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Social Benefits and Costs of the National Flood Insurance Program
James Patrick Howard, II
University of Maryland Baltimore County
31 March 2014 – c2b332da54e0
1 of 23
Outline of This Presentation
• Motivation
• Model and data
• Consumer surplus for the NFIP
• Results
• Discussion and implication
2 of 23
Motivation
• National Flood Insurance Program (NFIP) is the largest monoline insurer in the
United States
• Created as government program in the 1960s
• The program was designed to benefit the government
• Participation in required in“high”risk areas
• Participating communities required to implement building code standards
• The NFIP is more than 24 billion dollars in debt
• The NFIP’s impacts are not evenly distributed
• Study is retrospective
3 of 23
The NFIP and the FMA
• FMA started in 1996
• Provides grants for flood mitigation to local communities
◦ Project may be physical flood protection, such as a dam
◦ Project may be to improve building, planning, or zoning codes
◦ Projects must“pass”a benefit-cost test prior to award
• Mitigation to reduce claims against the flood insurance program
• Grant money drawn from flood insurance premium pool
• Programs are politically and financially linked
4 of 23
Research Questions
This dissertation addresses three key policy questions about the NFIP:
1. Does the NFIP have a positive net social benefit?
2. Does who gains and loses from the program change the assessment?
3. Does the NFIP save the government money?
5 of 23
Development of the Sufficient Statistic
• The change in the net social benefits of the NFIP, ∆S, comprises four sources:
◦ The change in the consumer surplus, the benefit to consumers
◦ The change in the producer surplus, the benefit to producers
◦ The change in the government surplus, the benefit to government
◦ The change in the external surplus, the effects of externalities
• The model is developed by finding each surplus and summing the results
6 of 23
With NFIP Without NFIP
Benefits Costs Benefits Costs
Consumer Surplus
consumer surplus for flood insurance w
payments for claims κ
premium payments µ
ad hoc disaster relief grant a
Alternative Summary w + κ − µ a
Change in Consumer Surplus w + κ − µ − a
Producer Surplus
administrative fees to insurers ϕµ
administrative costs to insurers ϕµ
Alternative Summary ϕµ − ϕµ = 0
Change in Producer Surplus 0
Government Surplus
admininstrative fees to insurers ϕµ
payments for claims κ
premium payments µ
NFIP expenses ζ
ad hoc disaster relief grant a
Alternative Summary µ − κ − ϕµ − ζ −a
Change in Government Surplus µ − κ − ϕµ − ζ + a
External Surplus
environmental benefits / costs B β
marginal tax burdern mζ ma
Alternative Summary B − mζ β − ma
Change in External Surplus B − mζ − β + ma
NFIP Sufficient Statistic γλ − ϕµ − ζ − mζ + mκ
7 of 23
Data Sources for the Sufficient Statistic
• Most values are available directly from the NFIP’s financial data
• Other data is available from government documentation and budget
• The consumer surplus for the NFIP required additional research from survey data
8 of 23
Data Sources for the FMA Study
• Incorporates study by Rose, et al., that finds benefit-cost ratio for FMA projects
• Used a sample of FMA projects to find 50-year net social yield
• Value found is benefit-cost ratio of 5 (estimated s.d., 1.1)
• The benefit-cost ratio can be applied to all projects for NSB of FMA program grants
• This study will use their results for the FMA element
9 of 23
Consumer Surplus Versus the WTP
• Consumer surplus is the net economic gain to consumers
• Comes from being able to purchase a good or service for less than consumers are
willing to pay
• The consumer’s values for incremental willingness to pay lie along the demand curve
• The consumer surplus is the area between the demand curve and the equilibrium
price
10 of 23
Consumer Surplus Model: Primary Research
• A censored regression model can find the consumer surplus, e.g., Tobit
• Censored model useful because some people don’t have to buy insurance and there
is a cap
• The model is a GLM where the dependent variable is the amount purchased
• An explanatory variable is the price
• For Tobit models, a simple transformation of the coefficient on price yields the
consumer surplus per consumer
11 of 23
