B School for Public Policy

Howard Kunreuther

Insuring High Risks Fairly, Protecting Individuals Against Flood Losses

As Congress looks at restructuring the National Flood Insurance Program — legislators must address the issue of fairness. Howard Kunreuther, Professor of Decision Sciences and Business Economics and Public Policy at the Wharton School, joins host Dan Loney on Knowledge@Wharton to discuss this important and timely topic.

An edited transcript of the conversation follows.

Knowledge@Wharton: As part of the current Wharton Series in Washington DC, to bring experts forward to explain further to members of Congress and their aides on a variety of topics, Professor Howard Kunreuther recently made a presentation on the National Flood Insurance Program and the changes that may be coming forward. But the word that best describes what needs to be seen going forward may be fairness, and that’s a word that sometimes is not associated with what is going on in Washington DC.

Howard, great to talk to you.

Howard Kunreuther:  Always good to be here, Dan.

Knowledge@Wharton:  Let’s begin with what you were trying to bring forward when you were making your presentation in Washington DC.

Kunreuther: What we are really trying to do with a lot of these programs is to make sure that people understand the risks that they face and, in the case of flood insurance, having a risk-based premium is certainly one way to do it.

Transparency is one of the important elements here, with respect to any program. And in the case of flood, having a risk-based rate, a risk-based insurance premium, is a principle I think that we would support very strongly in our risk center, and a lot of other people support that.

A risk-based rate let’s people know how hazardous the area is that they’re living in. A risk-based premium also should let homeowners know that they can reduce their risk, as well as their premium, if they invest in mitigation measures. But there is a problem, as you indicated, with fairness. And that relates to people who all of a sudden find that their insurance premiums are sky rocketing because of the fact that they had been subsidized earlier; they actually had received a premium that was a lot lower than what the risk is. That’s the way the National Flood Insurance Program (NFIP) started in 1968. The (NFIP) subsidized premiums so that the property values weren’t going to go way down by virtue of the fact that people would have to pay a high premium, and they were moving towards risk-based premiums. But they felt that it would not be fair for that to happen. Well, we feel exactly the same way. 

When you move towards essentially a risk-based premium, which is the way Congress has been talking, with a program that’s in debt – they say, “Let’s have risk-based premiums.” But we have to address affordability issues to be fair to people so that they have the rug not pulled from under them, by virtue of all of a sudden, facing a very, very high premium.

Knowledge@Wharton: What is the status of the Flood Insurance Program here in the United States right now, as we are moving through the course of 2017?

Kunreuther: Well, one of the reasons I was in Washington a week ago Friday was to talk with a group of people, many of whom were Congressional staff people, about the re-authorization of the program. It’s up for re-authorization, it ends on September 30th, 2017. So there’s a great deal of effort now being spent by Congress, both in the House and Senate on new bills for that. And one of the reasons that I think this whole issue was important is to put on the table – what does it mean to get a risk-based premium? Better mapping, being one of them. Also, what does it mean to have transparency? And what does it mean to deal with the issues I’ve just mentioned a moment ago on affordability?

Knowledge@Wharton:  Is it your feeling that in terms of fairness that there are too many people out there that are not being treated fairly in terms of the premiums that they are having to pay, depending on where they live?

Kunreuther:  Well, I think there are two issues on that, Dan. One is that when you have a better map, and there are states like North Carolina, that have better maps – you will really know what the risk is. So mapping becomes a very important element. There are people who are paying too much, perhaps.

And then, there are others who may be paying somewhat too little. And what we are particularly concerned about is on both levels. You want to make sure that everyone has a fair and a transparent premium from that point of view. But we need to provide some mechanisms and some ways to helping out the lower income people who are living in high flood hazard areas, who will all of a sudden find that their premium has been $1,000 and now it goes up to $10,000 or $12,000.

And people are worried about that right now because of legislation that had been passed, even as early as 2012, before Hurricane Sandy, that was moving in that direction.

It got modified after Sandy in 2014 and now, we’re still moving in that direction. The question is, “How far do we want to move in the context of a risk-based premium, without at least recognizing there have to be other ways that the public sector needs to be involved in some fashion?”

Knowledge@Wharton:  And for some of those people, they could be paying the much higher premium, living in an area such as a flood plane, where the value of the property itself may not warrant them keeping such a high premium on their property to begin with.

