RFFs Parametric Flood Insurance Proposal

Friday January 29, 2016

•  bonds •  environmental policy •  environmental studies •  financial management •  flood insurance •  flood studies •  insurance •  markets •  NFIP • 

There’s a new proposal from RFF for community based flood insurance. In short, rather than individuals purchasing flood insurance at the property level, communities would purchase insurance at the community level. The proposal is available from RFF’s website. From the proposal,

The community policy proposed here adopts principles from parametric insurance. That is, it would pay a fixed claim amount, with the maximum claim capped at a relatively modest level, when a predefined “triggering event” occurs-in this case, flood stage reaching a certain height on a river or tidal gage. The advantage of a parametric policy is that it simplifies the process of setting the premium and greatly reduces the cost of settling claims.

Basically, if there’s a flood, everyone in the area gets a payment, regardless of damages. We see this same kind of policy in some catastrophe (cat) bonds. With these bonds, the insured gets a payment if an event happens, regardless of loss. For example, I could issue a cat bond where, for instance, I get a loan from you, and I pay you back some interest rate. The terms of the bond allow for some periodic interest payment to you. All is fine and dandy unless something bad happens. Something bad happens may be a 5.0 earthquake within 100 miles of St. Louis, or hurricane with windspeeds above 100 miles per hour, or Steve Harvey hosts an award show.

Then, and only then, I take the money and tell you to shove off. You get no more payments. Legally, the bond defaults. But that’s not the point. The point is, I have money when something bad happened, not when I took a loss. I may have no property within a thousand miles of St. Louis and not even care if there’s an earthquake. It doesn’t matter, the parametric bond pays on the event, not the loss.

At the end of the day, I can’t get excited about this proposal from RFF. While the NFIP is a mess, the political environment won’t support government funds paying people who happened to be near a water main break.

Image by National Archives and Records Administration via Wikimedia Commons. The 1906 San Fransisco earthquake was one of the largest disasters in the United States.