Opening Statement of

R.J. Lehmann

Editor-in-Chief and Senior Fellow

International Center for Law & Economics

“Roundtable on Pandemic Risk”

Hosted by

Ranking Member French Smith and Members of

U.S. House Committee on Financial Services,

Subcommittee on Housing, Community Development, and Insurance

Congressman Smith, and Members of the Committee and Subcommittee,

My name is R.J. Lehmann, and I am editor-in-chief and senior fellow with the International Center for Law & Economics. ICLE is a nonprofit, nonpartisan research center that works to develop and disseminate academic output in the law & economics tradition, in order to build the intellectual foundation for rigorous, economically grounded public policy.

Two years into the COVID-19 pandemic, it is appropriate that Congress explore whether a more targeted and potentially permanent approach would be preferable to the ad hoc pandemic assistance programs like Paycheck Protection Program, which have directed trillions of dollars of federal relief to affected employers and employees. It is also reasonable to inquire what role, if any, should be played by the insurance industry, the sector traditionally tasked with responding to disaster.

There are almost certainly lessons to be learned from COVID, and there may well be a role to play for insurance companies, agents, and claims adjusters in any future pandemic program Congress might devise. But I want to raise a note of skepticism that insurance products generally—and business-interruption insurance, in particular—are really the best means to respond to the macroeconomic challenges raised by pandemics.

First, the capital that the global insurance and reinsurance industry would ever be willing to devote to the risk of pandemics would never come close to approaching the scale of the problem. Unlike governments, insurers and reinsurers cannot print money. To respond to a loss event like a pandemic, they would need to have those assets on hand. Any world in which the insurance industry had the resources to replace half of global GDP is a world in which people are buying far too much insurance.

Proposals like the Pandemic Risk Insurance Act (PRIA) tacitly acknowledge this limitation, which is why they would have the industry retain only de minimis risk of 5%. Obviously, that risk-share contribution would not significantly offset costs to the taxpayer, but it might be a worthy idea if the goal is to leverage the industry’s expertise and capacity in other ways.

Most frequently cited among these is that insurers know how to price risk. That is true and, in many contexts, assigning risk-weighted premia performs a valuable social function. In the context of the pandemic, for example, it is crucial that businesses’ liability and workers’ compensation insurance rates reflect risk, because that produces the price signals that offer incentives for businesses to adopt safer practices and avoid spreading infection to their customers or their employees. But it is not as clear that assigning pandemic-risk insurance rates according to risk would achieve a socially desirable goal. Indeed, if businesses like bars and restaurants, which are most exposed the risk of closure in the event of a pandemic, had to pay insurance rates that reflected their risk, they would, at the margin, be less likely to buy the coverage. It would undermine the entire purpose of the program if those businesses that need the protection the most would be least likely to afford it.

This question of take-up is particularly important when you remember that only about a third of businesses currently have business-interruption insurance, and that’s with a product that does not cover risks like pandemic. While adding pandemic coverage might make the product more attractive, it will certainly be more expensive, even if it’s subsidized. It would not be ideal to attach a relief program to aid businesses with the risk of pandemic to an insurance product that most businesses do not have.

It’s also notable that, unlike the terrorism insurance crisis in 2002, in which lenders were canceling financing of projects that weren’t insured for terrorism risk, by and large, we are not seeing something similar today—at least, not with business-interruption insurance, which has never covered pandemic risk. There are other insurance products, like events cancellation and production insurance for films and television shows, where there’s more evidence of some degree of market dislocation, and those might be areas more ripe for a targeted solution.

Finally, I would caution Congress to be humble in what it can project about future public-health emergencies. The next crisis may look nothing like the current one, and even the current one continues to surprise us. Early in 2020, I consulted with the major insurance trades on the proposal that ultimately became the Business Continuity Protection Plan (BCPP). At the time, we debated whether a program that offered three months of assistance would be exceedingly generous. When I testified before the Subcommittee on this topic in November 2020, vaccines were about to start rolling out and it seemed this all was coming to a close. There are good reasons to want a transparent and predictable set of rules, but it may be that ad hoc solutions designed in the moment to address the problem immediately before us, are the best that we can do.

With that, I look forward to your questions.

Read the full written testimony here.

The COVID-19 pandemic hit state budgets particularly hard in 2020, with a $24.11 billion drop in tax revenue collected from 2019’s levels. But analysis of National Association of Insurance Commissioners (NAIC) data demonstrates that insurance regulation remained a profitable revenue source for the states, generating $3.29 billion in budgetary surpluses across the 50 states and the District of Columbia, up from $2.94 billion in 2019.

Read the full piece here.

Background…

Data is one of the pillars of the modern digital economy, but its value is contingent on its ability to flow around the globe in real time, permitting individuals and firms to develop new and novel insights and to operate at higher levels of efficiency and safety.

But…

Those data flows increasingly run into barriers when they seek to cross national borders. These often take the form of “data-localization” requirements to locate, store, and/or process data within national boundaries.

However…

Data-localization policies are often framed as necessary to protect critical digital infrastructure and national-security interests, but they serve instead as trade barriers that hurt consumers more than they help. An examination of the impact on the financial services industry helps to illustrate the problem.

Read the full explainer here.

ICLE Editor-in-Chief and Senior Fellow R.J. Lehmann was interviewed by Fox 26 Houston in a segment about his recent tweet mapping the borders of the American South. The full interview is embedded below.

