Why the National Flood Insurance Program Is Not Financial Viable

Why The National Flood Insurance Program Is Not Financial Viable?

The National Flood Insurance Program (NFIP) was a program created by the Congress of the United States in 1968 through the National Flood Insurance Act of 1968 (P.L. 90-448). The program enables property owners in participating communities to purchase flood insurance protection from the U.S. government. The NFIP's primary goals are to decrease the risk of flood loss, reduce the costs and consequences of flooding, lower the need for federal disaster assistance, and preserve and restore natural and beneficial floodplain functions (FEMA, 1986). Five years after the implementation of the NFIP, flood insurance became mandatory for the regulated lenders. The NFIP generates approximately $3.3 billion in annual premiums, but it continues to be propped up by borrowing from the U.S. Treasury. Massive insured flood losses from catastrophic events such as Hurricanes Ivan, Katrina, Rita, Ike, and Sandy have left the program over $30 billion in the red (Friedman, 2014). There are three predominant reasons why the NFIP is not financially viable. Firstly, as the NFIP is a federally mandated program, and it does not charge risk appropriate premiums for many of the properties that it insures. Even on “repetitive loss properties”, it is only allowed to raise rates by a maximum of 10% in any given year. Secondly, the NFIP uses premiums from low hazard properties to subsidize premiums for high-risk properties. However, the number of low risk properties that buy flood insurance is negligible compared to the number of high-risk properties that buy flood insurance from the NFIP. Thirdly, the majority of losses to the NFIP come from repetitive loss properties, and the NFIP cannot deny coverage to the property owner even if their property has flooded multiple times. These are the main reasons why the NFIP is not financially viable.

The first reason that the NFIP is not financially viable is because it charges inadequate premiums or rates. The NFIP sets two different premium levels: (1) "full-risk rates" intended to cover administrative costs and expected annual flood losses, and (2) "subsidized rates" primarily for high-risk properties. The Property Casualty Insurers Association of America (PCI) estimated the annual cash-flow deficit created by explicit rate subsidies to be about $2.0 billion (Friedman, 2014). Furthermore, NFIP rates cannot be raised beyond an annual maximum of 10%. When Hurricane Sandy hit the Northeastern United States in October 2012, the NFIP was already $20.7 billion in debt. After the floodwaters caused by Sandy receded, the NFIP had to borrow an additional $9.7 billion from the U.S. Treasury to pay claims, leaving the program over $30 billion in the red (Friedman, 2014). The interest rate charged by the Treasury is now 0.25%. After looking at the current deficit of the NFIP ($30 billion), the annual deficit