As the floodwaters of Hurricanes Harvey and Irma recede, they may reveal more than moldy drywall and fetid trash. They could lay bare the America federal government’s failure to police a basic tenet of its own disaster Insurance policy: that properties with government-backed mortgages in risky areas carry flood insurance.
The US government has known for decades that homeowners in flood zones often don’t have the insurance they should. Just two years ago, the Federal Emergency Management Agency estimated that as few as half of the 1.5 million residential structures required to carry flood insurance actually do. It can’t be sure, though: FEMA isn’t responsible for tracking that kind of data—nor is any other agency.

“This is a huge blind spot,” says Samantha Medlock, a senior adviser to President Obama on flood insurance policy. Homeowners with lapsed insurance could “mistakenly believe that if their luck runs out, the federal government will come in and take care of them,” she says.The magnitude of the risk is revealed partly by the numbers of uninsured homes in the paths of the recent storms. More than 80 percent of homeowners in the Texas counties hit by Harvey lack flood insurance, according to a Washington Post analysis. In Florida, FEMA estimated in 2015 that as many as 43 percent of those required to have coverage didn’t. And as climate change and coastal development increase the number of homes at risk, it’s becoming harder for the federal government to keep ignoring the problem.
When a mortgage is issued, the lender is supposed to check whether the home is in a flood plain, and if so, it should require the owner to acquire insurance. When that mortgage is sold to investors, the company that services it must make sure the premiums are paid or pay them through escrow. If the coverage lapses, the servicer is supposed to buy coverage on the homeowner’s behalf, then add the premiums to the mortgage payments.

Fannie Mae, Freddie Mac, and government entities own or guarantee 60 percent of U.S. mortgages. Lisa Tibbitts, a spokeswoman for Freddie Mac, says the insurer conducts yearly reviews of its loan portfolio, including rates of flood insurance coverage. “These reviews reveal a very low percentage of noncompliance,” she says.

And yet, since 2012, the Office of the Comptroller of the Currency, which regulates federal banks, has fined at least 27 institutions for failing to meet their obligations on flood insurance. Experts in flood insurance policy say the process appears to break down after the mortgage is made. Homeowners required to carry insurance typically keep paying their premiums for just two to four years, said University of Pennsylvania researchers in a 2012 study.
“There are plenty of areas to pass the buck in the chain of mortgage finance,” says Nela Richardson, chief economist for Redfin Corp. “That’s what makes it ultimately hard to track.” The National Mortgage Servicing Association, a trade group that represents servicers, didn’t respond to a request for comment. Four of the five largest servicers as identified by Inside Mortgage Finance declined to provide information about how many of their mortgages even require flood insurance, let alone how many comply. About 4 percent of mortgages at Wells Fargo & Co., the country’s largest servicer, require the insurance, according to spokesman Tom Goyda. He declined to say how many of those homeowners had stopped paying their premiums or how much time typically goes by between a policy lapsing and Wells Fargo finding out about it.

Mortgage lenders and servicers that are lax about flood insurance tend to be penalized lightly. In March 2013 the OCC, which regulates federal banks, determined that Amarillo National Bank had been making or renewing loans without requiring the necessary flood insurance. The fine? All of $7,250. In July 2015, Sumner National Bank of Sheldon in Illinois was fined just $3,000 for allegedly engaging in a pattern of “making, modifying, or renewing loans” without requiring coverage. First Federal Community Bank in Dover, Ohio, got dinged for $1,800. The banks neither admitted nor denied liability.

Ignoring flood insurance could soon become more costly for the mortgage industry, says Carolyn Kousky, a flood insurance expert at the Wharton School at the University of Pennsylvania. “So far there hasn’t been enough of a default risk to motivate lenders to do more on their own, voluntarily, but we’re seeing worse and worse events,” she says. “After Harvey, we might see a different kind of response.”

That’s because uninsured homeowners with severe damage may decide their only option is to abandon the property and stop making mortgage payments. “If you’ve lost your home and you don’t have insurance, that’s a good time to walk away from your property,” said R.J. Lehmann, an insurance expert at the R Street Institute, a libertarian research organization in Washington.

Fannie Mae and Freddie Mac can force servicers to buy mortgages they’ve sold or had guaranteed if they don’t have the required flood insurance, according to the Federal Housing Finance Agency. Susan Wachter, a professor of finance at Wharton, says that’s true—but it only works if the servicer has the money. And as flood events increase, so does the risk that individual servicers, which increasingly aren’t banks, will run out of funds.

“Servicers may be contractually on the line, but if they don’t have the capital, then they can’t pay up,” Wachter says, adding that taxpayers could be further exposed if clusters of homes default at the same time, reducing the value of houses around them.

Some experts have suggested that the federal government should require all homes to have flood insurance. Another possibility is to have policies last as long as 10 years.

Whatever the fix, Harvey and Irma have given the federal government a brief window to change its policy. “We can capitalize on this,” says Howard Kunreuther, a director of the Risk Management and Decision Processes Center at Wharton. “If you don’t take advantage after a disaster, you’re missing a critical opportunity.” —With Heather Perlberg, Joe Light, and Jeanna Smialek
BOTTOM LINE – The federal government has struggled for decades to enforce flood insurance requirements. Climate change is increasing the cost of that failure.
By Christopher Flavelle