The National Flood Insurance Program (NFIP) expired last September 30, but Congress passed a temporary measure reauthorizing the program until November. That gave the House and Senate more time to battle over their own versions of longer-term reauthorization bills.

Ideally, flood insurance would be provided by the private market, with actuarially sound rates that would discourage building in flood-prone areas. But it is unlikely that will happen in the United States, as generations of homeowners have purchased taxpayer-subsidized flood insurance, resulting in hundreds of thousands of homes and other buildings now located in flood zones. Besides, a private insurance market would invariably exclude the homes facing the gravest flood risk, with the result that government would feel obligated to provide financial assistance to any uninsured flood victims—a conundrum elegantly captured in the seminal 1977 paper by Finn Kydland and Ed Prescott that won them the Nobel Prize.

Having a national flood insurance program acknowledges this reality. If designed and administered effectively, the program would at least minimize the need for large future disaster aid outlays as well as force those who own buildings susceptible to flooding to bear the brunt of the costs via insurance prices that reflect the risk of flood damage. Unfortunately, that is not the sort of program the United States now has; instead, taxpayer subsidies have encouraged building in flood-prone areas.

Make no mistake—the NFIP has already caused a lot of damage and is in major need of reform. The below-market price premiums afforded by the NFIP have been a direct subsidy to developers who build in environmentally sensitive flood zones, as well as to owners of coastal vacation homes. The NFIP subsidizes premiums for the properties that are most likely to incur large flooding repair costs and bases its premiums on outdated flood risk maps.

Ideally, the legislation that comes out of Congress would do the following:

Insist that we more precisely measure risk. The NFIP relies on inaccurate and outdated flood risk maps to price its premiums, setting flood insurance rates on a nationwide basis according to broad flood risk categories that may fail to account for local factors. By not accounting for the “residual risk” of constructing behind levees, the NFIP has given residents a false sense of security and has encouraged development.

At the same time, the NFIP faces strong political pressure not to reclassify flood zones as high risk, since it inevitably leads to increased premiums for people living in those zones. Past attempts to update its maps have not led to significant changes in the premiums it charges, since property owners with flood insurance can typically “grandfather in” underpriced premium rates if their properties are remapped into riskier flood zones. Accurately reflecting risk will depend to a large extent on resisting community pressure to preserve outdated flood risk designations.

High budget deficits may provide the opportune cover for legislators grappling with having to tell constituents who live in a flood plain that their insurance may soon double. In an environment with more modest deficits, such an achievement would be nearly impossible to attain.

Price risk more accurately. The NFIP currently offers both “full-risk” and “subsidized” premiums for its flood insurance policies, both of which are underpriced by design. The NFIP’s full-risk premiums cover losses relative to the historical average loss per year, providing insufficient funds to handle infrequent, very large catastrophic losses, such as the $17 billion of flood claims resulting from hurricanes Katrina, Rita, and Wilma in 2005. The NFIP also subsidizes premiums for the properties that are most likely to incur large flooding repair costs and frequent flood losses. For example, it subsidizes 90 percent of insurance policies for “repetitive-loss properties,” which experience frequent flood losses. In other words, policyholders who experience repeat or annual flood losses can receive subsidized insurance to pay for near-certain damages.

Premium rates clearly need to rise in order to reflect the true risk of living in a flood zone. The conundrum is that if the NFIP raises rates too high, people will simply refuse to buy insurance. Despite existing mandatory flood insurance purchase requirements, compliance remains low.

The NFIP must find other ways of retaining participation in the program, such as increasing outreach and better informing people of flood risks. Yet the reality is that the promise of future federal disaster relief is itself a deterrent to buying insurance. One way to mitigate that deterrent would be to require residents of high-risk flood zones to sign waivers forfeiting their right to federal disaster aid unless they purchase flood insurance—an empty threat, most likely, but one that would at least increase the incentive to buy insurance, even at full-price rates.

Quit giving cut-rate prices to insure vacation homes. In addition to being irrational, the NFIP’s subsidies are regressive, essentially transferring wealth from taxpayers to communities along the Gulf Coast, and especially to upper-income homeowners residing there. According to the Institute for Policy Integrity, the wealthiest counties have historically filed 3.5 times more claims and received over a billion dollars more from claim payments than the poorest counties. A large share of insurance benefits flows to upper-income houses, since beachfront property tends to be the most valuable and also faces the greatest risk of flooding. Charging full-risk premiums would at least require owners of second homes to assume the risk they take for living in flood zones.

Another way to discourage buying vacation homes in flood zones would be to disallow the home mortgage interest deduction for second homes. Providing an impetus for homeownership in the form of a tax deduction means that most of the benefits go to taxpayers in the highest tax brackets, most of whom can afford to buy a house (as well as a second house) without subsidies, while middle-class households that own or rent smaller homes receive little or no tax benefits. A vacation home owner in a flood zone can get federally subsidized flood insurance and a tax deduction, and should get neither.

Abandon the idea that the government can provide flood insurance profitably. The NFIP currently has an $18 billion shortfall, and some in Congress have expressed a desire to try to reduce or eliminate that deficit via more aggressive pricing of insurance. While we share their indignation at government spending so much taxpayer money on such a program, it is impossible to charge premium rates that people would actually pay that would enable the NFIP to repay its $18 billion debt. Since the NFIP has limited means to compel people to buy flood insurance, the best it can do is charge premiums that are low enough to encourage participation in the program, but high enough to cover the cost of flood disasters to the greatest extent possible. High prices would leave us with few participants paying into the system, but a plethora of homeowners nevertheless expecting some form of government assistance in the event that their homes suffer major flood damage—and they would be likely to get it as well.

Conclusion | Both House and Senate reauthorization bills are a good start for reforming the NFIP. Both reestablish a Technical Mapping Advisory Council (which was disbanded in 2000) to review and update flood risk zones and rate maps. Both phase out subsidized premiums, introduce actuarial rates, increase annual limitation on premium increases, and set minimum deductibles. They provide for studies on longer-term reforms such as partial privatization, and the House bill also provides for a study on community-based flood insurance options. There are still details to work out, such as how much annual premium limits should be allowed to rise and what types of properties should have mandatory insurance purchase requirements. But, more than any other bill that is currently likely to gain passage, these hew close to the guiding principle that citizens, and not the government, should bear the risk they take for living in high-risk flood zones.