Affordability of National Flood Insurance Program Premiums: Report 1 (2015)

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Chapter: 2 National Flood Insurance Program History and Objectives

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Suggested Citation:"2 National Flood Insurance Program History and Objectives." National Research Council. 2015. Affordability of National Flood Insurance Program Premiums: Report 1. Washington, DC: The National Academies Press. doi: 10.17226/21709.

This chapter begins with discussion of the history leading up to the 1968 legislation that created the National Flood Insurance Program (NFIP). It is important to recognize that the original concept for the NFIP was a risk-sharing partnership with the private sector. With this history as background, this chapter discusses the enabling NFIP legislation and specific financial roles for the NFIP in the partnership. The changing nature of that partnership helps explain the motivation for provisions in BW 2012 and Homeowners Flood Insurance Affordability Act of 2014 (HFIAA, 2014).

Flood insurance was offered by private insurers between 1895 and 1927, but losses incurred from the 1927 Mississippi River floods and additional flood losses in 1928 led insurers to stop offering flood policies (Brown and Halek, 2010). In the absence of private insurance, post-flood financial aid took the form of flood disaster relief. Over time, the federal government was increasingly asked to provide aid to flood victims as a humanitarian action (Moss, 1999). It was in that context that President Truman proposed a national program of flood insurance. Initially, when requesting aid to victims of Midwest floods in 1951, Truman also asked Congress to “establish a national system of flood disaster insurance” (Truman, 1951a). Truman conceived of a flood insurance program “based upon private insurance with reinsurance by the Government,” and if such insurance were available,

“there should be no need in the future for a program of partial indemnities” (Truman, 1951a). Truman submitted draft legislation to Congress in 1952 that envisioned a central role for the private sector, noting that the program “should not compete with private insurance companies” and furthermore, the proposed legislation prohibited federal flood insurance where it was available privately at “reasonable rates” (Truman, 1952). Congress could create a reinsurance fund to “. . . make it possible for private companies to write flood insurance at reasonable rates” (Truman, 1951b) and he noted that rates could be lowered by a “nationwide pooling system” (Truman, 1951b). The proposed bill also put a cap on coverage and hence premiums, imposed a 10 percent deductible, and authorized federal agencies that guaranteed mortgage loans to require the purchase of flood insurance. Thus, as originally conceived, a federal program for flood insurance was designed to replace disaster aid and make private sector insurance more affordable by capping rates, pooling risks geographically, and offering reinsurance to private companies. However, no legislation was passed.

After the 1955 hurricane season, President Eisenhower proposed the creation of an “indemnity and reinsurance program, under which the financial burden resulting from flood damage would be carried jointly by the individuals protected, the States, and the Federal Government” (American Institutes for Research, 2005). That wording suggests that Eisenhower was especially interested in homeowners sharing future disaster aid costs with the government. Congress responded by passing the Federal Flood Insurance Act of 1956, which created the Federal Flood Indemnity Administration and established a flood insurance program, a reinsurance program, and a loan contract program. In 1957, specific implementation proposals were put before Congress, but Congress found them impractical and did not appropriate any funds. The Federal Flood Indemnity Administration was terminated on July 1, 1957.

Following Hurricane Betsy in 1965, Congress passed the Southeast Hurricane Disaster Relief Act. President Johnson pointed out that it was the “sixth law passed in 18 months for the specific purpose of broadening Federal aids for the victims of the unusually severe succession of disasters experienced since the spring of 1964” (Knowles and Kunreuther, 2014). In addition to relief, Congress called for “immediate initiation of a study . . . of alternative permanent programs which could be established to help provide financial assistance in the future to those suffering property losses in floods and other natural disasters, including but not limited to disaster insurance or reinsurance” (Knowles and Kunreuther, 2014).

