In recent years, an increasing number of people in Princeton have been told by bank loan officers they must purchase flood insurance before a mortgage loan can be finalized. To a majority of loan-seekers, this probably came as a big surprise. Fact is, few people know anything about flood insurance. Even fewer know why a bank may require them to purchase flood insurance when applying for a loan. The purpose of this article is to bring awareness about mandated flood insurance, how and why lending institutions are involved, and what flood insurance options are available to consumers.
First a little history. Historic levels of flood damage caused by the Great Mississippi Flood of 1927 prompted insurance companies all across the United States to begin excluding flood damage from home and business insurance policies. For decades that followed, the only hope for homes and businesses damaged by flood was federal disaster relief. Then in 1968, the National Flood Insurance Program (NFIP), currently administered by the Federal Emergency Management Agency (FEMA), was created to address the general lack of availability of private market flood insurance. At that time, the decision to purchase a flood policy or not was left up to the property owner and was entirely voluntary. To be eligible for NFIP coverage, a property had to be in a community that opted into the program and which adopted minimum regulations for areas mapped by FEMA as a “100-year floodplain”. Furthermore, the property had to be located within the 100-year floodplain in order to be eligible for flood coverage. Indeed, the City of Princeton was, and is, part of the program. However, until 2009 the number of properties affected was very small and was restricted mainly to structures in the Eddy Creek floodplain. Areas of the city with a history of short term flooding due to storm water were not initially included in Princeton’s 100-year floodplain.
In 1973, Congress passed the Flood Disaster Protection Act. A provision of this act was to require lending institutions to obtain proof of flood insurance before giving a loan to a property owner for a structure located in a high-risk flood zone. This provision was adopted because so few flood-prone structures were being covered by flood insurance (recall it was voluntary) and too many people continued to need federal disaster relief. For the most part this Act did not impact many residents of Princeton since so few high-risk flood zones were recognized by FEMA in the city.
Flooding along the Mississippi River in 1993, and massive payouts to cover insured losses, prompted further changes to the program. So in 1994, the National Flood Insurance Reform Act was passed. This Act included a significant boost to increase compliance with the (now) mandatory flood insurance purchase requirements by lenders, servicers, and secondary market purchasers. Then beginning in late 2005, large payouts to NFIP flood policy holders in the wake of Hurricane Katrina (August 2005), plus non-covered disaster relief, nearly put the NFIP into insolvency. This prompted FEMA to make further changes to the NFIP as a means of financially stabilizing the program and increasing the number of active flood policies. To accomplish these goals, FEMA made radical changes to Flood Insurance Rate Maps (FIRMs) nation-wide in 2008-2009.
A FIRM is the official flood map for a community and the place where specific flood zones are identified. The FIRM changes for the City of Princeton brought many new areas into high-risk, Zone A. Most of these areas are subject to short term flooding due to inadequate storm drainage. The changes to Princeton’s FIRM meant that more residents seeking or continuing loans were now required by lenders to obtain flood insurance. Banks have no discretion in this matter and are legally required to participate. If you do not have a mortgage, or if your property is in a low to moderate flood zone (Zones B, C and X) there is no flood insurance requirement.
The amount of insurance coverage required by the Flood Disaster Protection act of 1973, as amended by the National Flood Insurance Reform Act of 1994, is the LESSER of the following (Source=FEMA):
The maximum amount of NFIP coverage available for a particular property, or
The outstanding principal balance of the loan, or
The insurable value of the structure.
Currently, FEMA/NFIP underwrites 98 percent of the 5.2 million flood insurance policies active in the United States. For decades, NFIP was the only source of flood insurance available to consumers. These “NFIP-direct” policies were (and are) sold and serviced by a handful of regional or national insurance companies under contract with FEMA. These companies, in turn, market NFIP-direct policies through a network of local insurance agencies.
In 1983, FEMA initiated “Write Your Own” (WYO) flood policies whereby FEMA provides financial and technical assistance to private insurance companies to sell/service NFIP flood policies. Per the agreement, WYO partners receive a “very competitive” flat commission for each policy sold, plus servicing expenses are reimbursed. As of 2017, 87% of all NFIP’s policies were held in the WYO program.
Both NFIP-direct and WYO policies charge a variety of fees and surcharges (determined by FEMA) to offset the cost of program administration and provide revenue to pay claims. Both policy types are backed by the federal government. As such, claim payout has historically been problem-free. However, in recent years FEMA has been sued numerous times for failure to pay valid claims. This situation made national headlines in 2018. Lawmakers are beginning to seriously consider reinventing or phasing out the NFIP, which is currently operating at a $25 billion deficit. By all accounts, the projected debt status of the NFIP is unsustainable.
In recent years, a number of insurance companies have begun offering “private flood policies” which are not affiliated with the NFIP or WYO programs. These non-governmental, for-profit companies offer stand-alone flood policies at competitive prices, and often with superior coverage options. Most policies are underwritten by Lloyds of London, but there are other underwriters.
