Reforming the National Flood Insurance Program

The National Flood Insurance Program (NFIP) has offered insurance to homeowners in flood-prone areas of the United States for more than 40 years but many observers agree that the time has come to substantially reform the program. 

The Need for Reform 

A central weakness of the NFIP is that premiums are designed to cover the “average historical loss year”—not catastrophic loss years. In other words, when a catastrophic event does occur, there isn’t enough money to cover losses.

As of October 2009, there were over 5.5 million active policies nationwide with over $1 trillion in exposure. The 2005 flood season, headlined by Hurricane Katrina, drove a rising tide of debt to its current level around $19 billion.

In a new issue brief (10-01), “Reforming the National Flood Insurance Program,” RFF Fellow Carolyn Kousky presents four broad potential reforms to the program along with a discussion of whether to forgive the NFIP’s debt and whether the program should cover damages from wind in addition to water.

What are the Options? 

1. Raise capital by purchasing reinsurance and offering catastrophe bonds to investors.

Higher rates would help build a reserve fund, but could be politically difficult and better options may exist. The program could purchase private reinsurance, as previously done through a California program that insures homeowners in that state against earthquakes. Alternatively, NFIP could offer catastrophe bonds to investors, awarding them with returns and a portion of premiums.

2. Replace subsidies with rebates for low‐income households. 

Subsidies within the NFIP apply to more than 22 percent of policies. The largest portion was designed to avoid punishing homeowners with properties in place before flood maps existed. Replacing these with need-based rebates could financially stabilize the program and make full flood risk more apparent to residents.

Reforming the National Flood InsuranceProgram
Carolyn Kousky
Issue Brief

3. Insure communities instead of individuals. 

Despite rules mandating the purchase of flood insurance in some areas, participation rates in NFIP are still quite low. Insuring all property owners in an area would reduce the need for enforcement and account for all flood risk there. 

4. Offer reinsurance for flood claims instead of primary insurance. 

Reinsurance from the federal government would be cheaper than from private reinsurers because the federal government does not seek a profit and can spread losses over time. Flood coverage would be mandated as part of traditional homeowner’s coverage, ensuring flood coverage for all insured homes and full (wind and water) coverage against hurricane losses in one policy.