In August 1966, President Johnson transmitted a task force report to Congress that was to set the stage for broad reforms to the federal role in flood risk management. The task force’s report, A Unified National Program for Managing Flood Losses, described multiple strategies for

managing flood risks. One section addressed “. . . steps toward a national program for flood insurance” and concluded that flood insurance was “feasible” and could “promote the public interest” and could be used both to help victims bear the risk of floods, and discourage “unwise occupancy of flood-prone areas.” Other subjects of reform included improving knowledge about flood hazards, coordination and planning for new development in floodplains, technical services to floodplain managers, and adjustment of flood control policy based on “sound criteria” (Task Force on Federal Flood Control Policy, 1966).

The report argued that the choice to locate in a floodplain might be an individual choice, and that those who chose to locate in floodplains should understand the risk and bear the full costs of their decision. 1 That sentiment was endorsed and elaborated upon in a report from the Secretary of Housing and Urban Development (HUD) issued in the same year. That report stated the following:

If the new occupant of such areas bears the full cost of flood insurance premiums, then he has to balance up the advantages and the costs of such occupancy. In some circumstances, it may be economic to occupy an area with relatively high hazard of flood damage, because the advantages more than offset the unavoidable costs. This may often be true for summer homes along the coast. . . . In many situations, however, the full costs of occupying high-hazard areas are simply greater than the probable advantages. Under those circumstances, flood insurance premiums which place the full costs on those benefiting from the location can operate to keep unwarranted occupancy to a minimum (U.S. Department of Housing and Urban Development, 1966).

In accordance with earlier proposals, that report argued that flood insurance should be offered in partnership with the private sector. Congressional testimony by HUD, and ultimately the original NFIP legislation, was based on the findings of that report and its appendixes.

1 The 1966 report described this “occupancy charge” as an ideal policy instrument, but for practical reasons recommended a program of flood insurance. It further stated that “The full costs of flood plain occupance would be shifted to the prospective occupants themselves through the imposition of mandatory, risk-related, annual occupancy charges. The charge would be equivalent to the occupant’s estimated annual damages plus any costs his occupancy causes others. These payments would be made to an indemnification fund which would be used to compensate those suffering flood damages.”

The National Flood Insurance Act of 1968 (Public Law 90-448) created the National Flood Insurance Program, which was to be administered by HUD. Although modified many times, the act remains the legislative foundation of the NFIP. In creating the NFIP, Congress identified two primary objectives: to encourage state and local governments to use land-use adjustments to constrict development of land exposed to flood hazards and guide future development away from such locations, and provide flood insurance through a cooperative public–private program with equitable sharing of costs between the public and private sectors (42 US Code, Section 401 Congressional Findings and Statement of Purpose). With respect to insurance, the law provided that local communities limit new development in some areas of the floodplain, which later were known as Special Flood Hazard Areas (SFHAs; see Appendix E). Once a community agreed to such limits, its citizens would be able to purchase flood insurance policies offered by private insurers in a partnership with the federal government. The mechanism for the partnership was the flood insurance risk pool. The Senate Committee on Banking and Currency described the pool as follows (U.S. Senate Committee on Banking and Currency, 1967):

Insurance industry pool

The insurance pool authorized by this bill will be an association of private insurance carriers formed to make flood insurance available. It will be open to all qualified companies licensed to write property insurance under the laws of the separate States who meet minimum requirements prescribed under the bill. Relations between the Government and the insurance pool will be governed by an agreement which will set forth in detail the conditions of operation.

Participation in the pool by private companies can take the form of risk capital participation. Some companies can elect to operate as fiscal agents for risk-taking members of the pool. The significance of this arrangement is that small companies with limited capital resources will not be prevented from participating.

Operation of the pool

Participating member companies of the pool, either as risk bearers or as fiscal agents, will sell and service policies in much the same way as they now sell insurance against fire and other perils. Their relationship with the pool will be governed by an agreement, the conditions of which will be subject to approval by the Secretary of Housing and Urban Development. As fiscal agents they will be paid fees for selling and servicing of policies. As risk bearers, they will share in the aggregate profits or losses of the pool’s operation for a particular accounting period. Risk-bearing member