Why is the federal government in the flood insurance business?
Without government intervention, the private market will fail to supply enough flood insurance to cover the 5.5 million who demand it. Flooding claims more lives and property than any other natural disaster.
The problem is markets won’t work without better information.
- Floods are low-probability, high-consequence events. Just one can bankrupt an insurance company which complicates product pricing.
- Mandatory purchase flood zones include properties that have a one-in-four chance of flooding over 30 years, which means these properties are three times as likely not to flood.
- Without credible, verifiable information about flood risks and rates, home owners will roll the dice believing their property won’t flood … until it does.
Insurance companies won't be able to charge a market rate without "adverse selection."
- Higher risk properties will see the rate as a better deal and tend to buy flood insurance.
- Because more higher-risk properties buy, the average cost per claim in the insurance pool will rise.
- When companies raise the rates to cover the higher cost, some lower risks will choose to go uninsured and leave behind a smaller pool with an even higher average cost.
- The cycle will repeat - rates go up, lower risks drop out, pool costs climb, rates go up further - until no one, not even those who flood repeatedly, can afford flood insurance.
- Taxpayers will be "on the look" for the uninsured properties. Without flood insurance to pay for the charge, property owners will turn to the federal government for disaster relief.
The solution is the National Flood Insurance Program (NFIP) since 1968. See the chronology below.
- Provides a less expensive alternative to fully taxpayer-funded disaster relief.
- Guarantees access to flood insurance for 5.5 million properties across 20,000 communities.
- Enables property owners and renters to protect themselves with flood insurance rather than relying on taxpayers.
- Fills a void in the private market so no one has to take their chances without flood insurance.
- Administered by the Federal Emergency Management Agency which sets rates and coverage terms and contracts with private insurance companies to service individual policies under the “Write Your Own” program.
- Must be reauthorized to issue flood insurance every 5 years. If not, the program will sunset.
- Historically has been self-sufficient, taking in more premiums than paying out in claims, with the exception of catastrophic years like 2005 (Hurricane Katrina).
- Draws community flood maps outlining mandatory purchase zones where there is a 1% annual flood risk or about one-in-four over 30 years. These flood zones are represented on flood maps by darkly shaded areas lettered A or V.
- Requires flood insurance for a federally backed mortgage in these flood zones; that requirement is enforced by lenders at the direction of Federal regulators, Fannie Mae/Freddie Mac, FHA, etc.
- Conditions community participation on adoption and enforcement of regulations to construct or strengthen existing properties against flooding.
- Allows anyone in these participating communities to buy flood insurance; no one is excluded.
Aren’t floods coastal issues?
- Floods are not only coastal issues.
- Flood disasters have been declared in every state.
- Flood zones exist along rivers, lakes, creeks, as well as the coasts.
- Flood losses – 25% of NFIP claims – come from outside mandatory purchase “flood zones.”
Are some states paying more in premiums than they get back in claims?
- It may appear that way if one focuses on a simple snap-shot of premiums vs. claims in a given year, but the historic data won't predict extreme events outside the record.
- Mandatory purchase flood zones are drawn where there is a 1% annual risk of flooding, which won't change after 40 or 400 years.
- Just because a state has dodged this 1% annual chance over the past 30 years doesn't mean its luck won't run out tomorrow.
- All it takes is one major flood in a population center to wipe away any state "surplus."
- Just ask the Gulf Coast before Hurricane Katrina or New England before Superstorm Sandy.
Is the flood program nearly $30 billion in debt to the Treasury?
- Historically NFIP has been self-sufficient, bringing in more premiums than it paid out in claims.
- Then Hurricane Katrina struck in 2005, and the program had to borrow billions from taxpayers to cover several catastrophic years in a row.
- Recent legislation signed into law adds gradual rate reforms that will put NFIP back on the path to sufficiency, according to the Congressional Budget Office.
- Any NFIP borrowing must be fully paid back plus interest to compensate taxpayers – which costs less than disaster relief grants and loan subsidies that will never be repaid.
- Taxpayers are still “on the hook” for the $30 billion if NFIP ends, but a terminated program won’t be able to generate new premiums to help pay down some of the debt.
What about recent reports of an emerging private flood insurance market?
- Private insurance companies are cherry picking the low-risk, high-value properties from NFIP.
- A 2007 RAND study found 260,000 private insurance policies compared to 5.5 million in NFIP; private companies wrote mostly for the million-dollar homeowners.
- Some are providing surplus coverage on top of NFIP’s so they won’t payout on the first $350,000 ($250,000 per structure and $100,000 for contents) in property losses; others are purely private policies covered by a Lloyd’s-of-London syndicate of companies that pool risk.
- FEMA rates communities, not individual properties. By underwriting risk property-by-property, some private companies will be able to find lower risk properties and niche markets where they may be able to charge less than NFIP.
- Private companies will charge full cost for flood insurance including a normal rate of return; these companies must account for costs like taxes and reserves which NFIP doesn’t pay.
- Private companies are allowed to exclude, raise rates or drop coverage if a property floods.
- NFIP currently considers private insurance a “coverage lapse,” meaning the property owners will not be eligible for a lower rate if they leave the program and come back later.
- Even private companies will tell you that they will not cover all 5.5 million properties currently enrolled in the NFIP.
Chronology of Major Flood Events
|2014||“Grimm-Waters” will correct the severe implementation problems from the phase-out of subsidies, but first FEMA must implement these provisions.|
|2013||Superstorm Sandy strikes New England; NFIP borrowing now totals $24 Billion.|
|2012||Biggert-Waters reauthorizes NFIP through 2017 and will gradually phase-out subsidies for all older properties, including those with severe repetitive losses.|
|2008-12||NFIP extended 18 times and twice allowed to shutdown stalling 40,000 home sales a month.|
|2005||Hurricane Katrina strikes the Gulf Coast becoming costliest hurricane in U.S. history; NFIP borrows $17 billion from taxpayers to cover claims from the 2005 storm season.|
|2004||"Bunning-Bereuter" Act reauthorizes NFIP through 2008 and attempts to phase-out subsidies to the 1% of properties with "severe repetitive losses" accounting for disproportionate share of NFIP claims; however, loopholes prevent full implementation of this pilot project.|
|1994||NFIP amended to strengthen lender enforcement of the mandatory purchase requirement.|
|1983||NFIP supplemented through Write-Your-Own program which allows NFIP to continue setting rates and coverage terms but contract with private insurance companies to service individual policies on FEMA’s behalf.|
|1975||NFIP amended to require flood insurance for a mortgage in the mandatory purchase zones.|
|1968||NFIP created as insurance alternative to rising cost of fully taxpayer-funded disaster relief.|
|1965||Hurricane Betsy strikes Gulf Coast becoming first in U.S. history to cost a billion dollars.|
|1956||Federal Flood Insurance Act authorizes program which isn’t funded; the American Insurance Association finds that flood insurance is not commercially feasible.|
|1950||Disaster Relief Act creates the first permanent system for post-disaster aid.|
|1930-50||Government funds a series of flood-control projects and flood-specific disaster loans.|
|1929||Private insurance industry abandons coverage of flood losses.|
For the complete chronology, here is the original FEMA report.