Privatising the national flood insurance program
In the US, the National Flood Insurance Program (NFIP) provides flood coverage to homeowners and businesses to the near exclusion of the private insurance market. The coverage limits of up to $250,000 do facilitate a market above that limit, but as a practical matter, the federal government is the principal insurer of flood risk.
That was not always the case. As conceived in 1968, the NFIP was built on fundamentally sound principles of encouraging hazard mitigation and promoting the use of insurance to reduce post-event disaster assistance. But because the programme maintains premium subsidies for many properties and lacks a credible catastrophe factor in the premiums, the NFIP compromises, rather than embraces, sound insurance principles and practices.
That may soon change. When the NFIP was reauthorised in 2012, it had a debt of nearly $19 billion to the US Treasury for claims exceeding its ability to pay; in 2012, Superstorm Sandy brought another wave of claims and the debt ballooned to $26 billion.
In its reauthorisation of the NFIP, Congress mandated the Federal Emergency Management Agency (FEMA) to: (1) assess laying off risk to the private reinsurance sector or capital markets rather than assume additional debt; (2) transition its rates to actuarially-sound rates rather than retain the subsidy that supports nearly 25 percent of its policies; and (3) assess other, unspecified, private sector options.
In July 2013, FEMA initiated the process for this by requesting proposals from the private sector. It is expected that once the contracts are awarded, the assessment of private sector options will be completed by early to mid-2014.
The assessment is likely to reveal that various states have already explored and implemented privatisation of state-sponsored property catastrophe programmes and offer creative approaches to develop a private market and de-populate state-sponsored insurance programmes. Some states have offered insurers tax incentives to assume policies from government entities. Louisiana and Florida have even provided funds to bolster insurer surplus in exchange for assuming policies from government programmes.
In 2013, Florida adopted a clearinghouse approach that requires a private sector review by insurance carriers of certain properties before the state programme adds a new policy to its policyholder base. Some states prohibit certain structures from the state programme based on their value, construction cost or location. Other states have limited or reduced coverage to incentivise policyholders to seek additional coverage in the private sector.
States have also provided insurers access to policyholder information to encourage companies to provide coverage to existing state programme policyholders. In all of these cases, the states seek to make their government-sponsored programmes the insurers of last resort rather than compete with or pre-empt the private market. The NFIP, and American taxpayers, would be well served to explore these programmes at the state level to assess options for a private sector role in the NFIP.
For the first 10 years of the programme, the NFIP operated as a public-private partnership with the insurance industry. Participating insurers had a risk-bearing role. The legislative authority for an industry pool still exists in the authorising statute and was broadened in the 2012 reauthorisation.
Thus it offers an additional option for a private sector, risk-bearing role. The pool could be structured as a fronting entity for the NFIP, or as a co-insurer with it. The pool could serve as a reinsurance vehicle with the federal programme as a backstop. Or, the NFIP could serve as an insurer of last resort rather than an exclusive market.
Government insurance programmes are being closely scrutinised in the US to determine if a greater private market can be facilitated or relied upon. Precedents exist for the NFIP.
