U.S. National Flood Insurance Program

Let's cover some basic facts about the U.S. NFIP (National Flood Insurance Program) and how it operates. The primary reason for the existence of the program is to fill an unmet need in the marketplace. If private insurers charged actuarially sound rates, flood coverage would likely be unaffordable to those in high-risk areas who would need it the most.

Question: briefly describe the National Flood Insurance Program

• a federal flood insurance program administered by FEMA (Federal Emergency Management Agency)
• main provider of primary residential flood coverage (versus private flood insurance)
• involves private insurers and all tiers of government
• created in 1968 and participation is voluntary

Note that most other P&C risks (fire, accidents,...) are handled by private insurance. A primary reason for the creation of NFIP in 1968 was withdrawal of private flood insurance from the market (although private insurers still write and service policies underwritten by NFIP.) That left federal disaster relief as the only means of recovery for flood victims. Dealing with a disaster only after the disaster has occurred is an inefficient way to structure a program. If people in a high-risk area know they'll receive disaster relief, they may be less likely to take steps to mitigate losses before the flood occurs. (This is a moral hazard.)

The design of NFIP is guided by its policy goals.

Question: what are the policy goals of NFIP [Hint: AM&R]

1. Access:

   → provide access to primary insurance (transfers some of the financial risk to the federal government)

2. Mitigate & Reduce:

   → mitigate & reduce flood risk through floodplain management standards

Horn & Webel draw a distinction between policy goals versus objectives. Alice isn't really sure what the difference is, but she advises memorizing their wording. It seems that policy goals are more general, and objectives are more specific.

Question: what are the objectives of NFIP, according to Horn & Webel [Hint: RASH]

Risk-based premiums

Affordability

Sustainability (premiums should cover claims costs & expenses)

High participation rates

Note that for high-risk insureds, the objectives of risk-based premiums and affordability may conflict with each other.

Since NFIP is a government insurance program, it is designed differently from private insurance.

Question: identify ways that NFIP is different from traditional private insurance

social goals: (of NFIP)

   - provides coverage to high-risk customers who would not be able to obtain affordable coverage in the private market

non-insurance goals:

   distribute flood maps (to assist with flood-risk management)

   require land use and building standards for participation in NFIP

   reduce the need for other post-flood disaster aid

   fund rebuilding after a flood (makes it easier for people to recover)

   protect lenders against mortgage defaults due to uninsured losses

Alice-the-Actuary is training Ian-the-Intern in flood management practices, but Ian is already getting bogged down with all these lists to memorize. To help him, Alice related to him this story:

Diego-the-Dutiful runs a farm with his husband and has always taken steps to manage his business risks. His farm is near a river but has historically been subject to a low flood risk. Over the past 15 years however, the frequency and severity of weather events has increased substantially. The nearby river has overflowed 3 times in 10 years, causing significant flood damage to his land and buildings.

Fortunately, Diego has always purchased flood insurance through NFIP, and NFIP helps fund rebuilding after a flood. But NFIP has just distributed updated flood maps to reflect current climate trends. Since he is now officially in a high flood-risk area, NFIP requires him to upgrade his buildings to mitigate damage. If he doesn't do this, he will not qualify for coverage under NFIP.

If Diego follows through and upgrades his buildings to the new standards, it will reduce the need for other post-disaster aid. Unfortunately, not every farmer is as dutiful as Diego, and some farmers, wanting to save money in the short-term, won't upgrade their buildings. That means they can't get flood insurance through NFIP. If they have a mortgage on their buildings and the buildings are destroyed, the lenders will be left high and dry, so to speak. The farmer can't pay back the loan and the collateral is destroyed. The last non-insurance goal of NFIP is to protect lenders against this scenario of mortgage default.

Memory trick: NFIP's social goal of availability & affordability is easy to remember. For the non-insurance goals, just remember the 5 words in brown font:

• distribute – require – reduce – fund – protect