By Jared Council
For about a year, Michael McShane and Diane Horn have been studying flood insurance issues, mainly looking at what the U.S and the U.K. can learn from each other.
McShane is an Old Dominion University associate professor of risk management and insurance, and Horn is a professor of physical geology at Birkbeck College at the University of London.
In the U.S., flood coverage is only available through the federal government's National Flood Insurance Program, which is about $28 billion in debt. In the U.K., the private insurance market covers flood damage, but increasingly frequent flood events have prompted discussions for changes.
Despite the challenges, each country has practices that might be beneficial to the other, McShane and Horn said. The two presented their findings last month at an international conference at ODU and answered questions in an interview.
What do rising sea levels mean for flood insurance rates, and who are the stakeholders who will be impacted by those rising rates?
McShane: The rising sea levels will eventually lead to rising rates, but as of right now, rising sea levels are not even factored into the rising rates. The rates are going up now because of the Biggert-Waters Flood Insurance Reform Act of 2012, which is designed to get the rates up to what the risks currently are.
Anybody, especially in a coastal area, is going to be affected by these rates, particularly areas that are prone to hurricanes and storm surges. So businesses and homeowners are going to be affected. Coastal developers are going to be affected because if the rates go up to where it's truly risk-based, it's going to be a lot more expensive to own property on the coast. So if people are buying property from the developer, they're going to have to factor in the cost of flood insurance. In addition to asking how many rooms it has, they're also going to ask what flood zone is it in and how much is the flood insurance going to cost per year.
For municipal governments, once the rates are risk-based it should slow down development in the coastal areas. Governments depend on property tax revenues, so if there is less development eventually that's going to reduce the tax revenues. For the federal government, the reason they are raising rates in this new flood insurance reform act is because rates have been subsidized too low and the program is about $28 billion in debt. Under the new act, if your rates have been subsidized, rates could go up 25 percent a year until they reach the risked-based rates.
Horn: In both countries, any place that's already at risk of flooding is just going to have a worse risk of flooding as sea levels rise. Any place at risk of erosion is going to have a worse risk. In neither country have people in the highest flood-risk zones actually been paying the true price of insurance. They've been subsidized.
Here in the U.S., they've been subsidized by the taxpayer through the NFIP. In the U.K., because it's entirely private, the subsidies are not explicitly known, but they're actually coming from people who don't live in high flood-risk zones and probably from other perils that are in the same policy. So your fire insurance is subsidizing your flood insurance.
In both countries, because of big floods relatively recently, they're trying to move to a proper risk-based pricing. It's not going to happen as quickly in the U.K.; they're talking about doing it in 20 to 25 years. So it may not be as painful as it is here where premiums are going up by 25 percent every year. The only possible way that people's rates might not go up is as the (floodplain) maps get better, there may be some people who were in a flood zone and then come out as the maps get more detailed. We're already starting to see that happen. But for most people, the rate will be going up in the foreseeable future until they reach a proper level of risk-based pricing.
Explain the study you two have been working on, including what prompted it.
McShane: It was prompted by the ODU Climate Change and Sea Level Rise Initiative that was proposed, advocated and pushed by the president. The goal was to bring people together from all different disciplines. We academics usually work in our own silos, but this was an issue that required people to work across disciplines. So the provost agreed to fund Diane to come over for five weeks in the summer for us to work on flood insurance research.
We started by comparing the U.S. and the U.K. and we found that in almost every way flood insurance can be different in a country, the U.S. and the U.K. are opposites. We found that some of the things the U.K. does are better and some things that we do are better, and then we've come up with what we think would be the ideal flood insurance program.
Horn: We started with the assumption that the big difference was that the U.S. was entirely public and the U.K. was entirely private. And we found that they both changed very dramatically in the 1960s in response to floods, and they went in the opposite direction from the way you would expect. You would have expected for the U.S. to go for a private solution and U.K. to go for a public solution. But instead, they went in the opposite direction. And they continued fairly successfully until a couple of big floods caused problems. Here it was Hurricane Katrina. In the U.K., they had a series of floods in the 2000s - 2007 in particular was the big one. So in both cases, the main people running the scheme started to show that it wasn't sustainable. Private insurers in the U.K. wanted the government to get involved. Here, they wanted to find some way of reducing the government's exposure.
