Why Fairness Matters in Reforming Flood and Health Insurance Programs

As Congress looks at restructuring two national insurance plans — the American Health Care Act of 2017, and the National Flood Insurance Program — legislators must address the issue of fairness. That is the view of Wharton professors Howard Kunreuther and Mark Pauly, who co-authored the book, Insurance and Behavioral Economics: Improving Decisions in the Most Misunderstood Industry.

In this opinion piece, they argue that considering the issue of fairness in designing these programs is not merely an exercise to aid the old and needy. Rather, it is also to make legislators think about what policies will make premiums less onerous to people with lower risk so they will not be discouraged about getting coverage.

The United States of America is at a critical moment as Congress is attempting to determine how two insurance programs should be structured to help Americans who need protection from physical and financial risk. Both the reauthorization of the National Flood Insurance Program (NFIP) and the American Health Care Act of 2017 raise questions as to whether affected individuals would be treated more fairly under the new legislation than they currently are.

For us, fairness in the context of new legislation means consideration of the impact that a sudden increase in premiums or unexpected changes in the terms of coverage will have on the well-being of the affected individuals.

When the National Flood Insurance Program (NFIP) was enacted in 1968, there was a concern that high premiums would significantly reduce property values and that this could become an unfair economic strain. For this reason, the NFIP specified that homeowners living in high-risk areas at the time the law was enacted would be charged a subsidized premium.

The same potential conflict regarding fairness applies to health insurance. Is it fair that those with pre-existing medical conditions or those who unexpectedly acquire high-risk conditions might have to pay much higher health insurance premiums than when they were less at risk?  Yet this is what will happen if private insurers are allowed to charge risk-based premiums and politicians decide to provide limited subsidies to cushion those higher premiums.  However, is it fair to impose high premiums on individuals with low risks to finance such subsidies? And is it fair to offer no reward to those who take steps to improve their health status and thus reduce their future health spending risk?

Elected representatives on both sides of the aisle continually espouse the principle of fairness across a wide range of issues, including trade, tax reform, and jobs. If they truly want to extend that allegiance to the principle of fairness, they might wish to consider offering some form of financial assistance to help working class families who become high risk for floods or to help them buy or continue coverage for health care. The choice of the right amount of support regarded as fair is ultimately a political issue where voters’ perspectives may differ.

There are efficient ways to address the fairness problem for both insurance programs that might gain bipartisan support. With respect to health insurance premiums, it is easy to justify assisting low income and older people who want to buy coverage. Empirical studies of Medicaid programs suggest that individuals care about other people’s health conditions. Many taxpayers are thus likely to support having the public sector cover part of the cost of health insurance for those whose health might be improved by having insurance.

“There are efficient ways to address the fairness problem for both insurance programs that might gain bipartisan support.”

In the case of flood insurance, those subject to water-related damage should receive information on the cost of insurance that reflects their flood risk. If this risk-based premium exceeds a proportion of their income or housing costs, they could be given an insurance voucher or tax credit so they could afford insurance. A new RAND study recommends that those whose total housing costs — including flood insurance premiums — exceed a certain percentage of their income be provided with financial assistance. This would ensure that taxpayers are not subsidizing high-income individuals.

It is important to encourage property owners in flood prone areas to invest in cost-effective, loss-reduction measures. Homeowners could be offered a long-term home improvement loan, tied to the property, to pay for cost-effective ways to mitigate future losses, such as elevating the house or moving utilities to a higher floor, so that the annual cost of the loan, paid all or in part by vouchers or tax credits, would be less than their savings from the reduced risk-based premium. This proposal is not only fair, but also encourages property owners to reduce future losses from inevitable disasters. It also avoids using taxpayer dollars to assist uninsured and unprotected victims from hurricanes and floods who will demand and may receive federal disaster relief.

In summary, the proposed flood and health insurance programs should be designed with reasonable premiums for high-risk individuals so they will want to purchase coverage that protects them against catastrophic financial losses. At the same time, one needs to be concerned about not discouraging low-risk individuals from purchasing insurance by imposing the subsidy burden on them alone through premiums much higher than their risk rather than on the general population through a broad-based tax. By considering the issue of fairness as an important criterion in designing these programs, we will have taken a major step in enabling high-risk individuals to have coverage while at the same time maintaining the basic principles of insurance.