Fixing the National Flood Insurance Program, in three charts

by @alexandranewman October 27, 2013 5:02AM ET

Federal program that had no debt less than a decade ago is now more than $20B in the red

Sandy Anniversary

The indebted National Flood Insurance Program owes about $24 billion to the U.S. Treasury, and steep rate hikes kicked in this month as part of efforts to make the program more sustainable. Congress has eliminated nearly all subsidized coverage and is requiring more accurate rates for flood insurance — but some experts warn the new rates are simply unaffordable for low-income homeowners and the federal government hasn’t yet figured out a way to help them.

Without the flood insurance program, thousands of homeowners would be unable to afford policies. The original program tied flood insurance access to mitigation efforts in communities, but decades of subsidized rates have left homeowners unaware of the real risks they face and allowed building in dangerous areas.

“What’s happened is that people are required to buy it, they don’t buy it,” explained Howard Kunreuther, the co-director at Wharton’s Risk Management and Decision Processes Center at the University of Pennsylvania. “They buy it after an event and don’t renew it a few years later. The banks don’t enforce the requirement, and we have an awful lot of people who are uninsured. Everyone’s losing in the process.”

The result: a program that may be unable to pay its debts while insuring $1.2 trillion in properties, making the program one of the U.S. government’s largest financial obligations.

Why is the government in the business of flood insurance anyway?

In 1965, Hurricane Betsy left more than $1 billion in damage when it hit the Gulf Coast, overwhelming levees in New Orleans and flooding the city. Florida, Alabama and other parts of Louisiana were also affected by the storm.

Unlike auto or health insurance, flood insurance is more difficult for a private company to offer. When a flood occurs, many people in the community are affected, and the payouts overwhelm private insurance companies.

So in 1968, the government spread the risk around and began selling highly subsidized policies. Homes built before federal flood maps were created were given subsidies. Private flood insurance is available, but it is often incredibly expensive and out of reach for many homeowners.

“These were supposed to be temporary subsidies, and they’ve persisted over decades, and they’ve led to a system where premiums are seriously out of whack with what true flood risk is in many places,” said Rachel Cleetus, an economist at the Union of Concerned Scientists.

How did the debt happen?

The insurance program was fiscally solvent for many years, but several catastrophic events — including Hurricane Katrina, which resulted in $16.2 billion in insurance payouts — have taken their toll. And the 2005 hurricane season season didn’t end with Katrina: Rita and Wilma followed, adding almost $1 billion in claims.

NFIP shoulders crushing debt after Katrina
Source: Union of Concerned Scientists, Congressional Research Service Report. Estimate for Sandy debt from July 2013 GAO reports.Chart by Lam Thuy Vo.

“This is a program that is in dire need of reform, for many reasons,” Cleetus said. “It’s not communicating risk to people appropriately so they can take protective measures and this risk is growing over time because of development along the coast, just putting more people in harm’s way.”

Changes to the NFIP cut subsidies, charge higher rates

In July 2012, Congress changed the flood insurance program. The program no longer offers cheaper rates for secondary homes, for businesses or for repeat-loss policies. This means about 438,000 policies are no longer eligible for reduced rates, leaving about 700,000 subsidized policies.

Subsidy cuts target second homes, repeat loss properties
Source: Government Accountability Office, July 2013 report. Chart by Lam Thuy Vo.

For those no longer eligible for subsidized insurance, rate hikes are being phased in at 20 percent increases each year until the rate reflects the actual risk. But for some of those whose rates were artificially low, the new price of flood insurance will be out of reach for low-income households.

“It’s important for Congress to come back and address the affordability issues for low-income homeowners who could be priced out by the flood insurance premium increases,” Cleetus said. “It’s really important we do this in a thoughtful way so people have options.”

How much are rates going up?

The Federal Emergency Management Agency estimates that its subsidized rates represented as little as 45 percent of the actual risk.

“If somebody was paying $500, but their true rate is $10,000 that tells you, you’re going to get flooded,” said Larry Larsen, senior policy adviser for the Association of State Floodplain Managers. “The reality is your structure is obviously at high risk.”

Rates are based on what kind of flood plain a structure is built in and what kind of flood-prevention measures have been used to mitigate damage. While rates are rising, FEMA is also in the process of remapping many communities. Funding for mapping dried out in the 1990s and early 2000s, and many current flood plain maps are two decades old.

New, more accurate maps often mean homeowners are suddenly in a flood plain and required to buy insurance.

The recent changes by Congress include a new priority on flood plain mapping, but FEMA maps based on current conditions.

“Do you want us to map yesterday’s flood or tomorrow’s flood?” Larson asked. “It takes three years to do the map, and it’s already obsolete.”

Solving the affordability problem

Experts say accurate rates are necessary, but the national program was originally created to make flood insurance affordable. Instead of a subsidy-based system, experts said they favor a voucher-based system, more like food stamps to help homeowners shoulder heavy rate hikes.

“You need to have risk-based rates if insurance is going to have a meaningful role,” Kunreuther said. “Here’s the catch: They have to mitigate to get the voucher. The homeowner saves money and so does the federal government.”

Homeowners can keep the cost of their insurance down by making improvements to structures that will better protect them during a flood.

Raise your building, lower your insurance costs
Source: FEMA, Association of State Floodplain Managers.Chart by Lam Thuy Vo.

Not all homeowners can afford their new rates nor can they afford to invest in raising a home, which can cost upward of $50,000.

But proposals like Kunreuther’s give the homeowner a voucher against their premium while also providing a loan to better protect their property. Once the property is elevated, insurance rates go down drastically, and the federal voucher money can be used to pay down the loan, ultimately saving thousands of government money while improving flood protections.

“Over the next 20 years, let’s use that subsidy to pay off the loan, and then at the end of that 20-year period, the structure is safe and the risk has been mitigated,” Larson said. “The ultimate answer is to help them mitigate their homes. You don’t want these people to continue to be at risk.”

In a recent report, Cleetus recommended other options for fixing the flood insurance program and making communities less vulnerable to flood events such as last year’s Superstorm Sandy. Including climate change projection in flood plain maps is one suggestion; allowing for home buyout programs in the highest-risk areas is another. Regular updates to building codes and other protective measures, incentives to relocate and discouraging development in flood plains are also on the list.

“Communities are just now starting to grapple with this issue, and it’s a very painful and difficult issue,” Cleetus said. “I don’t want to gloss over it and make it seem like ‘if you fix the insurance program, you’ve fixed the problem.’ Fixing the National Flood Insurance Program is important, and it will be a really powerful tool to help people make better decisions going forward, but we’ve got a lot to do in this country.”