I’m going to throw out a new idea for the National Flood Insurance Program. I haven’t fully developed the details of the proposal but I want to put it out there for comments. First, a rather long preface to explain the need.
This proposal would address the very serious concern that every significant flood event causes flooding to many properties that do not have flood insurance coverage. The federal government ends up providing FEMA individual assistance, temporary housing, subsidized loans, and/or grant funds to help those homeowners recover and also has to provide more assistance to local governments, schools, businesses, etc. because the lack of insurance coverage delays the recovery of the local economy and tax base. (See the Hurricane Katrina figures for all that assistance in this post.)
Flood insurance is mandatory only for those properties that have federally-backed mortgages and are located within a mapped Special Flood Hazard Area (SFHA), also known as A-zones and V-zones or as the 100-year flood risk or the one-percent annual flood risk. If you don’t have a mortgage backed by the federal government, you are not required to buy flood insurance. If your house is outside the one-percent annual risk area, you are not required to buy flood insurance. Of course, whether or not you have a mortgage does not affect your risk of flooding, and mapping the one-percent flood risk is an extremely inexact science, so after every major flood event it is common for 25% or more of the flooded properties to have no flood coverage. Flood risk is very difficult to estimate – much more complicated than wind risk or fire risk – because the risk is constantly changing with development, erosion, deforestation, siltation, performance of levees, dams, drainage systems, and other changes within a watershed. Also, hurricanes, tropical storms, severe rain events, snowmelt, riverine flooding, and other flood events are not nearly as predictable as the modelers would have us believe. The worst flooding events result either from exceptional storm surge or catastrophic levee failures, or in the case of Katrina, both. These events flood many properties whose owners thought they had minimal risk.
The federal government is not in the business of backing flood insurance because it wants to be an insurer. I explained in a previous post why private insurance companies will not offer flood insurance. The larger public purpose of the federal flood insurance program is to reduce federal disaster assistance while facilitating disaster recovery. So, the program seeks to identify flood risk for the purposes of collecting premiums from the owners of at-risk properties and enticing state and local governments to adopt flood plain management regulation as a condition of participation. The flood program is the federal government’s way of making local communities acknowledge their flood risk and enact a minimal amount of flood plain management. Unfortunately, very few local governments are willing to regulate flood plain development beyond what they are required to do as a condition of participation in the flood program.
The federal government does not have its own insurance agents to sell flood insurance. It relies on contractors, insurance companies and their agents, mortgage lenders, Realtors, and local government officials to make sure that those who are required to buy flood insurance do so. We also expect them to advise those who are not required to buy flood insurance to consider buying it, particularly if they are not far from the mapped high flood risk area. In my opinion it is past time to declare the reliance on insurance companies and insurance agents as a major failure. Most put little effort into selling flood insurance, even though NFIP generously allows the companies to keep 30% of the premiums for commissions and administrative expenses – an amount that GAO found to be far more than their actual expenses. Even with that windfall, we cannot get the insurers to diligently comply with the mandatory purchase requirements, so there is almost no chance that they could be convinced to encourage flood policies outside the mandatory purchase areas. The unfortunate industry standard is for insurance agents, Realtors, bankers, and local officials to look at the maps and tell anyone who is not required to buy flood insurance that they do not need it. That is not true and we need to find a way to change that practice.
Lloyd Dixon and others at RAND published a good study a few years ago about the difficulties of achieving compliance with the mandatory purchase requirements of the flood program. They found that some communities had much higher percentages of market penetration and compliance than others, with high-risk communities in Gulf Coast states generally doing better than communities in other parts of the country. The most important finding of the RAND research was that generally if a significant portion of a community is required to buy flood insurance, then all or almost all of the insurance agents sell flood policies and most of the homeowners who are supposed to buy it do so, but if only a small portion of a community is required to have flood insurance then many of the local insurance agents do not bother to sell flood policies and homeowner compliance is worse. I have anecdotal confirmation of that from a former coworker who had to go to four different agents to find one who would sell her a flood insurance policy in Washington, DC, where only a small area near the waterfront is required to have flood insurance.
My take from this study and other anecdotal evidence is that we can get insurance agents to sell flood policies to people who know they need it and want to buy it, but very few agents are actively encouraging people to buy flood policies if they are not required by the government to do so. I do not think I am being too critical of the insurance companies and agents – just being realistic.
The insurance companies do not carry any of the risk of flood insurance and they do not carry any of the responsibility for paying disaster assistance for those who do not have it, so their only interests in the flood program are the commissions and administrative subsidies for selling the policies and the good business practice of providing flood policies to their homeowners insurance customers who are required to buy it.
