With Virginia still recovering from the after-effects of Hurricane Irene, the Government Accountability Office posted a new study on its website, “Action Needed to Improve Administration of the National Flood Insurance Program,” along with congressional testimony by Orice Williams Brown, managing director of financial markets and community investment.
The story was a dismal one. The National Flood Insurance Program has accumulated $17.8 billion in debt and its continued need to borrow to cover flooding claims has “raised concerns about the program’s long-term fiscal solvency.”
The program suffers from a number of problems, not the least of which is the Federal Emergency Management Administration’s lack of goals, objectives or performance measures for the program, and the abandonment after seven years and $40 million of the program’s inefficient, 30-year-old claims management system. But the biggest problem is the insanity of NFIP’s ongoing subsidy of flood insurance. Average 2o1o premiums of $1,121 were discounted from the true cost of $2,500 to $2,800.
Not all problems are of NFIP’s own making. The program works within rules that make it impossible to run a fiscally solvent operation, no matter how efficient the administration. Says the GAO report:
NFIP is also required to accept virtually all applications for insurance and cannot deny coverage or increase premium rates based on the frequency of losses. Private insurers, on the other hand, may reject applicants or increase rates if they believe the risk of loss is too high. As a result, NFIP is less able to offset the effects of adverse selection—the phenomenon that those who are most likely to purchase insurance are also the most likely to experience losses. Adverse selection may also lead to a concentration of policyholders in the riskiest areas. This problem is further compounded by the fact that those at greatest risk are required to purchase insurance from NFIP if they have a mortgage from a federally regulated or insured lender. … Finally, by law, FEMA is prevented from raising rates on each flood zone by more than 10 percent each year.
Local governments are of little help.
FEMA relies on state and local governments and communities to implement parts of the program, which can limit the effectiveness of some of FEMA’s efforts. For example, communities enforce building codes and other floodplain management regulations in an effort to reduce the flood risk that insured structures face, but some communities may not have sufficient resources to enforce existing regulations. FEMA also relies on communities to administer grant funds that are intended to mitigate high-risk properties. However certain types of mitigation, such as relocation or demolition, might be met with resistance by communities that rely on those properties for tax revenues, such as coastal communities with significant development in areas prone to flooding. Finally, communities and individuals have sometimes mounted challenges to and resisted flood map revisions that place homes in higher-risk flood zones and would thus raise premium rates.
The GAO recommends a variety of congressional reforms, including the obvious, if politically unpopular one of raising insurance rates. The problem, authors suggest, is that many property owners will simply refuse to buy insurance of any kind, exposing FEMA to greater damage liability in the event of a disaster.
Here’s a solution that GAO didn’t recommend: Raise the insurance rates to a level consistent with sound actuarial principles, tell people they are not eligible for FEMA aid for flood damage in a disaster, and then let nature take its course. I can guarantee one thing: There will be a lot less building of multimillion-dollar houses on Atlantic coast beach front or other flood-prone areas. I cannot think of a single reason why that would be a a bad thing.
