This week’s revelation that fewer than one in five Americans have flood insurance is a devastating indictment of the National Flood Insurance Program (NFIP).

Often touted as a possible blueprint for solving Australia’s flood conundrum, endemic underinsurance is undermining any claim the US has for world’s best practice on flooding.

The situation is only marginally better in areas prone to flooding, with fewer than half the family homes in special flood hazard areas (SFHAs) covered by flood insurance, according to a Rand Corporation report for the Insurance Information Institute.

That’s despite a Federal Emergency Management Authority (FEMA) study indicating properties in SFHAs have a one-in-four chance of flooding over the lifetime of a 30-year mortgage.

Quite simply, homeowners are sizing up the risk situation and judging it’s not worth their while to spend an average of $US438 ($461) a year on flood coverage. They may be “playing Russian roulette,” to quote III President Robert Hartwig’s presentation to the 2005 Senate committee hearing on the NFIP’s future, but it appears to be paying off.

Last month the Senate voted overwhelmingly to extend the NFIP by five years, rejecting a proposal to add wind damage without addressing the need for fundamental reform.

The Senate also forgave $US17 billion ($17.9 billion) in debt racked up by NFIP administrator FEMA following Hurricane Katrina in 2005.

The NFIP was created four decades ago as a user-pays solution to the skyrocketing cost of taxpayer-funded flood relief.

Soon after its inception, an amendment to the National Flood Insurance Act handed the NFIP potentially the most valuable weapon in its armoury: the mandatory requirement for new homeowners to take out flood insurance when taking out a mortgage with a lender holding federal insurance or finance.

But, critically, “enforcement of this law has been poor”, according to a paper delivered to last year’s Insurance Actuaries of Australia conference by Deloitte’s Elaine Collins and Lucy Simpson, particularly after the initial mortgage has been sold on to another bank.

Attrition rates are at critical levels, with about 10-15% of NFIP’s policies lapsing annually, Dr Hartwig says.

He believes the only way for the NFIP to be truly effective is to “dramatically increase the proportion of at-risk properties that are insured and stay insured through the program”.

And the best way of doing this is to expand mandatory participation through a lender-based system for all mortgaged properties in 100-year flood plains.

But climate change is rapidly rendering flood maps obsolete and making previously safe areas prone to flooding. More than 11 million Americans might live in flood zones but almost a third of paid losses over the NFIP’s lifetime have been in areas “not officially designated as flood-prone at the time of loss”, according to the Deloitte paper.

In 1993 there was another significant NFIP reform, adding a 30-day period of grace to new policies after policyholders enjoyed a $US48 million ($50.5 million) claims windfall from taking out $US625,000 ($658,000) in premiums as flood waters were rising.

About 100 US insurers play an administrative role in the NFIP, but don’t take on any of the risk. Some insurers, however, offer excess coverage for prestige homes over and above the NFIP’s maximum coverage of $US250,000 ($263,000) for structure and $US100,000 ($105,000) for contents.

According to the III’s latest figures, there were 5.5 million policies in force at the end of 2006, with just over 20,000 claims for a total payout of $US550 million ($579 million).

Unsurprisingly, the highest payout was in 2005, when Hurricane Katrina resulted in claims worth $US17.4 billion (18.3 billion), more than eight times greater than any other year.

So why are Americans not bothering to take out flood insurance?

The Deloitte paper lays some of the blame at the feet of poor risk assessment on the part of American homeowners “underestimating the risk of flood”.

Dr Hartwig blames the four horsemen of the flood apocalypse – denial, cost, legal assistance and government aid.

The increasingly litigious nature of US society means many Americans are seduced by lawyers into the false promise of a fat payout, even when there has never been a significant judgement against insurers. Indeed, if there were, Dr Hartwig says “there would be an immediate national crisis in the availability and affordability of homeowners insurance”.

But the promise of successful legal action acts as another disincentive. “Why buy flood coverage from the NFIP when you can just sue your homeowners’ insurer and get it for free?”

Homeowners relying on the chimera of legal assistance are likely to be disappointed. But unfortunately, government handouts are all too real, playing into the hands of the canny non-insured.

Dr Hartwig believes government handouts act as a disincentive to homeowners accepting personal responsibility.

“There is a widespread belief that large amounts of government aid will be made available to disaster victims after an event and so there is little point in buying flood coverage if largely the same benefit is available for free.”

Under the current system, property owners are being given economic incentives not to take out insurance. And while that continues, the NFIP’s finger in the dyke will prove increasingly unable to hold back the tide.