Protecting the Environment Through the Ownership Society — Part I

Energy and Natural Resources | Policy Reports

No. 282
Wednesday, January 25, 2006
by H. Sterling Burnett, Ph.D.

Subsidizing Disaster: Flood Insurance

"Property owners should be responsible for their bad decisions."

When people own property and are fully responsible for losses due to their poor land use or development decisions, they are less likely to build or rebuild in areas regularly prone to flooding or erosion. This link — between a person's ownership of property and responsibility for their land-use decisions — disciplines people who use their property badly.

Unfortunately, a host of government programs break this link by subsidizing unwise housing and commercial development decisions. All too often the result is lost lives, destroyed property and livelihoods, and environmental destruction. The U.S. Army Corps of Engineers (Corps) flood control program, federal flood insurance and Corps beach replenishment projects subsidize construction in flood-prone areas, encourage high-risk development and harm environmentally sensitive areas.

Environmental Impacts of Coastal and Floodplain Development. Many species are dependent upon floodplains and coastal wetlands or marshes for their survival. Indeed, according to the USFWS, up to 43 percent of federally threatened and endangered species rely on wetlands for survival. Aside from habitat, wetlands provide other important environmental services. They improve water quality through filtration and often provide the same level of flood control as expensive dredge operations and levees. For instance:

  • The Congaree Bottomland Hardwood Swamp in South Carolina eliminates the need for a $5 million wastewater treatment plant. 61
  • In Georgia, researchers found a 2,500 acre wetland saves $1 million in water pollution abatement costs annually. 62
  • Replacing the natural flood control function of 5,000 acres of wetlands in Minnesota would cost $1.5 million annually. 63
  • The Corps found protecting wetlands along the Charles River in Boston , Mass. , reduced potential flood damage by $17 million. 64

"Subsidized coastal development causes pollution and destroys wetlands."

As discussed in the previous section, conversion to agriculture has historically been responsible for the decline in wetlands. Recently, however, wetland losses to agricultural development have declined while commercial and residential development in floodplains and along the coasts have increased. As a result, today, less than half of the original 220 million acres of wetlands in the United States remain. And the environmental results of this development have been devastating.

Along the coasts, commercial and residential development — including sewage overflow and untreated runoff of chemicals from roads and lawns — have contributed to the decline in oyster beds, sea grasses and other flora and fauna dependent upon unpolluted water. For instance, coastal development and its associated pollution in the three-state Chesapeake Bay region has resulted in:

  • A loss of 58 percent of its historic wetlands,
  • A loss of 88 percent of its historic underwater grasslands,
  • A historic low in the Bay's crab harvest and in crab reproductive rates,
  • A 98 percent decline in Bay oyster production, and
  • An increasing number of fish advisories. 65

Other areas report similar environmental impacts related to increased coastal development — much of which is encouraged by subsidies. 66 Many people are beginning to object to the subsidized destruction of these valuable natural areas. 67

A Brief History of U.S. Flood Control Policy. Prior to 1917, flood control was entirely each state's responsibility. By 1929, the federal government had assumed a major role after several devastating floods revealed a lack of coordination between states sharing borders and rivers. These issues concerned the appropriate location of flood control measures, engineering standards and flood response. For example: 68

  • A 1913 flood in the Ohio River Valley caused $200 million in property losses and killed 415 people.
  • The Great Mississippi Flood of 1927 showed the limits of the combined efforts of the Corps and state agencies to control flooding through the use of levees alone. Levees were breached, almost 13 million acres were flooded, 250 to 500 people were killed and 700,000 were left homeless. Property damage exceeded $236 million.

The federal government began assuming responsibility for flood control with the 1917 Flood Control Act, which called for a comprehensive flood control program for the lower Mississippi and Sacramento Rivers . Federal flood control efforts under the Corps have expanded ever since.

In 1929, the private insurance industry abandoned coverage of flood losses. 69 And in 1934, federal disaster relief was made available to victims of all natural disasters, including floods — this relief has at various times included low-interest or no-interest loans and outright grants or gifts of money, housing, food, etc.

