LAST MONTH, President George W. Bush signed into law a bill kicking up the National Flood Insurance Program's borrowing authority to $20.775 billion from $18.5 billion. Since September, when the NFIP's line of credit stood at $1.5 billion, the president has signed several such bills in response to the enormous number of flood insurance claims filed in the aftermath of hurricanes Katrina, Rita and Wilma. As the NFIP burns through one pile of money, the government dutifully forwards another. It really has no choice; it can't choose not to honor policies written under its own program. In fact, the next installment already is in works. Last month, the House Financial Services Committee marked up the Flood Insurance Reform and Modernization Act of 2006 (H.R. 4973). Among other things, it would allow the NFIP to raise its IOU to $25 billion–although you'd have to be de-lusional to think these borrowed funds will ever be repaid.
Eventually all the 2005 flood insurance claims will be dealt with, but the big question–Where do we go from here?–will remain. As Congress continues to tweak H.R. 4973 and legislation like it, it could do worse than study a report issued last month by the Republican Policy Committee. The report, "National Flood Insurance: Crisis and Renewal," does not mince words. "The NFIP is now bankrupt," it says. But it also does a good job of explaining how the program got in this fix and how it might get out of it.
At the core of the problem, as others have pointed out, are subsidized rates and low participation. The report notes that in 1973, Congress explicitly subsidized rates for properties in 100-year flood plains. "The Congressional Budget Office estimates that these policyholders pay only 35% to 40% of the risk-based rate, which translates to an annual subsidy of $1.3 billion," the report states. "This means that the program is 40% underfunded on an actuarial basis." Changes to the program in 1981 were meant to ensure the flood-insurance program collected enough premium to cover losses in a "normal" year, the report notes, but did not allow it to charge anything extra to build reserves. "The lack of a reserve of claims-paying capital exposes taxpayers to considerable risk in the event of a catastrophic loss event like Hurricane Katrina," the report points out.
Worse than the explicit subsidies, the report notes, have been the "implicit" subsidies created by the NFIP's ace in the hole: its ability to "borrow" funds from the U.S. Treasury. "The NFIP's implicit subsidization has directly encouraged lenders, homebuilders and homebuyers to take imprudent risks," the report states. Quoting Sen. Richard Shelby (R-La.), the report added, "Where, prior to the program, there were areas where construction did not occur because financing was not available for it, we now see expensive homes and commercial properties." In short, Congress, through the NFIP, played a key role in bringing into existence many of the properties on which last year's hurricane claims were filed. Can you say, "Self-inflicted wound"?
Despite the subsidies, fewer than 30% of homeowners vulnerable to floods are insured for the peril, according to estimates cited in the report. In 1993, Congress tried to increase participation by requiring federally regulated lenders to see to it that anyone taking out a mortgage or home equity loan on a property in a 100-year flood plain have flood insurance. FEMA estimates, however, that lenders' noncompliance rate is 40% to 60%.
The report offers a number of suggestions for fixing the aforementioned problems, including the following:
–Phase out explicit subsidies. The report advocates increasing rates on subsidized structures by an average of 20% per year for five years. Local governments could use federal Community Development Block Grants to help low-income property owners obtain coverage.
–Extend mandatory coverage provisions. The report calls for expanding mandatory coverage to properties in the 500-year flood plain. While the terminology suggests that such property has a miniscule chance of being flooded, the report notes that homeowners in 500-year flood zones are more likely to experience flood damage than fire damage over the lives of their mortgages. To increase compliance, the report suggests that Congress could ratchet up penalties on lending institutions for failing to enforce coverage requirements or even bring developers into the process by requiring them to buy multiyear flood coverage on the properties they build.
–Give the NFIP more rate-setting flexibility. Right now, the NFIP can't bump up rates by more than 10% annually. The report calls for raising that to 25%: "This would allow the NFIP to boost rates in the aftermath of a catastrophe loss year in a manner more akin to private insurers."
–Create a separate pricing category for coastal properties. I love this suggestion. As is now apparent, hurricanes are the real drivers of catastrophe flood losses, and areas vulnerable to them should be treated differently from those that are not. Private insurers certainly make that distinction when covering the wind peril. In these coastal areas, the report says, "the NFIP would be free to dramatically increase rates … or refuse to insure yet-to-be constructed coastal properties altogether." By doing so, the report notes, the NFIP would be functioning more like a traditional nonadmitted market, with all the freedom that implies.
Certainly, many of the affected property owners could afford to take the hit. The report cites a study stating that only 21.1% of coastal properties are primary residences, while the rest are second homes and rental units. These properties cost 42% more than the national average, the reports notes, while the average annual income of the owners is more than twice the national average. "It is difficult to see how implicit subsidies for the vacation homes of high-net-worth individuals fit into the NFIP's social insurance structure," the reports says.
Say "Amen," somebody.
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