What did you find?
Horn: We found that the big difference between the U.S. and the U.K. isn't whether the system is public or private. Really the big difference is whether there's a way to ensure that most people have flood insurance. In both cases it's linked to the mortgage, but in the U.K. it seems to be enforced. About 91 percent of homeowners who have mortgages have insurance. And there, flood insurance isn't a separate policy; it's bundled in with the others. That seems to be the key.
In the U.S. if you have a choice about whether or not to buy flood insurance, it looks like a lot of people choose not to. If you don't have a choice, then people do it. That seems to be the really big difference.
McShane: So in the U.K., if you buy a homeowner's insurance policy, it covers fire damage and wind damage, and flood is just one of the perils it covers. In the U.S. it's a completely separate policy. So we have a much lower penetration of flood insurance in the U.S. because in most cases it's optional whereas in the U.K., it's part of your homeowners insurance.
So would that be a good direction for the U.S. to move toward?
McShane: We're saying so, if the U.S. wants to overcome a lot of the problems it has. The problem in the U.S. is the only people who are required to buy flood insurance are certain people in high-risk areas. Any insurance scheme like that is going to break down because insurance depends on having a lot of low-risk policy-holders together with a few high-risk policy holders in the same risk pool. But in the NFIP it's mainly high-risk people that buy it and that's one of the reasons the program is $28 billion in debt. No private insurance scheme would survive that, but the U.S. can survive it because it can borrow the money from the U.S. Treasury. So [adopting some U.K. practices] would solve a lot of problems.
Another problem it would solve is, after events like Katrina or Superstorm Sandy, people thought flooding was covered by their homeowner's policy. So there's a lot of confusion in having two policies. Having it as one single policy would solve a lot of problems in the U.S.
What impact would one policy have on private insurers? It's been reported that after Katrina, private insurers had a tough time deciphering which claims were flood-related - and therefore not covered - and which claims weren't.
Horn: That's exactly right. You're talking about these "slab suits" after Katrina. People just came back and there was nothing left but a slab and they didn't know what brought it down. If it was wind that brought it down, it was [covered by] their homeowner's policy. If it was water, then it was [covered by a] flood insurance policy. So to that extent, bundling would help. I don't know whether the insurers would want that because they'd be picking up much bigger risks than they're bearing at the moment.
McShane: After Katrina and Sandy, it was almost impossible to know if wind knocked down a house first or did the storm surge later knock it down? And, of course, there's billions of dollars at stake, so there's a lot of contention between the NFIP and private insurers about what caused it because that determines who's going to pay for it. And that delayed a lot of flood damage claim payments going to those disaster areas. So just by themselves, the regular insurers got out of flood insurance a long time ago because it's a huge risk and they would need at least some federal backstop from the government.
The way terrorism insurance is handled is that private insurers take on that risk, but once they reach a certain number of losses, the government comes in and pays the rest. So we would think there has to be some kind of private-public partnership on something like flood insurance. The private insurers are not going to want to do it on their own.
Are there any drawbacks to bundling?
Horn: Well, in the U.K., people don't really know what proportion of the premium they're paying relates to flood. It doesn't matter because the policy doesn't distinguish between wind and water. But what happens is a lot of people may not know they're in a flood risk zone until their property floods. If you're near a river or the coast, you might know it, but there's no legal requirement to disclose flood risk or to buy flood cover, and real estate agents don't have to give purchasers any information on that. So with some of the floods we saw in 2007, a lot of people didn't realize that their property was prone to flooding until it actually did.
What can the U.K. learn from the U.S.?
Horn: The thing that the U.S. does that the U.K should be doing is here there's a link between flood insurance and floodplain management. So the community rating system is a way that communities, as they improve the way they deal with floods, can help send individual premiums down. If people do things to make their properties more resilient, it can also help them with discounts for flood insurance.
