Private Flood Insurance and the National Flood Insurance Program
Released: 2019-05-07T00:00:00

Introduction

Congress is currently considering reauthorization of the National Flood Insurance Program (NFIP) for either a shorter or longer term, while the program is still dealing with the financial impact of the 2017 and 2018 hurricane seasons. Total losses (insured and uninsured) for the 2017 hurricane season are estimated at a record $273 billion, with losses for Hurricane Harvey estimated at $128.8 billion, Hurricane Maria at $92.7 billion, and Hurricane Irma at $51.5 billion. Total losses for the 2018 hurricane season are estimated at $49.4 billion, with Hurricane Florence at $24.2 billion and Hurricane Michael at $25.2 billion. NFIP claims for Harvey, Irma, and Maria amounted to more than $10.1 billion as of January 31, 2019, while NFIP claims for Florence and Michael amounted to more than $850 million as of that date. The NFIP is designed to borrow money from the Treasury to cover claims for extreme events; however, the 2017 losses would have pushed the program over its authorized borrowing limit. Rather than increase the borrowing limit, in 2017, Congress canceled $16 billion of NFIP debt to allow the program to pay claims.

Expanding the role of private insurers, including reinsurers, has been seen by many as an answer to the variability of the financial position of the NFIP. Increasing participation by private insurers could transfer more flood risk from policyholders to the private insurance sector, as opposed to transferring the risk to the federal government through the NFIP. In addition to the possible advantage to the NFIP, the increased availability of flood insurance as private companies enter the market may benefit households and businesses, as insured flood victims are likely to recover more quickly and more fully after a flood.

Private insurer interest in directly providing and underwriting flood risk has increased in recent years. Advances in the analytics and data used to quantify flood risk along with increases in capital market capacities may allow private insurers to take on flood risks that they shunned in the past. However, increasing the private sector role in providing flood insurance coverage directly to consumers may have implications for the operations and fiscal solvency of the NFIP as currently structured. Increased access to private flood insurance could provide individual policyholders with a wider choice of coverage and possibly cheaper premiums, but may also lead to variable consumer protections.

The extent to which private insurance companies participate in the U.S. flood insurance market represents an area of congressional concern. Both the 114 th and 115 th Congress addressed the issue with legislation passing the House; however, no legislation was ultimately enacted. The NFIP is currently operating under a short-term reauthorization until May 31, 2019.

This report describes the current role of private insurers in U.S. flood insurance, and discusses barriers to private sector involvement. The report considers potential effects of increased private sector involvement in the U.S. flood market, both for the NFIP and for consumers. Finally, the report outlines the provisions relevant to private flood insurance in House and Senate NFIP reauthorization bills from the 115 th Congress. It will be updated to reflect legislative developments in the 116 th Congress, particularly focusing on private flood insurance.

Background6

The NFIP is the main provider of primary flood insurance coverage for residential properties in the United States, providing nearly $1.42 trillion in coverage for over 5 million residential flood insurance policies. In FY2018, the program collected about $3.5 billion in annual premium revenue, $1.1 billion in assessments, fees, and surcharges and $1.0 billion in payments from private reinsurers. Nationally, over 22,000 communities participate in the NFIP. The role of the federal government in flood insurance is in contrast to the majority of other property and casualty risks, such as damage from fire or accidents, which are covered by a broad array of private insurance companies. Total premiums for private property and casualty insurance in 2018 totaled $611 billion, with the policies backed by over $2 trillion in assets held by private insurers.

Objectives of the NFIP

The NFIP has two main policy goals: (1) to provide access to primary flood insurance, thereby allowing for the transfer of some of the financial risk of property owners to the federal government; and (2) to mitigate and reduce the nation's comprehensive flood risk through the development and implementation of floodplain management standards. A longer-term objective of the NFIP is to reduce federal expenditure on disaster assistance after floods.

As a public insurance program, the NFIP is designed differently from the way in which private-sector companies provide insurance. As currently authorized, the NFIP also encompasses social goals to provide flood insurance in flood-prone areas to property owners who otherwise would not be able to obtain it, and to reduce the government's cost after floods. The NFIP also engages in many "non-insurance" activities in the public interest: it disseminates flood risk information through flood maps, requires communities to adopt land use and building code standards in order to participate in the program, potentially reduces the need for other post-flood disaster aid, contributes to community resilience by providing a mechanism to fund rebuilding after a flood, and may protect lending institutions against mortgage defaults due to uninsured losses. The benefits of such tasks are not directly measured in the NFIP's financial results from selling flood insurance.

From the inception of the NFIP, the program has been expected to achieve multiple objectives, some of which may conflict with one another:

To ensure reasonable insurance premiums for all; To have risk-based premiums that would make people aware of and bear the cost of their floodplain location choices; To secure widespread community participation in the NFIP and substantial numbers of insurance policy purchases by property owners; and To earn premium and fee income that, over time, covers claims paid and program expenses.

Primary Flood Insurance Through the NFIP

The NFIP offers flood insurance to anyone in a community that chooses to participate in the program. Flood insurance purchase generally is voluntary, except for property owners who are in a Special Flood Hazard Area (SFHA) and whose mortgage is backed by the federal government. Flood insurance policies through the NFIP are sold only in participating communities and are offered to both property owners and renters and to residential and non-residential properties. NFIP policies have relatively low coverage limits, particularly for non-residential properties or properties in high-cost areas. The maximum coverage for single-family dwellings (which also includes single-family residential units within a 2-4 family building) is $100,000 for contents and up to $250,000 for building coverage. The maximum available coverage limit for other residential buildings is $500,000 for building coverage and $100,000 for contents coverage, and the maximum coverage limit for non-residential business buildings is $500,000 for building coverage and $500,000 for contents coverage.