Private flood policies are not subject to the same fee and surcharge structure as NFIP-direct and WYO policies. Coverage-wise, most private carriers offer up to $500k for building and $250k contents coverage. NFIP and WYO policies, on the other hand, are capped at $250k for single family dwellings and $100k for contents. Lower coverage limits are likely adequate for most customers. However, higher levels of coverage might be needed to cover catastrophic losses due to a flood.
With NFIP/WYO policies, structures and contents are always valued at “actual cash value”. This means depreciation is taken out prior to claim payment. Conversely, most private flood policies offer endorsements for replacement cost on both structures and contents. Private policies also offer coverage on “loss of use”, “business income interruption”, property outbuildings and structures, and below-grade basements and contents. None of these are covered by NFIP-direct or WYO flood policies.
The overwhelming majority of stand-alone private flood policies comply with NFIP mandatory purchase-of-flood-insurance guidelines. Consequently, most lenders in the United States accept private flood policies to satisfy federally-mandated flood insurance lending requirements.
The main disadvantages of private flood policies are: 1) a private insurer can choose not to insure your property; 2) policy deductibles are often higher, and 3) policies can be cancelled by the insurer. The NFIP and WYO programs, on the other hand, must accommodate all comers and policies cannot be cancelled as long as premiums and fees continue to be paid. Some also have concerns about the private insurance claims payout process. However, my research on this found that most customers have been generally satisfied. Lastly, if you currently have a NFIP-direct or WYO flood policy and move to a private insurer, you will likely pay higher premiums for the same coverage if you later choose to return to the government program.
If you are in the market for flood insurance, by all means shop around. Prices can vary considerably from one policy type and insurer to another. For example, I solicited estimates from different insurance providers (none local) and found that the cost of a $250,000 flood policy ranged from $922 (private) to $3,975 (NFIP-direct) for the same property. That’s a difference of $3,053! A policy for $25,000 ranged from $182 (private) to $481 (NFIP-direct) to $570 (WYO), again for the same property. There are many factors that come into play when an insurance company or NFIP prices a flood policy. Thus, you may not experience such a range in pricing options.
Be aware that individual insurance companies cannot, by law, sell both WYO and private flood insurance. This is due to a “non-compete” clause in the WYO agreement. However, independent insurance agencies often do sell and service more than one flood policy type (i.e., NFIP-direct, WYO and private). Some insurance companies do not offer any type of flood insurance. Therefore, the burden falls to you, the consumer, to research the best policy type to fit your specific needs, budget and lender proof-of-flood-insurance requirement.
Flood zones identified on the flood map (FIRM) for Princeton were determined remotely using various data sources and computer models. For the most part, flood zones are not determined by “flesh and blood” civil engineers or land surveyors. In fact, many FIRMS nationwide are sorely out of date and are prone to having significant errors. Recognizing this, FEMA has made provision for property owners to challenge the flood zone status of their property. The process requires the submission of a Letter of Map Change (LOMC) application requesting that a property be removed from community’s FIRM or reclassified to a lower risk zone. According to public records, Princeton has had nine successful map amendments since 2010.
Aspects of the LOMC application must be completed and signed by a Licensed Land Surveyor or Registered Professional Engineer. I’m told that hiring a professional to develop a LOMC application typically costs $600 to $1,000. Although this is not a small amount of money, this one-time cost could negate the need to pay annual flood insurance premiums if your request is granted by FEMA. On the other hand, you won’t know if your property can be removed from a flood zone without first submitting a LOMC application. Thus, there is a risk that you would pay to develop an application only to discover that the property cannot be excluded from a high-risk flood zone. Such is life.
The NFIP and mandated flood insurance is an extremely complicated subject. I’ve done my best to summarize how we got to where we are and what flood insurance options exist. Much, by necessity, had to be excluded from this article. I’ve put selected links, below, for those interested in more detailed information.
The majority of the information contained in this article came from FEMA websites, www.fema.gov/national-flood-insurance-program and www.FloodSmart.gov . In addition, there is a gargantuan amount of information on the internet on the history, function, status, and future of the NFIP, WYO, and private flood insurance providers in the United States. One such website is www.floods.org.
If you’re interested in knowing if your property is located in a flood zone, go to the FEMA Flood Map Service Center at http://msc.fema.gov/portal/home. Simply put in your address and FEMA will do the rest.
Finally, FEMA maintains an Office of the Flood Insurance Advocates (OFIA). The OFIA advocates for the fair treatment of policyholders and property owners by providing education and guidance on all aspects of the NFIP, identifying trends affecting the public, and making recommendations for program improvements to FEMA leadership. The OFIA website can be found at www.fema.gov/flood-insurance-advocate.
• Don Hershman has dealt with flood insurance as a consumer for 9 years and flooding in Princeton for 35 years. Many thanks to Kim Cook at Farmers Bank, and to former Princeton Councilperson, Alyson Van Hooser, for reviewing this article and providing input on its content.