Floods are the most common natural disasters in the United States. They can also result in great damage and loss. Everyone actually lives in a flood zone, but the levels of risk vary from low to high-risk areas. This loss exposure leaves homeowners all across the nation susceptible to huge repair cost and substantial loss.
According to the Federal Emergency Management Agency, or FEMA which is part of the U.S. Department of Homeland Security (DHS), between 2011 and 2016 all 50 states have experienced a food or flash flood. This raises concern because it means that no single region across the U.S is immune to the risk of flooding. Just an inch of flood water can cause you thousands of dollars’ worth of damages.
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There are over 13 million homes in America located in high-risk flood zones, with a 26 percent chance of flood within the duration of a 30-year mortgage. This is 10 percent higher than the risk of having a fire within the same timeframe, but most homeowners wouldn’t even consider living in a home without having an insurance policy that covers damage caused by a major fire.
Developing effective mitigation and protection strategies is a challenge. The status quo is to let the National Flood Insurance Program continue to dominate flood insurance policies while leaving private insurers to be less than 10 percent of the market.
To opt-in for partial privatization of flood insurance would be to accept some government assistance while also letting private insurers offer flood insurance policies to homeowners. Full privatization is the option of completely removing government assistance and eliminating the national flood insurance program to allow the private companies to provide most of the nations need for flood insurance.
In this paper, I will discuss the options for structuring the roles of the private and public sectors in managing flood risk for homeowners and discuss the advantages and disadvantages of sticking to NFIP’s status quo, converting to partial privatization, or full privatization.
Flood insurance is not included in the typical homeowner’s policy, instead underwritten by the National Flood Insurance Program (NFIP), which is overseen by FEMA and has practically been the sole provider since 1968. The reason it was developed was to provide flood insurance to homeowners who were considered too high risk. Private insurers ceased writing coverages for these areas because they were of high catastrophic risk and would result in large losses. The NFIP provided these properties with protection and a sense of security. According to Diane P. Horn in collaboration with FEMA, property owners are required to purchase flood insurance if their property is identified as being in a Special Flood Hazard Area, or SFHA which is equivalent to having a 1% or higher risk of flooding every year and is in a community that participates in the NFIP. However, FEMA also reports that moderate-low risk areas account for more than 20 percent of the country’s NFIP claims. They even receive a third of flood-related assistance. In low and moderate risk areas, their risk of a flood is reduced but not removed. In 1968 flood was considered an uninsurable risk and the NFIP opened up possibilities for homeowners to protect against the highly probably flood loss. Their main three components include to provide flood insurance, to improve floodplain management and to develop maps of flood hazard zones. The NFIP has also contributed to the enhancement of flood prevention with stricter building codes and standards.
Flood insurance is available to include coverage over the home for up to $250,000 and its contents for $100,000. According to FEMA’s “Flood Insurance: How It Works,” the average premium for a yearly flood insurance policy is about $700 per year. Moreover, underestimation of risk and the misconception that flood loss is included into homeowners’ insurance continues to keep homeowners unprotected. In recent years there has been an aim to make the National Flood Insurance Program more financially and structurally sound or risk phasing out.
The status quo
In the original NFIP statute, Congress agreed that “a program of flood insurance can promote the public interest by providing appropriate protection against the perils of flood losses and encouraging sound land use by minimizing exposure of property to flood losses.” At the time of the National Flood Insurance Act implementation, it was determined that many factors made uneconomic for private insurance industry alone to make flood insurance available for all those who are in need of protection while still maintaining reasonable terms and conditions. This is the status quo that is still the case today. Less than 10 percent of flood insurance is written by private insurers.
This way of managing and financing flood risk has its unique advantages. For example, it enables homeowners in both low and high-risk areas to purchases federally backed flood insurance. It provides flood insurance in flood- prone areas that otherwise would not be able to obtain it, which in turn reduces the government’s cost after the event of floods. It also maintains a repository of Flood Insurance Rate Maps that are available during the planning and zoning of buildings and homes. This can be used as a preventative measure to educate a more conscious public who is aware of their risks. unlike disaster assistance and disaster home loans, NFIP payouts are not dependent on federal disaster declarations and does not need to be repaid.  The Reform Act of 2017 mandated coverage responsibility from individuals to lenders with links to the federal government, ultimately increasing the amount of flood insurance coverage. They’ve also managed to reduce the nations comprehensive flood risk through the development and implementation of floodplain management standards, where “adequate land use and control measures” have been adopted.  According to Morris & Reynolds insurance NFIP’s popular Write Your Own program allowed private insurers to sell and process flood insurance by using NFIP’s rates, rules, and regulations. The WYO program includes almost 20 insurers including well-known firms such as The Travelers, The Hartford, and Wright Flood. The NFIP is also not subject to state regulations unlike the rest of the industry.
