Flood Insurance

Because of frequent flooding of the Mississippi River during the 1960s and the rising cost of taxpayer funded disaster relief for flood victims, in 1968 Congress created the National Flood Insurance Program (NFIP).

It has three mandates: to provide residential and commercial insurance coverage for flood damage, to improve floodplain management and to develop maps of flood hazard zones. While the comprehensive section of an auto insurance policy covers flood damage to vehicles, there is no coverage for flooding in standard homeowners, renters or commercial property insurance policies.

It is available in a separate policy from the NFIP and from a few private insurers. Despite efforts to publicize this, many people exposed to the risk of floods still fail to purchase flood insurance. It was the widespread flooding associated with Hurricane Katrina in 2005 that drew attention to the NFIP and set in motion debate about how to improve it.

So far, Congress has not taken steps to significantly revamp the program. Federal flood insurance is only available where local governments have adopted adequate flood plain management regulations for their floodplain areas as set out by NFIP.

About 20,400 communities across the country participate in the program. NFIP coverage is also available outside of the high-hazard areas. The NFIP law was amended in 1969 to provide coverage for mudslides and again in 1973.

Until then, the purchase of flood insurance had been voluntary, with only about one million policies in force. The 1973 amendment put constraints on the use of federal funds in high-risk floodplains, a measure that was expected to lead to almost universal flood coverage in these zones.

The law prohibits lenders that are federally regulated, supervised or insured by federal agencies from lending money on a property in a floodplain zone when a community is participating in the NFIP, unless the property is covered by flood insurance.

Legislation was enacted in 1994 to tighten enforcement of flood insurance requirements. Regulators can now fine banks with a pattern of failure to enforce the law and lenders can purchase flood insurance on behalf of homeowners who fail to buy it themselves, then bill them for coverage.

The law includes a provision that denies federal disaster aid to people who have been flooded twice and have failed to purchase insurance after the first flood. Buildings constructed in a floodplain after a community has met regulations must conform to elevation requirements.

When repair, reconstruction or improvement to an older building equals or exceeds 50 percent of its market value, the structure must be updated to conform to current building codes.

A 2007 NFIP study on the benefits of elevating buildings showed that due to significantly lower premiums homeowners can usually recover the higher construction costs in less than five years for homes built in a “velocity” zone, where the structure is likely to be subject to wave damage, and in five to 15 years in a standard flood zone.

The Federal Emergency Management Agency (FEMA) estimates that buildings constructed to NFIP standards suffer about 80 percent less damage annually that those not built in compliance.

How It Works: The NFIP is administered by FEMA, now part of the Department of Homeland Security. Flood insurance was initially only available through insurance agents who dealt directly with the federal program.

The “direct” policy program has been supplemented since 1983 with a private/public cooperative arrangement, known as “Write Your Own,” through which a pool of insurance companies issue policies and adjust flood claims on behalf of the federal government under their own names, charging the same premium as the direct program.

Participating insurers receive an expense allowance for policies written and claims processed. The federal government retains responsibility for underwriting losses.

Today, most policies are issued through the Write-YourOwn program but some nonfederally backed coverage is available from the private market. The NFIP is expected to be self-supporting (i.e., premiums are set at an actuarially sound level) in an average loss year, as reflected in past experience.

In an extraordinary year, as Hurricane Katrina demonstrated, losses can greatly exceed premiums, leaving the NFIP with a huge debt to the U.S. Treasury that it is unlikely to be able to pay back. Hurricane Katrina losses and the percentage of flood damage that was uninsured led to calls for a revamping of the entire flood program.

As with other types of insurance, rates for flood insurance are based on the degree of risk. FEMA assesses flood risk for all the participating communities, resulting in the publication of thousands of individual flood rate maps.

Highrisk areas are known as Special Flood Hazard Areas, or SFHAs. Flood plain maps are redrawn periodically, removing some properties previously designated as high hazard and adding new ones.

New technology enables flood mitigation programs to more accurately pinpoint areas vulnerable to flooding. As development in and around flood plains increases, run off patterns can change, causing flooding in areas that were formerly not considered high risk and vice versa.

People tend to underestimate the risk of flooding. The highest-risk areas (Zone A) have an annual flood risk of 1 percent and a 26 percent chance of flooding over the lifetime of a 30-year mortgage, compared with a 9 percent risk of fire over the same period.

In addition, people who live in areas adjacent to high-risk zones may still be exposed to floods on occasion. Ninety percent of all natural disasters in this country involve flooding, the NFIP says.

Since the inception of the federal program, some 25 to 30 percent of all paid losses were for damage in areas not officially designated at the time of loss as special flood hazard areas. NFIP coverage is available outside high-risk zones at a lower premium.

To prevent people putting off the purchase of coverage until waters are rising and flooding is inevitable, policyholders must wait 30 days before their policy takes effect. In 1993, 7,800 policies purchased at the last minute resulted in $48 million in claims against only $625,000 in premiums.

Proposals for Change: The NFIP has four major goals: to decrease the risk of flood losses; reduce the costs and consequences of flooding; reduce the demand for federal assistance; and preserve and restore beneficial floodplain functions.

In a final report published in 2006 by the American Institutes for Research (AIR), which conducted an evaluation of the federal flood insurance program, AIR said that although much had been accomplished, the program fell short of meeting its goals in part because the NFIP did not have the ability to guide development away from floodplains and cannot restore beneficial floodplain functions once they have been impaired.

In addition, AIR said, many people still are not covered or not adequately covered for flood damage. AIR also noted that the NFIP was hampered in reaching its goals by insufficient Congressional funding, lack of pertinent data, misperceptions about the nature of the program and the breakdown in coordination among its three major sectors.

A report published by FEMA in 2007 suggests that development patterns should be changed to protect environmentally sensitive areas and that communities in the flood program should be encouraged or required to ban development in these locations.

Another criticism of the NFIP is that it does not charge enough for coverage. Among the reasons for the premium shortfall is that the cost of coverage on dwellings that were built before floodplain management regulations were established in their communities is subsidized.

As a result, the premiums paid for flood coverage by the owners of these properties reflect only 30 to 40 percent of the true risk of loss. In January 2006 FEMA estimated an annual shortfall in premium income of $750 million due to these subsidies.

Some subsidized properties also suffer repetitive losses. Repetitive loss properties accounted for about $4.6 billion in claims payments between 1978 and 2004. The AIR report acknowledged that the current system is not eliminating existing damage-prone buildings as quickly as expected.

Location: Indonesia