Every state in the union has had at least one weather related billion-dollar disaster during the 30-year period between 1980 and 2010, according to an article on the Weather Channel’s website. Federal Emergency Management Administration (FEMA) data shows that the number of disasters warranting a Presidential Disaster Declaration jumped from below 50 per year to over 100 per year in the mid-1990s.
But the reason for that jump isnot the focus of this article. The focus of this article is how to pay for the cleanup, recovery and, particularly, resilience to the next event.
In recent years, Congress has moved to solve the multi-billion dollar deficits of disasters, particularly the National Flood Insurance Program. The Biggert-Waters Act of 2012 (BW-12) would phase out federal government subsidies over a five year period. The congressional intent of BW-12 was to have flood insurance premiums address the actual flood risk in a flood zone.
However, this action caused drastic premium increases. Selling an existing home or constructing a new structure activates the drastic premiums. The new BW-12 premiums could devastate the real estate market in many areas of the nation. In an Op-Ed in the January 2014 issue of the Insurance Journal, Michael Hecht, president and CEO of Greater New Orleans, Inc., provided an example of the impact of the new BW-12 insurance premiums.
He said, “An example is a primary residence in Belle Chasse, Louisiana that was built two feet above the FEMA standard in 1996 – and has never flooded – that will see its premium rise from $633 to $17,723. With a 2,800 percent increase in insurance, the viability and value of this home and homeowner will be destroyed.”
Belle Chasse is located in Plaquemines Parish, Louisiana. The City-Data website reported that the annual median income of Plaquemines Parish in 2011 was $65,653. To maintain the same affordability of the new premium of $17,723, the annual median income would have to rise to $1,838,180. Furthermore, the median cost of a home in Belle Chasse in 2011 was $246,266. The BW-12 premium is sufficient to pay for the home in 13.9 years!
Congress enacted the Homeowner Flood Insurance Affordability Act of 2014 to mitigate the impact of BW-12. Accordingto an analysis by the National Association of Realtors, three highlights of the Affordability Act are that it:
- Increases funding to reimburse property owners for successful flood map appeals;
- Reduces rates based on flood-proofing and alternative methods to elevating property; and
- Provides a higher deductible (up to $10,000) before insurance covers flood losses.
Angelyn Treutel-Zeringue, president of SouthGroup Gulf Coast, a leading insurance provider along the Mississippi Gulf Coast, suggested the flood insurance program should have several deductible levels. Different deductible levels increases affordability for a greater number of homeowners. Different deductibles and the bullets above are important to the concept of a disaster savings account.
Disaster savings accounts
A strategy already adopted by at least two states — South Carolina and Alabama — to help property owners save for a rainy day disaster is a state tax free individual disaster savings account (IDSA). These tax free accounts encourage property owners to either save to build in pre-disaster resilience to the property, or pay to recover from a disaster.
In the 113th Congress, Rep. Dennis Ross (R-Fla.) and Sen. Jim Inhofe (R-Okla.) introduced bills in their respective houses of Congress to create a national tax free disaster savings account. Ross said on his website that, “This legislation provides critical relief to Americans in disaster-prone states, allowing them to save pre-tax money for use toward disaster preparation and recovery expenses.”
The bill would allow individuals to save $5,000 annually in a federal tax free savings account that the bill calls a “disaster savings account” (DSA). The funds roll over from year to year. In two years, the rollover feature would enable a property owner to save the $10,000 deductible of the Homeowners Flood Insurance Affordability Act. Individuals set up a DSA on a voluntary basis.
The model for DSA is similar to that of Individual Retirement Accounts (IRA) and Health Savings Accounts (HSA). IRAs and HSAs are tax deferred or tax free accounts designed to build a contingency fund for retirement and health needs, respectively. The accounts are funded by individuals (and employers for some IRAs), but not by governments. However, the government created tax benefits as a major incentive for individuals to use these accounts. IRAs and HSAs have proven popular with middle and upper income individuals.