In the U.K., there's absolutely no link at all between flood plain development and flood insurance. In fact, there's no way you can stop someone from building on a floodplain. The central government provides guidance but not regulations. That's something where everyone is a little bit surprised: Even though they're moving to a completely new flood insurance scheme now, there's no link between building on the floodplain - how many buildings, the way they're built - and flood insurance. And individuals, even if they made their property more resilient, don't get a discount for doing that.
Are the rising flood insurance rates in the U.S. intended to lower the $28 billion debt to make sure that it doesn't get worse?
McShane: Well, they definitely don't want it to get worse. But they're hoping to have a surplus to pay down that debt. So I think it's to serve both purposes. We haven't really had a category one storm recently - Sandy, by the time it hit, had been lowered to a tropical storm. It wasn't even hurricane-strength. But if we had a category one, two or three storm hit an area that was rich in assets, it'll probably cause it to go up again.
Describe how the conversation about sea level rise has been lately in the U.K. How big of an issue is it there?
Horn: I think people have focused on floods, in general, since there have been a series of floods. Ironically, the U.K. went through a period of time from 1953 to 1998 where there were virtually no floods. The last major coastal flood was in 1963, and then there were some minor local ones. But they didn't start having big ones with big insurance payouts until 1998, then 2000, then 2007 and then last year.
I think there's still more discussion about floods in non-coastal locations than the implications of sea level rise. I think most people are aware that sea level is rising. And the place that would be most at risk is London, but the view is that the Thames Barrier would protect London for at least the next 50 years. So at some point they're going to have to think about doing something, but the general feeling now is that there are some coastal communities that are eroding that are probably going to be allowed to erode, but that the most important places are protected and will be protected for quite a while.
What is being done in the Netherlands? And are there any countries that have a hybrid - public/private - approach to flood insurance?
McShane: The U.S. is probably the most public system and the U.K is probably the most private system that we've seen. In the Netherlands, what they've done is focus on flood defenses. So they have a relatively minimal flood insurance program because they've built dikes and other structures that are supposed to protect from 10,000-year floods. So their goal has been protection. And it's a small country, so it's easier to do it. I think they do have flood protection for things like flash floods, things that don't come from storm surges.
Horn: In both the Netherlands and the U.K., the way they developed was in response to these 1953 floods. It was a storm surge that hit on Feb. 1, 1953. Three hundred-eight people were killed in the U.K., and 1,850 people were killed in the Netherlands. As a result, the Netherlands started working on the Rhine Delta Work project. Like Michael said, they're protecting against the 1-in-10,000-year flood. They basically have a policy that they're going to stabilize the coast where it is.
The U.K. spent a lot of time debating what to do and about 20 years later started working on the Thames Barrier, which protects against the 1-in-1,000-year flood. The Thames Barrier was built to protect Central London. If there's a storm surge coming, they raise the gates and basically block the tide from coming in for about three hours and lower it. It was finished in 1976 and the anticipation was it would probably have to close five or six times a year. Now it's getting to the point where they think that fairly soon they may not be able to close it every time they need to - they may not be able to close it for river flooding - to keep it functioning. It's certainly been closed increasingly frequently. And some of that seems attributed to climate change, both from increased rainfall and river flooding and also from storm surges and rising sea level.
Can the U.S. and the U.K. learn anything from the Netherlands, and can a defense-heavy approach be practical?
Horn: For a few locations, yes. I mean the Netherlands is a small country, it's densely populated, it's a wealthy country and they don't have anywhere to retreat to. I think a place like London needs to be defended. It's easy there because they can just put a barrier across the Thames. If you don't have the right geography, finding a location to put a barrier in becomes much trickier.
McShane: In the U.S. it's a bit more difficult. It's a big country and there's so much coastal exposure. But I've heard it proposed to do something to protect New York. And a lot of big engineering companies from the Netherlands like Fugro NV are working with New York on whether that's feasible. In the U.S. I think it would be kind of an intense political issue. If we spent $50 billion to put a big barrier around New York, but it had to be paid from general taxpayer funds, people from Oklahoma and those areas might question why their money should go toward something that doesn't protect them. That type of political issue might limit the U.S., whereas in the Netherlands, the country is small and most have some close relations to the sea.
