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 correct: 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, lack 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, all of which boil down to the potential for property in the area to sustain flood damage. 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” is covered below.) Because the NFIP is a federal government program, and therefore someone else’s money, not for 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 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 areas are designated by flood zones A, AE, A1-A30, AH, AO, AR, and A99.

• In general, a chance of flooding greater 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 areas.

High Risk – Coastal Areas designated by flood zones V, VE and V1-V30.

• Generally the same probability of flooding as the A (High Risk) zones.
• Mandatory flood insurance rules apply to mortgages in these areas.

There is also a Zone D, “undetermined” risk area.

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 step back and consider what Congress is and isn’t authorized to do under the Constitution.

The federal government cannot constitutionally mandate that people purchase 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 did not set a 55 and then 65 MPH speed limit. 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 the 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. Because of 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 not participating, in the form of requiring assisted homeowners to purchase a flood insurance to be eligible for similar help 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 for most people smart enough to have bought a home is that the federal government will pay for uninsured homeowners’ flood damage once.

Who is subject to the “mandatory” flood insurance law?

Do not 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 hazard area has flood insurance.

If necessary, flood insurance will be required at the time a loan is made, including a refinance. Homeowners are generally notified that they are required to purchase flood insurance at their own expense. If they fail after notice, the lender can buy it out and add the cost to the monthly payment if the property is in a flood hazard area.

The monitoring of the life of the loan is not required by law. (This becomes important in a way we’ll 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 not have insurance?

This is the heart of the matter. Given the history, politics, and division of responsibilities for ensuring flood-prone homeowners have insurance, here’s why they don’t:

1. People think that homeowner’s insurance covers flooding. he does not do it
2. Your property may not technically be in a FEMA-designated flood zone as requiring insurance, so it is not required.
3. They worked through a mortgage lender not regulated by the federal government, which did not sell their loan to Fannie Mae or Freddie Mac, so it is not required.
4. They don’t have a mortgage, it may be paid off or it may never have been encumbered (the 90 year old house that has been in the family for three generations).
5. Lenders may not comply. A company that originates $50 billion in mortgage loans in a quarter might economically find that avoiding a potential $100,000 penalty is not worth the cost of rigorous compliance.
6. Homeowners get the insurance to get them through closing, but then let the coverage lapse and haven’t been “trapped” because there’s no mandatory life of loan follow-up.
7. Your community cannot participate in the program.
8. They assume that the government will repair them after losses without buying insurance. In general, they are right.

Flood insurance represents a failure of central planning and an adequate 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 for reasons beyond their needs). 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 life-of-loan monitoring if you really want to enforce an insurance requirement. And sanctions need to be increased: the current one is simply not an economically feasible deterrent.