Daniel Schwarcz is a professor at the University of Minnesota Law School.
With Hurricane Irma bearing down on the southeastern coast so soon after the devastating onslaught of Hurricane Harvey in Texas, the economic cost of severe weather has been made painfully clear this summer. In the United States, much of this cost is borne by the National Flood Insurance Program, which already owed the Treasury $23 billion before Harvey's landfall. Congress is nonetheless poised to once again temporarily reauthorize the program without any long-term plan for stabilizing its finances.
This would be a mistake. The federal flood insurance program's dysfunction is hardly limited to its fiscal cost. Perversely, the program's subsidies for insurance principally benefit affluent individuals who own property near the coast. These subsidies also induce homeowners to build in areas prone to flooding, while blunting their incentives to invest in cost-effective risk mitigation strategies such as elevating their homes. The subsidies baked into federal flood insurance have similarly perverse effects on local governments, causing them to tolerate lax zoning rules and encourage development in flood-prone areas.
For these reasons, some insurance experts and lawmakers have suggested reforms that would foster a more robust private market for flood insurance. Shifting policyholders from government-provided coverage to private insurance, it is claimed, could theoretically reduce the fiscal costs of the National Flood Insurance Program. By charging premiums that reflected policyholders' actual risks, private insurance could also limit the reckless building of expensive property in flood-prone areas and induce appropriate precautions among property owners and municipalities.
But theory is one thing, and practice is another. Current proposals to foster private flood insurance markets would do more harm than good because they envision private insurers operating alongside government flood insurance. This approach would allow private insurers to cherry-pick the few policyholders in the National Flood Insurance Program who pay more for their coverage than they ought to, based on their riskiness. While these policyholders would benefit from private flood insurance, the federal insurance program would emerge even less actuarially sound.
Meanwhile, none of the other problems associated with federal flood insurance would be solved: Wealthy property owners would still be able to purchase subsidized property insurance, causing them and the communities they live in to build in harm’s way while taking insufficient precautions against flood risk.
A much better option for facilitating private flood insurance is to look to another arena where the federal government has revitalized private insurance markets: Obamacare. Both the successes and failures of the Affordable Care Act offer important lessons for fostering a robust and sustainable private market for flood insurance.
Just as Obamacare does not include any “public option” that competes directly with private plans, private flood insurers should not compete with a government flood insurer that plays by a different set of rules. Also like Obamacare, the government should explicitly subsidize the purchase of flood insurance but tie those subsidies directly to policyholders’ income levels. This approach would avoid the subsidization of affluent homeowners.
Further paralleling Obamacare, flood insurance reform should induce private insurers to sell coverage by offering reinsurance that capped insurers’ exposure in particularly catastrophic scenarios. Such reinsurance should be permanent to avoid the instability caused by the cessation of Obamacare reinsurance. Finally, flood insurance reform could establish insurance exchanges that allowed consumers to compare private insurance options in a single place, on an apples-to-apples basis. A flood insurance exchange would not only foster market transparency but could also limit the government’s hefty payments to insurance agents who sell federal flood insurance on its behalf.
To be sure, there are important differences between flood insurance and health insurance. Most important, charging people with preexisting conditions more for health insurance is morally troubling and unlikely to lead to healthier lifestyle choices. That is why Obamacare prohibits this practice. By contrast, it is both appropriate and prudent to charge individuals who own homes in flood-prone areas more for property insurance, because they have substantial control over their exposure to risk. Flood insurance reform should therefore not restrict private insurers' underwriting and rating practices, as does Obamacare. For this reason, there is also no need to "mandate" the purchase of flood insurance; this Obamacare requirement was necessitated only by the act's rating and underwriting restrictions on health insurance.
In today’s toxic partisan environment, this approach to flood insurance reform offers something for everyone. Republicans would get a less costly, privatized program. Democrats would replace a system that subsidizes mansion owners with one that helps those who need it most. And coastal representatives would make flood insurance more widely available. Best of all, we would limit the costs of the next horrific hurricane that threatened our shores.