However, things are not perfect, and there is still room for improvement in flood insurance. The NFIP prices their premiums without the typical feature of a catastrophic loading surcharge. As a result, they unavoidably accumulate massive debt during the years of the most lost. This can be evident in the financial hit the program got after hurricane Katrina, and other large storms. To continue, it also consistently fails to charge program participants rates that cover the full risk of flooding to their homes. As a result, on average revenue from premiums don’t include the number of claims in a year and the Congressional Budget Office estimates a program shortfall of $1.4 billion annually. Even after Congress forgave nearly $16 billion in debt, the program still owed over $20-25 billion to the U.S Treasury. Premiums are not prices to be actuarially sound and do not reflect covered risk, they are also inaccurate and distort the cost. This can even result in moral hazard by underpricing their policies and encouraging development in flood prone areas. Robert W. Klein of Georgia State university’s Center for RMI Research suggests that the key is increasing taxpayer support for the program which would allow for premiums to rise in price without deterring at-risk homeowners from opting out of the program.  Kousky and Kunreuther argue in their article “Addressing Affordability in the National Flood Insurance Program,” that the NFIP must address premiums affordability, and this cannot be fixed by discounting them. Inadequate rates and underwriting have proved there is much improvement to be done. Instead, Homeowners should be required to hold their property to standard, to reduce flood loss. Wealth redistribution is also a concern. This is because taxpayer funds subsidize the cost of the few homeowners who choose to live in high-risk flood zones. This can be considered unjust and poorly designed.
Although private insurers have taken on relatively little flood risk in relation to the NFIP, they have still been involved in the program. Private insurers have administered NFIP through sales of policies and servicing of claims. Recently, thanks to the development of more advanced analytics used to better predict risk, more and more private insurers have expressed interest in working with the NFIP to tackle the managing and financing of flood risk. Some advantages this may bring to the NFIP. Some of those advantages include more flexible flood policies because they can more accurately identify and track risks and offering rates that better represent the danger that homes face. They also provide the ability for integration with homeowner’s insurance policies. They also create competition in the market offering affordable coverage to consumers in need. Increasing private coverage from the mere 10 percent it at now could also mean the reduction of the NFIP debt and necessary borrowing from the U. S Treasury. The 2017 H.R. 2874 under section 1313 included provisions that promoted private flood insurance coverage in order to strengthen the NFIP; such provision consists of the risk sharing pilot program where the “Write Your Own companies insure properties up to at least $50,000 and NFIP issues policies in excess of that coverage limit.” These changes collectively would evolve the NFIP into a more effective program that will better serve homeowners in flood areas. Private capital will bring innovative products, progressive practices, all while alleviating the burden of bearing full risk and increasing expense of the NFIP. Ultimately giving Americans more options to protect their investments.
Partial Privatization has some downsides alike. For example, unlike the NFIP, private insurers would not be available to all floodplain residents and could be protection could be altered or vary depending on the state or region you reside in. According to the Congressional Research Service, or CRS, increased private insurance could also have an impact on the provided subsidies from NFIP to some consumers. According to FEMA, an estimated 20% of insured properties pay subsidized premiums which would be at risk with the inclusion of private insurers. The spread of risk is also hindered by adverse selection because owners who have a lower risk of floods are deciding to pass up coverage. Partial Privatization could also increase the issue with adverse selection through “cherry-picking” homes which are less flood-prone and leaving the high-risk areas for the NFIP. This could continue to place all the financial burden on the program even when prices reflect actual risk. The reason the National Flood Insurance Program was put into place was that private sectors did not want to commit to the possibility of significant loss by offering coverage in high-risk flood zones. Although it is not 1968 anymore and Flood risk is better quantifies, the possibility of history repeating itself is still possible which keep the public reluctant to jump on board with this change.
