Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why the Government Keeps Bailing Out Its Own Insurers
Transcript
- Lucas: So the government runs something like a hundred different insurance programs, and a surprising number of them lose money year after year. But there's one that's become the poster child for how broken the whole system can get. Luna: I'm guessing you mean the National Flood Insurance Program, right? The one that keeps having to borrow from the Treasury? Lucas: Exactly. The National Flood Insurance Program, run by FEMA, is now around thirty billion dollars in debt to the federal government. And the reason is pretty simple: it charges premiums that don't reflect the actual risk of flooding. Politicians don't want to raise rates on constituents who live in flood zones, so the program keeps setting them too low, and every big hurricane pushes it deeper into the red. Luna: But isn't the whole idea that the government provides coverage that private insurers won't? So there's a public good angle here. Lucas: There is, and that's a legitimate argument. Private insurers pulled out of flood coverage decades ago because the risk was too correlated and too hard to price. But here's the issue: when the government steps in, it doesn't usually price the risk properly either. It caps premiums below what an actuary would say is needed, and it doesn't build up enough reserves for the big catastrophes. So you get a program that's designed to be affordable, but it ends up costing taxpayers billions when the storms hit. Luna: And it's not just flood insurance, though. The same pattern shows up in crop insurance, and even in things like pension insurance. Lucas: Right, crop insurance is another classic. The Department of Agriculture subsidizes about sixty percent of premiums for farmers, and the program costs the government roughly ten billion dollars a year. The rationale is that without it, farmers couldn't get coverage for drought or hail, and that would threaten the food supply. But the subsidies encourage farmers to plant on marginal land and take on more risk than they otherwise would, because the government is absorbing the downside. It's a textbook moral hazard problem. Luna: So it's not just about the insurance itself, it's about how the presence of government insurance changes people's behavior. Lucas: That's the deeper story. When you subsidize risk, you get more of it. And that's true across the board, from flood insurance encouraging building in floodplains to deposit insurance encouraging banks to take on more risk than they should. The government is essentially telling people, 'build here, it's fine, we'll cover you.' But it's the taxpayers who end up holding the bag. Luna: And the flood program is the most visible example because the debt is so concrete. Thirty billion dollars is a lot of money. Lucas: It's one of the largest debts of any federal program. And it keeps growing because the program only pays back interest on the loans, not the principal. After Hurricane Katrina, it borrowed about seventeen billion and never repaid it. Then Sandy and Harvey added more. Now, every time there's a major flood, the program has to borrow again, and the debt just rolls over. It's a fiscal black hole. Luna: But why don't they just raise premiums to break even? Is it purely political? Lucas: Mostly, yes. There was an attempt in 2012 to push rates closer to true risk, but it caused such a backlash that Congress rolled it back within two years. People in coastal communities and their representatives in Washington didn't want to pay market rates. So the program continues to underprice risk, and the debt keeps mounting. It's a classic case of short-term politics versus long-term fiscal sustainability. Luna: That's the thing about insurance programs: they're not just about spreading risk, they're about who pays for the risk. And when the government sets rates, it's making a political choice about that. Lucas: Exactly. And it's worth remembering that the government has a lot of these programs. The Pension Benefit Guaranty Corporation, which insures private pension plans, is also running a deficit. It's about fifty billion dollars in the red. It doesn't get the same attention as flood insurance, but it's the same fundamental problem: premiums aren't set at a level that covers the liabilities. Luna: So what's the fix? Is there a way to make these programs more actuarially sound without abandoning the people who really need them? Lucas: There are a few ideas. One is means-testing: keep subsidies for low-income and vulnerable households, but charge market rates for everyone else. Another is to use better risk modeling, like FEMA's new pricing system that tries to incorporate more granular data about flood risk. But the fundamental tension is that the people who live in high-risk areas tend to be there because it was historically affordable, and they're often not wealthy. So you can't just jack up rates overnight. You need a transition that gives people time to adapt. Luna: But the longer you wait, the more debt accumulates, and the bigger the eventual burden on taxpayers. Lucas: Right. And there's also the climate angle. As sea levels rise and storms get more intense, flood risk is increasing, which means the program's liabilities are growing. A recent analysis put the true flood risk in some coastal areas at several times what current premiums charge. So the gap between premiums and risk is widening, not shrinking. Luna: That sounds like a recipe for a much bigger crisis down the road. Lucas: It's one of those slow-burn fiscal problems. It's not like a banking crisis where everything collapses at once. But it's a steady drain on the budget, and it distorts where people choose to live and build. That's a costly distortion in the long run. Luna: If today was actually useful to you, the way we keep this podcast ad-free is through listener support. If you'd like to help, you can buy us a coffee at buy me a coffee dot com slash fexingo. It's a small gesture that goes a long way. Lucas: We really do appreciate that. And we're glad to have you with us. Luna: So coming back to flood insurance: there are some interesting practical examples of how this plays out. Like, in Louisiana, some homeowners are paying more for flood insurance than their mortgage payment. Lucas: That's a real consequence. FEMA's new pricing, which started rolling out a few years ago, did increase rates for many properties, especially those with high risk and older homes. It was a step toward actuarial fairness, but it's still capped by law, and the program is still not allowed to charge the full risk premium for many policies. So the debt continues. Luna: So even with the new pricing, the program is still underwater. Lucas: Underwater is a good word for it. And that's why the debate over reforming these programs is so hard. If you raise rates too much, you could make housing unaffordable in vulnerable areas. If you don't raise them, you're subsidizing risk and accumulating debt. There's no easy answer. Luna: But it seems like the status quo isn't sustainable either. Lucas: Not at all. And that's the takeaway for anyone listening: when the government charges less for risk than the market would, it's not free money. It's a hidden subsidy, and someone has to pay for it eventually. In this case, it's the taxpayer. Luna: Thanks for joining us, and we'll see you next time.