Flood insurance was a hot topic in the wake of Hurricanes Katrina and Rita on the Gulf Coast. The lesson from these disasters from a flood insurance perspective was generally correct: The flood insurance program mandated by Congress does not work. Not enough people buy flood insurance; Ironically, far fewer people 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, lack flood insurance, it is necessary to learn a little about how flood insurance works in America.
The who and what of federal flood insurance
Flood zones are designated by the Federal Emergency Management Agency (FEMA) based on a number of factors, all boiled down to the potential for property in the area to suffer 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 “required” is described below). Because the NFIP is a federal government program, and therefore someone else’s, nonprofit money, 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.
- Generally, 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.
- Generally, a probability 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 zones A (high risk).
- Mandatory flood insurance rules apply to mortgages in these areas.
There is also a Zone D, an “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 helps to step back and consider what Congress is and is not authorized to do under the Constitution.
The federal government cannot constitutionally require people to 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 approve and enforce floodplain building codes. You may be more familiar with Congress’ threat to withhold highway funding to states that did not set a speed limit of 55 MPH 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 the NFIP by taking steps to ensure that new construction and existing structures mitigate the risk of flooding.
The NFIP was created in 1968 as a voluntary program. Due to low turnout, Congress “ordered” (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 severe new penalties for non-participation, requiring homeowners who have received assistance to purchase flood insurance. to be eligible for similar assistance in the future.
You could stop reading here and find out a lot about what’s wrong with flood insurance – Congress said Would only take care of flood damage from uninsured homeowners one time. What this means to most people smart enough to have bought a home is that uninsured homeowners’ flood damage will be taken care of by the federal government once.
Who is subject to the “mandatory” flood insurance law?
Not the owner, rather, lenders regulated by the federal government, GSE 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 must purchase flood insurance at their own expense. If they fail after the notice, the lender can buy it and add the cost to the monthly payment if the property is in a flood risk area.
The duration of loan tracking is not required by law. (This becomes important in a way that we will see.)
Lenders face civil monetary penalties: no more than $ 100,000 total by year – if (and only if) they participate in a pattern or practice of avoiding your flood insurance responsibilities.
Why couldn’t a homeowner in a flood prone area have insurance?
This is the heart of the matter. Considering the history, politics, and division of responsibilities to ensure flood-prone homeowners have insurance, here’s why they don’t:
- People think that homeowners insurance covers floods. It is not like this.
- 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 do not have a mortgage; it may or may never have been taxed (the 90-year-old house that has been in the family for three generations).
- Lenders may not comply. A business that originates $ 50 billion in home loans in one quarter might economically find that avoiding a potential $ 100,000 penalty is not worth the cost of rigorous compliance.
- Homeowners get the insurance to go through the closing, but then they let the coverage lapse and have not been “caught” because there is no mandatory loan monitoring life.
- Your community cannot participate in the program.
- They assume that the government will compensate them after the losses without having to buy insurance. They are generally 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 go to the trouble and withhold assistance where flood insurance was available at low cost and the decision was made not to buy it (continue to help to those without insurance for reasons beyond their control). You should continue to require flood insurance at loan closing when you have the power to do so, but open the market to private insurance companies and require a loan life tracking if you are serious about applying a requirement for sure. And the penalties must be increased: the current one is simply not an economically viable impediment.