Financing Flood Losses: A Discussion of the National Flood Insurance Program

• Author: Carolyn Kousky
• DOI: http://doi.org/10.1111/rmir.12090
• Published date: 01 March 2018
• Date: 01 March 2018

Risk Management and Insurance Review

C

Risk Management and Insurance Review, 2018, Vol.21, No. 1, 11-32

DOI: 10.1111/rmir.12090

PERSPECTIVE

FINANCING FLOOD LOSSES:ADISCUSSION

OF THE NATIONAL FLOOD INSURANCE PROGRAM

Carolyn Kousky

ABSTRACT

The National Flood Insurance Program (NFIP), housed in the Federal Emer-

gency Management Agency,has been providing flood insurance to households

and businesses for almost 50 years. To inform the policy discussion leading up

to reauthorization, this article analyzes five aspects of the NFIP: (1) risk mod-

eling and risk communication, (2) the roles of the public and private sector,

(3) take-up rates, (4) incentives for risk reduction, and (5) rate setting and the

financing of catastrophic flood events. Suggestions for reform are discussed.

INTRODUCTION

The global average annual direct cost of natural disasters between 2000 and 2012 was

approximately $100 billion (Kousky, 2014). Of all natural disasters, floods are the costliest

(Miller et al., 2008) and have affected the most people (Stromberg, 2007). This is true

worldwide, as well as in the United States, where of all natural hazards, floods accounted

for the most lives lost and the highest amount of property damage over the 20th century

(Perry, 2000). Further, climate change is projected to increase losses from flooding and

coastal storms over the coming decades (IPCC, 2012).

The National Flood Insurance Program (NFIP), housed in the Federal Emergency Man-

agement Agency (FEMA), has been providing flood insurance to households and busi-

nesses for 50 years. It was created in 1968 as a voluntary partnership with local com-

munities. Communities that join the NFIP adopt minimum development regulations

governing the 1 percent annual chance floodplain. Their residents then become eligible

to purchase flood insurance policies through the program. Single-family and two- to

four-dwelling residences can purchase up to $250,000 of building coverage and $100,000

of contents coverage. Nonresidential policyholders can insure both structure and con-

tents up to $500,000 each. As of October 27, 2017, more than 5 million policies were in

force nationwide, representing close to $1.27 trillion in coverage.

Carolyn Kousky is the Director of Policy Research and Engagement at the Wharton

Risk Center at the University of Pennsylvania. The author can be contacted via e-mail:

ckousky@wharton.upenn.edu. This article was prepared for the “Improving Disaster Financ-

ing: Evaluating Policy Interventions in Disaster Insurance Markets” workshop held at Resources

for the Future on November 29–30, 2016. The author would like to thank the sponsors of this

project: the American Academy of Actuaries, the American Risk and Insurance Association, Risk

Management Solutions, the Society of Actuaries, and XL Catlin.

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12 RISK MANAGEMENT AND INSURANCE REVIEW

The NFIP has always been broader than just an insurance program. Three program

goals are usually articulated: identifying and mapping risk, encouraging floodplain

management, and providing flood insurance. Some NFIP documents also state a pro-

gram objective to reduce the need for and reliance on federal disaster assistance (Hayes

and Neal, 2011). Beyond providing insurance, the program maps flood hazards and has

a series of regulations, grants, and incentive programs for household- and community-

level investments in flood risk reduction. These multiple goals inform all aspects of the

program, including pricing.

The past half century has seen many changes in data availability,modeling, and the pri-

vate market, as well as studies and evaluations of multiple aspects of the NFIP. Over the

years, the program has been modified as the need for minor changes or improvementsbe-

came evident, but it still needs much modernization. Most recently, changes were enacted

in the Biggert Waters Flood Insurance Reform Act of 2012 and then the Homeowners

Flood Insurance Affordability Act of 2014. The program is currently up for reauthoriza-

tion, providing an opportunity to update the programand address some well-recognized

shortfalls in risk modeling, risk communication, and pricing. Reauthorization also

presents an opportunity to adopt policies aimed at closing the flood insurance gap.

To inform the policy discussions, this article analyzes five aspects of the NFIP: (1) risk

modeling and risk communication, (2) the roles of the public and private sector, (3)

take-up rates, (4) incentives for risk reduction, and (5) rate setting and the financing

of catastrophic flood events. The last section of the article explores a menu of possible

reform options for congressional consideration.

RISK MODELING AND RISK COMMUNICATION

FEMA maps flood hazards in participating communities on flood insurance rate maps

(FIRMs).1These form the basis of the NFIP’s risk modeling and risk communication

efforts. A focus of mapping is identifying 1 percent annual chance floodplains (100-year

floodplains), referred to as special flood hazard areas (SFHAs). SFHAs are the basis of

many NFIP regulations and requirements: propertyowners in an SFHA with a loan from

a federally backed or regulated lender are required to purchase flood insurance; partic-

ipating communities must adopt minimum floodplain regulations in the SFHA (see the

“Incentives for Risk Reduction” section); and pricing is different inside and outside the

SFHA (see the “Rate Setting and the Distribution of the Costs of Catastrophes” section).

The SFHA boundary is thus central to much of the NFIP as currently structured, and a

considerable amount of time and effort goes into its determination.

FIRMs also designate different flood risk zones. These include two zones in the SFHA:

the V zone, which is subject to breaking waves of at least 3 feet, and the A zone, which is

not. Outside the SFHA is the X zone. FIRMs generally show both the 500-year floodplain

(shaded X) and the area beyond it (unshaded X). In the SFHA, the FIRM also shows base

flood elevations (BFEs), the estimated height of water in a 1 percent annual chance flood.

The zones and BFEs from the flood maps are an input into rate setting.

FEMA established the Cooperating Technical Partners program in 1999 as a way for

local governments and organizations to aid in FIRM production. The objective is

to stretch limited mapping funds and let local communities have direct input into

1FIRMs are accompanied by a flood insurance study.