Is It Time for Opt-Out Flood Insurance?

Ignorance is not bliss when it comes to flood insurance, especially for those who don’t realize until after a disaster like Superstorm Sandy that their home or business doesn’t have any coverage under standard policies.

Insurers and their agents have tried for years to get the word out about this glaring coverage gap. But too many policyholders either don’t pay attention or don’t recall being told they needed to buy a separate policy from the National Flood Insurance Program (NFIP) to cover that specific risk. Others may get the message but choose to pass on the option—either because they don’t believe they can afford the additional coverage, or figure the worst-case scenario won’t happen to them.

In any case, insurers and their agents are often blamed (fairly or unfairly) for either neglecting to tell clients about the lack of flood coverage in standard policies—or if they do, for not being clear or convincing enough to prompt more exposed policyholders to buy the federal insurance.

Industry leaders lamented this frustrating state of affairs during their annual family reunion—better known as the Property-Casualty Insurance Joint Industry Forum in New York. A general complaint was that a client’s eyes often glaze over whenever agents talk about coverage issues, including flood.

Many producers try to mitigate their own errors and omissions exposure by insisting that buyers sign a disclosure statement to the effect that they were told their standard policy doesn’t cover flood. But too many policyholders speed-read their paperwork or are willing to sign anything to get the tedious process of buying insurance over with.

There were many calls at the Forum for more creative efforts to educate consumers about the lack of flood insurance in standard policies, as well as the wisdom of buying the extra coverage—especially if a client’s home or business is near a body of water that could overflow due to heavy rain or storm surge. Going the extra mile on education couldn’t hurt.

But I am starting to wonder whether we can ever expect the average consumer to get the message, or to act on it even if they receive it. Perhaps it’s time to employ some behavioral economics here and try a radically different approach.

What if federal flood insurance was automatically added to all home- and business-owner policies—at least for properties in higher-risk zones? The policy and any bill delivered would include a cover sheet explaining that flood coverage is being offered, while emphasizing that keeping it is voluntary.

Anyone could choose to opt-out at the time of purchase or when they pay their bill. But they would be warned in no uncertain terms that by refusing the optional coverage, their home or business would be exposed to substantial out-of-pocket losses if a flood should hit.

To actually implement this idea, regulatory and perhaps even legislative changes might have to be made. At the very least, insurance-department permission might have to be acquired. And in some states, mortgaged properties in high-risk zones may already be required to have flood insurance. It all depends on the individual state and its insurance-regulatory regime.

But for the sake of argument, would automatic inclusion with an opt-out provision solve a lot of the problems noted above by making people realize they have a gap in their standard policies and are being offered an opportunity to cover it? At the very least, people couldn’t plausibly claim they did not realize they were exposed and could buy federal-flood coverage.

What are the potential downsides to this opt-out idea?

There certainly would be sticker shock if federal-flood coverage is automatically included in a premium quote. And while insurers and agents would simply be the messenger here, consumers might take their anger out at the industry for having flood insurance foisted upon them. 

But frankly, what has the industry got to lose? Insurers and agents are already being blamed (and even sued) after a disaster for allegedly not making policyholders aware of the lack of flood coverage in standard policies, or for failing to make a compelling enough case to add it on. 

The potential upside is that many more people may end up buying insurance for flood and not be left exposed if a disaster like Sandy strikes again. They can rebuild more quickly, and be less dependent on Federal Emergency Management Agency grants and loans. There would also be less negative publicity about policyholders being sold insurance with a gaping hole for flood damages, and likely fewer E&O suits against agents and coverage litigation with carriers.

Perhaps a small but significant percentage would accept flood coverage without a fuss if it was automatically offered in conjunction with their standard policies. Others might be persuaded to do so in a conversation with their agent or carrier at the point of sale when the potential implications of opting-out are explained.

There is a precedent here. An opt-out approach has proven to be somewhat effective in getting more people to start saving for retirement. The Pension Protection Act of 2006 provides companies with a safe harbor to automatically enroll employees in their 401 (k) plan, while giving workers the option (and the responsibility) of opting out if they choose.

It is clear that too many people are leaving their homes and businesses exposed to flood losses. It’s also clear that there seems to be a failure to communicate when it comes to educating consumers about the lack of flood coverage in standard policies, the availability of federal insurance for that risk, and the possible consequences of going bare.

An opt-out provision might just do the trick by making buyers more aware of the need for flood insurance, while taking insurers and their agents off the proverbial hook if informed consumers consciously choose to decline the additional coverage.

What do you think? File your comments below, or e-mail me directly at samfriedman@deloitte.com.

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