Is the NFIP Doomed?

When the National Flood Insurance Program was extended for another year earlier this month, it was tempting to view it as more of a stay of execution than a new lease on life. Yet, after two years worth of 90-day extensions and the occasional lapse in the program, the year-long extension seems positively indulgent.

The NFIP has limped along for several reasons. One is the contentious issue of whether to include coverage for wind damage in the program. This disagreement essentially boils down to a shoving match between the insurance industry and legislators representing coastal districts such as Rep. Gene Taylor, (D.-Miss.) who were less than enamored with industry claims practices following Hurricane Katrina. While Taylor’s efforts to establish a multi-peril federal insurance backstop were largely thwarted in the last congressional session, they may well reappear in the next.

The perhaps more consequential issue revolves around the program’s finances. A 2008 report by the U.S. Government Accountability Office (GAO) concluded that the NFIP owes the U.S. Treasury $17 billion, and is ill equipped to meet losses in the event of a future catastrophe.

According to a recent study by the Santa Monica, Calif.-based Rand Corp., the state of the programs dire finances can be traced back to the fact that the premiums paid by homeowners are insufficient to cover the cost of the program. “Subsidies in the NFIP have also been substantial,” the study states. “Authorized by Congress when the program was established in 1968, these subsidies apply to about 20 percent of insured properties and cost the program over $1 billion per year. Because the NFIP has not been allowed to charge full premiums and build up a reserve, it had to borrow $20 billion from the U.S. Treasury following hurricanes Katrina and Rita. In effect, these subsidies require federal taxpayers to transfer funds to residents holding flood insurance policies.”

Moreover, the report concludes that the program is a classic example of moral hazard-- encouraging homeowners, builders and insurers to take on risk they would otherwise avoid. “Because the premiums do not reflect expected losses, they do not provide appropriate incentives to avoid construction in high-risk areas or to build structures that can withstand powerful winds,” the report states.

Ouch. In a bailout-fatigued and increasingly deficit-conscious political climate, the case for extending the NFIP without requiring the beneficiaries of the programs to shoulder more of its financial burden seems a tough one to make. While staking a position on wind coverage doesn’t risk much political blowback, asking taxpayers to bailout a program that benefits a relatively small section of the public and the insurance industry does. However, the relative obscurity of the NFIP outside the insurance industry likely insulates it from becoming a political football.

Yet, this hardly solves the matter. Indeed unless all parties with a stake in the NFIP—property/casualty insurers, reinsurers, homeowners, the Federal Emergency Management Agency—come to the table ready to face reality and fundamentally alter the way the program is funded and administrated, we’ll be back to 90-day extensions before long.

Bill Kenealy is a senior editor with Insurance Networking News.

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