At the moment, Americas federal flood-insurance program covers damage from high water, not from high winds. But the House of Representatives has just passed a bill to add wind coverage. The bill, the Flood Insurance Reform and Modernization Act of 2007, is a thinly disguised bailout of governments in powerful states. Its also a recipe for future problems, if storm-prone Floridas own experience with a similar program is any indication.
Congress is acting for several reasons. First, after Hurricane Katrina, residents and politicians in coastal Mississippi were angry that private insurersasserting that flood damage, not wind damage, was to blamerefused to pay out on windstorm policies, leaving many homeowners with only federal flood-insurance proceeds to rebuild. Representatives like Mississippis Gene Taylor figure that they can eliminate that problem by holding the government responsible for wind damage, too. Second, in many areas vulnerable to frequent hurricanes, private insurance companies dont offer windstorm coverage at all. Their refusal is partly due to state regulations that prevent them from charging the high rates that would correspond to the risks posed by huge storms. Congresss new bill, by filling this vacuum, could replace the citizens insurance companies some coastal states have created, which charge property owners for wind coverage and then pay them for damage after a storm. Florida has written more than 1.3 million policies through such a company.
State lawmakers have directed these state-backed insurance companies to charge property owners annual rates that are actuarially soundthat is, the premiums that customers cumulatively pay should be enough to cover all damages from storms, plus the companys operating expenses. But Florida, for one, has failed to ensure that the fund pays for itself in practice, not just in theory. Because of severe hurricanes in 2004 and 2005, Floridas state insurance company has suffered massive deficits. And its not just people in coastal areas who pay up to cover the shortfalls. Instead, Florida charges all state homeowners an assessment, really a tax, to fund the company. Further, Florida devoted more than $700 million in general state tax revenuesmoney from all state residentsto the insurance fund last year, in an effort to lower the monthly assessments in the future.
Through its insurance program, Florida has effectively subsidized torrid real-estate development in disaster-prone areas, particularly over the past half-decade or so. The availability of state insurance has helped propel several of Floridas coastal towns to some of the highest annual growth rates in the nation. Three vulnerable Florida citiesPort St. Lucie, Cape Coral, and Miramarwere on the latest U.S. Census list of Americas fastest-growing cities. Florida has created a very odd system for itself: the state borrows against an uncertain futurethe massive liability that it assumes in writing all those insurance policiesin order to reap tax revenues from development and high property values now.
This odd system has in turn created an even odder political dynamic, a kind of one-issue, middle-class populism. The northerners who fled to Florida over the past two decades were escaping not just cold weather but also northern states stratospheric taxes, which are often fueled by huge entitlement programs. But Florida residents have developed their own unsustainable entitlement: affordable property insurance, subsidized by the state. Voters along Floridas coast already complain that the government periodically raises their insurance rates. State officials know that if they gradually stop subsidizing insurance, property values will plummet, hurting the states main source of tax revenues and provoking another political crisis.
Having created an intractable political puzzle for themselves, Floridas officials, and officials in other coastal states, have turned to the feds. The bill that passed the House last week would solve the problem of unaffordable wind insurance by simply adding wind coverage to the national flood-insurance program, taking away states need to run their own massive insurance programs. The feds would pay for this national program, the bills supporters say, by doing what Florida is supposed to be doing now: charging actuarial premiums. Under the national program, the feds would also get rid of flood-insurance coverage subsidies for second homes.
The first problem with the federal plan is that its difficult to know what a sound market premium is for hurricane insurance in the nations most vulnerable coastal areas. As Michael Lewis documented recently in The New York Times Magazine, sophisticated insurance companies, hedge funds, and other investors are still trying to figure it out, after decades of expensive trial and error. (Thats the other reason, besides overregulation, that insurers are reluctant to sell policies in coastal areas.)
And even if the feds can magically figure out the right rate, its unlikely that they would be able to charge itbecause voters in coastal areas would continue to screech about how middle-class people couldnt afford it. The feds would be tempted to follow Florida and start asking taxpayers who dont live in coastal areas to shore up the fundeither through assessments on their own private insurance, or through general government borrowing. They wouldnt do this right away, true, but after a few big storms left the new program with a multibillion-dollar deficit, watch out.
Whats the real solution to coastal-insurance woes? Brutal economics. If hurricane-prone states and the feds let the market work, it would mean higher insurance premiums, or in many cases, no insurance availability, period. People wouldnt buy property on the coast unless they could afford those high premiums, or unless they could afford to rebuild after a stormand the second group would have to be rich enough to buy homes without mortgages, since mortgage lenders require windstorm insurance. Those costs would be capitalized, over time, into the prices of houses. A house that sells for $300,000 now, for example, might sell for $200,000, to account for the much higher storm payments that a homeowner would expect to pay in perpetuity.
But this economic solution would slowly strangle Floridas property market, already struggling in the nationwide real-estate slump. And before Floridians who couldnt afford the coast moved away, theyd be voting in the presidential electionwhich is why Washington is likely to choose politics over economics.