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National Flood Insurance Program

If you are keeping a list of national disgraces, your list is incomplete unless it includes the federal National Flood Insurance Program. The NFIP is set up and run in a way no state insurance commissioner would allow a real insurance company to be run: for example, the NFIP does not even go through the motions of capitalizing itself with reserves to meet anything other than an average year of losses. These chickens came home to roost when Hurricane Katrina hit, leaving the NFIP some $20 billion in debt to the Treasury, and since it is run as a political program rather than a true insurance program, it cannot raise premium rates to pay this money back or even build sufficient reserves for the next big disaster. Congress is currently considering some kind of fix to this broken system, and here is a report by the Congressional Research Service on proposed measures to make the NFIP more sound. It should be remembered the NFIP exists in the first place because homeowners policies sold by private insurers exclude flood damage from coverage, and the reason this coverage is excluded is that it creates potentially massive uncapitalized losses that can bankrupt an insurer, and when losses exceed reserves, the state regulators show up to padlock the doors. So when the federal government created the NFIP in 1968, it knew what it was getting into, but has often ignored economic reality.

The current proposals in the U.S. House include allowing the Federal Emergency Management Agency, which oversees the NFIP, to charge actuarially sound premiums for businesses and for second homes. However, the proposals do not include allowing the NFIP to charge real rates for primary residences. The proposals also include dramatically raising the penalty for mortgage lenders that fail to require flood insurance in high-risk areas. There are some other good ideas: allowing the NFIP to sell new lines of insurance, such as business interruption coverage, is a step in the right direction. But the proposals don't address what to do about the $20 billion the NFIP owes the Treasury -- there does not appear to be any option other than to forgive the debt, because raising premiums to cover the shortfall is politically unpalatable. One depressing thing about the report is the implicit admission that the incentive to buy flood insurance is frequently minimal, given that the report acknowledges that if people don't buy flood policies, they often will be "insured" directly from the Treasury anyway through disaster relief. Here is a post I wrote with further discussion of the report, and here is a past post I wrote on a related problem -- why people disregard flood warnings and the need to buy flood insurance.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.