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Is Federal Flood Insurance Defensible?


In the aftermath of Superstorm Sandy, the National Flood Insurance Program has come under intense scrutiny.

MINYANVILLE ORIGINAL Superstorm Sandy facilitated the coming together of Americans in many ways. Of course, people from all walks of life banded together to contribute to recovery efforts in the tri-state area. Unexpectedly, the destruction wreaked in the fall has also brought together Americans from differing ideological spectrums.

The issue at hand is the Federal Emergency Management Agency's (FEMA) National Flood Insurance Program (NFIP), which is a federally-backed insurance program sold through most private insurers, such as ACE (NYSE:ACE), AIG (NYSE:AIG), Progressive (NYSE:PGR), Hartford (NYSE:HIG), and Travelers (NYSE:TRV), that covers Americans living in flood-prone areas.

Damage wreaked by Hurricane Sandy in Seaside Heights, New Jersey. Source: Wikipedia
Before Sandy made landfall, the NFIP was already at least $17.75 billion in debt, and the final costs of the storm could wipe out the program's remaining $3 billion statutory borrowing authority.

Libertarians, unsurprisingly, are against the NFIP. Fox Business Network personality John Stossel, for example, wrote an article on the flaws of the program just over a month before Sandy struck the US.
Private insurance companies were reluctant to sell insurance to those of us who build on the edges of oceans, and were they to offer it, they'd charge an arm and a leg to cover the risk. But this wasn't a problem for me, because you offered to insure my house. I know you didn't do it personally, but you, as a taxpayer, are the guarantee behind federal flood insurance. Should a big storm wipe out half the coast, you'll cover our losses - up to a quarter-million dollars. Thanks - we appreciate it - but what a dumb policy.

Stossel argued that the NFIP all but incentivizes people to build property in flood-prone coastal areas, and that its cheap insurance premiums disproportionately benefited affluent homeowners with beachfront property.

However, in the aftermath of Sandy, even the more liberal New York Times published an editorial calling for the end of the NFIP.
Homeowners and businesses should be responsible for purchasing their own flood insurance on the private market, if they can find it. If they can't, then the market is telling them that where they live is too dangerous. If they choose to live in harm's way, they should bear the cost of that risk - not the taxpayers. Government's primary role is ensuring the safety of its citizens, so the government's subsidizing of risky behavior is completely backward....

The bottom line is that the flood insurance program is a fiscal time bomb for the government.

We should phase out the program, begin thinking strategically about how to shift populations away from the most risky coastal areas, and use the best available science to update the woefully out-of-date coastal-zone risk profiles that government agencies currently rely on to determine danger. We also need to encourage more stringent building codes that take into account the full range of climate risks. (Officials in New York and New Jersey this week estimated the overall costs of Hurricane Sandy in the two states at a combined $72 billion.)

With Americans across the political spectrum coming out against the NFIP, is the program defensible? Yes, Ann Myhr, senior director of knowledge resources for The Institutes, a leader in property-casualty insurance education, tells Minyanville.

Myhr says that there are a lot of provisions within the NFIP before a community can participate in the program.

She said, "[Communities] have to agree to participate in mitigation activities to lower the overall risk. They have to adopt certain land use regulations. That's why in towns with rivers that run through them – a lot of the land that is adjacent to the river is just a park or a parking lot."

Myhr also points out that the NFIP only insures up to $250,000 on a building and up to $100,000 on contents, "so it's not like it's a blank check," and wouldn't really help cover damage costs for the owner of a house worth millions.

As for the charge that the NFIP incentivizes risky behavior, Ken and Kate Goodersham of the American Shore & Beach Preservation Association wrote at the Gasparilla Gazette that it was actually the other way around. They asserted that people will always build beachfront properties, as they did before the appearance of the NFIP. Affordable NFIP rates, then, "[enable] government to apply the stick (better flood mitigation and building standards) to help reduce the overall risk of flood damage to properties."

Gavin Smith, the executive director at the Coastal Hazards Center at the University of North Carolina at Chapel Hill, tells Minyanville that the NFIP could be improved nonetheless. For example, he calls for "increasing incentives at the individual level to make improvements -- like in the current federal program, there's something about a community program where if you do X or build Y to improve flood safetyness, your premiums as a community go down. The problem is that this is easier to do for communities with resources and money."

In fact, the NFIP was only just re-authorized last summer through the Biggert-Waters Flood Insurance Act, which extended the program through 2017. Myhr says that the act was designed to respond to critiques of the federal flood insurance program.

Annual premiums increase caps, for instance, were raised to 20% for newer homes, and 25% for those built before the program, compared to 10% in the past. FEMA has also updated its flood zone mapping along the entire US coastline, with the net effect being that more properties are now considered to be in risky flood zones. The Climate Science Watch blog reported on further changes that were made this past summer to make sure the NFIP could be sustained in the future:
For starters, those who do not have flood insurance, but reside in a flood plain or newly updated flood hazard zones, will be required to purchase insurance. Insuring properties with repeated severe loss claims due to flooding will be phased out. Subsidies for vacation and second homes will also be phased out, along with business properties, homes substantially damaged or improved (i.e., in amounts greater than a percentage of the market value), and homes sold to new owners. This means less liability burden for the program. New provisions make it easier to apply for the Federal Emergency Management Agency's (FEMA) buyout program. The homes substantially damaged by flooding would be purchased by FEMA and demolished, left as open space so no future claims will be incurred.

Myhr says that the NFIP is not perfect, but that it remains "important from the perspective of consumers because [flood insurance] is not available under standard homeowners' insurance policies."

"Can the NFIP be improved? Certainly, I think that any program can be improved. In light of Sandy, we may see some more recommendations and some actions taken to strengthen the program," says Myhr. "[Nonetheless,] I believe that the changes that were made go a long way in responding to some of the concerns [of critics.]"

Twitter: @sterlingwong
No positions in stocks mentioned.
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