River and coastal floods are among the nation’s costliest natural disasters. One component of the nation’s approach managing flood risk is the availability of flood insurance policies, which are offered on an individual basis primarily through the National Flood Insurance Program (NFIP). Established in 1968, the NFIP is administered by the Federal Emergency Management Agency (FEMA). About 5.4 million individual policies are in the NFIP. Throughout the years, the program has experienced a mixture of successes and persistent challenges. Successes include a large number of policyholders in many flood-prone areas across the nation, the insurance of approximately $1.3 trillion in property, and the majority of policyholders (80 percent) paying NFIP risk-based rates. NFIP challenges include large program debt (roughly $23 billion), relatively low rates of purchase (takeup) in many flood-prone areas, a host of issues regarding affordability of premiums, and a large number of properties that experience severe repetitive flood losses.
To help address some of these challenges within the NFIP, the U.S. Congress passed the Biggert-Waters Flood Insurance Reform Act of 2012 (BW 2012) and the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA 2014). Part of the conversation regarding NFIP reform is the prospect of a community-based flood insurance (CBFI) option—that is a single insurance policy for an entire community. Section 23 of the HFIAA 2014 legislation asked FEMA to evaluate the prospects for CBFI. To satisfy this congressional request, FEMA asked the National Research Council (NRC) to convene an expert committee on a CBFI option (see Statement of Task in Box 1-1, Chapter 1).
This report identifies a range of key issues and questions about a CBFI option that merit further analysis and consideration. Consistent with its statement of task, the committee provides “food for thought”—but does not offer any recommendations—to FEMA and the U.S. Congress as they weigh the possible benefits and challenges of a CBFI option. To have an impact, a CBFI—either as a stand-alone policy option or as part of a suite of policies—will need to address specific challenges.
This report was written on a relatively short timeline and was based in part on presentations and discussions at the two meetings of the National Research Council (NRC) Committee on Community-based Flood Insurance Options. The committee’s first meeting was held in January 2015 and featured guest presentations; a second meeting was in March 2015 and was convened in a workshop-type format with multiple panels and numerous discussants. (Appendix A includes a list of guest speakers.) Short summaries and key points of these discussions and presentations are included in the body of this report.
To summarize the broad spirit of this report, CBFI may create new opportunities to reduce flood losses, and may enhance the likelihood of communities paying more attention to flood risk mitigation. At the same time, although CBFI may provide a solution in certain circumstances, it is unlikely that it will provide the sole solution for the nation’s pressing flood insurance challenges.
WHAT IS COMMUNITY-BASED FLOOD INSURANCE
Community-based flood insurance has been discussed as a possible policy option. A CBFI option could be based on aggregating the dollar sum of flood loss risks for community structures. Costs could be distributed in a variety of ways. For example, one method could be to distribute premium cost according to each individual’s assessed flood risk. The community could purchase the insurance, and premiums could be collected using mechanisms such as property taxes or utility charges.
FEMA defines a community as a “political entity that has the authority to adopt and enforce floodplain ordinances for the area under its jurisdiction.” In addition, it has the authority to enact and enforce development regulations. This present report does not define a community or CBFI; rather, it cites pertinent past work and examines the future prospects for CBFI—whatever form it may take—and discusses topic areas that will require further evaluation by FEMA and others. Clear definitions will be important if CBFI is to be implemented, and those definitions will be made based on input from elected officials, FEMA, and citizens. It may be helpful to broaden the current FEMA definition of community; a town or city would clearly qualify. It is unclear whether a geographic area in a city, a gated community, or a business district would qualify; however, these enti-
ties generally lack authority to enact land use controls to impact floodplain management, building code enforcement, and land use decisions at the local level.
FLOOD RISK MANAGEMENT AND A PRECEDENT FOR A COMMUNITY-BASED FLOOD INSURANCE
Within the NFIP, flood insurance is primarily offered to individuals. Although there is no present CBFI option, communities can participate in the NFIP in several ways. Communities play a substantial role in flood risk management and they often qualify for or receive federal resources to undertake mitigation. Chapter 3 highlights some of these examples to illustrate the precedent for community-based efforts to do mitigation and reduce flood risk.
An excellent example of community-level participation in the NFIP is the Community Rating System (CRS). This is a voluntary, incentive-based program for communities already in the NFIP that undertake various floodplain management measures to prepare for—beyond minimum NFIP requirements—and mitigate against flood losses. The CRS is a class rating system that recognizes measures to help reduce exposure to floods. Taken at the community level, these measures can result in flood insurance premium discounts for policyholders. As of March 2014, about 1,300 communities were actively participating in the CRS. Although this is a small percentage of the 22,000 NFIP participating communities, greater than 65 percent of NFIP policies are written in CRS communities. Within the NFIP, relevant community-based experiences already exist and merit assessment if a CBFI option is pursued.
KEY FLOOD INSURANCE TOPICS
A wide range of topics are pertinent to the NFIP’s current challenges. Chapter 3 focuses on key flood insurance topics, which include the following:
- Participating Communities. Many different types of communities participate in the NFIP. Some communities have thousands of policies-in-force, while others have only a few, which suggest that one size does not fit all and that CBFI should allow for various approaches.
- Takeup Rates. Low takeup rates for NFIP insurance policies, and low rates of policy retention.
- Community Involvement in Flood Insurance. Municipal governments do not write NFIP policies. They are, however, involved in floodplain management and mitigation activities that may impact flood insurance premiums.
- Communication of Flood Risk. Informed property owners are often well positioned to manage flood risk, which includes the flood insurance purchase decision. FEMA has spent considerable effort, with measurable success, in communicating flood risk at the individual and community levels.
