Plugging the flood insurance protection gap with behavioral economics

Plugging the flood insurance protection gap with behavioral economics | Insurance Business America

Plugging the flood insurance protection gap with behavioral economics

A recent study by Swiss Re found that 43% of Americans believe their homeowner’s insurance policy includes flood coverage, but in reality, only 15% of homeowners are estimated to have flood insurance.

There are multiple factors behind America’s gaping flood insurance protection gap, according to Matt Junge (pictured above), head of property solutions for the US and Canada, Swiss Re. One, as shown in the data above, is that many homeowners mistakenly believe they have coverage when they don’t. There’s also a general lack of awareness and education around flood risk. Many Americans believe that if they’re not close to a large body of water, then their home is not at risk of flooding. Time and time again, that has been disproven during heavy rainfall events at inland locations.

Then there’s the issue of the mandatory purchase requirement in the US. Homeowners in special flood hazard areas (SFHA) – designated by the National Flood Insurance Program (NFIP) and the Federal Emergency Management Agency (FEMA) - are often required to purchase flood insurance, especially if they have mortgages from federally regulated or insured lenders. Unfortunately, that requirement plays into the common misconception that properties outside of an SFHA are not at risk, but again, that’s not true.

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To combat misconceptions around flood coverage, Swiss Re has turned to behavioral economics (BE) – an approach that has historically been under-utilized by the insurance industry to understand buying decisions of consumers. Instead, most players rely on predictive data science approaches that are backward looking and often fail to account for the role of new information. Realizing this disconnect, Swiss Re conducted a comprehensive survey to understand consumer preferences and decision-making processes for buying flood insurance.

“In BE, we focus on human biases, and we look at where people are predictably irrational. Certain biases are really prevalent around flood insurance and natural catastrophe insurance – and these biases are amplified because severe floods are low probability, high consequence events. It’s hard for people to comprehend how and why those events happen because they happen so infrequently,” said Alexa Weise, senior solutions innovation designer at Swiss Re.

“One of the biases connected to flood insurance is the availability bias. That’s where we are predisposed to think about things that have happened recently. If a person hasn’t ever experienced or had recent experience with a flood [in the past 10 years], then [connection to flood] is not going to be readily available to that person. So, when an insurance agent asks that person if they want to buy flood insurance, they don’t see any immediate need based on their past experience.”

According to BE, humans typically find it difficult to think about the future in an unbiased way. We have no clear idea of how we will behave in the future, regardless of how we’re feeling at the present moment. That’s one of the factors that makes flood insurance such a hard sell. If an agent asks a homeowner: ‘Do you want to buy flood insurance because you have risk for the future?’ that is often interpreted as: ‘Do you think there will be a flood in the future?’ which is a hard concept for the average person to perceive. Recognizing that, Swiss Re is encouraging agents to put more emphasis on historical instances – past experience or past examples of flooding – because they’re a lot more tangible.

“Another part to it is trying to translate jargon like the ‘100-year floodplain’ and figure out how to actually communicate flood risk to people,” Weise added. “The 100-year floodplain can be a very difficult concept to understand. One thing that has been studied in BE – and we did this through the study we conducted at Swiss Re - is [the impact of shortening] timeframes. What if we could actually change the percentage chance of a flood occurring into a 30-year time span? That’s much more accessible for homeowners to grasp because 30-years is the standard mortgage length, so they can envision they’ll be in their house for 30-years and understand the possibility of a flood in that time span.”

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Flood insurance take up by those not subject to a mandatory purchase requirement is often reactionary to specific events. According to NFIP data, there’s often a major uptick in the purchase of flood insurance after a flooding event, but this only stays statistically significant for nine years following the event, after which the take-up rate returns to the baseline. When it comes to flood insurance, retention is finite.

“That’s another reason why we started investing in BE,” said Junge. “We have a strong flood product, and we believe the industry is well equipped to insure flood, and to do that profitably. But we need to make sure that our clients are well equipped to sell flood insurance, to get the best results, and then retain it. It takes a lot of work and a lot of money to actually educate folks about flood risk, and ultimately sell it – and our hope is that they would then retain that coverage long-term.”