It is the culture of Americans to be self-sufficient. And a DSA helps Americans be self-sufficient. It is also the culture of Americans to come to the aid of those impacted by a disaster. In major disasters, Americans expect the federal government to step in with assistance from lifesaving to financial aid to speed recovery. A DSA benefits all three of these aspects of our culture — It enables self-sufficiency, it can decrease the call for aid from individuals, and it lowers recovery costs for the government.
The government should establish certain ground rules for the disaster savings accounts. Below are some ideas for ground rules. All disasters are local. Therefore, at least one ground rule that differs from Ross and Inhoff’s bills is that the $5,000 maximum annual savings amount should be based on actuarial losses of a particular locality. If a maximum is set it should be based on local construction costs and limited to the value of the property.
Ground rule ideas for disaster savings accounts
The ideas presented herein are initial thoughts. The goal is to help individuals (and families) better prepare for disasters by having a sounder financial foundation to build-in pre-disaster resilience or for post-disaster recovery.
Individuals voluntarily establish and own the account. There is no government ownership role. Individuals make deposits to the account on a pre-tax basis.
The governmentmay set minimum and maximum periodic deposit amounts. The government may also establish two thresholds for the account balance. A “need to recover” balance would be an amount based on damage data from previous disasters in the area. It may be based on the damaged asset’s replacement cost and local real estate values. A “maximum” balance set by the replacement cost of the entire structure. The government will establish withdrawal rules for recovery and non-recovery uses.
The accounts are interest bearing. They may be managed under a managed fund concept (e.g., the Federal Thrift Savings Plan or private sector IRA plans).
Individuals contribute periodically (monthly, annually, etc.). Interest accrues on a tax free basis. Interest funds are subject to same withdrawal rules as deposited funds.
Withdrawal process when a disaster happens
Withdrawals are tax free. The disaster size does not matter – a small house fire to a nuclear blast. Any typical insurable loss satisfies as a disaster warranting a tax free withdrawal.
Insurance pays according to policy rules. If insurance is insufficient, owner may withdraw funds tax free to recover. If still insufficient, government aid (grant or loan) programs may help.
Government aid for Presidentially declared disasters (an important incentive)
For individuals with a disaster savings account, grants apply first – loans second. For individuals without a disaster savings account, loans apply first – grants second, if funding is available. For lower income individuals, grants may apply first.
Withdrawal process if a disaster does not happen
Withdrawn funds are taxable as ordinary income for the individual. Account balance must have met the “need to recover” level. The account holders may withdraw funds in excess of “need to recover” level, however, the government may set special circumstances where account holders may withdraw funds on a tax free basis.
Account balances may continue to rise to the maximum amount. There is no set point in time where withdrawals are mandatory. In other words, there is no set age (for example, 70.5 for IRAs) where withdrawal is mandatory. Nor is there a set point in time when the funds are lost (for example, as annually with HSAs).
Individual disaster savings accounts will not solve all of post disaster funding needs. High-income individuals likely do not need this type of savings account. However, they should be allowed to establish a DSA. Low-income individuals would not likely be able to fund such an account. Thus, the stipulation above that government grants may apply first for low-income individuals.
Disaster savings accounts are best suited for middle-income individuals. This group has the means to save. Additionally, many middle-income earners want to be self-sufficient. This type of savings account gives this group of citizens a path to be self-sufficient.
The bottom-line for the government is that tax-free disaster savings accounts can lessen the immediate budgetary impact on the government. It also may relieve or significantly reduce the government’s financial assistance to citizens during post-disaster recovery.
Robert L. “Bob” Zimmerman, Jr. is a distinguished analyst with the Homeland Security Studies and Analysis Institute (HSSAI). His first homeland security career began as a chemist with the Customs and Border Protection’s New Orleans Field Laboratory, where he rose to director of the lab. In early 2003, Zimmerman helped stand-up the Department of Homeland Security Science and Technology Directorate.