The commissions and subsidies totaling 30 percent of the premiums are enough incentive to sell policies inside the Special Flood Hazard Areas. A V-zone policy can have an annual premium as high as $6,410, so the insurance company’s 30% take would be $1,923 with a portion of that going to the agent as commission. An A-zone policy can have a premium as high as $2,930, with the 30% cut at $879. At those prices it is worth the agents’ time and effort to sell flood insurance. Those are the actuarially-priced rates for $250,000 for structure and $100,000 for contents – the maximum residential coverage available. (See NFIP pricing here.) The prices also help explain why the property insurance companies and associations are constantly lobbying to eliminate the premium subsidies for the older properties that were built before the flood maps went into effect. The reduced premiums cut into the insurers’ windfall from selling flood policies in the higher risk areas.
Outside the Special Flood Hazard Areas, the premiums are very cheap, so insurance agents do not get much commission for selling the policies. The rate for $250,000 structure/$100,000 contents coverage for a home without a basement is only $365. That is the rate for a Preferred Risk Policy (PRP) outside the mapped 100-year flood zones whether the home is just outside a zone or miles away from a flood zone.
At that price, and even less for smaller policy limits, there should be much better market penetration in places where people should know that they have some risk of flooding even if they are not required by the federal government to buy flood insurance. I have two specific categories in mind - areas that could be inundated by the storm surge from a direct hit by a major hurricane, and areas that could be inundated by the failure of a levee or dam or other flood control structure.
As I mentioned in a previous post, the flood maps do not anticipate storm surge from a major hurricane. Every year there is somewhere around a 10 percent chance that a major hurricane will hit somewhere along the more than 1,000 miles of coastline on the Gulf of Mexico, but at any specific location on the Gulf Coast the chances of major hurricane landfall are less than one percent. So, the one percent flood risk on the coastal flood maps generally reflects the expected flooding from a minor hurricane or tropical storm or just a heavy rainfall event. The maps do not change until after a major storm surge event, so the Mississippi Gulf Coast maps before Katrina showed 100-year flood elevations of 12 and 13 feet, but the new maps after Katrina show 100-year flood elevations over 20 feet. But in Alabama, Florida, Louisiana, and Texas there are still plenty of coastal maps showing 12-foot base flood elevations where houses built on slabs 14 feet above sea level and only two or three blocks from the beach would not be required to buy flood insurance.
Along rivers and other watersheds where levees and floodwalls protect buildings in the flood plains, the flood program does not mandate the purchase of flood insurance if the flood protection is projected to exceed the 100-year flood event. But because they are not in SFHAs, the policies are cheap so homeowners should be buying them. Levees fail, and when they do, we discover again and again that very few people behind the levees had flood insurance. New Orleans was an exception, in that it did have a large number of flood policies, but it still also had a lot of uncovered properties that were flooded. The main reason that there were so many flood policies in effect in New Orleans is because there is flood risk even without a levee failure because the levees can hold water in from a heavy rainfall event. New Orleans has had major flooding from ponding when storms dumped rain into the city faster than the water could be pumped out.
There is some support in Congress for requiring flood insurance for properties behind a levee, but it a contentious issue with strong opposition from communities that insist that they have spent a considerable amount to make sure that their levees and flood walls will not fail. With or without a flood insurance mandate, levees and similar flood control structures present difficult problems for NFIP. FEMA and NFIP have no jurisdiction or oversight over levee standards, certifications, or maintenance requirements, and do not have the personnel, the budget, or the expertise to inspect and grade the fitness of levee systems. The current NFIP system assumes that if a levee is higher than the 100-year flood elevation, it will hold back the 100-year flood. This means that flood insurance is not required behind the levees, and also means that there are no restrictions on further development in those areas. The Army Corps of Engineers does examine some of the thousands of levees in the country and has found many deficiencies, particularly in the maintenance of the levees.
Okay, so now we finally get to my proposal for group policies placed by local governments. A few years ago, Andre McDonald and other members of the board of Fort Bend County Levee District 2 in Texas came to our office to discuss the issue of mandating flood insurance for properties protected by levees. The levee board was opposed to such a mandate, but McDonald suggested that if Congress did pass a mandate, it should create an option for the levee boards to buy group policies for the homes behind the levees. This would ensure 100% coverage behind the levee, something the current system will never do, and allow the levee board to bill homeowners through ad valorem taxes, which would make the premiums tax deductible for the homeowners.
