With National Flood Insurance Program ‘Under Water,’ It’s Time to Move to an All-Natural-Hazard Plan

Flood Insurance

The expiration of the National Flood Insurance Program (NFIP) at the end of September poses a rare opportunity for Congress to impose smart, forward-thinking reforms on a program that is costing the government billions of dollars, author Joe Coughlin of Dawson & Associates writes.

With climate change beginning to impose real costs, a new approach to flood insurance is badly needed to address an increasingly expensive, dangerous situation for the federal government and U.S. property owners. The best option, Coughlin argues, is to integrate all other natural hazards into the flood hazard program.

By H. Joseph Coughlin, Jr.

Joe Coughlin is a Senior Advisor at Dawson & Associates specializing in flood control consulting. He helped develop the NFIP and was co-designer of FEMA’s Mandatory Purchase of Flood Insurance Guidelines, which is the federal government’s most authoritative source on statutory flood insurance requirements.

The expiration of the National Flood Insurance Program (NFIP) at the end of September poses a rare opportunity for Congress to impose smart, forward-thinking reforms on a program that is costing the government billions of dollars.

As climate change begins to impose real costs on the United States, a new approach to flood insurance is badly needed to address an increasingly expensive, dangerous situation for the federal government and U.S. property owners.

A 50-Year-Old Program

As background, flood insurance under the NFIP was originally made available by Congress in 1968 due to its unavailability in the private property insurance sector for residential and small business structures. Private property insurers did not consider it profitable largely due to the frequency and magnitude of large floods.

These observations had been made through studies conducted in the 1960s and presented to the Congress following several hurricanes and severe storms that resulted in significant areas being damaged and uninsured against flooding.

Congress and the Johnson administration created the NFIP in 1968, offering flood insurance coverage primarily to owners of residential and small business structures in communities that agreed to participate in the NFIP. Those communities had to agree to additional construction requirements, which were minimal building safety standards, primarily elevating the building to FEMA’s 100-year-flood elevations, for new construction located in Special Flood Hazard Areas (SFHAs) on FEMA’s flood maps. This flood mitigation component was considered essential to the NFIP.

Subsidized flood insurance coverage was offered on a voluntary purchase basis for existing structures with a goal of “grandfathering” those risks at subsidized rates because those structures were in harm’s way through no fault of their owner, as no such flooding information was available when those structures were constructed. The flood insurance in general, and the subsidized insurance in particular, were considered the “quid pro quo” for the mitigation component.

However, new construction in these areas was charged actuarial rates, as flood risks were known due to the availability of FEMA flood maps. NFIP rules required such construction to be above the flood elevations, thereby mitigating much of the risk from future floods.

The plan’s originators envisioned that houses would last, on average, about 50 years and then be replaced. This would eventually eliminate high-risk older structures along with their flood insurance subsides. At the time, Congress considered this a fair and equitable approach.

Some Unexpected Developments

But things did not quite work out as planned. Older structures have lasted longer because the expected replacement due to fire, natural hazards and urban renewal never occurred as anticipated. Also, Congress limited FEMA’s ability to restrict coverage and/or lower subsidies due to political pressure.

Had FEMA been able to do those things, the current financial deficit would have been reduced, although not eliminated. Also, more new construction than anticipated was built in flood zones. High flood risk areas near water have grown in attractiveness to the public. As the middle class and their discretionary income has grown, second homes in such areas have also multiplied.

A few years after the program began, serious flooding occurred in few of the many damaged structures being covered by the new flood insurance, which was available on a voluntary basis. Congress then decided to change the program’s concept and adopt a mandatory flood insurance purchase, or “loan link sanction,” requirement. In other words, flood insurance would be required for all forms of federal financial assistance on structures located in FEMA-designated SFHAs, the special hazard zones.

This included mortgage loans from financial institutions backed by the federal government and later all such loans purchased in the secondary mortgage market by Fannie Mae, Freddie Mac, and FHA. This mandate, however, does not apply to structures / mortgages located outside of FEMA’s SFHAs, where the flood insurance is also available, but on a voluntarily purchase basis, not covered by the mandate.

This is the system that has been in place since.

