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Conversation with the Andy Neal, Chief Actuary of FEMA’s National Flood Insurance Program

Andy Neal, Chief Actuary of FEMA’s National Flood Insurance Program
Podcast Series: 

FEMA’s own Andy Neal (and team) from the National Flood Insurance Program, was chosen as one of the 27 finalists for the Management Excellence Category of the Samuel J Heyman Service to America Medal – the “Sammie”. On this episode of the FEMA Podcast we talk with Andy Neal about the process of diversifying the NFIP’s risk through reinsurance, and what the Sammie Nomination has meant for his program.

Transcript

{Intro Music} [Mark Peterson] I'm Mark Peterson and this is the FEMA podcast. [Mark Peterson] Every year. The Partnership for Public Service, a nonprofit, nonpartisan organization whose mission is to help make our government more effective awards its highest prize - The Sammy - more formerly called the Samuel J Heyman service to America medal. It's like the Oscars for government service and just being nominated is an incredible feat. Named for the Partnership for public services, late founder who was inspired by President Kennedy's call to serve in 1963. These awards aligned with his vision of a dynamic and innovative federal workforce that meets the needs of the American people. The Sammies are the partnerships way of showing the world the many ways the government is making our country better, safer and stronger. This year, FEMA’s own Andy Neal and his team, from the National Flood Insurance Program was chosen as one of the 27 finalists for the management excellence category. Andy Neal is an actuary for the flood insurance program and admittedly the nomination isn't exactly a best actor or best screenplay nomination, but considering the program in which Andy serves for government, it might as well be. What Andy and his team did was become the first government entity to shift financial risk to the private markets through reinsurance, and because of this, he developed an innovative process that helped better prepare the nation for the historic 2017 hurricane season. [Mark Peterson] And as a result of Andy's efforts, the national flood insurance program recovered more than a billion dollars in losses from the private market during Hurricane Harvey. On this episode of the FEMA podcast, we talk to Andy Neal about the process of diversifying the NFIP’s risk through reinsurance and what the Sammy nomination has meant for his program. But first we'll find out what an actuary really does for FEMA. [Mark Peterson] Okay. Andy Neal, thank you so much for joining the FEMA podcast. [Andy Neal] Glad to be here. [Mark Peterson] You are an actuary for FEMA National Flood Insurance Program. So what is an actuary? [Andy Neal] So an actuary helps an organization manage its risk, particularly it's financial risk. We focus on those kinds of events that you need to manage by thinking about either how many, how risk portrays itself over long time horizons or for big events that you can't normally handle. So catastrophic kind of events. [Mark Peterson] So when I think of an actuary and I don't know much about actuaries, but I sort of think of a person who is working with some expert who knows what a risk is, whether it's a health expert and it's thinking about life insurance or property loss or something like that. And then is calculating by some very complicated math formula into a spreadsheet and then it spits out some premium that reflects the risk and the cost and all those things. Is that somewhat of an accurate estimate of what an actuary is? [Andy Neal] Somewhat. So one of one of the challenges is most of the actual profession takes the law of large numbers and applies it to real life. The law of large numbers works like this and you can think about in terms of either your own health insurance, your car insurance, or your own homeowner's insurance. Either one can be an example for you and each of those insurances. There is a situation that you could find yourself in where suddenly you need to pay a lot of money and it's more money than you could think about paying in that year. So you get really sick. You have a huge hospital bill, you get into a car wreck and it's not just the damage to your car, but there's actually liability involved with hurting someone else or your house burning down any of those things. There's a financial situation you're in that you can't handle. What insurance does is it takes that low probability of those things happening and it spreads it out over lots of people and if you get enough people in the pool, then things start behaving normally. Even though for each individual when it happens, it feels like a big event. For the big pool. It actually behaves normally and the insurance company can smooth it all out. [Mark Peterson] And you're looking at that big pool versus any individual risks, is that right? [Andy Neal] Or most of the time, yes, but the problem is for really catastrophic risks like flood insurance, the law of large numbers doesn't even work for the pool itself. [Mark Peterson] Why not? [Andy Neal] Because our pool isn't quite big enough to smooth the losses out. So for the NFIP, even though we cover 5 million policy holders all around the country, we still have years where we might only have a couple of hundred million dollars of losses in a year or we could have billions of