The U.S. government subsidizes flood insurance because those who want to buy it live in the flood plain and cannot get it at reasonable rates. What inefficiency does this create Solution As Hurricane Sandy continues to batter the Eastern seaboard of the U.S., one thing is for certain: insurance companies will be ponying up for billions of dollars in property damage caused by high winds. Last year’s Hurricane Irene cost insurance providers more than $4 billion in damage claims, with flood-insurance payments totaling nearly $1.3 billion. But what many Americans may not know is that this $1.3 billion was a bill footed by the federal government, which underwrites the vast majority of flood insurance across the nation. Historically, insurance companies have been wary of offering flood insurance to homeowners because the risks associated with flood insurance are difficult to forecast, so any private insurance that had been offered was prohibitively expensive for average homeowners. But in the 1960s, frequent flooding of the Mississippi River was driving up the costs of federal disaster-relief programs. In an effort to reduce these costs,Congress set up the National Flood Insurance Program (NFIP) to provide flood insurance to the general public and promote effective floodplain management. Under the program, homeowners in certain areas of the U.S. are required to buy flood insurance, and communities that hope to benefit from the program have to enforce city-planning regulations set out by FEMA, which manages NFIP. (MORE: Banks Waive Fees for Residents in Path of Hurricane Sandy) Though the program has been effective at making flood insurance widely available, a growing chorus of critics from environmentalists to libertarians has been attacking it for encouraging homeowners to build recklessly in areas that are prone to flooding. For instance, Ira Stoll wrote yesterday in the New York Sun: “Hurricane casualties are partly the result of unintended consequences of government actions: without federal flood insurance, many fewer people would take the risk of living in low-lying areas vulnerable to storm surges.” There is evidence to support the view that the government is actually encouraging citizens to live in areas most in danger of flood damage. According to a 2010 report issued by the Institute for Policy Integrity, Congress has historically set the premium rate too low for flood insurance — effectively subsidizing building in flood-prone areas at the expense of taxpayers at large. This practice has helped drive the fund $19 billion in debt, caused mostly by the unusually severe damage caused by Hurricane Katrina. In addition, the report argued that the environmental effects of the federal government’s flood- insurance policy may be more severe than the financial effects. According to the report: “River basins and coastal zones provide natural purification of water and wastewater; erosion control and weather mitigation; and habitat for fish and wildl.

1. The U.S. government subsidizes flood insurance because those who want to buy it live in the
flood plain and cannot get it at reasonable rates. What inefficiency does this create
Solution
As Hurricane Sandy continues to batter the Eastern seaboard of the U.S., one thing is for certain:
insurance companies will be ponying up for billions of dollars in property damage caused by
high winds. Last year’s Hurricane Irene cost insurance providers more than $4 billion in damage
claims, with flood-insurance payments totaling nearly $1.3 billion.
But what many Americans may not know is that this $1.3 billion was a bill footed by the federal
government, which underwrites the vast majority of flood insurance across the nation.
Historically, insurance companies have been wary of offering flood insurance to homeowners
because the risks associated with flood insurance are difficult to forecast, so any private
insurance that had been offered was prohibitively expensive for average homeowners.
But in the 1960s, frequent flooding of the Mississippi River was driving up the costs of federal
disaster-relief programs. In an effort to reduce these costs,Congress set up the National Flood
Insurance Program (NFIP) to provide flood insurance to the general public and promote effective
floodplain management. Under the program, homeowners in certain areas of the U.S. are
required to buy flood insurance, and communities that hope to benefit from the program have to
enforce city-planning regulations set out by FEMA, which manages NFIP.
(MORE: Banks Waive Fees for Residents in Path of Hurricane Sandy)
Though the program has been effective at making flood insurance widely available, a growing
chorus of critics from environmentalists to libertarians has been attacking it for encouraging
homeowners to build recklessly in areas that are prone to flooding. For instance, Ira Stoll wrote
yesterday in the New York Sun:
“Hurricane casualties are partly the result of unintended consequences of government actions:
without federal flood insurance, many fewer people would take the risk of living in low-lying
areas vulnerable to storm surges.”
There is evidence to support the view that the government is actually encouraging citizens to live
in areas most in danger of flood damage. According to a 2010 report issued by the Institute for
Policy Integrity, Congress has historically set the premium rate too low for flood insurance —
effectively subsidizing building in flood-prone areas at the expense of taxpayers at large. This
practice has helped drive the fund $19 billion in debt, caused mostly by the unusually severe
damage caused by Hurricane Katrina.
In addition, the report argued that the environmental effects of the federal government’s flood-

