After years of discussion, Congress finally passed some important reform measures for the troubled National Flood Insurance Program (NFIP). The NFIP is a federal program that makes flood insurance available in participating communities. Today, there are over 5.5 million NFIP policies nationwide representing over $1.2 trillion in coverage. The NFIP is currently struggling under a massive debt of $17.75 billion to the US Treasury as a result of the large number of claims from the 2005 hurricane season. Reforms are long overdue. The bill does many things, but four stand out as most important.
The first is simply extending the NFIP for 5 years. The program has been allowed to lapse four times since 2008 and has been operating on 15 temporary extensions. Every lapse imposes costs on the companies that administer the policies and process claims for the NFIP. Every lapse also delays or jeopardizes sales of homes in 100-year floodplains as new flood insurance policies cannot be written (flood insurance is mandatory in 100-year floodplains for loans from a federally backed or regulated lender). This longer extension will provide some needed stability to the program.
The second involves changes to the pricing structure of the NFIP. The prices of NFIP policies were never designed to be able to cover an event of the magnitude of Hurricane Katrina, hence the large debt the program faces. This is partially due to the fact that around a quarter of all policies receive discounted rates.
These discounts were put in place early in the program’s history to encourage community participation, homeowner purchase of insurance, and to not penalize homeowners who located in flood-prone areas unaware of the risk. Floodplains have been mapped for decades now in many locations. The original justification for these discounts is no longer valid and these discounted homes are responsible for many more claims than other properties. The new legislation phases out these discounts for a subset of properties: second or vacation homes, commercial residences, homes sold to new owners, homes substantially damages or improved, and “severe repetitive loss” properties, meaning those with a history of frequent and severe flood damage. While this would preserve the discount for primary residences when owners do not sell their home, it is a critical step toward improved NFIP pricing.
One side note: A potential pricing reform that has not been considered by Congress, but I believe should be, is eliminating the current discounts and replacing them with a pricing structure that includes a loading for catastrophic risk, as well as premium rebates for low income families. This would have the dual benefit of moving the program toward risk-based prices and helping lower-income families living in risky areas afford flood insurance.
The third provision in the bill worthy of attention is how it deals with levees. This has been a controversial issue. The bill originally had language that would require all homeowners behind levees to purchase a flood insurance policy. Last minute negotiations in the Senate removed this provision. Those behind levees also secured discounts in pricing. FEMA’s standing policy that if a levee cannot be shown to provide a 100-year level of protection, insurance will be mandatory, will remain, but communities that are repairing a deficient levee system can now qualify for lower premiums up to five years despite the risk before the levee repairs are completed.
Finally, there are a couple provisions in the bill that would encourage greater private sector participation in the program. The bill authorizes the NFIP to purchase private sector reinsurance to help manage catastrophic losses. It also requires a report on the use of reinsurance or other risk transfer instruments, as this has not been done to date by the NFIP. The bill also requires lenders to accept non-NFIP flood policies if the coverage meets NFIP requirements in the hopes some private insurance companies might be lured into the flood market. Whether that will really happened remains to be seen as private insurance companies to date have been wary of covering flood risk.
The Senate legislation does many other important things for the program, including, among other provisions: creating a council to advise ongoing map updates, the use of FEMA engineering formulas and NOAA data to establish whether damage to homes after a hurricane were caused by wind or flooding, requiring FEMA to examine the impact of sea level rise and storm surge on the program, creating a reserve fund, allowing rates to increase up to 20% annually (rate increases had previously been capped at 10%), phasing in rate increases for areas newly mapped into 100-year floodplains, and requiring analysis of options to eliminate the debt.
Overall, this bill provides some stability to a program whose future has been uncertain since Hurricane Katrina. It begins to move pricing of some policies toward risk-based levels by eliminating discounts that both sides of the aisle agreed were unsustainable. Issues remain to be worked out in the coming years, but this reform bill is an important first step to improving a program that it currently a critical piece of managing flood risk nationwide.
