Floods are natural phenomena in all rivers and river systems in the United States and occur with depths and durations that vary seasonally and annually. Coastal storms and their associated storm surges affect US shoreline locations, especially the eastern and gulf coasts. Riverine flooding and coastal storms are major news items nearly every year in the United States and in the last decade have included Hurricanes Katrina (2005) and Sandy (2012), large floods on the Missouri River and the Mississippi River in 2011, and flash flooding in Colorado’s Front Range (2014). Flooding causes property damage and may cause relocations of large portions of communities. Coastal flooding caused by storm surges can damage property along oceans and bays. Given the numerous economic advantages and aesthetic values of habitation and development in floodplains and coastal areas in the United States, many of these areas have large populations and high-value properties. That land settlement pattern is the result of both individual choices and government programs and policies that considered pros and cons of living and working in those areas that have flood risks. Many people who live in areas subject to flood risk do so because of historical, economic, and other circumstances, such as needing or wanting to live close to work, schools, health care, and so on. Some properties in areas of flood risk are second homes. In some locations, flood risk in low-lying areas has depressed property values and resulted in occupation by lower-income households.
The US federal government has adopted policies that seek an appropriate balance between advantages of and risks associated with human occupancy of floodplain and coastal-zone locations. The policies include
the requirement that before a federally funded flood-control project can be authorized and constructed, project benefits must be shown to exceed the costs (see NRC, 1999, 2004). Beginning in earnest in the 1970s, federal policies and programs have sought to encourage state and local governments to adopt floodplain management to manage flood risk (for example, Executive Order 11988: Floodplain Management, 19771). Among the policy options for balancing a location’s flood risk against its benefits is the availability of federal flood insurance and encouragement of its purchase.2 Insurance premiums can help increase property owners’ understanding of flood risk. Insurance also can be seen as a replacement for disaster aid, and ideally insurance premiums based on expected flood losses would cause property owners to balance advantages of floodplain location against associated risks as measured by the cost of insurance. For those results to be realized, people would have to purchase the insurance.
The National Flood Insurance Act of 1968 created the National Flood Insurance Program (NFIP), which made flood insurance available to floodplain property owners. After initially being housed in the Department of Housing and Urban Development, the NFIP today is administered by the Federal Emergency Management Agency (FEMA). Beyond setting flood-insurance premiums, issuing policies, and paying for claims, FEMA provides technical knowledge of flood risks to local professional staff and provides risk mapping for premium setting and risk communication purposes. In addition, FEMA has pre-flood mitigation grant programs and post-flood emergency aid and mitigation programs. Many of the programs are linked directly to FEMA’s administration of the NFIP. For example, pre-flood mitigation grants are targeted to insured properties that have a history of repetitive damage claims.
Beginning with passage of the Biggert–Waters Flood Insurance Reform Act of 2012 (Biggert-Waters 2012, or BW 2012), NFIP’s premium-setting practices have been under intense scrutiny. Understanding the cause of concerns about the NFIP requires understanding its origins. The National Flood Insurance Act of 1968 created the NFIP, in which private insurers would offer policy coverage in partnership with the federal government. Private companies were expected to rate risk and set premiums with NFIP technical assistance and oversight. Private insurers’ premiums included charges for administrative costs and profit, as would be the case for any line of insurance. Rather than have the private partners build a reserve fund to
1E.O. 11988 from 1977, including a summary of its description and intent, is available at https://www.fema.gov/environmental-planning-and-historic-preservation-program/ executive-order-11988-floodplain-management; accessed December 8, 2014.
2In the early 20th century, a small number of private companies offered flood insurance in the United States. The great Mississippi River floods of 1927 and additional riverine flooding in 1928 essentially terminated the industry as insurers dropped out of the market (King, 2005).
pay claims for this new line of business, the legislation allowed the federal government to make loans, if needed, to honor claims in years when accumulated premium revenues (net of all payments to the private providers) were inadequate and then to have the loans repaid in years when revenues exceeded claims and expenses.
