The U.S. National Flood Insurance Program (NFIP) needs to embrace risk-based pricing of flood insurance risks and leverage private risk transfer markets and reinsurance capital in order to reduce the burden and improve the flood insurance market, according to the ABIR.
In a statement to the National Association of Insurance Commissioners’ (NAIC) Property and Casualty Committee on 5th April 2016, Bradley Kading, president of the Association of Bermuda Insurers and Reinsurers (ABIR) called for reform to enable the U.S. flood insurance market to become better functioning.
Key to the proposed reforms are two factors, risk-based pricing and the use of private risk markets and reinsurance capital to reduce the potential burden on the U.S. government and tax payers, while enabling a functioning flood insurance market to develop.
“These measures collectively would increase the purchase of flood insurance in the United States and provide consumers with more comprehensive coverage and with a choice of flood insurance providers,” Kading said. “We favor policy changes that remove regulatory red tape to allow private insurers to voluntarily write more flood insurance; and that encourage the US National Flood Insurance Program (NFIP) to continue on a necessary and essential pathway to risk based pricing that will encourage transfer of risk to private insurance markets.”
Kading said that the NFIP should be encouraged to “continue on a necessary and essential pathway to risk based pricing that will encourage transfer of risk to private insurance markets.”
It is only through the broad adoption of risk based pricing and removal of subsidies, in their current form, that the NFIP can be reformed and the private insurance, reinsurance and also insurance-linked securities (ILS) market step in to provide the much-needed risk transfer capacity for U.S. flood risks.
Three important trends that will help the NFIP on a path to depopulation of risk and transfer to the private markets are development of new and more advanced risk models, the adoption of risk based pricing and the abundance of reinsurance and capital markets capacity for catastrophe risks, according to the ABIR.
By taking the correct policy decisions, the ABIR believes that U.S. flood insurance penetration can actually be increased, suggesting that the existence of the NFIP is hindering uptake and actually resulting in lower resilience and protection for U.S. citizens.
The six recommendations offered by the ABIR to the NFIP are:
- Continue work to support the Ross-Murphy bill, H.R. 2901; the NAIC’s statements in support are important to demonstrate that private insurance markets can well serve consumers under appropriate state regulation.
- Engage with members of the US House Financial Institutions Committee which has begun work on NFIP reauthorization legislation and is interested in advice on how to expand consumer flood insurance markets. Risk based pricing in the NFIP is critical to provide incentives for designing in resilience into construction and for supporting Mother Nature’s flood protection systems.
- Move from the current opaque subsidies which provide below cost insurance for people regardless of their means to ones that are transparent and focused on subsidies for low income individuals. Insurance regulators are good advocates for redesign of the elements of the NFIP. Over time, risk based pricing will encourage risk to be moved to the private sector. At the same time some subsidies will be needed in the NFIP to protect the interest of low income consumers who need flood insurance. The NFIP is needed but over the long haul it likely is best designed as a residual market that protects people that cannot buy flood insurance in private markets.
- Continue along the current NFIP glide path to risk based pricing – this is essential if private sector insurance utilization is the goal. Private insurers will underwrite risk better than the NFIP. In many areas today private insurers cannot compete with the NFIP due to the continued subsidization in NFIP rates; in other areas private insurers can compete as evidenced by Wharton research, individual insurer commentary and by press reports.
- Purchase private reinsurance for the NFIP – this will reduce the burden on federal taxpayers which now are shouldering $23 billion in debt for the NFIP.
- Focus scarce federal resources on designing and building in resilience in infrastructure and creating incentives for consumers to protect themselves via pre-event insurance and risk mitigation rather than over-reliance on post event disaster aid.
Both the traditional reinsurance market and the alternative capital or ILS market are equipped and ready to take on U.S. flood risks, as has been evidenced by the success of the UK’s Flood Re and its retrocession program.
Catastrophe bonds also offer a potential solution both for the NFIP’s own retrocessional reinsurance needs as well as for any commercial insurers that begin assuming more flood risk.
In fact the ILS market also has an opportunity here, as MGA’s will likely get to source and write flood risks for commercial businesses, which could lead to some innovative uses of ILS capital to transfer the risk more directly from primary insured to capital markets.
The ABIR’s recommendations are sound ones. The NFIP and U.S. policymakers need to take notice, follow the example being set by Flood Re in the UK and embrace the private risk transfer markets and abundance of reinsurance capital. The opportunity to de-risk the NFIP has perhaps never been bigger than it is today.