Insuring catastrophe

Introduction

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BROOKLYN, N.Y. — When Hurricane Sandy hit in 2012, Thalia Panton watched in disbelief as floodwaters careened down her quiet, tree-lined street in Canarsie, Brooklyn. Sparks flew from downed electrical lines as rushing rapids rose past her thighs.

The water receded as quickly as it appeared. But the damage was done. When the skies cleared, Panton was left with $60,000 in losses. The basement had flooded, damaging musical instruments her husband and son use for their gigs as well as electrical equipment that kept the house running. Panton and her neighbors didn’t get flood insurance until after Sandy because Canarsie wasn’t considered a major flood risk at the time of the storm.

Seven years later, as even more communities reckon with rising sea levels and catastrophic storms, the Federal Emergency Management Agency is encouraging homeowners and renters to “buy as much flood insurance as they can.” The agency provides over 96% of all flood coverage through its National Flood Insurance Program, making it the sole option for most Americans.

But FEMA is revamping the debt-ridden program to make it operate like a private insurer, raising concerns that coverage could become unaffordable for many higher-risk areas across the country. Agency officials have not said how many Americans could be affected. Private insurers champion the reforms as a way to modernize the NFIP, but the industry also stands to profit. Insurers are now competing directly with FEMA. Companies have also sold the agency on expensive deals with dubious benefits for taxpayers. 

New York City officials warn that skyrocketing flood insurance premiums could trigger a foreclosure crisis in neighborhoods like Canarsie, which never recovered from the 2008 housing crash and was a hotbed of predatory loans that targeted black homeowners. Annual premiums in Canarsie — now an average of $600 — could jump to a range of $3,000 to $6,000 as soon as 2022 and become mandatory for more residents.  

That expense could be out of reach for many in Canarsie already struggling to keep up with housing costs. “People are just going to be slowly picked off,” said Zachary Paganini, an urban geography researcher at the City University of New York. By forcing communities of color to shoulder the economic burden of escalating flood risk, the government is worsening inequality, he said.

While insurance is marketed as a way for households to bounce back, experts point out the policies themselves do little to prevent disasters. Hundreds of thousands of homes could face flooding from sea-level rise on a regular basis by 2050, according to estimates. Heavier rains will threaten properties far from oceans. As the cost of flood protection soars, insurance itself could be what pushes people from their homes long before climate change does.

Reforms could mean less risk for the government, but also less protection

Sandy still haunts Ronald Temple’s home seven years later. A discolored line in his basement is a reminder of how floodwaters crept toward the ceiling, knocking out the heat for several grueling winters until he could afford to replace the equipment. On sunny days, unexplained puddles seep from the floor, a problem Temple says has only worsened since the storm. And in October, he discovered a rusted sewage pipe that will cost $10,000 to replace — a defect he blames on saltwater corrosion that isn’t covered by his flood or homeowner’s insurance.

“I’m really seriously thinking about moving,” said Temple, who immigrated from Sierra Leone in 1981 and has lived in Canarsie since 1997. His home borders a salt marsh that spills into Jamaica Bay, which divides Brooklyn from the southern edge of Queens. Canarsie wasn’t included in the city’s mandatory evacuation zone, but residences here were among an estimated 80% of homes on Brooklyn’s waterfront that were damaged during Sandy.

FEMA flood maps at the time of the storm, which were based on historical experience, classified less than 40 of Canarsie’s 12,000 buildings as high flood risk, which mortgage lenders typically require to carry flood insurance. Revised figures now suggest more than 5,000 buildings are at risk. The number of flood policies in Canarsie has increased since 2012, but the area remains underinsured.

“We’re not talking about people who have irresponsibly built a beach house because they want to have a second home on the shore — these are generational neighborhoods,” said Elizabeth Malone, a program director and insurance specialist at Neighborhood Housing Services of Brooklyn, a housing advocacy organization.

Roughly 85% of Canarsie’s residents are black, and the area is often seen as a bastion of black homeownership, which is on the decline in New York City. The neighborhood’s high number of single and two-family homes gives it a sleepy, suburban feel. But just past the manicured lawns and paved driveways are signs of economic distress.

Bright yellow posters offering cash for houses can be found on nearly every street corner. Many residents — including a large share of immigrants and retirees — settled in Canarsie during the 1990s and 2000s at the height of subprime lending, receiving risky, high-interest loans. The area still has a large number of foreclosures compared to the rest of the city. Sandy likely played into that problem, experts say, causing some homeowners to default on their mortgages because they were unable to rent out flooded basements.