Consumer Surplus Regression
• Variables capture risk without being
substitutes for insurance
• The variable fprem is the price paid for
insurance
• CS =
Pc
P0
(β0 + β1P) dP = − y2
2β1
• β1 is the coefficient for fprem
• y is the amount of insurance purchased
High Premium Low Premium
(Intercept) −1842.98 (317.03)∗∗∗
−1503.55 (311.15)∗∗∗
fprem −564.95 (59.67)∗∗∗
−1032.06 (84.75)∗∗∗
log(income) 574.22 (55.71)∗∗∗
568.45 (54.72)∗∗∗
Brevard County −853.53 (234.11)∗∗∗
−1040.19 (231.20)∗∗∗
Brunswick County 369.15 (218.72) 275.89 (217.83)
Dare County −153.98 (223.35) −400.65 (221.75)
Galveston County −7.59 (218.27) −36.20 (217.01)
Georgetown County 1348.26 (265.65)∗∗∗
1105.89 (262.08)∗∗∗
Glynn County 102.61 (271.37) −178.29 (268.82)
Lee County 201.31 (259.88) −41.16 (257.10)
Sussex County −445.61 (211.14)∗
−647.38 (209.96)∗∗
ocean 831.61 (90.35)∗∗∗
787.84 (88.75)∗∗∗
vacant −255.10 (92.78)∗∗
−191.04 (91.51)∗
subsidy −530.15 (95.64)∗∗∗
−364.48 (93.18)∗∗∗
Log(scale) 7.40 (0.03)∗∗∗
7.37 (0.03)∗∗∗
AIC 15502.85 15415.52
BIC 15575.64 15488.30
Log Likelihood −7736.43 −7692.76
Deviance 1130.84 1115.91
Total 946 946
Left-censored 222 222
Uncensored 601 601
Right-censored 123 123
***p < 0.001, **p < 0.01, *p < 0.05
12 of 23
Consumer Surplus Results
High Premium Low Premium
Adjusted for year 1998 2010 1998 2010
Consumer surplus (fitted demand) 590.85 790.92 352.27 471.55
Sampled SE 1239.13 1658.72 695.92 931.57
Consumer surplus (observed demand) 1165.19 1559.75 637.83 853.81
Sampled SE 1755.47 2349.90 960.95 1286.34
13 of 23
Social Discounting and Retrospective Analysis
• Financial impacts over time so aggregation is necessary
◦ Present value for prospective analysis is based on inverting future value
◦ Retrospective study uses future value formula to calculate FV in year of interest, 2010
• Social discounting represents economic cost of not using funds for other purposes
• Selecting a discount rate is not straightforward
• There is little guidance on selecting a rate for retrospective analysis
• This analysis uses the government borrowing rate
◦ Government might not otherwise borrow the funds for other purposes
◦ Easily observable since the constantly yield rate is well known
◦ Only 10-year borrowing rate used since study period included period where 30-year
bonds were not issued
• Social discounting can also accommodate changes in value due to inflation
14 of 23
Retrospective Results
• The change in net social benefits is
78.28 billion dollars
• The net social benefits are driven by the
consumer surplus for the NFIP and the
METB gains
• Hurricanes Katrina and Rita are reason
for larger than average benefits in 2005
• Largest cost component is WYO fee to
private sector to administer policies
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0.0 2.5 5.0 7.5 10.0
Shift in NSB per component (billions of dollars)
Source FMA METB NFIP CS NFIP Exp. WYO
15 of 23
Summary of Retrospective Results
Value in year 2010 Forecast to 2060
Base analysis 78.28 81.18
Excluding 2005 68.63 71.42
Excluding METB 68.30 71.20
Excluding the NFIP Consumer Surplus 2.34 5.25
Sensitivity analysis mean 52.72 55.63
Sensitivity analysis mean (excluding 2005) 45.05 47.85
Sensitivity over ad hoc payments 76.57 79.38
Sensitivity over the producer surplus 81.62 84.53
Sensitivity over the PS (excluding 2005) 72.40 74.55
16 of 23
Distributionally Weighted Results
• The net social benefits decrease as the
Atkinson weight level increases
• As the Atkinson weight level increases,
the aversion to income inequality
increases
◦ At higher weight levels, lower income
counts for more and higher income
counts less
• Accordingly, the NFIP and FMA
programs must be regressive
◦ The net benefit is flowing to wealthier
households
◦ Shown by the decrease in NSB at
higher Atkinson weights
q
q
q
q
q
56
60
64
0.00 0.25 0.50 0.75 1.00
Atkinson Weight Level
Dollars(Billions)17 of 23
Government Income Results
• The change in government revenue is
34.62 billion dollars
• The premiums paid into the NFIP are a
significant benefit to the government’s
bottom line
• The claims amounts are excluded from
the summary since the claims amounts
are assumed paid even in the absence of
the NFIP
• The administrative fees and expenses
are a small portion of the NFIP from a
government finance perspective
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0 1 2 3
