National Flood Insurance Obstructs Development, Eliminates Options

OAKLAND, Calif., Oct. 19, 2009—Flooding represents one of the greatest weather-related threats in the United States, costing billions of dollars annually in damages. Despite this, most people have only one option for protection against flood-related losses, the National Flood Insurance Program. A new report demonstrates, however, that intervention in this market has only hampered its growth.

In Watery Marauders: How the Federal Government Obstructed the Development of Private Flood Insurance (October 2009), Independent Institute Research Fellow Eli Lehrer takes a detailed look at the decisive actions that resulted in a nationalized system of pooling flood-related risks. Lehrer’s report delves into the history of flood insurance markets in the United States and investigates whether such insurance could exist without political interference.

Lehrer, also a Senior Fellow at the Competitive Enterprise Institute, explains that in some ways, floods represent a unique type of risk. Unlike other insurable dangers such as fires, thefts, illnesses, and accidents, floods almost always affect more than one home and only occur in certain areas. Consequently, any insurer offering flood policies would need enormous capital reserves and would only find clients concentrated in specific regions. Because of this, flood insurance is a naturally unattractive business to enter and factors intrinsic to this market are partially responsible for the slower-than-average growth of the private sector. However, given time and independence, it would have likely materialized and flourished.

Unfortunately, the first move toward nationalization occurred in 1936 when Congress passed the Flood Control Act. Since then, the availability of private flood insurance has steadily decreased in direct correlation to increased government involvement. National flood insurance mandates inhibited the private sector’s growth by “tacitly encouraging development in frequently flooded areas, and by pre-empting the need for private insurance.” In other words, in addition to discouraging new firms from entering the market, federal action created a moral hazard by replacing plans to “calculate the actual risk of flooding with mapping efforts that avoided collecting data that would prevent development.”

This federally-commissioned mapping effort, conducted by the Tennessee Valley Authority (TVA), was intended to supply comprehensive flood risk predictions, but politically entrenched agendas compromised the goal of risk management. The project “provided fatally flawed data, distorted development patterns, and made market entry even more unattractive for private insurers.” Impaired by conflicting objectives, the TVA’s data collection inhibited successful floodplain management and changed the National Flood Insurance Program from a risk-based system into “a charity—an open-ended entitlement to be made whole after a flood—in the guise of insurance.”

Lehrer’s report employs primary sources, insurance industry studies, and opinions from other experts to support his explanation of the federal government’s effect on private flood insurance. He argues that “the government should get out of the flood insurance business altogether” and allow private insurers to provide “a safe, secure, and environmentally sound form of protection.” Watery Marauders is a timely reminder that increased government involvement will always negatively affect private ventures and consumer welfare; in the long run, a free market allowed to develop at its own pace would reward consumers with the least costly, most efficient, and most beneficial system.

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