Flood

This new flood reading by Horn and Brown was introduced to the syllabus for the 2018.Fall exam. The old reading covered similar topics but was presented very differently. That means the old exam questions may not be very helpful, other than giving you a very general idea of what might be asked in the future. Previously, they asked a lot of questions about the funding of the NFIP (National Flood Insurance Program.)

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BattleTable

The Horn & Brown reading on the National Flood Insurance Program (NFIP) was new to the syllabus for 2018.Fall. It is dated September 12, 2017. The previous NFIP reading was dated February 6, 2013 and although many components of NFIP are unchanged, the reading is organized differently. (It isn't just a minor update.) You can quickly look over the old exam questions in the BattleTable but I'm not sure how relevant they are. Questions from the old flood reading are highlighted in tan.

Based on the past exams on the old flood reading (King) the main topics were:

• funding for NFIP including mechanisms & concerns about sustainability
• Biggert-Waters flood insurance reform act of 2012

But again, these old problems may no longer be relevant.

reference	part (a)	part (b)	part (c)	part (d)
E (2017.Fall #8)	funding: - concerns regarding NFIP	participation rate: - why it's low for NFIP	participation rate: - how to increase	wind coverage under NFIP: - arguments for & against
E (2017.Spring#8)	risk transfer process: - crop & flood insurance1	risk transfer process: - criticisms
E (2016.Fall #9)	NFIP challeneges: - sustainability, assessment	flood plain development: - ways to reduce
E (2016.Spring#9)	uninsurability: - of flood risk	functions: - NFIP	Biggert-Waters: - provisions
E (2015.Fall #8)	funding: - NFIP	Biggert-Waters: - NFIP premium subsidies	Biggert-Waters: - NFIP participation rate
E (2015.Spring#9)	see Germani.GovtIns - [Hint: FCC(ES)]	statutory mandate: - NFIP	moral hazard: - impact on NFIP	adverse selection: - impact on NFIP
E (2014.Fall #9)	funding: - NFIP	funding: - social security	funding: - shortfall for NFIP
E (2013.Fall #13)	ratemaking principles: - satisfied by NFIP?	improvements: - to NFIP

¹ See Germani.GovtIns for the crop insurance part of this question.

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In Plain English!

Intro

Alice says don't bother reading the Summary from the Horn reading. (And no, she isn't using reverse psychology!) The summary is confusing. I've outlined below what it covers. The remainder of this wiki article then provides details for the items mentioned in the summary. I just used common sense along with old exam problems to predict likely future questions. The point is not to acquire a comprehensive knowledge of NFIP. The point is to memorize as few key facts as possible to be able to answer likely exam questions. Cynical, I know, but that's our Alice! She wants you to minimize study time and maximize life enjoyment.

Keep in mind that the flood reading is ranked in the #13-18 range in terms of points-per-exam on recent exams. Use this fact to assess the level of detail required. (If this were a Top 6 reading, you would definitely have to learn more details than what I've presented below.)

An interesting side note is that the Canadian flood reading (published by the Insurance Bureau of Canada) is very heavily tested on Exam 6-Canada. It was the worst done question on the 2018.Spring exam, and it is because people don't realize how long it takes to memorize facts reliably. For Exam 6-US, the SAO material is the most important but the same advice holds true: Drill, drill, drill on memorization.

paragraph # (Summary page)	topic	specific questions
1	general info	- purpose of NFIP (flood insurance & mitigation) [Hint: AM&R] - participation in NFIP is voluntary, conditions required for participation
2	flood maps	- FEMA makes FIRMs (FIRMs = Flood Insurance Risk Maps) - FIRMs identify SFHAs (SFHAs = Special Flood Hazard Areas) - intentions & KEY CONDITIONS for floodplain management
3	policies	- 3 types of SFIPs (Standard Flood Insurance Policies) - property owners in SFHAs must buy flood insurance - property owners in moderate risk areas may buy PRPs (Preferred Risk Policies) that are cheaper - servicing arrangements & private insurers
4	premiums	- should reflect true costs but some subsidies are available
5	suspension from NFIP	- probation or suspension from NFIP makes it hard to get disaster relief
6	NFIP funding	- funded by congressional premiums, appropriations, borrowing - NFIP owes treasury $25b (serviced by NFIP, not taxpayers) - repayment schedule is uncertain (NFIP may not be sustainable)

Paragraph 1 (General Info)

Alice the Actuary has a friend named Diego the Dutiful. He knows he should probably buy flood insurance but is clueless on how the program works. Alice loves talking insurance and is only too happy to teach him using the Socratic Method.

