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The man-made disaster called flood insurance

Critics unanimously pan the Federal Emergency Management Administration's (FEMA) National Flood Insurance Program, or NFIP for short. Since the 1970s the NFIP has -- almost literally -- poured money into the ocean each time there's been a major hurricane that washes away coastal homes.

But now a report by the Government Accountability Office (GAO) goes even further, hinting that the NFIP might be beyond saving. The GAO's recent report to Congress says that Congress's own meddling has "weakened the financial soundness" of flood insurance.

"FEMA owes $24 billion to the U.S. Treasury . . . and hasn't made principal payments since 2010," claims the GAO report.

The report is a torpedo amid ships, not only for the 5.5 million people who have federal flood insurance, but also for the millions more who may be required to purchase it if they own or buy flood-prone homes. And, some believe with global warming, the U.S. will have more of them each year.

It could also be a potential depth charge to American taxpayers, who would be responsible for $180 apiece to help pay off the crushing and increasing debt that FEMA owes as a result of this failed insurance program, according to published reports.

flood insurance problemsLooking for private insurance companies

So, is there any good news? Not really, except perhaps for insurance companies. FEMA's woes could create an opening for private property-casualty insurers who might be willing to take the place of the NFIP if they are given enough incentives.

As part of its options to reduce the cost of federal flood insurance, the GAO suggests that FEMA could "increase private sector participation," thereby taking FEMA out of the flood insurance game except to provide backup coverage in the event of a major hurricane.

And some consumer groups think this is an idea whose time has come.

"I am pounding the pavement looking for private insurance options," says Executive Director Amy Bach of United Policyholders in San Francisco.

Ace, AIG, Chubb, Fireman's Fund and Lloyds are among the insurers who offer private flood insurance, while Warren Buffett's Berkshire Hathaway provides backup coverage to some insurers. But while many of these private insurers do offer their own flood insurance, it's only for clients who've already maxed out their federal flood insurance at $250,000 per building and $100,000 for contents.

Bach says, "We need to develop a private market so that flood insurance is an option for everyone, not just the wealthy."

She says that the barriers to introducing more choices in the private flood insurance market aren't insurmountable, and that much of Europe already has private flood insurance. Bach points to the Homeowners Catastrophe Insurance Fund, which is active in five western states. Participating insurance agents work with the underlying coverage of a customer's homeowners insurance policy to provide additional protection.

Bach says she'd also like to put a list of private insurers who offer flood coverage on the United Policyholders' website, "if we could compile a reasonably accurate one."

This idea of private flood insurance also has support from New Jersey Gov. Chris Christie, whose state suffered the most from Superstorm Sandy, and from academics like Andrew Young of the University of Mississippi Department of Economics.

"The NFIP should be eliminated, allowing private insurance to be offered . . . and property owners to make informed choices," says Young in an abstract.

Critics point out, however, that private insurers might offer less coverage with higher deductibles, could cancel policies and may be less capitalized, creating a bigger risk of default.

Congress could muck it up

The GAO report warns that this option would require Congressional action, and says that recently Congress has been moving in the opposite and wrong direction.

Congress passed the widely hailed Biggert-Waters Act in 2012, which raised flood insurance rates in order to put the program on sound financial footing. And it would have worked, suggests the GAO, except that in 2014, Congress reacted to pressure from coastal constituents who saw their flood insurance premiums soar thousands of dollars in a single year.

So Congress reversed direction. President Obama signed a revised law in March extending the NFIP's subsidies and curbing the price increases, making FEMA's situation worse than ever, says the GAO.

But the blame goes beyond politics, according to the GAO.

  • Banks are responsible for not insisting that homeowners within a flood plain pay for flood insurance along with their mortgage, which would ease the shortfall.
  • FEMA flood maps are inadequate and the promised revisions to make them more accurate haven't been done.
  • Consumers who should have bought flood insurance didn't, and some of those who did let it lapse. Many still think that it's part of their homeowner's insurance policy.

The GAO also criticized private insurers who sell and service the NFIP policies. These private insurers get a 40 percent cut of all premiums in some years -- without risking any of their own money for claims.

'Moral hazard'

One of the biggest obstacles to making the NFIP efficient is that FEMA, in addition to offering flood insurance, also provides free financial help to people who've been flooded out.

"FEMA actually will provide free aid if you can prove you didn't have flood insurance," says President Robert Hartwig of the Insurance Information Institute, which represents the property-casualty insurance industry. "It's what we call a 'moral hazard.' By helping homeowners FEMA discourages them from helping themselves."

Another moral hazard is that if you make flood insurance too expensive, people won't buy it. "Successive years of 15, 18 or 25 percent annual increases will force more and more homeowners to default on their mortgages and experience foreclosures and bankruptcies," warns attorney Ann Pellegrino, of Largo, Fla., who represents coastal homeowners.

Kicking the can

And perhaps the biggest challenge to both flood insurance and coastal homeowners is the rising tide of water, along with the potential for more severe storms, as a result of global warming and melting icebergs. While this year's hurricane season is predicted to be a light one, some climatologists predict that Miami Beach and parts of New York City could be underwater by 2050.

"The exposure of the NFIP to flooding is $1.25 trillion dollars," says Dr. Erwann Michel-Kerjan of the Wharton School of the University of Pennsylvania and the author of "The Irrational Economist."

"So we have to ask ourselves: 'Can we afford another flood like Katrina that could inflict $150 billion in losses . . . or even more?'" he says.

"Eventually there will be another movement toward reform" of flood insurance, predicts Hartwig. "We just can't keep kicking this can down the road."

More from Ed Leefeldt here

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