At the moment, America’s 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. It’s also a recipe for future problems, if storm-prone Florida’s 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 insurers—asserting that flood damage, not wind damage, was to blame—refused to pay out on windstorm policies, leaving many homeowners with only federal flood-insurance proceeds to rebuild. Representatives like Mississippi’s 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 don’t 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. Congress’s 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 sound”—that is, the premiums that customers cumulatively pay should be enough to cover all damages from storms, plus the company’s 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, Florida’s state insurance company has suffered massive deficits. And it’s 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 revenues—money from all state residents—to 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 Florida’s coastal towns to some of the highest annual growth rates in the nation. Three vulnerable Florida cities—Port St. Lucie, Cape Coral, and Miramar—were on the latest U.S. Census list of America’s fastest-growing cities. Florida has created a very odd system for itself: the state borrows against an uncertain future—the massive liability that it assumes in writing all those insurance policies—in 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 Florida’s 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 state’s main source of tax revenues and provoking another political crisis.
Having created an intractable political puzzle for themselves, Florida’s 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 bill’s 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 it’s difficult to know what a sound market premium is for hurricane insurance in the nation’s 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. (That’s 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, it’s unlikely that they would be able to charge it—because voters in coastal areas would continue to screech about how middle-class people couldn’t afford it. The feds would be tempted to follow Florida and start asking taxpayers who don’t live in coastal areas to shore up the fund—either through “assessments” on their own private insurance, or through general government borrowing. They wouldn’t do this right away, true, but after a few big storms left the new program with a multibillion-dollar deficit, watch out.
What’s 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 wouldn’t buy property on the coast unless they could afford those high premiums, or unless they could afford to rebuild after a storm—and 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 Florida’s property market, already struggling in the nationwide real-estate slump. And before Floridians who couldn’t afford the coast moved away, they’d be voting in the presidential election—which is why Washington is likely to choose politics over economics.