The Mandatory Purchase Requirement

By law and regulation, federal agencies, federally regulated lending institutions, and government-sponsored enterprises (GSEs) must require the property owners in an SFHA to purchase flood insurance as a condition of any mortgage that these entities make, guarantee, or purchase. In addition to this legal mandatory purchase requirement, lenders may also require borrowers outside of an SFHA to maintain flood insurance as a means of financially securing the property.

In order to comply with this mandate, property owners may purchase flood insurance through the NFIP, or through a private company, so long as the private flood insurance "provides flood insurance coverage which is at least as broad as the coverage" of the NFIP, among other conditions. The mandatory purchase requirement is enforced by the lender, rather than FEMA, and lenders can be fined up to $2,000 by banking regulators for each failure to require flood insurance or provide notice. Property owners who do not obtain flood insurance when required may find that they are not eligible for certain types of disaster assistance after a flood.

Premium Subsidies and Cross-Subsidies

Flood insurance rates in the NFIP generally are directed by statute to be "based on consideration of the risk involved and accepted actuarial principles," meaning that the rate is reflective of the true flood risk to the property. However, Congress has directed FEMA not to charge actuarial rates for certain categories of properties and to offer discounts to other classes of properties. FEMA is not, however, provided funds to offset these subsidies and discounts, which has contributed to FEMA's need to borrow from the U.S. Treasury to pay NFIP claims.

There are three main categories of properties that pay less than full risk-based rates:

Pre-FIRM : properties that were built or substantially improved before December 31, 1974, or before FEMA published the first Flood Insurance Rate Map (FIRM) for their community, whichever was later; Newly mapped : properties that are newly mapped into a SFHA on or after April 1, 2015, if the applicant obtains coverage that is effective within 12 months of the map revision date; and Grandfathered : properties that were built in compliance with the FIRM in effect at the time of construction and are allowed to maintain their old flood insurance rate class if their property is remapped into a new flood rate class.

NFIP Reauthorization and Legislation

116th Congress

The NFIP is currently authorized until May 31, 2019. Since the end of FY2017, 10 short-term NFIP reauthorizations have been enacted. As of the date of this report, in the 116 th Congress, no NFIP legislation has been considered in committee in the Senate. The House Financial Services Committee held a hearing on March 13, 2019, on NFIP reauthorization at which four draft bills were circulated.

Prior Congresses

In the 115 th Congress, a number of bills were introduced to provide a longer-term reauthorization of the NFIP as well as make numerous other changes to the program. The House of Representatives passed H.R. 2874 (The 21 st Century Flood Reform Act) by a vote of 237-189 on November 14, 2017. Among its numerous provisions, H.R. 2874 would have authorized the NFIP until September 30, 2022.

Three bills were introduced in the Senate that would have reauthorized the expiring provisions of the NFIP:

S. 1313 (Flood Insurance Affordability and Sustainability Act of 2017); S. 1368 (Sustainable, Affordable, Fair, and Efficient [SAFE] National Flood Insurance Program Reauthorization Act of 2017); and S. 1571 (National Flood Insurance Program Reauthorization Act of 2017).

None of these bills were considered by the full Senate in the 115 th Congress. Among their other provisions, S. 1313 would have authorized the NFIP until September 30, 2027; S. 1368 would have authorized the NFIP until September 30, 2023; and S. 1571 would have authorized the NFIP until September 30, 2023.

The four reauthorization bills differed significantly in the degree to which they would have encouraged private participation in flood insurance, particularly flood insurance sold by private companies in competition with the NFIP. In general, legislation passed by the House was more encouraging of private flood insurance than Senate legislation. The House passed standalone legislation to encourage private insurance in the 114 th Congress ( H.R. 2901 ); however, the Senate did not take up H.R. 2901 in the 114 th Congress. In the 115 th Congress, the House included the same provisions in H.R. 2874 and in an unrelated bill to reauthorize the Federal Aviation Administration ( H.R. 3823 ). The Senate removed the flood insurance language from H.R. 3823 before passing it. Reportedly, the provisions relating to private flood insurance were a particular issue of concern. The Senate ultimately did not take up H.R. 2874 during the 115 th Congress. S. 1313 included some similar provisions to H.R. 2874 , but S. 1368 and S. 1571 did not.

Details of the provisions relating to private insurance in the 115 th Congress House and Senate bills are described in the Appendix, and Table A-1 relates the provisions in the bills to the issues discussed in this report.

The Current Role of Private Insurers in the NFIP

Private insurers can be involved in the flood insurance market in a number of ways, including (1) by helping to administer the NFIP; (2) by sharing risk with the NFIP as a reinsurer; or (3) by taking on risk themselves as a primary insurer, where the insurer contracts directly with a consumer. Since 1983, private insurers have played a major role in administering the NFIP, including selling and servicing policies and adjusting claims, but they largely have not been underwriting flood risk themselves. Instead, the NFIP retains the direct financial risk of paying claims for these policies. Since 2016, the NFIP has purchased a limited amount of reinsurance, thus transferring some of the flood risk to the private sector.

Servicing of Policies and Claims Management

While FEMA provides the overarching management and oversight of the NFIP, the majority of the day-to-day operation of the NFIP is handled by private companies. This includes marketing, selling and writing policies, and all aspects of claims management. FEMA has established two different arrangements with private industry. The first is the Direct Servicing Agent, or DSA, which operates as a private contractor, selling NFIP policies on behalf of FEMA for individuals seeking to purchase flood insurance policies directly from the NFIP. The DSA also handles the policies of severe repetitive loss properties. The second arrangement is the Write-Your-Own (WYO) program, where private insurance companies are paid to issue and service NFIP policies. With either the DSA or WYO program, the NFIP retains the actual financial risk of paying claims for the policy, and the policy terms and premiums are the same. Approximately 13% of the total NFIP policy portfolio is managed through the DSA and 87% of NFIP policies are sold by the 60 companies participating in the WYO program.