"Flood control subsidizes floodplain development."

The Flood Control Act of 1936 created the first truly national flood control program. It called for the construction of about 250 projects using funds for work relief. Funding for initial construction was set at $310 million and $10 million was appropriated to complete examinations and surveys. 70 The Act also addressed the growing desire to reduce flood damage by instructing the USDA to develop plans to reduce runoff from agriculture and the U.S. Army Corps of Engineers to develop engineering plans for downstream projects.

By 1942, with the release of Gilbert F. White's Human Adjustment to Floods: A Geographical Approach to the Flood Problem in the United States , 71 it was already becoming apparent that flood control efforts were exacerbating rather than reducing the human and economic toll from floods. White describes the nation's flood policy as "essentially one of protecting the occupants of floodplains against floods, of aiding them when they suffer flood losses, and of encouraging more intensive use of floodplains." Interestingly, White's findings echoed earlier arguments by W. J. McGee, who wrote in 1891 that "as population has increased, men have not only failed to devise means for suppressing or for escaping this evil [flood], but have in a singular shortsightedness, rushed into its chosen path." 72

A 1958 study by Gilbert White and colleagues on the correlation between land use and floods, explained how the demand for land use and the lack of incentives to stay out of flood-prone areas caused the occupancy of these flood zones to increase. 73 Furthermore, they reported, federal incentives created a perception that the federal government would take care of any flood hazard.

This is especially true of Corps program. The Corps approves and regulates the construction of levees and other flood control structures. From 1928 through 2001, it spent $123 billion (adjusted for inflation) on flood control projects nationwide. 74 The federal government pays 65 percent of these projects' costs, while state and local taxpayers are responsible for the balance. These projects not only encourage continued development in flood-prone areas, but also bolster the Corps' annual demand for larger budgets. Indeed, according to the Association of State Floodplain Managers, new developments in designated at-risk flood areas reinforce the economic justification for new Corps projects.

Corps flood control projects all too often undermine the incentive to purchase flood insurance (more about this below), since the presence of levees and other flood control devices often eliminates federal and state requirements that the property's owners purchase flood insurance.

However, flood control structures do not guarantee protection. For example, the 1993 Great Midwest Flood caused $20 billion in damages when more than 1,000 levees failed and 100,000 homes were damaged. 75 But instead of responding with better policies and nonstructural solutions, the Corps continues to subsidize 100 percent of repair costs for all damaged levees it constructs and 80 percent of repair costs for nonfederal projects. 76

Figure II - Annual Flood Damage Averaged over 10-Year Periods

"Flood insurance subsidizes rebuilding in floodplains."

Federal Flood Insurance: Adding Water to the Torrent of Bad Flood Policy. Talk of a national flood insurance program began in the 1950s after significant flooding in Kansas and Missouri caused more then $870 million in damage. 77 Concerned about the rising cost to taxpayers for disaster relief and the increasing amount of damage from floods, both President Harry Truman and President Dwight Eisenhower recommended legislation for a national flood insurance program. However, it was not until President Lyndon Johnson submitted a feasibility study of flood insurance in 1966 that the idea really took off.

In recognition of growing flood losses, the National Flood Insurance Program (NFIP), administered by the Federal Emergency Management Agency (FEMA), was established in 1968 to insure private property at risk of flooding. The NFIP provides flood insurance to residents in communities that meet minimum NFIP requirements and adopt and enforce floodplain management criteria. In return, the NFIP is responsible for identifying local flood-hazard areas and establishing actuarial rates. Structures already located in floodplains pay subsidized premiums while structures built following enactment are supposed to pay actuarially-based premiums.

However, by 1970 only four communities had joined the NFIP, and only 16 policies had been sold. By 1972, when Hurricane Agnes struck the East coast, only 1,200 communities participated in the NFIP, which had issued only 95,000 policies. Thus, less than 1 percent of insurable damages were covered — there were $400 million in damages, but only $5 million was paid in flood claims.

