The federal‐government‐managed National Flood Insurance Program (NFIP) is $25 billion in debt, stokes moral hazard, and entails a regressive wealth transfer that favors coastal areas. The NFIP is set to expire at the end of September, offering policymakers an important chance to rethink the program. The House Financial Services Committee is considering the Flood Insurance Market Parity and Modernization Act Wednesday, the current version of the bill takes important steps in moving the U.S. towards a private flood insurance market. Private insurance would improve upon the NFIP by ending transfers from the general taxpayers to the wealthy and the coasts and by limiting moral hazard.
Private insurance functions as a market‐driven regulator of risk. Private insurers devise premium payments to accurately reflect risk, forcing economic agents to internalize the risk they choose to assume. For instance auto insurance premiums depend both on a driver’s performance as well as other factors that correlate with risk, such as age or area of the country.
The enactment of the NFIP in 1968 reflected a belief that a centrally planned insurance program could better fulfill the regulatory function of insurance than the private market. Government‐managed insurance could, it was held at the time, “limit future flood damages without hampering future economic development” and “prompt an adjustment in land use to reduce individual and public losses from floods,” reported a Housing and Urban Development study integral to the program’s design.
However, the NFIP’s fifty‐year record shows why the reasoning behind the creation of the program was misguided. The NFIP is beset by many design flaws, especially in terms of how premiums are priced. About 20% of all NFIP policies are explicitly subsidized and receive a 60–65% discount off the NFIP’s typical rate. These subsidies are in no way a subsidy to poor homeowners but instead relate to the age of a property. They turn out to be wildly regressive.
Even the 80% of the NFIP’s so‐called “full risk” properties are not priced accurately. For instance, despite their name the full risk rates do not include a loading charge to cover losses in especially bad years, so even these insurance policies are money‐losers in the long run.