Companies participating in the WYO program are compensated through a variety of methods, but this compensation is not directly based on the costs incurred by the WYOs. In the Biggert-Waters Flood Insurance Reform Act of 2012 (Title II of P.L. 112-141 , hereinafter BW-12), Congress required FEMA to develop and issue a rulemaking on a "methodology for determining the appropriate amounts that property and casualty insurance companies participating in the WYO program should be reimbursed for selling, writing, and servicing flood insurance policies and adjusting flood insurance claims on behalf of the National Flood Insurance Program." This rulemaking was required within a year of enactment of BW-12. As of April 2019, FEMA has yet to publish a rulemaking to revise the compensation structure of the WYO companies. Without this analysis, it is difficult to ascertain how much it actually costs WYO companies to administer the NFIP policies, or the WYO's profit margins (if any). In the 115 th Congress, H.R. 2874 would have capped the allowance paid to the WYOs at 27.9% of premiums, while S. 1368 would have capped the allowance at 22.46%.

Reinsurance

In the Homeowner Flood Insurance Affordability Act of 2014 ( P.L. 113-89 , HFIAA), Congress revised the authority of FEMA to secure reinsurance for the NFIP from the private reinsurance and capital markets. The purchase of private market reinsurance reduces the likelihood of FEMA needing to borrow from the Treasury to pay claims. In addition, as the U.S. Government Accountability Office (GAO) noted, reinsurance could be beneficial because it allows FEMA to price some of its flood risk up front through the premiums it pays to the reinsurers rather than borrowing from Treasury after a flood. From a risk management perspective, using reinsurance to cover losses in only the more extreme years could help the government to manage and reduce the volatility of its losses over time.

Transfer of risk to the private sector through reinsurance, however, is unlikely to lower the overall cost of the NFIP because reinsurers understandably charge FEMA premiums to compensate for the risk they assume. The primary benefit of reinsurance is to transfer and manage risk rather than to reduce the NFIP's long-term fiscal exposure. For example, a reinsurance scenario which would provide the NFIP with $16.8 billion coverage (sufficient for Katrina-level losses) could cost an estimated $2.2 billion per year. Such a reinsurance premium, however, would be a large portion of the total premiums paid into the NFIP, approximately two-thirds of the current premium amounts. Devoting such a large portion of premiums to reinsurance could leave insufficient funds for paying claims outside of large disasters, or for covering the other purposes for NFIP funds, such as flood mitigation, mapping, and improving NFIP rating structures.

Reinsurance has been purchased by FEMA through two different mechanisms, "traditional" reinsurance and reinsurance backed by catastrophe bonds. The traditional reinsurance has been purchased from a varied group of reinsurance companies with each reinsurer bearing part of the risk. The catastrophe bond reinsurance is facilitated by a single company, with the risk then transferred to capital market investors who purchase the bonds. The specifics of each reinsurance purchase has varied, but in general, the reinsurance has been designed to pay a certain percentage of the losses from a single, large scale event, with a higher percentage if losses are higher. Coverage has typically started after $4 billion in losses, a loss level that has only been reached by the NFIP in three events—Hurricane Katrina, Superstorm Sandy, and Hurricane Harvey. Table 1 outlines the various reinsurance purchases, including the dates in force, type of reinsurance, amount of coverage, premiums paid by FEMA, and claims paid to FEMA.

To date, the reinsurance purchases have been a net fiscal positive for the NFIP with a total of $655 million in premiums paid and $1.042 billion received from claims. This is due to the extremely high losses experienced after Hurricane Harvey, which resulted in over $8.6 billion paid by the NFIP to policyholders. Unless another large scale flooding event occurs, the balance of premiums vs. claims is likely to turn negative in the next two to three years if FEMA continues similar reinsurance purchases.

In the 115 th Congress, H.R. 2874 , S. 1313 , and S. 1571 all contained provisions that would have required or encouraged the NFIP to transfer a portion of its risk to the private reinsurance market.

Private Flood Insurance Outside the NFIP: Issues and Barriers

One of the reasons that Congress created the NFIP in 1968 was the general unavailability of flood insurance from private insurers. Private flood insurance was offered between 1895 and 1927, but losses incurred from the 1927 Mississippi River floods and additional flood losses in 1928 led most insurers to stop offering flood policies. Private flood insurance companies largely concluded that flood peril was uninsurable because of the catastrophic nature of flooding, the difficulty of determining accurate rates, the risk of adverse selection, and the concern that they could not profitably provide risk-based flood coverage at a price that consumers felt they could afford.

Currently, the private flood insurance market most commonly provides commercial coverage, secondary coverage above the NFIP maximums, or coverage in the lender-placed market. The 2018 premiums for private flood insurance as reported to the National Association of Insurance Commissioners (NAIC) totaled $644 million, up from $589 million in 2017 and $376 million in 2016, compared to the $3.5 billion total amount of NFIP premiums. In general, the private flood market tends to focus on high-value properties, which command higher premiums and therefore the extra expense of flood underwriting can be more readily justified.

Currently few private insurers compete with the NFIP in the primary residential flood insurance market. One illustration of this is that the NAIC only began systematically collecting separate data on private flood insurance in 2016.

As discussed in the following sections, private insurers have identified a number of potential barriers to more widespread private sector involvement in providing flood insurance. Increasing private insurance may present a number of issues for the NFIP and for consumers.

Flood Insurance Coverage "at Least as Broad as" the NFIP

In BW-12, Congress explicitly provided for private flood insurance to fulfill the mandatory purchase mortgage requirement as long as the private flood insurance "provides flood insurance coverage which is at least as broad as the coverage" of the NFIP, among other conditions. Implementation of this requirement has proved challenging. The crux of the implementation issue is in answering the question of who would evaluate whether specific policies met the "at least as broad as" standard and what criteria would be used in making this evaluation. Some lending institutions feel that they lack the necessary technical expertise to evaluate whether a flood insurance policy meets the definition of private flood insurance set forth in BW-12.