Many of Malone’s clients in Canarsie are choosing to forego flood insurance because of the cost, she explained, not because they don’t believe the risk is real. Escalating flood risk could also cause home values to plummet, leaving families owing more on their properties than what they’re worth.  “We will be underwater financially,” she said, “long before we are underwater physically.”

Complicating matters is the NFIP’s hazy fate. The program began in 1968 primarily because private companies were unwilling to insure floods. Since then, the NFIP has been America’s primary flood insurer, backing more than 5 million homes and businesses. Policies provide limited coverage for structural and equipment damages as well as loss of contents. But the program requires periodic congressional approval, putting it at the mercy of partisan politics. As a result, policy rules and conditions have continually shifted.

“They’ve been kicking the can for almost two years now,” Jainey Bavishi, director of the New York City Mayor’s Office of Resiliency, said of the standstill over flood insurance. Congress has been unable to reach consensus on the direction of the program, which some see as a lifeline and others as a liability. The NFIP has been temporarily extended 15 times since 2017, most recently in December, in lieu of a bill spelling out the program’s future. Previous attempts have been jarring: Congress tried to reform the NFIP in 2012, only to renege on most of those changes just two years later.

Right now, what NFIP customers pay is impacted by their location on a FEMA flood map and whether their property is eligible for subsidies. In most cases, mortgage borrowers in higher-risk zones must carry insurance and pay higher premiums. But structures built before the NFIP program designated an area as high risk often receive subsidized rates, a congressional compromise to not penalize owners for construction that complied with existing standards.

In 2015, New York City officials appealed new FEMA flood maps that would drastically expand high-risk areas, making flood insurance mandatory and more expensive for thousands of New Yorkers. FEMA is working with the city to finalize new maps, but it’s unclear what they will look like and how long the process will take.

Risk Rating 2.0, an initiative FEMA began working on in 2017 and plans to implement in October 2021, could have further effects on costs here and in other higher-risk parts of the country. Under the initiative, premiums will be priced to fully reflect flood risk, a move FEMA says would make the NFIP more financially sound but experts worry could make coverage less accessible. The revamp is part of a long-simmering effort to transform the program so it operates more like a private insurance company.

The NFIP is also relying on private consultants and proprietary computer models used by top insurance companies — a first in the program’s 50-year history. The overhaul marks a radical departure from the current pricing structure. FEMA has divulged little about the initiative, worrying lawmakers and housing advocates who say the agency is keeping the public in the dark.

FEMA has yet to provide specifics about premium changes. But New York City and outside experts say the agency’s decision to set prices based on risk signals big increases for higher-risk communities — the places that need flood insurance most.

In an interview, FEMA Deputy Associate Administrator David Maurstad said the goal of Risk Rating 2.0 is to deliver “rates that are fair, easy to understand and better reflect a property’s unique flood risk,” which can also help the public figure out whether an area is safe to live in.

The initiative will reduce premiums for policyholders of “lower-value homes” who are “paying more than they should be paying,” he said, and those who take measures to flood-proof their properties like elevating homes on stilts.

But Maurstad was less clear about the fate of high-risk, coastal areas like Canarsie, where property values are high but rising premiums could easily upend fragile households. “There comes a time when you have to evaluate the program and make these types of hard changes because they’re important for the sustainability of the program,” he said. Only Congress has the authority to make NFIP policies affordable, he added.

Officials fear ‘a huge foreclosure crisis’

What worries New York City officials is that communities like Canarsie could be left on their own to shoulder rising costs. “If we transition to risk-based pricing immediately, it would lead to a huge foreclosure crisis and that’s exactly what we do not want to do,” Bavishi said. “We feel very strongly that this is at its core about environmental justice.”

City officials are lobbying Congress to provide vouchers or some other discount on NFIP premiums for those who cannot afford them. FEMA itself has acknowledged how cash-strapped Americans are — a 2018 agency survey found many U.S. households would not be able to cover a $500 emergency expense.

Under the current NFIP, retrofitting a building is one of the few ways to qualify for premium reductions. A city study estimated a typical Canarsie homeowner would have to shell out up to $100,000 to modify a home, which would entail making the basement uninhabitable. The expense is out of reach for nearly everyone but real estate developers, who are increasingly building in the city’s most flood-prone areas.

Scholars like Paganini point out NFIP’s “one-size-fits-all” approach means “working-class people increasingly can’t afford the cost of living by the coast, but wealthier populations can.” The program also ignores the impact of discriminatory mortgage lending on communities of color.

Instances of “environmental gentrification,” where luxury development displaces low-income residents following a natural disaster, have played out in post-Hurricane Katrina New Orleans and storm-prone Miami-Dade County in Florida.