dollars of losses in a year like we saw during Sandy, like we saw in Katrina and most recently with Harvey, [Mark Peterson] we currently insure $5 million policies. Is that right? Okay. So what does that represent in terms of the housing market in the United States? Do you, do you have any estimate of what that is? [Andy Neal] So I'm going to use rough numbers because people argue about this and one difference between what you might think about an actuary and what actually really is. Accountants care about east little been the actuaries. We can just say, oh, it's about this. So there's roughly a 100 million single family homes in the United States. Uh, there's more nonresidential, but if you're looking at our 5 million, our bread and butter, single family homes, and so we're covering, let's say five percent of homeowners now out there. [Mark Peterson] Okay. So in that five percent, what is the total liability that the NFIP, you know, currently has. [Andy Neal] So I'll confess, I don't really liability of risk, right? Because that, that, that, that's what you would say is like the, the US flood event. Like if all the US flooded the same time, it's, you know, over a trillion dollars of total exposure that our program faces. But not all of that's going to hit in the same year. But so we often talk as actuaries in terms of maximal probable losses or probable maximum losses. And when we talk about a probable maximum loss, it's often couched in terms of probability and exceedance probability, which means what's the level of event that we might exceed with a low probability? So what's a one percent probable maximum loss or a point two percent probable maximum loss for our program that one percent probable maximum loss is above $20,000,000,000. The point two percent probable maximum loss is above $30,000,000,000. So we know that we can face events that are far in excess of the premiums that we take in. [Mark Peterson] So we know that, that those events are possible, at least from an actuarial standpoint. Um, and yet we faced a number of very large events that have cost the program quite a bit of money. And so currently the, the program itself is in, a relatively high amount of debt. So how did we get to that point? How did we get to the point where we're at right now with the NFP? [Andy Neal] So there's a couple pieces that play into that. One is that a, I'll use a word unlucky, and that is that we had many large events in a fairly short timeframe [Mark Peterson] and is that going back to like 2004 where we had four hurricanes I think hit within two months or so, [Andy Neal] and then 2005 when Katrina and in 2008 with Ike and then, and then we had sandy in 2012 and we had Harvey just last year [Mark Peterson] and not to minimize those, but those are a handful of very large events, but even within those years were having riverine flooding throughout the United States that the flood insurance is still paying, um, policies out on. [Andy Neal] So our program really is a tale of two kinds of flood loss there. The flood losses that you never read about in your papers that if I look for any given calendar year, all 50 states have losses in them, have hundreds of thousands of dollars or millions of dollars of losses that you'll never see in the papers that don't get reported. But our program is, they're helping those people rebuild after what for them is a personally catastrophic event. And then there's the story about the large catastrophic events. It's interesting to note that for something like Katrina in the whole 40 years, the program prior to Katrina happening, the program had not paid out as many losses as it did in that single year. [Mark Peterson] That's incredible to think about. It is when you add up that this year the NFIP is celebrating its 50th anniversary, the year of Katrina. It was a 2005, so 13 years ago. Um, I mean, that's an extensive period of time of existence and it hadn't paid out all of that money leading up to Katrina. [Andy Neal] And what's interesting is that the program has always had that level of risk associated with it and it took Katrina to show us the level of risks that this program actually needs to manage. Now, what's interesting is that you look at Katrina and there's ways that you can look at the particulars of that event and you can start trying to wash it away and say it was an anomaly. There were a lot of levies involved in New Orleans. There was the angle of the storm, there was the way that it came in, how exactly that particular storm manifested itself. You can start saying, but those manifestations won't exactly happen again, so that's an anomaly. Let's forget about it. Then you have sandy and of course sandy comes in and it's at a particular angle and uh, it's two storms that combine. It Hits The New York New Jersey area, and you can start trying to say, well, that's an anomaly as well. And even Harvey, you can start saying, well, let's look at how long the rain actually fell over Houston. That's not typical. Now. Each one of those is a unique event with a unique characteristics, but one of the things that we're learning as a program and that there's actually new technology giving us the ability to model it, is that even though those particular events are unique, to have events like those happen for the program is to be expected. And so we expect to have events of the Katrina size. We expect to have