FEMA’s Risk Rating 2.0: Property Owner Impacts

FEMA’s Risk Rating 2.0: Property Owner Impacts

“The FAIR Foundation applauds FEMA’s efforts to modernize the National Flood Insurance Program and move toward offering more actuarially sound rates through Risk Rating 2.0. That being said, it is critical that consumers are educated about this coming change, its impacts, and that Congress considers the affordability of these reforms.” – FAIR Foundation President, Paul Handerhan

Author: Taylor Handerhan        

Date: August 13, 2021

FORT LAUDERDALE, FL: The biggest flood insurance rating change in 50 years is coming to an often-misunderstood government program.  The National Flood Insurance Program (NFIP) is a government funded program under the Federal Emergency Management Administration (FEMA). The NFIP was enacted in 1968 to provide insurance coverage for emergency flood disasters of qualifying communities.  Over the years, the NFIP’s debt has taken an unmeasurable toll on the program’s solvency.  Therefore, the NFIP is now taking steps to implement Risk Rating 2.0 to increase its solvency and modernize its program’s offerings. Risk Rating 2.0 is the NFIP’s newest and most advanced insurance rating reform that will move towards requiring policyholders to pay an actuarial indicated rate based on the unique risk variables of the individual properties being underwritten. Risk Rating 2.0’s proposed structure will modernize the NFIP, improve opportunities for stakeholder communications, and increase competition to support market stability for both private and public flood insurers.  FEMA recently announced that the implementation of the NFIP’s Risk Rating 2.0 is planned for October 2021 for new policyholders and April 2022 for existing policyholders.

 

Within the NFIP’s Risk Rating 2.0 reforms, several innovations have been stress-tested and prepared for implementation to modernize the program’s operations.  Some of the most impactful modernization reforms include utilizing advanced catastrophe models to better predict property damages and a new rating methodology that bases the NFIP’s insurance rates on a property’s unique risk variables versus the historical binary flood insurance rate mapping.  Although FEMA has decades of valuable claim’s data, Risk Rating 2.0 will be supplementing that historical data with the latest advances in catastrophe modeling and actuarial science.[1]  Those technological advancements in catastrophe modeling will incorporate multiple risk variables that will provide greater accuracy in predicting flood damage assessments and will result in more equitable insurance rates for policyholders.  For NFIP policyholders, Risk Rating 2.0’s new ‘Equity in Action’ initiative will replace the historical rating methodologies that have not comprehensively considered a property’s unique risk variables.  For many decades, flood insurance policies have been using outdated methodologies to underwrite a property’s risk and replacement cost value, which often resulted in owners of lower-valued properties paying a higher share of the NFIP’s insurance premiums than the owners of higher-valued properties.[2]  The Equity in Action initiative will more fairly allocate NFIP policyholder’s flood insurance premiums based on a properties’ unique risk variables.

 

In addition to greater insurance premium equity, Risk Rating 2.0’s technological innovations will also improve communications with stakeholders.  These advancements in stakeholder communications will benefit both policyholders and insurance agents.  NFIP policyholders are often confused about their properties’ flood risk and how performing different mitigation projects could positively impact their risk profile and insurance premiums. This is in part, because of the lack of clear communication and direction from the program.[3]  Fortunately, the newly advanced catastrophe models being utilized by the Risk Rating 2.0 initiative will have the ability to show a visual representation to insurance agents and policyholders about their properties unique risk profile.  As a result, communicating the value of performing mitigation projects to policyholders will be more transparent under the program.  This ability for insurance agents to better communicate a policyholder’s risk profile and associated insurance premiums, will help the insurance agent sell more policies.[4]  This will make the sales process more attractive for insurance agents to offer and bind NFIP flood policies, and help them scale and grow their insurance agencies. These factors working in combination with consumer’s increased knowledge and understanding of their flood risk will result in greater flood insurance adoption across the country.

