The National Flood Insurance Program (NFIP) seems like a program built on reasonable motives, explains Peter Van Doren in “The National Flood Insurance Program: Solving Congress’s Samaritan’s Dilemma” (Policy Analysis no. 923). It is difficult for private insurers to cover the risks of flooding, where a single highly clustered event can cause immense damages, either bankrupting insurers or requiring very high rates. On the other hand, subsidizing encourages building in flood-prone areas, offloading the risk onto taxpayers.

After a long history of ad hoc congressional appropriations, in 1968 Congress attempted to strike a balance with the National Flood Insurance Program. As Van Doren notes, policymakers “face the Samaritan’s dilemma: either render aid after a catastrophe or else withhold aid to encourage people in calamity‐​prone areas to purchase disaster insurance, take preemptive measures to reduce losses, and build robust private charity systems.” The NFIP was supposed to solve this problem while ensuring that insurance was available but also charging actuarially fair rates, intended to avoid taxpayer subsidies and eventually discourage building on frequent floodplains.

That was the idea. In practice, political incentives have made it difficult for Congress to avoid doling out subsidies. Some buildings were grandfathered in at discounted rates, with the intent that this accommodation would be phased out over time, but rules have been creatively interpreted to stretch these discounts long beyond their intended time frame. Requirements that localities adopt certain zoning restrictions and building codes for high-risk flood zones have proven to be an inapt counterbalance. And the rules of the program itself require actuarial rates based on only floods with a 1 percent or greater annual chance, leaving much of the risk not reflected in the rates charged and in effect backstopped by the Treasury. The result is that taxpayers remain on the hook and development has not moved away from flood-prone areas as intended.

In 2012, Congress attempted to address some of these problems with the Biggert‐​Waters Flood Insurance Reform Act, with the goal of phasing out taxpayer-subsidized discounts and charging rates closer to what is required by the real actuarial risks. That reform soon became untenable when later that same year, Hurricane Sandy ravaged New York and New Jersey, with property owners facing a sharp increase in rates because of both the reform and the recalculated flood risks. So Congress relented under the political pressure, passing another law to partially restore the cheaper taxpayer-subsidized rates with the 2014 Homeowner Flood Insurance Affordability Act.

How much do federal taxpayers subsidize flood insurance? According to estimates by the Federal Emergency Management Agency, policyholders pay somewhere between 40 and 60 percent of the full-risk price. The consequence isn’t only a bad deal for taxpayers but is also the exact moral hazard Congress had been trying to avoid. When people don’t have to bear the full cost of the risk, the result is excessive building in risky places.

In recent years, for the first time in a century, private flood insurance has appeared on the market. Unfortunately, this development appears to be largely the effect of cross-subsidies from the NFIP, rather than a true market development. Unless and until a real market develops, the NFIP should refocus on its stated goals of avoiding subsidies and ensuring that the risks are internalized for property owners.

“The NFIP was an important decision by Congress to move away from providing ad hoc disaster aid to flood victims at taxpayer expense,” concludes Van Doren. “But lawmakers’ commitment to a subsidy‐​free system has been imperfect from the beginning, and they have backslid further from that in recent years. The NFIP needs to re-embrace the goal of insureds paying actuarially fair premiums.”