A Community-Based Flood Insurance Option (2015) / Chapter Skim
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4 Community-Based Flood Insurance: Issues and Considerations
4 Community-Based Flood Insurance: Issues and Considerations
Pages 45-72
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From page 45... ...
Conceivably, if flood insurance premiums were paid at the community level, then leaders would become more strongly oriented toward mitigation e fforts on behalf of their constituents. These are all conceptual arguments; 45
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From page 46... ...
A CONCEPTION OF COMMUNITY-BASED FLOOD INSURANCE A basic premise underlying CBFI is that it may be less expensive and more effective to write single flood insurance policies at the community level than having insurance companies or the NFIP write multiple policies at the individual level. For this to be true, either the community must be more efficient than FEMA in writing policies covering individual entities, or the shift of responsibility from individual owners to the community will foster incentives to protect properties from floods.
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From page 47... ...
Perhaps relevant information is not available to the parties that must take actions to control flood risks, or perhaps incentives are insufficient. A second justification would be that placing insurance through communities would reduce or eliminate failures in providing and recognizing relevant information on flood risk.
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From page 48... ...
A flood example might include damming of a river that negatively impacts downstream flooding. The analogue of the Coase Theorem in the flood insurance context, where the interests of the two parties (community and residents)
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From page 49... ...
Second, the community could impose regulations that appropriately control residents' actions, for example, by imposing building codes that efficiently control the risk and magnitude of flood losses to each resident.1 For these conditions to hold, of course, the residents and the community must also be well informed about how their exposure to flood risks and losses is affected by the actions that they take. If the community employs the regulatory approach to secure appropriate actions from residents, then it must understand the costs to residents in adhering to such regulations, for example, how much they would pay to live in such areas.
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From page 50... ...
It is required as well that insuring at the community level will work better than insuring at the individual level. Below are eight reasons why the RII proposition might fail to hold: 1.
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From page 51... ...
When assessing at the community level, to establish a community premium, the community decision makers need not be concerned if some residences are over assessed and others under assessed. Deter mining a reasonable overall level is important.
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From page 52... ...
Some of the above reasons, by themselves, would indicate that insurance at the community level is superior, others that it is inferior, and others that it depends on the underlying empirical situation. The most important lesson to emerge from this discussion is that any analysis of CBFI should begin with understanding of the RII Proposition and whether the evidence points in favor of, or against, insurance at the community level.
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From page 53... ...
Such an option might provide solutions -- but not the sole s olution -- to recurring issues within the NFIP. The potential solutions identified and discussed in the following sections are whether CBFI can reduce administrative and transaction costs; increase takeup rates; and promote mitigation and floodplain management.
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From page 54... ...
The mandatory requirement to purchase flood insurance increased takeup rates, but compliance is not complete and takeup remains low among those not subject to the requirement. The issue of mandatory purchase is both complicated and controversial, especially in a world where mortgages are often securitized and resold.
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From page 55... ...
Public support for flood mitigation peaks and fades with flood events and tends to be sustained only after a community has repeated flooding. A CBFI option has the potential for creating a monetary measure to enhance community floodplain management and mitigation action over the long term without waiting for flooding to become chronic.
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From page 56... ...
Providing residual insurance could increase the program's exposure, but NFIP would be insuring fewer properties. Key Challenges for a CBFI Option It is easy to envision a community that purchases insurance optimally on behalf of owners, collects the required monies inexpensively either through premiums or taxes or some combination, undertakes efficient mitigation actions on its own, and requires its constituents to take efficient actions.
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From page 57... ...
To help address issues related to community capability to carry out a CBFI option, multi-jurisdictional programs based on experience with hazard mitigation planning under the Disaster Mitigation Act of 2000 (DMA)
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From page 58... ...
• uthorizes up to 7 percent of the Hazard Mitigation Grant Program A (HMGP) funds available to a state to be used for development of state, local and tribal mitigation plans.
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From page 59... ...
Land Use and Revenue Collection Authority The discussion above implicitly and explicitly assumes that communities would be able to regulate land use to achieve flood protection at the lowest possible cost, accounting for all cost elements. Absent this authority, individuals might choose to live where risks are high, particularly if they could expect -- perhaps incorrectly -- either subsidized insurance rates or post-flood disaster relief.
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From page 60... ...
If CBFI were implemented, then there may be potential for delay in disbursements to individual property owners or renters. An additional administrative layer may extend this period even longer, particularly for those who are un- or underinsured, which may lengthen the recovery period and make it more variable for the most socially vulnerable households and neighborhoods within a community.
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From page 61... ...
Diversification across geographic areas can help to reduce risk, but pooling a large number of exposures that are correlated does not help the insurer reduce its risk because additional exposures do not reduce the variation of expected losses. This largely explains why individual private insurers do not write flood risk exposures: their ability to diversify geographically is often limited.
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From page 62... ...
Moving to a CBFI option, however, might yield new opportunities for managing risk and uncertainty. For example, the NFIP could require that communities seeking coverage provide a comprehensive analysis of the flood risk.
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From page 63... ...
Despite the scientific uncertainty about the impacts of climate change, many actions could be taken to mitigate against flood risks at a given location. For example, the scientific evidence indicates strongly that the observed increases in flood losses are mostly explained by what is done to or on the landscape and this will be true for decades to come (Kundzewicz et al., 2014)
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From page 64... ...
This is done largely for reasons of solvency, to ensure that the entity has sufficient capital, or access to capital, in the event that larger-than-expected losses are incurred. The fundamental nature of floods complicates private insurers' ability to underwrite flood risk.
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From page 65... ...
, and the insuring agreement itself, which outlines the coverage provided. A CBFI option could capitalize on the already-existing expertise and capability of NFIP and WYO insurers for writing policies for individual homeowners.
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From page 66... ...
If designed to include all individual homes in a defined flood-prone area, then a community-based policy has the potential to achieve full compliance with lenders' mandatory purchase requirements. This is because all properties included in the community policy would have the required coverage by design and, furthermore, the ability of individual homeowners would not be able to opt out of coverage.
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From page 67... ...
The ability of individuals to opt out of a CBFI policy option could result in greater adverse selection. Administrative Capabilities If insurance contracts remain the vehicle for transferring risk, then private insurers would remain the most efficient entities for handling administration of contracts.
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From page 68... ...
The mandatory purchase is only for the amount of a federally backed mortgage: a bundled communitybased policy providing the minimum required coverage would likely need to maintain some aspect of individual coverage and monitoring, which would be administratively burdensome. Alternatively, if the CBFI option covered all structures to a defined limit, such as replacement costs, then the mandatory purchase requirement would be met.
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From page 69... ...
Similarly, structures built in compliance with the floodplain mapping effective at the time of construction and at a later time identified as being in a higher risk area would also tend to be grouped geographically. Specific conditions must be met for structures to retain a low-risk policy pricing.8 Given this generalization that structures with grandfathered or subsidized rates would be geographically clustered, high-risk areas with structures dating to a time when flood risk was unknown or considered low could be addressed at the community level for mitigation action consistent with community values.
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From page 70... ...
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.
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From page 71... ...
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.
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From page 72... ...
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.
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