Four Necessary Steps Towards Avoiding Future Bailouts

1.     Eliminate the current subsidy for older structures. The only way to avoid still more congressional bailouts of NFIP is to make the program actuarially sound and to target it towards people who actually live or work full-time in covered structures. Today’s NFIP subsidizes about one-fourth of the structures that it covers. About 76 percent of policyholders pay risk-based premiums that include the possibility of a catastrophic loss. However, structures that existed before the surrounding community joined NFIP—24 percent of the total—receive flood insurance at subsidized rates that imply a substantially lower risk of flooding than actually exists. The Government Accountability Office (GAO) estimates that some premiums are only 35 to 40 percent of what they would be without the subsidy. The total value of this subsidy is an estimated $1.3 billion annually. In addition to making NFIP’s finances shaky, the subsidy discourages private insurance companies from competing with the federal program. Finally, the program assumes that flood control measures such as levies and dykes will protect the properties near them, regardless of whether they are adequate and in good repair.

NFIP should eliminate the subsidy for older structures because its continued existence is a danger to the program. In order to minimize the impact on home and business owners, the subsidy could be phased out over several years. To some extent, the higher premiums will make it more attractive to replace older structures that are prone to higher flood losses with new buildings that incorporate architectural features that would minimize such damage. NFIP should also assess the possibility that flood control measures in an area are likely to fail or are inadequate when determining premiums. In addition to making actuarial sense, this step would help to better inform homeowners of the risk of flood damage that they actually face.
 

2.     Require flood insurance where storm surges are possible and require coverage for the replacement value of the property. Currently, NFIP coverage is required only where there is a one-percent chance of a flood and not in low-lying areas where surges are likely following major storms. A significant number of property owners affected by Hurricane Katrina suffered water damage despite the fact that their structures were outside of the 100-year floodplain where flood insurance is required by law. Finally, many NFIP policies only cover the remaining balance on a structure’s mortgage, not the cost of actually replacing it. This protects the lender but can leave homeowners with a ruined property that they cannot afford to rebuild.

Flood insurance should be required in areas where a storm surge is likely. Especially with serious hurricanes more likely to occur in the future, it makes little sense to continue to leave structures at risk of storm-surge damage outside the system. Flood insurance should also cover the cost of replacing the structure, rather than just the cost of repaying its mortgage. Although this would increase premiums, insuring for replacement value will make it more likely that homes and businesses will be able to rebuild, rather than relocate.