The responsible federal agencies issued two separate Notices of Proposed Rulemaking (NPRM) on the question, the first in October 2013, and the second in November 2016. On February 12, 2019, the agencies announced a final rule implementing this BW-12 requirement. Of particular note, the agencies indicate the rule

"allows institutions to rely on an insurer's written assurances in a private flood insurance policy stating the criteria are met; [and] clarifies that institutions may, under certain conditions, accept private flood insurance policies that do not meet the Biggert-Waters Act criteria."

This second point may seem unusual, because BW-12 included a specific definition of private flood insurance, while the agencies indicate that the rule allows acceptance of private flood insurance that does not meet this statutory definition. In creating the exception that allows private flood insurance that does not follow the statutory definition of "private flood insurance," the agencies relied on the usage of the more general term "flood insurance" in 42 U.S.C. 4012a(b)(1)(A) combined with the perceived congressional intent to promote private insurance in BW-12.

The rule takes effect on July 1, 2019. Press reports described it as generally welcomed by the banking industry, but it is unclear to what extent this new rule will encourage private flood insurance or whether additional legislative changes might be needed if Congress seeks to further encourage development of the private flood insurance market.

In the 115 th Congress, H.R. 2874 and S. 1313 included provisions that would have revised the definition of private flood insurance, striking existing statutory language requiring private flood insurance to provide coverage "at least as broad as the coverage" provided by the NFIP in order to meet the mandatory purchase requirements. Instead, the new definition would have relied on whether the insurance policy and insurance company were in compliance with the laws and regulations in the state where the insurance was purchased. S. 1368 and S. 1571 had no similar provisions.

Continuous Coverage

An associated issue is that of continuous coverage, which is required for property owners to retain any subsidies or cross-subsidies in their NFIP premium rates. Under existing law, if an NFIP policyholder allows their policy to lapse, any subsidy that they currently receive would be eliminated immediately. Unless legislation specifically allows private flood insurance to count for continuous coverage, a borrower may be reluctant to purchase private insurance if doing so means they would lose their subsidy should they later decide to return to NFIP coverage.

In the 115 th Congress, H.R. 2874 included a provision that would have specified that if a property owner purchases private flood insurance and decides then to return to the NFIP, they would be considered to have maintained continuous coverage. S. 1313 included a provision to allow private flood insurance to count as continuous coverage. S. 1368 and S. 1571 had no similar provisions. In the 116 th Congress, H.R. 1666 , introduced on March 11, 2019, would consider any period during which a property is covered by a flood insurance policy, either through the NFIP or a private company, to be a period of continuous coverage.

The "Non-Compete" Clause

Before FY2019, the Write Your Own carriers, private insurers who sell and service NFIP policies, were restricted in their ability to sell flood insurance policies on their own behalf while also participating as a WYO, due to a "non-compete" clause contained in the standard NFIP contracts. These contracts governing the WYO companies' participation in the NFIP restricted the WYO carriers from selling their own standalone private flood products. A non-compete clause would require WYO companies to decide whether to offer private flood insurance policies in their own right or to act as WYO carriers, thus potentially limiting the size of the private flood market. In the 115 th Congress, H.R. 2874 would have eliminated the non-compete clause in place at the time, while S. 1313 would have provided temporary authorization for WYOs to sell private flood insurance for certain types of properties, with a follow-up study by FEMA to determine if the authorization should be made permanent.

FEMA implemented changes in the standard WYO contracts for FY2019 removing the restrictions on WYO companies offering private flood insurance, while maintaining requirements that such private insurance lines remain entirely separate from a WYO company's NFIP insurance business. This action removes the non-compete clause without legislation, although FEMA in the future would retain the authority to reinstate the non-compete clause. Possible implications of the removal of the non-compete clause are discussed later in this report in the section on " Adverse Selection ."

NFIP Subsidized Rates

FEMA's subsidized rates are often seen as one of the primary barriers to private sector involvement in flood insurance. However, even without the subsidies mandated by law, the NFIP's definition of full-risk rates differs from that of private insurers. Whereas the NFIP's full-risk rates must incorporate expected losses and operating costs, a private insurer's full-risk rates must also incorporate a profitable return on capital. As a result, even those NFIP policies which are considered to be actuarially sound from the perspective of the NFIP may still be underpriced from the perspective of private insurers. In order to make the flood insurance market attractive, private insurers would want to be able to charge premium rates that reflect the full estimated risk of potential flood losses while still allowing the companies to make a profit. A reformed NFIP rate structure could have the effect of encouraging more private insurers to enter the primary flood market because NFIP full-risk based rates would be closer to the rates that private insurers would likely charge; however, this could lead to higher rates for households.

In the 115 th Congress, H.R. 2874 would have phased out the pre-FIRM subsidy for primary residences at a rate of 6.5%-15% (compared to the current rate of 5%-18%), in a staged manner. In the first year after enactment, the minimum rate increase would have been 5%; in the second year after enactment, the minimum rate increase would have been 5.5%; and in the third year of enactment, the minimum rate increase would have been 6%. The phaseout of the pre-FIRM subsidy for other categories of properties would have remained at 25%. The Senate bills did not contain any provisions related to premium rate subsidies.

FEMA is in the process of developing a redesigned risk rating system for the NFIP, known as Risk Rating 2.0. The new flood insurance rates for single-family properties are to be announced on April 1, 2020, and the new rates planned to go into effect for single-family properties across the country on October 1, 2020. As of January 31, 2019, there were 3.53 million single-family policies in force nationally. Many details are not yet known, but FEMA representatives have indicated the new rating structure will include replacement cost value and the distance between the property and a source of water. Risk Rating 2.0 is to also include new sources of flooding, such as intense rainfall, that are not currently included in the rating structure.

