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Affordability in question: The National Flood Insurance Program needs $1.4 billion more to function

Here are the two main reasons why

As the expiration date of the National Flood Insurance Program draws nearer, the Congressional Budget Office, a nonpartisan analysis for the U.S. Congress, calculated that the program has an expected one-year shortfall of $1.4 billion.

Flood insurance, whether it’s private or the national flood insurance program, has struggled to gain a lot of attention over the years despite the urgency of the program expiring.

The program was established in 1968, and authorization for the program, which is administered by Federal Emergency Management Agency, expires on Sept. 30, 2017.

According to the FEMA’s website, “The National Flood Insurance Program aims to reduce the impact of flooding on private and public structures. It does so by providing affordable insurance to property owners and by encouraging communities to adopt and enforce floodplain management regulations.”

“These efforts help mitigate the effects of flooding on new and improved structures. Overall, the program reduces the socio-economic impact of disasters by promoting the purchase and retention of general risk insurance, but also of flood insurance, specifically,” it stated.

But after the devastating destruction caused by Hurricane Harvey, the attitude toward the program completely changed, pushing the urgency for the program to the surface.

Given the looming deadline, the CBO said lawmakers sought information from them about the NFIP’s financial soundness and its affordability for policyholders.

The CBO analyzed roughly 5 million policies in effect on Aug. 31, 2016 to assess the program’s financial soundness. The CBO then compared expected annual costs and premiums. Expected costs include estimates of expected claims projected using commercially available models that simulate large numbers of potential flooding events along with their probability.

From there, the CBO compared premiums with household income to assess the NFIP’s affordability for policyholders.

The CBO did caution that the estimate of expected claims accounted for low-probability, high-cost events, such as Hurricane Harvey, which first made landfall in Texas one week before this report was published.

As a result, the estimate is probably greater than actual costs would be in a typical year, although lower than costs could be in the aftermath of a catastrophic storm, the CBO stated.

So, after considering all of this, the CBO estimated that overall, the program had an expected one-year shortfall of $1.4 billion.

However, this number changes depending on what expected costs and premiums are considered.

The CBO included an alternative measure, the actuarial shortfall, which amounted to $0.7 billion. The actuarial shortfall compares premium income with the subset of costs associated with paying claims for existing policies and writing and servicing those policies. This excludes $0.7 billion for mapping floodplains, mitigating flood risk, and making interest payments on debt accumulated from previous claims.

The extreme $1.4 billion shortfall comes down to two main sources, according to the CBO:

  1. CBO’s estimate of expected claims exceeds FEMA’s estimate by about $1 billion. Because FEMA’s estimate is its basis for premium setting, the difference between the two estimates causes premiums to fall $1 billion short of CBO’s estimate of expected claims.
  2. The cost of providing discounted rates for certain policies is about $0.3 billion more than the receipts from surcharges created to help cover the costs of those discounts. The discounts are mainly for properties built before flood insurance rate maps (FIRMs) were developed. They are intended to prevent households from facing significant new costs that could impose hardship and cause some homeowners to forgo coverage.

This isn’t the first time that the future of the program has been in question. The National Association of Realtors has pointed out that when the NFIP expired in 2010, more than 1,300 home sales were disrupted every day as a result.

“That's over 40,000 every month. Flood insurance is required for a mortgage in the 100-year floodplain, but without access to the NFIP, buyers simply couldn't get a mortgage or vital protection from the No. 1 cause of loss of property and life: flooding,” said NAR President William Brown, founder of Investment Properties.

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