Cato: Senate Poised to Reform Flood Insurance

Posted by Mark A. Calabria at http://www.cato-at-liberty.org/senate-poised-to-reform-flood-insurance/

As I’ve written elsewhere, the National Flood Insurance Program (NFIP) has to rank as one of the most misguided and destructive federal programs.  In addition to subsidizing the destruction of the environment, it also encourages families to live in harm’s way.  The solution should be to end it and let the private market appropriately price the risk.  If Congress chooses not to end the NFIP, it should at least reduce the subsidies behind the program.  Surprisingly enough, S. 1940, currently on the Senate floor, does just that.
Over the next 9 years, S. 1940 would increase revenues under the NFIP by $4.7 billion, as estimated by CBO.  This is $4.7 billion that wouldn’t have to be paid by the taxpayer but instead would be paid by those who benefit from flood insurance.  My estimate is that this represents about half of the program’s current subsidies.  Such a major reduction in subsidies would also allow the private sector to have some chance at actually competing.
There have been some complaints raised that S. 1940 expands the program and “gasp” actually includes an “individual mandate” like ObamaCare.  Such misunderstands the nature of the NFIP.  The core nature of NFIP is that if a community wants to be eligible for federal disaster assistance, then it must participate in the NFIP and borrowers, in said community, with a federal mortgage, who live in the 100 year floodplain, must buy flood insurance.  S. 1940 extends that requirement, over a number of years, to homes with federal mortgages that exist behind dams, levees and other man-made structures.  As Hurricane Katrina taught us, having a levee is no absolute protection for either the homeowner or the taxpayer.  While dams and levees can reduce the frequency of flood loss, they do so at the cost of increasing the severity when it does happen.
The important point is that the current program and “residual risk” provisions of S.1940 do not require anyone to do anything.  Every community in America is free to leave the program.  Also homes within communities that stay can avoid the purchase requirement by not getting a federal mortgage (which the taxpayer stands behind).  If this encourages an expansion of a mortgage market not backed by the taxpayer, then all the better.  S.1940 also exempts small dollar premiums from the residual risk requirement.  The residual risk provisions would also incorporate into the premium pricing any real reduction in flood risk that results from a dam or levee.
Again the ultimate solution is to eliminate the NFIP, so that free individuals can choose which risk they take and which they pay others to bear.  Until then, reducing federal subsidies and forcing federal programs to more actually price risk will not only help protect the taxpayer, but also improve the functioning of our mortgage market.  S.1940, along with its residual risk requirements, is a step in that direction (and considerably better than the House version, which does actually increase the taxpayers’ exposure).