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The Climate Crisis Could Pose Hikes to Homeowners Flood Insurance Costs

The Climate Crisis Could Pose Hikes to Homeowners Flood Insurance Costs

Flood risk is not often top of mind for potential home buyers, real estate agents, insurance companies, and creditors. That may change thanks to a new study that examines the potential financial impact to homes due to flood risk, a topic that has garnered more and more attention due to global warming.

In recent years, we have faced ongoing challenges related to the climate crisis. Climate change has caused weather patterns to shift across the country, resulting in a greater number of floods occurring in all states. Unfortunately, as patterns have changed, policy structure has remained the same, and insurance premiums have not shifted to accommodate the increased damage caused annually by flooding.  As a result, the National Flood Insurance Program (NFIP), which covers more than 5 million homeowners across the country, is now more than $20 billion in debt, prompting calls to reform the system.

First Street Foundation recently released new research analyzing “the economic impact of underestimated flood risk to properties throughout the United States.” This research has been a significant contributor to the proposed Risk Rating 2.0 that the Federal Emergency Management Agency (FEMA) is planning to implement in October 2021, “which will adjust insurance premium calculations to better reflect individualized risk for households.” Some experts predict that these changes could translate into a 400% increase in premiums on homes located in specific high-risk areas.

Recent Research Supports Need for Updated Policies

Historically, FEMA has assessed premiums based on a property’s location in a flood zone, the occupancy type, and the structure’s elevation. Its review is based on the risks of flooding associated with rising rivers and coastal storm surge. In addition, the program’s current base rate for home insurance premiums is based on replacement cost rather than real property value. This means that the owner of a $5 million mansion with the same flood risk as the owner of a $500,000 home pays the same rate as the latter.

These policies have been representative of FEMA’s business model since the 1970s. Recent research conducted by First Street Foundation, which analyzed today’s climate crisis and the impact it has had on communities less impacted by flooding, has shown how out of date FEMA’s traditional assessment model is and how the system has failed to accurately assess the risk of flooding and associated damage.

“Over time, this has inadvertently caused a disparity – policyholders with lower-valued homes are paying more for their insurance coverage than they should while policyholders with higher-valued homes are paying less,” said David Maurstad, senior executive for the National Flood Insurance Program. “There is also a disparity at the edge of flood map zones where neighboring property owners often have vastly different flood insurance costs for the relatively same level of risk.”

Impact on Homeowners and NFIP

Insurance is one of the best ways to protect a home against unexpected financial losses due to flooding. However, NFIP is facing a long-overdue reckoning that could make flood insurance premiums more equitable for homeowners across the board, according to Carolyn Kousky, executive director of the University of Pennsylvania’s Wharton Risk Center and a First Street advisory board member.

Not all homeowners, though, are likely to experience a massive spike. According to First Street Foundation data, most homeowners won’t see rate changes, and others could actually experience a decline in their premiums. Homeowners who would experience the highest spikes are those who have been grossly underpaying for their premiums over the years. This includes luxury properties located in high flood-risk areas. 

However, the increase in premiums could protect NFIP from future financial loss and preclude federal bailouts such as those that have historically occurred after major hurricanes. For example, in 2017, the U.S. Congress had to bail out the program with a $16 billion debt relief package following Hurricanes Sandy, Harvey, and Irma. These bailouts could be avoided with accurate premiums – premiums based on the specific features of an individual property, like structural vulnerability to floods – paid by homeowners across the United States.

California Homeowners: What can they expect?

With 655 miles of coastline dotted with ocean-view properties, California can expect some of the highest increases in homeowner’s insurance. As flood risk increases due to global warming, so does the potential financial damage to prime real estate along the coast.

It is reported that nearly a quarter of a million Californians live in a region that is below sea level, placing them at high risk of flooding. According to FEMA, California experienced more than 150 flood events in 2018 and more than 200 in 2019. However, most standard insurance policies do not cover recent floods, and their premiums have not been adjusted to accommodate the rising trend of impactful flooding events in the state. On average, homeowners paid only $700 annually for flood insurance – far below the amount required to keep up with the destructive impact of flooding caused by global warming.

First Street Foundation reports that “if insurance prices in California were increased to reflect the economic risk these homes carry in 2021 and into the future, that added cost of ownership would have a significant negative impact to the homes’ value.”

When will changes occur?

So, when does the day of reckoning come for policy owners in California and beyond? FEMA is expected to announce its new premiums on April 1, 2021, with policies taking effect on October 1. Although most changes will occur between April and October, homeowners across the country should start preparing now for the financial impact of increased policy rates, and those living in high-risk areas, like the California coast, should be ready to cover massive hikes. FEMA has stated, however, that the increases will be phased in – an existing policyholder can expect a maximum increase of 18% per year. New policyholders will be expected to pay the full amount.

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