 

While Risk Rating 2.0’s improved stakeholder communications will benefit both insurance agents and policyholders, having a strong private and public flood insurance marketplace will ultimately result in greater competition of insurance product offerings and services.  Currently the NFIP has set policy coverages that are not as broad or as flexible as those coverage offerings available within the private flood insurance marketplace.[5]  The competition that Risk Rating 2.0 will create between private and public flood offerings, will likely result in even broader coverage than what is currently being offered by private flood insurance products. Consequently, solely competing on price will increasingly become less of a competitive advantage for private flood insurance products after the implementation of the Equity in Action initiative.  Ultimately, Risk Rating 2.0’s innovations in data analytics and flood risk modeling will converge the private and public insurance markets into offering very similar rating and insurance premium allocation methodologies based on a property’s unique risk variables.[6]  Utilizing advanced data analytics will provide greater rating accuracy, support insurer solvency, and enhance overall market stability.

 

While much of the updates to the NFIP bring welcome changes, the program has been an emergency lifeline for more than five million policyholders.  In updating the NFIP’s premium rating methodology through Risk Rating 2.0’s, Equity in Action, 77% of these 5 million policy holders will see their premium rates increase, and only 23% will see their premium rates decrease.[7]  This raises questions of affordability for many policyholders who may not be able to afford these premium increases.[8] This is especially critical when considering the fact that natural disasters disproportionately impact our society’s most vulnerable populations (i.e., low income, BIPOC, etc.). Therefore, for those individuals who truly cannot afford increased insurance premiums, Congress can and should create a means tested affordability program to subsidize and protect our most vulnerable populations.

 

The rating methodology based on Risk Rating 2.0’s, Equity in Action initiative will propel the flood insurance market towards broadly implementing the latest advancements in catastrophe modeling to establish actuarily indicated rates based on a property’s unique risk profile.  Additionally, the utilization of catastrophe models to accurately represent flood risk numerically and visually will improve the communication of flood risk down to the policyholder level, and make the process of explaining and underwriting flood insurance more streamlined for insurance agents.  Furthermore, establishing a more risk-based flood insurance market should result in a broadening of coverage options offered by both private and public flood insurers over time.  The aggregate impacts of Risk Rating 2.0 will improve awareness as to a property’s true flood risk, and better position policyholders to make informed decisions about their risk transfer needs, which will ultimately support the public policy goals of improving NFIP solvency and narrowing the insurance protection gap.

 

[1] “Risk Rating 2.0: Equity in Action.” FEMA.gov, www.fema.gov/flood-insurance/risk-rating.

[2] “Risk Rating 2.0: Equity in Action.” FEMA.gov, www.fema.gov/flood-insurance/risk-rating.

[3] Rossi, Joe. “Equity in Action: Why Risk Rating 2.0 Will Change the Industry.” Independent     Agent Magazine, Independent Insurance Agents & Brokers of America, Inc., 1 July 2021, www.iamagazine.com/magazine/issues/2021/june/equity-in-action-why-risk-rating-2-0-will-change-the-industry.

[4] “NFIP Risk Rating 2.0.” Risk Rating 2.0, www.selective.com/agents/flood-agents/risk-rating selective.

[5] Mary Van Keuren. “Private Flood Insurance vs NFIP.” Coverage.com, 21 July 2020,  www.coverage.com/insurance/home/private-flood-insurance-vs-nfip/.

[6] Diane P. Horn, ‘National Flood Insurance Program: The Current Rating Structure and Risk Rating 2.0’, Congressional Research Service, 4 June 2021,7, https://crsreports.congress.gov/product/pdf/R/R45999.

[7] “Risk Rating 2.0: Equity in Action.” FEMA.gov, https://www.fema.gov/sites/default/files/documents/fema_risk-rating-2.0-national-rate-analysis.pdf

[8] “Kennedy: Biden RAISING Flood Insurance Premiums at Worst Possible Time.” U.S. Senator John Kennedy, 20 May 2021, www.kennedy.senate.gov/public/press-releases?ID=CC5C73A7387D-46C4-9C07-BA08E8B490D1.