Question: what is the purpose of NFIP [Hint: AM&R] (see top of page 2 in Horn & Brown reading)

• Access: provide access to primary insurance (transfers some of the financial risk to the federal government)
• Mitgate & Reduce: mitigate & reduce flood risk through floodplain management standards (these standards are discussed further down)

Question: is participation in NFIP voluntary or mandatory

• participation is voluntary (of course if participation is voluntary, there is risk of adverse selection – only people living in a floodplain would participate but then cost-based rates would be unaffordable)

Question: describe the required condition for communities/regions to participate in NFIP

• The Federal Emergency Management Agency, or FEMA, is allowed to provide flood insurance only to regions that adopt and enforce adequate land use and control measures.
• This is done through local or state laws for minimum floodplain management standards as described in FEMA regulations

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Paragraph 2 (Flood Maps)

Diego's husband likes fresh eggs so they keep chickens on their rural property. Their chicken coop was near the river and earlier this year, it was washed away in a flash flood. Diego asks Alice if he should rebuild it on stilts to protect it from future flooding. Alice's response: "Forget the stilts - just build it far away from the river!"

Question: how does NFIP reduce flood risk (page 2)

NFIP requires participating communities to:

• create FIRMs (communities collaborate with FEMA to create & adopt Flood Insurance Rate Maps)
• enact minimum floodplain management standards based on these maps

Question: identify specific intentions of the minimum floodplain management standards [Hint: restrict-guide-reduce] (page 6)

restrict development on flood-prone land

guide development away from flood-prone land

reduce damage caused by floods

Question: identify KEY CONDITIONS of the minimum floodplain management standards

There are many answers:

• require permits for development in the SFHA (Special Flood Hazard Area)
• lowest floor of SFHA buildings must be above a minimum height
• restrict development in floodways (this means you, Diego, with that darn chicken coop of yours)

A Special Flood Hazard Area, or SFHA, is an area, according to FIRMs, that has greater than 1% chance of flooding in any given year. This is also referred to as a 1-in-100 year flood.

Question: what happens if FEMA discovers that a participating community is not in compliance with floodplain management standards

• the community may be placed on probation or suspended from the program completely (this is discussed further down)

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Paragraph 3 (Policies)

NFIP offers 3 different SFIPs (Standard Flood Insurance Policies). The 3 policies are Dwelling, General Property, and Residential Condos, but I doubt you have memorize that. Page 8 of the Horn & Brown reading also has a table showing NFIP coverage limits. Obviously you don't have to memorize coverage limits, but this may relate to another potential exam question:

Question: given the existence of NFIP, what role does the private market play in flood insurance

• private market can provide excess coverage (higher limits)
• private market can provide broader coverage (may cover NFIP exclusions like alternate living expenses and/or business interruption)

If you own a property in a SFHA and you want a federally-backed mortgage then you must buy flood insurance. The lending agency is just protecting their investment. Conversely, if you own a property outside a SFHA, you don't have to have flood insurance. If such a property owner does buy flood insurance, they may buy a lower-cost PRP (Preferred Risk Policy).

Question: even though flood insurance is optional for property owners outside a SFHA, why does FEMA still encourage purchase of PRPs for such property owners

This is like DUH. There are 2 reasons:

• even outside of a SFHA, there is still a risk (maybe it's 1-in-50 year, or 1-in-25 year) but FEMA is still totes concerned about you :-)
• if low or moderate risk insureds purchase insurance, this spreads the risk over a large group ==> increases availability & affordability (this is the whole point of insurance - spread the risk!!!)

Question: what is the relationship between FEMA and private companies within the NFIP framework (Page 12)

FEMA provides management & oversight. Private companies handle day-to-day operations (marketing, sales, claims management.)

Question: describe the 2 specific servicing arrangements available to private companies within the NFIP framework

Direct Serving Agent (DSA):

- private contractor for FEMA

- facilitates purchase of flood insurance directly from NFIP

Write-Your-Own program (WYO):

- private companies directly write and service policies themselves

- the majority of NFIP policies are currently written through WYO

Note that for both types of servicing arrangements, NFIP retains the financial risk. Also, policy terms & premiums are the same through DSA & WYO. Sweet deal! It works the same way in crop insurance - remember Alice's cousin, Fanny the Farmer?

