Risk Rating 2.0: An Overview of Stakeholders

Since the publishing of this blog post, we've written a bit more about Risk Rating 2.0's methodology documentation. You can view our latest post here.

We are a little more than half a year out from the rollout of Risk Rating 2.0 that is scheduled to go into effect October 1, 2021. While not much has changed publicly regarding Risk Rating 2.0 since our last blog post on the topic, the conversation has continued to evolve. The Risk Rating 2.0 space is complicated with several stakeholders that, at times, hold competing interests. In this blog post we review the concerns and goals of these stakeholders each of whom play a critical role in the U.S. flood risk ecosystem.

FEMA

The Federal Emergency Management Administration is the driving force behind Risk Rating 2.0. In short, risk Rating 2.0 is the largest change to occur to the National Flood Insurance Program (NFIP) since its inception in 1968. The reasons for this overhaul are many. Since the NFIP was established in the late-60s much has changed. Namely, our scientific understanding of flooding and climate change, the ways we can quantify and visualize risk, as well as the physical geography of the country have all undergone drastic transformations.

The goal of Risk Rating 2.0 is to bring the NFIP into the twenty-first century. According to FEMA, Risk Rating 2.0 will create, on a structure by structure basis, “rates that are fair, make sense, are easier to understand and that better reflect a property’s unique flood risk.” The new rating structure will be similar to what private insurance companies use to rate risk today. This has raised concerns about affordability, particularly in coastal states with high flood risk.

The new premium rates established by Risk Rating 2.0 are scheduled to go into effect on October 1, 2021, for the 5.074 Million NFIP policies across the country. This will do away with the current NFIP rating model which mainly takes into consideration a property's FEMA flood zone and lowest floor elevation compared to the Base Flood Elevation (BFE). Much of the data used to rate insurance premiums is currently provided by Flood Insurance Risk Maps (FIRMs). FIRMs are utilized for both rating flood insurance and for floodplain management regulation enforcement. While they've been central to floodplain management for decades, they are frequently critiqued for a number of reasons:

• FIRMs do not incorporate variables like sea level rise and climate change.
• It takes a long time to update flood mapping and large swaths of FEMA maps are out of date. Among the 166 counties most at risk counties in the US, 17 counties had maps that were 16 years or older. Some maps have been in place for more than 4 decades.
• The maps can be misleading as they don't reflect true vulnerability (As of a 2017, only 42% of issued maps adequately identified the level of flood risk).
• They are relatively binary and not individualized (Homes are either in flood zones or located outside of them. This can create situations across the country where one property might be categorized in an A or V zone (with a more expensive flood insurance policy that corresponds to this risk), and their immediate neighbor might fall on the other side of that boundary in a low or moderate zone (and, consequently, have a relatively low-cost policy).
• FIRM maps define flood zones on a nationwide scale. This is often considered an overly general an approach as a Zone A in flat, coastal Florida is, in many ways, very different from a Zone A in mountainous, interior Colorado. 
  

To remedy these concerns, Risk Rating 2.0 will do away with utilizing FIRM flood zones as a variable to calculate a property’s flood insurance premium. Instead, the variables included in determining the premiums will include structural variables such as the foundation type of the structure, the height of the lowest floor of the structure relative to the base flood elevation, and the replacement cost value of the structure. This creates big unknowns pertaining to the future of FIRMs that, with the rollout of Risk Rating 2.0, will ironically no longer be utilized in determining flood insurance rates. It is generally expected that they will continue to be used to determine mandatory purchase requirements and floodplain compliance, but how that continuity will play out remains to be seen.

Risk Rating 2.0’s implementation might be complicated but a forthcoming Congressional vote, although it is still not clear when this vote will take place. Nonprofit First Street Foundation recently published a study analyzing the cost of flood risk in the United States, which highlighted the relationship between current insurance premiums and the potential damage that may be caused by flooding in the coming years. The study also compared average insurance premiums and what some are speculating may be an estimate of updated premiums under Risk Rating 2.0. Prior to implementation, Bill H.R. 8311 will require a study of Risk Rating 2.0. It is not expected this will disrupt implementation plans but there are concerns amongst several members of Congress that Risk Rating 2.0 will increase the flood insurance rates of their constituents. Coupled with the recent research from First Street, it is possible these concerns get louder in the coming weeks and months.

