Federal Flood Insurance Folly

August 30, 2010

The National Flood Insurance Program was created in 1968 to allow flood-prone communities to purchase insurance protection from the government. Overseen by the Federal Emergency Management Agency, the program was supposed to alleviate the need for emergency federal aid. Instead, communities still receive emergency aid in addition to insurance payments.

The Government Accountability Office recently testified to Congress on the NFIP’s shaky condition. The following are key problems cited by the GAO:
  • The NFIP is “by design, not actuarially sound.”
  • The NFIP has borrowed almost $20 billion from the U.S. Treasury and “is unlikely ever to be able to repay the entire amount.”
  • Unlike private insurance companies, the NFIP is not structured to build capital surpluses, doesn’t purchase reinsurance to cover catastrophic losses, cannot accept or reject applicants in order to manage risk, and is legally constrained in its ability to raise rates as needed.
  • Twenty-five percent of participants pay subsidized premium rates, which don’t reflect the full risk of flooding. Even “full-risk” premium rates may not reflect the actual risk of flooding.
  • The NFIP must continue to insure properties that have suffered repeated losses. These “repetitive loss properties” represent only 1 percent of flood insurance policies but account for 25 to 30 percent of claims.
  • FEMA doesn’t do a good job of managing the program. For instance, “FEMA continues to lack an effective system to manage flood insurance policy and claims data, despite having invested roughly 7 years and $40 million in a new system whose development has been halted because it did not meet user needs and was not ready to replace the legacy system.”
USA Today recently reviewed FEMA records and found almost 20,000 homes and commercial buildings that have collected insurance payments in excess of what the properties are worth. For example, one Mississippi home has flooded 34 times since 1978. Valued at $69,900, the property has received $663,000 in insurance payments.
This is no way to run an insurance system. But that’s what you get when spend-happy politicians try to operate a business. The USA Today notes:
The program’s financial problems reflect a broader government reluctance to restrain benefits. FEMA leaders and some lawmakers have tried to end the premium discounts and the multiple insurance payments, “but there’s always been a few in Congress that have had enough political muscle to hold that back,” former FEMA assistant administrator David Maurstad said.
When I worked in the U.S. Senate, the topic of the NFIP came up during a meeting of “conservative” Republican Senators. Alabama Senator Jeff Sessions, whose state is a major beneficiary of the program, admitted that it was ridiculous that beachfront properties were repeatedly rebuilt using insurance payments. However, Sessions said he had to continue to support the program because “those are my voters.” 
People who choose to live on flood-prone land should purchase insurance from a private company, which would charge premiums based on the actual risk. If an insurance company will not provide flood coverage to particular properties under any circumstance, that’s a good market signal that it’s not safe for anyone to live there. The federal government should get out of the property insurance business.



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