NAIC Examination Oversight (E) Task Force Climate Change and Global Warming (E) Working Group Testimony of J. Kevin A. McKechnie, Senior Vice President & Director ABA Office of Insurance Advocacy, to be presented Monday, August 26, 2013 Mortgage Servicing: Flood Insurance Administration after Biggert-Waters Good morning Mr. Chairman and members of the working group. I m Kevin McKechnie, Senior Vice President & Director of the American Bankers Association s Office of Insurance Advocacy. Members of the American Bankers Association include banks that provide loans in connection with property that is required to be insured with flood insurance backed by the federal government via the National Flood Insurance Program, or NFIP. Members of ABA s insurance subsidiary, the American Bankers Insurance Association, include insurance agents that write and administer flood insurance for what are called Write Your Own companies. I will discuss the Biggert-Waters Flood Insurance Reform Act of 2012 and its effect on the administration of the NFIP by banks and insurers, but first, some background on what led to the Biggert-Waters amendment. Up until 1968, when a flood hit, the only assistance available to flood victims was in the form of state and federal disaster assistance. When private flood insurance was first considered in the 1950s, it became obvious that private insurance companies could not 1
provide coverage at an affordable price and still make a profit. NFIP, created in 1968 and administered by FEMA, provides government-guaranteed flood insurance to homeowners and businesses. It protects the property that collateralizes many loans. Flood insurance is mandatory for owners of properties located in areas vulnerable to flooding. To participate in NFIP, communities agree to enforce regulations for land use and new construction in high-risk flood zones and to adopt and enforce state and community floodplain management regulations to reduce future flood damage. Currently, more than 20,000 communities participate in NFIP. A bank is not permitted to make, increase, extend or renew a loan on property located in a FEMA-designated Special Flood Hazard Area (SFHA) unless the building or mobile home and any personal property securing the loan is covered by flood insurance for the term of the loan. If during the term of a loan, a bank or servicer determines that the collateral is not adequately covered by flood insurance, then the bank must follow certain notification requirements before force-placing flood insurance. The NFIP heavily relies on the private insurance industry to sell and service policies via what is called the Write-Your-Own (WYO) program. WYO insurance companies issue NFIP-backed flood policies in their own name and adjust flood claims; but they assume no flood risk. Insurance agents working for these companies are the main point of contact for most policyholders. When flood losses occur, policyholders report them to their insurance agent, who notifies the WYO insurance company. FEMA reimburses the WYO 2
insurance company for the amount of the claim plus expenses for adjusting and processing the claim, using rates that FEMA establishes. The WYO program was established to increase the NFIP policy base and the geographic distribution of policies, to improve service to NFIP policyholders through the infusion of insurance industry knowledge, and to provide the insurance industry with direct operating experience with flood insurance. As of September 2012, about 85 WYO insurance companies accounted for about 85 percent of the more than 5.5 million flood policies in force. In sum, ABA and ABIA members, either acting as lenders or as agents for WYO insurance companies, play an extremely important rule in the success of the National Flood Insurance Program. Financial distress at NFIP; Biggert-Waters: The NFIP does not permit FEMA to reject applicants based on risk. As flood disasters have increased in number and intensity in recent years, the NFIP has taken on more risk without a commensurate increase in insurance premiums. NFIP offers two types of flood insurance premiums: subsidized premiums (also called pre-firm rates) and full risk premiums. Subsidized rates are not based on actual flood risk. According to FEMA, subsidized premium rates are less than half the rates of those that reflect full flood risk. As of 2012, FEMA estimates that subsidized rates apply to only about 20 percent of all NFIP policies (about 1 million), most of which are in high-risk areas. 3
Because of the magnitude and severity of the losses from the 2005 hurricanes and from Super-Storm Sandy last year, FEMA owes the U.S. Treasury approximately $20 billion on loans taken out to pay flood claims. Last January, Congress temporarily increased NFIP s borrowing authority an additional $10 billion to address future claims. Because of its financial problems, NFIP has been on the Government Accountability Office s list of high-risk governmental programs since 2006. In addition to extending the NFIP through September 30, 2017, the Biggert-Waters Flood Insurance Reform Act of 2012, or Biggert-Waters, did several things to strengthen NFIP s finances. The Act requires FEMA to update its flood maps so that they more accurately reflect risk. The result will be higher flood insurance premiums. Biggert-Waters also increases the limit for annual rate increases within any risk classification of structures from 10% to 20%. Most importantly, Biggert-Waters eliminates subsidized rates (pre-firm rates) for about 438,000 NFIP policies, and will eventually eliminate most of the subsidies on the remaining 715,000 policies across the nation. Thus, FEMA has routinely permitted some insured properties to keep their original flood-risk rating and the subsidized rates that apply, specifically for buildings built before 1975 or before the relevant community received its first Flood Insurance Rate Map (FIRM) (pre-firm properties), or for post- FIRM properties that complied with a FIRM but a more recent FIRM shows the building at greater risk of flooding. Biggert-Waters ends both of these subsidies. 4
