1 Mar 2017

The failure of national flood insurance

Edward writes*

A specific exception in all homeowner’s insurance, generally noted in a bolded all-caps statement.


Flood insurance has historically been a tricky concept in the United States. Phased out after the 1927 Mississippi Floods by most private insurers, flood-related insurance sees atypical claims. Claims are inconsistent, and when they occur, they do so with high spatial correlation. This is different from most other forms of insurance, where risk is far more spread out.

For several decades, disaster relief was handled by Congress on a case-by-case basis, until under President Johnson, the National Flood Insurance Program (NFIP) was introduced in 1968. Heralded as a self-supporting solution, the NFIP has been suffering from inefficiencies since day one, being unable to reach a large part of the population, incapable of monitoring its regulations and -- since hurricane Katrina in 2004 -- in endless debt.

With climate change and rising sea levels in our future, the role of the NFIP becomes only more vital.

Despite this, it has seen a strong opposition from the Obama administration as well as congress in the past. Hurricanes Katrina and Sandy devastated the NFIP’s reserves, leaving it 23 billion in debt with the US Treasury. The interest on this loan equals 900 million a year, and with premiums totalling 3.7 billion, it is currently not feasible for the NFIP to pay back. As such, the Bigger-Waters Act of 2012 (BW-12) [pdf] was developed. It cracked down on premium rates as well as discounts, and removed grandfathering. These changes were considered too radical, and an exodus was feared. As such, the Consolidated Appropriations Act and Homeowner Flood Insurance Affordability Act, both of 2014 [pdf] were introduced to repeal parts of BW-12, lowering premium hikes and reintroducing grandfathering. Neither tackled one of the actual key issues with the NFIP however, where almost a third of its income is appropriated to the contracting of a middle man; local insurance providers that promote and provide flood insurance to the people for the NFIP, as well as handling claims. They do not run any actual risks, yet take a massive portion of the NFIP budget, without having to show proof of actual costs.

All in all, the NFIP is rough waters. Unless a serious stimulus is introduced, the programme cannot continue to exist in its current form. Participation is too low, and control is too lax. On top of this, the Trump administration is considering the promotion of privatized flood insurance, which would jeopardize what is left of the NFIP. Instead, a change to a full mandatory insurance for all dwellings within floodplains could be considered. An increase in reach of that magnitude could change the scale on which the NFIP operates. 39% of all Americans live on the coast, yet only 4% (a part of which does not even live near the coast) is insured through the NFIP. Right now, this is only mandatory for those living in houses financed through federally backed mortgages, but control is lax. A second problem suffered from lax control is the continued building and appropriation of land that should be left alone due to flood risk, as local governments are enchanted by the short term gains of development rights.

Bottom Line The current NFIP is beyond broke. A full reform is unavoidable, and I for one am very curious to see what will happen next.

* Please comment on these posts from my environmental economics students, to help them with unclear analysis, alternative perspectives, better data, etc.

1 comment:

Jonathan Abra said...

Nice piece, Edward. It is always interesting to see how things are done differently around the world.

For me, one of the keys to this lies in your final paragraph. If there are no controls on the development in flood prone areas (flood plains in particular) it is inevitable that property will be inundated. Where is the insurance sector in this? If they were to have a say in the insurability of property I feel certain that developers would be forced to build outside the modelled flood-prone areas.

It is intriguing to a Brit that the state seems to have become the insurer of last resort. Why, in the land of the free and free enterprise, isn't the market allowed to address the failure? I do not mean this as a criticism. Genuinely interested in the dynamic at work here.

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