Introduction

Chairman Brown, Ranking Member Toomey, and Members of the Committee,

My name is R.J. Lehmann, and I am a Senior Fellow with and Editor-in-Chief of the International Center for Law & Economics. ICLE is a nonprofit, nonpartisan research center that promotes the use of law & economics methodologies to inform public policy debates. Working with a roster of more than 50 academic affiliates and research centers from around the globe, we develop and disseminate academic output to build the intellectual foundation for rigorous, economically grounded policy.

I have been an active observer of the challenges facing the National Flood Insurance Program (NFIP) for 18 years. In my former life as a business journalist, I was from 2003 to 2011 the Washington bureau chief of two major trade publications covering the business of insurance. That stint included covering the 2004 and 2008 NFIP reauthorization debates and, of course, the devastating impact of Hurricane Katrina in 2005. In 2012, I co-founded the R Street Institute, where I remained until joining ICLE six months ago. Among my duties at R Street was running the Institute’s insurance policy research program, and I made NFIP reform a major part of my research focus.

I thank the committee for conducting this hearing, its first in four years on the topic of NFIP reauthorization. It has been nearly a decade since Congress last approved a long-term reauthorization of the NFIP. The program remains in need of structural reform, and the series of short-term extensions on which it has relied for the past four years leaves many parties—homeowners, business owners, builders, lenders, realtors, insurers, and insurance agents—without the clarity they need to make forward-looking decisions. One hopes Congress will be able to reach agreement this session on legislation that provides that clarity, while also making the adjustments needed to address the long-term challenges this program faces.

The past year has given us all an up-close view of how Americans respond when faced with the realization of remote and nominally “unforeseen” catastrophic risks. But, of course, the COVID-19 pandemic was not unforeseen at all. Public health officials and catastrophe modelers have long known that a viral contagion of this sort was not only possible, but inevitable. The 1918 influenza pandemic was within the lifetime of some Americans. Much more recently, another H1N1 influenza spread as a pandemic in 2009; we were merely fortunate that it did not prove to be terribly deadly. And we have in recent years seen other coronaviruses like SARS and MERS reach epidemic levels abroad.

Similarly, there is nothing unforeseen about the challenges facing the National Flood Insurance Program. It was established more than 50 years ago to provide coverage that private insurers would not; to reduce the nation’s reliance on post-hoc disaster assistance; to provide incentives for communities to invest in mitigation; and to be self-sustaining.

What is now clear is that the NFIP has not been—and, as currently structured, cannot be—self-sustaining. Since Hurricane Katrina, the program has been forced to borrow nearly $40 billion from the U.S. Treasury. Reforms passed as part of the Biggert-Waters Flood Insurance Reform Act of 2012 were intended to place the program on a path toward long-term fiscal sustainability by phasing out explicit premium subsidies and shifting more risk to the private insurance, reinsurance, and capital markets. But some of those reforms were scaled back or repealed almost immediately in the Grimm-Waters Act, passed in 2014. And even with $16 billion of the program’s debt erased by Congress in 2017, the NFIP remains $20.5 billion in debt to U.S. taxpayers as of the first quarter of Fiscal Year 2021,[1] with no feasible plan ever to repay that debt in full.

Post-hoc disaster spending also continues to grow, with more than 90 percent of all federally declared disasters involving floods. And while the program has provided incentives for mitigation, by making cheap flood insurance available, it also has played a role encouraging development in flood-prone and environmentally sensitive regions. Moreover, due to the looming threat of climate change—which we know will drive both rising sea levels and more frequent and more severe precipitation events—it is more crucial than ever that Congress address the NFIP’s structural issues and the ways to correct its perverse incentives for where and how Americans live.

Structural Problems of the NFIP

At its inception in 1968, the NFIP was not designed as a risk-based program. Property owners in participating communities were charged flat rates, irrespective of the level of flood risk their properties faced. That design was intentional, as the overarching goal was to encourage take-up, particularly by residents of the riskiest communities.

Shortly thereafter, in 1973, the program was redesigned to account for risk with the introduction of Flood Insurance Rate Maps (FIRM) that assign properties to various risk-rated zones and assess premium rates commensurate with the flood risk faced by that zone. Federally related mortgages on homes in high-risk zones that face a greater than 1 percent annual chance of flooding—also known as Special Flood Hazard Areas or 100-year flood zones—are required to purchase flood insurance.

But exceptions to risk-based ratings were built into the FIRM process from early on. Properties that joined the program prior to the introduction of rate maps could continue to pay non-risk-based rates through what are known as “subsidized” policies, which historically were assessed rates that were only 45 percent of their true actuarial liability.[2]

Moreover, while the Federal Emergency Management Agency (FEMA) is required by statute to revise and update all its maps at least once every five years, mapping changes do not force rate changes for existing structures. These are treated as “grandfathered” properties, which continue to pay the rates assigned when their community joined the program or when its prior rate designation was finalized.

As a result, the NFIP has always taken in less in policyholder premiums than actuarial assessments would recommend. In the years just prior to Biggert-Waters, from 2002 to 2013, the Government Accountability Office (GAO) estimates the program collected $11 billion to $17 billion less in premiums than was actuarially prudent.[3]

Biggert-Waters and the subsequent Homeowner and Flood Insurance Affordability Act of 2014 (HFIAA) placed business properties and second homes on a glidepath toward actuarial rates, with annual premium increases that are capped at 25 percent, while rate increases on subsidized primary homes are capped at 15 percent. Biggert-Waters would have placed grandfathered properties on a glidepath to actuarial soundness with a rate cap of 20 percent, but HFIAA amended that provision such that it only takes effect if a grandfathered property’s map changes again in the future. If it does, the grandfathered property would see rate increases that likewise would be capped at 15 percent.