The concept for the NFIP was relatively simple: 1. Provide flood insurance coverage for structures with the worst flood risk exposure, 2. Mitigate flood risk to new structures in high flood risk areas by requiring local governments to adopt and enforce minimal building safety standards for new construction. Together, these were designed to help NFIP become financially self-supporting.

While some of this has worked reasonably well, some has not.

Flood insurance is available in over 20,000 communities across the U.S., in every state and every congressional district, covering about 5.5 million structures, representing over $1 trillion in such coverage. Minimum flood building safety standards are in place in all of those communities for new construction in their SFHAs. All of this helps the nation.

However, the level of the insurance subsidies, although declining, remains too high due to congressional involvement. This has added to NFIP’s financial problems. Flood maps require more modifications than planned, as local conditions change. Keeping up with such changes is time-consuming and expensive, in order to make the resulting maps and related data accurate.

Second, the flood insurance purchase mandate hasn’t gone far enough, as about a quarter to a third of the NFIP’s annual losses are on policies on structures located outside the flood hazard areas. Although this represents a significant portion of NFIP claims, it represents a smaller portion of total structures in such areas and damaged by floods each year. The bulk of these are uncovered by flood insurance, as the mandates don’t apply to them.

Climate-Change Challenges

As the earth warms and sea levels rise, Congress must face such questions as:

· Will climate changes cause more floods across the country?

· How will the sea level rise issue impact coastal flood risk?

· How often will NFIP maps need to be revised?

· What will be the impact on flood insurance rates in impacted areas?

· Can the NFIP afford to continue making flood insurance available in such impacted areas?

Flood insurance is a classic example of something everyone believes in but is difficult to implement effectively. All structures located in hazard areas are exposed to flood risk, but only those with mortgages are covered under the purchase mandate. The fact that the NFIP insurance purchase mandate only addresses the worst flood risk areas means that FEMA is not able to effectively spread the risk enough by covering low, as well as high, risk structures. This is a fundamental insurance principle and has contributed significantly to NFIP’s deficit status.

For all the need for a robust federal flood insurance program, the NFIP no longer meets that goal. Its deficit continues to grow and many flood maps remain hopelessly out of date despite FEMA’s best efforts. Many structures are not covered by insurance and continue to suffer flood losses.

To fix the NFIP and ensure it is sustainable going forward, we should think about three big principles.

Updating the Flood Maps

First, Congress must provide the means for FEMA to update flood insurance maps so they accurately reflect current risk. FEMA already uses state of the art technology and has an annual review process that helps set future priorities. But these maps require continual updating since local conditions are dynamic. New developments change local drainage; watershed changes impact floodplain boundaries and depths; and rising sea levels impact coastal predictions for 100-year flooding boundaries.

However, FEMA’s budget for keeping up with such changes is limited, meaning that under the current system, there will always be outdated maps.

Several years ago, the agency undertook a “Map Modernization Program” after securing a special appropriation from Congress. Many maps were updated, which benefited mortgage lenders, insurers, and local governments. But without continual updating, these maps will soon be outdated. This is important because accurate maps are essential in allowing the NFIP to apply actuarial rates, and for local communities to require their building safety standards for new construction, both in high risk areas.

Also, Congress needs to determine whether NFIP maps should incorporate the impact of sea level rise and if so, should it be based on current or future flood risk? Although most agree that sea levels are rising, its coastal impact is not certain.

Second, FEMA needs a new approach to updating its maps that allows either more real-time updates, or at least a decoupling of the mandatory purchase of flood insurance requirement from designated flood hazard areas, or both. About three quarters of structures covered under NFIP policies are within the flood hazard areas, mostly due to the mandatory purchase requirement. The rest are in lower risk areas and voluntarily purchased.

Moreover, the requirement for lenders to use the maps needs to be eliminated. Expanding the purchase requirement to all mortgaged structures would spread the risk, result in more structures covered and simplify the process.

Many structures suffer flood damage but are not covered by flood insurance. As such, Congress should consider changing the mandatory purchase requirement to apply to all mortgages regardless of location in a participating community.

This would allow a much greater spreading of risk. The lower risk would be reflected by lower rates. It would also not require lenders to use FEMA’s flood maps and would relieve federal agencies that examine lenders for compliance.

