Rather than do anything about it at the time, congress increased NFIP’s borrowing authority, from $1 billion to $25 billion. Before Harvey and Irma, the NFIP’s debt stood at around $24 billion. Allowing the NFIP to accumulate more debt was stupid because it did nothing to reduce the underlying cost of the program while adding the cost of interest payments on that debt.
It may seem odd that a capitalist country like the US has a government run insurance scheme (but not for healthcare thank god (that’s sarcasm, though the shambles the NFIP is in isn’t too confidence inspiring)). Private insurers stopped providing flood insurance a while ago, with many leaving the market after the Great Mississippi Flood of 1927 (which I wrote about here). So the government filled the gap.
A government run flood insurance scheme can work in theory. With just one insurer, the risk pool is larger and more diverse than with multiple smaller insurers. Because the government doesn’t have a profit-motive, the monopoly power of a single insurer is not used to raise prices and reduce supply as a private monopoly would. But the NFIP does not work. Some of the reasons are not unique to the NFIP. Insurance works best for non-correlated, predictable, and rare risks; floods don’t fit any of those criteria. Risk is correlated: if your neighbor’s house is inundated in a flood yours is very likely to be as well. The weather is not very predictable. And because of where development has occurred – near bodies of water – flood damage is not rare and is becoming even less so.
Additionally, due to the amount of chance involved, individuals may lack the information, or even the ability, to rationally calculate their personal risk. If they underestimate this risk, they will irrationally conclude that insurance is too pricey and forego it even if it is priced correctly from the market’s point of view. These same issues explain why private health insurance markets seem to death spiral. And handing flood insurance back to the private sector will not fix these problems. Though one key difference between flood and health insurance is that there are positive externalities to better health, which justify public subsidy, whereas there are no external benefits to anyone from someone being able to live in a bigger house closer to the ocean than they otherwise would. This means, in purely economic terms, there is no justification for the government running a flood insurance program. But fat chance of them getting out of the business and letting people lose everything in a storm.
There are also many well-known obvious problems that are unique to the way the NFIP is set up. Most obviously, it doesn’t charge enough in premiums to cover its payouts and does not charge homeowners based on the true risk of their property flooding. This ends up subsidizing development in flood prone areas, further increasing the cost to the NFIP. The NFIP grandfathers in low rates for current customers when it raises rates, pushing the cost onto new development. The NFIP uses old flood maps and averages estimated risk across flood districts, underestimating risk for the most vulnerable properties in particular. The NFIP does not factor in future expected risk, say from erosion or sea level rise. So even if it charged based on present risk with up to date maps, it would be underpricing based on future expected payouts. Congress tried to address some of these issue in 2012, but property owners were outraged that they wouldn’t continue to get as big of handouts from the government for living in flood prone areas and congress mostly watered down the reforms (pun intended).
Another problem is that properties that do flood are simply rebuilt in the same place. Repeatedly flooded properties account for 1% of NFIP insured properties and 25 to 30% of payouts – equivalent to half the program’s debt. 75% of these properties have done nothing to mitigate future risk. In some cases, owners have received payouts totaling many times the value of the property. And the job of selling, assessing, and processing claims for flood insurance is still in the hands of private sector insurers for some reason (cause they have lobbyists and bribe – I mean donate to the campaigns of – lawmakers). The private companies get paid per claim, giving them the incentive sell to the riskiest properties, maximize the number of claims, and assess damages as quickly as possible. Basically, repeatedly flooded properties are cash cows for them and they don’t want that problem fixed.
The NFIP must be re-authorized by congress this September. They will either have to increase FEMA’s budget and basically accept that the federal government is paying the $24 billion debt or increase NFIP’s borrowing authority. Neither will fix the long-term problems, and I bet congress won’t implement reforms that will. On the plus side, there’s only about a month and a half of Hurricane Season left to go.
Part II
A government run flood insurance scheme can work in theory. With just one insurer, the risk pool is larger and more diverse than with multiple smaller insurers. Because the government doesn’t have a profit-motive, the monopoly power of a single insurer is not used to raise prices and reduce supply as a private monopoly would. But the NFIP does not work. Some of the reasons are not unique to the NFIP. Insurance works best for non-correlated, predictable, and rare risks; floods don’t fit any of those criteria. Risk is correlated: if your neighbor’s house is inundated in a flood yours is very likely to be as well. The weather is not very predictable. And because of where development has occurred – near bodies of water – flood damage is not rare and is becoming even less so.
Additionally, due to the amount of chance involved, individuals may lack the information, or even the ability, to rationally calculate their personal risk. If they underestimate this risk, they will irrationally conclude that insurance is too pricey and forego it even if it is priced correctly from the market’s point of view. These same issues explain why private health insurance markets seem to death spiral. And handing flood insurance back to the private sector will not fix these problems. Though one key difference between flood and health insurance is that there are positive externalities to better health, which justify public subsidy, whereas there are no external benefits to anyone from someone being able to live in a bigger house closer to the ocean than they otherwise would. This means, in purely economic terms, there is no justification for the government running a flood insurance program. But fat chance of them getting out of the business and letting people lose everything in a storm.
There are also many well-known obvious problems that are unique to the way the NFIP is set up. Most obviously, it doesn’t charge enough in premiums to cover its payouts and does not charge homeowners based on the true risk of their property flooding. This ends up subsidizing development in flood prone areas, further increasing the cost to the NFIP. The NFIP grandfathers in low rates for current customers when it raises rates, pushing the cost onto new development. The NFIP uses old flood maps and averages estimated risk across flood districts, underestimating risk for the most vulnerable properties in particular. The NFIP does not factor in future expected risk, say from erosion or sea level rise. So even if it charged based on present risk with up to date maps, it would be underpricing based on future expected payouts. Congress tried to address some of these issue in 2012, but property owners were outraged that they wouldn’t continue to get as big of handouts from the government for living in flood prone areas and congress mostly watered down the reforms (pun intended).
Another problem is that properties that do flood are simply rebuilt in the same place. Repeatedly flooded properties account for 1% of NFIP insured properties and 25 to 30% of payouts – equivalent to half the program’s debt. 75% of these properties have done nothing to mitigate future risk. In some cases, owners have received payouts totaling many times the value of the property. And the job of selling, assessing, and processing claims for flood insurance is still in the hands of private sector insurers for some reason (cause they have lobbyists and bribe – I mean donate to the campaigns of – lawmakers). The private companies get paid per claim, giving them the incentive sell to the riskiest properties, maximize the number of claims, and assess damages as quickly as possible. Basically, repeatedly flooded properties are cash cows for them and they don’t want that problem fixed.
The NFIP must be re-authorized by congress this September. They will either have to increase FEMA’s budget and basically accept that the federal government is paying the $24 billion debt or increase NFIP’s borrowing authority. Neither will fix the long-term problems, and I bet congress won’t implement reforms that will. On the plus side, there’s only about a month and a half of Hurricane Season left to go.
Part II
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