Sandy’s happen and Harvey's happen and even events that are bigger than ones we've yet seen are indeed possible. And when we know they're there, shame on us if we don't manage to the expectation of those events. [Mark Peterson] Hurricane Harvey was part of last year storm system, which was one of the largest hurricane seasons on record, if not the largest in terms of impact to the, to the continental United States as well as the territory's. And I would think that the NFIP has got to be looking at some more unique ways to manage its, uh, its funds rather than looking at more borrowing authority. And you put those in place in 2017, right? With a reinsurance. [Andy Neal] That's, right. So the NFIP is in the process of building what we call a financial framework. So you talk about what happened that created this debt. Some of it is the premiums that we set and the, that not all of our premiums were full risk, but even then there's also the financial framework that not only the premiums themselves but what other monies are available, what other investments are available. And what other risk management, financial tools are available to help you manage the risks? The program faces and reinsurance is one tool that we're beginning to deploy to help delineate that line between what our program is managing with its own resources and the premium that it takes in. And by virtue of managing that well and measuring it well, we can then illustrate what risk is left for Congress or for the Treasury to be managing. [Mark Peterson] So just so I understand it. So what is reinsurance? How does that work? [Andy Neal] So reinsurance works a lot like the insurance that you buy. So just like I, I mentioned that you're buying insurance for your homeowner, for your auto, for your health insurance because there are financial events that are more than you can manage on your own reinsurance that the same thing except for an insurance company. So when the law of large numbers isn't working out for the pool of policies that the insurance company is managing, it can buy reinsurance to kick in at the level where it can no longer manage that risk to help spread that risk out to other companies called reinsurance companies. [Mark Peterson] So 2017 was the first time at the NFIP weighted into the reinsurance waters, right? [Andy Neal] Not only the first time the NFIP had rated in weighted into the reinsurance waters. This was the first time any federal agency or the federal government had waded into those. [Mark Peterson] But the private sector has been doing this for years and they always do this right? [Andy Neal] They have indeed, [Mark Peterson] so what took so long for the federal government to do it? [Andy Neal] Some of it was that until Katrina happened, we largely ignored the risk exposure of the program and Katrina was a wakeup call that eventually led to some legislation to say, hey, we do want you to look at whether reinsurance makes sense for the NFP. And we spent some years doing a study and unlike studies that often get shelved onto a shelf after we completed our study and that study illustrated ways that reinsurance could help the NFIP manage its risk, uh, we pushed on to, and FEMA leadership pushed us on to actually put reinsurance in place for the NFIP. [Mark Peterson] What did that reinsurance looked like a last year. [Andy Neal] So the reinsurance looked like a protection for the program. It was a billion dollars of protection. Uh, it kicked in as soon as our losses hit $4,000,000,000. And then we had 25 reinsurance companies taking a share of the risks that we have between four and $8,000,000,000 for a single event. And unbeknownst us and we replacing it. Uh, we actually ended up having Harvey completely, not only what we call attached the reinsurance, which means that hit that $4,000,000,000 level so that it would start paying, but it went all the way through the cover and the top of it at the top of the $8,000,000,000. So one of them in just in a single event. And therefore we collected a billion dollars from our 25 reinsurers and then renewed reinsurance for the 2018 year where we even grew the program, some to almost one point $5 million of coverage. [Mark Peterson] So we paid a premium of, I think I read $150 million, that's about 25 reinsurance companies and for a billion dollars of coverage [Andy Neal] that is correct. [Mark Peterson] And that kicked in in one event, one single event. So if I think about it in terms of fiscal responsibility and saving the government money in one event, we saved the government $850 million dollars. [Andy Neal] So that's one way of looking at it. But a better way of looking at it is the value of protection. So that value is there. Whether you actually have the harvey of Internet year or a harvey like event or not, just like the insurance that you buy is actually protecting you and you hope not to use it. I hope not to be in the hospital and run up a million dollar hospital bill, but I'm thankful that I have insurance that will help me there. It gives me peace of mind and it is providing me value because in any given year, just like you hope a catastrophic event doesn't happen to you, it could in any given year and having that coverage helps you manage your risk. [Mark Peterson] I think that's a really great piece of advice given what the administrator is trying to focus on right now for FEMA, which is personal