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12/13/2017

National Flood Insurance Program (NFIP)

The National Flood Insurance Program, administered primarily under the National Flood Insurance Act of 1968 (NFIA) and the Flood Disaster Protection Act of 1973 (FDPA), has come under increased scrutiny in recent months as its $30B in borrowing capacity has been exhausted.  Most recently, the program had $16B in debt forgiven by Congress to keep the program temporarily afloat.  Even with the passage by the House of Representatives of the 21st Century Flood Reform Act, the risks that banks and lenders face will remain. The flood risk exposure to mortgages in concentrated coastal and flood prone areas still exists and if the new bill fails to pass the Senate, the program will collapse. Without the continuation of this initiative, banks and lenders would have potentially billions at risk with no recourse to insure mortgages on their books against floods. This exposure is augmented by the fact that NFIP-subsidized coastal homes have disproportionately higher values than unsubsidized properties as the insurance subsidies help to raise property values.

Lending Risks Surrounding the NFIP

The National Flood Insurance Program, administered primarily under the National Flood Insurance Act of 1968 (NFIA) and the Flood Disaster Protection Act of 1973 (FDPA), has come under increased scrutiny in recent months as its $30B in borrowing capacity has been exhausted.  Most recently, the program had $16B in debt forgiven by Congress to keep the program temporarily afloat.  Even with the passage by the House of Representatives of the 21st Century Flood Reform Act, the risks that banks and lenders face will remain. The flood risk exposure to mortgages in concentrated coastal and flood prone areas still exists and if the new bill fails to pass the Senate, the program will collapse. Without the continuation of this initiative, banks and lenders would have potentially billions at risk with no recourse to insure mortgages on their books against floods. This exposure is augmented by the fact that NFIP-subsidized coastal homes have disproportionately higher values than unsubsidized properties as the insurance subsidies help to raise property values.1

In a number of instances, some banks have not taken the necessary steps to ensure that flood insurance is in place for these at-risk properties (including potentially additional properties serving as collateral) and face not only the mortgage exposure but also fines and penalties from regulators. As of August 2015, of the roughly 1.5MM homes in high risk areas that were required to have flood insurance in force, only 53% had policies in place. While banks are supposed to ensure that any mortgages they make to high risk areas have policies in place, non-compliance can be high. The consequences are that insurance is never purchased, policies are allowed to lapse, or in some instances, mortgage lenders advise homeowners not to purchase the insurance. This has resulted in fines levied and consent orders issued, upon the completion of a regulatory exam, most recently against Bank of America and SunTrust Bank. 

Issues Facing the FDPA

In the wake of what is shaping up to be the 2nd most expensive hurricane season in history for the U.S. mainland, the NFIP will likely require serious reform if it is to survive. The program in its current form, given the increased frequency of years with outsized losses, is not likely to be sustainable and will not be able to continue to cover the claims paid out.  Premiums collected in 2016 totaled $3.3B, yet claims paid out in the same year were roughly $3.7B.  That same total will pale in comparison to the losses suffered this year with current projections of the program’s gross losses to be $7B to $10B from Hurricane Harvey alone.3

The figure above shows the dollar amount paid out to flood victims under the NFIP while the figure below displays flood insurance premiums collected by the program. Although premiums have steadily increased since 1978, the difference between capital issued and collected has progressed far into the red over the course of the 21st century.

The 21st Century Flood Reform Act that passed the House on November 14th, 2017, looks to address some of the issues facing the program and help to open a private market for flood insurance.

Some of the issues addressed by the bill are:

  • Allowing “Write Your Own” Insurance companies to sell their own private policies.
  • Reducing costs from repetitive loss properties (currently 1% of the NFIP subsidized properties accounting for 25% of losses).
  • Improving flood mapping and sharing FEMA data with insurance companies.
  • Capping annual premium increases and surcharges.
  • Ensuring that the NFIP generates sufficient revenues to cover losses.

Lending Compliance Surrounding NFIP

The potential losses homeowners and lenders in flood prone areas face has resulted in the FDPA mandating insurance coverage through the NFIP.  Lending institutions are directed to not make, increase, extend, or renew any loan secured by real estate located or to be in an area identified as having special flood hazards unless flood insurance covers it.  Homeowners have 45 days to purchase flood insurance and if it is not in place the lender must purchase on behalf of the borrower and may charge the borrower for costs incurred. 

Developing a Plan of Action to Comply with NFIP

As scrutiny increases over the FDPA and NFIP, lending institutions need to comply with the regulations to avoid penalties.  Financial Institution’s plans to avoid sanctions and increase compliance should assess the frameworks in place and guide any changes to enhance controls as well as policies and procedures.  

While developing a plan, some of the key pieces that should be considered as part of its implementation include: 

  • Establishment of comprehensive policies and procedures, including identification of controls that help ensure compliance.
  • Enterprise-wide internal guidance, guidelines, and documentation that convey complete and accurate information regarding the FDPA to be used by employees involved with designated loans.
  • Training for personnel who have responsibilities associated with loans covered under the FDPA.
  • Conduct periodic reviews and update aforementioned internal guidelines when deemed appropriate.
  • Procedures to ensure that any risk management or compliance entities within the organization have the status to identify deficiencies and initiate remediation of those deficiencies.
  • Development of reporting tools to identify flood insurance coverage across properties collateralizing loans/mortgages.
  • Ongoing monitoring and testing within applicable business lines to ensure adherence with the guidelines.
  • Reporting by managers responsible for overseeing the implementation of new FDPA guidelines to senior officers and compliance committee at the enterprise, including metrics.
  • Appropriate oversight of third parties to ensure they are aware of and comply with FDPA regulations.

Conclusion

The National Flood Insurance Program has gained notoriety over the course of the 21st century, largely for negative reasons. The increased frequency of super storms as well as extensive construction in flood-prone areas has aided in the revelation that the program is fiscally unsustainable. As the NFIP faces increased scrutiny in the public domain, it is likely that regulators will increase their efforts to identify and punish financial institutions for a lack of compliance. It is therefore necessary for any institution that the NFIP applies to take a proactive approach to ensure their compliance.

 

Sources 

Page 8 - https://www.cbo.gov/sites/default/files/110th-congress-2007-2008/reports/06-25-floodinsurance.pdf

http://time.com/4952628/hurricane-season-harvey-irma-jose-maria/

https://seekingalpha.com/article/4104514-nfip-harvey-loss-7-10bn-reinsurance-layer-likely-loss-rms  

https://www.fema.gov/loss-dollars-paid-calendar-year  

https://www.fema.gov/total-earned-premium-calendar-year  

https://www.nytimes.com/2017/11/04/business/a-broke-and-broken-flood-insurance-program.html?emc=edit_ta_20171105&nl=top-stories&nlid=68614691&ref=cta

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