While flood insurance might represent the biggest growthopportunity for private carriers in years, it's no certainty theindustry would be eager or even willing to take on a greater shareof such exposures unless conditions are established to give them areasonable chance of making a profit. 

That won't be easy in a line that historically has beendifficult to write, for both private and public entities alike.

Facing a deficit of around $30 billion, it's no wonder theNational Flood Insurance Program and other government agencies havebeen exploring the potential for greater private marketparticipation. Yet despite the prospect of having a portion of themore than $3 billion paid annually for NFIP coverage in play, mostinsurers and capital market investors are still likely to take apass on this risk unless the factors that have undermined theprogram's solvency in the first place are addressed to theirsatisfaction.

That was our conclusion in a report released this month by theDeloitte Center for Financial Services, "The Potential for Flood Insurance Privatization in the U.S.: CouldCarriers Keep Their Heads Above Water?"

Among the challenges cited in the report that would confrontprivate insurers interested in writing more flood coverage:

Subsidized flood premiums for some 20% of NFIP-insuredproperties, which not only might have compromised the program'ssolvency, but also may have exacerbated the exposure byfacilitating construction in flood hazard zones.

Repetitive loss properties, which accounted for one-in-four NFIPclaims paid between 1978 and 2011.

The relatively low take-up rate for flood insurance, even amonghomeowners with federally-backed mortgages who are mandated by lawto buy the coverage.

Adverse selection, in which few property owners facing only amoderate chance of flooding buy a policy, thereby undermining theprogram's spread of risk. 

The likelihood of federal disaster assistance for victims offlooding, which may have prompted many property owners to pass onbuying insurance and take their chances on getting a governmentgrant or loan if a worst-case scenario comes to pass.

Washington tried to address many of these issues when Congresspassed the Biggert-Waters Flood Insurance Reform Act of 2012, whichincluded measures to gradually phase-out subsidized rates as wellas update flood maps so risk could be more accurately assessed andpriced accordingly.

However, once the pricing provisions of Biggert-Waters began tobe implemented, there was a political backlash in the mosthighly-exposed states, with state and federal lawmakers beinginundated with complaints about rate hikes that were rendering thecoverage unaffordable, while undermining property resalemarkets. 

In response, the U.S. Senate passed a measure in January todelay rate hikes for four years while an affordability study wascompleted, but a counterproposal in the House of Representativesprevailed which kept the transition to risk-based rates in place,but limited the scope and slowed the pace of premium increases. Thenew measure was signed into law by President Barack Obama lastmonth.

The decision to delay, limit, and even roll back efforts toincrease prices to risk-based levels is likely to raise red flagsfor private insurers and reinsurers that may have been open to theidea of entering the flood insurance market. The GovernmentAccountability Office noted this potential repercussion in aJanuary 2014report on strategies to increase private sectorinvolvement.

"…[D]emonstrating the political will to charge full-risk rateswithin NFIP could signal to private insurers a greater likelihoodof being allowed the freedom to charge adequate rates in a privateflood insurance market, thus encouraging their potentialparticipation," reported GAO, while any move in the oppositedirection "would increase private insurers' skepticism about thefeasibility of participating…"

Still, even though these challenges may seem daunting forcarriers interested in writing flood insurance, they are notnecessarily insurmountable. Indeed, a few private carriers havealready entered the market in certain states, such as Florida, andlocal legislative efforts are underway to encourage more insurersto join in, perhaps on a surplus lines basis.

In addition, Deloitte's report outlines a number of ways inwhich primary insurers, reinsurers and capital market investorscould be eased into the flood insurance market—options which arenot mutually exclusive. These include initiatives in which:

Private carriers would serve as primary insurers for manypolicyholders, with the federal government acting as reinsurer.

The federal government continuing to be the predominant primaryinsurer, but limiting taxpayer liability by purchasing reinsurancefrom private carriers.

Spreading flood exposures across the capital markets throughsecuritization, via the sale of catastrophe bonds.

We elaborate on 10 potential privatization options in our report, and will detail them further in our next blog onPC360later this month.

The bottom line is that in theory having the privatemarket—whether primary insurers, reinsurers, the capital markets,or some combination of all three—pitch in to take on significantlymore flood exposure could be a win-win for policyholders andtaxpayers as well as the insurance industry. However, that visioncan only be realized if government and the private sector can worktogether to create the conditions to make such an effort mutuallybeneficial.