Were the NFIP actuarially sound, it would have the resources to sustainably administer the program—including marketing and claims-adjustment expenses—and pay all expected claims that fall within the ordinary distribution of potential outcomes. But the NFIP would still experience—and in recent years, has experienced—outsized claims events like Hurricane Katrina, Superstorm Sandy, and Hurricane Harvey that fall in the tail end of the probability distribution. Indeed, those three events alone account for the overwhelming majority of the $40 billion the program has had to borrow since 2005.

Since Hurricane Katrina, the NFIP has made $5.06 billion in interest payments to service its debt to the Treasury but has managed to repay just $2.8 billion of principle. It is, by all accounts, completely infeasible that it will ever repay its debt in full. Indeed, in 2017, the Congressional Budget Office (CBO) estimated that, under its existing structure, the NFIP is expected to post an average annual loss of $1.4 billion.[4]

That the program has proven structurally unsustainable was foreseen by its creators. In 1966, Lyndon Johnson’s Presidential Task Force on Federal Flood Control Policy warned Congress that creating a federal flood insurance program “in which premiums are not proportionate to risk would be to invite economic waste of great magnitude.”[5]

Congress could assess that the benefits to homeowners and business owners in flood-prone regions merit the cost of subsidies. Even if that were the determination, however, the program’s existing structure largely functions not through express taxpayer subsidies, but by enabling cross-subsidies from inland NFIP policyholders to those in coastal regions. The CBO has found that 85 percent of NFIP properties exposed to coastal storm surge (properties classified as “Zone V”) pay below full risk-based rates. Altogether, 69 percent of Zone V properties are grandfathered, 29 percent are subsidized, and 13 percent are both grandfathered and subsidized.[6]

In addition to subsidies flowing from inland policyholders to coastal policyholders, NFIP subsidies broadly flow from higher-income areas to lower-income areas. In 2013, the GAO reported that 29 percent of subsidized policies were in counties in the top decile of median household income and 65 percent were in counties among the top three deciles, while just 4 percent were in the bottom decile and 10 percent in the bottom three deciles.[7]

Should Congress determine that it does expressly want to subsidize property owners in flood-prone regions, those subsidies should properly flow directly from the taxpayers. Laying the burden on inland and lower-risk NFIP policyholders discourages take-up of flood insurance, at the margin, when the goal should be much broader take-up to close the protection gap. Moreover, to the extent that subsidies are necessary to protect at-risk populations from displacement, it would be proper to transition to an income-based voucher system, rather than the existing system of subsidies and grandfathering tied to when the property joined the NFIP.

Rising Waters, Rising Risks

Over the past 50 years, the NFIP has helped to shape the landscape, with significant impact on the country’s built environment. In the first four decades after its passage, from 1970 through 2010, the number of Americans living in coastal counties grew by 45 percent and now comprises more than half the U.S. population.[8] Nowhere is this shift more apparent than in my state of Florida. At the beginning of World War II, Florida was the least-populated state in the Southeast. As the recent 2020 U.S. Census figures confirmed, it is now the third most populated state in the nation. The NFIP was not the sole driver of that growth, of course. Air-conditioning also played a part. But by providing guaranteed and affordable coverage for the most common catastrophe risk facing property owners in a place like Florida, the NFIP has been a key enabler of the mass conversion of wetlands and barrier islands—nature’s built-in defenses against tropical storms and flooding—into acres and acres of manicured lawns and suburban tract housing.

But even as Americans spent much of the past half-century moving to areas at greater risk of catastrophic flooding, we have begun to see how anthropogenic climate change will make that problem much worse. Global sea levels rose by 2.6 inches from 1993 through 2014 and are projected to continue to rise by an average of one-eighth of an inch per year for the foreseeable future.[9] Projections for the 21st century anticipate sea level rise of between 20 inches, should we manage to make sharp and immediate cuts to global carbon emissions,[10] and six and a half feet, should the Antarctic ice sheet break up.[11]

And yet, even facing these challenges, there has been no slowdown in Americans preferring to build and live in flood-prone areas. A 2018 analysis of FEMA records conducted by Governing magazine found that 15 million Americans lived in 100-year floodplains, where current rules for federally related mortgages require the purchase of flood insurance. That was a 14 percent increase from the turn of the 21^st century, compared with 13 percent population growth in all other zones.[12] Even more strikingly, a 2019 report by ClimateCentral looked at areas projected to have a 10 percent risk of coastal flooding by 2050. They found that, in eight coastal states, there were more homes built within this project 10-year flood zone than in all other areas.[13] Development was twice as fast in the 10-year flood zone than outside of it in Delaware, Mississippi, New Jersey, and Rhode Island, while in Connecticut, it was three times as fast.

Losing land to the sea is not an entirely new phenomenon, of course. Sen. Kennedy’s home state of Louisiana has lost more than 2,000 square miles of land since the 1930s.  But the scale of land loss we may now face, combined with the surge in development in flood-prone areas, is new. In 2016, a piece in the journal Nature Climate Change overlaid anticipated population growth with projected sea-level rise of roughly three feet to six feet, finding that between 4.2 and 13.1 million Americans would be displaced by inundation.

