Wednesday, October 12, 2005

FEMA's Flood Insurance

A comment left by an Anonymous at the end of yesterday's blog entry, Pensacola Perversity, says, "[L]ast time I checked the national flood insurance program was not subsidized by the gov't. Premiums exceeded payouts. The gov't will loan money to the program but the program must pay it back."

The comment hints at an interesting, and as it turns out, difficult question. Is FEMA's flood insurance program paid for with taxpayer money -- or, as Anonymous believes, is it self-sustaining? The answer seems to be ambigous, depending on which FEMA we're talking about -- or, more precisely, which part of FEMA's flood insurance program and at what point in time.

It is an article of faith-based conviction with many beach people that the National Flood Insurance Program is self-sustaining through annual premiums. As a group, we tend to get cranky if someone suggests that we might be relying on taxpayer give-aways when so many among us in 'Red State' Northwest Florida enthusiastically vote against sharing taxpayer funds with anyone else in society, including the young, the poor, the medically needy, or the less fortunate.

What we receive from the government, you see, are sensible subsidies and incentives. What you get are undeserved welfare payments and the dole.

So it seems some people get exercised over the largely ideological issue of whether FEMA's Federal Flood Insurance is, or is not, a common welfare program in disguise.

The Big Picture

Astonishingly, Russ Knocke, the Bush administration's current spokesman for FEMA/Homeland Security finds it "really tough to say" what FEMA's budget, which includes NFIP expenses and income, actually amounts to. "There are so many ancillary pockets," he says. "People can play the numbers game."

Nevertheless, it seems from a review of more reliable, although voluminous, publicly available budget records and reports that yesterday's commentator has it only half-right. The NFIP is a federal program and, overall, it has been 'subsidized' in past years as well as the present by Government funds: First, when the government appropriates money to the NFIP -- that is to say, every year when the NFIP has to borrow ahead of anticipated premium receipts, (although it is expected to repay those funds with interest); second, in those years when FEMA's NFIP cumulative deficit has grown so large that Congress sees fit to 'forgive' the whole thing; and third, as with last year's four Florida hurricanes and this year's devastation of the central Gulf Coast, when Congress makes outright appropriations for disaster relief that cover both insured and uninsured diaster victims. (See, for example, the first $10.5 billion Emergency Supplemental Appropriation for FEMA and the Department of Defense for Hurricane Katrina relief.)

The first happens at least annually. The latter two occur irregularly, depending on the frequency and size of the accumulated debt and the severity of new natural catastrophes. In between times, the overall National Insurance Flood Program, with a little political lipstick and rouge, can be gussied up to look as if it is self-funded and self-sufficient. So score one for our Anonymous commentator.

Even that picture blurs, however, when you look more closely at congressionally-mandated subsidies for certain sub-sets of the insured property population, including pre-FIRM (older) homes in flood zones and the privately owned casualty insurance companies themselves.

FEMA's Flawed Design

On its web site, FEMA boldly declares, "The NFIP is self-supporting for the average historical loss year... ." But that curious phrase -- "average historical loss year" -- masks a larger truth, as surely as it would be deceptive to say 'on average' you're paying your bills when you write rubber checks for the rent and run up credit card charges for food.

A fair summary of why this is so can be found in Douglas Clement's contribution to the Minneapolis Federal Reserve Bank's FedGazette for November, 2001:

The problem is, NFIP is broken. In fact, it was designed to be that way.

To encourage people to enroll in the program, NFIP subsidized premiums from the start, charging policyholders less than would be required in an actuarially sound insurance program. In other words, policyholders don't have to assume the full risk because taxpayers cover part of it.

Because of these premium subsidies — and with the extensive flooding of the 1990s — NFIP incurred losses totaling $1.56 billion between 1993 and 1998. To finance those losses, NFIP borrowed from the U.S. Treasury. Fortunately, lower payouts in 1999 and 2000 enabled NFIP to repay its debt, according to a July 2001 General Accounting Office (GAO) analysis. But chances are good that NFIP will again be knocking on the Treasury's door, "because it does not collect sufficient premium income to build reserves to meet the long-term future expected flood losses," according to GAO [the nonpartisan Government Accounting Office]. "The program is not, by design, actuarially sound."

Still, if you put a hand over one eye, look narrowly at a few recent "good" years, and don't think about the billions of dollars in relief bills appropriated in "bad" years like 1992-93, 1995, and 2004-2005, there is something to the point our commentator made yesterday. As the Federal Reserve Bank's article acknowledges:
The subsidy has been reduced since the program's inception in 1968. Eligibility requirements for lower premiums have tightened, and the size of the premium reduction itself has diminished. Nevertheless, about 30 percent of policies remain eligible for subsidized rates, and those policyholders pay only 38 percent of the full-risk premiums for their properties.
[emphasis added]
Who is among that 30 percent? For sure, many Florida -- and Pensacola Beach -- properties, as a detailed study of NFIP claims payments has shown.

