Reauthorizing the National Flood Insurance Program

Howard Kunreuther

Many U.S. homeowners are inadequately protected against flood hazards. Relatively few purchase flood insurance and even fewer invest in cost-effective risk-reduction measures. As a result, many are left in financial straits when floods, storms, or hurricanes wreak havoc on their homes.

The National Flood Insurance Program (NFIP) – the primary mechanism through which the federal government can influence homeowners’ flood risk management decisions – is scheduled to be reauthorized this month.  This provides Congress with the opportunity to make the program more transparent with respect to the risk that people face, more cost-effective, more equitable, and more relevant to property owners in areas subject to flood-related damages.

In undertaking the reauthorization of the NFIP, Congress should bear in mind two guiding principles for insurance, detailed below.  In addition, with increased knowledge of consumer behavior, a behavioral risk audit provides strategies that will nudge and incentivize individuals to make decisions that will ultimately reduce their future flood-related losses.

Guiding Principles

Principle 1: Premiums should reflect risk. Insurance premiums should be based on risk to provide individuals with accurate signals as to the degree of hazard they face and to encourage them to engage in cost-effective adaptation measures to reduce their vulnerability.

Accurate flood maps are necessary to set risk-based insurance premiums. FEMA’s current approach of simply identifying the 1-percent-annual-chance floodplain and associated base flood elevation is inadequate. As recommended by the Technical Mapping Advisory Council (TMAC), FEMA should transition to a “structure-specific flood frequency determination” for insurance rating purposes. In other words, premiums should account for more details of the hazard, beyond just the 1% annual chance event, as well as aspects of the property, including features that reduce flood damage.

Accurate flood maps also need to account for pluvial, or storm water flooding, such as Baton Rouge, Louisiana, and Houston, Texas, which suffered major damage from rain-driven flooding in 2016 and 2017. These storm-related flood events are not accounted for in FEMA flood maps, yet make up more than 20% of flood claims.

Accurate flood maps, created with LIDAR technology, coupled with elevation data on individual structures, would provide robust flood risk information that FEMA and other stakeholders could use to effectively communicate the risk to homeowners.

Principle 2: Dealing with fairness and affordability.  Any special treatment given to low- and middle-income individuals currently residing in hazard-prone areas who cannot afford risk-based premiums should come from general public funding rather than through insurance premium discounts. Means-tested vouchers are proposed for this purpose. To reduce government expenses, homeowners can be incentivized to invest in cost-effective loss reduction measures through long-term loans and well-designed building codes.

Risk-based premiums provide essential signals to homeowners about their level of flood risk, but the cost of insurance can cause economic hardship to some.  One way to maintain risk-based premiums while addressing these affordability and fairness challenges is to offer means-tested vouchers or tax credits that cover part of the premium cost. Existing federal efforts such as the Supplemental Nutrition Assistance Program (the food stamp program) could serve as a model for developing such a voucher system. Voucher funding could come from sources such as general taxpayer revenue, state government, or taxes on insurance policyholders. As a condition for the voucher, the property owner could be required to invest in cost-effective loss-reduction measures, which have been shown to reduce premiums and lower government costs.

For new construction, loss-reduction measures and well-enforced building codes will reduce future flood losses.   For example, in 2001, Florida enacted the strongest statewide building code in the U.S. and over the next ten years, homes built to the new standards suffered far less wind damage than homes that were not. Although it costs more to build to the stricter code, every $1 of increased construction costs results in average savings of $2 to $8 in expected damage reduction.

Designing a behavioral risk audit

An insurance program only works if consumers are willing to purchase coverage. It is important to recognize that consumers are not driven strictly by cost-benefit calculations, but often by emotional reactions and simple rules of thumb they’ve acquired through personal experience. These factors limit consumers’ ability to understand the risk and make insurance choices in the same way that experts would. To design an effective program, it is necessary to address the biases that lead homeowners to underinvest in insurance and preventive measures. These biases include: myopia, amnesia, optimism, inertia, simplification, and herding.

A behavioral risk audit can guide strategies to deal with these biases. The audit starts with a systematic analysis of the cognitive barriers to buying insurance and/or undertaking mitigation and articulates their consequences. It then invites possible solutions that work with rather than against people’s risk perceptions and decision biases. An audit of the flood-risk problem might yield a matrix such as the one below, which generates a suite of measures for enhancing flood preparedness.

Behavioral Risk Audit for Protecting Against Flood Damages 

For more detail, see The Ostrich Paradox: Why We Underprepare for Disasters

The recommendations proposed in the behavioral risk audit reinforce the need to prepare now for future floods. An important first step is for Congress to provide significant funding for more accurate flood maps in reauthorizing the NFIP. It is essential that residents in flood-prone areas have accurate information about their risk, the steps they can take to reduce future losses, and how insurance can protect them if they suffer severe damage.

The success of such a program requires the support and interest of many stakeholders, including real estate and insurance agents, banks and financial institutions, builders, developers, contractors, and local officials. If these parties recognize the importance of reauthorizing the NFIP to adhere to the guiding principles for insurance, we will be more successful in financially protecting property owners in hazard-prone areas and reducing flood-related losses in the future.

More details on the challenges and opportunities facing Congress in reauthorizing the NFIP can be found in the paper “Reauthorizing the National Flood Insurance Program” to be published in the National Academy of Science publication, Issues in Science and Technology (Spring 2018). See full paper here.