How National Policy Can Respond to Floods

In 1968, the federal government established the National Flood Insurance Program (NFIP). By creating new incentives, our lawmakers thought they could manage natural disasters more wisely.

It did not quite work out as they expected.

Flood Insurance

The National Flood Insurance Program was supposed to solve several problems. Because flood insurance policies were separate from property insurance, homeowners weren’t buying them. Then, when disaster hit, too many tax dollars covered the expense. In addition, the Congress wanted to make insurance affordable to the people who were unable to obtain it.

So yes, it became available–perhaps too available. The insurance was so cheap that people were happy to pay for it. The result was what insurers call repetitive loss properties. Flooding 34 times in 32 years, a $69,000 home in Mississippi received close to $663,000 in payouts. Similarly, for 16 floods in 18 years the owners of a Houston home valued at $115,000 got $800,000.

Their big mistake was mismatching the cost of the premiums and the level of risk. Relatively inexpensive premiums encouraged people to build homes in disaster prone areas. And even when the Congress tried to correct the problem in 2012, the opposition was so intense that they reversed themselves two years later.

Our Bottom Line: Price

In a market system, price sends the message that a commodity is cheap or expensive. With inexpensive premiums, the NFIP had been sending the wrong message. It was encouraging people to repair homes rather than abandon them. They were developing flood, prone areas rather than avoiding them. Now all will change. Explaining the new policy, the NFIP said that it wanted its premiums to reflect flood risk more accurately. Consequently, depending on their location, policyholders will see big and little increases and even sometimes a decrease. Last Friday, one new waterfront homeowner’s yearly insurance premium soared to $4,986 from $441.

We should note one huge concern. Less available insurance can lower property values. Researchers point out that lower income households have the incentive to locate where property is cheaper. Then they ask, are subsidized insurance policies appropriate? Should means-testing affordability perpetuate some low rates?

I suspect that we wind up with a bit of a contradiction. The purpose of NFIP remains to provide affordable, available flood insurance while also reducing flood risk. Rather than complements, the two goals are tradeoffs that new prices are indeed conveying.

But we do have a big problem:

https://www.wsj.com/articles/climate-change-report-points-to-rise-of-flash-flooding-11628609644

My sources and more: The Wall Street Journal, here and here, reminded me it was time to return to flood insurance. For the academic  perspective, this is it, while the federal program is described here. (Do look at p. 21 for the especially relevant description of Risk Rating 2.0.) Then, for some history from Michael Lewis, this NY Times Magazine article was superlative. (Please note that today we’ve repeated several sections of a past econlife post on flood insurance,)