Flood insuranceTying insurance rates to flood risk for low-lying structures

Current methods used by the National Flood Insurance Program for setting risk-based insurance rates do not fully capture the flood risk for low-lying structures, which are more likely to incur losses because they are subject to longer duration and greater depth of flooding and are flooded more frequently and by smaller flood events, says a new report from the National Research Council. The report offers alternative approaches for calculating risk-based premiums for these structures, ranging from incremental changes to current methods to a complete overhaul of the system, although it does not recommend which approach the NFIP should adopt or what the new rates should be.

The NRC says that NFIP currently assesses flood risk in terms of the probability and depth of flooding, the economic value of the assets subject to damage, the vulnerability of the structure, and the performance of flood protection and mitigation measures. This information is combined to calculate the average annual loss, which is then converted into insurance rates for classes of structures that share similar characteristics.

However, structures that existed in low-lying areas before floodplain maps became available receive subsidized rates that do not reflect the actual risk of flooding, and therefore have lower premiums. The Biggert-Waters Flood Insurance Reform Act of 2012 and subsequent legislation require these subsidies to be phased out, which will result in substantial premium increases for nearly one million of the 5.5 million NFIP policies nationwide. In particular, these rate hikes will affect “negatively elevated” structures, whose lowest floor, including the basement, lies below the NFIP benchmark for construction standards and floodplain management.

The report offers seven possible incremental changes to current methods to more accurately determine risk-based rates for these structures:

• Use information from existing detailed flood studies to better define the water surface elevations for frequent floods;
• Calculate the average annual loss component of the flood insurance rate using local rather than national flood hazard data;
• Research which drivers of flood damage beyond inundation depth, such as flood duration, water contamination, and debris content, are most important and develop an appropriate damage prediction function for calculating rates;
• Build a large set of flood damage reports from relevant agencies and use it to adjust damage estimates annually;
• Assess the ability of levees to prevent inundation of negatively elevated structures by frequent events;
• Discourage deliberate underinsurance and compensate for it, for example, by tying the underinsurance adjustment to the replacement cost of the structure, reducing loss payments or imposing penalties for severely underinsured structures;
• Adjust deductible discounts or increase minimum deductibles to reduce high risk-based premiums.

Alternatively, NRC says, NFIP could develop and use a comprehensive risk assessment to improve estimates of flood loss and the accuracy and precision of rates, the report says. This approach would describe risk over the entire range of flood hazard conditions and flood events, including large, infrequent floods that cause substantial losses and smaller, frequent floods that make up a significant portion of loss to negatively elevated structures. A comprehensive risk assessment would determine flood hazard for individual structures by modeling watershed and floodplain characteristics at fine spatial scales; it would describe the varying levels of protection offered by all elements of a flood protection system and mitigation measures; and it would account explicitly for uncertainties, including those related to current and future flood hazard, structure value and vulnerability, and the current and future performance of flood protection measures.

Regardless of whether NFIP makes incremental changes or takes on a new approach, collecting supporting data is crucial for implementing risk-based premiums for negatively elevated structures, the report says. Data needs include structure elevation, inundation depth for frequent flood events, and information on the characteristics of insured structures, such as basement usage, properties of the foundation, architecture, interior and exterior finishes, and construction quality.  In addition, improvements in the quality of NFIP claims data are needed to increase the accuracy of flood loss estimates.

The report says that some of the suggested changes to methods for determining risk-based premiums are already being implemented by other organizations, demonstrating that the changes are feasible and could be implemented quickly at low or moderate cost. A comprehensive risk assessment would provide greater improvements in flood loss estimates, but would take longer and cost more to implement.  Either approach would improve the accuracy of flood loss estimates and lead to insurance rates for negatively elevated structures that are more credible, fair, and transparent to policy holders, the report concludes.

The study was sponsored by the Federal Emergency Management Agency.

— Read more in Tying Flood Insurance to Flood Risk for Low-Lying Structures in the Floodplains (National Academies Press, 2015)