A concern at the time was that the private insurers’ premiums be kept at “reasonable” levels. In practice, the desire to keep rates “reasonable” resulted in two NFIP design features that affected premiums. First, a fully risk-based flood premium would need to include the cost to maintain solvency for expected claims from low-probability–high-damage storms that result in widespread damage (catastrophic-loss events). Fully reflecting such a possibility in NFIP policies might result in higher premiums. The legislation stipulated that the US Treasury would be prepared to serve as the reinsurer, and would pay claims attributed to catastrophic-loss events so that private insurers did not need to include that cost in premiums. The result was that an NFIP risk-based premium for a property might not be based on the full risk associated with the property.3
Second, existing properties at especially high risk for flooding might require private insurers to set premiums at extremely high levels. The legislation required the NFIP to determine a reasonable premium for such properties, which would be less than an NFIP risk-based premium. Private insurers would charge the reasonable premium, and the federal Treasury would make annual equalization payments to make up the difference between the NFIP risk-based rate and the lower premium. To qualify for the subsidized premium, a property had to be in a community that was enrolled in the NFIP. A condition of enrollment was that the community would limit new development to areas above the 100-year base flood elevation (BFE), as the BFE was depicted on an NFIP flood-insurance rate map (FIRM) for that location (see the List of Terms, which is included at the end of this report and before the report appendixes, for definitions of these and other technical terms in this report). Once a community was enrolled, these subsidized premiums became available to property owners whose properties were built before the local FIRM was prepared (and referred to as pre-FIRM subsidies). The expectation was that properties receiving pre-FIRM subsidized premiums would eventually be lost to floods and storms and pre-FIRM subsidized premiums would be phased out by that attrition. At that point, the federal role in the partnership would be to provide loans and act as the reinsurer.
3Throughout this report, the term NFIP risk-based premium is used to recognize that NFIP premium-setting practices are constrained by legislative and executive-branch decisions (see List of Terms). Design features that affect premium levels are discussed in detail in Chapters 2 and 3.
Within a decade, however, the original concept of partnering with the private sector was replaced by a process whereby the NFIP took responsibility for setting rates, issuing policies, collecting premiums, and paying claims. After that transition, the federal Treasury was expected to make loans to the NFIP as needed to honor claims in high-loss years and be repaid in low-loss years. As will be discussed through this report, NFIP risk-based rate setting practice proceeded as though catastrophic losses would not be paid from premiums. Another rate setting practice that continued was to offer less than NFIP risk-based rates to properties that existed before local FIRMs were issued. Equally important, the fundamental premise that premiums be kept reasonable to encourage purchase retained its level of importance in rate-setting. The agency executing those responsibilities today is the Federal Insurance and Mitigation Administration (FIMA), which is in FEMA. Currently, the private sector’s role in the NFIP is to serve as the local agent through which property owners apply for insurance and settle claims (see definition of “Write Your Own” [WYO] agent in the List of Terms).
Despite efforts to keep premiums reasonable, the NFIP has always experienced a low level of insurance-policy purchase, or voluntary takeup rate (see List of Terms). Over time, the desire to increase takeup rates has led to a number of program changes and initiatives. Flood insurance purchase was made mandatory for property owners who have a federally insured or backed mortgage on a property that is in a special flood hazard area (SFHA). Voluntary purchase still applies to properties outside an SFHA that do not have such mortgages. To motivate voluntary insurance purchase, there has been enhanced NFIP marketing of its polices, support for building floodplain-management expertise at the local level, development of the preferred-risk policy (PRP), WYO agent training, and such other reforms as imposing a waiting period to prevent coverage purchase only right before a flood event. Although some 5.5 million policies are in force today, they do not provide coverage for all properties in the nation’s 100-year and 500-year floodplains. Among the roughly 5.5 million NFIP policies, in 2013 about 20% of policyholders were eligible to pay pre-FIRM subsidized premiums.