Regulatory Uncertainty

As addressed above, the rules on the acceptance of private insurance for the mandatory purchase requirement, and whether or not private flood insurance would count for continuous coverage, have had a significant impact on the market potential for private insurers. Another driver of private sector concern is regulatory uncertainty at the state level. The role of state regulators would increase in a flood insurance market with increased private sector involvement, which could increase the burden of oversight. The involvement of 56 state and territorial insurance regulators is likely to add complexity and additional costs for insurers, lenders, or property owners. For example, some private insurers cited the intervention of state regulators in controlling rates for wind insurance in Florida as a reason for withdrawing from that market. However, this could also lead to the development of state-specific insurance solutions, which might better suit local social and economic conditions. In the 115 th Congress, H.R. 2874 and S. 1313 referenced state laws and regulations in their definition of private flood insurance that could meet the mandatory purchase requirements.

Ability to Assess Flood Risk Accurately

Many insurers view the lack of access to NFIP data on flood losses and claims as a barrier to more private companies offering flood insurance. It is argued that increasing access to past NFIP claims data would allow private insurance companies to better estimate future losses and price flood insurance premiums, and ultimately to determine which properties they might be willing to insure. However, FEMA's view is that the agency would need to address privacy concerns in order to provide property level information to insurers, because the Privacy Act of 1974 prohibits FEMA from releasing policy and claims data which contain personally identifiable information. Private insurers have also suggested that better flood risk assessment tools such as improved flood maps and inland and storm surge models are needed in order to price risks at the individual and portfolio level. In the 115 th Congress, H.R. 2874 would have required FEMA to make all NFIP claims data publicly available in a form that does not reveal personally identifiable information, while S. 1313 would have authorized FEMA to sell or license individual claims data while requiring FEMA to make aggregate claims data available.

Adequate Consumer Participation

Insurers need sufficient consumer participation to manage and diversify their risk exposure. Many private insurers have expressed the view that broader participation in the flood insurance market would be necessary to address adverse selection and maintain a sufficiently large risk pool. A long-standing objective of the NFIP has been to increase purchases of flood insurance policies, and this objective was the motivation for introducing the mandatory purchase requirement.

Despite the mandatory purchase requirement, not all covered mortgages carry the insurance as dictated, and no up-to-date data on national compliance rates with the mandatory purchase requirement are available. A 2006 study commissioned by FEMA found that compliance with this mandatory purchase requirement may be as low as 43% in some areas of the country (the Midwest), and as high as 88% in others (the West). A more recent study of flood insurance in New York City found that compliance with the mandatory purchase requirement by properties in the SFHA with mortgages increased from 61% in 2012 to 73% in 2016. The escrowing of insurance premiums, which began in January 2016, may increase compliance with the mandatory purchase requirement more widely, but no data are yet available.

The mandatory purchase requirement could potentially be expanded to more (or all) mortgage loans made by federally regulated lending institutions for properties in communities participating in the NFIP. Another possible option would be to require all properties within the SFHA to have flood insurance, not just those with federally backed mortgages. Consumer participation could also be increased if the federal government were to mandate that homeowners' insurance policies include flood coverage or require all homeowners to purchase flood insurance. All four 115 th Congress bills contained provisions for some form of study to assess the compliance with the mandatory purchase requirement. H.R. 2874 would also have increased civil penalties on lenders for failing to enforce the mandatory purchase requirement.

Potential Effects of Increased Private Sector Involvement in the Flood Market

Increased Consumer Choice

Current NFIP policies offer a relatively limited array of coverages, particularly compared to what is available in private markets for similar insurance against perils other than floods. Private insurance companies could potentially compete with the NFIP by offering coverage not available under the NFIP, such as business interruption insurance, living expenses while a property is being repaired, basement coverage, coverage of other structures on a property, and/or by offering policies with coverage limits higher than the NFIP. The NFIP currently also has a 30-day waiting period in almost all cases before the insurance coverage goes into effect, whereas private insurance companies may have a shorter waiting period. Private companies could also offer flood coverage as an add-on to a standard homeowners' policy, which could eliminate the current problem of distinguishing between flood damage (which is covered by the NFIP) and wind damage (which is often covered by standard homeowners' insurance). Unlike the NFIP, private flood insurance companies may also issue a policy without necessarily requiring elevation certificates, perhaps by using new technology to measure the elevation of individual structures.

Cheaper Flood Insurance

Since some properties receive lower NFIP rates due to cross subsidies from other NFIP policyholders, it seems likely that some of the non-subsidized NFIP policyholders would be able to obtain less expensive flood insurance from private insurers. Private insurers may also be able to offer premiums more closely tied to individual risks than the NFIP currently does, which would provide lower premiums for some policyholders. Quantifying the potential savings for some policyholders from private insurance is, however, difficult. The amount and extent of cross-subsidization within the NFIP is not currently known, as the NFIP has not historically tracked the number of grandfathered properties. One example of an attempt to provide estimates of NFIP versus private insurance is a modeling exercise carried out by two private companies, Milliman and KatRisk, which looked at premiums for single-family homes in Louisiana, Florida, and Texas. Their modeling suggested that 77% of single-family homes in Florida, 69% in Louisiana, and 92% in Texas would pay less with a private policy than with the NFIP; however, 14% in Florida, 21% in Louisiana, and 5% in Texas would pay over twice as much. Milliman did not provide any details of the coverage offered by these private policies, nor the basis on which their figures were estimated.

Variable Consumer Protections

The consumer protections associated with private policies are likely to be enforced at a state level and will therefore be variable; some states may offer a higher level of protection than others. Because private insurers are free to accept or reject potential policyholders as necessary in order to manage their risk portfolio, private insurers may not necessarily renew a policy. A private flood insurance policy might be less expensive than an NFIP policy, but it might also offer less extensive coverage, which a policyholder may not realize until they make a claim following a flood. Unlike the NFIP, the language in private flood insurance policies is not standardized and has not yet been tested in court in the same way as, for example, homeowners' insurance. Thus there may be greater variability in claims outcomes for consumers in the early years of private flood insurance penetration.