Shift in government revenue per component (billions of dollars)
Source Admin Fees FMA NFIP Exp. Premiums
18 of 23
Summary of Government Income Results
Value in year 2010 Forecast to 2060
Base analysis 34.62 36.89
Excluding 2005 32.38 34.56
Sensitivity analysis mean 34.61 36.84
19 of 23
Key Findings
• The overall net social benefit of the NFIP is positive
• This is driven primarily by the consumer surplus for the NFIP
• There is a slightly regressive effect of the NFIP
• The program has saved the government money compared to the baseline
20 of 23
Changes From August
• There’s a substantial change since August, in both sign and magnitude
• Due to misinterpretation of the Tobit analysis results
• Originally interpreted as the willingness-to-pay
• The value should be consumer surplus
• By implication, the insurance premiums were subtracted twice which is now
corrected
• The effect swings the consumer surplus in the model substantially
21 of 23
Limitations of this Analysis
• Model structure a strength and weakness
◦ Makes assumptions explicit and yields what is the first synthesized analysis of the
program
◦ Further research could change results
• Ecological impacts of the program
◦ Not enough known to quantitatively analyze
◦ Here assumed to be equal with and without program
• Government behavioral response could be more complex than an equal amount of
ad hoc grants without the NFIP
• The consumer surplus estimate uses a relatively small sample in high risk areas
22 of 23
Contributions and Policy Implications
• Major contributions
◦ Developed first model of integrated assessment of NFIP and FMA
◦ First research on the consumer surplus of the NFIP
◦ First quantitative results on monetized NSB, distributional impacts, and change in
government revenue
• Policy Implications
◦ Shows consumers, producers, and government are better off with the NFIP
• Influenced by the baseline selected
• Does not attempt to find an optimal premium to maximize NSB
◦ There is a large consumer benefit due to the program
23 of 23

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NFIP Dissertation Defense

  • 1. Social Benefits and Costs of the National Flood Insurance Program James Patrick Howard, II University of Maryland Baltimore County 31 March 2014 – c2b332da54e0 1 of 23
  • 2. Outline of This Presentation • Motivation • Model and data • Consumer surplus for the NFIP • Results • Discussion and implication 2 of 23
  • 3. Motivation • National Flood Insurance Program (NFIP) is the largest monoline insurer in the United States • Created as government program in the 1960s • The program was designed to benefit the government • Participation in required in“high”risk areas • Participating communities required to implement building code standards • The NFIP is more than 24 billion dollars in debt • The NFIP’s impacts are not evenly distributed • Study is retrospective 3 of 23
  • 4. The NFIP and the FMA • FMA started in 1996 • Provides grants for flood mitigation to local communities ◦ Project may be physical flood protection, such as a dam ◦ Project may be to improve building, planning, or zoning codes ◦ Projects must“pass”a benefit-cost test prior to award • Mitigation to reduce claims against the flood insurance program • Grant money drawn from flood insurance premium pool • Programs are politically and financially linked 4 of 23
  • 5. Research Questions This dissertation addresses three key policy questions about the NFIP: 1. Does the NFIP have a positive net social benefit? 2. Does who gains and loses from the program change the assessment? 3. Does the NFIP save the government money? 5 of 23
  • 6. Development of the Sufficient Statistic • The change in the net social benefits of the NFIP, ∆S, comprises four sources: ◦ The change in the consumer surplus, the benefit to consumers ◦ The change in the producer surplus, the benefit to producers ◦ The change in the government surplus, the benefit to government ◦ The change in the external surplus, the effects of externalities • The model is developed by finding each surplus and summing the results 6 of 23
