Will Congress privatize federal flood insurance?

November 5, 2012

This summer, as part of the Federal Transportation Act, Congress made legislative changes to the Federal Emergency Management Agency’s (FEMA) National Flood Insurance Program because it had borrowed $17 billion from the U.S. Treasury to pay off claims for flood damage from the 2005 Hurricane Katrina, and it was deeply insolvent. The editorial board of the Washington Post wrote:

In July, Congress reauthorized the program for five years and included reforms such as the gradual set-aside of a reserve fund, the phase-out of subsidized insurance for second homes and repeatedly flooded properties, a phased-in premium increase and $400 million in annual budget authority for flood-map modernization.

The program was also authorized for the first time to buy reinsurance from private companies. This is progress; whether the NFIP is sustainable post-Sandy is another question.

There are no estimates of insured flood losses from Sandy, but a wide geographic swath was impacted. Some have suggested that the damage from Sandy could consume all the current borrowing capacity that FEMA has from the U.S. Treasury. This could expose the agency to more Congressional scrutiny at a time when legislators are looking for government functions to move to the private sector. The requirement that FEMA buy reinsurance for it’s $1.25 trillion of insured coverage is a small start, but maybe there are ways that flood insurance could be pushed back to the private insurers.

There is a tiny market for private flood insurance, but the bulk is provided through the FEMA program:

Standard homeowners’ insurance does not cover flooding. The government set up the NFIP in 1968 to provide affordable insurance, impose flood management policies on vulnerable communities, and reduce federal disaster aid costs.

The NFIP provides coverage through roughly 80 companies that sell policies and collect premiums on the government’s behalf for a fee. The premiums go to FEMA.

FEMA/NFIP has responsibility for the full spectrum of flood assessment, mitigation, insurance and cleanup. The NFIP creates flood insurance rate maps that define high risk areas. FEMA/NFIP also conducts extensive mitigation work (see video above) where they pay homeowners who have properties that have flooded multiple times to raise their homes or abandon them. Of course FEMA is mostly known for underwriting and subsidizing flood insurance for homes and businesses.

I think the federal government doing high tech mapping is a great use of federal resources (and hopefully is available to everyone in the public and private sector). But I don’t think government administrators (who have to work through Congress to adjust rates) are in a good position to run an insurance business to protect millions of homeowners. That  is, unless it is understood that the program will use federal money beyond insurance premiums to pay for damaged homes and property.

Since the federal government faces enormous fiscal constraints, I wonder if there is there a way to move this program into the private sector. This would allow the private market to properly price homes that are in exceptionally risky areas. Of course, this should be done over a long transition period with some basic principles of fairness in place.

Australia has taken a very logical approach to its private flood insurance industry. The main emphasis was to standardize the coverage in private insurance contracts. Here is the background from the Australian Treasury:

In 2010-11 there was severe flooding in Queensland, New South Wales and Victoria. The large number of people affected by the floods who held inadequate insurance cover highlighted consumer confusion over the extent to which policies provide cover for flood and what cover for flood means.

On 15 April 2012 the Insurance Contracts Amendment Act 2012 which provides a legislative framework to allow regulations to require insurers to provide consumers with a one page key facts sheet for home building and home contents insurance policies received Royal Assent.

Australia’s private flood insurance plan mirrors what the Consumer Financial Protection Agency is doing for home mortgages in the U.S. with the two page mortgage disclosure form. Simplifying what can be a complex financial product.

The private insurance industry has already begun writing flood insurance in specific geographic areas. The Florida Flood Insurance company quotes a  residential policy, in a moderate-to-low risk area, for $365 a year for $250,000 of building and $100,000 of content coverage. We need a lot more of this kind of private underwriting using one or two page disclosure forms.

The federal government should focus on mapping risk and emergency support for homeowners, and it should get out of the business of insuring and replacing private property. It’s public policy we can no longer afford.

Further: FEMA is now crowdsourcing visual damage analysis to more quickly assess where emergency resources need to be deployed.

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