Adding Wind to Federal Flood Insurance Invites Trade-Offs

May 6, 2008

Adding wind coverage to the current federal flood and wind insurance program could benefit some policyholders and market participants but would also involve trade-offs, says a new government report.

While current legislation to add wind to the flood program would require premium rates to be adequate to cover any exposure and restrict borrowing by the program, the potential exists for losses to greatly exceed expectations, as happened with Hurricane Katrina in 2005, according to the Government Accountability Office (GAO). This could increase FEMA’s total debt, which as of December 2007 was about $17.3 billion.

A new federal flood and wind program could reduce the exposure of some insurers by insuring high-risk properties that currently have private sector coverage. However, an unknown portion of the exposure currently held by state wind programs—nearly $600 billion in 2007— could be transferred to the federal government, the GAO reports.

H.R. 3121, the Flood Insurance Reform and Modernization Act of 2007, would create a combined federal insurance program with coverage for both wind and flood damage. Congress asked GAO to evaluate this potential program including the steps the Federal Emergency Management Agency (FEMA) would need to take to determine premium rates that reflect all future costs and how it might affect policyholders, insurance carriers and the federal government.

In one trade-off, not requiring adjusters to distinguish between flood and wind damage could reduce both delays in reimbursing participants and the potential for litigation, the GAO found. However, borrowing restrictions could also leave property owners without coverage after a catastrophic event.

In addition, the proposed coverage limits are relatively low compared with the coverage that is currently available, potentially leaving some properties underinsured.

Setting premium rates adequate to cover all the expected costs of flood and wind damage “would require FEMA to make sophisticated determinations,” adds the report. For example, FEMA would need to determine how the program would pay claims in years with catastrophic losses without borrowing from the Department of the Treasury. H.R. 3121 would require the program to stop renewing or selling new policies if it needed to borrow funds, effectively terminating the program.

The GAO report raises questions about reinsurance under a new program, maintaining that it is “unclear” whether the program could obtain reinsurance to cover losses. But attempting to fund losses by building up a surplus would potentially require high premium rates.

Further, the GAO adds, FEMA would need to account for the likelihood that participation would be limited and only the highest-risk properties would be insured. “These factors would further increase premium rates and make it difficult to set rates adequate to cover future costs,” the report says.

Source: Government Accountability Office

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