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Dead in the Water

The federal flood insurance fiasco.

Jan 28, 2013, Vol. 18, No. 19 • By ELI LEHRER
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On paper, the flood insurance law passed by Congress in 1968 looked sensible: It required participating communities to take steps to avoid building in disaster-prone areas, left requirements loose enough that private companies could take on risk if they wanted to, assured that rates on all future construction would be “actuarially adequate,” and promised that the federal government would draw up the maps that the private sector needed in the first place. As an incentive for people to buy the insurance, it denied all federal aid to those who qualified for the program but didn’t buy in. Although its creators allowed it to borrow funds from the Treasury—a stop-gap measure, lest major floods had hit in its first few years—the program was intended to break even over time and, some thought, might eventually be sold off to the private sector.

Almost none of these good intentions proved justified. The requirement to purchase insurance or lose federal aid fell by the wayside as soon as hard-hit areas came crying to Congress. Government definitions of “actuarial adequacy” ended up leaving out most of the costs private companies would factor into their rates. While communities wishing to let their residents buy into the program did have to discourage the most obviously foolhardy building, poor mapping and the natural clout of local developers made these requirements a triviality. So much for a financially responsible program. “Temporary” subsidies became permanent. Congress periodically forgave the program’s debts and, following Hurricanes Katrina, Rita, and Wilma in 2005, authorized it to borrow $20 billion from the Treasury that it had no chance of ever paying back. On the eve of Hurricane Sandy, the NFIP still owed the Treasury more than $17 billion, with another chunk of debt taken out to pay claims from Hurricane Ike in 2008.

With Congress expected to re-authorize the program every five years, many aspects of the NFIP grew worse over time. Even as Congress corrected obvious absurdities—such as subsidies for writing insurance on coastal barrier islands and other areas likely to wash away entirely—members added various benefits and even made the private insurance industry a beneficiary of the program. Under a “write your own” (WYO) program that pays them to adjust claims and service policies, private insurers get to keep about a third of the total premiums collected, but take on no real risk. While this program isn’t enormously lucrative for insurance company home offices—the tasks they’re asked to undertake are reasonably labor-intensive—it’s not a money loser either. Most large, well-known national property insurers participate in this WYO program, and not a single one was willing to step forward and offer to take on any risk when lobbyists and activists surveyed them about the topic last year.

Over the NFIP’s 45 years of existence, moreover, it has influenced the built environment to such an extent that full-scale privatization couldn’t happen, even if insurers were willing. For those whose mortgages were issued by federally chartered banks, or were purchased by Fannie Mae or Freddie Mac, policy requires the purchase of flood insurance if a property faces at least a 1 percent chance of flooding in a given year. Because NFIP rates have been kept artificially low for decades, millions of people now live in places that wouldn’t be inhabited at all absent the program’s subsidies.

Under Congress’s budget rules, eliminating the program outright would actually cost more money than keeping it operating. Once it finishes paying claims from Hurricane Sandy, the NFIP will owe nearly $30 billion to the Treasury. So long as those loans are outstanding, they don’t count toward the federal budget. Discontinuing the program, on the other hand, would leave taxpayers on the hook for that debt (and for scheduled mapping improvements) without any new premium dollars coming in the door.

The legally binding insurance contracts the program offers, likewise, make it impossible for Congress not to offer bailouts like the one that took place earlier this month. Had Congress not approved the funding, flood insurance policyholders would have gone to court and won judgments ordering the government to pay the claims anyway. Furthermore, the program, to the extent it will repay its debt at all, will never reach the point where it would look attractive to private suitors.

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