2. insurance policy may be more severe than the financial effects. According to the report:
“River basins and coastal zones provide natural purification of water and wastewater; erosion
control and weather mitigation; and habitat for fish and wildlife. They also offer opportunities
for valuable recreational use, improve irrigation return flows for agriculture, and support
fisheries and other raw natural resources with considerable economic value.”
Subsidizing building in these areas can have environmental costs that far outweigh the actual
cost of subsidization.
The report also found that the NFIP usually benefits the very wealthy at the expense of the poor.
Excluding payments made as a result of Hurricane Katrina, “the wealthiest counties in the
country filed 3.5 times more claims and received over a billion dollars more in claim payments
than the poorest counties,” between 1998 and 2008.
(MORE: Tackling the Myth of Indian Inefficiency)
In July, Congress extended the program through 2017 and tried to address some of these
concerns by raising premiums on insurance holders, increasing the minimum deductible and
requiring the NFIP administrator to come up with a plan to resolve its debt problem. Mike Barry
of the Insurance Information Institute argues that these reforms have “put the NFIP on more
actuarially sound footing going forward.”
And while the NFIP does help a number of wealthier citizens find insurance, that doesn’t mean it
doesn’t help poorer Americans who without the program would probably have no way of getting
their properties insured. If the NFIP were to disappear tomorrow, “people would be very hard
pressed to find cost-effective flood insurance,” and for many Americans “it would be a
significant financial burden.”
And the fact that so many homeowners and businesses rely on this program is good reason to
believe that we won’t see it disappear anytime soon. Even if we are convinced that government-
supported flood insurance does transfer wealth from the poor and the middle class toward
wealthy owners of vacation homes, or that it encourages environmentally detrimental
development of coastal areas, the program would be very difficult to get rid of. The reason: the
countless Americans who have bought homes and businesses under the assumption that this
insurance would be available. If the government were to pull the rug out from under those people
now, they would most likely lose their insurance and see their property values tumble.
The bill that reformed and extended the NFIP was one of the few bills to make it through a
profoundly gridlocked Washington, D.C., this summer, and it’s not difficult to see what
separated it from the pack. Like many other government programs like the home-interest
deduction and agricultural subsidies — which are reviled by economists as distortionary — the
NFIP is fiercely defended by those who benefit from it. Representatives from districts that
benefit from the NFIP will fight to keep the program, while the stakes are lower for those who

3. bear the costs.
The National Flood Insurance Program, run by FEMA, provides subsidized flood insurance to
policyholders living in flood-prone regions. In 2005, the program had to borrow from the U.S.
Treasury to cover losses from the catastrophic hurricanes that year, including Katrina, and still
has an outstanding debt of $17.8 billion. NFIP’s need to borrow to cover claims in years of
catastrophic flooding, along with management challenges at FEMA, has raised concerns about
the program’s long-term stability. NFIP has landed on GAO’s high-risk list since 2006.
To participate in NFIP, communities agree to enforce regulations for land use and new
construction in high-risk flood zones and enforce state floodplain management plans to reduce
future flood damage. More than 20,000 communities participate in NFIP. To encourage program
participation, the program does not charge all participants rates that reflect the full risk of
flooding to their properties. The percentage of subsidized properties was expected, but almost
one out of four policies is based on a subsidized rate.
FEMA has tried, unsuccessfully, to reduce the number of properties that have experienced
repeated losses. Repeat property losses account for just 1 percent of NFIP’s insured properties
but are responsible for 25 percent to 30 percent of claims. Despite FEMA’s efforts, the number
of repetitive loss properties increased from 76,202 in 1997 to 132,100 in 2011, an increase of 73
percent. FEMA can also raise premium rates for property owners who refuse mitigation offers.
According to the Government Accountability Office, subsidized premium rates are generally 40
percent to 45 percent of the full-risk price. The average annual subsidized premium was $1,121
in 2010, discounted from the $2,500 to $2,800 that FEMA said would be required to cover the
full risk of loss.
Because many premium rates charged by NFIP do not reflect the full risk of loss, the program is
less likely to be able to pay claims in years with catastrophic losses, as occurred in 2005, and
may need to borrow from Treasury. Raising the cost of the premiums would decrease costs to
taxpayers but make the insurance unaffordable for many current taxpayers. If policyholders leave
the program, it could increase the amount of federal assistance needed after a disaster.
Virtually no private market for flood insurance exists for most residential and commercial
properties. Unlike private insurance companies, NFIP does not purchase reinsurance to cover
catastrophic losses. As a result, NFIP has had to borrow from Treasury after the fact.
GAO criticized FEMA for significant management challenges in areas that affect its
administration of NFIP. FEMA has not finalized strategic guidance for NFIP, and lacks goals,
objectives and performance measures to assess the program’s effectiveness.
“Collaboration between program and support offices that administer NFIP has been ineffective,
leading to challenges in effectively carrying out some key functions, including information
technology, acquisition, and financial management,” the GAO said.

4. For example, FEMA invested about seven years and $40 million to modernize NFIP’s policy and
claims management system, only to cancel the project in 2009 for failing to meet user
expectations. FEMA still relies of NFIP’s costly 30-year-old system.
FAST FACT: In special flood hazard areas where property owners with loans from federally
insured or regulated lenders are required to purchase flood insurance, as few as 50 percent of the
properties had flood insurance in 2006.