The following article will set out to provide an overview of the current problems, and recent solutions enacted, surrounding the flood insurance market in the United States. It will do so from two different lenses, beginning with an economic perspective framed in terms of supply and demand, in which topics from population migration, the reinsurance industry, and federal interest rates will be discussed. Next, the article will approach the issue from a governmental viewpoint, exploring recent changes in policy such as risk rating methodologies, building code enforcement, and premium growth rate caps. It will conclude by reiterating the importance of tackling these issues proactively, with a high degree of foresight to achieve the resilience the federal government has set as a goal.
Introduction
From flash floods and atmospheric rivers to the rainiest single January day in California since 18501, the extraordinary rainfall experienced along the southern Pacific Coast in 2024 reflects a broader pattern of nationwide flooding, now common across large swaths of the western and southeastern United States. Over the last three decades, the increased frequency and severity of flood-related disasters and the subsequent economic damage they cause, have led federal, state, and local governments to discuss flood insurance policy with an increased sense of urgency. However, the complex dynamics impacting the effectiveness of such policies are still under-discussed in public discourse at large relative to their importance. Helping to fill this gap, this paper will look to distill the primary factors affecting the flood insurance industry to their core, ultimately concluding that a successful approach to optimizing the nation’s flood insurance market for both protection and profitability must respond to the economic realities, addressing both supply and demand-side factors, as well as leveraging the myriad of potential governmental and policy levers available to regulators and agency officials.
Economic Lens
From an economic standpoint, it is easiest to characterize the problems that have plagued the flood insurance market by categorizing them into two buckets: demand-side factors, which affect the number of homeowners who desire coverage; and supply-side factors, which impact the quality and quantity of insurance available. As will be explored in this section, the fundamental cause of the economic distress experienced in the flood insurance market can be explained in the simplest microeconomic terms, by an expansion of demand and a diminishment of supply, resulting in rising prices which are transferred to either the insurance companies, the consumers, or the government.
On the demand side, a multitude of both direct and indirect elements have contributed to rapid growth in the number of homeowners seeking flood insurance coverage. Among these is a significant population increase in areas more vulnerable to natural disasters, driven by population migrations to more flood-prone climates in the southeast that have taken place over the last couple of decades2; 3, as well as the increased rate of flooding and disaster throughout the entire country4; 5 due to global climate change. This has resulted in more homes requiring coverage in exactly the locations where insurance premiums have risen the most recently.6 In response to these demand-driven factors, federal agencies such as the Federal Emergency Management Agency (FEMA) and the U.S. Army Corps of Engineers7 have begun to increase spending on construction projects to reduce the potential flood risk of these areas, in addition to ramping up their purchase of homes in flood-prone regions to reduce the number of properties requiring intensive coverage.
In terms of supply, several factors have converged to reduce the number of insurers able to offer coverage to meet the rising demand for flood protection. This is evidenced most glaringly by the decisions of numerous national insurance companies to substantially raise rates, restrict coverage to homes in less disaster-prone areas, or pull out of states entirely3, as State Farm recently did in California.8 What’s more, growth in the unaffordability of insurance restricting access to flood protection is particularly problematic because such price hikes and pull-outs have often been found to disproportionately affect communities of socio-economic disadvantage, further perpetuating cycles of economic inequality due to historical practices in real estate and financial markets, and unequal access to institutional knowledge of the federal landscape and insurance industries.9; 10
Driving many of these decisions, but far less discussed in the national media, is the rising cost of premiums passed on to primary insurers by reinsurance companies, which offer insurance for insurers.11 Such corporations often require premiums to be prepaid12, resulting in underwriting losses if the revenue from the premiums doesn’t cover the damages. As costs have continued to rise due to the growing frequency and intensity of storms13, reinsurance companies have turned to issuing “catastrophe bonds”, which pay higher interest, “Than comparable corporate bonds due to the risk, but unlike mortgage-backed bonds and the like, have no assets behind them”.14 However, since the Fall of 2022, the Federal Reserve has continued to sustain high interest rates, providing investors with less risky alternatives to catastrophe bonds and decreasing demand. Bond prices in such a high-interest environment, which historically move in inverse proportion to interest rates15, leave reinsurance companies with little choice but to pass off costs to primary insurers.16
Compounding the issue are state laws, such as in California, which restrict primary insurers from passing on reinsurance costs to consumers. The result is that primary insurers have had little choice but to leave states entirely. This has further led to the creation of “insurance deserts”, where homeowners no longer have access to adequate coverage from the private market, forcing them to turn to “insurers of last resort” which often offer only bare-bone minimums, such as the California state-created Fair Access to Insurance Requirements Plan17, and Citizens Property Insurance Corporation in Florida, which recently made it mandatory for Citizens policyholders within designated hazard areas to hold flood insurance coverage.18 Filling some of this void are “non-admitted” insurers, which are not subjected to the same rules as traditional insurance companies and often charge more than primary insurers for less coverage.19 The combination of this shrinking of the supply of insurers with growth in the demand for coverage has thus ultimately led to the policy debates and changes discussed in the section to follow.
