Tropical Storm Harvey and Why We Should Privatize Flood Insurance

Texas and Louisiana have been getting hit by Tropical Storm Harvey these past few days. The flooding was so bad that the National Weather Service had to update the graphics on their mapping to effectively reflect the unprecedented amount of rain. Since about 80 percent of those affected by the storm do not have insurance, Harvey can cost as much as $30 billion to $50 billion in damage. The pending Texas insurance law of reducing the penalty interest in insurance claims cases complicates matters further for those in Texas. This got me thinking about the nature of flood insurance.

Back in 1968, Congress passed the National Flood Insurance Program (NFIP) Act, a program that is presently administered by FEMA. The NFIP is a government-administered program that enables property protection from floods. It was created with the hopes that it would better insure [primarily] coastal buildings from flooding than the private sector has. The NFIP has been around for nearly fifty years and is up for congressional reauthorization next month. As such, it only seems fitting to see how the NFIP has performed, especially since the NFIP the only coverage for the vast majority of Americans. Here are but a few criticisms I have for NFIP:

• Before Tropical Storm Harvey hit, the NFIP was already $25 billion in debt. FEMA has still not paid its NFIP debt from Hurricane Katrina over a decade ago. In its September 2017 report, the Congressional Budget Office is expecting more net shortfalls. 
• Aside from being a form of wealth distribution from non-coastal areas to coastal areas, premium shares are larger than income shares for lower-income households (Bin et al., 2017). What this means is that this regressivity insures higher-value homes more than it does lower-value homes. 
• The Government Accountability Office recognizes that the NFIP charges subsidized rates, which affect the market. 
• Here is a bad sign that FEMA is lousy at assessing risk. According the Congressional Research Service in its June 2017 report (p. 1), the NFIP is on the hook for $1.24 trillion while only charging a total of $3.5 billion, as of early 2017. That is not simply the sign of fully reflecting the risk of flooding. It is the sign of a ticking time bomb, not a solvent or financially sound program.  
• It doesn't help when FEMA is using outdated flood maps to assess risk, either, which is another example of mismanagement. It also doesn't help when FEMA is not allowed to exclude high-risk properties from NFIP coverage (Wriggins, 2016, p. 1450).
• Moral hazard comes with the NFIP because it contributes to encouraging people to live in hurricane-prone, flood-prone areas (Ben-Shahar and Logue, 2015).

Since the global sea levels are rising and people are still incentivized to move to coastal areas vis-à-vis the NFIP, it is clear that the government is not helping by offering the NFIP as a form of flood insurance, even though some advocate for its continued existence. In the GAO's 2017 report, it states that none of its main criteria (see below). The NFIP is dealing with issues in financial exposure and challenges in management and operations, which is why the GAO ranks it as "High Risk." The American Academy of Actuaries are not hopeful of NFIP, either.

Maintaining the NFIP and creating perverse incentives is neither moral nor financially sound, so how do we deal with a program that looks like it is going from bad to worse? Privatization of flood insurance. It is not just when the Cato Institute puts out a wonderful policy analysis on privatization. It should be a red flag when FEMA, the very government agency that is responsible for NFIP, has even encouraged more privatization as a partial solution since 2012. Greater privatization can lead to "multiple coverage options, lower costs, and rates that accurately measure risk."As Deloitte points out in its 2014 report on flood insurance privatization, not only do United Kingdom, Germany, and Australia privatize it, but depending on the insurance model used, it could also work here in the United States. We need to do something to reform the NFIP quickly before the American people drown from NFIP's mismanagement.