The changing nature of flood risk makes it even more crucial that FEMA, as the NFIP’s administrator, regularly update its Flood Insurance Rate Maps to keep up with changes on the ground. The evidence, however, is that the agency is failing to do that. A 2017 Department of Homeland Security Inspector-General’s report found that FEMA was up to date on just 42 percent of the NFIP’s flood hazard miles, far short of a goal of 80 percent set in 2009, and that the agency had not properly ensured that “mapping partner quality reviews are completed in accordance with applicable guidance.”[14] In 2017, the CBO found that, of the 166 counties that produce more than $2 million in average annual flood claims, half were using maps that were more than five years old.[15]

Sea-level rise and other impacts from climate change threaten to radically transform how we must deal with the risk of flooding. A 2019 study in Nature Communications had a grim projection about the frequency and severity of flooding and coastal storm surge: By the end of this century, today’s 100-year flood events in the Southeast and Gulf Coast will be expected every 1 to 30 years. Today’s 100-year events in New England and the mid-Atlantic can be expected every single year.[16]

It is inevitable that, in at least some locations, we will have to consider pulling back from the coasts and moving Americans to higher ground. But an important first step is to stop making the problem worse.

Baby Steps Toward Managed Retreat

“Managed retreat” is a controversial phrase, both because it connotes surrender in the battle against climate change and because it is taken to mean a radical realignment in the way we live. And yet, in some respects, managed retreat is longstanding policy. It is seen most clearly in FEMA’s Hazard Mitigation Grant Program (HMGP), the Flood Mitigation Assistance (FMA) Grant Program, and Pre-Disaster Mitigation (PDM) Program, all of which execute buyouts of flood-prone properties, which are then demolished, and the vacated land dedicated in perpetuity to open space.

While buyouts are likely to continue to be part of the solution to rising flood risk, there are serious questions about whether they could ever scale anywhere close to meet the scope of the problem. A 2019 report from the Natural Resources Defense Council found that, at the pace FEMA executed buyouts in the 30 years between 1989 and 2019, it would only be able to buy out another 115,000 properties by the end of the 21^st century.[17] For comparison, current projections are that as many as 13 million properties will be completely inundated by the year 2200.

Rather than tearing down the flood-prone properties that already exist, a more immediate approach would be to remove the incentives to build new ones. I authored a report last year that proposed doing so directly—by barring any new construction in 100-year floodplains from NFIP eligibility. Based on my review of NFIP claims data, had this policy been in place starting in 1980, the program’s payouts between 1990 and 2019 would have been roughly 13 percent smaller, representing $16.5 billion in savings.[18]

What I could not quantify in my research, but which is likely even more crucial to the pressing challenge of climate adaptation, is how many of those severely flood-prone properties would not have been built in the first place, but for guaranteed NFIP coverage. In some cases, property owners in such areas might turn to the emerging private market for flood insurance, but they would be assessed risk-based premiums that, in many cases, likely would be prohibitive.

Of course, an additional benefit of this approach is that, unlike phasing out subsidies, it does not lay any new burden on existing policyholders. Similar approaches can be found in the Coastal Barrier Resources System (CBRS), a 37-year-old program that bars federal subsidies to development across a 3.5-million-acre zone of beaches, wetlands, barrier islands, and estuaries along the Atlantic Ocean, Gulf of Mexico, and the Great Lakes. Likewise, in Florida, the Legislature adopted a similar rule in 2015 that bars the state-sponsored Citizens Property Insurance Corp. from writing coverage for new construction located seaward of the state’s Coastal Construction Control Line.[19]

But it is not enough simply to tell people where they cannot build; we must also tell people where they can. Many areas remain gripped by a serious housing affordability crisis caused by stringent land-use controls that make it excessively difficult to build new housing in places where people wish to live.

Therefore, in addition to the “stick” of removing the NFIP’s incentives to build in flood-prone areas, I propose an additional “carrot” of federal incentives for states that liberalize their land-use policies in areas of lowest flood risk.

Specifically, the Stafford Act currently requires that, when the federal government provides post-disaster relief to repair, restore, or replace damaged facilities, state, and local governments are responsible to pick up 25 percent of the cost. I propose that providing for dense housing in the lowest-risk flood zones—those classified as 1-in-500-year zones, or Zone X and Zone C in the current mapping system—would enable states to “buy down” the local cost share. For example, if a state were to abolish single-family zoning in the lowest-risk flood zones—e.g., allowing construction of accessory dwelling units and up to four-family homes, by right—the federal government’s cost-share for post-disaster recovery would rise to 80 percent or even 85 percent. This would begin the process of ensuring that, as rising seas force more Americans to move to higher ground, there will be sufficient housing stock to absorb them.

Other Considerations

• I mentioned earlier that it would be proper to transition the current subsidies to an income-based voucher system. An important element of such a system is that policyholders should be made aware of the full risk-based cost of flood insurance. The same applies to current subsidized and grandfathered policyholders. Any NFIP policy with rates that are less than the full risk-based cost should disclose to policyholders what that cost would be. Similarly, a complete flood history should be made available to buyers as part of all real estate closings.
• Many of the implementation questions that surrounded Biggert-Waters’ provisions permitting private flood insurance to satisfy mandatory purchase requirements have, in recent years, been resolved by state authorities and the federal lending regulators. One additional point of clarification this committee could provide is to determine whether consumers who move from the NFIP to private flood insurance and then maintain continuous coverage can later return to the NFIP at the same rate as if they had remained with the program all along. This would protect consumers if, for example, after switching to a private policy, the private insurer raised rates or exited the market.
• Some have proposed forgiving the NFIP’s current $20.5 billion debt to the Treasury. Should Congress opt to do so, the program’s existing $30.425 billion borrowing authority would be far too large to offer any meaningful check. Congress should instead simply set the borrowing authority cap 1 percent of the NFIP’s total insurance in-force. Based on its current total of $1.3 trillion, this would mean the NFIP could borrow up to $13 billion without needing further authorization.