Governmental Lens
As a result of the numerous economic factors distressing the flood insurance market as explored above, several federal, as well as state and local, policies currently in place to regulate the flood insurance industry have been examined and discussed for reform. This has led to highly beneficial and constructive changes taking place across agencies and programs such as the National Flood Insurance Program (NFIP), a branch of FEMA.
One such change enacted this year within NFIP is to offer federal assistance of up to $42,500 towards damages that private insurance does not cover20, revising the previous guidelines that made residents with private insurance over a certain amount ineligible for federal assistance, even if such coverage didn’t cover the full extent of damages. This reform followed an ambitious legislative proposal to Congress by NFIP outlining the administration’s request for a multi-year reauthorization as well as their strategic priorities, which included improving affordability for low-and-moderate income policyholders, enhancing the communication of flood risks and mitigation tools to safeguard against damage, and instituting a more transparent financial framework.21
While these policy changes and legislative proposals have been welcome news, opportunities for further changes still abound, such as addressing the low coverage amount limit of $250,000 for residential buildings and $100,000 for their contents22, which limits the value homeowners can recoup from loss. Another such possibility for reform exists in the 18% annual cap rate limit that insurance premiums can rise if home ownership remains consistent.23 This policy, while beneficial in the short-run for long-time homeowners, hinders insurers’ abilities to align premiums more accurately with risk24, a discrepancy that can reach as high as sixfold in states such as Louisiana25, ultimately causing more significant long-term issues.
Driving this need to adjust rates to reflect flood risk more accurately has been an extremely advantageous change, enacted in 2021, to NFIP’s risk rating methodology. Previously following coarser guidelines26 established in the 1970s to calculate risk based on a combination of factors such as flood insurance rate maps, elevation, and occupancy, FEMA and NFIP’s much improved “Risk Rating 2.0” methodology now considers a wider range of variables, with increased emphasis placed on the specifics of individual structures rather than their geographic location.27
This enhanced significance of strengthening properties’ structural components mirrors yet another beneficial reform within FEMA surrounding improving the adoption and enforcement of building codes, especially in flood-prone areas, which often have weak or unenforced standards.28 One such highly successful program enacted by FEMA to encourage this is the Community Rating System, a voluntary incentive program with over 1,500 participants across the country designed to reward communities that adopt floodplain management practices that exceed the minimum requirements of NFIP.29 Following the example of localities that have heeded the guidelines of federal agencies to put in place more stringent standards such as Alabama30, state and local governments could substantially reduce the risk of flood damage within their communities and encourage insurance companies to continue providing coverage at reasonable rates.
Conclusion
Ultimately driven by the rise in the severity and frequency of flooding due to global climate change, the U.S. flood insurance market has primarily been impacted through economic and governmental channels. As explored in the sections above, this has manifested itself in economic terms through a marked rise in the demand for flood insurance. This has been driven primarily by population migration to more flood-prone regions, as well as a significant decline in the supply of insurers, impacted by rising costs and higher premiums passed off from the reinsurance industry. From a policy lens, issues have arisen from numerous regulations such as low coverage limits and caps on premium growth rates.
While there has been substantial progress made reforming several of these policies, such as the much-improved risk rating methodology and encouragement by FEMA for state and local governments to strengthen building code standards, significant further advances are needed from a regulatory and market standpoint to continue building upon the progress recently made. As the rate of natural disasters continues to rise, making these changes proactively, with a high degree of foresight, will become even more critical across all levels of the U.S. government to achieve the resilience agencies and programs have so laudably set out to reach.
