The Receding Tide of the National Flood Insurance Program
So I recently had an argument with myself about the NFIP. Just in case someone from the “outside” world (outside insurance, that is), made it onto this particular thought-provoking article and is unsure of what the NFIP is, I will fill you in.
In 1968 Congress enacted the National Flood Insurance Act. This act created the National Flood Insurance Program. The NFIP’s goal is to provide insurance protection and risk-management techniques to people that own property in flood prone areas.
Now, if you’re even a little like I am, you probably are wondering to yourself, why would the government feel like it needed to provide flood insurance? They don’t provide auto insurance or home insurance or pet insurance. In fact, the only other insurance program the US government has enacted is retirement insurance, more commonly known as Social Security.
So why would they create an act that covered flood insurance? Well, in 1965 a disastrous lady named Hurricane Betsy visited several of our southeastern states, breaching the levees of New Orleans and severely flooding one of the most populous areas in the Gulf States. Betsy’s havoc caused over a billion (1965) dollars in damage and the federal government stepped in to help those that were impacted. The hurricane’s impact was so draining on the area, and taxpayers of the U.S., that Congress took several steps, including the passage of the National Flood Insurance Act, to prevent it from happening again. In addition, a study in the 1950′s showed that insurance companies could not offer flood insurance at an affordable rate and still make a profit. This is mostly due to adverse selection, or the phenomenon of people that own property most prone to damage purchasing the coverage.
Ok, so now you know the cause and the history, let’s get down to the voices in my head.
As a former long time resident in Florida, I am aware of the controversy that surrounds the building of homes in flood prone areas. People want beach homes so they can regale themselves in the beauty of the sea so they build in places that are often affected by water damage. Just a few years ago, a home was nearly washed away by beach erosion due to excess rain. A loud plea for help went through our city as people were implored to provide man hours and materials to keep the million dollar home from washing away.
To me, that’s the irony. Such homeowners are obviously wealthy enough to afford these types of homes, and if they had flood insurance — which typically does not have exorbitantly high rates due the government’s subsidization through the NFIP — it would help them protect their homes. But instead, these homeowners often choose to put their family and all of their belongings in an area that had to, at some point, be negatively impacted by the ocean without flood insurance. So basically, as I see it, the government is often subsidizing poor decisions.
But then the other voice – the pained, calm, more empathetic voice – speaks up.
My home town of Ocean Springs, Mississippi was devastated almost six years ago as category 3 winds from Hurricane Katrina made land fall. Driving home to survey the damage a week after the storm, I saw boats in trees and on roof tops, trees toppled onto houses and red Xs on the doors of homes where dead bodies had been found. Oak trees that had withstood a hundred years of abuse by Mother Nature, including the torments of Hurricane Camille in 1969, were uprooted, their former majesty pounded into the ground by wind and rain. The sorrow I felt as I took in all of the damage cause by Katrina was only compounded by the knowledge that many of the people that live in these impacted areas were not millionaires.
As people moved into tent cities and trailers provided by FEMA, the aid received by the NFIP went towards the rebuilding of homes in the surrounding cities, mostly damaged by the flooding that occurred as storm surges brought gargantuan tides into the bayous and waterways that are laced through the area. Hurricane Katrina’s travels through the Gulf States resulted in $1.8 billion dollars of debt in the region as of today.
Efforts are underway to reform the NFIP, which will lapse on September 30, 2011, if Congress does not take the appropriate actions. Regardless of the scenario — a single home impacted by flooding because of where the owner chose to build or mass devastation across and entire region — changes in the NFIP must be made to make it sustainable in the future. More actuarially sound methods need to be used to determine rates and participation requirements need to be enforced.
Join my internal argument: Should NFIP continue? Should it be left to the free market to fill the need for flood insurance? Should building in risky areas not be allowed? Should the government, in effect, be supporting the habitation of people in flood prone areas? Let me know what you think.
Karen Jordan is an actuarial analyst at Merlinos & Associates.
This is an excellent article! You have done a good job articulating the ambivalence of any fair minded person when contemplating the issue. Clearly, it does not make sense to subsidize people who keep rebuilding where it is a certainty that they will be wiped out every few years, or for wealthy people who can afford the insurance or afford to assume the risk themselves. But for the remainder, who have limited means, and have reasonable expectation that they are building in locations of moderate risk, and adhere to appropriately restrictive building codes,we should look for affordable insurance solutions. As an actuary, you know too well that “affordable insurance solutions” are elusive if impossible, without “affordable” catastrophe reinsurance protection for insurance companies. Some years ago, I was on the cusp of a contract agreement with a fine,reasonably sound Florida centered insurance company. This company had all of their eggs in one basket…mostly property coverage for modular home parks in Florida. They were reasonably protected from insolvency in event of a hurricane, having purchased affordable catastrophe reinsurance protection. They were seeking to spread their risk beyond hurricane country, and programs like mine would have helped accomplish that aim. However, before they could act upon this prudent move, They were hit by three consecutive storms in one season. Their reinsurance had an annual 2 storm limit, so the third storm wiped out their policy holders surplus, leaving them insolvent. New owners stepped in to rescue them, replenishing their surplus and even retaining their excellent financial ratings. However, seeing the opportunity to make a fast buck by staying in the Florida property market at greatly inflated premiums, they backed out of their new agreement with me to dedicate all of their new capital to hurricane country opportunities. This dice roll has served them well, since the company has not suffered a storm hit for several years now, while enjoying what some might say are exorbitant premiums. However, this story digresses from the real issue you raised, since this story involves wind losses and not flood losses. However, it illustrates that there are free market insurance solutions, but not satisfactory solutions. The free market would be overwhelmed if relied upon entirely, and would not provide a solution for many people who would be left with no coverage available, or unaffordable coverage. But, as you say, the NFIP should be actuarially sound, and that will only be possible if people who choose to live in high risk locations are required to buy insurance, and government should stop bailing people out and have the political will to prevent building where the probability of loss is too great.