The Natural Resources Defense Council, an environmental group, supports FEMA’s pricing shift as a way to communicate risk to the public, but only if premiums are made affordable through some kind of program and the agency ramps up investment in flood prevention.

“You can have as much insurance as you want — the water doesn’t care,” said Anna Weber, a policy analyst for the group. NFIP shouldn’t punish vulnerable communities for living in risky areas, especially when racist real estate practices like redlining have long steered people of color into undesirable neighborhoods, Weber said. “Flood insurance has the potential to be the linchpin in our climate policy. Right now, it’s a liability.”

FEMA often cites a study showing every $1 spent on disaster mitigation returns $6 in benefits. But the agency spent $8.3 billion on such efforts from 2007 to 2016, a small portion of its total budget over the same period. Agency pamphlets outlining “low-cost” do-it-yourself projects to minimize flood risk tell property owners to “consult local architects, engineers, contractors, landscapers, or other experts in design and construction,” as well as secure “permits or other regulatory approvals” before making any changes.

Such an undertaking isn’t an option for Thalia Panton. Now retired, she lives on a fixed income — a chunk of which goes toward the $60,000 debt her family racked up from Sandy. Flood insurance has done little to alleviate the anxiety she feels when menacing clouds gather in the sky and start pelting the cement with rain.

“I haven’t been made whole and I guess I’ll never be made whole,” Panton said. Her voice hardens when she’s asked whether she’s considered leaving Canarsie. “I have no interest in selling my home, and I don’t want flood insurance to force me out. I don’t think that it can. I will find a way around it.”

Companies profit as flood insurance goes private

The NFIP was financially solvent for much of its history.  But since Hurricane Katrina in 2005, it’s accumulated billions of dollars in debt, borrowing more and more from the U.S. Treasury as disasters hit.

The insurance industry, whose abandonment of the flood market nearly a century ago was a major reason the NFIP was created, now see the program’s woes as an opportunity to make money.

Much of what FEMA has been doing to recast its flood insurance program in recent years follows recommendations from the insurance industry. If the NFIP operated more like a private insurer, upping its rates, it would be easier for companies to compete for the less risky and more profitable policies they wanted. The NFIP would also pay for deals the industry has been trying to strike with the program for years.

Reinsurance, for instance. Every year, to avoid being overwhelmed by claims, private insurers like State Farm transfer some of their risk to reinsurers like Munich Re, handing over a cut of premiums in exchange.

The Reinsurance Association of America lobbied Congress in 2012 and 2014 to confirm FEMA’s authority to purchase reinsurance and to take out catastrophe bonds — a newer form of risk transfer. “Cat bonds” are high-stakes gambles that Wall Street players like hedge funds make on Mother Nature. If a storm devastates, investors could lose their cash, which goes toward paying claims. But if a storm underwhelms, investors keep their cash and take a hefty profit, leaving insurers to foot bills on their own.

Consumer advocates warned that a government agency entering into these deals amounted to easy Wall Street profits that would cost taxpayers money. Robert Hunter, a former NFIP risk manager and Texas insurance regulator, said reinsurance makes “no sense” for FEMA, which can borrow from the Treasury at low interest rates set by the federal government.

By comparison, reinsurance prices are set by private companies that need to turn a profit and tend to raise rates after major disasters. And countries that have relied on cat bonds have found the deals don’t always pay out as expected.

Nevertheless, Congress urged FEMA to see if reinsurance and cat bonds could work for the NFIP. For answers, the agency turned to Guy Carpenter, a company that brokers those very deals.

The resulting FEMA report in August 2015 found reinsurance would be more expensive than borrowing from the Treasury but could encourage private insurers to start competing with the NFIP, offering flood policies of their own. This could help the federal government reduce its share of flood risk over time as private insurers step up, the report found.

Months earlier, Guy Carpenter unveiled a new specialty practice to sell insurance products to big government clients to “relieve the burden on taxpayers” — meaning the company stood to profit if FEMA took its recommendation.

That’s exactly what happened.

By September 2016, Guy Carpenter had its first deal with FEMA. It’s been involved in all the NFIP’s private-sector deals since, helping the program secure nearly $6 billion in coverage for potential storm losses through reinsurance and cat bonds.

FEMA’s Maurstad said the deals have strengthened the NFIP’s finances and helped it avoid accumulating more debt. Guy Carpenter declined requests for an interview. Its parent company, Marsh & McLennan Companies, is now expanding its insurance offerings to include private flood policies that compete with the NFIP.

