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Drowning in Red Ink, The National Flood Insurance Program

March 5, 2014
Chris Garlasco, Owner & Managing Partner - Founders Insurance Group

Chris Garlasco, Owner & Managing Partner – Founders Insurance Group

Insurance is often complex, yet at its core, insurance is actually quite a simple concept. Simply put, insurance mitigates risk by spreading that risk over a large pool of people with the understanding that only a sub group of that large pool of people will actually have a claim during a set time period. To use simple numbers, imagine a pool of 100,000 people. We know that over the course of a year’s time that pool will be used to pay out a total of $1,000,000 (to pick a round number) in claims. Add to that pool the cost of expenses generated by the insurance company such as paying their employees, the cost of running their facilities, the legal expenses involved with covering claims and a host of other expenses. In a free market system there will also be room for a profit, held in check by competition. So in order to cover both the claims generated by that 100,000 person pool and the expenses that a company incurs managing that pool, the company will arrive at a premium amount that each of Flood insurance Feb 2011_img_2those 100,000 people must be charged during that year.

Here is where it gets more complex if not interesting. Expenses, for the most part, are a fixed cost. However predicting the actual dollar amount of the claims paid out of that pool is an actuarial science. Companies that are good at predicting losses out of that pool will make a profit. Justified government regulation helps in keeping consumers from being overcharged, but the role of regulation is also to help keep companies financially viable so that they can be counted on to cover their losses. The government understands that the balancing act of expenses and claims is a sensitive thing.

Using the analogy of the “fox guarding the henhouse”, the government struggles with its own insurance programs. Government run insurance programs often don’t adhere to the very laws that they rightfully impose on companies to protect the public and the solvency of the insurance company. In addition to that, politics often comes in between the delicate balance between expenses and claims. So instead of actuarial science we have the shifting winds of politics setting rates. To make things even worse, there is generally no competition to keep government costs in check.

Today, The National Flood Insurance Program, which is already swimming deeply in red ink, nixed the planned and needed rate increases due to public pressure. If a private insurer responded that way, not only would the insurer be in violation of insurance regulation, but would be on its way out of business. The National Flood Insurance Program is currently in debt to the tune of 24 billion dollars to the US Treasury; yet getting the rates correct is determined by the level of public outcry rather than the very mathematical science required by law for private insurers.

So why should we care? The reason is simple. The National Flood Insurance Program cannot cover its debts and as a result, a year with unexpected losses will possibly require the tax payer to bail out the program. So rather than those that actually need flood insurance protection paying the accurate premium, the portion of the general public that doesn’t need flood coverage will end up paying for it anyway. Imagine for a minute that you don’t drive a car, but will be required to bail out a car insurance company for their losses. Or, imagine for a moment that you don’t own a home, but through your tax dollars you are going to pay out of pocket in order to cover that nice beach house that someone else owns because they are not paying the correct amount of money to cover their home insurance. Here is what is really important to understand as it relates to increased cost; typically when an insurer sees the pricing on the risk pool as inadequate, most often the end result will be a rate increase. When the government is in the same position, those increases are passed on in many different forms, often hiding from the consumer the true cost. It is one of the reasons why oftentimes there isn’t an outcry from the public. In the case of the ACA, not only have rates increased for many people, but there is a slew of fees, reductions in coverage, false rates being charged to other policy holders (such as young people covered under the ACA), and decreases in payments to doctors and hospitals. I have tried to raise awareness to the plight of people suffering from chronic pain. The ACA is seeking to cut payments to pain management doctors by a whopping 58%! This a cut in reimbursements to a payment level that was already lower than payments made to private insurers. Medical device taxes and fees to the consumer to cover a possible bailout of the insurance industry are also built into the program. So the actual cost to Americans is actually much higher than what most people realize.

The fact is that this problem exists in just about every insurance program run by the federal government. In addition to the National Flood Program, Medicare and Medicaid are also running deeply in the red. Whether you support the Affordable Care Act or you don’t, it is important to know that even with this law in its infancy, politics are already messing around with the delicate mathematical science needed to run a self-sustaining program. A great example is the “waiver” that some organizations have been granted; this only means that those not in those organizations will have no choice but to cover that cost for them. The health insurance carriers saw this sloppy math coming and it is one of the reasons that the ACA actually has a built in an insurance company bailout!

In the end, the costs of all of these insurance programs cost far, far more than they actually should. Today’s nixing of the Flood Insurance rate increase will ultimately, at some point, affect every American whether they need flood coverage or not.

It’s something to think about.

Have a great day!

Chris Garlasco

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