What Drives Flood Insurance Pricing?
In September 2022, Hurricane Ian dealt a devastating blow to the state of Florida, causing $109 billion in damage. Newsweek reports that 1.8 million homes in the hardest hit counties were thought to be without flood insurance. The cost to repair flood damage to homes can be staggering. As of 2021 the average National Flood Insurance Program (NFIP) claim payout in America was $44,401. What about those Floridians who are without insurance?
One of the causes for low enrollment may be tied to misunderstandings about flood insurance rates. We sat down with John Dickson, CEO of the private flood insurance company Edge, to discuss the current flood insurance market and the factors that drive pricing.
What Is the Value of Flood Insurance?
The severity and frequency of rainfall and drought events have increased dramatically in the last 20 years, and are expected to continue to do so over time. Despite this trend, only 4 percent of American homeowners have flood insurance, and those numbers may be decreasing. Recent reports have indicated that the NFIP has seen a decrease of almost 9 percent of its policies since the 2021 implementation of Risk Rating 2.0, possibly related to misconception about rate changes.
It is understandable that Americans are concerned about the price of insurance, but Dickson urges homeowners to think deeper about the true value of flood insurance.
“Imagine if your home was flooded with a foot of water. That kind of damage would cost you $40,000 to $50,000 to repair. Rather than asking yourself, “Can I afford flood insurance?’, you should ask yourself, ‘Can I afford to not have flood insurance?’”
In the U.S., flood insurance is available from the federal government or the NFIP and from the private market or insurance companies. While both provide policies their mandates and pricing methods differ.
What Affects Private Flood Insurance Pricing?
Unchained by the requirements that the NFIP must meet, insurers have greater flexibility with the types of coverage offered and the limits available for those coverages. Private flood insurance also demonstrated the ability to incorporate technology and risk analytics faster than the NFIP.
Private flood insurers determine rates by considering a number of factors related to the property being insured, as well as the likelihood and potential severity of flooding in the area.
“There's not one pricing algorithm that everybody in the private industry uses, but there are some common aspects that they consider,” Dickson explains. “First, you have to understand the risk characteristics of the property: what it’s made of, where it’s located, how it’s fortified, and how it has withstood prior events.”
Second, insurers work with catastrophe models. Dickson explains, “The extreme volatility that is inherent with catastrophe events requires you to use probabilistic models. These models have the ability to simulate hundreds of thousands of flood events, which are used to generate a location-level view of flooding risk. That output guides insurance eligibility and pricing decisions. ”
Dickson adds, “Private flood insurers must also consider the distribution of risk across and the concentration of risk across their entire book of business. Companies that, for example, only insure properties in the state of Florida will charge a very different rate than a nationwide company where 5 percent of their business is in Florida. Those scenarios represent very different risks, and you must price for those differences.”
The private flood insurance industry has grown significantly in recent years, notably in 2021 when direct premiums rose by 42 percent. Dickson attributes this growth to the private flood insurance industry’s alacrity. “The NFIP is a government program and must operate within the processes established by our federal government, limiting the speed at which it can act.” By contrast, the private flood industry is “unchained by those federal mandates, so it has the ability to absorb learnings and put them into action more quickly.”
The NFIP Rating Factors: Before and After Risk Rating 2.0
The NFIP’s pricing methods have changed dramatically in recent years. From the 1970s until 2021, rates were primarily based on fixed measurements like a property's elevation level and flood zone designation. This method was criticized for its simplistic approach, and for failing to take into account the home replacement value, leading to higher rates for lower-valued homes. Combined with a desire to better reflect actual flood risk, this inequity led Congress to direct FEMA to revamp NFIP pricing.
Following the implementation of Risk Rating 2.0, the NFIP reported it had increased its “capability and tools to address rating disparities by incorporating more flood risk variables.” New flood variables used to determine rates include:
- Distance to a water source
- Flood types including heavy rainfall, storm surge, river overflow and coastal erosion
- Building characteristics like elevation and cost to rebuild
Risk Rating 2.0 is in its early stages but appears to be moving towards its goal of more equitable premiums. So far, premiums have decreased for almost 1.2 million policyholders in 2022. Among those policyholders with increased rates, 86 percent saw increases of $10 per month or less.
What Homeowners & Agents Should Know About Flood Insurance
Flood insurance is an essential aspect of home insurance that helps provide financial protection against the damages caused by floods. For homeowners, it is crucial to have flood insurance coverage to help protect their property and personal belongings from the devastating effects of flooding.
Dickson advises, “I think the most important thing that homeowners should know is that if they don't like the price, or if they have questions about the price, don’t hesitate to ask questions or shop around. Every property owner has different requirements, so make sure you invest the time to find the right solution for your individual situation. Just don't take the first thing that comes to you.”
On the other hand, insurance agents may find themselves overwhelmed by the number of options available to their clients. Dickson suggests, “Make sure you have options at your disposal. If you only have one solution to provide to your customers, you just won’t be able to meet everybody's needs. It's also very important that agents understand what options are available, and the specifics of both pricing and coverage within those options.”
The Future of Flood Insurance Rating
The future of flood insurance will be shaped by our ever changing climate. As the frequency of floods grows, insurance companies will need to adapt to keep up with risk.
“I see increasing investment in computer models, mapping technologies, and technologies that help us understand how our environment is changing,” Dickson says. “More than ever before, it’s important that insurers are mindful about the changes that are happening in weather.”
Dickson continues, “We have to take into account the interests of all constituents. We have to offer real value to homeowners, consider the impacts to capital markets, and offer fair commissions to agents. For the flood insurance industry to make positive change, we have to make sure that our solutions work for all of those stakeholders.”
This article is provided for general informational purposes only and is not intended to provide individualized advice.