The National Flood Insurance Program (NFIP) – which is already strained after piling up $24 billion in debt from previous hurricane disasters – faces a formidable challenge with this season’s trio of damaging storms. Congress will have to raise NFIP’s debt cap to finance the flood of expected claims, as its borrowing authority balance is now at zero. The program’s authorization is also set to expire on December 8th. As Congress considers how to extend federal flood insurance, lawmakers must also take steps to set it on a more fiscally-sound foundation. NFIP is supposed to be self-financing, but policyholders in areas with a high-risk of floods are shielded from the burden of that risk. As a result, NFIP faces a long-term sustainability problem – a challenge that is bigger than previously thought because the official method of forecasting the program’s net liabilities underestimate those costs.
Each year, the Congressional Budget Office (CBO) lays out a baseline of spending through federal programs over the next decade. This information, updated periodically, is used to track the budgetary impact of proposed legislation. Using data provided from the Federal Emergency Management Administration (FEMA), CBO projected NFIP would see claims costing $2.7 billion, requiring it to borrow an additional $1 billion from the Treasury to cover the shortfall in premiums. This summer, the CBO re-examined NFIP’s outlook using a commercially-developed actuarial model and found a fiscal gap that was 40 percent higher than foreseen with FEMA’s figures.
A CBO report released last month took a deeper dive into NFIP, highlighting how costs and risks are shifted away from property owners in flood-prone areas, and the private insurers that write their policies. NFIP policies in inland counties have a surplus of $200 million, while policies in coastal counties have an overall shortfall of $1.5 billion. The root of the problem is that homeowners in the coastal regions are shielded from premium costs that would cover the full risk of flood damage. In 2014, CBO reported that, on average, premiums are a bit less than half of full-risk levels. There are two main structural reasons for this:
Annual premium rate hikes are capped. Legislation enacted in 2012 raised the cap from 10 percent to 20 percent, but after pressure, the limit was rolled back to 15 percent in 2014.
Many policyholders in high-risk zones are eligible for grandfathered or discounted rates. Periodically, NFIP reassesses a region’s flood risk. Policyholders in areas that were reassessed into higher-risk zones are allowed to continue to pay premiums based on the outdated, lower risk. Over two-thirds of policyholders in the zones with the highest-risk for floods – known as Zone V – are subsidized through this grandfathering system. This group includes discounts provided to owners of properties built before rate maps were developed. These subsidies are explicitly financed through surcharges on policyholders in other areas.
Because of these cross-subsidies, NFIP policy holders live in areas where the median income is higher than the national average. The program has created a process whereby policies in areas that are sheltered from risk-based premiums drive up the value of the properties. This in turn drives up the cost of the claims paid out and a viscous circle manifests where properties are repeatedly bailed out. Only 2 percent of policies in NFIP face repetitive losses, but they have accounted for nearly 30 percent of all claims paid through the program.
Outdated flood maps are used to factor flood-risks and determine premium rates also confound accurate forecasting. Older maps do not reflect changes in topography, wetlands, sea level, and storm probabilities. Even as FEMA updates its flood maps, there have been many errors in the process. In Kill Devil Hills, North Carolina, for example, maps issued in June of 2016 included areas no longer in flood zones that are known to flood, and the addresses in the map were incorrect. In other areas, FEMA hasn’t properly included topography. Homeowners in San Diego received warnings that they were suddenly listed in flood zones even when their houses were “perched high above the water that are now drawn into the ocean, while other maps show homes at risk from rivers and creeks that have been dried up for years.”
It is important that lawmakers have accurate information while conducting oversight of existing programs and crafting legislation. This why there has been so much controversy over CBO’s analyses of programs and proposals ranging from the original effort to push through the Affordable Care Act, to reforms to repeal and replace it, and even to air traffic control reform. Too often, the scoring agency’s cost estimates rely on flawed methodology that do not report accurate information. In other cases, their estimates could do a better job of illustrating baselines so that policymakers – and taxpayers – have a clearer understanding of how much has been spent on a given program and what trajectory outlays will take under reauthorization proposals.
But in this case, CBO’s re-analysis of NFIP’s accounts using a model developed by private sector firms provides a stronger understanding of its liabilities. The development of these models to account for risks has made it easier for private insurers to write flood insurance policies. Actuarial Review reports, “Insurers can get more detailed information than they could five decades ago, and they have far more sophisticated models to handle it.” Thanks to CBO’s efforts, lawmakers now have this information.
This also provides a precedent and a standard for CBO to conduct similar analyses of other federal programs to more accurately calculate risks and liabilities to taxpayers. And it also provides a wake-up call for it to re-assess the models it currently uses. The goal of NTU Foundation’s Taxpayers’ Budget Office project is to provide such role through an independent, thoughtful evaluation of CBO’s budgetary analyses.