For NFIP, When is a Loan Not a Loan?

By Ray Lehmann | Right Street Blog | November 21, 2012

The White House and U.S. Department of Homeland Security are expected to come forward in the coming days or weeks with a request to raise the National Flood Insurance Program’s borrowing authority, as the program appears certain to need additional resources to pay all the claims arising out of Hurricane Sandy.

Alas, nailing down a precise figure on how much the NFIP will need is a fraught exercise, and the tally continues to rise. Before the storm, the program had about $900 million in cash premiums to pay claims, and the ability to borrow nearly $3 billion from the U.S. Treasury before it would reach its statutory cap of $20.775 billion.

Given initial claims estimates of $6 billion to $10 billion in flood insurance losses from the storm, sources initially reported DHS would be seeking to raise the borrowing cap to an even $25 billion. But as estimates continue to rise, Mississippi Insurance Commissioner Mike Chaney said he believed the request could be as high as $30 billion.

We at R Street have opined publicly that we think the request should be granted, provided there is a public commitment from the Federal Emergency Management Agency to explore the use of reinsurance and catastrophe bonds to transfer more of its risk to the private sector and reduce the likelihood of borrowing following future catastrophic floods. FEMA was granted the authority to use reinsurance, at its discretion, by the flood insurance reform bill approved by Congress earlier this year, so it would simply be a matter of publicly committing to a path that is already provided for under existing law.

There are certainly other reforms we would like to see Congress explore for the flood program, but now is not the time for that debate. Such issues should be debated in due course through the democratic process, just as the prior set of reforms were. There are millions of policyholders who have been paying their premiums in good faith and now must pick up the pieces after this devastating storm. It would be terribly unfair to them to hold up payment of their claims, which the NFIP is contractually obligated to pay, with an extended debate on further changes to the program.

But one thing is certain. No matter if the NFIP ends up asking to borrow $25 billion, $30 billion or even $50 billion, there is no way the program will ever pay off that debt. This has been evident ever since the program first pierced its original $1 billion borrowing cap back in 2005, and has been affirmed by every competent review of the program in the years since. There was never any chance the program could even pay off the $18 billion it already owed before Hurricane Sandy, much less the billions more in debts it will accrue now.

Back in February 2009, when the NFIP’s debt was about $19.2 billion, the U.S. Government Accountability Office estimated that the program was paying $766 million in interest just to service its existing debt, which left little to ability to pay down principle, much less build a reserve for future catastrophes.

As we found in our previous reports, NFIP’s debt has resulted in part from the program’s inability to charge premiums that are sufficient to build the capital that most private insurers have to offset losses or purchase private reinsurance. Under its authorizing legislation, NFIP must offer subsidized flood insurance premiums along with its full-risk premiums. The subsidized premiums, which represent only about 35 to 40 percent of the cost of covering the full risk of flood damage to the properties, account for about 23 percent of all active residential NFIP policies. In addition, NFIP’s full-risk rates are currently based on outdated information and processes, so even these rates may not accurately reflect the full risk of flooding.

By June 2011 (although before the additional $1.3 billion in losses incurred by that fall’s Hurricane Irene) the program had brought its borrowing down to $17.8 billion. Yet, GAO’s assessment had not changed:

NFIP still owes approximately $17.8 billion of the amount it borrowed from Treasury for losses incurred during the 2005 hurricane season. The high cost of servicing this debt means it may never be repaid, could in fact increase, and will continue to affect the program’s solvency and be a burden to taxpayers.

So, in a sense, talking about the program’s “borrowing” is effectively just perpetuating an accounting fiction. Sooner or later – but most likely, later – Congress will have to bite the bullet and forgive the program’s debt.  Doing so would have the upside of allowing the NFIP to begin building the catastrophe reserve fund this year’s reform bill also authorized and, we hope, to use those funds to buy reinsurance.

Alas, doing so would also mean acknowledging that these funds were never truly “loans,” but were appropriations from the taxpayers to the program. That would bring the debt onto the federal government’s balance sheet as a debit, rather than a credit.  For a member of Congress, there is no upside to voting for a bill that raises the federal deficit without being able to take credit for some tangible current benefit, like tax cuts or spending programs, in return.

That’s precisely why these sorts of accounting fictions, ludicrous though they may be, can persist for a long, long time.

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