Horn: Locations that are dangerous will have to be protected, so in the U.K there are a lot of nuclear power plants on the coast, and those are going to have to be defended. They don't have sea walls anything like Japan does, but they're going to have to do something as seal level rises and they're still planning to build more on the coast. So there are some locations that are too expensive to let go - like London - some that are too dangerous - like nuclear power stations - and others where we're going to have to find a way of living with the flooding.
Some initiatives in South Hampton Roads cities involve raising freeboards, or the space between finished floors and the federally determined 100-year flood level. What impact would higher freeboards have and is it enough to offset rising risks and rising insurance costs?
McShane: That is a big issue because houses have to be built to certain elevations. That definitely helps reduce the risk. Diane has a great photo she's showing me that we plan to use in our presentation. It's about Texas before and after Hurricane Ike. On one side of the road there are these houses up on stilts, and on the other side where they didn't elevate, it's just slabs.
Horn: It wasn't entirely elevation. These were pilot studies from the Institute for Building and Home Safety, and they built them stronger too. But at the end of Hurricane Ike, these were the only buildings left standing.
McShane: So if you do want to maintain an area and keep houses there that are subject to frequent flooding that's only going to increase, elevating the houses is one way to do it if you don't want to retreat. And that is the biggest discount that flood insurers will give you for elevating your house. I just heard an interview on NPR a couple days ago about how in New York, a lot of people are starting to want to do that after Sandy. There are two companies that have elevated homes there over the last 50 years and suddenly there are about 16 companies that are advertising that they'll elevate your house. So it seems to have become a growth industry. The problem is, some of these people are just getting in and they don't really know that much about it. But any time there's that type of economic opportunity and there's a shortage of companies that know how to do it, all kinds of companies get into it when the money starts flowing.
Could you summarize the solutions to improve the U.S. and the U.K.? I suspect not everyone will be entirely happy, but what might that look like?
McShane: The main one is about bundling flooding with other coverage. If you want to get near 100 percent coverage and solve a bunch of other problems, then bundling flood with other perils will help. And there's one thing that we haven't mentioned yet. In the past year, there's been intense debate. In the U.S., Congress passed Biggert-Waters. In the U.K., it's not decided yet but the preferred solution seems to be this thing called "Flood Re." Under this, all the low risk property-owners will pay an extra $15 to $20 per year on their policies - a higher amount, but nothing to scream about - to help subsidize the people that are going to be paying high rates. In the U.S., that could have good implications. There are some desirable flood-prone areas on the coast and if rates go up too high, only the wealthy will be able to afford the rates and have coastal property.
There are other areas that are flood-prone that are less desirable like the Lower 9th Ward in New Orleans. So if low-income people aren't able to afford the high insurance rates, they might not be able to sell their property and abandon it. That causes all types of issues, including lower tax revenues.
So the idea is these rates are going up in the U.S. and it might cause some social issues. The question is does some subsidization need to occur? The U.S. might think about something similar to [Flood Re]. Most people aren't in the flood zone, so maybe they could pay $15 to $20 a year to subsidize people in the high risk areas. But you've got to be careful about that because you don't want to subsidize too much. You want rates to reflect the amount of risk people are taking on.
Horn: The U.K. is moving to a completely new system for flood insurance. The insurance industry and the government have been discussing this for five years and they've finally put forward a proposal in June of this year and now they're going through a consultation process. One of the things they're doing is passing the cost of higher risk properties to other policy-holders. The insurers are also going to be kicking in quite a bit as well, depending on their share of the market.
What hasn't happened is there hasn't been any consideration of sea level rise, climate change and what would happen if you build more on the floodplain. And critically, the government still plays no role in this. Basically, the insurers have to pay out up to a 1-in-200-year event. That's about 2.5 billion pounds [or $4 billion]. If they have a bigger flood than that, nobody knows what would happen; the government hasn't said if they would step in.
Politically, it seems unlikely that if there were a flood that big the government would just stand by and not do something. But the government is not taking on any responsibility at this point. It's all down to either the insurance companies or the individual policy-holders. So I think that's where the U.K. could learn something from the U.S.: That the government has to play a role. Part of the role is going to be putting some money into the pot if necessary. And part of that role is regulating and controlling what types of things are built on the floodplain.