I was intrigued by the idea, and thought it was worth pursuing even if Congress did not mandate coverage behind levees. I shared the idea with my contacts on and off Capitol Hill. The Association of State Flood Plain Managers showed the most interest, and they helped pitch the concept to the staff of the Water Resources Subcommittee of the House Transportation & Infrastructure Committee when the subcommittee was looking into various levee issues. There was no interest in the idea from the House Financial Services Committee, the Senate Banking Committee, or insurance industry groups. That was not surprising. The House Financial Services Committee and the Senate Banking Committee treat the flood program as a partnership between the federal government and the property insurance industry, and show very little interest in flood mapping or flood mitigation issues or anything else that is separate from the insurance industry’s agenda. (ASFPM still mentioned the group policy recommendation in its testimony last year.)
In the House, NFIP is under jurisdiction of the Financial Services Committee where it is an afterthought to banking and financial industry matters; FEMA disaster programs are under jurisdiction of the Transportation and Infrastructure Committee where they are an afterthought to highway, rail, and air transportation; and some parts of FEMA, but no one knows exactly what, are under jurisdiction of the Homeland Security Committee. That division of authority is one reason these programs are so difficult to reform. If we are ever going to make NFIP work for federal taxpayers, we first have to disabuse Congress of the notion that it is the insurance industry’s program. NFIP is first and foremost a partnership with local governments designed to prepare for future flooding events and to mitigate and manage flood risks in order to reduce future flood losses. The insurance companies are useful to serve as contractors if they can sell and service policies without putting their own interests ahead of those of NFIP and federal taxpayers. Where they have shown no interest in selling flood policies outside the mandatory purchase areas, it is best that we devise a mechanism to bypass them and deal directly with the local governments that do have an interest in ensuring that more of their residents are prepared for their flood risk.
I want to resurrect the idea of group policies, not just for levee districts but for all local governments that have areas at risk of storm surge or levee or dam failure. The group policy program would give a local government the option of covering a defined category of properties for some minimum amount of coverage. For example, almost every coastal community has a storm surge risk map for identifying hurricane evacuation priorities. Comparing the flood insurance risk map to the evacuation map generally shows that flood insurance may be required in the Category 1 hurricane storm surge risk area but not in the Category 2, 3, and 4 storm surge areas. Under my proposal, the local government could offer a group flood insurance policy for properties with some storm surge risk that are not in the mandatory purchase areas. Of course, the other obvious areas where the group policy option could be used are the places protected by levees, as originally suggested by Andre McDonald and advocated by the Association of State Flood Plain Managers.
The local government could offer a standard coverage amount – say $50,000 for structure and $20,000 for contents (currently available outside the SFHAs for $211 premium), or $100,000 for structure & $40,000 for contents ($274). Anyone who wants more coverage than the small group policy could opt out of the group policy and purchase a policy from an insurance agent. Whether the local government should require every property in the designated area to purchase flood insurance is open for debate. I would say no, but would require a homeowner who opts out to sign a document opting out of flood insurance and forfeiting any future disaster assistance for flood damage.
There would have to be incentives to get local governments to do this. I would let them keep the 30% of the premiums that the insurance companies get to keep, and use that money to administer the program and fund flood mitigation projects. I would expect that most local governments would contract with a local insurance agency or broker to handle the transactions and keep track of the policies. Those administrative contracts should cost considerably less than the 30% share retained by the local government. The remainder of the local share could be used for projects and programs that manage the flood risk, including as the local cost-share of flood mapping modernization, levee maintenance and improvements, drainage improvements, hazard mitigation projects, including buying out or elevating flood-prone properties, etc. The local government’s 30% share from the group premiums should be transparent and accountable. I would consider giving additional incentives for certain projects, especially buying out repetitively flooded properties, something local governments are reluctant to do because it removes properties from their tax rolls.
FEMA already places group flood policies after a flooding disaster. Those properties that receive FEMA assistance or SBA disaster loans for flood damage are placed in a small group policy as a condition of the assistance. The group policies are administered by the NFIP Direct Agent under contract, not by the regular insurance agents in the Write Your Own program. Because these are small policies, NFIP Direct receives a flat-fee per policy instead of a percentage of the premium. The group policy lasts for only three years. FEMA sends the homeowners several notifications telling them that they should buy a flood policy from an insurance agent, and that if they do not, they cannot receive FEMA assistance if they flood again. Despite the notice and warning, many of the homeowners do not sign up for a regular NFIP policy when the group policy ends.
I do not recommend that my new group policy proposal be given to the NFIP Direct Agent. I am not just looking for a way to sell more flood policies, but am also looking for a way to get local governments more invested in the management of flood risk, and especially for a way to get local governments to start telling people that just because the federal government does not mandate the purchase of flood insurance that does not mean they do not need it.