Private Insurers

The National Flood Insurance Program (NFIP) is the main source of primary flood insurance coverage in the United States, covering over 5 million properties in over 22,500 communities. The creation of the NFIP in 1968 was partially caused by the withdrawal of private insurers from providing flood insurance coverage, which left federal disaster assistance to provide coverage to those impacted by floods. As a result, the private residential flood insurance market in the United States is small relative to the NFIP. A 2018 Wharton Risk Center study estimated that private flood insurance accounts for roughly 3.5 to 4.5 percent of all primary residential flood policies purchased.

Cherry Picking

There is anecdotal evidence suggesting that there is an uneven distribution of low-risk and high-risk properties between private insurers and the NFIP, with private insurers potentially choosing more favorable policies. Insuring properties with a lower likelihood of experiencing loss while passing over higher risk policies is colloquially known as “cherry-picking”. Data points from recent storm events and the payouts indicate that:

• During 2018’s Hurricane Michael, 8% of policies statewide in Florida were covered by private insurers, but private insurers were only on the hook for 3.8% of the claims.
• In 2017 the private-sector insurers provided about 11% of flood coverage in Texas, yet only paid 6.3% of the claims from Hurricane Harvey.
  

This suggests, but in no way proves, that private insurers may be covering less risky and more profitable properties, leaving higher risk properties to be insured by the NFIP. Risk Rating 2.0 might shift this landscape but it is still unclear how the rating system will play out.

Many insurance experts that believe that private flood insurance can complement FEMA, the NFIP, and Risk Rating 2.0 – especially since insurance penetration is relatively low across the country. A 2018 paper found that nearly 41 million Americans live within the 100-year floodplain compared to only 13 million when calculated using FEMA's FIRMs. Different research from First Street Foundation found that there are 14.6 million properties in the 100-year flood zone, far more than the 8.7 million properties shown on FEMA flood maps. Within this context of growing flood risk, advocates of private insurance coverage and FEMA argue that private flood and the NFIP have the ability to work together to increase coverage for all properties subject to flooding.

Property Owners‍

A 2019 Core Logic report found that there are 7.3 million homes, representing an estimated value of $1.8 trillion, along the Gulf and Atlantic Coasts that have the potential for storm surge damage. Currently, the NFIP bases insurance rates on FIRM variables rather than structure replacement cost. This means that the homeowner of a multi-million dollar house might pay the same rate as the homeowner of a $200,000 house with equivalent flood risks, even though the more expensive house would be much more expensive to repair.

A key tenet of Risk Rating 2.0 is making sure that homeowners pay their “fair share” of risk. While this undertaking may make the NFIP more financially sound, it could also make coverage more expensive and less accessible. This is a serious problem for homeowners throughout the country who are short on cash. A 2018 FEMA report found that half of all adults have set aside no more than $500 for an emergency. A different 2018 FEMA research study found that although low income families are more likely to live in high risk zones, they were less likely to purchase flood insurance. A significant body of research also exists that suggests that those with insurance recover more completely and more quickly post-disaster than those without insurance. In the context of our coastal communities, where very high-income and very low-income households can live very close to one another and to water, it's crucial to root conversations about premium changes in dialogue about historic inequalities and distributive justice.

Discussions about Risk Rating 2.0's impacts on residents and homeowners already abound, despite the fact that many of the program's details are unclear. Many organizations have tried to produce estimates using available knowledge – First Street Foundation recently published research that determined average annual expected loss of built structures and compared it with the average premium of municipalities around the country. FEMA has been quick to point out that the impact of Risk Rating 2.0 cannot yet be evaluated by the public, because the methodology has yet to be published. However, First Street Foundation’s research draws attention to the large difference between current premiums and expected annual losses.  The report highlights cities like Charleston, SC (where the Average Expected Loss is $18,211 while the Average Premium is $2,264) and Malibu, CA (where the Average Expected Loss is $121,975 while the Average Premium is $1,534) show a concerning difference between what people are paying in insurance rates and built asset exposure. Furthermore, it was estimated that there are 4.3 million residential homes with substantial flood risk that would result in financial loss. Rates would need to increase 4.5 times to cover estimated risk in 2021, if these homes were to insure themselves against Floodrisk through the NFIP. This number grows to 7.2 times to cover the growing risk by 2051.