The financial obligation for paying insurance claims after Katrina and other large and catastrophic-loss events in 2005—Hurricanes Dennis, Emily, Rita, and Wilma—was assigned to the NFIP. The claims greatly exceeded any available reserve, so as an accounting matter the NFIP was driven into debt. As of December 31, 2013, FEMA owed the US Treasury
$24 billion (its borrowing authority is $30.4 billion; GAO, 2014). The Government Accountability Office concluded that the NFIP “is unlikely to generate sufficient revenue to cover future catastrophic losses or repay billions of dollars borrowed from the Department of the Treasury” (GAO, 2014) and has included the NFIP on its “high fiscal risk” list since 2006. It is worth noting that the intent and design of the NFIP never envisioned burdensome levels of debt in the program.
Concerns regarding long-term NFIP fiscal soundness led to Congress’s passage of the Biggert–Waters Flood Insurance Reform Act of 2012. A goal of the legislation was to transition toward an insurance program whose premiums reflected expected flood losses on all insured properties; all NFIP policies would have risk-based premiums. To that end, BW 2012 directed FEMA to review and report to Congress on reforms to set NFIP risk-based rates that would better reflect possible claims. BW 2012, Section 100236, also mandated the present National Research Council study of affordability of NFIP premiums (Box 1-1).
The legislation also required the elimination of pre-FIRM subsidized premiums and removal of “grandfathered” premiums. The grandfathering practice allowed owners of buildings that were built in compliance with previous FIRMs to maintain their original rating classification even if a new FIRM indicated a greater risk of flooding (see List of Terms). The grandfathering practice also allows structures that were not built in compliance with previous FIRMs, but nevertheless demonstrated compliance with those previous FIRMs, to maintain their demonstrated rating classification as long as continuous coverage of NFIP insurance is maintained. Meanwhile, new FIRMs were being produced for many areas across the nation. Some properties that had been mapped outside the SFHA (and often were built intentionally outside) were remapped as inside the SFHA. Owners of these properties who may not have purchased an NFIP policy may now be required to purchase one; in addition, because they would now be in the SFHA, the properties that have new polices would have higher premiums than properties outside the SFHA.
As the provisions of BW 2012 began to be implemented, there was an outcry from some parts of the nation. News accounts reported on possible premium increases that might be in the thousands of dollars per year (see, for example, New Orleans Times Picayune, 2013; New York Times, 2013). Some households that would lose pre-FIRM subsidized premiums argued that the insurance would become unaffordable. Others argued that households had followed the NFIP rules and made financial plans on the basis of expected insurance premium levels and that because they had followed NFIP rules the sharp increases in premiums would be unfair. That argument was especially important to policyholders who would lose grandfathered premiums and now were having to pay more and to policyholders that had
Statement of Task
The Federal Insurance and Mitigation Administration (FIMA) is a component of the Department of Homeland Security (DHS), Federal Emergency Management Agency (FEMA), which operates the National Flood Insurance Program (NFIP). On March 21, 2014, President Obama signed the Homeowner Flood Insurance Affordability Act (HFIAA) of 2014 into law. This law repeals and modifies certain provisions of the 2012 Biggert–Waters Flood Insurance Reform Act, and makes additional program changes to other aspects of the program not covered by that Act. One modification regards a study being conducted by the National Research Council of the National Academy of Sciences. HFIAA requires the submission of the Affordability Study by the FEMA Administrator in 18 months from enactment of the Act. FEMA has asked the NAS to provide two reports as part of the NFIP Affordability Study.
The first report, due in February 2015, will discuss the underlying definitions and methods for an affordability framework and describe the affordability concept and applications, and program policy options.
The second report, due in September 2015, will propose alternative approaches for a national evaluation of affordability program policy options, based in part on lessons gleaned from a proof-of-concept pilot study to be guided by the NRC committee.
An ad hoc committee under the auspices of the National Research Council will prepare both reports according to the following statements of task:
The first report will discuss the underlying definitions for an affordability framework and describe the affordability concept and applications and program policy options.