  • 7. With NFIP Without NFIP Benefits Costs Benefits Costs Consumer Surplus consumer surplus for flood insurance w payments for claims κ premium payments µ ad hoc disaster relief grant a Alternative Summary w + κ − µ a Change in Consumer Surplus w + κ − µ − a Producer Surplus administrative fees to insurers ϕµ administrative costs to insurers ϕµ Alternative Summary ϕµ − ϕµ = 0 Change in Producer Surplus 0 Government Surplus admininstrative fees to insurers ϕµ payments for claims κ premium payments µ NFIP expenses ζ ad hoc disaster relief grant a Alternative Summary µ − κ − ϕµ − ζ −a Change in Government Surplus µ − κ − ϕµ − ζ + a External Surplus environmental benefits / costs B β marginal tax burdern mζ ma Alternative Summary B − mζ β − ma Change in External Surplus B − mζ − β + ma NFIP Sufficient Statistic γλ − ϕµ − ζ − mζ + mκ 7 of 23
  • 8. Data Sources for the Sufficient Statistic • Most values are available directly from the NFIP’s financial data • Other data is available from government documentation and budget • The consumer surplus for the NFIP required additional research from survey data 8 of 23
  • 9. Data Sources for the FMA Study • Incorporates study by Rose, et al., that finds benefit-cost ratio for FMA projects • Used a sample of FMA projects to find 50-year net social yield • Value found is benefit-cost ratio of 5 (estimated s.d., 1.1) • The benefit-cost ratio can be applied to all projects for NSB of FMA program grants • This study will use their results for the FMA element 9 of 23
  • 10. Consumer Surplus Versus the WTP • Consumer surplus is the net economic gain to consumers • Comes from being able to purchase a good or service for less than consumers are willing to pay • The consumer’s values for incremental willingness to pay lie along the demand curve • The consumer surplus is the area between the demand curve and the equilibrium price 10 of 23
  • 11. Consumer Surplus Model: Primary Research • A censored regression model can find the consumer surplus, e.g., Tobit • Censored model useful because some people don’t have to buy insurance and there is a cap • The model is a GLM where the dependent variable is the amount purchased • An explanatory variable is the price • For Tobit models, a simple transformation of the coefficient on price yields the consumer surplus per consumer 11 of 23
  • 12. Consumer Surplus Regression • Variables capture risk without being substitutes for insurance • The variable fprem is the price paid for insurance • CS = Pc P0 (β0 + β1P) dP = − y2 2β1 • β1 is the coefficient for fprem • y is the amount of insurance purchased High Premium Low Premium (Intercept) −1842.98 (317.03)∗∗∗ −1503.55 (311.15)∗∗∗ fprem −564.95 (59.67)∗∗∗ −1032.06 (84.75)∗∗∗ log(income) 574.22 (55.71)∗∗∗ 568.45 (54.72)∗∗∗ Brevard County −853.53 (234.11)∗∗∗ −1040.19 (231.20)∗∗∗ Brunswick County 369.15 (218.72) 275.89 (217.83) Dare County −153.98 (223.35) −400.65 (221.75) Galveston County −7.59 (218.27) −36.20 (217.01) Georgetown County 1348.26 (265.65)∗∗∗ 1105.89 (262.08)∗∗∗ Glynn County 102.61 (271.37) −178.29 (268.82) Lee County 201.31 (259.88) −41.16 (257.10) Sussex County −445.61 (211.14)∗ −647.38 (209.96)∗∗ ocean 831.61 (90.35)∗∗∗ 787.84 (88.75)∗∗∗ vacant −255.10 (92.78)∗∗ −191.04 (91.51)∗ subsidy −530.15 (95.64)∗∗∗ −364.48 (93.18)∗∗∗ Log(scale) 7.40 (0.03)∗∗∗ 7.37 (0.03)∗∗∗ AIC 15502.85 15415.52 BIC 15575.64 15488.30 Log Likelihood −7736.43 −7692.76 Deviance 1130.84 1115.91 Total 946 946 Left-censored 222 222 Uncensored 601 601 Right-censored 123 123 ***p < 0.001, **p < 0.01, *p < 0.05 12 of 23
  • 13. Consumer Surplus Results High Premium Low Premium Adjusted for year 1998 2010 1998 2010 Consumer surplus (fitted demand) 590.85 790.92 352.27 471.55 Sampled SE 1239.13 1658.72 695.92 931.57 Consumer surplus (observed demand) 1165.19 1559.75 637.83 853.81 Sampled SE 1755.47 2349.90 960.95 1286.34 13 of 23
  • 14. Social Discounting and Retrospective Analysis • Financial impacts over time so aggregation is necessary ◦ Present value for prospective analysis is based on inverting future value ◦ Retrospective study uses future value formula to calculate FV in year of interest, 2010 • Social discounting represents economic cost of not using funds for other purposes • Selecting a discount rate is not straightforward • There is little guidance on selecting a rate for retrospective analysis • This analysis uses the government borrowing rate ◦ Government might not otherwise borrow the funds for other purposes ◦ Easily observable since the constantly yield rate is well known ◦ Only 10-year borrowing rate used since study period included period where 30-year bonds were not issued • Social discounting can also accommodate changes in value due to inflation 14 of 23