With that, I would be glad to answer any of the Committee’s questions.

 

[1] “The Watermark Fiscal Year 2021, First Quarter, Volume 13,” Federal Emergency Management Agency, p. 2. https://www.fema.gov/sites/default/files/documents/fema_watermark-report_12-2020.pdf.

[2] Bill Jones, “Biggert-Waters Flood Insurance Reform Act of 2012 Summary,” Nebraska Dept. of Natural Resources, February 2013. https://agriculture.ks.gov/docs/default-source/dwr-floodplains/summary-of-the-biggert-waters-act.pdf?sfvrsn=ce3ffec1_0.

[3] “Forgone Premiums Cannot Be Measured and FEMA Should Validate and Monitor Data System Changes,” Government Accountability Office, GAO-15-111, Dec. 11, 2014. https://www.gao.gov/products/GAO-15-111.

[4] “The National Flood Insurance Program: Financial Soundness and Affordability,” Congressional Budget Office, Sept. 1, 2017, p. 1. https://www.cbo.gov/publication/53028.

[5] Gary William Boulware, “Public Policy Evaluation of the National Flood Insurance Program (NFIP),” doctoral dissertation, University of Florida, December 2009, p. 14. https://ufdc.ufl.edu/UFE0041081/00001.

[6] “The National Flood Insurance Program: Financial Soundness and Affordability,” Congressional Budget Office, Sept. 1, 2017, p. 1. https://www.cbo.gov/publication/53028.

[7] “Flood Insurance: More Information Needed on Subsidized Policies,” Government Accountability Office, July

2013. https://www.gao.gov/assets/gao-13-607.pdf.

[8] Ross Toro, “Half of US Population Lives in Coastal Areas (Infographic),” LiveScience, March 12, 2012. https://www.livescience.com/18997-population-coastal-areas-infographic.html.

[9] “Is sea level rising?”, U.S. National Oceanic and Atmospheric Administration, Feb. 26, 2021. https://oceanservice.noaa.gov/facts/sealevel.html.

[10] Carling C. Hay et al., “Probabilistic reanalysis of twentieth-century sea-level rise,” Nature 517 (Jan. 14, 2015), pp. 481–84. https://www.nature.com/articles/nature14093.

[11] Robert E. Kopp et al., “Evolving Understanding of Antarctic Ice-Sheet Physics and Ambiguity in Probabilistic Sea-Level Projections,” Earth’s Future 5 (Dec. 13, 2017), pp. 1217–33. https://agupubs.onlinelibrary.wiley.com/doi/full/10.1002/2017EF000663.

[12] Mike Maciag, “Analysis: Areas of the U.S. With Most Floodplain Population Growth,” Governing, August 2018. https://www.governing.com/gov-data/census/flood-plains-zone-local-population-growth-data.html.

[13] “Ocean at the Door: New Homes and the Rising Sea,” ClimateCentral, July 31, 2019. https://ccentralassets.s3.amazonaws.com/pdfs/2019Zillow_report.pdf.

[14] “FEMA Needs to Improve Management of Its Flood Mapping Programs,” U.S. Department of Homeland Security Office of the Inspector-General, Sept. 27, 2017, p. 3. https://www.oig.dhs.gov/sites/default/files/assets/2017/OIG-17-110-Sep17.pdf.

[15] “Age of Flood Maps in Selected Counties That Account for Most of the Expected Claims in the National Flood Insurance Program: Supplemental Material for The National Flood Insurance Program: Financial Soundness and Affordability,” Congressional Budget Office, November 2017, p. 3. https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53028-supplementalmaterial.pdf.

[16] Reza Marsooli et al., “Climate change exacerbates hurricane flood hazards along US Atlantic and Gulf Coasts in spatially varying patterns,” Nature Communications 10:3785 (Aug. 22, 2019). https://www.nature.com/articles/s41467-019-11755-z.

[17] Anna Weber and Rob Moore, “Going Under: Long Wait Times for Post-Flood Buyouts Leave Homeowners Underwater,” Natural Resources Defense Council, Sept. 12, 2019. https://www.nrdc.org/resources/going-under-long-wait-times-post-floodbuyouts-leave-homeowners-underwater.

[18] R.J. Lehmann, “Do No Harm: Managing Retreat By Ending New Subsidies,” R Street Institute, February 2020. https://www.rstreet.org/wp-content/uploads/2020/02/195.pdf.

[19] Jane Smith and Michelle Quigley, “Along the Coast…A line in the sand,” The Coastal Star, Aug. 30, 2017. https://thecoastalstar.com/profiles/blogs/along-the-coast-a-linein-the-sand.

Fresh off his second-place finish — behind only former President Donald Trump — in the presidential straw poll at the Conservative Political Action Conference in Orlando, Gov. Ron DeSantis’ top priority heading into this year’s legislative session is custom-fit to appeal to the CPAC crowd: going after Big Tech social-media companies for their alleged anti-conservative bias.

Read the full piece here.

