Flood insurance became a hot topic after Hurricanes Katrina and Rita on the Gulf Coast. The lessons learned from those disasters from a general flood insurance perspective are true lessons – The Congressional-mandated flood insurance program didn’t work. Hardly enough people buy flood insurance – ironically, far fewer buy mandatory flood insurance than 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 don’t have flood insurance, it’s important to learn a little about how flood insurance works in America.
Who and what of federal flood insurance
The Federal Emergency Management Agency (FEMA) defines flood zones based on a number of factors, all of which boil down to the likelihood that property in the zone will experience flood damage. Whether federally subsidized flood insurance will be required (in the circumstances described below) depends on the flood zone the property is in or will be located in.
The National Flood Insurance Program (NFIP) provides federally subsidized flood insurance, including where mandatory. (The mechanics of how insurance can be legally “mandated” are covered below.) Because NFIP is a federal government program – and as such, other people’s money, not tainted by the profit motive – flood coverage is very cheap.
Flood zones and their meanings (for insurance purposes)
There are three basic types of flood zones designated by FEMA, subdivided into more detailed zones.
Moderate to Low Risk areas designated by flood zones B, C and X.
- Generally the probability of flooding is less than 1% per year.
- Flood insurance is “available” to homeowners in this zone through NFIP.
High risk The area is defined by flood zones A, AE, A1-A30, AH, AO, AR and A99.
- Generally greater than 1% chance of flooding per year.
- Which generally translates to a 26% chance of flooding over the life of the 30 year mortgage.
- Mandatory flood insurance rules apply to mortgages in this zone.
High Risk – Coastal Area designated by flood zones V, VE and V1-V30.
- Generally the chance of flooding is the same as zone A (High Risk).
- Mandatory flood insurance rules apply to mortgages in this zone.
There is also Zone D, an “undetermined” risk area.
The bay coast is almost entirely designated High Risk – Coastal Area.
Flood insurance “mandatory”
To understand what “mandatory” means when it comes to flood insurance, it helps to step back and consider what Congress can and cannot do under the Constitution.
The federal government cannot constitutionally mandate that people buy flood insurance. It cannot enforce building codes that would limit the types of construction allowed in certain flood zones.
What it can do is create a program, such as NFIP, and make it available to communities that pass and implement flood zone building codes. You’re probably more familiar with Congress’ threats to withhold highway funding to states that don’t set a speed limit of 55 and then 65 MPH. Same principle: What Congress cannot constitutionally ask for, can be achieved by creating gains and threatening to withhold them.
So: Communities become eligible to participate in NFIP by taking steps to ensure new construction and existing structures reduce flood risk.
NFIP was created in 1968 as a voluntary program. Due to low participation, Congress “required” (we are still getting to what that means) flood insurance in certain areas (now flood zones) in 1973. Participation remains low.
In 1994, Congress enacted flood insurance reforms, continued the “mandatory” nature of flood insurance and established severe new sanctions for non-participation, in the form of requiring homeowners who had received flood insurance purchase relief to qualify for similar assistance in the future. .
You can stop reading here and find out a lot about what’s wrong with flood insurance: Congress says that will only take care of flood damage of uninsured homeowners once. What this means for most people who are smart enough to buy a home is that the federal government will take care of flood damage for uninsured homeowners once.
Who is subject to “mandatory” flood insurance laws?
No homeowners – more precisely, lenders, GSEs, and federally regulated public agencies. This entity is required to ensure that any mortgage underwritten by a structure in a flood hazard area has flood insurance.
If required, flood insurance will be required at the time the loan, including refi, is made. Generally, notice is given to homeowners that they are required to purchase flood insurance at their own expense. If they fail after notification, the lender can buy it for them and add a fee to the monthly payment if the property is in a flood hazard area.
Loan monitoring life is no required by law. (This becomes important in a way that we will see.)
Lenders face civil penalties — no more than $100,000 in aggregate per year — if (and only if) they are involved in a pattern or practice neglect their flood insurance responsibilities.
Why don’t homeowners in flood-prone areas have insurance?
This is the crux of the problem. Considering the history, politics, and division of responsibilities for ensuring that flood-prone homeowners have insurance, here’s why:
- People think homeowners insurance covers flooding. Not.
- Their property may not technically be in a flood zone designated by FEMA as requiring insurance, so it’s not mandatory.
- They work through non-federally regulated mortgage lenders, who don’t sell their loans to Fannie Mae or Freddie Mac, so it’s not mandatory.
- They don’t have a mortgage – probably paid off or never been charged (a 90 year old house that’s been in the family’s possession for three generations).
- Lenders may not comply. A company that derives $50 billion in mortgage loans in one quarter might economically view avoiding a possible $100,000 penalty as disproportionate to the cost of strict compliance.
- Homeowners get insurance to skip closure, but then let coverage expire, and they haven’t been “caught” because there’s no mandatory lifetime loan monitoring.
- Their community may not participate in this program.
- They assume the government will keep them whole after the loss without them buying insurance. Generally, they are right.
Flood insurance represents a failure of central planning, and an apt demonstration of its inferiority to the free market. To further ensure that homeowners in hurricane-prone areas are insured for greater amounts, Congress must be persistent and withhold aid where flood insurance is inexpensively available and the choice is made not to purchase it (continue to assist those who lack insurance for reasons beyond their control). ). It should continue to require flood insurance at loan closing where it has the power to do so, but opens the market to private insurance companies and requires lifelong loan monitoring if it is serious about enforcing insurance requirements. And penalties should be increased – current penalties are not an economically viable barrier.