- Flood Insurance Pricing. Pricing in the NFIP differs from insurance pricing in the private sector. If discounted or subsidized policyholders had to pay risk-based premiums, then policyholders may be more motivated to engage community officials to undertake measures to reduce flood exposure, thereby reducing flood insurance premiums.
- Socioeconomic Factors. Because increasing takeup rates is a goal of the NFIP, it would be helpful if nonfinancial and intuitive thinking be considered. Movement toward full-risk premiums in a community could significantly affect real estate and local tax base. Socioeconomic factors are not limited to private property within a community; other important considerations include public infrastructure and the environment.
RATIONALE AND JUSTIFICATION FOR COMMUNITY-BASED FLOOD INSURANCE
The committee developed a conceptual rationale for CBFI (Chapter 4) that helps to identify where CBFI might be desirable, and where it may not. The Coase Theorem, developed in the economics field, holds that where parties—both individuals and groups—account for all costs and benefits, markets are functional, information is freely and widely available, transactions costs are zero, and economically efficient outcomes are reached irrespective of with whom the property rights are vested. If the collective economic interests of communities and residents fully coincide and are fully accounted for, the outcomes of a flood insurance purchase decision do not rely upon which party—communities or residents—bears responsibility for insurance.
In considering practical applications of the Coase Theorem to flood insurance, there are at least eight reasons (see further details in Chapter 4) to explain why a “Proposition of Responsibility of Insurance is Irrelevant” may fail to hold. Two of these reasons are free riding—when some or all residents do not buy insurance because they expect disaster relief to provide adequate post-flood aid—and externalities—when self-interested parties fail to account for all of the impacts, when deciding to buy or not buy insurance. These reasons help guide the identification of circumstances when CBFI may be superior or inferior. Choosing the CBFI option requires confidence that insuring at the community level will work better than at the individual level.
There are circumstances where CBFI may provide partial solutions to NFIP challenges. Solutions include reducing administrative and transaction costs, increasing takeup rates, and promoting flood mitigation and floodplain management. Even if CBFI does not effectively address these challenges, it could help in certain areas. For example, moving insurance to the community level would likely enhance attention to risk-reduction activities at that level. Under certain circumstances, however, CBFI may be difficult to implement, for example when a community is not interested or lacks the capability to implement CBFI. Successful implementation would likely require communities to enact some land use restrictions, adopt complementary flood risk management measures and raise additional revenue to pay CBFI premiums.
Central to the concept of insurance is protection from losses incurred from uncertain events such as fire, automobile accidents, and floods. Regarding floods and flood insurance, past patterns of climate and hydrology are limited predictors of future patterns. In addition, changes in land use and population sizes influence flood risk and flood damages in uncertain ways. Scientific evidence shows that flood losses are mostly explained by what is or is not done to the landscape; therefore, efforts to improve landscape management are important. For insurance purposes, uncertainties would need to be evaluated on a case-by-case basis.
DESIGN FEATURES AND CONSIDERATIONS
Chapter 4 of this report has two main sections—a conception of CBFI, and CBFI design considerations. The chapter identifies overarching features and considerations that would require further assessment when planning for and designing CBFI. Each point noted below is elaborated upon in Chapter 4.
- Risk Bearing and Sharing
A CBFI option could conceivably shift risk-bearing to communities, private insurers, or individuals depending on how it is structured. Although as a federal entity, the NFIP may be well positioned to bear the risk, movement to a CBFI option allows for reexamination of how some risk might be transferred to and/or shared by other stakeholders.
- Responsibilities for Writing Policies and Loss Adjustments
Write-your-own (WYO) insurance agents write policies and collect premiums under the NFIP, but CBFI policies would have to be writ-
ten at the community level. If CBFI were to proceed, FEMA would need to expand a range of administrative duties to process applications from communities.
- Coverage Limits, Standards, and Compliance
Under CBFI, deductible choices would depend on the community’s size, the nature of the risk (e.g., type of flooding), existing infrastructure, and other community characteristics. A CBFI option may provide an opportunity to reconsider flood exposure.
- Underwriting, Pricing, and Allocation of Premium Costs
Several complex issues fall under this topic: the extent of actuarial principles to be used in setting premiums (NFIP premiums are legislatively and administratively constrained; see NRC, 2015); the extent to which catastrophic losses would be reflected in premiums for a given community; and the allocation of premium costs among property owners (and renters) in a given community. This third issue could involve deriving some portion of funding from owners of properties that are not in areas subject to flooding.
- Administrative Capabilities
If insurance contracts remain the vehicle for transferring risk, private insurers likely would remain as efficient entities for handling their administration. Communities (probably regardless of definition) would likely not have adequate expertise for undertaking the administration of policies. However, some definitions of community include entities that could effectively and efficiently collect the revenue needed to pay for a community policy through special assessments, property taxes and other sources.
- Confirming Compliance with Mandatory Purchase Requirements
Currently, the mandatory purchase of flood insurance is only for properties that have a federally backed mortgage. A bundled community-based policy that provides a minimum required coverage would need to maintain some aspect of individual coverage insurance and monitoring. This could be administratively burdensome. CBFI could cover all structures to a defined limit. Another alternative would be CBFI that provides a set base coverage amount.
- Pricing Expertise, Including Valuation of Mitigation Measures
If private insurers were to underwrite risks associated with a CBFI policy, then they would want to price polices according to actuarial principles. Private insurers thus would have to possess or acquire the information and expertise to price community-based policies to reflect the risk underwritten and the savings expected from mitigation measures. If the NFIP were to assume the risk of community-based policies, then presumably it would also assume the function of pricing these policies to account for the savings expected from mitigation measures. FEMA has expertise in setting premium costs based on flood risk, and would have to work with communities to communicate individual property coverage costs bundled into a community policy.