A Rising Tide Lifts All Premiums
The Future of Flood Zones and Flood Insurance
Over the past year, I’ve noticed something hitting my desk more and more frequently: financing requests for properties in flood zones. Whether it’s a restaurant on a river’s edge, a camp on a lake, or a home being used as an AirBNB along the Atlantic coast, people like to live and do business near water. This is not really a new concept, mind you, as most large American cities were established near navigable bodies of water, although that was generally for the benefits of transportation and trade and not for the nice views and general ambiance sought by many of today’s property owners.
As waterfront properties in places like Maine and elsewhere are becoming more and more sought after, being able to navigate flood zone rules is increasingly important for both borrowers and banks. If a property is in a flood zone, particularly a higher risk flood zone, it can undermine the viability of a deal altogether, so it is important for the borrower (and the bank) to know early on in the process what they are dealing with. If a property is identified as being in a flood zone, there are a number of things that need to happen before the loan closes all resulting in the borrower ultimately obtaining flood insurance, which can sometimes be pricey especially for expensive properties in high risk zones. Finding out that a property is in a flood zone is so impactful to the lending process and such a frustration to the borrower that our bank, for example, started ordering flood checks as early on in the process as possible, sometimes even before we order an appraisal. I will even order a flood check on a property a customer is thinking about acquiring, knowing the cost of potential flood insurance premiums might impact whether they even want to pursue the deal.
There are two problems with the Federal flood insurance program as it currently stands, however: it is massively underfunded and flood zones are likely to become broader in the years to come due to rising seawaters and the propensity of people to want to live and do business near bodies of water.
The Future of Flood Zones
Let my own frustrations about the flood insurance process not suggest that there is not a very real need for insurance programs. The reason the Federal National Flood Insurance Program (NFIP) exists is to protect property owners including homeowners from catastrophic financial losses from flooding, which is undoubtedly a worthy and necessary mission. When Michael Grimm of FEMA testified before Congress in February 2020, this is what he had to say:
As millions of American families have unfortunately experienced first-hand, flooding is the most common and costly natural disaster in the United States. Ninety-eight percent of counties across our country have experienced a flooding event, and flood waters continue to pose a greater potential for damage than any other natural disaster. Moreover, in the last decade, floods alone have caused over $155 billion in property damages and they continue to account for the majority of federally declared disasters.
One problem with the program, however, is that it is not solvent enough to cover the financial losses from flooding that follows major storms that impact a wide geographic area, like large hurricanes. The NFIP has over five million policies with over $1.3 trillion in coverage. The program is funded by premiums and fees paid by policyholders, but more and more frequently the program has had to borrow from the U.S. Treasury to pay for extraordinary claims after significant weather events including Hurricane Katrina in 2005, Hurricane Sandy in 2012, and Hurricane Harvey in 2017. The chart below shows the amount of payments made out each year to policyholders relative to premiums paid:
In most years, the amount of premiums paid actually outpaces the amount of claims paid, but the spectacular losses following major hurricanes far outweigh the other years and make the NFIP a net financial loss to taxpayers since the program simply borrows money directly from the U.S. Treasury when it needs to bridge any gaps. In October 2017, Congress actually cancelled $16 billion in NFIP debt that had been racked up following these various hurricanes and other large weather events, which means they paid the claims and then wiped the debt off the books.
By drawing on the U.S. Treasury to cover losses related to flooding, this means that the average U.S. taxpayer is on the hook for these losses even for properties that are not their own. It is a worthy policy discussion to ask whether this is fair or whether we want policyholders who own properties in flood zones to actually pay more in premiums than they pay now, which would make the flood program more financially stable and require less support from the U.S. Treasury (a.k.a. the collective taxpayers). I am just speculating here, but in the immediate aftermath of a catastrophic weather event when people are hurting, there are not many politicians who are willing or interested in pointing out the perils of relying on the U.S. Treasury to cover financial losses after such tragedies, especially as large storms appear to be becoming more frequent and more impactful; it’s much easier to just draw on the U.S. Treasury and then write off the losses if not morally hazardous, to use an economics phrase.
And that is the second problem with the flood program as it currently stands now: it is not written or structured to face the reality of stronger storms and rising seawaters as a result of climate change in the years to come. Per Bloomberg, a 2020 study that mapped a database of 150 million properties in the lower 48 states identified six million properties in the United States that are not currently in a flood zone but should be due to the high risk of flooding. It also anticipates an increase of 1.6 million more properties in addition to that initial six million that will become high-risk for flood in the years to come due to rising seawaters. Certain states including Louisana, Florida, Delaware, and New Jersey are particularly vulnerable.
What Comes Next
It will be a rude awakening for homeowners, business owners, and property developers when they get a call from their bank or insurance company at some point in the future to tell them their property is now in a flood zone (or that it has been moved from a lower risk flood zone to a higher risk one, thereby necessitating a bump up in insurance coverage). But that is exactly what is likely to happen in the years to come for some people. According to Adele Peters in Fast Company, “This year, the costs from flood damage to homes could total $20 billion. By 2051, that could increase to $32 billion.” Premiums will go up to help offset these growing losses.
Just last weekend, Arian Campo-Flores of The Wall Street Journal reported that FEMA is currently rolling out a new pricing mechanism for flood insurance that will more accurately reflect risk:
Under the new system, dubbed ‘Risk Rating 2.0',’ some policyholders in especially vulnerable areas will face big premium increases while others in less-exposed spots will see smaller increases or even decreases…the changes could present some homeowners in flood-prone areas across the U.S. — especially along the Gulf Coast and Eastern Seaboard — with difficult decisions about whether they can afford to live there.
