President Obama indicated last Friday that he will sign the Homeowner Flood Insurance Affordability Act of 2013, which eases the earlier Biggert-Waters reforms and grants property owners a reprieve from a planned sharp increase in flood insurance premiums.
The problem is that politicians have overruled the actuaries for years, setting National Flood Insurance Program premiums far too low. As a result, the NFIP is, well, actuarially insolvent. Its liabilities exceed assets by $24 billion, and that’s going to have to come from somewhere. If the NFIP were a private insurance company, it would be put into receivership.
An earlier version of flood insurance reform, the Biggert-Waters Flood Insurance Reform and Modernization Act of 2012, attempted to close the actuarial gap. That law, had it been allowed to take full effect, would have mandated the following:
- Subsidies would gradually phase out for second homes, commercial properties, properties that have resulted in severe and repetitive losses, or substantially improved/damaged properties.
- Rates for properties in these categories would increase by 25 percent per year until premiums reached “full actuarial cost.”
- All new policies for any property not currently covered by an existing policy must be priced on actuarially determined rates.
- The cap on premium rate increases would have increased from 10 percent to 20 percent.
- Allowed policyholders to pay premiums in installments, rather than with an annual payment.
- Penalties against lenders who failed to enforce the escrow of flood insurance premiums would increase from $350 to $2000 per incident, and overall caps would be removed.
The new bill – soon to be the new law, assuming President Obama follows through on his promise and signs – puts most of the Biggert-Waters reforms on hold for another four years – conveniently after the 2016 presidential elections – and more. For property owners who have had to pay premium increases because of the Biggert Waters bill, the new law grants them refunds. The new bill also caps average premium increases at 15 to 18 percent, and allows for subsidies.
The new law also directs FEMA, the overseer of the National Flood Insurance Program, to “strive to minimize the number of policies with annual premiums that exceed 1 percent of the total coverage.”
The challenge to policymakers, though, is that there are vast areas of developed land in which houses have a one-in-four or better chance of incurring a flood within any typical mortgage duration of 30 years. Any pricing regime that does not take that likelihood into account is going to lead to insolvency and an eventual bailout.
The problem is compounded by overdevelopment in coastal areas and other desirable areas that are susceptible to flood damage. When you subsidize something, you get more of it. Artificially low prices for flood insurance in these areas resulted in more building – distorting the risk pool.
As a result, critics of the National Flood Insurance program argue that because the taxpayer supports the NFIP and helps keep premiums lower than actuarially required, the NFIP has become a massive wealth transfer program from poorer people to wealthy coast dwellers, and from inland states to coastal states.
Some politicians are calling on their states to withdraw from the NFIP altogether. For example, Rep. Candace Miller (R-Mich) called on her state’s governor, Rick Snyder, to take its ball and go home. “Since the federal flood insurance program started, homeowners in Michigan have paid multiple times more in premiums than has been paid back in claims. This is wrong. And, just like Obamacare, this costly, unworkable, unfair and failed program is exactly why the federal government shouldn’t be in the insurance business,” said Miller.
Biggert-Waters required that FEMA conduct a massive affordability study. But the study was never completed when the new, higher rates kicked in at the beginning of the year.
The flood insurance rate issue was compounded by confusion and debate over FEMA’s evolving map of high-risk flood zones. Many of the recent changes – which had big consequences on flood premiums – were being hotly contested, and the uncertainty was making it difficult for real estate agents and lenders to close deals in affected areas.
One of the major provisions of the new bill was the change in premium calculation for new property owners. While under the Biggert-Waters Act new owners would have been hit by the full brunt of the scheduled rate increase, the new law will allow new owners to benefit from the phase-ins enjoyed by existing property owners. This provision had caused some property values to plummet.
To make up the shortfall, the new law imposes a $25 surcharge on primary residences and $250 on all second homes and all businesses.
Even so, a look at the Congressional Budget Office analysis of the fiscal effects of the National Flood Insurance Program indicates a $2.1 billion reduction in net income to the program over the next decade.