An important note is that the limitations on annual premium increases are set in statute. Risk Rating 2.0 will not be able to increase rates faster than the existing limit for primary residences of 5%-18% increase per year. Therefore, rate hikes will be phased in slowly for existing policyholders. Those buying insurance after October 1st will pay the full amount and those that leave and re-enter the program would have to pay the full amount upon their return. While a majority of homes will see their rates capped at 5-18% per year, there are a handful of homeowners who will see their rates rise up to 25% increases per year. These include:

• any residential property which is not the primary residence of an individual
• any severe repetitive loss property;
• any property that has incurred flood-related damage in which the cumulative amounts of payments under this chapter equaled or exceeded the fair market value of such property;
• any property which on or after July 6, 2012, has been substantially improved or substantially damaged.

As of July 2020, business and other non-residential policies accounted for 6% of NFIP policies. Commercial property owners, just like homeowners, will face changes under Risk Rating 2.0. The main difference is that their yearly insurance increase will be capped at 25% compared to the 5-18% for a majority of private homeowners. 

Municipalities and Communities

Municipalities are often the first point of contact for residents looking for information on flood insurance. As a result, floodplain managers and planners working for cities of all sizes are keen to learn more about Risk Rating 2.0, and anxious about what individualized risk means for resident outreach and education. The NFIP's current rate structure, while outdated, is relatively transparent. This enables local governments to communicate potential impact to premiums and changes relatively easily. Questions about insurance can often lead to further conversations about disaster preparedness, mitigation, and adaptation so flood insurance knowledge is a crucial tool for many local governments. The details of Risk Rating 2.0's methodology are largely unknown and many of the floodplain managers we've spoken with have expressed concern over how the shift might impact their ability to promote insurance as a mitigation option. Further, many communities believe that the burden of explaining potential rate increases to upset policy holders will fall on the shoulders of municipalities. In response to this, we have heard that many municipalities have yet to inform their community members on this topic as the municipalities themselves do not have the information or knowledge to respond to questions.

Another concern with the Risk Rating 2.0 rollout is how the CRS cross-subsidy will be affected, but in our informal conversations we have heard that CRS is here to stay. Other pertinent questions that have yet to receive answers are:

• Will Risk Rating 2.0 slow down the already problematic FIRM mapping program now that insurance is decoupled from it?
• How is FEMA going to share Risk Rating 2.0 data with the broader floodplain management community? 
• Will Risk Rating 2.0 shift the landscape for Repetitive Loss Properties?
• Will communities be equipped with the tools necessary to understand how shifts in premium affect changes in their housing markets?

Surveyors

Also affected by the rollout of Risk Rating 2.0 will be Certified Land Surveyors whose main responsibility today is the creation of Elevation Certificates. Elevation Certificates (ECs) are administrative forms developed by the Federal Emergency Management Agency (FEMA) that are used for a range of purposes. They provide elevation information necessary to ensure compliance with community floodplain management ordinances and they are used to determine the proper insurance premium rate. They are generated by Licensed Land Surveyors, Registered Professional Engineer, or Authorized Architects. Most importantly, Elevation Certificates list the elevation of the lowest floor (LFE) of a structure. 

The role of ECs post Risk Rating 2.0 is still unknown but it has been announced that FEMA will use the United States Geological Survey (USGS) 3-D elevation data as a data source to establish rates. For FEMA there are several advantages to be gained by using USGS elevation data rather than EC LFE data. A large majority of homes in the US do not yet have elevation certificates, they are costly to procure ($400 - $1000), and collecting them would require close communication with every municipality. With USGS Elevation data FEMA will centralize this data source decreasing the time, energy, and money it takes to procure it.

While this will make Risk Rating 2.0 significantly more efficient, it remains to be seen how this will impact the business of land surveyors. If homeowners no longer need to obtain ECs for insurance purposes, this could significantly affect the land surveying market of states with many at risk homes such as Florida or Texas. Further, through our conversations with various stakeholders it appears as though not everyone in the surveying business is aware of potential impacts from Risk Rating 2.0.

Looking Forward

Risk Rating 2.0 will be rolled out in a little more than six months. It is expected that between now and October information about rates, price increases, and other expected changes to the NFIP program will slowly trickle out. We will continue monitoring this space and updating this blog post with the relevant developments pertaining to Risk Rating 2.0. We'll also be keeping Risk Rating 2.0 in mind as we continue to build features for our floodplain management platform.

‍This blog post was written by our former research analyst, Kyle Sweeney! If you have any questions about this article or if you'd like to learn more about what we do please reach out to us at hello@withforerunner.com.