As storms leave a drenched eastern seaboard, it provides a reminder of the potentially ruinous effects that storms and hurricanes can bring — communities can be lost, businesses destroyed and families uprooted. It is the cost of having a thriving coastal economy, but it is also a cost that impacts those who live far away the path of the storm’s destruction.
In recent years, the National Flood Insurance Program (NFIP), which insures homes and businesses in coastal areas, has been hit with billions of dollars in losses, threatening both its financial future and that of the millions of policyholders who rely on it for affordable coverage. Because the program often subsidizes coastal homeowners (and disproportionately wealthier homeowners) and because it is prone to paying repeat claims, it does not do a good job of discouraging people from living in flood-prone areas and, as a result, its finances are constantly spiraling downward. In one instance, repeat flood claims for a home totaled 10 times higher than the value of the home itself. A recent University of Chicago study finds many perverse consequences of government insurance programs. Ultimately, taxpayers are on the hook to cover the financial losses from these program.
Flood insurance reform advocates have long said private insurers can play an important role in stabilizing NFIP and preserving it for the future. In fact, private insurers have increasingly entered the flood insurance market in some states, leading to more options for consumers. And new reports from FEMA encourage this privatization trend and describe how to make it a reality for more policyholders.
FEMA has acknowledged that the NFIP is in need of reform and that private sector competition could provide a partial solution, noting that the “present environment represents an opportunity to reconsider how to increase the role of the private sector in the flood risk financing chain.” These are suggestions lawmakers should strongly consider before the program collapses and consumers are left footing the bill.
The NFIP’s fiscal challenges have accelerated in recent years as a string of devastating storms from Katrina to Sandy shattered its finances and stacked up billions in debt. In the wake of these storms, lawmakers have struggled to find a solution for keeping the program financially viable.
It is not likely that change will come from within the program. As noted earlier, the NFIP has consistently subsidized rates, discouraging mitigation and promoting more development in harm’s way. Efforts to make these rates actuarially sound have been met with fierce resistance from policyholders.
FEMA has taken an important step toward solving these concerns by opening the door for the private sector to play a greater role in the NFIP in an effort to alleviate some of the program’s staggering $23 billion debt. Many other insurance markets, such as auto and health insurance, are largely comprised of private providers. Such a system encourages a multitude of coverage options, lower costs and rates that accurately measure risk.
The flood insurance market would similarly benefit from private involvement. Private insurers can more accurately identify and track risks and offer rates that better represent the dangers that homes and businesses face. Permitting more competition in the market would be a win for consumers, who would have access to more options and cheaper, accurate rates.
Another important step in managing the NFIP is the formation of a working group to determine if FEMA should move forward with a reinsurance pilot program. While recommendations will not be made until the end of 2016, this is a step in the right direction.
Knowing that disasters can strike at any time and place, reinsurance helps provide a financial safety net by limiting the exposure of individual policies so that a single Katrina-like storm will not wipe out an insurance provider and its policyholders. While it entails a significant initial outlay, it will save money and better protect the NFIP’s finances in the long run.
The NFIP is ripe for such a change. Using private capital would make it easier to manage the program and keep it more stable as it weathers new and stronger storms. Down the road, Congress can ease the way for more privatization by making it easier for homeowners to purchase insurance from private insurers, phasing in risk-based rates that allow the private sector to compete, and implementing affordability requirements for subsidies.
Together, these changes would transform the NFIP into a far more effective program that better serves homeowners in flood prone areas. It would also protect the tens of millions of American taxpayers who will ultimately be responsible for the NFIP’s debt if the program defaults. As lawmakers grapple with the future of the NFIP, privatization and reinsurance should be central pieces of a long-term solution.