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Flood Insurance Adjustments in the Forecast

Thu, 04/01/2021 - 12:00

New rates for federal flood insurance that were to take effect today are on hold after Senator Charles Schumer of New York, the majority leader, objected. Mr. Schumer said that the rate changes, intended to more accurately reflect risk, would increase costs to residents of Long Island. 

Meanwhile, the Federal Emergency Management Agency's new system for setting flood insurance premiums, known as Risk Rating 2.0, which was to have taken effect in October, was postponed for the same reason: Members of Congress feared the effect of increasing premiums right before an election. The Trump administration delayed implementation to Oct. 1 of this year. 

The National Flood Insurance Program, managed by FEMA, owes more than $20 billion to the U.S. Treasury, and is limited to borrowing $30.425 billion. Congress canceled $16 billion in debt in 2017, when the program "maxed out the amount of debt that could accumulate during a year we had Hurricanes Harvey, Irma, and Maria," said Emily Mott, vice president in charge of high net worth marketing at Epic Brokers in East Hampton. "The government actually forgave $16 billion in debt to [the flood insurance program] so they could continue to pay claims, and then the [program] had to borrow another $6 billion. . . . If we were looking at this in the private sector, they wouldn't be in very good standing now."

The current approach to rating dates to the 1970s and does not reflect newer technology and mapping data. Risk Rating 2.0 "is looking to take advantage of data out there to create rates that make sense and take into account the individual property's flood risk," Ms. Mott said. This, according to FEMA's website, will allow the program to "deliver rates that are fair, make sense, are easier to understand, and better reflect a property's unique flood risk." 

Risk Rating 2.0 will offer a "glidepath discount" to policyholders and those buying property from them, with existing caps on rate increases preventing significant premium increases, according to FEMA. But research by the First Street Foundation, a nonprofit whose mission is to define the nation's flood risk, concluded in February that the flood insurance program would have to more than quadruple premiums on residences at substantial flood risk in order to cover the current estimated risk. By 2051, given expected increases in flooding due to climate change, those premiums would require a more than sevenfold increase in order to accurately reflect risk. 

"This research reveals a vastly expanded mapping of economic risk associated with flood risk," according to the foundation, "and demonstrates the extent to which information asymmetries on flood risk contribute to financial market asymmetries, specifically in the form of underestimations of financial and personal risk to property owners."

FEMA uses a nationwide rating system now that combines flood zones across many geographic areas and calculates expected losses for groups of structures that are similar in flood risk and structural aspects, assigning the same rate to all policies in a group, according to the Congressional Research Service. It uses two sources of flood risk, the 1-percent annual-chance event for river and coastal floods. 

Under Risk Rating 2.0, a property's premium will be calculated based on specific features including foundation type, the height of the lowest floor relative to base flood elevation, and replacement cost. It will incorporate a broader range of flood frequencies and sources, as well as variables such as distance to water, type and size of nearest water bodies, and elevation of the property relative to the flooding source. 

The implications for South Fork property owners are difficult to predict, according to a survey of insurance professionals. "It would be great if there was a little more transparency," said Joshua Borsack of the Strong Insurance Agency in East Hampton, "so that we could better prepare our clients, and ourselves, for what we are going to see in terms of rate increase/decrease." The current system, he said, "does not generate accurate rates from home to home." Risk Rating 2.0, he said, will more closely align with how the market operates for property insurance, in which structures are rated on specific features including cost and method of construction, the existence of an alarm system, fireplaces or wood-burning stoves, and whether it is a primary or secondary residence. 

That said, "There are a great number of existing homes in this area that are sitting very low in relation to tidal waters that are realistically going to see some significant increases in their premiums," according to Mr. Borsack. "Existing policies are going to be limited in terms of how much they can be increased each year, but at the maximum  yearly increase you could see premiums more than double in a span of five years."

The focus is on coastal properties, he said, but property owners in currently lower-risk zones farther inland may be surprised at premium rate increases under Risk Rating 2.0. "If you think of some of the more hilly areas like Noyac and Northwest Woods, you can have neighbors who are all in the lowest risk flood zone but are 20 to 30 feet above or below each other."  Those in low areas "are in danger of flooding when heavy rains wash down the hills from all directions and settle in the valley where their home sits. Under the current system they are in the same low-risk flood zone and paying the same low rate, but I can see situations where those homes are going to see increases, as the new system will evaluate each home individually."  

"Whether or not this is all handled correctly, with rates being implemented fairly and accurately, will remain to be seen," Mr. Borsack added. 

George Yates of Dayton Ritz and Osborne Insurance in East Hampton also wondered about implementation. "Nobody wants to confront solving a deeply flawed government insurance plan," he said. "Obviously, if you paid out $35 billion more than you took in, somebody is not assessing risk correctly." 

Given Senator Schumer's move to stall adjustment of flood insurance rates, politicians' general aversion to delivering bad news, and the already-delayed rollout of Risk Rating 2.0, its implementation remains ambiguous. "When it comes to what the government's going to do," Mr. Yates said, "politics trumps actuarial science."


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