This month, the Federal Emergency Management Agency (FEMA) announced that its National Flood Insurance Program (NFIP) had to borrow another $1.6 billion from the Treasury to break even on its 2016 losses. Add that to the existing debt, largely due to hurricanes Katrina and Rita and Superstorm Sandy, and the NFIP currently is almost $25 billion in debt. The NFIP is up for reauthorization later this year, and Rep. Jeb Hensarling (R-Texas), who chairs the House Financial Services Committee, has already said that reforming the program will be a “major focus” for his committee this year.
First, program must begin charging premiums that reflect risk.
Current premiums charged by the NFIP have fatal flaws. They don’t reflect risk, there are artificially low caps on premium increases, “full risk” premiums are too low, and premium rates rely on outdated or inaccurate data. Unlike other property or health insurance, claims on flood insurance policies tend to come in large groups and all at once as the result of a natural disaster. Because of this, the NFIP has struggled to find the right premium that would be appropriate for small, “average” flood events, but that would also cover catastrophic events.
Further complicating things is FEMA’s need to subsidize premiums in low-income areas. NFIP has attempted to account for all of this by establishing Flood Insurance Risk Maps (FIRMs) to account for higher risk, higher premium areas, but many properties were built long before FIRMs were ever created and were not taken into account. Without the ability to charge proper risk-based premiums on all covered properties or generate sufficient loss revenues, NFIP will never be self-sustainable.
Second, NFIP must update program technology.
In order to accurately account for risk, the NFIP must be able to rely on accurate data and mapping. Despite a recent $40 million investment in new technology, the Government Accountability Office (GAO) found that NFIP’s own managerial malpractice has led to the use of inaccurate data to price payments and a lack of adequate procedures for managing insurance policy and claims data.
Malpractice aside, the NFIP must update its FIRMs and the technology it uses to make them. Instead of relying on technologies and processes from the 1960s to assess and analyze flood elevation on individual properties, the NFIP would be smart to look to some of the mapping techniques developed by the private sector in recent years. At the very least, the use of a central repository of elevation data and the use of GPS would be a vast improvement over the status quo. Without the ability to accurately map flood zones and update them regularly, the NFIP will not be able to charge appropriate premiums based on risk.
Third, NFIP should increase the number of policyholders through enforcement.
Of the 1.5 million structures in designated Special Flood Hazard Areas that are required to have flood insurance, only about 53 percent, or 783,000 structures, are covered. Even the most compliant state, Louisiana, only has 80 percent of mandatory structures covered. Fewer policies mean fewer premiums being paid, which means less revenue for the NFIP—even though many of the uninsured properties will receive FEMA and NFIP aid if and when they are flooded.
FEMA must increase its oversight of the insurance purchase requirements, especially for homeowners with federally-insured mortgages located in designated flood zones. (The Biggert-Waters Flood Insurance Reform Act stipulated compliance requirements, but most were repealed with the passage of the more recent Homeowner Flood Insurance Affordability Act.) Driving compliance growth through sectors like the mortgage industry will not only help to disperse risk among more policyholders, but will increase program revenue from the additional premiums, ultimately reducing the NFIP’s debt.
Lastly, NFIP should share risk with the private insurance market.
In addition to enlisting the private sector to help with the development of flood maps, the NFIP would be well served to share some risk with private insurers. Not only would this reduce the risk on NFIP’s books, but it would allow FEMA to focus on flood risk mitigation and let the market focus on underwriting flood insurance policies.
The correlated nature of flood risk makes the possibility of a totally private flood insurance market highly unlikely. However, there are options that would allow for efficient sharing of risk across the board. For example, some combination of scenarios in which private insurers either provide primary coverage to a majority of policyholders or they acquire the transferred risk from the NFIP by way of reinsurance or they jointly underwrite primary flood risk and pool any reinsurance. In any of those cases, the NFIP could act as a reinsurer of last resort or could provide primary insurance focuses solely on residual market risks left over from what they private insurers could not underwrite.
As of October 2014, the Congressional Budget Office (CBO) estimated that the NFIP was subsidizing premiums to the tune of $1.3 billion annually. These subsidies have the effect of crowding out private capital. To get a sense of the magnitude of the crowd out, the $1.3 billion in reduced premiums is the equivalent (estimated using a 10-year bond rate of 1.9 percent) of lost coverage for more than $68.4 billion of at-risk property.
That is a significant gap that must be filled with policy changes that will accurately account for risk, increase the number of policyholders, and share the risk and the burden of underwriting with the private market.
Meghan Milloy is director of financial services policy at the American Action Forum.
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