Why Is The Government In The Flood Insurance Business?

By David Kestenbaum

Published January 24, 2013 at 3:34 AM EST

Hurricane Betsy hit the Gulf Coast in 1965.

There's a quick, one-word explanation for why the federal government started selling flood insurance: Betsy.

Hurricane Betsy, which struck the Gulf Coast in 1965, became known as billion-dollar Betsy. Homes were ruined. Water up to the roofs. People paddling around streets in boats. Massive damage.

This would be the time when you'd expect people to be pulling out their flood insurance policies. But flood insurance was hard to come by. You could get fire insurance, theft insurance, car insurance, life insurance. Not flood.

"There was a lack of data," says Eric Smith, president and CEO of Swiss Re in the Americas. "One of the bedrock principles of insurance is it has to be something that's somewhat measurable. You have be able to calculate its frequency, its severity. How often this going to occur and how much damage is it going to do?"

A few years after Betsy, in 1968, the government decided it would take on the job of selling flood insurance. Some people hated this idea. If private insurance companies wouldn't sell policies to people who wanted to live in flood zones, they argued, why should the government?

This argument did not win the day. The government created flood maps, gathered data, and set up the National Flood Insurance Program.

"I think it generally worked out OK overall, until Katrina," says Mark Browne, a professor of risk management and insurance at the University of Wisconsin, Madison. "Katrina was a major loss for the National Flood Insurance Program. It blew through its money and went into deficit.

"This is why flood insurance is a tricky business. You can have a quiet three decades, then a huge hurricane plows into a major city. Suddenly you're back in the red."

Over the past few years, the National Flood Insurance Program has had to borrow $17 billion from the government.

So were the critics right? Is the government running a bad business? Maybe not. After a big national disaster, Browne argues, the government is on the hook anyway. It might as well collect some money by selling insurance.

The head of the National Flood Insurance Program says the program plans to repay the money it borrowed from the government — but it may take 20 or 30 years to do so.