annual loss for residential properties with flood risk, First Street Foundation identified tens of billions of dollars in potential losses outside SFHA-designated areas.
Florida is exposed to $1.4 billion in annualized economic risk in zones not classified as SFHAs, on top of $4.8 billion within those zones. Around half of California’s annualized economic risk also sits outside SFHAs, the group found.
“The Cost of Climate: America’s Growing Flood Risk,” First Street Foundation, 2021
FEMA TOUTS RISK RATING 2.0 as both equitable and “actuarially sound.” That means there should be enough money in the system to meet future liabilities. But critics see this as a narrow and short-term view of risk.
“We’re dealing with a market where there’s a lot of long-term choices that are made—where you place a building, what buildings you purchase. Decisions made today have long-term implications,” Keys, the Wharton professor, told the Prospect. If your goal is to encourage resilient building or strategic retreat, he said, “it’s very difficult to signal that with a static, one-time price. You begin to run up against the limits of what a simple, one-year insurance contract can do in terms of giving markets guidance.”
Even taking the goal of actuarial soundness as given, however, there’s reason to question whether the new price schedule achieves it.
Asked how FEMA plans to make the NFIP more solvent, Maurstad said the agency will continue working with Congress “to provide better predictability to the American taxpayer, to the extent that they’re going to continue to support the program, as they have in the past.”
A major part of that strategy will be heavier reliance on private-sector reinsurance and catastrophe bonds.
Currently the agency has $2.428 billion in reinsurance coverage, which includes a mix of insurance-linked securities and traditional reinsurance giants. If risk is scattered, that might work, but global climate change is likely to increase flooding everywhere, fattening tail risk and triggering large payouts that could put FEMA deeper in the hole on its bonds.
(The standoff between oligopolistic reinsurers and insurgent securitizers is its own fascinating story. Reinsurers, an idiosyncratic and old-fashioned coterie, have traditionally relied on personal trust, private information sharing, and consensus pricing. Gentlemen’s agreements allowed prices to fluctuate from one year to the next, rising after years with heavy losses. But the securitization of these markets is eroding those buffering norms, one recent study found.)
The U.S. government is now shelling out fees as high as 5.5 percent per year on catastrophe bonds, one investor in that sector told the Financial Times. And if cat bond investors see losses, those rates could rise. The system will likely remain opaque, the London business journal noted, since “the non-disclosure agreements between the NFIP and the insurers are among the strictest in the trade.”
In the meantime, the American liberal press continues to cover rate hikes as FEMA’s ruthless-but-much-needed reckoning with mounting climate risk. If only!