Consumer advocates wonder what FEMA expected other than a sales pitch. “Guy’s constantly involved in big deals for reinsurers,” said Hunter, now director of insurance at the Consumer Federation of America. “Of course, they’re going to say, ‘Here’s a wonderful idea.’”

Frank Nutter, president of the Reinsurance Association of America, defended the new direction of flood insurance. Private insurers will provide consumers with more choice, he said, which could encourage greater adoption of flood coverage. Both reinsurance and cat bonds are reliable transactions that have helped the NFIP become more financially sound, he added.

But it’s not clear whether the benefits outweigh the costs. FEMA has paid roughly $886 million in premiums to the private insurance industry so far. This doesn’t include additional millions in commissions and fees FEMA has paid to a long list of contractors like Guy Carpenter to execute each deal, which the agency declined to fully disclose.

In the four years FEMA has purchased reinsurance, it has collected payment once. The agency recouped $1 billion in 2017 after hurricanes Harvey, Irma and Maria. Neither of the agency’s two cat bonds to date has resulted in a payout.

David Birnbaum, executive director of the Center for Economic Justice, argued that FEMA’s deals are about political expediency, not taxpayers. “If I can operate the NFIP using reinsurance and not have to go to the Treasury to borrow more money, that’s accomplishing two things,” he said. “It means I don’t have to involve Congress, number 1, and number 2, I don’t have to publicize that we’re losing money.”

Government at risk of being left on the hook for riskiest policies

Pressure to privatize the NFIP has been mounting for years, but efforts have sped up under the Trump administration. In 2017, Congress cancelled $16 billion of the program’s debt at the insistence of the White House, which claimed debt forgiveness was necessary to keep the NFIP running and “enable the private market for flood insurance to expand.”

The White House’s Office of Management and Budget provided a laundry list of NFIP reforms to help “stimulate development of private insurance markets,” many of which have now found life in Risk Rating 2.0.

More options for flood insurance could be good for some customers. But consumer advocates worry private insurers will “cherry-pick” the NFIP by insuring only low-to-moderate risk policies, which generate bigger profits. The NFIP could enter a “death spiral,” Birnbaum said, leaving it on the hook for the riskiest and least profitable policies.

That could further jeopardize the program’s stability and the availability of flood insurance for those most at risk — people living in places like Canarsie.

Cherry-picking appears to be happening in Florida, which has heavily promoted private flood policies. Data shows private insurers covered 8% of policies statewide but only paid 3.8% of flood claims from 2018’s Hurricane Michael, which suggests they are backing less risky properties. Guy Carpenter itself agreed cherry-picking was inevitable, noting in its 2015 FEMA report that private insurers as “profit-seeking entities” were mostly interested in “lower risk, high net worth property owners.”

To gain an advantage, some insurers are hiring the same firm FEMA is using to revamp the NFIP. KatRisk produces catastrophe models, proprietary programs that price and assess risk. The firm’s models are being used by FEMA to develop Risk Rating 2.0 as well as private insurers in North Carolina looking to offer flood coverage for the first time. KatRisk co-founder Dag Lohmann said his firm aims to be “impartial and independent” and provides all users with “the same scientific input.”

Operating the NFIP like a private insurer comes with downsides that FEMA itself has outlined. A 2011 report by the agency found privatization scored poorly on affordability and ranked as the worst option for reducing public exposure to floods. That’s because, experts believed, the private sector could undermine efforts to make properties less flood prone.

Adaptation efforts have already suffered as a result of insurance, according to research by Paul O’Hare, a researcher at Manchester Metropolitan University in Britain focused on climate resilience. He found homes in the United Kingdom that repeatedly flooded were often reconstructed the same way each time and insurers routinely denied requests by homeowners to rebuild to a higher standard.

“There’s no incentive for insurers to encourage to build back better,” O’Hare said. Similar issues plague NFIP policyholders in the U.S.

The mismatch speaks to a larger issue of who is responsible for protecting communities from future disasters. By recommending property owners buy as much insurance as they can, FEMA puts the onus on individuals. But that distracts from what experts say is really needed to reduce flood risk: large-scale government action.

Sitting in her neighbor’s living room one autumn night, Thalia Panton and other Canarsie homeowners commiserated about their uncertain futures and the little government support they’ve received. Federal officials recently greenlit construction of a six-mile-long sea barrier along the eastern shore of Staten Island, another area in New York City hit hard during Sandy. But discussions about a far less extensive barrier to protect communities like Canarsie are in their infancy.

“It’s been seven long years,” Panton said, “and not a lot has happened.”