This week, Leonard Shabman discusses the problem of low take-up rates for flood insurance among residential and commercial properties located in flood plain regions and outlines a series of proposals to expand the use of (locally managed) group insurance programs.
In the mid 1960s, as Congress began work on a National Flood Insurance Program (NFIP), a House report described the nation’s flood-risk management objective:
“It seems highly probable that the total flood hazard in the United States will increase over the next several decades, even with careful weighing of the risks involved. A growing population, with higher average incomes per person, and attendant increased economic activity of many kinds will probably lead to greater use of flood prone areas. ... Increased use of these areas, in spite of flood hazard may well be economically rational if the new occupants bear the full cost of the occupancy of these areas.”
Under these guidelines, a successful flood-risk management policy would assure that a landowner’s decision to locate an activity on a flood plain or coastal hazard area was informed: he or she would understand the river and land-use practices that could lead to possible flood damage and be responsible for any subsequent repair or replacement costs. (I will use the term flood plain to include coastal hazard areas). However, it was recognized then, and is still the case, that individuals can not readily understand their exposure to flood damage from rarely experienced storm events.
So, requiring purchase of flood insurance where annual premiums reflect expert-determined estimates of expected property damages was a practical way to inform landowners of flood risk as well as replace taxpayer costs of post-disaster relief with insurance payouts.
With this logic in mind, in 1967, the nation instituted the NFIP. However, the NFIP as implemented today makes few flood-plain occupants informed or cost responsible and there are several reasons why. Less than 25 percent of individual homes and businesses in areas that will experience at least one significant flood over a 30-year period actually purchase flood insurance. There have been many efforts to increase purchase but even an NFIP requirement that mortgage lenders require flood insurance has had only limited effect. Of equal importance, insurance purchase requirements only apply to that portion of the flood plain where the chance of a flood is 1 percent in any year (a so-called 100-year flood)—ignoring floods that would be less frequent, but of possibly greater potential damage.
A Reform Proposal
|Expecting properties located throughout the whole flood plain to have actuarially sound insurance remains an attractive objective for a national flood-risk management policy. One way to achieve this is for the NFIP to offer group flood insurance policies for all at-risk properties in the community. These policies would be purchased by local governments or specially designated flood-risk management districts. The costs could be recovered through special assessments (user fees or taxes) levied on each covered property as an adjunct to the regular property tax and assessments would vary with flood risk.
Furthermore, Congress should affirm that flood-risk management is a shared governmental responsibility, authorizing and funding federal programs that create incentives for community purchase of group flood insurance. Requiring land owners to pay for flood-risk management services is not a new or radical proposal; for example, levee districts across the nation collect taxes for construction, repair, and maintenance. Offering flood insurance coverage through landowner assessments is simply building on the well-established practice of local governments taking fiscal responsibility for flood-risk mitigation.
However, providing and then charging for flood protection, which would enhance land value, would be more likely to meet with landowner approval than special assessments for flood insurance. Therefore, several actions must be taken to make this proposal practical and attractive to local governments and their citizens.
After three decades on the faculty at Virginia Tech, Leonard Shabman joined RFF in 2002 as a resident scholar. His special interest is in expanding the contributions of economic analysis to the formation of water and related land resource policy.
Community Flood Insurance
The NFIP would continue to offer flood insurance to individual residences and small business, with other risks insured through the private insurance market, as is now the case. However, Congress should authorize the NFIP to develop and offer a new form of insurance—a community (group) policy—covering all properties throughout the whole area of the flood plain. The group premium cost for the community would be set by the NFIP, but in accord with the aggregate flood risk for that individual community. This approach would increase the number of policies in effect and therefore expand market penetration (increase in the pool of insured properties), spread risk, and lower premium costs. Properly designed, it should also reduce administrative costs for individual coverage and claim filing, further lowering premiums.
In the longer term, if group policy purchase proves attractive, private insurers might enter the market as an alternative to the NFIP group plan. Today, localities can purchase private all-risk insurance (including flood) for local infrastructure. Group flood coverage to homes and business insurance might be offered by private sellers as an extension of those local infrastructure policies.
Beyond NFIP offering a group policy, the federal government should finance the group premium of communities that purchase insurance either from the NFIP or private companies. This cost sharing could vary with the degree of community effort to reduce flood exposure or vulnerability, much as is now done through the community rating system under the existing NFIP. Cost sharing may be tied to the expense of providing coverage for pre-existing structures or might offset high insurance costs for low-income people located in flood-prone areas.
The federal government has struggled for decades to define and execute a national flood-risk management policy and as a result, there are myriad federal flood-risk management programs. With modest modifications, these could be redesigned to become incentives for local community purchase of group policies. As just one example, funding priorities for flood protection projects might favor communities that have purchased a group policy.
Of particular importance to encouraging group purchase, Congress should create a catastrophic disaster-aid trust fund with payments from that fund reserved for storms meeting clear, predetermined criteria. The fund would be financed by an annual on-budget allocation of general revenues and with annual fees paid by localities purchasing group insurance. If damages exceed insurance coverage (after considering deductibles) payment would be made from the catastrophic fund to the individuals in communities that were covered by the group insurance. One benefit of this approach is that group insurance premiums would be for less extreme events, lowering premiums for local communities to more attractive levels.
Those communities that might have implemented a group insurance program and paid into the catastrophic trust fund, but chose to not do so, would not be eligible for payments from this fund. Instead they would continue to have access to the uncertain, not very generous, and red-tape bound “off-budget” disaster-aid programs that now exist. Recognition of this program reality might place pressure on local jurisdictions to make group purchases and participate in the catastrophic loss fund.