In its monthly e-magazine Foreclosure Report RealtyTrac takes a look at the current and potential impact of legislation designed to rescue the nation's flood insurance program.  Within that legislation RealtyTrac says there may be looming another demonstration of the theory of unintended consequences.

The National Flood Insurance Program (NFIP) was created by an act of Congress in 1968 to help deal with the escalating cost of the government's emergency response to flood disasters.  Because there was little shared risk, i.e. persons who live outside of flood prone areas do not purchase the insurance, private companies were either pulling out of insuring in high risk areas or raising premiums to the point of unaffordability, leaving government to clean up and repair damages after a disaster.  The program provides a government subsidy to keep premiums more affordable and as of April 2010 insured about 5.5 million homes, the majority of which were in Texas and Florida.

High-cost flooding disasters such as Hurricane Katrina drained the coffers of the program which is administered by the Federal Emergency Management Agency (FEMA) so in July 2012 Congress passed the Biggert-Waters Flood Insurance Reform Act to help stabilize the program's finances.  The changes required NFIP to "raise rates to reflect true risk." 

These rate changes are being phased in and currently affect only homeowners who purchased their first flood insurance after July 6, 2013 with full-risk rates starting on October 1, 2013.  Virtually all lenders have long required mortgaged homeowners who reside in a flood plain to carry the insurance so it is primarily new homeowners and those who take on a mortgage after previously owning a home free and clear who are initially being affected by the new rates.  However flood plains are periodically redrawn and with the increased intensity of weather in some areas, more long-time homeowners may find themselves required to purchase coverage.

RealtyTrac's article Private Industry Bridges Gap for Skyrocketing Flood Insurance, written by company vice president Daren Blomquist, says that Biggert-Waters "intentionally exempted FEMA from providing any meaningful disclosure to the insurance, mortgage and real estate industries - not to mention consumers - prior to the implementation of the law earlier this year." Thus the rate increases blindsided many of those affected by them.  The article looks specifically at areas on Florida's Gulf Coast and towns such as New Port Richey, in Pinellas County, interviewing homebuyers, lenders, and real estate agents.

One new homeowner, George McLaughlin, purchased a future retirement home in Port Richey in 2012 and paid a $3,300 premium for his first year of coverage.  When he received his new bill for $24,300 both he and his insurance agent assumed it was a clerical error.  It was not.  Even his bank was unaware of the pending increase when they wrote the loan.  RealtyTrac says this was "certainly a big oversight for that bank given the additional risk of default that comes with such a dramatic increase in the cost of flood insurance."

McLaughlin, who purchased the Florida property while still employed and owning a home in Maryland is now carrying two mortgages and facing the insurance bill due November 2 which he still has not paid.  Thus he is technically in default on the Florida mortgage.  The bank has given him 40 days (which would have taken him into early December) to provide proof of coverage and have told him that forced placed insurance will cost as much as $60,000.

Blomquist says the skyrocketing flood insurance premiums "have shocked the entire real estate ecosystem in and around New Port Richey."  He quotes local real estate agent Colleen Monagas as saying the rate quotes started hitting in October and absolutely came as a surprise.  She predicts that the new law could ultimately lead to more foreclosures in the area as homeowners decide to walk away from their homes rather than pay the insurance bills.  At the very least she expects the law to cause home prices to drop in high risk flood zones.  She said she has already had buyers abandon plans to purchase such houses in favor of those outside the zones, others won't even look at houses affected by the rates.

"Monagas cautioned that although many rumors are floating around about how to mitigate the impact of the Biggert-Waters legislation, the short term impact of the law is to hobble the nascent recovery in her local housing market, which she said hit bottom around July 2012 and really heated up in the spring of 2013.  'This spring we were chasing houses,' she said. 'I had buyers if you weren't there in two or three days it was already under contract'."

Blomquist calls Pinellas County "the epicenter" of the Biggert-Waters impact but says other areas are affected as well.  He cites the popular retirement city of Hilton Head, South Carolina which he says has never experienced a hurricane or flood in recorded history, as well as coastal areas of Louisiana and Texas.

Of course the counterparties to buyers who don't wish to buy in an area are the sellers who won't be able to sell.  Hilton Head real estate broker Frank Moriarty said, "People who have been here a long time...and need to move on, that house is no longer your safety net."  He predicted that values could decrease on the roughly 30 percent of Hilton Head homes located below the 14-foot elevation requirement needed to avoid high cost insurance and cautioned that the biggest issue could be a fear of rules changing again and pushing more homes into that category.  "'Some people are saying it might not even be 14 feet, it might be 16 feet or something like that,' he said." That would be devastating he points out, as that would include 70 percent of the properties on the island.

Pinellas County insurance agent Jake Holehouse told RealtyTrac that the elimination of an entitlement program like subsidized flood insurance represents a broken promise by the federal government which said, it would back these risks if the cities enforced the flood zone requirements.   Holehouse was referring to the 1968 implementation of the NFIP that grandfathered in flood insurance for homes built prior to Jan. 1, 1975. "'But now 45 years later they are going back on that'," he said.

But there may be hope.  Holehouse points to the venerable underwriter Lloyd's of London which has written flood insurance for 320 years.   Previously it could not compete with FEMA's rates but now, Holehouse says, "'Lloyd's rates look really good."    His company has been working with Lloyds to come up with flat rate coverage and can offer insurance in Pinellas's highest risk areas for $4,000 where he has seen FEMA quotes as high as $60,000.

Lloyds is still reviewing premiums on a case-by-case basis in an attempt to avoid what Holehouse called the "rampant fraud" he believes was the downfall of the FEMA program.  Lloyd's, he said, is being careful but are also hungry and want to underwrite a lot of flood. 

If Lloyd's leads, other companies will undoubtedly follow and they could find an expanding market.  With areas such as Boulder, Colorado experiencing first-time severe flooding, lenders may look at requiring the insurance in locations outside of traditional flood plains.  Cautious homeowners may also be receptive to subscribing to flood insurance if they can do so at a cost that accurately reflects their risk histories.  This increase in the pool would also help to lower premiums for higher-risk homeowners.