Background…

Thousands of U.S. businesses have filed insurance claims for business interruption since the start of the COVID-19 pandemic, particularly where civil authorities have ordered businesses to shutter. The overwhelming majority of such claims have been denied, however, as standard commercial property insurance policies typically require an insured to demonstrate evidence of physical damage. Most policies also explicitly exclude losses related to viral contagion. Many of these claims disputes have ended up in the courts.

But…

Lawmakers at the state and federal level have responded to these claims denials with several ill-considered legislative proposals. Bills that would vitiate contract language and require coverage retroactively for COVID-19 business interruption claims were introduced in more than 10 states in 2020, though none were passed into law. In May 2020, U.S. Rep. Carolyn B. Maloney introduced the Pandemic Risk Insurance Act of 2020 (PRIA), establishing a $750 billion reinsurance program that would have the federal government pay 95 percent of business interruption claims arising from a future viral contagion.

However…

Both the magnitude and the extreme correlation of business interruption losses arising from a pandemic make them nearly impossible to insure. Rewriting contract language to require payment of claims that are explicitly excluded would jeopardize both the rule of law and the solvency of the global insurance industry. Disallowing virus exclusions in future policies could threaten the availability of coverage for business interruption altogether. While it is possible to structure a government backstop that could draw interest from private insurers, the details of any such proposal need to be closely scrutinized. Ultimately, the question should be raised whether insurance is actually the tool best suited to the problem

Read the full explainer here.

Chairman Clay, Ranking Member Stivers and members of the subcommittee,

My name is R.J. Lehmann, and I am editor-in-chief and senior fellow with the International Center for Law & Economics. ICLE is a nonprofit, nonpartisan research center that works with a roster of more than 50 academic affiliates and research centers from around the globe to develop and disseminate academic output and build the intellectual foundation for rigorous, economically grounded public policy.

I am a recent addition to the ICLE staff. My own background is that I have spent the past 17 years as a journalist and public-policy analyst specializing in the business of insurance. That includes running the insurance policy program at the R Street Institute, which I co-founded in 2012.

The COVID-19 outbreak has triggered unprecedented interruption in the operations of businesses across the country and around the world. While roughly 37 percent of U.S. businesses maintain insurance policies to cover the loss of business income due to direct physical damage to a business property, such policies are not designed to insure revenue loss resulting from a pandemic, even where closure is required by a civil authority order. Indeed, many policies contain explicit endorsements clarifying that viruses and bacteria are excluded as causes for business interruption and loss-of-use coverages.

Earlier this year, Congress sought to address the disruption caused by COVID-19 through the Paycheck Protection Program and there have been various efforts to extend further relief to affected employers and employees. But it is understandable that many seek a more permanent solution and look to insurance markets as offering the framework to provide it.

I agree entirely with the analysis that the pandemic has highlighted a massive protection gap in commercial insurance products. I also agree that it is a problem that almost certainly calls for a governmental solution. I would, however, raise the threshold question of whether insurance is actually the best means to accomplish the public policy goals in question.

Insurance is a system of risk transfer, not a system of economic relief. Even if private insurers could provide this coverage—on their own or with government support—it is not clear their incentives would align with public health goals or with the aims members of Congress likely have in mind.

I would urge the subcommittee and Congress generally to proceed deliberatively before erecting structures that may not prove to be well-suited to the crisis we are currently experiencing, much less unforeseen future crises whose nature and scope we cannot know. In sum, do not legislate for the next pandemic when we are still in the midst of dealing with the current one.

I.      Are Pandemics Insurable?

In the business of insurance, there are certain general characteristics that determine whether it is possible, in theory, to insure a given risk. These include having a large number of similarly exposed individuals and having losses that are reasonably predictable. A textbook example of an uninsurable risk would be intentional acts, such as arson. You could not transfer to an insurer the risk that you will burn down your own home, because that risk is fully within your control.

Business interruption caused by a pandemic is not uninsurable in the same sense that intentional arson is uninsurable. There were insurance products available to cover loss of business income due to viral contagion before COVID-19 hit our shores, although clients’ interest in those products was reportedly fairly limited. There are still products that offer such coverage now, although the price of coverage has gone up significantly. On the micro level, for any given insurer and any given insured, viral business interruption is an insurable risk.

The problem is at the macro level. There is only a limited amount of capital that insurers would be willing to devote to a risk like pandemics. Some insurers will write some coverage. They might, for instance, cover a restaurant’s risk of food spoilage resulting from an extended shutdown. But they will not and should not gamble their entire balance sheets. And the capacity that the global insurance and reinsurance industry would ever be willing to devote to this risk cannot possibly match its unique scale.

In this macro sense, for a risk to be insurable, it must be possible to manage it through careful underwriting and diversification. Global pandemics make that impossible. They hit every business sector and every geographical region simultaneously. They even degrade the invested assets insurers use to back up their promises. In a scenario where half the global economy shuts down overnight, there is no world in which the insurance industry can single-handedly carry the other half on its back.

The only entity with the financial resilience, the balance sheet and the risk tolerance to offer such assistance is the federal government itself.

II.      Moral Hazard and Government Insurance

When I have appeared before this committee in the past, it has been to warn about the dangers of moral hazard that frequently accompany government intervention in insurance markets. The 50-year-old National Flood Insurance Program is a prime example of this danger. By providing insurance coverage to all comers at rates insufficient to match the level of risk, the NFIP encourages development in disaster-prone and environmentally sensitive regions.