preparedness, but also financial preparedness and a huge chunk of that is closing the insurance gap and having a individuals as part of their preparedness plan. Not just look at their flood insurance coverage but all of their insurance coverage and is it up to the level of protection that they really need. [Andy Neal] And it's important to know that when it comes to protecting yourself, your mortgage company, the different laws about the NFP and whether you have to buy flood insurance or not. Those give you a minimum basis to begin protecting yourself. But like the administrator wants everyone to do. You need to look at the risks that you're exposed to and know what you're going to do. Should any of those risks happen. So in California, you don't necessarily have to buy earthquake insurance, it's important to look at whether you can buy that earthquake insurance so that you can ensure your assets and not have to be relying on the hope of FEMA assistance, which the individual assistance that you get when you're uninsured is often only a fraction of what you'd need to fully recover. [Mark Peterson] Right. Um, so I want to go back to this idea of reinsurance and what you and your team have put together a, which is, like you said, completely unique and a first time ever for the federal government to transfer risk to the private market. So as a result, you and your team have been recently nominated for us, Samuel J. Heyman service to America medal and that's often called the Sammy and it's like the Oscars for, for federal workers. Um, so congratulations for that nomination. The nomination itself is a, is a very big deal [Andy Neal] and I can't say enough how thankful I am for the team of people that I had working on this. And it's both my immediate team. So I had another actuary working alongside of me. I had lawyers working alongside of me, but even the different components of FEMA that had to help us. So the procurement office, the Legal Office of External Affairs, the finance folks. So many people came together to make this happen and they worked in a way that is rare and the federal government. So rather than being normal bureaucrat that say, follow my process and this is going to take eight weeks or wait in line with everyone else. People really did help us work with an objective that said we want to have this reinsurance in place by the end of the year. How can we make that happen? And people really did move mountains with us and for us to make that possible. So as much as we've been nominated for this award, I have to say that this award is not for me and not even only for my team who really did pull off some amazing heroics, but really for all of FEMA and DHS and by extension the federal government for really working in a way that is, uh, not what people often expect to the federal government, but was a beautiful thing to see. [Mark Peterson] What has it meant to the morale for the team here in the NFIP to be recognized like that because I think, um, I've worked with the NFIP for a long time and they do really, really fantastic work that people here really do care about covering the risk for everyday Americans, um, and what is probably their largest asset, their home and trying to give them options that are more affordable to protect that. So to be recognized by your peers and the rest of the federal government, what does it, what does that mean to the team? [Andy Neal] The team is so amazingly excited to have this honor bestowed upon them. And I'll just say as an actuary and the other actuaries working with me, we're not used to being popular. Actuaries are usually the people that, uh, they might not even go to the dance and if they're there, they're definitely the wallflowers. Um, and it's been interesting to suddenly have our team become popular around here. People coming up to us and telling me, I voted for you. I voted for you and your team. Great work. And that's a strange position for an actuary to be in. But my team is, we're just excited to have the opportunity to shed some good light on the good work of this program, the good work that FEMA is doing. And it really hopefully can start changing the image of a, of this little known program into something that really does help America recover from its flood disasters. [Mark Peterson] There really are a lot of talented people here and a lot of people that, like I said, care a great deal about making America a better place. [Andy Neal] And what's amazing about the national flood insurance program is it really is a combined effort where you've got these fine people here in the NFP who have dedicated their lives really to this program. And then we have always been a public private partnership where we have insurance companies that are partners. We have other stakeholders out there that are excellent partners for us. And adding this reinsurance component is just another component where we are working together public, private individuals and corporations to achieve an end where we are helping Americans recover from floods. [Mark Peterson] We've linked to this episode on our FEMA Facebook page and we invite you to join the conversation in the comments. If you have ideas for future topic, send us an email@FEMA-podcastatFEMAdotdhs.gov. If you would like to learn more about this episode or other topics, visit FEMA.gov/podcasts.
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