Covering Wind, Fire, Earthquake Hazards

Third, the administration, Congress and private insurers should explore developing a natural hazard property insurance policy that would include flood, wind, fire and earthquakes. Such a policy would replace the NFIP policy. Since all structures are exposed to one or more of these risks, every property owner would be required to purchase natural hazard insurance on mortgaged structures.

If an all-natural-hazards policy were mandated to be purchased on all mortgaged structures, it would likely result in 50 - 80 million additional structures being covered for all such risks.

An all-natural-hazards policy administered as suggested would result in a significantly larger number of structures nationwide being covered for all such risks, than is the case today.

In figuring the insurance rates for such a policy, the risks for each natural hazard would have to be determined and calculated into the rates charged. It would appear that the component rates for the flood risk may drop from the rates under the NFIP, since that risk would be spread among more than 50 million structures, instead of the 5.5 million of the worst flood risk structures currently covered under the NFIP.

Such a policy, although transparent to the public, would have the private property insurance industry covering the wind and fire risks, the federal government covering the flood risk and the earthquake risk possibly being shared by both. The benefit to the public would be one policy covering all natural hazards, with the property owner dealing with the same insurance agent and company, with no direct involvement with the federal government apparent to the policy holder.

The financial risk with such a policy could be shared between FEMA for its flood risk portion, and the private property insurance industry for their wind and fire risks as they currently handle.

The Time Is Ripe

In the 1980s, I was involved with a White House Task Force that looked at such a policy. At the time, private insurers strongly opposed such a measure but today, since they are suffering more losses, there may be more openness to the concept. The new program could be administered in a similar manner as the NFIP is today, but with some significant modifications. The private property insurance industry would still sell and service the policies, as they do for their current property policies, and with the NFIP policies. They would, however, have a major role in setting that portion of the rates, for that portion of the risks the private sector would be covering. It would also have a major role in developing the underwriting terms and conditions for those risks. Due to the much larger spreading of the risk on at least the flood and earthquake components of the all-natural-hazard policy, those rate component amounts may wind up being less than today, thereby lowering the total costs of all such coverages to consumers from what they are today.

An additional benefit to such an approach towards dealing with natural hazards would be the reduction in amount and cost of federal disaster financial assistance to property owners. Following a natural hazard disaster, when FEMA makes a disaster declaration, uninsured or underinsured property owners may apply for the appropriate federal agency, typically FEMA or the SBA, for disaster assistance, which is usually a grant or loan, to repair or replace their damaged or destroyed structure. If most structures were insured for all natural hazard damage, it would significantly reduce the need for such federal assistance and/or tax deductions for uninsured losses.

The impact of such an “all natural hazard” approach on rates is subject to debate. Some believe that with such massive spreading of risk, the rates for such total coverage would drop. Others say that adding the other hazards would possibly cancel out any significant rate reductions. More detailed specific analysis would be needed, but could be done by government and private sector actuaries.

Of course, the main obstacle to such a policy would be all parties—the federal government, including the Congress, the private property insurance industry and the mortgage lending industry—all agreeing to sit down and work out and negotiate all of the details, so that all would benefit appropriately by growing the market and sharing in the results. Property owner policy holders would benefit because they would be covered for all natural hazard risks, and the taxpayers would benefit by seeing a lowering or elimination of NFIP debt and the lowering of federal disaster relief costs.

Under this new all-natural-hazards insurance policy approach, current flood maps would not have to be used for voluntary or mandating purposes by lenders, as it would be required on all mortgaged property, as explained above, so no need for them to determine flood zone location, removing a major burden for them. The maps, however, still may have to be used by insurance agents and companies for insurance rating purposes, but that would depend on the rating approach decided upon.

The flood maps, or at least the underlying flood data, would still need to be used by local governments for their administration of the NFIP’s flood mitigation measures mentioned above. The mitigation component for an “all natural hazard” approach would still be essential, as an insurance solution alone cannot solve all natural-hazard risk problems. They could largely be left as is, however, with the private insurers responsible for wind and fire safety mitigation criteria, as is currently the case, and an earth movement standards jointly handled by FEMA and the private sector. Flood mitigation criteria would remain with FEMA.

All such mitigation criteria would have to be well coordinated to assure effectiveness and minimize conflicts such as requiring a building to be elevated to lessen flood risk while, as a result, exposing it to greater wind risk.

The time is ripe for a new approach to the NFIP. This could be a win-win for all parties.

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