While I remain disposed to skepticism about government insurance programs, I do not believe any of the proposals discussed here today—such as Rep. Maloney’s Pandemic Risk Insurance Act (PRIA) or the joint-trades’ Business Continuity Protection Plan (BCPP)—pose much, if any, risk of moral hazard. With or without insurance and with or without government support, there is likely nothing at all a business owner could do to avoid the impact of a pandemic. Indeed, the greater threat is a business that would go out of its way to keep its doors open, despite the dangers that could result.

Which is not to say moral hazard is irrelevant to the pandemic or to how insurance responds to it. Business interruption is far from the only insurance coverage implicated by viral contagion. Most obviously, employers in nearly every state must provide, on a no-fault basis, workers’ compensation coverage for illnesses contracted on the worksite or in the usual course of job duties. Businesses also obtain various commercial liability coverages that could be triggered if they breach a duty of care or otherwise recklessly cause foreseeable harm by exposing a customer or other third party to the virus.

Where a business is a potential nexus of contagion, we should want them to internalize that cost and to adjust their operations in the interest of better protecting public health. That could mean investments in mitigation, adaptation and prevention. It could mean making sure a worksite is well-stocked with personal protective equipment or that the spatial orientation is changed to reduce the risk of infection.

These casualty and liability lines of business exemplify how risk-based insurance rates can serve a regulatory function, providing price signals that encourage businesses to adopt those practices that best protect their employees and others. If Congress is to move forward with creating a federal insurance or reinsurance program to manage pandemic risk, I would strongly urge to focus tightly on the unique challenges of business interruption and not extend it to casualty and liability lines of coverage. It would be extremely unwise to extend public subsidies that could serve to encourage recklessness.

III.      A Murky Role for Business Interruption Insurance

The approach proposed by PRIA is to graft coverage for pandemic risks onto the existing structure of business interruption coverage by providing a $750 billion federal backstop for insurers who choose to participate, with the industry retaining only about 5 percent of the total risk. But only a minority of businesses—a little over a third—currently maintain business interruption coverage. Given that the program would be voluntary for insurers to offer and voluntary for insureds to purchase, it is reasonable to assume less than a third would ultimately elect to carry it.

Even for those who do, there are real questions about whether the sorts of claims we can reasonably anticipate policyholders to make would actually be paid. PRIA is a good faith attempt to extend coverage and avoid the sorts of claims disputes that have prompted hundreds of businesses to sue their insurance companies. The program may well extend coverage but there are some predictable areas of conflict that will almost certainly land policyholders back in court.

Business interruption and contingent business coverages are components of commercial property insurance policies. PRIA would ask participating insurers to vitiate standard contract language that excludes claims for viral pandemics. But that would not change a more fundamental presumption of any property insurance policy: that there must be demonstrable physical damage to the insured property.

To be sure, there are legal theories—some of them currently being tested in the courts—that business closures are necessitated by viral contamination of surfaces within the covered property. But whether that is applicable in any given case is going to depend both on the nature of the virus and the nature of the property. If contamination can be easily cured by wiping down surfaces, that is going to be an extremely limited claim. The reality is, creative legal theories aside, most business closures in this pandemic have had nothing to do with potentially contaminated surfaces. They have instead sought to avoid transmission between people. That is not a risk covered by property insurance.

There is also the question of what triggers coverage. Both PRIA and the BCPP proposal tie coverage to public health emergency orders, such as mandated shutdowns. But the experience we have had in this pandemic shows why that is almost certainly insufficient. The initial wave of business closures did not come as a result of mandated shutdowns; they were in response to customers choosing to stay home. A number of states and localities never formally “shut down” businesses at all and yet still suffered precipitous drops in economic activity. As of October, after nearly all states lifted shutdown orders, airport traffic remained down 60 percent from before the pandemic and OpenTable restaurant reservations were down nearly 40 percent.

There is no “business is bad” insurance. Without some sort of external trigger, there is no cause to make a business interruption claim for a business that has merely been depressed, not interrupted.

Again, insurance is risk transfer, not economic assistance. It should give lawmakers pause that PRIA would represent a $750 billion investment of taxpayer dollars in a program that two-thirds or more of businesses will not access, where many claims will still be denied and where the kind of loss that will be most commonly experienced by businesses does not and cannot constitute a claim.

IV.      Why Risk-Based Coverage May Be Bad

A central argument for a public-private partnership to support business interruption insurance for pandemics is that, while the federal government can bring its balance sheet to bear, it does not have the insurance industry’s expertise in modeling, managing and mitigating risk. I find myself in the uncomfortable position of critiquing that argument, given that it is one that I myself have made for the entirety of my career in public policy, whether the subject was flood insurance or crop insurance or terrorism insurance.

But it is important to ask: modeling, managing and mitigating the risk of what, specifically? In the case of business interruption insurance, it is not the risk of viral transmission. It is not even the risk of a pandemic, not quite. It is the risk of business closure as a result of a pandemic.

I mentioned earlier that I do not believe there is anything a business owner could do to avoid the impact of a pandemic. What they could do—what risk-based insurance might encourage them to do—is to avoid making a claim by refusing to shut their doors and by pressuring local leaders not to issue mandatory shutdown orders. From a public health perspective, that is the opposite of what we want to happen. And yet, we see it has happened. It is one reason we see the incoherent outcome that, in some cities, schools are closed while bars and restaurants are allowed to remain open.

