December 26, 2012

Hatteras Island Real Estate:
Important National Flood Insurance Program changes


Last July, Congress and the President approved the Biggert-Waters Flood Insurance Reform Act of 2012.  This legislation made numerous changes in the National Flood Insurance Program (NFIP).

These changes, which take effect on January 1, 2013, have the potential over time to significantly increase the cost of federal flood insurance.  The legislation and its implications can be fairly complex, so the operative caveat when you are finished reading this article is that you need to contact your insurance agent to understand how the revisions directly affect your personal insurance situation.

If your eyes glaze over and your head starts to ache when you read technical information, you are in good company.  With 64 pages to digest, even insurance professionals are scratching their heads trying to decipher the details and ramifications of the NFIP modifications that are taking place.

Let’s start to unravel this new legislation by looking at some historical aspects of the NFIP. In 1968, Congress passed the National Flood Insurance Act to promote protection against the perils of property losses due to flooding and to encourage sound land use by minimizing the exposure of properties to flood losses.

The National Flood Insurance Program has had a spotty record of collecting enough premiums to cover its losses.  In technical jargon, the program has been unsound on an actuarial basis. In recent years, the deficit has accelerated with losses of about $18 billion, mostly from Hurricane Katrina in 2005. This figure does not include the still undetermined losses from Super-storm Sandy.

A secondary issue is that since 2008 there has been no permanent long-term funding for the NFIP program. It has been kept alive by a series of stop-gap extensions. The new legislation includes a five-year reauthorization of the NFIP and reform measures to assure the financial solvency and sustainability of the program.

At this point, I think the easiest way to begin to understand the impacts of the legislation might be to look at the changes as they affect various property categories and provisions contained in the bill.

Pre-FIRM Properties

The first Flood Insurance Rate Maps (FIRM) were created in 1974. Properties constructed prior to 1974 are known as Pre-FIRM.  Many of these homes were built at ground level vs. being elevated. All of these properties currently enjoy subsidized flood insurance rates. Subsidized rates are rates that are below the actual cost of the risk being insured.

Beginning Jan.1, Pre-FIRM properties will lose their subsidies over the next four to five years. Their flood insurance rates will increase to the point where the cost of flood insurance equals the actuarial rate for the risk. The actuarial rate is the estimated cost associated with the true risk of loss for the property.

Primary Residences

The subsidized rates currently enjoyed by primary residences will remain in place. To be considered a primary residence, a building must be lived in by a policyholder or his or her spouse for 80 percent of the year.

Secondary Properties

At the risk of oversimplification, secondary properties could be defined as all properties that are not primary residences. This is the classification into which most of the vacation rental homes and commercial properties on Hatteras Island fall.

More specifically, secondary properties include rental properties, non-primary residences, second homes, severe repetitive loss properties, commercial properties, properties that have incurred flood damage exceeding their fair market value, and properties that have been substantially damaged or substantially improved in a cumulative amount exceeding 30 percent of fair market value.

Existing NFIP subsidies, i.e. discounted rates, for secondary properties will be reduced 25 percent per year with actuarial rates being phased in over four years.

New or Lapsed Policies and New Construction

The Biggert-Waters bill prohibits subsidies on new or lapsed NFIP policies. New or lapsed policies will be charged rates associated with the current flood risk of the property, as will newly constructed homes.

Annual Rate Increase Cap

The limit on annual NFIP premium rate increases has been raised from 10 percent to 20 percent.

Policy Deductibles

For structures valued at $100,000 or less, the policy deductible will be increased to $1,500. For structures valued over $100,000, the deductible will now be $2,000.

New Flood Insurance Rate Maps

For any property that is covered by a new FIRM or that is subject to a revision of an existing FIRM, there will be no “grandfathering” as is the case now. For example, if your home was built several years ago, and your flood insurance cost was based on the FIRM in place at the time, the way it works today, you could retain the rate associated with the original flood zone as long as your policy did not lapse. 

Under the new rules, if a new or revised Flood Insurance Rate Map places your property in a higher risk flood zone, you would pay the rate based on the new flood zone.  The increased cost associated with the new flood zone would be phased in over a five-year period.

This change could be important for some Hatteras Island properties, especially oceanfront homes and those located close to the Pamlico Sound. The last Flood Insurance Rate Map change for Dare County took place in 2006. Prior to that time, many oceanfront and soundside properties were located in standard risk (AE) flood rate zones. After the map revisions, a lot of these homes were placed in a high risk (VE) zone.  It is my understanding that new flood maps are currently being developed.

Home Sales

When a home is sold in today’s market, it is possible for the new owner to be grandfathered at the previous owner’s NFIP premium rate classification. Beginning Jan. 1, the new owner will have to pay the flood insurance premium associated with the flood zone in effect at the time of purchase. 

In conjunction with the increased cost of coverage, this change has potential significance because a borrower must have flood insurance in order to obtain a federally guaranteed loan. Also, the cost of insurance is included in the lenders’ calculations when they determine the financial qualifications of a buyer for a mortgage.

Preferred Risk Policies

Preferred Risk Policies (PRP) offer low-cost NFIP coverage to owners of eligible buildings located in moderate risk flood zones. On Hatteras Island, this would probably include properties located in an “X” flood zone.

As of Jan. 1, it appears that Preferred Risk Policies may continue beyond a previously designated 2-year period until the Federal Emergency Management Agency completes an analysis and implements a revised premium structure based on the Biggert-Waters legislation.

I hope that you find this preliminary look at the new National Flood Insurance Program changes to be informative and helpful.  As you can readily see, this is not a simple topic to understand, and, of course, this is a highly simplified explanation. Therefore, I again encourage you to contact the insurance agent who writes your flood insurance policy, and ask what the changes mean for your personal circumstances.

I am sure that there will be a lot more coverage of the component provisions as people become aware of the issues and as details are clarified. I will do my best to keep you updated as new information becomes available.

(Tom Hranicka is an associate broker with Outer Beaches Realty. Questions, comments, or suggestions for future articles may be sent to Tom Hranicka at P.O. Box 237, Avon, NC  27915, or e-mail to [email protected]

Copyright 2012 Tom & Louise Hranicka.  All rights reserved.

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