Adverse Selection

Private sector competition might increase the financial exposure and volatility of the NFIP, as private markets will likely seek out policies that offer the greatest likelihood of profit. In the most extreme case, the private market may "cherry-pick" (i.e., adversely select against the NFIP) the profitable, lower-risk NFIP policies that are "overpriced" either due to cross-subsidization or imprecise flood insurance rate structures, particularly when there is pricing inefficiency in favor of the customer. This could leave the NFIP with a higher density of actuarially unsound policies that are being directly subsidized or benefiting from cross-subsidization. Because the NFIP cannot refuse to write a policy, those properties that are considered "undesirable" by private insurers are likely to remain in the NFIP portfolio—private insurers will not compete against the NFIP for policies that are inadequately priced from their perspective. Private insurers, as profit-seeking entities, are unlikely independently to price flood insurance policies in a way that ensures affordable premiums as a purposeful goal, although some private policies could be less expensive than NFIP policies. It is likely that the NFIP would be left with a higher proportion of subsidized policies, which may become less viable in a competitive market.

The extent of such "cherry picking" is uncertain with some arguing that it would have little effect. However, evidence from the UK flood insurance market suggests that even in an entirely private market "cherry picking" can be difficult to avoid. Interviews of private insurers indicate that one of the key drivers for the introduction of Flood Re, the new UK private flood insurance scheme, was the emergence of new entrants in the flood insurance market after 2000. These new entrants had little or no existing high-flood-risk business and no commitment to continue to insure this business under the terms of the informal agreement with the government. This gave them a competitive advantage, as they could choose to select the more profitable lower-risk business. One driver for change therefore was that Flood Re would include these new entrants and force them to contribute by charging their clients for the cross-subsidy for Flood Re, leveling the playing field between the private insurers.

A significant increase in private flood insurance policies that "depopulates" the NFIP may also undermine the NFIP's ability to generate revenue, reducing the amount of past borrowing that can be repaid or extending the time required to repay the debt. If the number of NFIP policies decreases, it would likely become increasingly difficult for the remaining NFIP policyholders to subsidize policies, raising prices for the non-subsidized policyholders and thus accelerating the move to private insurance. In the long term the program could be left as a "residual market" for subsidized or high-risk properties. Residual market mechanisms are used in areas such as auto insurance, where consumers may be required to purchase insurance, but higher risk individuals may be unable to purchase it from regular insurers. The exact form of residual market mechanisms vary in different states and for different types of insurance, but they typically require some form of outside support either from the government or from insurers themselves.

In the 115 th Congress, CBO cost estimate of H.R. 2874 considered the impact of eliminating the WYO companies' non-compete agreement. CBO estimated that, over the 2017-2027 period, holders of about 690,000 properties that, under current law, would have been purchased under the NFIP would instead choose to buy private flood insurance to cover those properties if H.R. 2874 were enacted. CBO did not expect any property owners who are subsidized by the NFIP to be among those leaving the program. CBO estimated that eliminating the non-compete clause and making NFIP data publically available would lead to an increase in spending of $39 million for the 2018-2022 period and $393 million for the 2018-2017 period.

S. 1313 would have required FEMA, within two years of enactment, to report on the extent to which the properties for which private flood insurance is purchased tend to be at a lower risk than properties for which NFIP policies are purchased (i.e., the extent of adverse selection), by detailing the risk classifications of the private flood insurance policies. S. 1313 would also have provided the FEMA Administrator the power to limit the participation of WYO companies in the broader flood insurance marketplace if the Administrator determined that private insurance adversely impacts the NFIP.

Issues for NFIP Flood Mapping and Floodplain Management

If the number of NFIP policyholders were to decrease significantly, it might also be difficult to support the NFIP's functions of reducing flood risk through flood mapping and floodplain management. NFIP flood mapping is currently funded in two ways, through (1) annual discretionary appropriations; and (2) discretionary spending authority from offsetting money collected from the Federal Policy Fee (FPF). The FPF is paid to FEMA and deposited in the National Flood Insurance Fund (NFIF). The income from the FPF is designated to pay for floodplain mapping activities, floodplain management programs, and certain administrative expenses. About 66% of the resources from the FPF are allocated to flood mapping, with floodplain management receiving about 19% of the overall income from the FPF. To the extent that the private flood insurance market grows and policies move from the NFIP to private insurers, FEMA will no longer collect the FPF on those policies and less revenue will be available for floodplain mapping and management. Concerns have been raised about maintaining the activities funded by the FPF, with some stakeholders arguing that a form of FPF equivalency, or some form of user fee, should be applied to private flood insurance. In the 115 th Congress, both S. 1313 and S. 1368 contained mechanisms by which private insurance companies could have contributed to the costs of floodplain mapping in lieu of paying the FPF.

Enforcement of floodplain management standards could be more challenging within a private flood insurance system, as the current system makes the availability of NFIP insurance in a community contingent on the implementation of floodplain management standards. For example, the Association of State Floodplain Managers (ASFPM) has expressed concerns that the widespread availability of private flood insurance could lead some communities to drop out of the NFIP and rescind some of the floodplain management standards and codes they had adopted, leading to more at-risk development in flood hazard areas. ASFPM suggested that this issue could be addressed by allowing private policies to meet the mandatory purchase requirement only if they were sold in participating NFIP communities. FEMA suggested that access to federal disaster assistance could be made partially contingent on the adoption of appropriate mitigation policies, but noted that this approach could be politically challenging. However, a positive consequence is that government investment in mitigation could increase private market participation by reducing the flood exposure of high-risk properties and thereby increasing the number of properties that private insurers would be willing to cover.

