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The twelve year U.S. major hurricane drought came to an end with landfalls by two Category 4 storms within three weeks. Harvey and Irma highlighted the weaknesses of the National Flood Insurance Program (NFIP), which Congress recently reauthorized through December. While the cost to taxpayers has received much attention, I think that a more serious problem with the NFIP is the poor protection provided to homeowners, businesses and communities.
The cost to taxpayers, though, is significant. The NFIP already owed $25 billion to the U.S. Treasury, due to Hurricanes Katrina, Ike, and Sandy. Current estimates put Harvey’s loss at $11 billion, while Irma may cost $9 billion. With cash reserves of about $1 billion, NFIP’s debt to the Treasury will likely top $40 billion.
A small number of properties have accounted for a shockingly large share of these losses. The National Wildlife Federation found that two percent of properties account for about 40 percent of all program losses. Numerous properties have had repeat losses exceeding their value. They include the following: a $120,000 home in Houston with 16 claims in 18 years totaling almost $1 million, and homes in St. Louis and Baton Rouge with 34 and 40 claims. These homes get rebuilt and insured again and again.
Subsidizing vulnerable properties is dubious public policy. But the reauthorization debate has assumed that the NFIP provides good insurance coverage. The evidence suggests otherwise, and reflects a recurrent quality problem for many government-provided services.
Coverage limitations explain why the NFIP poorly protects policyholders. Homeowners can insure only up to $250,000, and businesses up to $500,000 (including the value of contents). Many homes and small businesses exceed these limits, leaving many Americans who buy the insurance underinsured. Furthermore, businesses get little coverage of expenses to protect against flooding and no coverage for interruption losses (revenue lost while a business is closed). A study found that half of insured businesses with flood losses in Hurricane Sandy received no NFIP payout. Inadequate insurance coverage makes businesses rely on Small Business Administration loans, owners’ savings, or even donations.
Homeowners and businesses can and do supplement NFIP policies with coverage from private insurers. The existence of the NFIP, however, results in few insurers offering such coverage, and then only at high rates. Few insurance companies will invest in the extensive learning required to price policies competitively (especially given inaccurate government flood maps) when they write only a handful of supplemental policies. The NFIP largely preempts a private market.
Other government services similarly suffer from low quality. Consider Medicaid, the government health insurance program for the poor and disabled. The Medicaid expansion debate following passage of the Affordable Care Act largely presumed that beneficiaries received decent coverage. Yet low reimbursement rates for doctors and hospitals leave Medicaid patients unable to schedule appointments, leaving their medical conditions untreated. A Virginia study found that Medicaid patients had worse outcomes following surgery, controlling for age and other factors, than patients with private insurance, Medicare, or even the uninsured.
America’s very expensive public schools perform poorly on international tests. Furthermore, the cost of college hides some sins of public schools. A 2016 study found that our nation spends $1.3 billion annually on remedial coursework for high school grads not ready for college.
Why are so many government services of low quality? For programs like the NFIP, subsidies produce a lack of competition, eliminating pressure for improved customer service. The NFIP is assured business regardless of whether they offer customers their desired coverage.
Politicians can also take advantage of people. Because voters more readily see price and availability than quality, politicians can score points by making something available for a low price. Policyholders do not realize until a flood that their inexpensive coverage leaves a lot unpaid. Cutting corners on quality also allows politicians to seemingly deliver on their many promises.
Subsidized flood insurance fails to protect even many of the Americans who buy coverage. Underinsurance yields business failures and job losses after floods. Both taxpayers and ultimately policyholders would benefit if Uncle Sam got out of the flood insurance business.