Kunreuther: Right. Well, there is that real challenge. Do they stay there? Do they move? Faced with a high premium—our feeling very strongly is that you have to recognize that these people may have a very hard time moving. And so, we have at least put forward proposal—not just us, but a large number of people have been thinking about the idea of giving people a voucher or a tax credit or something if they are in a position where they actually cannot afford the very high premium. And at the same time, indicating maybe they get a loan, maybe a low-interest loan or even a mitigation grant as a way of making their house safer, so they are more comfortable in the house. Homeowners should have a much lower premium and then they can afford to invest in the mitigation measures.

Knowledge@Wharton: You mentioned North Carolina, which if you go back—I guess it was about a year or so ago—there was a storm coming up the coast, and originally they thought it was going to hit around Jacksonville. It kept going north and it actually hit into North Carolina. And about 100 miles in, they were, you know, experiencing significant flooding in low areas. And that ends up being an important point to bring up, is the fact that we normally think about these issues around the coast lines. Yet, there are so many situations where it’s not specifically the coast-line that is impacted by this, whether it be rivers that overflow, streams, or other bodies of water.

Kunreuther: You raise a really important point, Dan, Hurricane Matthew had exactly that characteristic. And North Carolina is still working through all the challenges that they faced inland with respect to that. So we are talking about flooding on the coast that could be due to storm surge from hurricanes, but we’re also talking a great deal about river in-flooding, for the reasons that you’re saying. And there are lots of rivers in the United States that could flood, the Mississippi certainly being one of them.

Knowledge@Wharton:  Are we seeing a greater concern because of the number of storms we are seeing on an annual basis? I looked online and in terms of 2016, I think I counted approimately 16 or 19 storms, whether they be hurricanes, tropical storms, or tropical depressions. I mean, are we seeing more and more storms on an annual basis these days?

Kunreuther: Some of it could be cyclical, but I think that we are definitely moving into a period of time when more intense hurricanes are occurring. And a lot of that is being attributed to global warming and climate change. Sea level rise obviously is going to cause a problem, maybe not tomorrow, but over ten or 20 years, you’re going to find that homes that look like they were really safe are not safe now—Miami being one of those areas, New Orleans being another, where they really have challenges. Given these changes, we really have to give attention to how we reduce these risks? That’s why mitigation is so important. And how do we enable people to adopt those measures, to invest in those measures? It comes back again to the fairness question.

Knowledge@Wharton: Going back on that for a second, you mentioned people that may be in a high flood potential area that maybe are paying too much on their insurance premiums. But there also seems to be the issue of people that may not be paying enough. And I guess part of it is to try to balance that out a little bit, correct?

Kunreuther:  Exactly. The risk-based premium with good maps would do exactly that. You might have high income people who are living in or have a second home in a very nice area, who wouldn’t be getting any kind of subsidy at all, a voucher or tax credit. They would have to pay a risk-based premium that would reflect that. And so, you absolutely want to move in that direction, there are people who are not paying necessarily enough. And that has certainly been true in other areas, not so much with the flood program, as with wind damage from hurricanes. There have been a lot of subsidies to people in second homes that really could afford to pay a higher premium.

Knowledge@Wharton:  You mentioned North Carolina having good mapping in terms of the layout of the land and the areas in that state that are truly at risk for flooding.

Kunreuther: Yes

Knowledge@Wharton: How is that the case in the rest of the states? Are we at a point now where many states are behind the times in terms of having the proper mapping so that they can be able to truly gauge where the most high risk and where those premiums would really come into play?

Kunreuther:  Yes, to my knowledge North Carolina is quite unique. They have developed structured-based premiums for every home in the state using LIDAR technology. John Dorman, who heads the technical mapping advisory committee to FEMA, which I’m a member and he’s the chair, has basically taken a lead in this with a number of other people. And this is a model for things that could be done in the rest of the country. And so, I would say that if you looked at North Carolina, you would be in a better position to say, “What would be a risk-based premium?” How high is the elevation of that house? What is the context of the rivers in North Carolina? And then, what is the damage that could be caused to the house? Those are the things you need in order to be able to develop a risk-based premium.

Knowledge@Wharton:  I guess playing off of that then, when you look at North Carolina as the example of how to be able to map this out properly, where does a state like South Carolina or Georgia stand, or Florida? Florida and obviously, along the Gulf Coast, those areas have been battered by storms pretty much every year for ages now. So I mean, do they have good enough mapping right now?

Kunreuther: The real challenge is we need funding which will hopefully come with the re-authorization of the flood program.

Knowledge@Wharton: Thank you, Howard. Thank you very much.