Concluding Comments

The policy debate surrounding NFIP and private insurance has evolved over the last few years. The discussion in 2012 was framed in the context of privatization of the NFIP and actions that might be taken to create conditions for private sector involvement. One of the primary interests of Congress at the time was to reduce the federal government's role in flood insurance by transferring its exposure to the private sector, with an expectation that a realignment of roles would allow the federal government to focus on flood risk mitigation while private markets focused on providing flood insurance. One argument for increasing private sector participation in the U.S. flood market was that competition should lead to innovation in flood risk analytics and modeling and produce new flood insurance products that would better meet customer needs and lead to greater levels of insurance market penetration. In fact, private sector flood risk analytics and modeling have improved significantly before any sizable entry of private insurers into the market. Another argument was that, in contrast to the NFIP, which cannot diversify its portfolio of flood risk by insuring unrelated risks, the insurance industry can diversify catastrophic risks with uncorrelated or less correlated risks from other perils, other geographic regions, non-catastrophic risks, or risks from unrelated lines of business.

FEMA considered a range of concrete steps by which the barriers to private sector involvement could be addressed. One of these has been introduced: the purchase of reinsurance. Two others are in progress: the reduction of premium subsidies for some properties and reporting to make premium subsidies and cross-subsidies more transparent. Although BW-12 directed FEMA to make a recommendation about the best manner in which to accomplish the privatization of the NFIP, FEMA presented the report without a recommendation, arguing that any privatization strategy is complex and involves significant policy decisions that would require input from a variety of stakeholders. They concluded that there is no single, clear solution; it is heavily politicized; and harsh criticism of any change is inevitable.

Currently the discussion is more focused on sharing risk, with the recognition that neither the NFIP nor the private sector is likely to be able to write all of the policies needed to cover all of the flood risk in the United States. FEMA has identified the need to increase flood insurance coverage across the nation as a major priority for NFIP reauthorization, and this also forms a key element of their 2018-2022 strategic plan. FEMA has developed a "moonshot" with the goal of doubling flood insurance coverage by 2023 through the increased sale of both NFIP and private policies.

The 2017 hurricane season highlighted the flood insurance gap in the United States, where many people that are exposed to flood risk are not covered by flood insurance. For example, in Texas and Florida, less than a third of the flooded residential structures in SFHAs were insured, and no more than 10%-12% of flooded residential structures outside the SFHA were insured. Recent floods have also demonstrated that insured flood victims generally receive significantly more from NFIP flood insurance than from FEMA Individual Assistance (IA). For example, in the 2015 South Carolina floods, the average NFIP claim was $35,172, while the average IA payment was about $3,199. In the 2016 Louisiana floods, the average NFIP claim was $91,507, while the average IA payment was about $9,349. For Hurricane Harvey, the average NFIP claim was $116,823, while the average IA payment in Texas was about $4,426. For Hurricane Irma, the average NFIP claim in Florida was $51,773, while the average IA payment was about $1,315.

FEMA's view is that both the NFIP and an expanded private market will be needed to increase flood insurance coverage for the nation and reduce uninsured flood losses. However, the private market is unlikely to expand significantly without congressional action. The concerns of private companies related to the mandatory purchase requirement and continuous coverage and the concerns of some Members of Congress about adverse selection are among the most pressing issues likely to be addressed in any long-term NFIP reauthorization.

Appendix. Provisions Related to Private Flood Insurance in Legislation in the 115th Congress

The provisions in the 115 th Congress legislation that related to private flood insurance, and the issues raised as barriers to private sector involvement, are summarized below and compared side-by-side in Table A-1 . All of the bills also included provisions related to administrative reforms of the NFIP, some of which may be relevant to private insurance companies, which are not described in this report.

H.R. 2874 , 21 St Century Flood Reform Act

H.R. 2874 , Section 102, would have phased out the pre-FIRM subsidy for primary residences at a rate of 6.5%-15% (compared to the current rate of 5%-18%), except that in the first year after enactment, the minimum rate increase would have been 5%; in the second year after enactment, the minimum rate increase would have been 5.5%; and in the third year after enactment, the minimum rate increase would have been 6%. The phaseout of the pre-FIRM subsidy for other categories of properties (non-primary residences, non-residential properties, severe repetitive loss properties, properties with substantial cumulative damage, and properties with substantial damage or improvement after July 6, 2012) would have remained at 25%. This section would have made it possible, but not certain, for FEMA to raise premiums more rapidly than under current law by increasing the minimum rate at which the pre-FIRM subsidy could be removed for primary residences. H.R. 2874 , Section 201, would have revised the definition of private flood insurance previously defined in BW-12. This section would have struck existing statutory language describing how private flood insurance must provide coverage "as broad as the coverage" provided by the NFIP. Instead, the new definition would have relied on whether the insurance policy and insurance company were in compliance in the individual state (as defined to include certain territories and the District of Columbia) where the policy applies. Further, "private flood insurance" would have been specifically defined as including surplus lines insurance. Though the majority of regulation of private flood insurance would have rested with individual states, federal regulators would have been required to develop and implement requirements relating to the financial strength of private insurance companies from which such entities and agencies accepted private insurance, provided that such requirements not affect or conflict with any state law, regulation, or procedure concerning the regulation of the business of insurance. The dollar amount of coverage would still have had to meet federal statutory requirements and requirements relating to the financial strength of such companies offering flood insurance could still be implemented. This section would also have specified that if a property owner purchased private flood insurance and decided then to return to the NFIP, they would be considered to have maintained continuous coverage. This section would have allowed private insurers to offer policies that provide coverage that might differ significantly from NFIP coverage, either by providing greater coverage or potentially providing reduced coverage that could leave policyholders exposed after a flood. H.R. 2874 , Section 202, would have applied the mandatory purchase requirement only to residential improved real estate, thereby eliminating the requirement for other types of properties (e.g., all commercial properties) to purchase flood insurance from January 1, 2019. This would likely have affected the policy base of the NFIP by reducing the number of commercial properties covered. However, it is uncertain how many would have elected to forgo insurance coverage (public or private) entirely. H.R. 2874 , Section 203, would have eliminated the non-compete requirement in the WYO arrangement with FEMA that restricted WYO companies from selling both NFIP and private flood insurance policies. This would have allowed the WYO companies to offer their own insurance policies while also receiving reimbursement for their participation in the WYO program to administer the NFIP policies. This section was largely pre-empted by FEMA's proposed changes for FY2019 to remove the WYO non-compete clause. H.R. 2874 , Section 204, would have required FEMA to make publicly available all data, models, assessments, analytical tools, and other information that is used to assess flood risk or identify and establish flood elevations and premiums. This section would also have required FEMA to develop an open-source data system by which all information required to be made publicly available may be accessed by the public on an immediate basis by electronic means. Within 12 months after enactment, FEMA would have been required to establish and maintain a publicly searchable database that provides information about each community participating in the NFIP. This section provided that personally identifiable information would not have been made available; the information provided would be based on data that identifies properties at the zip code or census block level. H.R. 2874 , Section 506, would have established that the allowance paid to WYO companies would not be greater than 27.9% of the chargeable premium for such coverage. It would also have required FEMA to reduce the costs to WYO companies participating in the program. H.R. 2874 , Section 507, would have increased the civil penalties from $2,000 to $5,000 on federally regulated lenders for failure to comply with enforcing the mandatory purchase requirement. In addition, the federal entities for lending regulations, in consultation with FEMA, would have been required jointly to update and reissue the guidelines on compliance with mandatory purchase. H.R. 2874 , Section 513, would have required GAO to issue a report, within 18 months of enactment, on the implementation and efficacy of the mandatory purchase requirement. H.R. 2874 , Section 511, would have required that, no later than 18 months after enactment, FEMA begin to annually transfer a portion of the risk of the NFIP to the private reinsurance or capital markets to cover a FEMA-determined probable maximum loss target expected to occur in the fiscal year.