Actuarial Accuracy

Few have devoted more energy to uncovering the details of the matter or have had a larger influence in pushing FEMA toward more permanent and satisfactory solutions for flood insurance reform than David Conrad of the National Wildlife Federation. As he says when regularly testifying to Congress (for two examples, see here and here) :
The National Flood Insurance Program (NFIP) is not actuarially sound. It has faced serious and rather chronic deficits. The premiums charged by the NFIP often fail to generate the funds needed to cover flood insurance payments, creating a substantial strain on the program’s financial stability. Between August 1995 and 1998, the NFIP had net borrowing from the U.S. Treasury of $810 million. When the NFIP had accumulated a similar deficit in the early to mid-1980's, Congress was forced to spend more than $1.2 billion to bail out the program.
Things haven't changed much since Conrad's testimony. Three months ago, a useful and easily-accessed analysis of the NFIP was transmitted to Congress by the non-partisan Congressional Research Service and added to the web: Federal Flood Insurance: The Repetitive Loss Problem by Rawle O. King (June 30, 2005) [pdf file].

King slaps a little lipstick on FEMA's NFIP budget numbers when he states that at the core of the NFIP mission is the expectation that it will be self-funding over the long haul: "The NFIP has been able to cover losses through the premiums charged to all policyholders, total income generated from insurance premiums and investments... ." But he also acknowledges that "in heavier loss years the program has had to borrow from the U.S. Treasury to cover losses and other expenses in the short term." And he mostly ignores, presumably because it was irrelevant to the immediate purpose of his report, the huge ad hoc direct relief appropriations that Congress occasionally has provided the agency in years past.

With all of that, Mr. King's tables and apprendices show that before the full bill for Florida's horrific 2004 hurricane season had arrived -- much less the expense of Dennis and Katrina in 2005 -- over the course of its existence FEMA's National Flood Insurance program had fallen in the red by about $14 billion and was 'borrowing' another $200 million for the coming year.

Nuanced Definitions

Is that bad? Not necessarily. As originally established by Congress, only part of FEMA's NFIP was theoretically expected to be self-sustaining -- at least in our lifetime. As King's CRS report infers, one way to view it depends on what is meant by words and phrases like "self-sustaining" and "financially solvent."

The definitional problems are those only an accountant would love, but the voters in a democracy need to understand them if we are to make sound public policy choices through our elected representatives. King writes:
The NFIP does not operate on the traditional insurance definition of fiscal solvency; rather, it operates under a statutory mandate that premiums on pre-FIRM structures — i.e., structures built before the issuance of a FIRM or before [January 1,] 1975, whichever is later — must be reasonable and, if necessary, be subsidized. The subsidy is provided by charging premium rates discounted from full actuarial rates.
This is done by charging premiums based on a so-called "target level of premium income for the program as a whole" that is sufficient to cover losses for a theoretical "average historical loss year."
The premium level generated to cover the average historical loss year must accommodate the combined effect of the portion of NFIP business paying less than full risk premiums and the portion of the business paying full risk premiums."
In other words, more modern structures that meet the latest flood mitigation standards are expected to subsidize older "pre-FIRM" structures that do not. Eventually, the theory goes, those older structures will matriculate out of the picture and the NFIP will be placed on a sustainable pay-as-you-go basis. Meanwhile --
In the event that premium and investment income are inadequate in a given year, the NFIP has statutory authority to borrow up to $1.5 billion from the U.S. Treasury to cover losses. Borrowed funds must be repaid with interest.
Unless, that is, a calamity like Katrina hits a major metropolitan area. Then it's time write home for help.

Corporate Subsidies

Other policies effectively handcuff FEMA's ability to become self-sustaining. One is the congressionally-mandated "Write-Your-Own" flood policy.

The WYO program is characterized as "privatization" or a "private sector business incentive" by its advocates, but it looks a lot more like corporate welfare to the rest of us. A large share of FEMA's insurance business simply is handed off to private insurance companies who are virtually guaranteed a profit without taking any risk. In effect, under the WYO program, insurance corporations are asked to gamble with the house's money while being paid to take an appreciable slice for themselves.

As King explains --
Under the WYO program, private insurers enter into a "Financial Assistant/Subsidy Arrangement" whereby they agree to issue flood policies in their own name and take responsibility for policy administration, claims processing, marketing and sales. Private insurers handle all claims issued in their name, and adjust and settle flood loss claims consistent with their general claims practices. In adjusting flood insurance claims, which are binding upon the federal government, a WYO insurer is authorized to use staff adjusters or independent contractors selected and supervised by the company. The WYO insurer also determines when and how adjusters will be compensated for their work on flood claims.
Repetitive Loss Subsidies

But King's CRS report, like that of the National Wildlife Fund referred to below, focusses on the larger problem of "repetitive losses." These are insured losses which certain dwellings suffer storm-after-storm-after-storm.

You know who you are. From 1978 to 2004, Florida had 5,987 residential properties, alone, that collected a total of $ 292.2 million in repetitive losses, according to FEMA data summarized at Appendix B in King's report.

