Report: Flood Insurance Rates Far Too Low to Cover Risks

Published May 25, 2011

Flood insurance rates in many areas are only one-third as high as they should be to reflect the true risk of flood damage, according to a new report from the Property Casualty Insurers Association of America.

“We conclude that the federal government is providing overall flood insurance at one-half the true-risk cost; specifically, in higher-risk areas, it is providing flood insurance at one-third the true-risk cost,” writes the PCIAA in “True Market-Risk Rates for Flood Insurance,” released in May. “This comports with the General Accountability Office’s (GAO) analysis which found that requiring the NFIP to build a capital surplus fund would involve a doubling or tripling of current rates.”

Program Up for Renewal
The report could add to debate expected to heat up this summer over whether Congress should extend the National Flood Insurance Program. The NFIP provides flood insurance coverage on approximately 5.6 million properties and is set to expire September 30. The Federal Emergency Management Agency runs the program.

The rate inadequacies in the federal flood insurance program could be even worse than estimated in the report. The PCIAA researchers noted many NFIP flood maps are outdated, and little private-sector risk modeling information or claims experience exists.

‘Non-Actuarial Approach’
“The average true market-risk rate for all flood insured properties was found to be more than twice the average NFIP rate ($1,166 market vs. $585 NFIP). While the market rate was only 23% higher for lower-flood-risk properties, the market rate for properties explicitly subsidized under the NFIP was 208% higher than the current rate. These large disparities between NFIP and market-risk rates are the result of the non-actuarial approach required of the NFIP, in addition to the fact that program rates do not reflect lost tax revenue, capital costs, nor the costs of a catastrophe backstop (with Treasury backstopping the risk exposure for very large, less frequent events),” according to the report.

Congress created the NFIP in 1968 with the promise that it would pay its own way, yet the program owes the U.S. Treasury approximately $18 billion and has no practical way of paying it back, says Eli Lehrer, a Heartland Institute vice president who heads Heartland’s Center on Finance, Insurance, and Real Estate.

“If private insurers were to charge these rates for this coverage, state regulators would see how inadequate the rates are and shut them down,” says Lehrer. “Yet the federal government has gone decades charging rates that fail to generate enough revenue for the program to pay its way, as the nation was promised the program would do.”

No Risk Management Tools
The PCIAA report explains how this has happened:

 “NFIP’s rate-setting method is very different from that of private insurers. Rather than considering the economic value or true cost of the risk, the NFIP bases its rates on its average annual administrative and cash-flow losses for very broadly defined types of flood zones. The NFIP does not use catastrophe risk models or other underwriting/risk management tools. It cannot deny insurance to “repetitive loss properties,” making it subject to adverse selection. The NFIP also does not purchase reinsurance, impose a catastrophe load, or build up or maintain a surplus to cover unexpectedly large events. It does not seek a rate of return for the capital employed in the program nor does it include a tax provision in its rates. Furthermore, NFIP rates cannot be raised beyond an annual maximum of 10%.”

And, the report notes, when there is less flood damage than in a typical year, excess premiums are returned to the Treasury Department.

Record flooding this year on the Mississippi River and its tributaries also highlights another program failure. One of the program’s goals is to reduce the nation’s risk of flood damage. It has failed to do this and, notes Lehrer, ends up subsidizing development of properties in floodprone and environmentally sensitive areas.

Steve Stanek ([email protected]) is a research fellow at The Heartland Institute and managing editor of Finance, Insurance & Real Estate Policy News.

Internet Info

“True Market-Risk Rates for Flood Insurance,” Property Casualty Insurers Association of America: