The National Flood Insurance Program Needs Reform

The National Flood Insurance Program (NFIP) was reauthorized as it approached its funding deadline. NFIP has been there many times before. Unfortunately, reauthorization comes without much needed reform.

NFIP insures five million flood insurance policies. Over the years, NFIP has had difficulty setting rates high enough to cover the claims that policy holders file in the wake of flooding. Recurring losses have been offset through loans from the federal government. Over the years, and prior to last year’s storms, NFIP losses accumulated into a deficit of nearly $25 billion. In effect the $25 billion in loans is a subsidy that is unavailable to private insurers who could provide flood insurance. One effect of government loans to absorb losses due to NFIP’s underpricing of rates is to crowd out private sector flood insurers, who must price at actual cost. Some government reports have shown that the beneficiaries of these subsidies tend to be the wealthiest of homeowners on beachfront properties – all at the cost of regular taxpayers.

If NFIP pricing were to more accurately tracks costs, private insurers would more readily enter that market. Getting private market into offering flood insurance is essential for curtailing this debt-laden program – because it would transfer risks from the government program to the private sector, and it would encourage price competition.

NFIP faces several pricing challenges. NFIP uses flood plain maps to help establish which structures are likely to be exposed to flooding. These maps have not always accurately reflected the physical conditions that lead to flooding. Such inaccuracies lead to erroneous ratings for risk and thus improper pricing for insurance policies. Flood plain maps are updated by major studies that establish current land height and historical water flows under extreme conditions.

Maintaining the flood plain maps is an ongoing, but necessary chore.  Improving these flood maps is expected to help NFIP set rates more accurately, avoid government debt, and encourage private insurers to enter the market.

A secondary thread to proper rate-setting is the use of reinsurance to offset catastrophic aggregate losses. NFIP dipped its toe in the reinsurance water in 2016, when it transferred over $1 billion of its risk to 25 private reinsurers. Because the cost of reinsurance is reflected in prevailing rates, it helps the entire market present more realistic premiums to property owners.  The NFIP needs to do more work to reduce its exposure.

For many years, due to political pressure, NFIP insured properties that were located near bodies of water that flooded regularly. There are examples where some property has flood year-after-year to a taxpayer cost that exceeds the value of the property by several fold.  More recently, FEMA has injected sanity into flood insurance through its Severe Repetitive Loss Program. That program purchases NFIP-insured properties that pose predicable, recurring, substantial claims to NFIP. To qualify for the program, the property should have four or more claims of $5,000+ and a total of more than $20,000; or two or more claims that total more than the value of the property. This should reduce NFIP costs and rate levels. If cases where properties are rebuilt, they should be build resiliently in order to mitigate the probably of a subsequent loss.

Wharton reports that 4.8 million residential flood polices are in force from NFIP, and another 175,000 to 220,000 private residential flood policies are currently in force in the United States. In other words, private flood insurance represents only 3.5 to 4.5 percent of the total residential flood market.

While the NFIP debt continues to grow, Milliman reports that 94% of New Jersey homes and 96% of New York homes could see cheaper rates from private flood insurance than from NFIP’s current structure. Clearly there is an advantage to reforming NFIP’s behavior in ways that cease pushing private insurers away.

The time for reform is now. Inflation-adjusted insured catastrophe losses have reached an all-time high of $135 billion in 2017. Total losses (including uninsured ones) reached $330 billion, of which 97% was weather related, up from the 85% average since 1980.

The market potential for pushing flood risk to private insurers promising and that should expand to help those who face $200 billion of uninsured losses. Reforms can attract private insurers, develop better flood plain maps, using reinsurance, aggressively curtain repetitive loss and encourage smart building codes to mitigate losses. 

These prospective NFIP reforms deserve support from Congress and consumers.

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