Washington Post calls for an end to Federal Flood Insurance.

In an editorial today, the Washington Post has called for an end to federal flood insurance.  THey argue:

The theory of the program is that people who choose to live in areas prone to flooding should pay for that risk by buying insurance; they should not expect taxpayers around the country to rescue them from their own recklessness. But the truth is that, after a disaster like Katrina, the federal government will bail everybody out whether they are insured or not; it's humanly and politically unthinkable to do otherwise. Because the likelihood of a federal rescue is so strong, there never was much incentive to buy insurance. 

Great point.  If people in high risk areas know that the federal government will provide implicit iunsurance ever time a disaster comes along, there is no incentive to buy the federal insurance, even if it's subsidized.  But there's a problem with the program the editorial suggest in its place:

The first response must be to make flood insurance compulsory, as auto insurance is. Currently, homeowners have to buy flood insurance if they live in a flood-prone area and they have a mortgage through a federally regulated or insured lender...Congress needs to mandate coverage for everyone and then come up with a mechanism to enforce compliance.

The second response must be to price flood insurance properly. In a vain attempt to persuade homeowners to buy coverage, the current system is subsidized; this allows people to build houses in exposed locations and then collect a federal check when the inevitable occurs, sometimes repeatedly. By pricing flood insurance accurately, the government would create price signals that would drive housing development to higher, drier land.

The problem?  No private insurer would be able to survive with 'properly priced insurance.'  Flood insurance is different from car insurance because it is impossible to pool risk across the insured parties.  Auto insurers rely on the fact that the probability of my having an accident is independent of the probaility of you having an accident.  So, it's unlikely they would have to pay both of us at the same time.  But with a flood, everyone in an affected region files a claim simultaneously (called systemic risk).  The only way to ensure the ability to make such a large payout is for the insurance company to charge really high rates.  Those rates would be so high that no one would be willing or able to buy the insurance.  The private market simply will not work in the case of systemic risk.

So, if the private market doesn't work let's subsidize federal insurance so that more people can afford it.  The problem here is that underpriced insurance provides an incentive to move to high risk areas (called moral hazard).  So we end up with more people insured in high risk areas, with the possibility of everyone filing a claim at the same time.  So what happens?  From ABCNEWS.COM:

More than 100,000 Gulf Coast homeowners who are expecting help from the federal flood insurance program may be in for a bitter surprise, according to victims of a hurricane that hit the state of Maryland two years ago this week.

"Pennies on the dollar.  And they'll be unable to rebuild their homes and lives just as victims from numerous storms across the country have been subjected to for the last years," says Steve Kanstoroom, founder of FEMAINFO.us, a Web site advocating for flood victims, including those whose homes were damaged when Hurricane Isabel triggered a flood surge in the Chesapeake Bay.

Flood insurance is available through the National Flood Insurance Program, which is run by the Federal Emergency Management Agency.   More than 4.5 million people pay premiums to be covered up to a maximum of $250,000.  Residents have to pay extra to cover household goods.

"My first thing was, 'We have flood insurance,'" recalled Jennifer Dieux of Shady Side, Md.  Her home was hit by the Chesapeake Bay flood surge.  "It's not going to matter.  We're covered.  We're going to be fine," Dieux remembers thinking.

Two years later, Dieux and her family are still living in a government-provided camper parked in front of their flood-ruined home, which they cannot afford to fix. 

  While mold and mildew have spread up the walls to the ceiling, the flood insurance program only pays to replace those portions actually touched by the storm's water. 

  Adjusters offered $44,000 for the necessary repairs.  Builders say $115,000 is needed to restore the home to its pre-flood condition.

  "We have no savings, nothing," Dieux admits.  "We have no way to pay for it."

  Maryland Insurance Commissioner Alfred W. Redmer told ABC News that FEMA adjusters systematically low-balled the losses of Maryland flood victims.

My guess is they don't low-ball on purpose.  Instead, I bet if they had to pay full indemnities on all claims, the system would go bankrupt.

Comments

[Doug]

The system IS bankrupt (practically a mathematical certainty due to the underpricing described above) - but it doesn't matter, because the government refills the piggy bank each year. (Just like AMTRAK and the Postal Service.) The government has in the past attempted to curtail some of the moral hazard issues - they reportedly moved an entire town of 5,000 2 miles east to higher ground - but they cave in to the big challenges, such as New Orleans.

You are correct - flood insurance is unpriceable, so the real question is "does the benefit to the country (whatever that means) from flood zone development overcome the cost of repeatedly paying out greater claims than premiums every year?" I have no idea. My guess is that, in the long run, the answer is no, but the short-term shock of pulling the plug on this system will be too painful to take.

[Debra Riley]

477186: Hey, does anyone know where I can find a list of gas stations with low prices in my area?

[Nola Girl]

There are plenty of other subsidies in the US besides the NFIP--social security, crop insurance, farm subsidies, mortgage interest write-offs, fuel efficiency tax credits, etc--that exist because the American people (or rather the people we have elected to represent us in group decision-making) have decided that there is a social benefit to subsidizing a social or economic outcome that would not occur under "free market/pure capitalism" conditions.

If the American people want to get rid of flood insurance because it's a subsidized program, then we should also eliminate federally-sponsored crop insurance because of the high level of repetitive losses; farm subsidies because they only encourage people to repeatedly invest in a business that is no longer economically-viable; industry tax credits because they only prop up industries that can't survive under "free market" conditions; and mortgage interest tax write-offs, because they are really nothing more than a personal property subsidy.

[Sem Prada]

It is amazing to watch money evolve from worthwhile to worthless.The United States is running the country on borrowed money. People are not succeeding in life, they are buying success and going bankrupt because they are not following any restraint or fear of loss. Their is always cheaper money to buy in the US. This is so
dangerous and I believe the value of the US dollar would crash if the actual value that is placed on our own currency was understood by the rest of the world.
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