An increase in natural disasters has made flooding a major concern in the U.S., and the federal flood program that handles national flood insurance is feeling the brunt of both flooding incidents and their associated costs.
Since it was created by Congress in 1968, the National Flood Insurance Program (NFIP), which is a part of the Federal Emergency Management Agency (FEMA), has lost more than $36 million, at least in part because it undercharges for premiums. Now, FEMA plans to overhaul its fee structure with a new plan scheduled to go into effect on October 1, 2021.
We’ll look at the current flood insurance model, examine how and why it’s changing, and explain how the new risk rating may affect homeowners.
- FEMA’s Risk Rating 2.0 is scheduled to take effect on October 1, 2021.
- Risk Rating 2.0 will determine flood insurance premiums based on a property’s individual risk.
- The change in rating methodology comes as a result of increased flood risk due to climate change.
- The cost of damage from flooding is predicted to increase by $12.2 billion over the next 30 years.
What Is FEMA Flood Insurance?
Through the NFIP, FEMA provides more than five million flood insurance policies in the U.S. It’s primarily designed to serve those in flood-prone areas, adopt floodplain standards that reduce flood risk, and eventually reduce the amount that the federal government spends on flood disaster assistance.
But here’s the problem: While the program collects $4.6 billion annually in premiums, fees, and surcharges from policyholders, it provides coverage to the tune of $1.3 trillion. So, while the NFIP serves others who are literally underwater, it is, itself, figuratively underwater.
The First Street Foundation, a nonprofit research and technology group based in Brooklyn, NY, projects that flooding will result in $20 billion in damage in 2021. But by 2051, the amount will balloon to $32.2 billion. This growth rate is attributed to climate change.
What Is FEMA Flood Insurance Risk Rating 2.0?
In an attempt to create a more sustainable flood insurance program, FEMA has created Flood Insurance Risk Rating 2.0, which is scheduled to go into effect on October 1. Current policyholders can start contacting their insurance company on August 1 to learn more about the new changes. The rates for new policies starting on or after October 1 will be determined by the new rating method. And those with policies scheduled to renew on or after April 1, 2022, will see the changes reflected when they renew.
Current rates are based on static data, such as the policyowner’s elevation within a zone on a FEMA Flood Insurance Rate Map. However, Risk Rating 2.0 is based on more advanced tools and capabilities that would better reflect a property’s individual flood risk.
“It would take a risk-based approach to pricing insurance premiums, using an algorithmic model similar to the one we employed in our Cost of Climate national report,” Dr. Jeremy Porter, head of research and development at the First Street Foundation, told The Balance by email. “This risk-based approach would allow the NFIP to use best actuarial practices in pricing risk, aligning costs to actual flood risk, and ensuring that premiums within the NFIP are commensurate with risk.”
One change is that the risk rating would be applied to homes both within and outside of Special Flood Hazard Areas (SFHA).
FEMA Flood Insurance Risk Rating 2.0 was actually introduced in 2019 but has encountered some roadblocks. Some people argue that since it is a subsidized program, NFIP premiums should not keep up with costs. One high-profile opponent is Senate Majority Leader Chuck Schumer of New York. When the plan was first announced in 2019, he pushed back on the idea of raising premiums for homeowners in his state, noting that it could severely impact some communities.
Why Change Flood Insurance Pricing?
FEMA’s plan to change flood insurance pricing is based on the fact that flood insurance premiums aren’t keeping up with costs.
Porter said that due to the growing severity of storms, exacerbated by a changing climate, “there have simply been more claims than the National Flood Insurance Program (NFIP) is designed to handle.” But while the climate has changed, the NFIP method of assessing risks and price premiums is still based on financial and scientific climate data dating back to the 1970s. “As a result of this zone-based approach, the program hasn't collected sufficient premiums to cover the true extent of the risk over the past several decades,” Porter said.
But with Risk Rating 2.0, FEMA can address such variables as flood type (heavy rainfall, coastal erosion, river overflow, etc.), distance to a water source, and flood frequency.
How Will It Affect Me?
According to FEMA, some policyholders are paying more than their fair share while others (those with higher-valued homes) are paying less than they should. The goal is to ensure that premiums are fair, based on the home’s flood risk.
However, some people could be surprised to learn that they will now need to purchase flood insurance as well. “Our studies suggest that a great deal of flood risk exists outside of SFHA's, which has had further deleterious effects on the NFIP's ability to keep up with claims, because homes outside the SFHA are not required to carry flood insurance, and those that do receive a steeply discounted price under the current system,” Porter said.
He applauds the upcoming rollout of Risk Rating 2.0, and said it would align risk and price across the board. “And this would lead to better financial solvency for the program,” Porter said.
Congress has placed a ceiling on how much flood insurance can increase on a yearly basis. Right now, that ceiling is 18% for individual policies. However, this means that policyholders could experience these increases for several years.
FME projects that 23% of current policyholders will actually experience a premium decrease, and 66% will see an increase of up to $10 per month. Also, 7% of current policyholders will experience a $10 to $20 per month increase, and only 4% will see a monthly increase over $20.
The Bottom Line
FEMA’s Risk Rating 2.0, which is scheduled to take effect on October 1, 2021, will change how the NFIP rates flood risks and prices policies. FEMA has been using data from the 1970s, but incorporating more modern tools can allow it to provide more accurate floor risk estimates. The new rating is likely to increase premiums for those with higher-priced homes while reducing premiums for some people at the other end of the spectrum.