  • 15. Retrospective Results • The change in net social benefits is 78.28 billion dollars • The net social benefits are driven by the consumer surplus for the NFIP and the METB gains • Hurricanes Katrina and Rita are reason for larger than average benefits in 2005 • Largest cost component is WYO fee to private sector to administer policies 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 0.0 2.5 5.0 7.5 10.0 Shift in NSB per component (billions of dollars) Source FMA METB NFIP CS NFIP Exp. WYO 15 of 23
  • 16. Summary of Retrospective Results Value in year 2010 Forecast to 2060 Base analysis 78.28 81.18 Excluding 2005 68.63 71.42 Excluding METB 68.30 71.20 Excluding the NFIP Consumer Surplus 2.34 5.25 Sensitivity analysis mean 52.72 55.63 Sensitivity analysis mean (excluding 2005) 45.05 47.85 Sensitivity over ad hoc payments 76.57 79.38 Sensitivity over the producer surplus 81.62 84.53 Sensitivity over the PS (excluding 2005) 72.40 74.55 16 of 23
  • 17. Distributionally Weighted Results • The net social benefits decrease as the Atkinson weight level increases • As the Atkinson weight level increases, the aversion to income inequality increases ◦ At higher weight levels, lower income counts for more and higher income counts less • Accordingly, the NFIP and FMA programs must be regressive ◦ The net benefit is flowing to wealthier households ◦ Shown by the decrease in NSB at higher Atkinson weights q q q q q 56 60 64 0.00 0.25 0.50 0.75 1.00 Atkinson Weight Level Dollars(Billions)17 of 23
  • 18. Government Income Results • The change in government revenue is 34.62 billion dollars • The premiums paid into the NFIP are a significant benefit to the government’s bottom line • The claims amounts are excluded from the summary since the claims amounts are assumed paid even in the absence of the NFIP • The administrative fees and expenses are a small portion of the NFIP from a government finance perspective 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 0 1 2 3 Shift in government revenue per component (billions of dollars) Source Admin Fees FMA NFIP Exp. Premiums 18 of 23
  • 19. Summary of Government Income Results Value in year 2010 Forecast to 2060 Base analysis 34.62 36.89 Excluding 2005 32.38 34.56 Sensitivity analysis mean 34.61 36.84 19 of 23
  • 20. Key Findings • The overall net social benefit of the NFIP is positive • This is driven primarily by the consumer surplus for the NFIP • There is a slightly regressive effect of the NFIP • The program has saved the government money compared to the baseline 20 of 23
  • 21. Changes From August • There’s a substantial change since August, in both sign and magnitude • Due to misinterpretation of the Tobit analysis results • Originally interpreted as the willingness-to-pay • The value should be consumer surplus • By implication, the insurance premiums were subtracted twice which is now corrected • The effect swings the consumer surplus in the model substantially 21 of 23
  • 22. Limitations of this Analysis • Model structure a strength and weakness ◦ Makes assumptions explicit and yields what is the first synthesized analysis of the program ◦ Further research could change results • Ecological impacts of the program ◦ Not enough known to quantitatively analyze ◦ Here assumed to be equal with and without program • Government behavioral response could be more complex than an equal amount of ad hoc grants without the NFIP • The consumer surplus estimate uses a relatively small sample in high risk areas 22 of 23
  • 23. Contributions and Policy Implications • Major contributions ◦ Developed first model of integrated assessment of NFIP and FMA ◦ First research on the consumer surplus of the NFIP ◦ First quantitative results on monetized NSB, distributional impacts, and change in government revenue • Policy Implications ◦ Shows consumers, producers, and government are better off with the NFIP • Influenced by the baseline selected • Does not attempt to find an optimal premium to maximize NSB ◦ There is a large consumer benefit due to the program 23 of 23