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5 Insuring Properties Behind Levees
Pages 63-96

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From page 63...
... Concerning the peril of flooding, building unelevated property below the base flood elevation in a floodplain is a hazard, and the financial consequences of partial or total destruction of property due to flooding is the risk that the property owner faces. Risk is an adverse consequence of uncertainty concerning perils, and without uncertainty there can be no risk.
From page 64...
... As part of the National Flood Insurance Program (NFIP) , the insurance component is one pillar to address catastrophic loss potential from floods (other pillars include motivating building and land-use restrictions in vulnerable areas and construction of dams, levees, and other structures)
From page 65...
... Manual rate encompasses two basic methods: the loss ratio method and the pure premium method (Casualty Actuarial Society, 1990)
From page 66...
... . CURRENT RATE-SETTING PRACTICES WITHIN THE NFIP FEMA's National Flood Insurance Program (NFIP)
From page 67...
... Risk pooling in this regard is also used by private insurers to spread the risk.11 7  Severe repetitive loss properties, as established in Section 1361A of the National Flood Insurance Act, as amended, 42 U.S.C.
From page 68...
... Analysis of such data provides information on changes in losses by geographic area that are useful in identifying loss trends and geographic anomalies in loss patterns. The data are also useful to leaders in establishing policies and priorities and developing flood risk management strategies.
From page 69...
... This is consistent with standard property and casualty actuarial practice in private insurance. 14 Once the expected loss is determined, the actual premiums or rates for the NFIP are determined by "loading" the expected losses in a manner similar to equation (5-3)
From page 70...
... . Finally, the factor EXLOSS represents the expected loss ratio and contingency loading 15 and adjusts the rate to accommodate commissions, acquisition costs, and other costs such that the rate times the expected loss ratio is sufficient to cover the expected loss accounting for the loss adjustment expenses as well as the idiosyncratic choices by the purchaser of the deductible and underinsurance amount.
From page 71...
... . Group Flood Insurance Policies A group flood insurance policy is a discounted policy offered after a presidentially declared flood event for property owners who qualify for federal individual assistance.
From page 72...
... , nor a reasonable long-term estimate of the actual expected future loss because it diminishes the impact of real or anticipated catastrophic loss events that have happened in the past and can be expected to happen again in the future.18 The method used to calculate the average historical loss year ensures that in the long run there will be inadequate premiums collected to cover costs in significant flood years.19 Even with the mandate in the Biggert-Waters Act that catastrophic loss years be fully incorporated into the NFIP calculation of the "historical loss year average," there is still a potential long-run shortage becausee larger but less frequent catastrophic floods (500-year floods, 1,000-year floods, etc.) may not have been recorded in the flood record at a particular location (although their likelihood might be modeled)
From page 73...
... . Thus, initially, private localized insurers were reluctant to include flood coverage because of potential highly correlated losses and catastrophic total loss payment possibility (floods would simultaneously affect many of their customers, undermining the law of large numbers and central limit theorem for advantageous risk pooling)
From page 74...
... In 1968, Congress passed the National Flood Insurance Act 21 with the goal of creating a preloss (insurance) financing arrangement that would lower post-loss disaster relief, encourage responsible development in floodplain areas, and encourage maintenance of flood control operations (e.g., levees)
From page 75...
... . Although in truth the amount of money received by 23  Under provisions of the Biggert-Waters Act, FEMA is to establish a National Flood Insurance Reserve Fund that contains at least 1 percent of the total potential loss exposure funded by putting in 7.5 percent of the required amount each year until fully funded (Nechamen and Inderfurth, 2012)
From page 76...
... To achieve actuarial soundness, predictability, and affordable rates, private insurers use risk pooling (over either policyholders such as occurs in automobile insurance or commercial general liability insurance, over space as occurs in property insurance, or over time such as occurs in life insurance, or some combination of these techniques) to hedge, spread, diversify, or pool risk so that in the aggregate the premiums collected would be sufficient to pay 25  The NFIP can collect interest when there is a surplus in the fund, but its borrowing authority is legislatively set and was significantly raised in the wake of hurricanes Katrina and Sandy.
From page 77...
... The statements of actuarial principles do allow actuaries to use differing models with different assumptions, provided they can be reasonably justified and estimate future loss costs in a defensible manner, so the notion of actuarial soundness in the context of legislatively mandated discounts can be defended in a governmental context apart from strict fiscal soundness that is appropriate for private insurers. For catastrophic governmental insurance programs, such as the NFIP, the California Earthquake Authority (CEA)
From page 78...
... Indeed, in the case of the NFIP, legal constraints on the premiums that can be charged to certain groups of policyholders constitute an economic externality on the cash flow such that the program's financial viability would be threatened were it to rely solely on its own generated premium income. Financial soundness and actuarially soundness are coincident in private insurers, but they need not be in governmental insurance programs.
From page 79...
... If the levee is accredited by FEMA to the one percent annual chance flood level, the "all other" or X zone category is applied. If not, the property is considered in the category that would apply without the levee being there.
From page 80...
... . Two houses next door to each other can have one just above the one percent annual chance flood level (and have no mandatory flood insurance mandate, and a low-priced policy if the property owners do decide to buy)
From page 81...