Projected changes in premiums are not scheduled to go into effect until April 2022 and while 23% of current flood insurance policyholders could see a decrease in their premiums under the new pricing mechanism, it is projected that 66% will see an increase. The article by Arian Campo-Flores gives an example of Tyler Payne, the mayor of Treasure Island, Florida, who is slated to see his own premium jump from $2,710/year to $5,415/year and Chris Dailey of St. Petersburg, Florida, who is projected to see his annual insurance premium increase from $441/year to $4,986/year!
The implications of these changes are profound. Some people are applauding the pricing updates, arguing that homeowners who live in particularly risky areas due to the potential of flooding should bear more of the cost, which is a concept that is hard to argue with; those living with risk should be the ones whop pay to offset that risk. But there are two sides of that coin in that many homeowners have been completely unaware of this potential issue and many may now be priced out of their homes if they cannot afford the new premiums. In the Fast Company article referenced above, Adele Peters speculates that policy implications of these changes could include limiting new construction in high risk areas or the government needing to provide help moving to those who live in particularly vulnerable areas. One neighborhood in Louisiana has flooded so frequently (17 times in 30 years), that the Louisiana Office of Community Development is helping to relocate the entire neighborhood to higher ground (“Everybody’s Tired of the Water”).
There is also a qualitative question about whether coastal living continues to be the bastion of the financial elite (even more so than it already is) as lower income people will be less likely to be able to afford the flood insurance premiums as those premiums rise in response to the potential insolvency of the program and due to the flood zone lines themselves getting drawn in more expansive ways.
The question of how to react to climate change, stall the progress of warming seas and air, and ultimately reverse it is, for now, beyond the scope of this article. But it something for all of us to bear in mind. I am always fascinated by policy issues that cut across atypical party lines. On the topic of climate change, I see opportunities for business owners and property developers, who might more typically be placed on the conservative side of the political spectrum (although not always) to align with those on the left calling for action to protect the environment from the risks and ravages of climate change. Whether cooperation actually can happen in such a divided political landscape remains to be seen. As constituents and voters start opening their mail next April and see their premiums for flood insurance skyrocket, you can bet they are going to react, and the question of who pays after the storm passes will be a major one in Washington D.C. and in state capitols around the country for the foreseeable future.
Ben Sprague lives and works in Bangor, Maine as a V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram and subscribe to this weekly newsletter by clicking below.
Weekly Round-Up
Here were a few things around the web that caught my eye this week:
On the topic of warming seas, the Maine Science Festival, of which I am a big fan, is planning its 2022 event, which will feature a commissioned piece by Bangor Symphony Orchestra Conductor Lucas Richman about climate change in the Gulf of Maine. The story even got some national attention this week as it was featured by the likes of the New York Post and others: https://nypost.com/2021/10/04/symphony-about-climate-change-to-headline-maine-festival/
Per Redfin, home prices are growing at a slower pace in regions impacted by wildfires: https://www.redfin.com/news/california-wildfire-housing-market-impact/
More on the neighborhood in Louisiana that is being moved out of a high-frequency flood area: https://www.theadvocate.com/baton_rouge/news/communities/westside/article_66c1ea0a-0802-11eb-bbc2-e37800e32e7f.html
Continuing the conversation on my recent article Where Are All The Workers, there is more data showing that early retirements are a key variable at play:
I’ve written about inflation and interest rates before, but this is a good take on the role of supply chains and overall demand right now:
More on supply chains and shipping (a topic for a future article):
Inflation watch!
A dinosaur on its way to the Museum of Science in Boston 37 years ago:
Got news tips or story ideas? Email me at bsprague1@gmail.com or ben.sprague@thefirst.com. Have a great week, everybody!
I am a fan of just banning new construction in areas that are major flood risks because of the political constraints.
There are three ways that you can deal with issues like periodic flooding, either you 1) tell people they knew what they were getting into and are on their own to find private insurance/support and rebuild, 2) force people to take out flood insurance if they live in these areas to make sure the general tax payer isn't on the hook, or 3) just ban new construction in these areas, and move people out of them over time.
The issue with number one is that flood events by definition are largish and not very regular (if the lot flooded twice a year no one would build on it). So they are following extreme weather events, dam failures, etc., and there are zero politicians who are going to say after a hurricane, you made your choices tough shit. At least not if they want to continue being politicians. Bush Jr just made a poor transit decision during one of these events, and he took a bigger hit to his standing in the country than from either the war on terror, or the war on social security. So there is no governor who when faced with major flooding is going to be the one telling survivors they are SOL.
So why not take route two, and just insure against the risks? The problem is that the rates will never be large enough to accurately price the risk, because again these are by large and irregular events. The bureaucracy and politicians don’t have a strong incentive to make these programs solvent since most years claims are low, and they know that if a massive disaster does strike the government will backstop the program. So over time it is easier to acquiesce to lower rates, or not keep them in pace with inflation, or to not increase them to track increased risks. So even if after a massive disaster they raise the rates to make sure “this doesn’t happen again”, all of the human and economic incentives over the proceeding 10-20 years is for them to fall out of alignment again.
So given that failure is basically inevitable, I prefer option three, which is just banning habitation and commercial construction in these areas. It hurts my neoliberal soul to not just use prices to solve the problem, but given political constraints your real options are either have the taxpayer bail these areas out every 15-25 years, or just stop people from living there, and door two seems more rational.
There is also an interesting comp here with healthcare provision, since it also suffers from similar political constraints, which make insurance an ineffective solution.