S. 1313 , Flood Insurance Affordability and Sustainability Act of 2017

S. 1313 , Section 101, would have required annual transfer of a portion of the risk of the NFIP to the private reinsurance or capital markets in an amount sufficient to maintain the ability of the program to pay claims, and limit the exposure of the NFIP to potential catastrophic losses from extreme events. S. 1313 , Section 102, would have required FEMA to conduct a study in coordination with the National Association of Insurance Commissioners to address how to increase participation in flood insurance coverage through programmatic and regulatory changes, and report to Congress no later than 18 months after enactment. This study would have been required to include but not be limited to options to (1) expand coverage beyond the SFHA to areas of moderate flood risk; (2) automatically enroll customers in flood insurance while providing customers the opportunity to decline enrollment; and (3) create bundled flood insurance coverage that diversifies risk across multiple-peril insurance. S. 1313 , Section 401, would have allowed any state-approved private insurance to satisfy the mandatory purchase requirement, and allowed private flood insurance to count as continuous coverage. This section would also have changed the amount of insurance required for both private flood insurance policies and NFIP policies in order to satisfy the mandatory purchase requirement. S. 1313 , Section 402, would have provided temporary authority during the first two years after enactment for WYO companies to sell private flood insurance for certain properties (e.g., non-residential properties, severe repetitive loss properties, business properties, or any property that has incurred flood-related damage in which the cumulative amount of payments equaled or exceeded the fair market value of the property) with the possibility of expanded participation after two years and further study. S. 1313 , Section 403, would have required FEMA to study the feasibility of selling or licensing the use of historical structure-specific NFIP claims data to non-governmental entities, while reasonably protecting policyholder privacy, and report within a year of enactment. This section would also have authorized FEMA to sell or license claims data as the Administrator determines is appropriate and in the public interest, with the proceeds to be deposited in the National Flood Insurance Fund (NFIF). S. 1313 , Section 404, would have required an insurance company issuing a policy for private flood insurance to impose and collect an annual surcharge equivalent to the Federal Policy Fee (FPF), to be transferred to the FEMA Administrator and deposited in the NFIF. S. 1313 , Section 602, would have required FEMA, not later than one year from enactment, to create and maintain a publicly searchable database that includes the aggregate number of claims filed each month, by state; the aggregate number of claims paid in part or in full; and the aggregate number of claims denials appealed, denials upheld on appeal, and denials overturned on appeal; without making personally identifiable information available.

S. 1368 , Sustainable, Affordable, Fair, and Efficient [SAFE] National Flood Insurance Program Reauthorization Act of 2017

S. 1368 , Section 302, would have established that the total amount of FEMA reimbursement paid to WYO companies could not be greater than 22.46% of the chargeable premium for such coverage. S. 1368 , Section 303, would have required FEMA to develop a fee schedule based on recovering the actual costs of providing Flood Insurance Rate Maps (FIRMs) and charge any private entity an appropriate fee for use of such maps. This requirement would have provided a mechanism by which private insurance companies could contribute to the costs of floodplain mapping in lieu of paying the FPF. S. 1368 , Section 304, would have required FEMA, within 12 months of enactment, to develop a schedule to determine the actual costs of WYO companies, including claims adjusters and engineering companies, and reimburse the WYO companies only for the actual costs of the service or products. S. 1368 , Section 410, would have required FEMA to conduct a study and report to Congress within one year of enactment on the percentage of properties with federally backed mortgages located in SFHAs that satisfy the mandatory purchase requirement, and the percentage of properties with federally backed mortgages located in the 500-year floodplain that would satisfy the mandatory purchase requirement if the mandatory purchase requirement applied to such properties.

S. 1571 , National Flood Insurance Program Reauthorization Act of 2017

S. 1571 , Section 302, would have specified that FEMA may consider any form of risk transfer, including traditional reinsurance, catastrophe bonds, collateralized reinsurance, resilience bonds, and other insurance-linked securities. S. 1571 , Section 303, would have required the federal banking regulators to conduct an annual study regarding the rate at which persons who are subject to the mandatory purchase requirement are complying with that requirement. Section 303 would also have required FEMA to conduct an annual study of participation rates and financial assistance to individuals who live in areas outside SFHAs.