It’s Time to Rethink Flood Insurance

The federally-backstopped National Flood Insurance Program (NFIP) is broken. The sole bulwark against rising flood risk in the United States for 5.2 million policyholders, this program sits atop more than $20 billion of debt—even after a $16 billion write-off in 2017—and desperately needs an overhaul, especially as rising sea levels and heavy precipitation events are expected to increase the number of policies by 80 to 100% before 2100.

Early last year, the Trump administration announced plans to transition subsidized NFIP insurance rates to fully risk-based ones starting this October, but backlash about affordability has delayed implementation until 2021. This follows a half-century string of efforts to normalize risk-based rates that have been beaten back by affordability concerns.

As the NFIP awaits reauthorization this September, we must recognize that this rates-affordability paradox can only be resolved with a macroprudential rethinking of flood insurance. The NFIP should no longer just retroactively backstop losses, but actively help reduce aggregate flood risk in the United States by facilitating voluntary buyouts and managed retreats.

The problem originates from the NFIP’s paradoxical mandate: offer affordable flood insurance while leveraging risk-based premiums to disincentivize floodplain development. Initially, subsidizing rates for properties predating flood insurance maps was deemed prudent, as policymakers assumed these structures would be lost over time, naturally phasing out subsidies.

However, about 20% of NFIP policies remained subsidized in 2012, and despite laws effectively requiring flood insurance for properties in high-risk areas, take-up rates remained too low to adequately pool risk. The annual cost of claims, on the other hand, increased tenfold, forcing the NFIP to shoulder larger-than-ever payouts with artificially reduced revenue.

The program has resorted to loans from the treasury, and it’s this growing debt burden that motivates many who call for reform. Normalizing risk-based rates, they say, is the fiscally responsible solution.

In the long-run, it’s true that rates must fully capture flood risk. Risk-based premiums would incentivize policyholders to take appropriate mitigation steps, discourage shortsighted post-flood redevelopment, and provide the NFIP with the revenue it needs to support burgeoning payouts. But sharply undermining affordability could gut already-low take-up rates, counteracting any fiscal benefit.

More importantly, blindly raising rates would ignore the fact that the NFIP’s debt burden is not just a proxy of lingering subsidies, but also the growing impact of climate change. Marginally increasing premium revenue won’t offset the fact that more Americans, especially those living in Repeat Loss Properties (RLPs), will be more frequently and severely hurt by floods. Already, it is estimated that just 1% of NFIP-insured properties have received one-third of all payouts, thanks to severe repeat losses. This suggests payouts—and the debt burden—will only snowball as rising sea levels create up to 2.5 million RLPs by 2100. Financing the cyclical rebuilding of these properties could cost the NFIP nearly $450 billion.

Sustainably reducing NFIP debt, therefore, must involve both the easing-in of risk-based rates and a systematic way of counteracting growing aggregate flood risk—through managed retreat.

One way to begin this transition is the Natural Resource Defense Council’s proposal to integrate subsidized rates with voluntary pre-disaster buyout agreements as risk-based rates are introduced. The proposal, raised in 2015, urges the NFIP to allow low- and middle-income homeowners living in RLPs—often those who most need subsidies—to opt into being bought out after the next flood at pre-disaster market value and, in exchange, qualify for insurance rate subsidies.

This proposal makes microprudential sense. Buyouts, although seemingly costly, are cheaper than financing inevitable cycles of flooding and rebuilding. However, accessing FEMA buyout funds today requires extensive post-crisis coordination between federal, state, and local officials, a process that drags on for five years on average and disadvantages small communities lacking administrative resources. Exasperated homeowners, in the meantime, find themselves selling their properties at loss to redevelopers or rebuilding for the next flood.

The NFIP stepping in and financing buyouts at equitable prices with premium revenue would ease burdens on flood-ridden homeowners, government bureaucracies, and the NFIP itself, as subsidized rates are finally phased out.

Most importantly, this policy makes macroprudential sense. It’s time to face the fact that parts of the country will simply become uninsurable, and managed retreat—as socially, psychologically, and politically difficult as it is—must become an integrated part of the national climate risk management strategy.

Brian Lee

Undergraduate Seminar Fellow

Brian Lee is an undergraduate student studying economics in the Wharton School. Lee was also a 2020 Undergraduate Student Fellow.