FHA borrowers better served by private flood insurance
Data from the federal government reveals that many FHA-insured homeowners are not meeting the mandatory flood insurance requirement.
A recent study that my company, Poulton Associates, LLC, did in conjunction with HazardHub discloses that those with lower incomes pay a higher rate than those with higher incomes through the National Flood Insurance Program (NFIP). This is especially significant when examined in concert with FHA (Federal Housing Administration) insured borrowers because the FHA was created to assist lower-income borrowers in keeping their monthly mortgage payments as low as possible. It seems only natural, therefore, that the FHA would champion private flood insurance as a less costly alternative to the NFIP.
Fortunately, the U.S. Department of Housing and Urban Development (HUD) appears ready to join the rest of the lending community by accepting private flood insurance. The public comment period just closed on a proposed rule issued by HUD that, if finalized, would remove internal guidelines that have limited borrowers to the use of NFIP coverage only. As in the past, FHA borrowers whose properties are located in a Federal Emergency Management Agency (FEMA) Special Hazard Flood Area are required to secure flood insurance before an FHA loan can be approved. If this rule is finalized, they will finally be able to do so using private flood insurance products.
Disconcerting data from HUD demonstrates that many FHA-insured borrowers are slipping through the system and not meeting the mandatory flood insurance requirement necessary for obtaining and retaining an FHA loan. This trend highlights the FHA’s considerable exposure to flood risk, and consequently, an immediate need for HUD to allow insurance buyers and their insurance producers to obtain private flood insurance products.
Growing FHA risk exposure
A January 2021 HUD audit found that the FHA insured at least $940 million in loans in 2019, which should not have been FHA eligible. HUD officials wrote in a summary of the report, “We found loans that had private flood insurance instead of the required National Flood Insurance Program coverage, coverage that did not meet the minimum required amount, or no coverage at the time the loan was closed and endorsed.”
If the FHA had allowed the acceptance of private flood insurance over the last decade, this kind of costly and dangerous oversight would have been corrected by market forces to the benefit of insurance agents and brokers, lenders, the homeowners and the FHA. By finalizing their proposed rule reasonably and quickly, the FHA will help ensure a competitive flood insurance marketplace. The private market’s unfettered entrée into the FHA homeowners market will also help to raise awareness of the need for flood insurance among these borrowers as enhanced access to flood coverage causes producers to quote flood coverage more frequently. Competition will hopefully lead the NFIP to charge more accurate rates than it has in the past as it responds to competition.
A March 2020 report published by HUD and the Office of Policy Development and Research reviewed flood insurance coverage and exposure for the FHA program. Though the data used in the report was from two states only — North Carolina and Florida — it revealed that HUD’s FHA book of loans there “is very exposed to flood risk.
The report went on to quantify the risk further, “In both states, over one-half of the FHA-insured mortgages in these states are located within or very close to a high-risk flood zone, yet less than one-fifth of such homes have insurance, and only about one-half of homes required to have insurance are in compliance.”
From this limited data, one could infer that the FHA loans in other flood-prone regions are also lacking the required flood insurance.
Keeping it simple
With the new rule, HUD will bring its regulations in line with what has been standard industry practice for many years and with a 2019 rule made by federal banking regulators; that is, regulated financial institutions must accept private flood insurance, as well as NFIP policies, to meet the mandatory flood requirement.
While HUD and the FHA see the benefits in accepting private flood, having noted that it would “expand options for obtaining flood insurance, rather than continuing to lock in borrowers to one federal option without any ability to comparison shop,” they’ve also proposed one provision in their proposed rule that would be counterproductive.
The new FHA rule calls for creating a compliance aid that is almost identical to the compliance aid already used in the federal lending regulators rule. The tacitly identical FHA compliance aid proposed in the new rule will create needless burdens and increase costs for all parties.
That said, HUD should move forward quickly with issuing the rule, minus the compliance aid language. In doing so, they will best serve the borrowers whom they were created to serve, as well as insurers, lenders, other borrowers and taxpayers.
Craig Poulton (cpoulton@poulton.com) is chief executive officer of Salt Lake City-based Poulton Associates, LLC, which administers various catastrophe-related insurance products including the country’s largest private flood insurance program, the Natural Catastrophe Insurance Program, at CATcoverage.com.
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