One of our recent homework questions asked us to think about whether or not the market for hurricane insurance would be an efficient one. I thought about this question further while reading a recent New York Times article, “Millions of Carolina Homes are at Risk of Flooding. Only 335,000 Have Flood Insurance.” Of the many news stories about Hurricane Florence over the past several weeks, this one seemed particularly relevant to our class given its reflection on the failure of both the private market and the government to effectively insure homeowners against flooding.
The article explains that the private market for flood insurance all but disappeared after the Great Mississippi Flood of 1927, when private insurance companies realized that floods on a large enough scale could put them out of business. Because of the unpredictability of flooding and the fact that thousands or millions of people would be making claims at once in the event of a flood, it was not a profitable market for private companies.
The government stepped in in 1968, creating the National Flood Insurance Program (NFIP). In theory, homeowners in flood-prone areas are required to purchase flood insurance through this program each year. However, for a number of reasons – outdated flood plain maps, people who pay off their mortgages or who inherit property and don’t take out a new mortgage – the annual insurance payment is hard to enforce, and NFIP does not have sufficient funds to operate very effectively.
I got a better understanding of the financial challenges of NFIP by looking at this article from July, when the Senate most recently extended funding for NFIP. The article explains that NFIP has been deeply in debt since Hurricane Katrina, when it had to borrow billions of dollars to compensate everyone who made claims. The program has operated at a deficit ever since, borrowing more and more money and relying on Congress to extend its borrowing authority so that it can remain in operation.
It seems like NFIP is in a bit of a catch-22: it has more obligations to pay claims than it can afford, but it needs more people to join the program and pay premiums to have any hope of staying afloat. As extreme weather events become more common in the coming decades, major action needs to take place on this front to avoid catastrophically high costs to government and homeowners.
It seems clear that there is not a private market for flood insurance; it also seems clear that providing such a service is a major challenge for government as well, given the challenges with enforcing people’s responsibility to pay into the program. Perhaps this is a real-world example of the “free-rider problem” – if people know that the government will provide some level of emergency response services and funding, what incentive do they have to pay into this additional program?
In another class, we recently discussed a case study of Hurricane Katrina and the idea was raised that perhaps the government should simply prohibit people from living in certain highly-flood-prone areas. However, this too seems untenable given the likely pushback from people for whom those areas are home. In the short term, at least, making some policy changes to improve the enforcement mechanisms for NFIP could help factor the cost to society of bailing out flooded homes into the cost of buying and maintaining those homes, making those areas less attractive to live in and incentivizing people to move to higher ground.