Introduction to Flood Insurance: Why Are So Few Homeowners Insured?
Flood insurance was a hot topic after Hurricanes Katrina and Rita hit the Gulf Coast. The lesson learned from those disasters from a flood insurance perspective was generally the right one: the flood insurance program mandated by Congress doesn’t work. Not enough people buy flood insurance; Ironically, far fewer people buy mandatory flood insurance than would if the market were allowed to educate the public and convince them to buy it. To understand why so many homeowners, even in hurricane-prone areas, go without flood insurance, it is necessary to learn a little about how flood insurance works in the United States.
The who and what of federal flood insurance
The Federal Emergency Management Agency (FEMA) designates flood zones based on a number of factors, which boil down to the potential for flood damage to property in the area. Whether federally subsidized flood insurance will be required (under the circumstances described below) depends on the flood zone in which the property is or will be located.
The National Flood Insurance Program (NFIP) offers federally subsidized flood insurance, even when it is required. (The mechanics of how insurance can be legally “mandatory” are covered below.) Because the NFIP is a federal government program, and therefore someone else’s money, a non-profit, flood coverage is incredibly cheap.
Flood zones and what they mean (for insurance purposes)
There are three basic types of FEMA-designated flood zones, subdivided into several more detailed zones.
Moderate to low risk the areas are designated by flood zones B, C and X.
- In general, less than 1% chance of flooding per year.
- Flood insurance is “available” to homeowners in these areas through the NFIP.
High risk the areas are designated by flood zones A, AE, A1-A30, AH, AO, AR, and A99.
- In general, a probability of flooding greater than 1% per year.
- Which typically translates to a 26% chance of flooding over the life of a 30-year mortgage.
- Mandatory flood insurance rules apply to mortgages in these areas.
High Risk – Coastal Zones designated by flood zones V, VE and V1-V30.
- Generally the same probability of flooding as zones A (High Risk).
- Mandatory flood insurance rules apply to mortgages in these areas.
There is also a Zone D, “undetermined” risk zone.
The gulf coast is designated almost entirely High Risk – Coastal Zone.
“Mandatory” Flood Insurance
To understand what “mandatory” means when it comes to flood insurance, it’s helpful to take a step back and consider what Congress is and is not authorized to do under the Constitution.
The federal government cannot constitutionally mandate that people buy flood insurance. You cannot enforce building codes that would restrict the type of construction allowed in certain flood zones.
What you can do is create a program, like the NFIP, and make it available to communities that pass and enforce floodplain building codes. You may be more familiar with Congress’s threat to withhold highway funding from states that didn’t set a speed limit of 55 and then 65 MPH. Same principle: what Congress cannot constitutionally require, it can achieve by creating a benefit and threatening to withhold it.
So: Communities become eligible to participate in NFIP by taking steps to ensure that new construction and existing structures mitigate flood risk.
The NFIP was created in 1968 as a voluntary program. Due to low turnout, Congress “mandated” (we’re still getting to what that means) flood insurance in certain areas (now floodplains) in 1973. Turnout remained low.
In 1994, Congress enacted flood insurance reform, continuing the “mandatory” nature of flood insurance and establishing tough new penalties for failure to participate, in the form of requiring assisted homeowners to purchase a flood insurance to be eligible for similar assistance in the future.
You can stop reading here and learn a lot about what’s wrong with flood insurance: Congress said that would only take care of uninsured homeowners flood damage once. What this means to most people smart enough to have bought a house is that the federal government will take care of flood damage for uninsured homeowners once.
Who is subject to the “mandatory” flood insurance law?
Nope the owner, rather, federally regulated lenders, GSEs, and public agencies. These entities are required to ensure that any mortgage secured by structures in a flood risk area has flood insurance.
If necessary, flood insurance will be required at the time a loan is made, including a refinance. Homeowners are typically notified that they are required to purchase flood insurance at their own expense. If they default after notice, the lender can buy it back and add the cost to the monthly payment if the property is in a flood risk area.
The monitoring of the life of the loan is No required by law. (This becomes important in a way that we will see.)
Lenders face civil money penalties – no more than $100,000 total by year — if (and only if) they get involved in a pattern or practice to ship your flood insurance responsibilities.
Why might a homeowner in a flood prone area have no insurance?
This is the heart of the matter. Considering history, politics, and the division of responsibilities to ensure flood-prone homeowners have insurance, here’s why they don’t:
- People think that homeowner’s insurance covers flooding. he does not do it
- Your property may not technically be in a flood zone designated by FEMA as requiring insurance, so it is not required.
- They worked through a non-federally regulated mortgage lender, who did not sell their loan to Fannie Mae or Freddie Mac, so it is not required.
- They have no mortgage, it may be paid off, or never encumbered (the 90 year old house that has been in the family for three generations).
- Lenders may not comply. A company that originates $50 billion in home loans in a quarter might economically consider avoiding a potential $100,000 fine not worth the cost of rigorous compliance.
- Homeowners get the insurance to get through the closing, but then let the coverage lapse and have not been “caught” because there is no mandatory life of follow-up on the loan.
- Your community cannot participate in the program.
- They assume the government will fix them after losses without buying insurance. In general, they are right.
Flood insurance represents a failure of central planning and a fitting demonstration of its inferiority to the free market. To better ensure that homeowners in hurricane-prone areas are insured in greater numbers, Congress should do what is necessary and withhold aid where flood insurance was available at low cost and the decision was made not to purchase it ( continuing to help those who are uninsured through no fault of their own). control). You should continue to require flood insurance at loan closing where you have the power to do so, but open the market to private insurance companies and require loan life monitoring if you really want to enforce an insurance requirement. And the penalties need to be increased: the current one is simply not an economically feasible deterrent.