Like any efficient insurance market, a risk-based insurance market for pandemic business interruption insurance would seek to align the incentives of the insured and the insurer. Among the ways this is generally accomplished is through deductibles, which discourage policyholders from making claims for shallow losses. More broadly, it is accomplished by matching premiums to the level of risk. For example, businesses that could continue operating remotely even in the midst of a pandemic are low-risk and would be offered the most affordable coverage.

On the other hand, risk-based insurance premiums for restaurants, gyms, theatres, barbers, manicurists—any environment where you have close personal contact with strangers or indoor mass congregations of people—would be punishingly expensive. Actuarial science is notoriously complex, but the basics of risk-based premiums are fairly simple: frequency times severity. The severity of a pandemic contagion, even if it happened just once a century, is so extreme that a risk-based premium could not be affordable for the overwhelming majority of small businesses—or even churches and social groups—that rely on in-person human interaction. If they were forced to buy this coverage, many could simply no longer exist. That is not a socially desirable outcome.

The saving grace—the reason we would not likely see that outcome—is itself discouraging. Because the coverage would be voluntary, these sorts of businesses almost certainly would not take it up. Thus, the very businesses who have been hardest hit by this pandemic and would likely be hardest hit in any future one would remain the most exposed.

V.      Learning from the Current Pandemic

Proposals like PRIA and the BCPP initially were put forward in the early days of the pandemic. The folly of imagining that lawmakers could have the foresight to craft structures that anticipate future pandemics is just how much has changed in the few months since those proposals were debuted.

I consulted with the insurance trades on the earliest drafts of what became the BCPP. I believe it was my idea to cap the maximum coverage the program would offer at three months of business income. Back in April, that seemed like a generous benefit. Seven months later, with caseloads breaking new records every day and a vaccine at least months away from broad distribution, it seems much less so.

PRIA was originally a $500 billion proposal. It is now a $750 billion proposal. But it is also clear that that amount, while a lot of money for a federal program, is not nearly enough for the scope of the problem. Moreover, PRIA is structured as a single pot of money. Were it in place during COVID-19, it may well have been completely depleted by the earliest phases of the pandemic, when the virus was contained largely to New York and New Jersey. By the time the second wave spread across the Sunbelt in June and July, there may have been nothing left, to say nothing of the third wave we are now encountering.

Any program that Congress does establish should follow some broad principles gleaned from our experience thus far with COVID-19. But we also should be humble about how much we still do not know even about the current pandemic, much less the next one.

The program should endeavor for broad participation, with a bias toward encouraging small businesses, nonprofits and community organizations to take part. Larger enterprises already have available to them a number of insurance options that small businesses do not, from the ability to create captive insurance companies to relatively easy access to bespoke products in the excess and surplus lines market. Indeed, our experience with the Terrorism Risk Insurance Act suggests we should be particularly skeptical of how large companies might use captives to game a structure like PRIA, including for tax-avoidance purposes, with the overwhelming majority of risk passed on to taxpayers.

If there is to be a premium or a participation fee for the program, it should be flat, not risk-based. One common concern of insurance markets is the problem of adverse selection. Because an insured has more information about their own risk than an insurer does, the riskiest businesses are also the most likely to buy coverage. While that is a problem for writing insurance profitably, the public health goals of pandemic response turn that issue on its head. The businesses most at risk of shutting down are the ones to whom we most need to extend a safety net. We want them to cooperate with shutdowns, not push back.

In the spirit of broad participation, the insurance industry should not be the sole marketing force for any federal pandemic risk program. PPP was administered primarily by banks and credit unions and that appears, on balance, to have worked pretty well. There is no reason that lending institutions, payroll processing companies or credit card issuers could not help to sign up participants.

The same applies when it comes to distributing benefits. The insurance industry’s claims-adjustment force is already pushed to capacity to keep up with disasters like hurricanes and wildfires. Adjusting business interruption claims requires special training. Moreover, adjusting claims is a slow and laborious process, which conflicts with the goal of getting money out the door as quickly as possible. A parametric trigger, such as the one in the BCPP, would better accomplish that goal.

The BCPP balances the parametric structure by enumerating specific purposes for which benefits can be used, like rent and payroll. Any disbursed benefits not used for those purposes could later be clawed back. While this is how PPP worked and how the BCPP would work, it is not how business interruption insurance works. A policyholder that makes a claim for business interruption might use the money to continue paying staff, but there would be nothing requiring them to do so. Even with PRIA in place, a business owner could make a claim for interruption while simultaneously placing all his or her employees on furlough. Lawmakers should understand that.

Another question is whether it is wise to create a federal program at all. Given that public health orders are overwhelmingly the jurisdiction of state and local governments, one option would be to allow the states to create their own programs, with the U.S. Treasury partially reimbursing the cost. This would require Congress to establish some minimum guidelines for qualifying programs. But so long as the reimbursement formula was relatively transparent and applied equitably, it would permit innovation and local customization in program design, while also limiting the “run on the bank” danger that a single pot of federal money like PRIA might face.

But above all, my recommendation to lawmakers is to take your time. Perhaps more private solutions, from the insurance industry or some other source, will emerge to meet these challenges before the next pandemic. Perhaps Congress would again have to provide ad hoc assistance. It is profoundly more important that Congress do its job to get assistance to the businesses, workers and communities who need that help right now that it is to pretend to have the answers in 2020 to a crisis of unknown and unknowable dimensions that may befall us in 2025 or 2050 or 2100.

Thank you, and I would be happy to answer any questions.