Who pays the cost of flooding?

This post was contributed by Dr Diane Horn, Department of Geography, Environment and Development Studies and former visiting scholar at Old Dominion University’s Climate Change and Sea Level Rise Initiative, and Michael McShane, associate professor of finance and co-director of the Emergent Risk Initiative at Old Dominion University. It was originally published by the Pilot.

The U.S. National Flood Insurance Programme is facing rough seas  ahead. The programme is about $26 billion in debt after Hurricane Katrina in 2005 and Sandy in 2012. Worse, a large percentage of US property owners are heavily subsidized and do not pay full, risk-based rates. In addition, flood insurance is required only for certain property owners in high-risk flood zones.

No private insurance scheme would survive in a market where only the high risk buy insurance and do not pay risk-based rates.

The insurance programme has survived for 45 years because it can borrow from the U.S. Treasury when flood payouts are more than the amount paid in by policyholders, paying back the loan with interest in years where there aren’t many floods.

This worked pretty well until the 2005 hurricane season and the massive payouts after Katrina. Since then, much of the programme’s income has gone to cover interest on the debt, with little available to pay the debt down. The situation has resulted in calls for fiscal responsibility and the end of subsidies for all high-risk properties.

In this case, however, the “solution” has caused more problems. The Biggert-Waters Flood Insurance Reform Act of 2012, which aims to phase out these subsidies, has created another set of angry constituents – property owners who are experiencing big increases in their flood insurance premiums.

Bipartisan bills in Congress would delay the move toward risk-based rates. The programme finds itself between a rock and a hard place: those who are calling for fiscal responsibility and the end of the subsidies, and those who are having a hard time affording the new rates.

Ongoing research, part of the Climate Change and Sea Level Rise Initiative at Old Dominion University, is looking at how other countries deal with flood losses in the search for solutions to this dilemma.

Our research started by comparing flood insurance in the United States and the United Kingdom, where flood insurance is completely handled by private insurers. In the U.K., flood insurance is included as part of standard homeowners’ policies. This avoids one of the big problems in the U.S., where even people who live in the floodplain don’t buy flood insurance.

Including flood damage as part of a single policy would solve another U.S. problem: determining whether wind or water caused the property damage. Hurricane Katrina shone a light on this problem. If wind caused the loss, it was covered by the homeowner’s insurance policy. If storm surge caused the loss, the flood insurance programme policy would pay.

However, the use of private insurance in the U.K. doesn’t solve the problem of subsidies. Just like in the U.S., British property owners who live in the floodplain pay a lower rate than they should because flood insurance is subsidized. The difference is that in the U.K., subsidies come from other policyholders; the government doesn’t pay anything toward the cost of flood damage.

The U.K. is moving to a new flood insurance system, however. Under the new scheme, policyholders outside flood-prone areas will pay around $17 per year to make the rates more affordable for the high flood-risk policyholders. Rates will still be high in flood-prone areas but not so high as to be unaffordable, at least not initially. The system is designed to end subsidies in 20-25 years, unlike the U.S., where the national flood insurance subsidies are ending over a five-year period.

In the U.S., some are calling for private insurers to take over the flood insurance programme. However, you would be hard pressed to find a private insurer interested in offering flood insurance. Private insurers could not survive in an insurance market where only those most at risk buy flood insurance; they would need to charge even higher rates for those high flood risk policyholders than the national programme charges. The premium shock would be even worse, and Congress would be under even more pressure to step in and reduce rates.

Floods aren’t going to go away, and whenever a flood occurs, someone has to pay to repair the damage. Even with flood insurance, most policyholders don’t pay a price that reflects their true risk, and most flood insurance policies are subsidized to some extent. The real question is who pays the subsidy.

The U.K. experience shows that leaving everything to the private sector doesn’t work, but the U.S. experience shows that leaving everything to the public sector doesn’t work, either. We need to come up with the right mix of contributions from government, individuals and insurance companies – before the next Katrina or Sandy comes along.

Dr Horn and Dr McShane’s paper Flooding the Market” was published in the November edition of the journal Nature Climate Change.


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