The first report shall discuss
deliberately built outside the SFHA and now had an unexpected new insurance purchase requirement. In addition, communities where those effects might occur argued that higher premiums might depress real estate values, business profitability, and neighborhood viability. Furthermore, Congress had heard concerns that higher insurance premiums might discourage voluntary purchases and thereby reduce flood insurance takeup rates.
This report shall be delivered by September 20, 2015.
As a result of the vigorously stated concerns about affordability, Congress passed the Homeowner Flood Insurance Affordability Act of 2014
- methods for establishing an affordability framework, including means-tested vouchers, for the National Flood Insurance Program;
- appropriate and necessary assumptions and definitions, including “affordability” and “full risk-based premiums.”
This report shall be delivered by February 28, 2015.
The second report will propose alternative approaches for a national evaluation of affordability program policy options. The second report will include lessons for the design of a national study from a proof-of-concept pilot study.
The second report shall discuss
- data issues such as needs, availability, quantity, and quality;
- appropriate analytical methods and related considerations, including models, computing software, and geographic areas to be analyzed;
- a proof-of-concept pilot analysis will be subcontracted as part of the study. This analysis will apply different methods for conducting a flood insurance affordability analysis for a state (North Carolina) in which data on elevations of structures and hydrologic flood hazards are readily available. This analysis will inform the committee’s deliberations and findings regarding the possibilities for a national-level flood insurance affordability study, for which these data on elevations and flood hazards are less readily available;
- national implications from the proof-of-concept pilot results including, but not limited to, possible impacts on participation rates (the analytical work for the proof-of-concept pilot may be carried out by the NRC directly or using subcontractors as necessary).
(HFIAA 2014). One result of HFIAA 2014 was that grandfathering practices that had been phased out under BW 2012 were reinstated. A second result was that pre-FIRM subsidized premiums would not be lost when a property was sold, as was the case with BW 2012. However, HFIAA 2014 introduced a requirement that owners of primary residences, whether the property was sold or not, face rate increases each year of no less than 5%, and as much as 18%, until the NFIP risk-based premium was reached. HFIAA 2014 left unchanged the BW 2012 requirement that pre-FIRM
Considerations in Setting
National Flood Insurance Program Premiums:
Affordability, Reasonableness, and Fairness
The present report uses numerous technical terms, many from the NFIP itself and some from the insurance, actuarial sciences, and other fields. Some of the terms may be unfamiliar to readers or may have been used inconsistently in writing and testimony about the NFIP through the years. Key terms are defined in each chapter of this report. The report also includes a “List of Terms” that are specific to the NFIP. To the extent possible, those terms were taken from FEMA Web sites and reports. Terms that were not defined by FEMA are defined in this report to ensure consistency.
A term that warrants particular discussion is affordability. This term was used in BW 2012 (Section 100236) that mandated this report. It also is used in HFIAA 2014 (Section 9) to refer to “targeted assistance to flood insurance policy holders based on their financial ability to continue to participate in the National Flood Insurance Program.” Although there is no explicit definition of affordability, use of the phrases means-testing and financial ability suggests that Congress expected affordability to be defined in relation to an NFIP policy holder’s income or wealth. That is consistent with the understanding of the term in the present report.
At the same time, HFIAA 2014 asks the NFIP to “strive for” premiums that are no more than 1% of the policy coverage, a number that is unrelated to either the income or wealth position of the policy holder. It is not clear whether the suggested 1% cap was offered as a definition of premium affordability or had some other basis (for example, to define when premium levels were “reasonable” or “fair”). (The term reasonable had been used to describe the desired level of NFIP premiums during hearings for the original legislation that led to the creation of the NFIP in 1968).
Congress strove to set NFIP premiums that were reasonable for two reasons. First, at the NFIP program’s inception, all purchase was voluntary. A reasonable premium therefore would not be so high that households would be unwilling to purchase a policy. Second, NFIP risk-based premiums could be extremely high for properties in areas mapped as floodplains but built before the flood risk was identified; some households in this situation would not be able to pay a high NFIP risk-based premium. A reasonable premium for properties built before an area had been mapped was therefore calculated by using lower than NFIP risk-based rates.
