I had the pleasure of serving on a National Academies committee the past two years. Our report entitled “Tying flood insurance to flood risk for low-lying structures in the floodplain” was just released [Link].
If you don’t know much about the National Academies, it is a private, independent, nonprofit institution that provides technical expertise to important societal problems (engineering, in my case). The National Academies committees like the one I participated in address a specific challenge and has a very specific charge. The committee is composed of a bunch of really smart people who work together to answer the questions posed in the charge. FEMA provided the charge for my committee.
The specific charge is below, but a bit of background is necessary to know why the problem is so important and was it had to be addressed now. Recently, I blogged about floods and their huge impact on society [Link]. After a series of hurricanes that caused extensive flood damage to properties, the National Flood Insurance Program (NFIP) was created (in 1968) to reduce the risk of flood and mitigate flood damage by encouraging better flood management and building practices. The idea was that homeowners in flood-prone areas (“Special Flood Hazard Areas” – areas with an annual chance of flooding of 1% or more) would have to pay for flood insurance to help pay for the cost of disasters. Today, most homeowners in Special Flood Hazard Areas pay the going rate based on an elaborate formula set by FEMA. There are currently about 5.5 million flood insurance policies.
Those houses that already existed in a Special Flood Hazard Area in 1968 could be grandfathered into the program and receive subsidized rates. Over time, the hope was that these existing houses in Special Flood Hazard Areas would be replaced, thus reducing exposure in flood-prone areas. But they were not. They continue to exist and are expensive for FEMA when disasters strike. This is a huge problem. FEMA’s insurance premium formula as well as risk-based actuarial rates are incredibly sensitive to the elevation of the home relative to base flood elevation. These homeowners may pay $200 for a flood insurance premium per year when a risk-based actuarial rate may thousands of dollars. These houses are negatively elevated, meaning that they are below base flood elevation and flood frequently. There are a lot of these structures out there and they are costly to FEMA.
The Biggert-Waters (BW) Flood Insurance Reform Act of 2012 required these subsidized policies to disappear overnight, turning this important problem into an immediate problem. Subsequent legislation changed some of this, but the bottom line was that subsidized rates would rise, substantially for some. FEMA wanted a review of how they set their rates to be credible, fair, and transparent. That is where the committee came in.
Here is our study charge set by FEMA. In our conversations with FEMA actuaries, FEMA asked for shorter-term (within 5 years) and longer-term recommendations for improving their methods. FEMA asked us to look at how premiums are set and how the process could be improved. We focused on the math; another committee addressed the societal impact of the changes.
An ad hoc committee will conduct a study of pricing negatively elevated structures in the National
Flood Insurance Program. Specifically, the committee will:
- Review current NFIP methods for calculating risk-based premiums for negatively elevated structures, including risk analysis, flood maps, and engineering data.
- Evaluate alternative approaches for calculating “full risk-based premiums” for negatively elevated structures, considering current actuarial principles and standards.
- Discuss engineering, hydrologic, and property assessment data and analytical needs associated with fully implementing full risk-based premiums for negatively elevated structures.
- Discuss approaches for keeping these engineering, hydrologic, or property assessment dataupdated to maintain full risk-based rates for negatively elevated structures.
- Discuss feasibility, implementation, and cost of underwriting risk-based premiums for negatively elevated structures, including a comparison of factors used to set risk-based premiums.
We constructed ten conclusions:
- Careful representation of frequent floods in the NFIP water surface elevation–probability functions (PELV curves) is important for assessing losses for negatively elevated structures.
- Averaging the average annual loss over a large set of PELV curves leads to rate classes that encompass high variability in flood hazard for negatively elevated structures, and thus the premiums charged are too high for some policyholders and too low for
- NFIP claims data for a given depth of flooding are highly variable, suggesting that inundation depth is not the only driver of damage to structures or that the quality of the economic damage and inundation depth reports that support the insurance claims is poor.
- When the sample of claims data is small, the NFIP credibility weighting scheme assumes that U.S. Army Corps of Engineers damage estimates are better than NFIP claims data, which has not been proven.
- Levees may reduce the flood risk for negatively elevated structures, even if they do not meet NFIP standards for protection against the 1 percent annual chance exceedance flood.
- When risk-based rates for negatively elevated structures are implemented, premiums are likely to be higher than they are today, creating perverse incentives for policyholders to purchase too little or no insurance. As a result, the concept of recovering loss through pooling premiums breaks down, and the NFIP may not collect enough premiums to cover losses and underinsured policyholders may have inadequate financial protection.
- Adjustments in deductible discounts could help reduce the high risk-based premiums expected for negatively elevated structures.
- Modern technologies, including analysis tools and improved data collection and management capabilities, enable the development and use of comprehensive risk assessment methods, which could improve NFIP estimates of flood loss.
- Risk-based rating for negatively elevated structures requires, at a minimum, structure elevation data, water surface elevations for frequent flood events, and new information on structure characteristics to support the assessment of structure damage and flood risk.
- The lack of uniformity and control over the methods used to determine structure replacement cost values and the insufficient quality control of NFIP claims data undermine the accuracy of NFIP flood loss estimates and premium adjustments.
You can read more about our report and its conclusions in the press release.
The committee was composed of 12 members and included civil engineers, risk analysts, actuaries, and one retired FEMA employee. Our fearless chair David Ford did a lot of the heavy lifting in terms of crafting our core conclusions. National Academies staff member Anne Linn was incredibly helpful in terms of getting us focused, staying on track, and writing the report. National Academies staff member Anita Hall did the logistics and was incredibly responsive to our travel needs. The committee met in person four times and wrote parts of the report. The report was sent out to reviewers, and we changed parts of the report in response to reviewer comments much like in a peer-reviewed journal. We couldn’t have done this without David and Anne (many thanks!)
Serving on the committee helped me understand the importance of flooding from many possible perspective. I bought a new house during the my time on the committee. My new house is on the top of a ridge with virtually no chance of flooding.
Serving on the committee also helped me to learn about state-of-the-art techniques in civil engineering and risk-based insurance. Our colleagues in other fields do some pretty cool things, and we can all work together to make the world a better place. I’m proud of our final report – I hope it leads to more credible, fair, and transparent NFIP flood insurance premiums.