May 23rd, 2019 Update: Congress is set once again to pass a short-term extension through September 30th without any reforms.
The National Flood Insurance Program (NFIP) is set to expire in a few days. And the habitual Congressional procrastinators are trying to figure out how to avoid a lapse. To get a flavor for the problems that plague the National Flood Insurance Program, namely that its financially unsound, enjoy a rendition of the Little Mermaid. Then check out our brief explainer.
Let’s start basic, what’s the deal with flood insurance?
Floods are among the most destructive hazards facing the nation. In the year 2016 alone, there were $17 billion in flood damages and 2017 was likely the costliest year ever for flood damage. The federal government, in partnership with private insurers and servicing contractors, is the primary provider of flood insurance in the United States.
While attempted until the 1920’s, historically, private-sector insurance companies have viewed the risk of flood events as uninsurable. After a string of natural disasters, Congress established the National Flood Insurance Program in 1968. The three foundations of the NFIP are to: (1) reduce suffering and economic losses due to floods through the purchase of flood insurance; (2) promote state and local land-use controls to guide development away from flood-prone areas; and (3) reduce federal expenditures for disaster assistance and flood control.
Currently, the National Flood Insurance Program covers over 5 million households and businesses across the country with about $1.28 trillion in risk exposure. Geographically, two-thirds of all policies are located in just five states (Florida, Texas, Louisiana, California and New Jersey). Florida alone has 37 percent of the policies.
How does the NFIP program work?
The NFIP’s primary purposes are to underwrite flood insurance and coordinate floodplain management. The federal government assumes all liability for the insurance coverage, sets the rates, coverage limitations, and eligibility requirements, designates special flood hazard areas (SFHA) with the issuance of Flood Insurance Rate Maps (FIRMS) and provides grant funding for mitigation planning activities.
Federal flood insurance coverage is available on almost all types of buildings up to $350,000 for residential types ($250,000 for residential building coverage and $100,000 for residential contents coverage), and $1,000,000 for non-residential structures ($500,000 building and $500,000 contents).
The program is offered primarily through a network of private insurance firms, who offer federal flood insurance as part of a larger set of insurance products. These are known as Write Your Own (WYO) companies, and they carry no risk for the flood insurance component of their business, but are compensated for administering the federal flood portion.
What’s the difference between federal flood insurance and other private insurance?
While similar in concept to private insurance schemes in the fact that its spreads risk over a large pool, there are several fundamental differences between the NFIP and private insurance. A major difference is that NFIP does not have to build and maintain capital to preserve its solvency, as it is guaranteed on the back end by borrowing capacity from the treasury. Private sector insurance policies must prefund their losses, therefore they include a profit provision sufficient to cover costs of risk transfer and maintain capital for solvency.
Unlike private insurance markets, the NFIP accepts all insurance applicants and is not selective in evaluating individual applicants for flood insurance. There is no individual risk analysis to determine the likelihood of a future loss, and individual property loss experience is not used as a rating criterion. The sole criterion for accepting an applicant is that the insured property is located in a community that participates in the NFIP.
We are still subsidizing flood prone properties?
There are two classes of premium rates, actuarial rates and subsidized rates. Actuarial rates are based on consideration of the risk involved and accepted actuarial principles. Subsidized rates are set at a level that “would be reasonable, would encourage prospective insured to purchase flood insurance and would be consistent with the purposes of the legislation.” Most of the subsidized properties were grandfathered in at reduced rates before the first flood maps were put into place in 1974. Sixteen percent of all NFIP policies are covered by subsidized rates, though that number is being slowly phased down by recent reforms. Other subsidies include when homes remapped into higher risk areas, they get to keep their old rate.
Once a property floods, can they stay in the same spot?
Yep, as long as the damage is less than 50 percent of the value of the home. A house in Texas has been flooded 22 times since 1979 and has claimed $2.5 million in damages. Eight times the value of the house. These types of properties are called repetitive loss properties (RLPs). One in every 10 homes that suffer repetitive flood damages have had cumulative claims that exceed the value of their homes. Due to this programmatic abuse, 1% of total NFIP policies account for thirty percent of the claims paid.
What is the financial condition of the NFIP?
Bleak. The NFIP is $20 billion in debt, which does not include the $16 billion that was forgiven last year. And because the program is not actuarially sound, the Congressional Budget Office projects it will continue to lose $1.4 billion annually. It is imperative that Congress address the fiscal sustainability issues facing NFIP.
What is Congress doing this week to address it?
Nobody wants the NFIP to lapse because the problem it will cause in the housing market. But there is a fight about whether to extend the program as-is or extend it with modest reforms to help its solvency (and the taxpayers). The House will likely pass an extension without changes. But there are members in the Senate that may block any extensions that do not include at least some reforms. Due to Senate rules, and the time crunch, these members would have the leverage to block it. Unclear whether the reformers or the status quo crowd will win out. But you can be sure until there are substantial changes made to NFIP – taxpayers will be the losers.