Although a premium might be affordable if a household’s income were considered, fairness could be a consideration in defining a reasonable premium. A reduced premium would be considered fair because property owners would not be penalized with high premiums if they chose property locations that were consistent with the applicable rules before the NFIP was created. This fairness argument was another reason that lower than NFIP risk-based rates were offered when the program began and is used to justify the practice of grandfathering.
subsidies be phased out through 25% annual increases for nonprimary residences, for properties that made frequent NFIP claims, and others. HFIAA 2014 also added premium surcharges on all polices to help to offset revenue lost to the program from pre-FIRM subsidies that would remain in place until all property owners were paying NFIP risk-based premiums. The HFIAA 2014 legislation expected that all pre-FIRM properties would eventually pay NFIP risk-based premiums; so in the long run, the difference between HFIAA 2014 and BW 2012 would be that grandfathering would be continued. HFIAA 2014 retained the BW 2012 direction that FEMA review its NFIP risk-based premium-setting procedures.
HFIAA 2014, as indicated in its title, reflected concerns about the affordability of flood insurance. Affordability had also been recognized in BW 2012 as a possible concern (Box 1-2 elaborates on the term affordability and other related terms central to the present report). Both BW 2012 and HFIAA 2014 contained numerous provisions for assessments and studies, including studies regarding flood-insurance affordability. Both acts mandated studies by the National Academy of Sciences (NAS) and called for related studies by FEMA. BW 2012 called for an “economic analysis” to be conducted by NAS that would, among other things, “compare the costs of a program of risk-based rates and means-tested assistance to the current system of subsidized flood insurance rates and federally funded disaster relief for people without coverage” (PL 112-141; 126 Stat. 957). Appendix A contains Section 100236 of BW 2012, which mandated the NAS study. The charge to NAS was amended in HFIAA 2014, which changed the schedule and resources available for conducting the NAS study; amendments were presented in HFIAA 2014 Section 16 and are listed in the present report in Appendix B). Appendix C contains BW 2012, Section 100236, as amended by HFIAA 2014 Section 16. HFIAA 2014 also called for FEMA to prepare a “draft affordability framework” (Section 9):
SEC. 9. DRAFT AFFORDABILITY FRAMEWORK.
(a) IN GENERAL.—The Administrator shall prepare a draft affordability framework that proposes to address, via programmatic and regulatory changes, the issues of affordability of flood insurance sold under the National Flood Insurance Program, including issues identified in the affordability study required under section 100236 of the Biggert–Waters Flood Insurance Reform Act of 2012 (Public Law 112–141; 126 Stat. 957).
(b) CRITERIA.—In carrying out the requirements under subsection (a), the Administrator shall consider the following criteria:
(1) Accurate communication to consumers of the flood risk associated with their properties.
(2) Targeted assistance to flood insurance policy holders based on their financial ability to continue to participate in the National Flood Insurance Program.
(3) Individual or community actions to mitigate the risk of flood or lower the cost of flood insurance.
(4) The impact of increases in risk premium rates on participation in the National Flood Insurance Program.
(5) The impact flood insurance rate map updates have on the affordability of flood insurance.
A key consideration throughout the history of the NFIP has been to offer policy alternatives that would be affordable to floodplain and coastal residents. In response to BW 2012 and HFIAA 2014 legislation for NFIP reform, and in response to a request from FEMA, the National Research Council4 formed a volunteer expert committee in 2013 to address a task statement (Box 1-1) and to issue two reports in 2015.
Like most National Research Council committees, this committee was guided by its statement of task (Box 1-1). When reading this report, it is important to recognize that the language from Section 100236 of BW 2012 as amended in HFIAA 2014 (see Appendixes A, B, and C) differs from the language in the committee’s statement of task. The language in the statement of task was discussed and agreed on by FEMA and the National Research Council with consideration of the resources available to the NRC and the needs of FEMA.