Specifically, Biggert-Waters removes subsidized rates (pre-firm rates) for the following classes of property and allows rates to increase annually by 25% until actuarial rates are achieved. o Second homes. o Property that has experienced severe repetitive losses. o Property that has had flood-related damages having a cumulative value that is at least equal to the property s fair market value (FMV). o Business property o Property that has sustained substantial damage exceeding 50 percent of the FMV or that has required substantial improvement exceeding 30 percent of the FMV. The following properties will no longer qualify for subsidies (no phase out): o Property whose owner has deliberately chosen to permit NFIP coverage to lapse. o A prospective insured who refuses to accept an offer for mitigation assistance (including relocation) after a major disaster. o Any property purchased after the date Biggert-Waters was enacted (July 6, 2012). 5
It soon became apparent after the passage of Biggert-Waters that, even with the multiyear phaseout of subsidized rates, some flood policyholders would have to pay significantly higher premiums for flood insurance earlier than expected. In response, the House recently voted to delay implementation of the subsidized rate phaseout, and several House members have asked FEMA s administrator to take administrative actions to delay some of the Act s provisions, citing concerns that flood insurance rates for some homeowners could rise to a level one-thousand times higher than their current subsidized rates. Both ABA and ABIA are committed to moving to actuarial rates for flood insurance coverage under the NFIP, but they recognize that a greater transition period may be necessary to ensure continued affordability for thousands of middle- and low-income homeowners and small businesses. Biggert-Waters also includes several provisions that will affect lenders and servicers directly. A lender or servicer is required to notify a borrower if it determines that required flood insurance has expired or is less than the required amount. If the borrower fails to buy the required flood insurance within 45 days after notification, the lender or servicer must purchase flood insurance on the borrower s behalf. Within 30 days of receiving a confirmation that a borrower has obtained the required flood insurance, the lender or servicer must terminate any force-placed insurance and refund all unearned force-placed premiums. 6
Biggert-Waters also raises two operational issues for lenders relating to the escrowing of flood insurance premiums and the acceptability of private insurance, both of which will result in lenders taking on more burdens under the NFIP program. For any loan outstanding or entered into after July 6, 2014, a lender will be required to escrow flood insurance premiums, unless (1) the lender has less than $1 billion in assets, or (2) as of July 6, 2012, the lender was not required to escrow taxes or insurance or other fees for the term of the loan and did not have a policy to do so. Most lenders escrow taxes and other fees; consequently, it appears that most large lenders will have to comply with the escrow requirement. The escrow requirement applies to loans entered into before July 2014, so banks will have to changes their systems to establish an insurance premium escrow account for existing loans a significant burden.. The Act also requires a lender to accept private flood insurance to satisfy the NFIP mandatory purchase guidelines, but it also requires that the private insurance coverage be at least broad as the coverage provided by a standard NFIP program, including when accounting for deductibles, exclusions and condition. Private policies often have an aggregate limit, whereas NFIP policies have no aggregate limit, so a private policy with an aggregate will not satisfy the NFIP requirements for acceptable private flood insurance. Consequently, a lender must read the contents of a private policy to determine if the policy satisfies the coverage requirement. Before Biggert-Waters, FEMA guidelines provided the lender with tools and discretion in making that determination. That is not the case under Biggert-Waters, which puts more burden on lenders. 7
The Act also increases lender penalties from $350 to $2,000 and eliminates the $100,000 penalty cap. Finally, for WYO insurance companies, Biggert-Waters establishes reporting requirements connected to the reimbursement of expenses. In conclusion, because of increases in the number and intensity of floods, there is a need to make the NFIP financially sound. But there are significant concerns that with the rate increases required by Biggert-Waters, some homeowners will see a significant rate increase for flood insurance premiums, which may make it difficult for them to stay in their home. Additionally, the new escrow requirement and the requirement regarding a lender s acceptance of private flood insurance whose terms and conditions are at least as good as those in an NFIP policy will add significant burdens on lenders. Because much of the Biggert-Waters Act does not become effective until July of 2014, there will likely be several efforts to amend the Act to address some of these concerns. I m happy to take your questions. 8