Smack in the middle of most debates over the fate of that three-legged dog known as the National Flood Insurance Program has been the assumption that private flood insurance from the Allstates and State Farms of the world would prove far more expensive than government-issue.
Well, Houston, turns out we may have a problem with that theory.
A new probabilistic study from the Wharton Risk Center based on a hypothetical model of flood damage to 300,000 residences in and around Galveston, Texas finds that prices charged by private insurers could potentially be lower than current NFIP rates for some homeowners.
It's not that NFIP is intentionally overcharging. The researchers found that flood insurance rates varied in the two counties they examined, with NFIP sometimes "too high" and sometimes "too low." That's hardly surprising given the $18 billion in claims damage wrought by Hurricane Katrina in 2005 and $2.6 billion by Hurricane Ike in 2008 that have left the NFIP $17.8 billion in the red.
But report co-author Erwann Michel-Kerjan says the findings point to a possible path out of financial ruin for the federal flood insurance program.
"This presents opportunities for private insurers to provide coverage in some of those areas, to complement the NFIP," he says. "There are several practical barriers that would need to be addressed for private insurers to sell such coverage, but if done, this could significantly increase the number of residents with proper coverage, thus reducing the need for government disaster relief."
The study couldn't be more timely given that 2011 was the most costly year on record for natural disasters worldwide with an estimated $350 billion in damage. Here in the U.S., the spring tornado disasters, widespread summer flooding from Hurricane Irene and other natural disasters prompted nearly 100 Presidential disaster declarations, two-thirds from hurricanes and floods.
There's a growing recognition that fundamental changes need to be made to NFIP. Wharton isolates two major disconnects: NFIP currently sets rates based on average annual losses without factoring in future funding needs and subsidizes one in four NFIP policies. Sustainable? Hardly.
However, the real $18-billion-dollar question raised by the study is whether private insurers have the appetite and the capacity to touch flood insurance – and at what initial and future cost to the consumer.
What's your guess: Is private flood insurance the best way out of this $18 billion hole?
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