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With Hurricane Sandy slated to cost the nation more than $50 billion, policymakers are scrambling to figure how to contain the rapidly rising costs of disaster relief. U.S. taxpayers have spent $250 billion over two decades helping states like Florida and Louisiana recover from natural disasters. In many ways, how the nation has elected to handle to costs of natural disasters mirrors many of the misguided choices that have guided health entitlements such as Medicare and Medicaid off the fiscal rails.
Let’s start with residential flood insurance. The National Flood Insurance Program (NFIP; run by FEMA) was started in 1968, because many private insurers refused to cover the risk of floods in flood-prone areas. Policymakers intended the federal program to make such coverage affordable-a move that has produced a river of unintended consequences.
First, by keeping premiums artificially low, the program encourages more building in flood-prone areas and disincentivizes homeowner investments in making their homes less prone to damage (e.g., elevating the house or strengthening the roof). Risk-based premiums from private companies offer a more promising path for encouraging personal responsibility. By charging more for riskier choices, such premiums discourage people from taking a lot of risks. For example, auto insurers routinely surcharge drivers who get speeding tickets both to deter behavior that elevates the odds of an accident and to ensure that speeders as a group self-finance their own risky behavior rather than having it cross-subsidized by more responsible drivers. That mechanism no longer exists when government subsidizes insurance in the highest-risk flood areas; likewise, we might consider whether Medicare should adopt the higher premiums for smokers that even Obamacare permits in the private insurance market.
Damage from hurricane in Pensacola in 1906 (Photo credit: Wikipedia)
Second, because premiums are so low, NFIP is woefully underfunded-having had to borrow $18 billion from the U.S. Treasury to cover claims after 2005 and 2008 hurricanes (and will soon have to borrow many billions more for Hurricane Sandy). All told, the program’s overall liability now amounts to $1.25 trillion. This may seem a pittance compared to the $106 trillion in unfunded liabilities facing Medicare, but the idea is the same.
Unless the flood insurance program is significantly reformed, the unfunded burden will predictably grow larger over time. Some of the most egregious problems with the program were addressed by changes to the program made last July. However, now policymakers in Florida are pushing for a national insurance pool that would socialize these costs even further-raising costs on Americans living in less risky areas while saving homeowners in Florida an average of $535 apiece, according to the actuarial consulting firm Milliman, Inc..
Third, the program forces those who live in non-risky areas to subsidize the decision of others to live in flood-prone areas. Of the 5.6 million people with flood insurance coverage, roughly 1 million get it for less than half the true price, because they live in houses built before flood hazard maps were created. Need an example on a more local scale? Since 1979, at least $80 million in inflation-adjusted federal dollars have gone to fixing the costs of storm-related damage on Dauphin Island, Alabama. That amounts to $60,000 for every permanent resident-quite a gift from other U.S. taxpayers!
There are two separate issues here. Like Medicare, the program is a “universal” entitlement that subsidizes premiums for rich and poor homeowners alike. In these days of frantically looking for ways to reduce federal spending to avoid going over a fiscal cliff, does anyone think that subsidizing flood insurance premiums for the beach houses of 1 percenters should be an urgent federal priority? For those who need assistance, means-tested vouchers would be a fairer way of targeting scarce federal resources to those who most need them.
But what about Medicaid? The lion’s share of the cost of rebuilding schools, hospitals, roads, bridges, utilities and transportation services is, under the Stafford Act, borne by Uncle Sam, with only 25 percent of such costs covered by state and local governments. This matching fund arrangement-a close cousin of the approach used to jointly fund Medicaid-creates some predictable adverse consequences.
First, having someone else pick up three-quarters of the cost does not incent state and local governments to necessarily spend these funds wisely.
Second, the “golden rule” firmly applies here. Precisely because of concerns that state and local governments were squandering taxpayer funds by rebuilding structures better than the ones that were destroyed, the federal government responded with restrictions that require destroyed buildings to be rebuilt the same way that they were standing before the disaster occurred. This ham-stringing of local authorities too often means that decades-old technologies and building standards are used for rebuilding even when more efficient and effective approaches are available.
Third, the federal government introduces one more layer of bureaucracy that one local official has described as a “stunning” level of bureaucratic red tape. This web of well-intended federal rules predictably slows down the process of recovery as local officials seek a way to bend the general rules to meet their unique circumstances on the ground.
If state and local officials had a fixed amount of dollars to spend, along with maximum flexibility in how to spend these dollars so long as they were tied to the purpose of disaster recovery or indigent medical assistance, this would greatly improve the effectiveness and efficiency of both Medicaid and national disaster recovery efforts.
In light of the myriad of problems just described, some experts have recommended that we simply end federal flood insurance. We do not necessarily need to end Medicare or Medicaid entirely, but we do need to fundamentally overhaul both programs if we want them to be sustainable for future generations. We would be well-advised to do this before the tsunami of red ink arrives to inundate us with a fiscal catastrophe of unprecedented magnitude.
 James Capretta and Tom Miller long ago outlined how these programs could be fundamentally overhauled and improved by moving away from guaranteeing defined benefits and instead relying on defined contributions. Giving recipients a fixed amount of dollars to spend (the amount could vary by income and health status to ensure that federal subsidies were targeted on those who most needed help and to ensure that individuals were not priced out of the private insurance market due to their high health costs) would encourage them to find the best value for the money, thereby stimulating a “virtuous cycle” of competition among health plans. As is evident in other markets such as computers, consumer electronics and cars, such competition should lead to persistent improvements in quality even as inflation-adjusted prices decline. Fellow Forbes contributor Avik Roy more recently has suggested how the new exchanges created under Obamacare might be harnessed to facilitate shopping among competing health plans for those on Medicare and Medicaid.
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