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Paragraph 4 (Premiums)

Alice tells me that the premium rate structure for NFIP is beyond the scope of the reading. There are just a couple of things you might need to know from pages 14-20.

Question: briefly describe the degree of cross-subsidization in premium rates for NFIP

• The rates are supposed to be based on the risk. In other words, low-risk policyholders are not supposed to subsidize high-risk customers. (Certain subsidies are available, however.)

Question: if NFIP premium rates are based on risk (with minimal cross-subsidization), won't rates for high-risk customers be unaffordable?

• Rates for high-risk customers will be higher, but a core design feature of NFIP requires participating communities/regions to adopt minimum floodplain management standards. This helps reduce risk and bring premiums down to an affordable level. (See above).
• As an added incentive, NFIP has implemented a community rating system or CRS. This provides credit for improving on the minimum floodplain management standards. (Examples may include steps to reduce erosion or measures to protect beneficial floodplain functions.)

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Paragraph 5 (Suspension from NFIP)

Recall that NFIP requires communities to adopt & enforce minimum floodplain management standards to be able to purchase NFIP flood insurance.

Question: identify & briefly describe two regulatory conditions that FEMA enforces to remove a participating community from NFIP

Condition 1: probation

• FEMA may place a community on probation if it fails to enforce it's own floodplain management standards
• policyholders may be charged a $50 fee
• community is given time to rectify deficiencies

Condition 2: suspension

• FEMA may suspend a community from NFIP if deficiencies are not rectified within a given time period
• community members may then have difficulty obtaining flood insurance
• a community may be reinstated when deficiencies are rectified

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Paragraph 6 (Funding)

Diego fell asleep 20 minutes ago and even Alice is starting to fade. But we're almost done.

When I read the section on NFIP funding from Horn & Brown, my impression was that NFIP is in deep trouble from a funding perspective. Unfortunately, Alice agrees. NFIP was actually doing pretty well prior to Hurricane Katrina in 2005. According to this Horn & Brown (published September 12, 2017) NFIP had borrowed $25 billion and were nearing their congressionally approved borrowing limit of $30 billion. Now, Hurricane Maria in Puerto Rico ravaged the island in late September 2017 and caused damages of $92 billion (according to the Wikipedia entry for Hurricane Maria.) This hurricane occurred after Horn & Brown published their analysis and I have no idea what has since happened with NFIP. Even though this is a new reading on the syllabus, it feels like it's already out of date. Anyway, let's look a some likely exam questions.

Question: identify the 3 NFIP funding methods [Hint: funding-PAB]

• Premiums: for administrative expenses & a reserve fund (reserve fund is for claim & debt expense)
• Appropriations: by Congress annually (there's a completely stupid table on page 23 of Horn & Brown - Alice says to ignore it)
• Borrowing: from the U.S. Treasury (this is the truly f**ked up part)

Say it out loud with me: funding-PAB. (You have to associate the word "funding" with the hint "PAB".)

I just read pages 24-25 in Horn & Brown on Borrowing from the U.S. Treasury, NFIP Debt and it was super-interesting but now I'm trying to think of how to create concise exam questions out of that material. I was stumped so I asked Alice and here's what she came up with.

Question: describe a major issue regarding NFIP funding (page 24)

• as of the publication of Horn & Brown, NFIP had borrowed $25 billion and the Congressionally approved borrowing limit is $30 billion
• debt repayment models predict a long repayment period (> 20years) or that the debt will increase (will not be paid off in the foreseeable future)
• debt is owed by NFIP policyholders (not by the general taxpayer) so premiums may become unaffordable

As if that weren't a big enough problem, the various provisions of NFIP are dependent on Congressional approval. Laws related to NFIP can change or expire, potentially leaving NFIP in ruins.

Question: describe a major issue regarding congressional authorization related to NFIP (page 25)

• authority to provide new flood insurance will expire without Congressional reauthorization
• borrowing limit will be reduced from $30 billion to $1 billion (I don't know what they're going to do about the $25 billion already owed.)

On page 25, Horn & Brown mention that Congress has authorized NFIP to purchase reinsurance but that doesn't really solve the problem. Somebody, somewhere, still has to pay for all these hurricanes.

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BattleCodes

Memorize:

Conceptual:

Calculational:

POP QUIZ ANSWERS

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