Federal Flood Insurance Subsidies and Floodplain Development
Federally subsidized flood insurance can increase exposure to flood risk by encouraging development in flood-prone regions. This moral hazard is well established, but there has been relatively little empirical work examining the causal impacts of government subsidies on induced development, and hence its costs. Coastal populations have increased dramatically in the past half century, as have the cost of flood damages. This paper investigates how subsidized insurance premiums offered by the National Flood Insurance Policy (NFIP) contributed to this rise in costs by encouraging residential and commercial development in flood-prone regions. I show that the rules regarding subsidy eligibility incentivized landowners and developers to participate in a “rush to build” in order to be grandfathered into a subsidized insurance policy. These eligibility rules were based on the completion of the community’s flood map. To estimate the effect of NFIP subsidies on both short-term and long-term development outcomes, I exploit a 1973 amendment to the Program that mandated communal participation but also created bureaucratic delays in the completion of community flood maps. Results reveal that an extra year of NFIP subsidy availability for a community corresponds to an increase in the probability of development of that community’s floodplains by 2.0-6.0 percentage points in the year 2000, resulting in an additional one billion dollars of nationwide annual flood costs in the year 2000.