... Additionally, the dramatic changes in rates that arise from moving between the few rating zones does not recognize the continuous nature of the flood risk. Rate setting for properties behind levees, accredited or not accredited, should be improved by using the modern risk analysis method employing advances in hydrology, meteorology, geotechnology, and engineering to more precisely calculate the probability of water inundation levels and the associated damage estimates throughout the area behind the levee in a graduated fashion.
From page 82...
... . The purpose of this Act was to require State or local communities, as a condition of future Federal financial assistance, to participate in the flood insurance program and to adopt adequate flood plan ordinances with effective enforcement provisions consistent with Federal standards to reduce or avoid future flood losses; and require the purchase of flood insurance by property owners who are being assisted by Federal programs or by federally supervised, regulated, or insured agencies or 31  In the short or intermediate term the individually assessed expected losses can be used for aggregation to form a smaller set of risk classes, each of which is charged an average price.
From page 83...
... As indicated in Chapter 2, following congressional hearings in 1973 that included discussion of the role of flood control structures in protecting those behind or below them from flooding, the Federal Insurance Administration determined that areas behind levees providing protection from the one percent annual chance flood would be considered outside of the SFHA, and the MPR and associated land-use restrictions would not apply to properties in these areas. This remains true today; property owners living behind an accredited levee (i.e., providing protection from the one percent annual chance flood)
From page 84...
... building or manufactured home financial assistance is used for in or to be located in an SFHA in a acquisition or construction of a participating community and whose building or a manufactured home loan is purchased by Fannie Mae or in an SFHA of a community Freddie Mac; participating in the NFIP (c) building for which any federal financial assistance is used for acquisition or construction of a building or a manufactured home in an SFHA of a community participating in the NFIP Responsibilities of Not applicable Require flood insurance for Determine whether the building or regulated lenders buildings or manufactured manufactured home is, or will be, homes located in the SFHA of a located in an SFHA participating community Complete a hazard determination Ensure that flood insurance is form maintained on such structures for the life of the loan Provide notice of availability of flood insurance to borrower, lending institution, and loan servicer Require flood insurance for structures located in SFHAs of a participating community Ensure that flood insurance is maintained for the life of the loan Escrow for flood insurance if other mortgage-related expenses are required to be escrowed Force place flood insurance in the event of nonrenewal or insufficient coverage SOURCE: Tobin and Calfee (2005)
From page 85...
... Areas behind the levee where susceptibility exceeds the one percent annual chance flood level are designated as inside the SFHA even though the area might have an accredited levee. For example, much of New Orleans, Louisiana, is susceptible to flooding from interior drainage despite having accred ited levees.
From page 86...
... From a flood risk management perspective, the NFIP encourages all who live in areas subject to any level of flooding to purchase insurance so as to provide loss coverage to them if their covered property is damaged from a flood event and to reduce the cost to the federal government for their recovery. Therefore, FEMA is interested in knowing what percentage of those living in flood-prone areas have insurance, that is the market penetration: 35 Number of buildings in SFHA eligible for insurance purchase that have policies a Market Penetration = Number of buildings in SFHA eligible for insurance purchase i Compliance with the NFIP MPR is a subset of the market penetration: 35  "Insurance may be written on any building eligible for coverage with two or more outside rigid walls and a fully secured roof that is af fixed to a permanent site.
From page 87...
... Market penetration of flood insurance policies across the country varies with, for example, geography (coastal versus inland communities) and frequency of major flooding events in an area (Figure 5-4)
From page 88...
... Given the emphasis that has been placed on market penetration and compliance with the MPR in FEMA's risk communication activities, the efficacy of the mandatory purchase requirement is called into question. The current policy of mandatory flood insurance purchase appears to be ineffective in achieving widespread purchase of NFIP flood insurance policies.
From page 89...
... . Mandatory Purchase Behind Levees: The Current Approach Verses a Modern Risk Analysis Beginning in the early 2000s, FEMA took steps to modernize FIRMs via "Map Mod." During Map Mod, FEMA discovered that because FIRM maps carried forward certification from previous years, many levees previously thought to be able to withstand the one percent annual chance flood were not able to withstand this event.
From page 90...
... If federal funding can be obtained, USACE would move ahead in a process that would carry out the required work for a 500-year levee and, as part of this work, obtain accreditation from FEMA for one percent annual chance flood protection (Colonel Christopher Hall, USACE, personal communication, February 7, 2013)
From page 91...
... INSURING PROPERTIES BEHIND LEVEES 91 BOX 5-6  continued FIGURE 5-5 Map of the Metro East Levee System.
From page 92...
... If NFIP policies continue to be concentrated in the same high-risk areas around the country, the diversification of risk and the fiscal soundness of the program will remain relatively unchanged. Upon implementation of a modern risk analysis, insurance rates will more accurately reflect flood risk behind a levee.
From page 93...
... 2010. Managing flood risk: The National Flood Insurance Program and alternatives.
From page 94...
... 2006. The National Flood Insurance Program's Market Penetration Rate: Estimates and Policy Implications.
From page 95...
... 2005. The National Flood Insurance Program's Mandatory Purchase Requirement: Policies, Pro cesses, and Stakeholders.


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