Traditionally, a legacy is something that is handed down from one generation to the next. In the legal world, it is literally an amount of money or property left to someone. More philosophically, a legacy can be an idea, mission, or purpose that future generations are asked to either pick up or reject.
Bringing this idea to the insurance industry: The National Flood Insurance Program entered a new era on April 1, 2022. On this date, the Legacy Rating System—the system that has defined the NFIP for much of its existence—was retired. The question is: With its retirement, what legacy is the old rating system leaving behind?
The NFIP has been in existence since 1968, but the history of flood insurance starts even earlier. For the first quarter of the 20th century, flood insurance was provided by the private market exclusively. However, in the late 1920s, extensive flooding along the Mississippi River caused private companies to rethink their appetite for flood risk.
Thereafter, the private market shortly dried up (pun obviously intended). For the next 40 years, flood insurance—as we know it—largely did not exist. Instead, flood damage was paid for by federal disaster relief packages. Finally, by the mid-1960s—after a period of about 18 months in which Congress had passed six different disaster relief bills—it had had enough and passed the appropriately named National Flood Insurance Act of 1968.
Since its inception, one of the hallmarks of the NFIP is that a building’s flood rates are based on the elevation of property within a given community’s Flood Insurance Rate Map or FIRM. The FIRM is the official flood map of a community, which is created by the Federal Emergency Management Agency, which runs the NFIP. The maps provide information on the likelihood of flooding in a particular community. The higher the risk of a flood in a FIRM, the higher the premium.
While the creation and use of FIRMs has been important in setting rates, FIRMs have had issues. They are updated infrequently, which means many communities do not have relevant flood information on which to base construction decisions. In addition, no matter how recently a FIRM has been updated, it does not consider certain critical features important to determine the actual risk that a particular building would experience flooding (i.e., the distance of a building from a water source, the different types of flooding, and the cost to rebuild). This results in buildings within the same flood zone having substantially the same rate, even if their individual risks of flooding are much different. In other words, some buildings in a FIRM pay more for flood insurance than their risk represents, while others pay less.
The NFIP under water
In part, due to inequalities in flood mapping, the NFIP’s current legacy is one of crippling debt. The NFIP is funded by premiums. When claims exceed premiums, the NFIP is forced to borrow money from the U.S. Treasury—which for most of its history, it did infrequently. That changed in 2005, when Hurricane Katrina hit the Southeast United States. The NFIP claims damage during that year exceeded $17 billion and the program was never the same again. Currently, the NFIP is $20 billion in debt—but only after $16 billion was forgiven by the federal government in 2017.
The NFIP will enter a new era when the Legacy Rating System is retired in April. Under the Legacy Rating System, generally rates were determined by a FIRM zone, base flood elevation, and foundation type. All NFIP polices issued or renewed on or after April 1, 2022, will be subject to a new rating methodology referred to as Risk Rating 2.0.
The defining feature of this new rating methodology, which went into effect on Oct. 1, 2021, for all new policies, is that it will use a different set of rating variables. Risk Rating 2.0 will use a host of different variables, including:
- distance to a flooding source,
- flood type,
- ground elevation,
- first floor height, and
- claims history.
FEMA, which has given Risk Rating 2.0 the tagline of “Equity in Action,” has stated that by using Risk Rating 2.0, it will better be able to equitably distribute premiums for all policyholders based on a particular building’s value and unique flood risk.
What does this mean for policyholders?
Change is coming. Moving away from FIRMs also is a move away from subsidized rates, another legacy of the NFIP. According to FEMA, 23% of current NFIP policyholders will see an immediate premium decrease due to the new system. Of course by my math, that leaves another 77%—what about them? Sixty-six percent of policyholders will see a relatively small increase in premium of $10 or less per month. Another 7% of policyholders will see increases between $10-$20 per month. While 4% of policyholders will see an increase of $20 or more a month.
How agents can help their clients
Since Risk Rating 2.0 considers more rating variables compared to the Legacy Rating System, insurance producers may discover that premium quotes for both new and renewal business are exponentially higher than under the old system.
Producers will need to be prepared to talk to their clients about these potential rate increases. The good news is that subsidized rates are not completely disappearing. While quotes may give the impression of drastic premium increases immediately, under existing law, rates for individual policyholders cannot increase by more than 25% per year.
 FEMA (bit.ly/3GueIIx)
 Congressional Research Service, 2021 (bit.ly/34FzC9B)
 FEMA (bit.ly/3fm3QAK)
 FEMA, (bit.ly/33zTXgf)