If American politicians want to diminish the harms of flooding, recently on deadly display on the other side of the Atlantic, an easy first step would be to eliminate the National Flood Insurance Program (NFIP). Keeping this failing program in place encourages people to live in dangerous, flood-prone areas.
Established in 1968, the NFIP aimed to reduce post-disaster aid by subsidizing flood insurance. Instead, by artificially lowering the risk premium of building new structures, the program exacerbates disaster-related risk and encourages more building in flood-prone areas. Meanwhile, costs went up, not down: The agency owed more than $25 billion to the U.S. Treasury until 2017, when taxpayers bailed out $16 billion of its debt.)
The program is a perfect example of moral hazard, a phenomenon in which people take more risks knowing they will not bear the full cost of the risk. In this case, the government gives homeowners insurance at premiums far below market prices. The program accepts all applicants, and rates do not increase when the same homeowner makes multiple claims for flooding. All this distorts the market signaling of risk.
The program also suffers from what economists call the time-consistency problem: Even if the NFIP stopped insuring new buildings in flood-prone areas, people know the government has bailed people out in the past and expect it will do so again. To the government, another bailout is seemingly harmless, since people already live in flood-damaged areas. So people keep moving to those areas, and the government keeps bailing them out. The estimated number of people living in America’s officially designated Special Flood Hazard Areas rose from 10 million in 1970 to more than 16 million—though some estimates say FEMA vastly underestimates this risk, and the real number is closer to 41 million. The “flood insurance program” is exposing more people to flooding risks.
Nor, for the most part, is the program helping low-income families afford homes. It’s not hard to imagine the main demographic of people buying houses in flood-prone coastal areas: high-income families escaping the suburbs for a vacation. Ending the NFIP would move these people away from flood-prone areas by making it more costly to build there.
As politicians go on a spending spree, hiding pet projects hidden in lengthy climate legislation, we need cheaper, smarter, and more effective policies. A private flood insurance market will make premiums expensive for people wanting to build in a flood-prone area—or not offer insurance at all where the risk is too high. That is how the market is supposed to work.
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