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Flood insurance was a hot topic after Hurricanes Katrina and Rita hit the Gulf Coast. The lesson from these disasters, from a flood insurance perspective, was generally correct: The flood insurance program mandated by Congress is not working. Not nearly enough people are buying flood insurance – ironically, far fewer people are buying mandatory flood insurance than if the market were allowed to educate the public and persuade them to buy it. To understand why so many homeowners, even in hurricane-prone areas, don’t have flood insurance, it’s necessary to learn a little about how flood insurance works in America.
The who and what of the federal flood insurance
The Federal Emergency Management Agency (FEMA) designates flood zones based on a number of factors, all of which boil down to the possibility of property in the zone suffering flood damage. Whether government-subsidized flood insurance is required (in the circumstances described below) depends on the flood plain where the property is or will be located.
The National Flood Insurance Program (NFIP) provides government-subsidized flood insurance, although it is mandatory. (The mechanisms by which insurance can be “mandated” by law are discussed below.) Because NFIP is a federal government program—and thus someone else’s money, unsullied by a profit motive—flood insurance is incredibly cheap.
Flood zones and their importance (for insurance purposes)
There are three basic types of flood zones designated by FEMA, broken down into several more detailed zones.
Medium to low risk Areas are identified by flood zones B, C, and X.
- Generally less than 1% chance of flooding per year.
- Flood insurance is “available” to homeowners in these zones through the NFIP.
High risk Areas are identified by flood zones A, AE, A1-A30, AH, AO, AR and A99.
- In general, a flood probability of more than 1% per year.
- Which generally translates to a 26% chance of flooding over the life of a 30-year mortgage.
- Mandatory flood insurance rules apply to mortgages in these zones.
High Risk – Coastal Areas characterized by the flood zones V, VE and V1-V30.
- Generally the same flood probability as A zones (high risk).
- Mandatory flood insurance rules apply to mortgages in these zones.
There is also a zone D, “undefined” risk area.
The Gulf Coast is almost entirely designated High Risk – Coastal Area.
“Mandatory” flood insurance
To understand what “mandatory” means when it comes to flood insurance, it’s helpful to step back and consider what Congress does and doesn’t have the power to do under the Constitution.
The federal government cannot constitutionally require people to take out flood insurance. It cannot enforce building codes that would limit the type of construction permitted in specific flood plains.
What it can do is create a program like the NFIP and make it available to municipalities that make and enforce floodplain building codes. You may be more familiar with Congress’s threat to withhold highway funds to states that haven’t imposed a 55 and then 65 MPH speed limit. Same principle: what Congress cannot constitutionally ask for it can achieve by creating an advantage and threatening to withhold it.
So: Municipalities will be eligible to participate in the NFIP by taking steps to ensure that new construction and existing structures mitigate flood risk.
NFIP was established in 1968 as a voluntary program. Because of low turnout, Congress “managed” (we’ll get to what that means) flood insurance in certain areas (now flood plains) in 1973. Participation remained low.
In 1994, Congress passed flood insurance reform that continued the “mandatory” nature of flood insurance and introduced new, severe sanctions for non-participation, requiring homeowners who had received assistance to purchase flood insurance in order to be eligible for similar assistance in the future.
You could stop reading here and know a lot about what’s wrong with flood insurance: Congress said so would only take care of the flood damage of uninsured homeowners once. What this means for most people smart enough to have bought a home is this The federal government takes care of flood damage for uninsured homeowners on a one-off basis.
Who is subject to the “Mandatory” Flood Insurance Act?
Not of homeowners – rather federally regulated lenders, GSEs and public bodies. These entities must ensure that any mortgage secured by structures in a flood prone area has flood insurance.
If necessary, flood insurance is required at the time of loan approval, including a rebate. As a rule, homeowners are advised that they must take out flood insurance at their own expense. If they fail after notice, the lender can buy it for them and add the cost to the monthly payment if the property is in a flood prone area.
Life of Loan Monitoring is Not required by law. (This becomes important in ways we shall see.)
Lenders face civil penalties — no more than $100,000 in total per year — if (and only if) they participate in a pattern or exercise to evade their responsibility for flood insurance.
Why might a homeowner in a flood prone area not have insurance?
That’s the heart of the matter. Given the history, politics, and division of responsibilities for flood-prone homeowners to have insurance, here’s why they don’t:
- People think that home insurance covers flooding. It doesn’t.
- Your property may not technically be in a flood zone designated by FEMA as requiring insurance, so this is not mandatory.
- They worked through a non-state regulated mortgage lender that didn’t sell their loan to Fannie Mae or Freddie Mac, so it’s not mandatory.
- You don’t have a mortgage – it may have been paid off or never been charged (the 90 year old house that has been in the family for three generations).
- Lenders may not be able to comply. A company that originates $50 billion in mortgage loans in a quarter might not find the avoidance of a potential $100,000 penalty economically worth the cost of strict compliance.
- Homeowners get the insurance to survive the deal, but then let the coverage expire, and they didn’t get “caught” because there is no mandatory loan life monitoring.
- Your community may not participate in the program.
- They assume that the government will make them healthy again after losses without them buying insurance. In general they are right.
Flood insurance represents a failure of central planning and aptly demonstrates its inferiority to the free market. To better ensure homeowners in hurricane-prone areas are covered in greater numbers, Congress should bite the bullet and withhold help when flood insurance was cheaply available and the decision was made not to buy it (continue to help those who have no insurance for other reasons). Control). It should continue to require flood insurance at loan origination where it is able, but open the market to private insurance companies and require loan life monitoring if it is serious about enforcing insurance requirements. And the penalties need to be increased – the current one just isn’t an economically viable deterrent.
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