Daniel Sutter: What to do about flood insurance

The National Flood Insurance Program (NFIP) expires at the end of September, and Congress is currently debating reauthorization. Congress should follow New Jersey Governor Chris Christie’s recent suggestion and privatize flood insurance. I do not propose that Congress end the program as of October 1. Rather, the reauthorization should initiate a five- or ten-year phase out.

Standard residential and commercial policies exclude flood losses. Coverage for floods requires purchase of a separate policy. The NFIP was created in 1968 and writes most of America’s flood insurance. Currently, the NFIP has 5.2 million policies.

I believe that government management of flood risk, of which NFIP is a part, has performed poorly. Why? Let’s start with the enormous cost to taxpayers: The NFIP currently owes $25 billion to the U.S. Treasury, thanks to decades of charging too little for insurance. Rates have been inadequate in two ways. First, many properties pay rates set deliberately low relative to their risk of flooding. Second, the NFIP does not charge sufficient rates to cover exceptional events, like Hurricanes Katrina, Ike, and Sandy. The NFIP has $1.3 trillion in coverage and only current premiums with which to pay losses; borrowing from the Treasury as needed has always been the plan.

Government subsidies typically involve rules to limit access to avoid just handing out money to all comers. For the NFIP, land use management in flood zones limits access. Communities must join the NFIP to allow residents to buy policies, and then limit building in flood zones. And yet inflation-adjusted, per capita annual flood losses have doubled since the NFIP’s establishment. Clearly, we’re still building in flood zones.

Government management of flood plains is also costly. Flood-proofing requirements for damaged properties in flood zones increase rebuilding costs. Disputes between insurers and the NFIP about whether water or wind damaged a property, so prevalent after Katrina, delays rebuilding. Governor Christie’s privatization suggestion reflected New Jersey residents’ frustrations in getting claims paid after Sandy.

One of the biggest costs of the NFIP, I think, is public confusion. Five years after Katrina, 30 percent of residents in Louisiana and Mississippi still thought that their homeowners’ insurance covered hurricane flooding. Further, many Americans seem to equate the legal requirements for insurance purchase with flood risk and think that they are not at risk if they do not “have” to buy insurance. Nature, however, does not care about bureaucratic rules. The 500-year flood inundates properties far beyond the 100-year flood plain, and frequently leaves victims with no coverage.

Victims without insurance create an irresistible political demand for disaster assistance. Less than 20 percent of New York City residential buildings flooded in Hurricane Sandy were insured, so Congress provided special aid. In addition to costing taxpayers billions, such assistance entrenches expectations of future assistance, further weakening the incentive to buy insurance.

The best rationale for the NFIP is that it makes flood zone residents contribute something toward rebuilding. Suppose we consider it inevitable that politicians will help flood victims without the resources to rebuild. Without the NFIP, all people might be uninsured, and taxpayers would have to pay the full cost. Making people buy flood insurance at half the full cost will lower taxpayers’ cost. Yet purchase requirements are not enforced: only 53 percent of properties legally required to be insured were insured.

Privatized flood insurance might seem like a radical proposition, but the United Kingdom, Germany, and Australia have market flood insurance. For a market to work, private insurers must be allowed to charge rates high enough to cover full costs, in some cases double or triple NFIP rates. While such increases would significantly burden low income families, a ten year transition would give time for adjustment.

Some properties are vulnerable to flooding. This is a fact of nature. Politicians often find denying economic and natural realities to be a winning electoral strategy. The NFIP tells people that living in a flood zone doesn’t cost much, which simply shifts the cost to taxpayers. It is time to end this costly political charade.

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Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.