The National Flood Insurance Program Has some severe flaws and considering the amount of debt that the program is in, it is undeniable that something must be done. If the program fails, the $20 to 25 billion dollars in debt will be placed on the taxpayers back which is a driving concern in trying to find a solution. Some argue that the answer is the total elimination of the program or limiting it to serve only as a residual market mechanism for homeowners who are not insurable by private companies. Full privatization would require assistance from Congress in order to compete with the NFIP. The 2011 study from The Property Casualty Insurers Association of America concluded that the NFIP’s rates unable to be competed with because they are half of the standard. This gap in the price of rates would mean that even partial privatization would face hardship because private companies would risk losing money.
According to Brannon and Black’s “Reforming the National Flood Insurance Program: Toward Private Flood Insurance,” evidence suggest that a private market is superior to a government-run flood insurance program. Some of the advantages of having a nearly inversed scheme include the introduction to various options on how to protect their home. The National Flood Insurance Program had a lack of choice off-putting some consumers because of the vast market. Full privatization remedies the issue. As the risk pool broadens, private insurers will be able to tailor policies for high-risk areas and ultimately compete with NFIP. Privatization can also spread awareness of how essential flood insurance is to a household financial planning and compelling homeowners. This can lead to overcoming adverse section through the acceptance of flood insurance as necessary. Full Privatization can also help simplify insurance by bundling policies. Then possibly in the future homeowner insurance will be able to include protection from different perils from flood to fire, further normalizing the inclusion of flood insurance. There could also be shorter waiting periods considering the NFIP has a 30-day window, and private insurers range from 0-15 days.
As Mentioned before, many factors made it uneconomic for the private insurance industry alone to make flood insurance available. It is challenging to privatize the entire market because the National Flood Insurance Program includes all homes and due to the amount of risk, some homes are high risk or flood too often to be considered insurable. This creates a need for the NFIP to stay in the market as a last resort. Other disadvantage includes the possible dramatic increase in policy prices. Mitigation would be funded by private markets while enforcing land use and practices. This could result in required inspections for coverage which could be seen as an inconvenience and costly if a home is regarded as high risk. Moving towards full privatization could also contribute to the loss of trust because the sense of security of being backed by the federal government is no longer present.
To summarize, every home in the United States lives in a flood zone, but the levels of risk vary from low to high-risk areas. This leaves homeowners susceptible to huge repair cost and substantial loss. Contrary to the misconception that homeowner’s polity includes flood insurance, the National Flood Insurance Program protects policyholders from the damages caused to their home and its contents. Structuring the roles of Private and Public sectors in managing flood risks is a challenging issue. The three schemes of structuring flood risk all had a positive and negative attribute.
For the status quo, the NFIP would continue as it is, it enables homeowners in both low and high-risk areas alike to purchases flood insurance and payouts are not dependent on federal disaster declarations and do not need to be repaid. Some notable of the disadvantages, however, where moral hazard, regressive subsidies, and seemingly out of control debt, among other problems. Consideration for partial privatization brought advantages like flexible flood policies, integration with homeowner’s policy, innovative products, progressive practices, all while alleviating the burden of the National Flood Insurance Policy. Partial privatization could, however, eliminate subsidized premiums and increase the risk of adverse selection. Full Privatization also held a substantial list of benefits of which included the various options on how homeowners protect their homes, which results in the spread of awareness and minimizing adverse selections effects on policy owners, while also allowing for the convenience of the consumers bundling with other homeowner policies. The disadvantages of full privatization included the complications with providing all homes with coverage and staying actuarially sound and economically efficient, while also losing trust from removing the security of the Federal government’s backing.
I believe that the best option is to pursue a partially privatized market. The reason for my conclusion is because I do not think it is economically sound to continue the status quo and fall further into a black tunnel of debt. Hurricanes Katrina and Sandy cause NFIP over 20 billion dollars. While as of July 24th, 2018, Hurricane Harvey’s payments where at an estimated 8.8 billion. Although this is a much more complicated issue, pooling and growing the number of policyholders is an essential requirement. Partial Privatization will give enough variety in policies to appeal to a wide market. It can also provide encouragement for more innovative and progressive calculations of flood risk. This would also leave the Federal Government to guide, assist, setting standards and provide incentives simply. Partial Privatization will also encourage homeowners to make good decisions about the location of their home and taking preventative methods to protect themselves. As our ability to assess and quality risk more accurately increases, we get closer to the ability to tackle this challenge and find a solution that is beneficial to both the insurer and the homeowners. Of course, this all depends on the market’s willingness and capability to comply, and a truly workable solution cannot be defined.
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