Federal Flood Insurance

Word today that President Obama has indicated his support for a Senate bill to reform and extend the National Flood Insurance Program (NFIP). Here is WSJ coverage of the proposed changes, which would reduce subsidy for second homes, commercial property, and homes with a history of flooding, reducing the cost of the program by $4.7 Billion over the next 10 years.

I wrote the words below just as Hurricane Irene was bearing down on the North Carolina coast last August, that provide an overview of how the U.S. has done flood insurance for the past 45 years or so. Many fascinating issues about public v. private insurance, aggregate cost benefit analysis and distribution of the costs and the benefits, and the role of government in society. I also did a 5 part series comparing principles embedded in the NFIP to health care. I will write more about that later.

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Flood insurance is provided in the United States by the federal government via the National Flood Insurance Program (NFIP), in two ways. First, the government directly provides coverage for some properties. Second, the government works in concert with around 90 private insurers who function as servicing contractors. In the second case, the profits from such flood insurance are private, but the losses are socialized as private insurance companies bear none of the underwriting risk associated with this insurance. How did this come to be the case?

As this American Academy of Actuaries monograph (July 2011) on the NFIP notes (p. 30):

The National Flood Insurance Act of 1968 filled this void and provided flood insurance for properties that were otherwise uninsurable. The creation of the NFIP has meant that homes and businesses could be built in places where they almost certainly would not have been absent this insurance. That was the overriding public policy goal of the NFIP. This outcome of course has costs and benefits in both a net, as well as a distributional sense. Further, the NFIB has had a sunset date for its entire existence, meaning it must be reauthorized to continue to operate, at intervals set by Congress. The next sunset date is September 30, 2011, and neither the House nor the Senate has moved to reauthorize the program, which will cease to operate even for those who have paid premiums on that day absent congressional action.

Since its inception, three principles have guided this program:

  • identification of risk and the development of maps that delineate flood risk (roughly 5 risk bands, with elevation serving as a risk adjuster within bands)
  • flood plain management, designed to mitigate risk of flood
  • the provision of flood insurance for uninsurable properties

A related goal has been to reduce the reliance on federal flood relief after catastrophic events.  Why could private insurance not cover such flood prone properties? Two main reasons. First, the goal of private insurance companies is to earn a profit, and they at least must earn excess premiums to cover their cost of capital (they have to pre-fund losses), whereas the U.S. government can easily borrow money to cover catastrophic flood events after they occur. Second, private companies could not compel the purchase of their product absent legislation, so would face tremendous adverse selection problems and/or no one buying their insurance. Into this situation stepped the federal government in 1968, and with a variety of modifications, it has remained the only flood insurance provider in the United States for the past four-plus decades.

Several notable aspects of the NFIB:

  • can compel the purchase flood insurance if the property resides in Special Flood Hazard Area (SFHA) (since 1974)
  • around 80% of covered properties are assessed full-risk premiums based on Army Corps of Engineers models; the other 20% have subsidized premiums because the covered dwelling was built prior to the identification of SFHAs in 1974
  • because of subsidized premiums, in some years the NFIP will run a loss, in others a “profit”
  • there are a variety of reasons that full risk premium policies may not in fact represent the expected value of future damages (the goal for such premiums)
  • has a statutory limit on the aggregate amount of money that can be borrowed to pay out damage claims; this limit was $1.5 billion from 1996-2005; after Hurricanes Dennis, Katrina, Rita and Wilma the cap is now $20.725 billion; once the cap is exceeded, no claims may be paid
  • Hurricane Katrina alone cost the NFIB $17.75 billion
  • Individual policies are limited to $250,000 for dwelling/$100,000 for contents for a home; $500,000/$500,000 for a business
  • Annual premium increases are capped at 10% annually
  • risk of loss is highly concentrated; 1% of the insured properties resulted in 38% of the losses incurred by the NFIP from 1978-2004
  • 60% of the single family dwellings covered by the NFIP are in the South; 38% in Florida alone
  • Perceptions of regional bias are incorrect; the true risk of flood differs by region of the country (a similar risk band property on the Florida coast would have the same premium as a home by a mountain river in Colorado; there are just more such similarly-risky properties in Florida)
  • Over time, more insured property has been serviced by private insurance companies, with the federal government holding all the underwriting risk
  • One large private insurer ceased participation in the program in 2010 because Congress 3 times in 2010 allowed the sunset date for NFIP to lapse but then reauthorized the program retroactively. All told, Congress has done this 11 times since 2002. Even though private insurers are not liable for losses in such cases, they fear bad publicity.
  • Very active Hurricane seasons in 2004, 2005 and 2008 have lead to a call for a comprehensive review of the NFIP

Author: Don Taylor

Don Taylor is an Associate Professor of Public Policy at Duke University, where his teaching and research focuses on health policy, with a focus on Medicare generally, and on hospice and palliative care, specifically. He increasingly works at the intersection of health policy and the federal budget. Past research topics have included health workforce and the economics of smoking. He began blogging in June 2009 and wrote columns on health reform for the Raleigh, (N.C.) News and Observer. He blogged at The Incidental Economist from March 2011 to March 2012. He is the author of a book, Balancing the Budget is a Progressive Priority that will be published by Springer in May 2012.