This document is the first of two reports from this committee. In keeping with the statement of task, this report offers and discusses alternative definitions of affordability, provides a framework for policymakers to use in designing assistance programs to make flood insurance more affordable, identifies options that in principle may make flood insurance more affordable, and describes possible benefits, drawbacks, and implications of the policy options for addressing affordability concerns. The report does not attempt to design programs or actions to promote flood insurance affordability, nor does it describe how risks associated with floods might be reduced through insurance or other actions. The report does not address how levees affect floodplain development and NFIP insurance rates; this topic was covered in detail in NRC (2013), which was prepared for FEMA. The present report naturally refers often to floodplains and floodplain ar-
4The National Research Council is the working arm of the National Academies. The National Academies is the collective entity that includes the National Academy of Sciences, the National Academy of Engineering, the Institute of Medicine, and the National Research Council. For more information see http://nationalacademies.org.
eas; unless otherwise specified, floodplain refers to an area inundated by a 100-year (1% annual) flood (see also Appendix E for further discussion of NFIP floodplain designations).
The committee’s second report will include alternative analytic procedures for FEMA to consider when it designs a national-level flood-insurance affordability analysis. It will discuss metrics for evaluating affordability policy alternatives described in the present report and possible computational procedures for estimating the effects of policy actions on each of the metrics. The second report will inform FEMA on costs of data collection and implementation of analytic protocols, including a sampling strategy for FEMA to use in implementing a national study. Implications for data and analytic needs for a national study of flood-insurance affordability will be inferred via a case study (or “proof-of-concept” exercise) in applying different analytic processes to available data that have been compiled by the North Carolina Department of Public Safety and that constitutes one of the nation’s extensive datasets of locations of structures in floodplains and coastal areas.
During the writing of this first report, the committee held four meetings that were devoted generally to topics under the rubric of “affordability.” Meetings were held in January, March, July, and November 2014, all in Washington, DC. In the course of its work, the committee spoke with numerous guest speakers who provided invaluable information for the committee’s deliberations about the content of its report. Appendix D lists all those who spoke with the committee during open public sessions of its meetings.
This report contains eight chapters. Chapter 2 provides an overview of the NFIP history and its legacy leading up to BW 2012, focusing on NFIP pricing practices before BW 2012. Chapter 3 explains the process for setting NFIP risk-based premiums and the constraints that the NFIP had to adhere to in setting them. With that understanding, distinctions among NFIP risk-based, pre-FIRM subsidized, grandfathered premiums, and Community Rating System discounted premiums can be explained, as can the reforms called for by BW 2012 and HFIAA 2014. Chapter 4 discusses the demand for insurance and the factors other than price that determine the willingness of floodplain-property owners to buy an NFIP policy. Chapter 5 uses NFIP policy data to locate the areas of the nation where there are concentrations of pre-FIRM policies that would increase to NFIP risk-based premium levels as a result of recent policy reforms. Chapter 6 first describes three alternative concepts of affordability that can be used to define when NFIP full-risk premiums might create a cost burden for homeowners and renters. Chapter 6 also describes potential eligibility criteria and other decisions that need to be made in designing an assistance program, such as the amount of assistance to be provided to eligible households. Chapter 7 describes
policy options that have been suggested by others or that the committee has developed that might make flood insurance more affordable. Some of the options are proposed as ways to lower premiums through mitigation actions that lower risk; others would directly reduce the amount paid for insurance by either cost-burdened groups of property owners and renters or all policy holders. Inasmuch as this is the first of two reports, Chapter 8 describes briefly the objectives of the second report and its relationship to the findings of the present report.
The audience for this report includes FEMA; other relevant federal agencies, such as the Department of Housing and Urban Development; Congress and congressional staff; governors of states that have flood-prone communities; mayors and citizens of flood-prone communities, especially NFIP policy holders; university faculty and other experts in the fields of natural hazards and flood insurance; local and state officials who have NFIP implementation responsibilities; and private sector experts, including insurance companies, mapping companies, and other firms that advise on flood insurance and floodplain management issues.