As Hurricane Sandy continues to batter the Eastern seaboard of the U.S., one thing is for certain: insurance companies will be ponying up for billions of dollars in property damage caused by high winds. Last year’s Hurricane Irene cost insurance providers more than $4 billion in damage claims, with flood-insurance payments totaling nearly $1.3 billion.
But what many Americans may not know is that this $1.3 billion was a bill footed by the federal government, which underwrites the vast majority of flood insurance across the nation. Historically, insurance companies have been wary of offering flood insurance to homeowners because the risks associated with flood insurance are difficult to forecast, so any private insurance that had been offered was prohibitively expensive for average homeowners.
But in the 1960s, frequent flooding of the Mississippi River was driving up the costs of federal disaster-relief programs. In an effort to reduce these costs, Congress set up the National Flood Insurance Program (NFIP) to provide flood insurance to the general public and promote effective floodplain management. Under the program, homeowners in certain areas of the U.S. are required to buy flood insurance, and communities that hope to benefit from the program have to enforce city-planning regulations set out by FEMA, which manages NFIP.
Though the program has been effective at making flood insurance widely available, a growing chorus of critics from environmentalists to libertarians has been attacking it for encouraging homeowners to build recklessly in areas that are prone to flooding. For instance, Ira Stoll wrote yesterday in the New York Sun:
“Hurricane casualties are partly the result of unintended consequences of government actions: without federal flood insurance, many fewer people would take the risk of living in low-lying areas vulnerable to storm surges.”
There is evidence to support the view that the government is actually encouraging citizens to live in areas most in danger of flood damage. According to a 2010 report issued by the Institute for Policy Integrity, Congress has historically set the premium rate too low for flood insurance — effectively subsidizing building in flood-prone areas at the expense of taxpayers at large. This practice has helped drive the fund $19 billion in debt, caused mostly by the unusually severe damage caused by Hurricane Katrina.
In addition, the report argued that the environmental effects of the federal government’s flood-insurance policy may be more severe than the financial effects. According to the report:
“River basins and coastal zones provide natural purification of water and wastewater; erosion control and weather mitigation; and habitat for fish and wildlife. They also offer opportunities for valuable recreational use, improve irrigation return flows for agriculture, and support fisheries and other raw natural resources with considerable economic value.”
Subsidizing building in these areas can have environmental costs that far outweigh the actual cost of subsidization.
The report also found that the NFIP usually benefits the very wealthy at the expense of the poor. Excluding payments made as a result of Hurricane Katrina, “the wealthiest counties in the country filed 3.5 times more claims and received over a billion dollars more in claim payments than the poorest counties,” between 1998 and 2008.
In July, Congress extended the program through 2017 and tried to address some of these concerns by raising premiums on insurance holders, increasing the minimum deductible and requiring the NFIP administrator to come up with a plan to resolve its debt problem. Mike Barry of the Insurance Information Institute argues that these reforms have “put the NFIP on more actuarially sound footing going forward.”
And while the NFIP does help a number of wealthier citizens find insurance, that doesn’t mean it doesn’t help poorer Americans who without the program would probably have no way of getting their properties insured. If the NFIP were to disappear tomorrow, “people would be very hard pressed to find cost-effective flood insurance,” and for many Americans “it would be a significant financial burden.”
And the fact that so many homeowners and businesses rely on this program is good reason to believe that we won’t see it disappear anytime soon. Even if we are convinced that government-supported flood insurance does transfer wealth from the poor and the middle class toward wealthy owners of vacation homes, or that it encourages environmentally detrimental development of coastal areas, the program would be very difficult to get rid of. The reason: the countless Americans who have bought homes and businesses under the assumption that this insurance would be available. If the government were to pull the rug out from under those people now, they would most likely lose their insurance and see their property values tumble.
The bill that reformed and extended the NFIP was one of the few bills to make it through a profoundly gridlocked Washington, D.C., this summer, and it’s not difficult to see what separated it from the pack. Like many other government programs like the home-interest deduction and agricultural subsidies — which are reviled by economists as distortionary — the NFIP is fiercely defended by those who benefit from it. Representatives from districts that benefit from the NFIP will fight to keep the program, while the stakes are lower for those who bear the costs.