Disaster relief was supposed to be denied to anyone who had the opportunity to purchase flood insurance for a year or more but did not do so. Of course, the absence of coverage did not mean that those affected did not receive federal aid. Millions were paid out in disaster relief to those who had not purchased flood insurance. While this helped them rebuild their lives and communities, it also undermined the incentive to purchase the insurance.

To boost participation, the NFIP's subsidized rates for flood insurance were lowered 37 percent in 1972. In 1974 they were lowered twice more. The NFIP estimated there were about 13,600 flood-prone communities in the United States at the time, but only about 2,850 communities participated, and there were only about 312,000 individual policyholders.

This 37-year-old program has arguably outgrown its original purpose, which was to provide temporary flood insurance to property owners who were unaware they were in flood-prone areas. As early as 1973, government reports noted two perverse effects of the flood insurance program: 78 1) federal disaster relief replaced rather than supplemented nonfederal efforts; and 2) disaster relief was often perceived to be so generous that "individuals, business and communities had little incentive to take initiatives to reduce personal and local hazards."

"Flood insurance pays claims for repeated flooding."

Indeed, federally subsidized flood insurance encourages people to build homes where they otherwise would not. It encourages lenders to finance mortgages they otherwise would not. Today, NFIP covers more than 4.5 million homes in more than 20,000 communities. 79 But because of full-disclosure mortgage and insurance requirements, most of those currently insured were aware of their area's flood problems when they purchased or developed their properties.

In 1976, the General Accounting Office (GAO) found that the Federal Insurance Administration still has "not established an effective system for monitoring community efforts to adopt and enforce required floodplain management regulations." Consequently, the federal government, "though heavily subsidizing the flood insurance program … had no assurance that the communities' flood-prone lands were being developed wisely to prevent or minimize future flood losses." 80

The NFIP continues to pay claims for homes damaged or destroyed by floods, mudslides and other natural disasters without requiring homeowners to relocate. They can use the money to rebuild in the same location, and their new home is also eligible for NFIP coverage. According to FEMA, repetitive claims are the most significant factor in increasing flood insurance costs.

  • NFIP pays claims averaging $200 million per year for about 40,000 repetitively flooded properties. 81
  • Since its creation in 1968, the NFIP has paid out nearly $1 billion for more than 10,000 properties that have experienced two or more losses, with cumulative claims often exceeding the value of the property. 82

Encouraging Development in At-Risk Areas. The Government Accountability Office reports that 90 percent of all natural disasters involve flooding. 83 Although they are called "natural" disasters, many would not be nearly as destructive had people and property not been placed in harm's way.

  • Flood damage costs increased from an average of $2.6 billion per year (in 2002 dollars) during the first half of the 20th century to more than $6 billion per year in the past 10 years. 84 [See Figure II.]
  • In 2004 alone, FEMA received 1.3 million applications for federal disaster assistance due to hurricanes and tropical storms — far exceeding the number for any comparable past period. 85

The National Climactic Data Center says that increased population and development of coastal areas is responsible for the increase in losses due to hurricanes. 86 According to the 2000 U.S. Census, more than half of Americans live within 50 miles of a coast and by 2025, 75 percent will. 87 Indeed, the Heinz Center determined that in the absence of insurance and flood control programs, development density in areas at high risk of flooding would be about 25 percent less than in low-risk areas. 88

"Flood losses have increased with development."

Subsidizing the Rich. More than 70 percent of the coastline in the lower 48 states is privately owned. 89 State and local governments own most of the rest. Homes with beach access or an ocean view are highly valued and often owned by the rich. Thus flood insurance, beach erosion control and disaster loans often subsidize higher income homeowners. According to the Heinz Center : 90

  • The risk of erosion to property — such as homes on hillsides, river banks and beachfronts — is comparable to the risk from flooding.
  • Nationwide, erosion causes property losses of approximately $500 million per year.
  • Over the next 60 years, coastal erosion may claim 25 percent of buildings within 500 feet of the U.S. shoreline, including 87,000 homes. Disasters like Hurricane Katrina could claim many, many more.