As many others have, too, King acknowledges the tremendous contribution of Conrad and the National Wildlife Fund for being the first to reveal how, on a nationwide basis, "only two percent of all insured properties" experience "25 percent of all losses" and "claimed 40 percent of all NFIP payments." Many of those were not oceanside properties, as it happens. At least until the past year, a majority tended to be damaged by flooding fresh water from inland rivers and streams.

In 1998, Conrad and his colleagues at NWF managed to drill down into the once-neglected data mine of FEMA NFIP payments. What they discovered was that out of more than 4,500 communities then participating in the NFIP, only 1 percent, or 32,000 insured properties, accounted for 20 percent of the $6.4 billion in NFIP insurance claims paid over the preceding 18 years. Each of these properties had been flooded at least twice, though not beyond the "50 percent rule," and all but a handful were pre-FIRM dwellings. See, Higher Ground: A Report on Voluntary Buyouts in the Nation’s Floodplains (1998). [Caution: this is a digitally-heavy 227-page book in pdf format which has not been optimized for downloading and is slow to load. A hard copy can be obtained by contacting the NWF] Indeed, it was found that "less than one percent (.08 percent) of all flood-prone properties -- those repetitive loss properties with three or more losses -- received more than one-fifth (21.5 percent) of all flood insurance payments costing the NFIP almost $1.4 billion."

Futile Engineering

The NWF also found that flood losses in the United States had risen dramatically over the last century, despite huge federal expenditures on traditional flood control (“structural”) projects. In a prescient passage that might have been written a month ago, after Hurricane Katrina, but in fact was penned seven years earlier, Conrad wrote:
All too often we've seen rivers straight-jacketed into concrete chutes and floodplains transformed into suburbs. Unfortunately, Nature's reminders that we are not her master too often produce more flood victims, more damaged property and more costly disaster relief.
Abandoning Solutions

The convincing facts and tightly reasoned policy proposals of the NWF report triggered among the experts seven years ago a national debate about "non-structural" ways to reduce flood damage and thus more quickly place NFIP premiums on a more realistic actuarial basis. Among them, most attention was devoted to the NWF's recommendations to buy out the rebuilding rights of those properties most at risk and to land-bank them in conservation easements so as to expand wetlands that absorb the brunt of flooding water. Or, as the CRS report puts it, policymakers began to consider new programs to increase funding for "voluntary buyouts, demolition, elevation, and flood-proofing."

All of these programs essentially were scuttled by the Bush administration, however, when FEMA was folded into the newly created Homeland Security Department. Incredibly, as Florida-based reporter Jon Elliston was reporting a year ago:
"[S]ince 2001, key federal disaster mitigation programs, developed over many years, have been slashed and tossed aside. FEMA's Project Impact, a model mitigation program created by the Clinton administration, has been canceled outright. Federal funding of post-disaster mitigation efforts designed to protect people and property from the next disaster has been cut in half, and now, communities across the country must compete for pre-disaster mitigation dollars.
Just a month ago, the Los Angeles Times found things had gotten even worse:
[I]n the aftermath of the Sept. 11 attacks, FEMA lost its Cabinet-level status as it was folded into the giant new Department of Homeland Security. And in recent years it has suffered budget cuts, the elimination or reduction of key programs and an exodus of experienced staffers.

The agency's core budget, which includes disaster preparedness and mitigation, has been cut each year since it was absorbed by the Homeland Security Department in 2003. Depending on what the final numbers end up being for next fiscal year, the cuts will have been between about 2% and 18%.

The agency's staff has been reduced by 500 positions to 4,735. Among the results, FEMA has had to cut one of its three emergency management teams... .

"They've taken emergency management away from the emergency managers," complained Morrie Goodman, who was FEMA's chief spokesman during the Clinton administration. "These operations are being run by people who are amateurs at what they are doing."
Whither National Flood Insurance?

Ideologues, as 'Anonymous' may or may not be, can take heart that the past trend for NFIP was toward a pay-as-you-go, actuarily sound NFIP system. That trend was principally driven by programs that removed repetitive loss properties from the rolls and replaced them with conservation wetlands. It was slow, to be sure, but it was working.

Rationalists, as 'Anonymous could be instead, will focus on the current administration's bungling and cronyism, hoping to stop whatever money FEMA may be given from being shifted away from mitigation to no-bid contracts for the likes of Halliburton and Shaw Group to engineer solutions that haven't solved the problem in the past and aren't likely to do so now.

Either way, calling one or another path 'welfare for the rich' or 'sensible incentives' is pointless. The real issue is, which approach is more likely to work for the betterment of the national community and society as a whole?

The answer is not a matter of faith or didactics, but facts. And, as perhaps 'Anonymous' will agree, on the facts the National Wildlife Federation proposals win, hands down.


morrie said...

I'm the one who posted about the NFIP yesterday.It seems the program is like all other Federal programs in that they get perverted just like social security. Thanks for your article as one of the most informative that I have read.

Captaingrubby said...

Who knows if FEMA is ever "really" going to have a good program in place. The best assistance my friends in FL received for flood damage that got from hurricanes was from a Public Adjuster but there are plenty of "non-licensed" agents acting as adjusters just trying to get your money to take advantage of the recent tragedies. Great article.