Examining the NFIP’s lamentable past and why change is sorely needed

The National Flood Insurance Program (NFIP) was established with the passing of the National Flood Insurance Act (NFIA) of 1968, with the aim of protecting Americans against the financial hardships of flooding.

Congress enacted the NFIP to mitigate increases in federal disaster assistance such as the costly floods of the early 1960s, particularly along the Mississippi River and to distribute the cost of flooding more equitably. At the time, flood was viewed as an almost uninsurable risk and coverage was virtually unavailable from private insurance markets because, at that time, the United States had no reliable methods to assess flood risk at the parcel level. In fact, very few flood zones had been designated at the city or county level. This meant that insurers were exposed to severe adverse selection as only the owners of the most flood exposed structures would purchase coverage.

T­he NFIP was established with three main objectives: to provide access to primary flood insurance coverage, to mitigate and reduce the nation’s comprehensive flood risk through risk mapping and floodplain management and to thereby, over time, provide private insurers with the data and the experience needed to unburden taxpayers through market-based pricing of flood risk.

When the NFIA was drafted, Congress allowed for two operational possibilities for the NFIP: Plan A, which permitted the private insurance industry to implement and operate the flood insurance program with limited federal involvement; and Plan B, which placed primary responsibility for the NFIP with the Department of Housing and Urban Development (HUD) and subsequently the Federal Emergency Management Agency (FEMA).

From 1968 to 1977, the NFIP used Plan A, operating primarily through a pool of private insurers represented by the National Flood Insurers Association, with limited supervision from the Department of Housing and Urban Development (HUD) and financial support from the US Treasury, which essentially served as a reinsurer.

Read next: NFIP “impeding access” to the private flood insurance market – Poulton Associates CEO

However, after a series of disputes between the private insurance pool and the government on issues of authority, financial control, and other operating matters, HUD asserted control over the program which engendered legal action on the part of the National Flood Insurers Association which contended it should remain in control. The courts allowed HUD to begin operating the program, which ended the National Flood Insurers Association and ushered in the effective nationalization of America’s flood insurance program. At the time, it was unlikely that anyone anticipated the financial disaster that would flow from these events, according to Craig Poulton (pictured), CEO of Poulton Associates and owner of CATcoverage.com

“What few people know is that the NFIP was only supposed to run [under Plan B] until 1997,” said Poulton. “The idea of the original legislation was to create conditions where, under government participation, would facilitate a takeover by the private market so that the government could exit the flood insurance business, not retain it.”

However, the US has maintained a nationalized flood insurance construct ever since 1977 – and with “disastrous” consequences, according to Poulton, who has heavily criticized the program’s moves to maintain a flood insurance monopoly as well as its inadequate rates. He said: “The NFIP has been reauthorized over and over again because it convinced Congress there was nobody to take its place, and to date, it continues to underprice its product so that no-one will want to take its place to the severe detriment of taxpayers.”

The NFIP is funded primarily from premiums, fees, and surcharges paid by NFIP policyholders, but it can borrow from the Treasury to pay claims after extreme events. Historically, the NFIP would borrow small amounts and then repay the loans with interest, but everything changed after hurricanes Katrina, Rita, and Wilma in 2005, when Congress had to increase the NFIP’s borrowing limit to $20.775 billion to pay claims.

“Over the next decade, the NFIP’s debt continued to grow, and Congress kept bumping up the borrowing limit,” explained Poulton. “When hurricanes Harvey, Irma, and Maria hit in 2017, it was clear the NFIP would need to have the debt ceiling raised even further, so Congress decided to turn part of the debt into a tax by simply forgiving $16 billion which replenished the NFIP borrowing authority.

“But there was no requirement from Congress that the NFIP act any differently to receive that $16 billion in forgiveness. That is money the taxpayer will never see again, and we can expect more of the same until the NFIP raises their rates to an actuarially sustainable level. Frankly, they could have easily achieved rate adequacy, paid off their debt and stopped incurring more if they had raised their rates as intended by Congress over the past decade. Fortunately, the NFIP now has a mechanism to achieve actuarily defensible rates with Risk Rating 2.0.”

Read more: An ‘equitable’ alternative to NFIP’s risk rating 2.0 construct

The NFIP’s new pricing methodology, called Risk Rating 2.0, is aimed at reflecting an individual property’s specific flood risk, as opposed to using general risk categories based on location and property type. The upgrade is intended to produce rates that are more equitable, and to inform policyholders of their true flood risk through more accurate premiums.

“The NFIP now has a mechanism to raise rates relatively fairly,” Poulton told Insurance Business. “They have the flood mapping authority to double their premium at those better rates, which would go a long way toward enabling the original intent of reducing the taxpayer funding of flood losses.”

Poulton is calling on the NFIP to start acting more like an insurer of last resort and less like a monopoly bent on preserving its position at the expense of the public good. According to Poulton, the NFIP refusal to return any premium to a policyholder who wants to switch to a private market insurer midterm, and their continued use of woefully inadequate rates, are just two examples of the NFIP’s efforts to impede private market flood insurance. This, he says is needlessly increasing the burden shouldered by US taxpayers, while exacerbating America’s flood insurance protection gap nationwide.  

Craig Poulton ([email protected]) is chief executive officer of Salt Lake City-based Poulton Associates, LLC, which administers various catastrophe-related insurance products, including the country’s largest private flood insurance program, the Natural Catastrophe Insurance Program at CATCoverage.com.