NFIP Reform Makes Sense

It is necessary to ensure the continued viability of the NFIP. At the same time, overly expansive extension of the flood insurance requirements could have unintended consequences, increasing the costs of affordable rental housing and occupancy costs for businesses. It could also increase delinquencies and foreclosures as well as reduce property values.

Another unintended consequence of a further expansion of the NFIP is the impact on state-regulated life-insurance companies that include commercial and multifamily loans in their overall investment portfolio. The National Flood Insurance Reform Act of 1994 did not address loans made by non-federally chartered lending institutions.

Life companies are regulated by state insurance commissioners. For example, the proposal of mandatory inclusion of all properties in the 100-year flood plain would scope life company loans into the NFIP, preempting the state regulatory authority for life companies. If expansion of the law is being considered to include mandatory purchase of flood insurance, such a preemption should be carefully considered, given the historic role that states have played in the regulation of life companies and other mortgage lenders and servicers.

Reform of the flood insurance program should be exercised with caution and full awareness of the implications of any actions. There is no quick fix.

In recent testimony before the Senate Committee on Banking, Housing and Urban Affairs Committee, NFIP's acting director for mitigation suggested phasing out subsidized premiums in order to charge policyholders more market-oriented actuarially sound premiums. Now that the NFIP has had to borrow substantial funds from the Treasury following the 2005 hurricane season, the thought of an actuarial rate structure is attractive, but the reality may be problematic. The Congressional Budget Office has indicated that nearly 25% of policyholders receive subsidized rates.

Under a true actuarial setup, many commercial property owners who are unable to raise their properties to the base flood elevation could find it financially impossible to retain or repair their structures. These properties could be rendered unmarketable. Defaults and foreclosures would increase. Given the unmarketable nature of the assets, property owners and lenders would pay a significant cost for this change in government policy.

Mortgage lenders have been the only enforcers of the mandatory purchase requirements since enactment of the Flood Disaster Protection Act of 1973, which restricts federally insured depository institutions from making loans in a Special Flood Hazard Area without flood insurance.

The National Flood Insurance Reform Act of 1994 expanded the mandatory purchase requirement to loans purchased by Fannie Mae or Freddie Mac. Both corporations, however, already required the purchase of flood insurance at the time of enactment of NFIRA. NFIRA also re-affirmed the lender's obligation to keep the policy obtained at origination in force for the life of the loan through the use of lender-placed insurance, if necessary.

As an industry, commercial mortgage companies execute flood-insurance obligations consistently, in good faith, and with few errors. Our members, especially servicers, have instituted significant procedures to ensure compliance with these and other statutory obligations. After all, it has always been in the best interest of the lender and the borrower to protect the property at-hand.

There are several reforms that NFIP should consider that will help increase property protection, its market penetration and revenues. These recommendations are based on the existing statutes and presume no increase in the scope of coverage of the law. Of course, each one of these suggestions carries some level of risk and potential costs that must be weighed against the benefits of additional premium income.

•Provide Additional Funding for Map Modernization. It is crucial for the NFIP to have the most up-to-date and accurate maps to mitigate hazards and more accurately determine the risks to property owners. The current maps are less than precise and often difficult to read. And every year, flooding occurs in areas outside of the currently designated flood plains. While modernization is important, it is also critical that any new properties determined to be in flood-hazard areas be provided a phase-in period to purchase insurance. Lenders need time to work with borrowers before enforcing new requirements.

•Reclassify Multifamily Properties. Increase the maximum structural coverage for apartment buildings to $500,000, adjusted annually for inflation, and increase the maximum content coverage to $500,000, also adjusted for inflation. The multifamily coverage would then run parallel to the commercial NFIP coverage. The current $250,000 maximum for multifamily properties is the same as for single-family properties and is simply inadequate. Even with the increase only a small percentage of the total value of most multifamily properties will be covered. Owners will continue to be required to find supplemental coverage, but that coverage will be less onerous if the NFIP maximum is raised.

•Consider Increasing Deductibles. Under the current program, the lowest deductible for structures and contents is $500, and we believe this could be increased to as much as 5% of the NFIP insurance coverage amount for multifamily properties with five or more units. This would lower premiums and encourage mitigation by borrowers.

•Consider Creating a "Deluxe" Flood Insurance Policy. For an extra premium, the policy could include the following optional features: (1) alternative-living expense coverage, set at a percentage of the structure limits, including commercial rental properties; (2) mortgage assistance payments or loss or rents coverage; (3) replacement cost coverage for personal property; and (4) basement coverage. The policy would also cover losses associated with civil-authority declarations that prevent the use or occupancy of a property in a designated area even though the property itself may not have been directly harmed by flooding. We have learned from the recent Gulf Coast hurricanes that a property can be adversely affected by a major food in the area even if the property is not flooded.

The NFIP was solvent up until the 2005 hurricane season. It is important that we do not make radical changes to the program as a knee-jerk reaction to the Katrina disaster. There is no easy recipe to ensure that the NFIP brings in sufficient premiums to cover the federal outlay of funds used to pay claims, particularly in the event of a disaster the magnitude of Katrina. But there are clearly incremental changes that can be made and should be made to improve the program, including increasing maximum policy coverage.

Lenders take very seriously their responsibility to ensure compliance with the flood laws and to assist in efforts to maintain a viable national flood-insurance program. MBA continues to work with Congress to identify prudent and thoughtful actions that can be taken to assure the continuation of the NFIP that do not impose adverse unintended consequences on property owners and communities.

Cheryl Malloy is senior vice president, Multifamily & Governance, at the Washington, DC-based Mortgage Bankers Association. The views expressed here are the author's solely.