Flooded AreaResearchers at UC Davis recently concluded that California should consider leaving the National Flood Insurance Program (NFIP) and explore implementation of its own statewide flood insurance program in order to invest in risk reduction rather than premiums.  This is an idea that has been talked about for years by state and local flood management experts.  But does it make sense?

The National Flood Insurance Program

The U.S. Congress established NFIP with the passage of the National Flood Insurance Act of 1968. NFIP is a Federal program enabling property owners in participating communities to purchase insurance as a protection against flood losses in exchange for state and community floodplain management regulations that reduce future flood damages. Participation in the NFIP is based on an agreement between communities and the Federal Emergency Management Agency (FEMA). If a community adopts and enforces a floodplain management ordinance to reduce future flood risk to new construction in floodplains, the government will make flood insurance available within the community as a financial protection against flood losses.

The NFIP Has Unsustainable Debt

Since Hurricane Katrina in 2005, NFIP has gone into significant debt, to the tune of about $23 billion as of 2014 (view a 2015 GAO report on the NFIP).

As part of the NFIP, FEMA maps areas of the country into Special Flood Hazard Zones, which are areas with more than a 1% chance of flooding annually.  In these zones, property owners with federally backed mortgages must purchase flood insurance.  Because FEMA’s understanding of flood risks has improved over time, the NFIP incorporates subsidies and grandfathering to prevent rate increases for properties in existence when flood risks in their area were increased through FEMA mapping.  As a result, a significant percentage of flood insurance policies do not accurately reflect the flood risk.

The NFIP was never designed to be actuarially sound.  Moreover, Hurricanes Katrina and Sandy resulted in huge payouts, putting the NFIP into about $24 billion in debt.  To address this major financial instability, the Biggert-Waters Flood Insurance Reform Act (BW12) was easily passed by Congress and signed by the President in 2012. Biggert-Waters extended the NFIP for five years and, more critically, provided for insurance rate increases that are tied to properties’ flood risk.  Rates were set to increase upon renewal or, in some cases, upon the sale of the property.

Not surprisingly, rate increases designed to help the NFIP get back toward financial stability were in some cases crippling for property owners.  Insurance rates could go from a few hundred dollars per year to a few thousand, for properties whose base floors are well below the base flood elevation (the elevation that would be reached during a storm that has 1% chance of occurring each year).  As the date for rate increases under BW12 approached for many property owners, members of Congress started hearing from constituents about the significant negative impact of drastically increased insurance rates in certain communities.  The States of Mississippi and Florida even filed suit against FEMA to halt the rate hikes altogether as arbitrary and capricious.

In 2014 Congress repealed certain parts of Biggert-Waters, restoring grandfathering and putting limits on rate increases.  The GAO notes that while the cleanup legislation addressed affordability concerns for certain property owners, it may increase NFIP’s long-term financial burden on taxpayers.  So the program remains hampered by unsustainable debt.   It is an interesting struggle between the Federal government’s need to balance its books and the policy implications on property owners grandfathered into rates that do not – and never did – reflect the true risk of flooding.  At some point it appears that either FEMA will increase rates very slowly and remain in debt for decades to come, or states will figure out a different way to provide insurance for flood losses at a reasonable cost.

California is a “Donor” State to the NFIP

Adding to the growing list of problems for the NFIP, as the UC Davis researchers note, California is a net payer into the NFIP; in other words, premiums paid by California policy holders significantly exceed NFIP damage payouts in California (to the tune of over $3 billion between 1994 and 2014; during that period, damage payouts in California total 14% of premiums collected).  The question is whether and how California should stop subsidizing the NFIP, including whether California could do a better job of managing its own flood risks outside of the NFIP.

The State is set to release its 2017 update to the Central Valley Flood Protection Plan and will likely recommend a study of whether a state insurance program would more effectively mitigate losses to those subject to flooding through flood insurance. By augmenting or replacing NFIP in California with a state-led insurance program, the state could theoretically use a portion of the premiums to fund flood system repairs and improvements and thereby reduce flood risk.  That way, resources would go into actually reducing the risk rather than insuring against it.

There are a number of questions associated with this approach that will need to be answered, including:

  1. How would the state determine who is required to pay flood insurance, and how would it enforce the program?  Currently the federal government enforces the NFIP by making insurance a condition for structures with a federally-backed mortgage.
  2. What will be the role (if any) of private insurers in insuring against flood risks?  Will private insurers act as “reinsurers” to protect the State against catastrophic loss?
  3. How does implementation of state-level insurance program increase or decrease the state’s potential liability for catastrophic flooding under the Paterno case?

Please continue to follow along as we examine these issues in the context of the NFIP reauthorization in 2017.