14 thoughts on “Federal Flood Insurance”

  1. Don,

    What is your take on the proposed revisions? Personally, I don’t have a problem with eliminating subsidies for second homes and for homes with a history of flooding. Well, I guess it would depend on how “history of flooding” is defined. A previously flooded home already located in a low risk area (according to the Corps models) should probably continue to be subsidized.

    But allowing (or worse, encouraging) towns built on river bottomlands or on Atlantic coast barrier islands to rebuild exactly where they are is simply stupid. We ought not be subsidizing that sort of silliness.

    I’m not sure about the commercial property exclusion.

  2. This sort of subject is where Brett should be jumping right in if he were really committed to market principles and small government, not subsidizing dumb activities, etc. Brett? Where is the outcry?

    1. *Shrug*

      You do realize that conservative and libertarian organizations do repeatedly editorialize against the NFIP, right?

      More moderate opposition (consistently advocating changes like the above) from groups like Heritage:
      http://www.heritage.org/research/reports/2005/12/fix-the-national-flood-insurance-program-to-reduce-future-losses

      And more extreme advocacy of just ending it from groups like Cato and the Heartland Institute:
      http://www.cato-at-liberty.org/put-federal-flood-insurance-out-of-its-misery/
      http://news.heartland.org/newspaper-article/2010/02/12/national-flood-insurance-program-failures-raise-concerns

      It’s generally the old moderate, bipartisan consensus that keeps this alive, much like other programs like the farm bill.

    2. I’m sure Brett is against the NFIP. It’s exactly the sort of thing libertarians rail against.

  3. This seems more than a little relevant to the post.

    http://www.usatoday.com/tech/science/story/2012-06-24/east-coast-sea-rise/55795690/1

    Note especially the point at the end:
    “Sea level projections matter in coastal states because flood maps based on those predictions can result in restrictions on property development and affect flood insurance rates.
    Those estimates became an issue in North Carolina recently when the Legislature proposed using historic figures to calculate future sea levels, rejecting higher rates from a state panel of experts. The USGS study suggests an even higher level than the panel’s estimate for 2100.”

    This is North Carolina proudly standing up and insisting that they don’t believe in global climate change and refuse to plan for what might happen if it’s true. But I can easily see Congress plus a GOP president doing the same thing over the next ten years.

    As Dennis says, what is the meaning of “history of flooding”? Especially when history is no guide to the future, and some of us are well aware of that while others of us refuse to be. There are probably very real, very large arbitration possibilities here for the ruthless.

    1. Yes, the NC honorables mandated maximum sea level rise in the latest session….see how powerful they are!

  4. Why isn’t there a federal Frog Rain insurance programme? (Prompted by my previous post.)

  5. @Dennis
    I think it is a reasonable modification given you want to keep it and need to reform it. One issue is that benefit coverages were frozen in nominal figures and haven’t increased, so there was an already an implicit cap of sorts. This program is an interesting lens through which to test how you (not you, but anyone) claims to view govt.

  6. On history of flooding, 1% of the dwellings have lead to 38% of the claims from 1978-2004. So, there are repeat locations that much more likely to flood, even within the subset of dwellings that are required and qualified for flood insurance.

  7. I’m not against the existance of the NFIP, but I do hope for some sanity with regard to the highest-risk areas. Also, make damned sure you take in enough premium to cover losses (which is to say, make sure you have decent actuaries and don’t let political considerations fudge the numbers).

  8. I see this analogy to health insurance as spurious. Brett has only his surrogates to speak his position so far, but I suspect he (libertarian and conservative) and I (left-leaning Democrat) would be on the same side on this issue.

    When you consider buying a house, one of the pieces of information you have prior access to is the flood risk. It’s become quite sophisticated over my lifetime, based on a huge data base of historical AND engineering data. If you have a heart attack, we the people have decided that it’s our collective obligation to save your life, irrespective of whether you can afford it. But I sure don’t feel any such obligation to pay you to rebuild your house if you decided you wanted to live on the beach in Nags Head.

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