U.S. Army Corps of Engineers' projects attempt to reduce damage to coastal properties caused by shore erosion, hurricanes and floods, making it arguably the largest contributor to coastal development. For instance, beach rebuilding has become the fastest growing area of work for the Corps, with federal taxpayers subsidizing 65 percent of the cost. 91

"Beach restoration is costly and encourages more development."

Replenishing beaches is an expensive, temporary solution to natural erosion. Over the 50-year life of the typical project, each mile of beach must be replenished every four years at a cost of more than $1 million per mile. 92 As of 2001, the Corps had spent more than $1.2 billion on 71 large shoreline protection projects, affecting 284 miles of the nation's 2,700 miles of "critical-erosion" coastline. 93

Private property owners and state governments benefit from Corps-funded beach replenishment. For example: 94

  • The Corps has begun a $10 million project to replenish two miles of beach on Captiva Island , Florida , although public access is essentially blocked by the South Seas Plantation, a privately-guarded, gated community.
  • On North Carolina's scenic Outer Banks, the Corps is committing to spend $1.8 billion to replenish and maintain 14.2 miles of beach for the next 50 years.
  • The Corps paid New Jersey more than $16 million for beach projects in 2003, and the state is currently seeking to widen all 127 miles of coastline, which could cost $9 billion over the next 40 years.

Arguably, projects to reduce coastal erosion should be funded by the states, communities and businesses that directly benefit, not federal taxpayers.

Reforming Flood Insurance and Disaster Assistance. Applying the ownership society ideal to these programs would require ending them. This would still allow the owners of the property involved to develop their property as they see fit, but it would have the added benefit of ensuring that they, rather than the general public, were responsible for any poor development decisions. Since the costs of making bad decisions are substantial, under the "ownership" regime of disaster response, we should expect fewer of them.

Government programs should neither subsidize those who choose to live in harm's way, nor encourage environmental destruction — but those are the results of NFIP, FEMA rebuilding loans and Corps beach restoration projects. Any development in high-risk areas should reflect its actual cost to the public and the environment and should be borne solely by the states, localities and individuals benefiting from them. Ending subsidies to development in high-risk areas would reduce the economic, human and environmental toll of natural disasters.

"Government programs subsidize environmental destruction."

Expanding the ownership society ideal to government disaster relief programs could be done in stages and need only modify emergency relief efforts, rather than end them. It is highly unlikely that Americans will ever turn their backs on those in temporary need due to a natural disaster. However, such relief efforts should at most provide funds for temporary housing, food and other essentials, should be time-limited by statute so that they do not become open-ended welfare benefits and should not extend to rebuilding the homes or businesses of those affected. The knowledge that emergency relief efforts are time-limited and do not extend to rebuilding permanent structures or attendant equipment and furnishings would provide individuals with incentives to purchase insurance against such contingencies in the private market.

Flood insurance should be left to the private market entirely. The government should allow private insurers and mortgage lenders to set the terms and rates for flood insurance. Currently, there are few private companies offering flood insurance outside of the government subsidized and regulated program. Under the NFIP, private insurers and brokers market flood insurance but the government is on the hook for claims. In addition, the government sets rates, coverage limitations and eligibility requirements.

As a beginning, the government should not enroll any new homes or businesses in federally-backed flood insurance, and it should stop offering below-cost insurance rates. When disasters occur, payouts should be limited to the value of the home or business at the time the "ownership" insurance regime is implemented. Absent this provision, the government's payout for flood and other disaster claims will grow with the value of insured properties and property owners will have little or no incentive to forgo rebuilding or to make anti-flood improvements. Freezing payouts would undercut the incentive to rebuild or begin new construction in high-risk areas. At the very least, it would encourage the development of a supplemental insurance market to cover the gap between the limited federal payout and the rebuilding cost at the time of any particular disaster.

Finally, the cost of beach replenishment and other federal erosion control projects should be borne by the states or property owners who own the property abutting the beach, except where federal properties are at risk. Beachfront property owners bought or, in the case of the state, claim ownership of the at-risk area, and it is they who benefit from both the amenities and the value (property value) it provides.

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