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April 27
07:09 2021

Public Policy Analysis & Opinion

By Kevin P. Hennosy


Federal loan insurance auditors want no part of flood risk

The National Association of Insurance Commissioners (NAIC) went to bat for private flood insurers in a letter to the U.S. Department of Housing and Urban Development (HUD).

The letter urges HUD “to consider further aligning its rule with the federal banking regulators’ private flood insurance rule.”

The NAIC comment letter says that “unlike the federal banking regulators’ rule, HUD’s proposed rule would not allow mortgagees to exercise their discretion to accept private flood insurance policies that do not meet the proposed rule’s definition.”

In short, the NAIC asked HUD to include a “just kidding” clause into its own new rule—a rule that establishes that parties must meet the following conditions … unless they decide not to do it.

Rather than understanding and trying to improve upon [a] HUD proposal … the NAIC makes recommendations that one would expect from an industry public relations or lobbying arm.

I suppose stranger things could happen, but I would want to consult the actuaries. And to be fair to those math geniuses, I will mention that the HUD Inspector General issued a report critical of the loosey-goosey world of flood insurance coverage in the department’s jurisdiction.

IG report

If one works for a federal agency, hearing that an Inspector General expressed interest in your office never feels recreational.

The Office of Inspector General (OIG), serves an independent oversight role in the federal government. In general, their assignment is detection and prevention of fraud, waste, abuse, and mismanagement of the government programs and operations.

An IG report can change policies and careers and even result in referrals to the U.S. Justice Department for consideration of “enforcement actions.”

On January 5, 2021, the OIG for Region 7 of HUD issued a “report on Federal Housing Administration (FHA)-insured loans to determine whether loans in special flood hazard areas met flood insurance requirements.”

The OIG auditors enumerated problems and recommended corrective action related to the required presentation of flood insurance on properties associated with loans insured by the FHA. The FHA program wants no part of flood risk, so such risk must be transferred prior to a loan receiving insurance coverage.

Increased risk

To the disappointment of large insurance firms, this column will not recount the increased risk of flood events related to climate change.

Humankind is doing enough to invite more financial losses from flood just through a lackluster approach to risk mitigation in the last 30 years.

This story of reducing flood risk mitigation could be told with data from many parts of the country, but I am most familiar with the midwestern experience.

In 1993, the midwestern watersheds of the Missouri, Grand and Mississippi rivers experienced historic flooding. At least 50 people lost their lives in the flood, when raging waters breached or over-topped 800 of 1,000 levees stretching across nine states and 534 counties. With the notable exception of locusts and fiery hail, the American Heartland suffered Old Testament-qualified weather.

Beyond the sorrow and anxiety caused by the deluge, the momentous event proved expensive to the public purse. The Federal Emergency Management Agency (FEMA) covered claims against the National Flood Insurance Program (NFIP) for nearly $320 million.

Policymakers covered the claims but promised to establish risk mitigation programs to reduce the risk of such massive financial loss in the future. (We will not discuss these mitigation policies in detail in this issue of Rough Notes, but this column did provide that detail in past ones.)

In short, the mitigation programs provided both financial disincentives and incentives aimed at reducing the number of structures in flood-prone areas or raising them above projected high-water levels. One of the prime financial disincentives that FEMA established resulted in higher premium pricing, and once a structure suffered a flood-related event it would no longer qualify for NFIP coverage.

Those 1990s mitigation policies reserved flood plains for—wait for it—floods. Natural riverbanks would foster the return of native flora and fauna. Bambi and Thumper would freely play, at least until hunting season.

Then, politics reared its ugly head. In some cases, local governments held authority to grant waivers for structures. Small-town councils received requests for variances from local businesspeople, relatives, and cronies. Once one council granted a variance, the town council down the road found it difficult to say no to variances in their jurisdictions.

With the passage of time, state officials found it advantageous to weaken mitigation efforts in their jurisdictions. As memories of the floods grew rarer, people questioned why these government rules kept them from using land the way they wanted to.

Of course, let us not forget our good friends in the U.S. Congress who placed pressure on federal agencies to build levees to the exclusion of other flood mitigation methods.

The waters rose, and the losses mounted. But now, let us return our attention to the HUD OIG report.

Risk conscious

The OIG auditors found that lenders often failed to report whether properties in high-flood risk areas were insured by the NFIP or private flood insurance.

As insurance professionals read the following quotes from the OIG report, please keep in mind that the proposal protects an insurance mechanism FHA offers on certain loans. Just as all private insurance companies maintain underwriting guidelines, so does the FHA program.

The auditors were not confident in the completeness of flood risk transfer provided through private flood insurance policies. The report does not condemn private flood insurance. The report notes, “While private insurance can be tailored to meet or exceed the NFIP standards, that cannot be assumed for private policies acquired without FHA guidance and oversight.”

The report explains, “Borrowers with private flood insurance might be exposed to additional risks. Private insurance might not include guaranteed renewal, rates might increase dramatically, and the policies might include coverage limitations.” Hence, those additional risks surreptitiously drift into the purview of the FHA insurance program.

I am prepared to say that no private sector insurance company would sit back and ignore that kind of surreptitious risk transfer once it became obvious. Such companies would make every effort to identify such risk transfers.

The OIG report continues, “HUD would be able to detect and mitigate this issue during review of loan files, but because more than 96 percent of the loan files were not reviewed by HUD, the lack of the required flood insurance was often not detected.”


In an understandable effort to protect the FHA insurance mechanism, the HUDOIG Report makes the following recommendations to the Deputy Assistant HUD Secretary for Single Family Housing:

  1. Require lenders to provide evidence of sufficient flood insurance or execute indemnification agreements for the 43 loans in our statistical sample that did not have sufficient flood insurance at the time of our audit to put nearly $5.2 million to better use.
  2. Add to FHA databases the information necessary to ensure that the required flood insurance is in place at loan origination, including flood zone, flood insurance type, flood insurance amount, and site value of the property, and include system checks that prevent endorsement of loans without the required flood insurance to put at least $432.6 million to better use by avoiding potential future costs to the FHA insurance fund.


Rather than understanding and trying to improve upon the HUD proposal in terms of regulating an insurance mechanism, the NAIC makes recommendations that one would expect from an industry public relations or lobbying arm.

The NAIC comment letter advocates for adopting a banking approach, which ignores the risk of financial loss to an insurance mechanism. If the “regulators association” made the same proposal apply to private sector insurers at one of its conventions, the assembled insurance carrier lobbyists would pick up torches and pitch forks.

Over the past century, in limited occasions, the NAIC has provided well-reasoned advice on national regulatory policy drawing from technical expertise on insurance mechanisms.

This comment letter to HUD will not be listed as one of those times.

I believe the NAIC’s letter falls in a larger ignoble pit of the association’s history when it simply tries to defend one parochial interest or another.

The author

Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.

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