Last week, in the wake of controversy concerning insurance claims after Superstorm Sandy, Senator Chuck Schumer (D-N.Y.) called for the Federal Emergency Management Agency (FEMA) to scrap its National Flood Insurance Program (NFIP).
Schumer is absolutely right. The NFIP is a disaster—just not for the reasons that he argues.
Insurance is a very important component of a free market economy. For the consumer, it mitigates some of the uncertainty inherent in our ever changing world. For a small fee—the insurance premium—property owners can offset large amounts of potential liability expense and property damage due to accidents or other unforeseen circumstances.
On a societal level, insurance guarantees a certain degree of personal responsibility. Insurers require specific conditions when they issue a policy. A carrier will mandate that, for instance, a house must be maintained according to certain standards. This requirement helps minimize the property’s exposure to physical hazards, i.e. conditions that increase the risk of loss like faulty wiring in a house or badly worn tires on a car.
In addition to physical hazards, the insurance carrier must guard against moral hazards—like arson committed by a homeowner—as well as morale hazards. While a moral hazard is deliberate, a morale hazard is based on carelessness or irresponsibility. An example of a morale hazard would be leaving your car unlocked because you know it’s insured.
An unintended, but well-documented, consequence of the NFIP is the increased morale hazard it created. Because of catastrophic flooding during the 1950s, private insurers began dropping flood coverage from their homeowners policies and making it a stand alone product. Eventually, the private market eliminated flood policies altogether, at which point the federal government stepped in.
As a result, many individuals now own property located in known high-risk flood areas. These properties have a history of repeated massive losses, something that would never happen in a private insurance market. Consequently, the NFIP acts as a subsidy for these property owners at the expense of taxpayers in the rest of the country
Additionally, the NFIP is a classic example of crony capitalism. FEMA authorizes 80 private insurance companies to sell flood insurance through the NFIP. The government mandates the premium rates AND the profit margins for these policies, making it a guaranteed moneymaker for these insurance carriers. Of course, this arrangement is also a surefire recipe for corruption.
The NFIP presents other problems for consumers. As with all government programs, rates are not set by market conditions, but political expediency. While some people pay ridiculously small premiums for the risk that their property presents, other folks who may not even need flood insurance are forced to buy a policy.
The pattern in the flood insurance industry is mirroring that of the health insurance industry. Many folks forget it was the federal government that created the HMO system (a result of prior government interventions in the health care industry). Instead of declaring this a failure as HMOs became more and more expensive and enacting free-market reforms, the government clamped down on the market even further, bringing us the Affordable Care Act, which will inevitably be replaced someday by a full-blown single-payer model.
Schumer’s idea of replacing our crony capitalist flood insurance system with an outright socialized one will not fix the problem. It will only result in higher taxes, more unwarranted regulation, and a one-size-fits-all policy that destroys consumer choice and freedom.
The NFIP should be scrapped and flood coverage should be left up to private insurers with no assurances of government subsidies. Where there is a profit to be made in the flood insurance industry, private enterprise will find it. Ignoring the profit incentive not only increases the morale hazard of building and owning property in dangerous areas, it places an unfair burden on the rest of society.
The free market is not a panacea that guarantees to fix every problem every time for everybody. Unfortunately, as the NFIP proves, when the government gets involved, it usually only makes things worse.