An Affordability Framework for the National Flood Insurance Program April 17, 2018 An Affordability Framework for the National Flood Insurance Program April 17, 2018 Message from the Administrator I am pleased to submit this Affordability Framework for the National Flood Insurance Program (NFIP). The Federal Emergency Management Agency (FEMA) developed options for an affordability framework for the NFIP pursuant to section 9 of the Homeowner Flood Insurance Affordability Act (HFIAA) of 2014, Pub. L. No. 113-89, 128 Stat. 1024. The Administration has submitted an affordability proposal that considers the findings and analysis in this Affordability Framework. FEMA is sending this framework to the following Members of Congress: The Honorable Mike Crapo Chairman, Senate Committee on Banking, Housing, and Urban Affairs The Honorable Sherrod Brown Ranking Member, Senate Committee on Banking, Housing, and Urban Affairs The Honorable Thad Cochran Chairman, Senate Committee on Appropriations The Honorable Patrick Leahy Ranking Member, Senate Committee on Appropriations The Honorable Jeb Hensarling Chairman, House Committee on Financial Services The Honorable Maxine Waters Ranking Member, House Committee on Financial Services The Honorable Rodney P. Frelinghuysen Chairman, House Committee on Appropriations The Honorable Nita M. Lowey Ranking Member, House Committee on Appropriations Please direct inquiries related to this framework to FEMA Congressional Affairs Division at (202) 646-4500. Sincerely, Brock Long Administrator i An Affordability Framework for the National Flood Insurance Program April 17, 2018 Preface Under the Biggert-Waters Flood Insurance Reform Act of 2012 (BW-12) Congress sought to build a more sound financial framework for the National Flood Insurance Program (NFIP) by directing the Federal Emergency Management Agency (FEMA), through the NFIP Administrator, to remove the discounts for some policyholders with homes insured by the NFIP, so that policyholders would realize flood insurance rates that more accurately reflected their expected flood losses. At that time, Congress recognized that removing discounts might cause flood insurance to become unaffordable for some households and mandated in BW-12 that FEMA study flood insurance affordability. Because of concerns about rising premiums from constituents in multiple communities, Congress later passed the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA), which rolled back some of the changes implemented under BW-12 and recognized additional affordability challenges associated with increased premiums required by the BW-12 implementation. HFIAA mandated that FEMA develop an affordability framework aimed at providing targeted assistance for policyholders in addition to dealing with BW-12 affordability requirements rather than the current approach that primarily provides discounted rates to properties based on their date of construction. To respond to the congressional mandate, FEMA engaged the broader policy community, including academia, and other government agencies to develop an affordability framework. The framework presented in this document is the result of FEMA efforts in this area. ii An Affordability Framework for the National Flood Insurance Program April 17, 2018 An Affordability Framework for the National Flood Insurance Program Table of Contents Message from the Administrator ..................................................................................................... i Preface............................................................................................................................................. ii Table of Contents ........................................................................................................................... iii List of Tables and Figures............................................................................................................... v I. Introduction ............................................................................................................................... 1 Background .................................................................................................................................... 1 Objective ........................................................................................................................................ 2 Approach to Developing the Affordability Framework ................................................................. 4 Framework Organization................................................................................................................ 5 II. Background on the Cost and Affordability of Flood Insurance Policies .................................. 6 Location of Policies ........................................................................................................................ 6 Policyholder Costs ......................................................................................................................... 9 Income of Policyholders and Non-policyholders ......................................................................... 10 Methods ........................................................................................................................................... 10 Household Income Inside and Outside High-Risk Areas ................................................................ 11 Percentage of Households That Are Low Income ........................................................................... 12 Household Income by Mortgage Status and Source of Flood Risk ................................................. 13 Flood Insurance Affordability ...................................................................................................... 15 III. Affordability Framework: Developing a Feasible Set of Flood Insurance Affordability Program Design Options ......................................................................................................... 20 What We Did ................................................................................................................................ 21 Background Research on Developing Flood Insurance Affordability Design Options................... 21 First Workshop ................................................................................................................................ 21 Second Workshop ............................................................................................................................ 23 Design Options for a Flood Insurance Affordability Program............................................................ 23 Program Design 1: Income-Based Premium Sharing ..................................................................... 23 Design Characteristics .................................................................................................................. 24 Advantages and Disadvantages .................................................................................................... 26 Program Design 2: Premium Burden-Based Benefit ...................................................................... 26 Design Characteristics .................................................................................................................. 27 Advantages and Disadvantages .................................................................................................... 27 iii An Affordability Framework for the National Flood Insurance Program April 17, 2018 Risk Communication .................................................................................................................... 28 Designs 1 and 2 with Income Bins Rather Than Continuous Subsidy ............................................ 28 Program Design 3: Housing Burden-Based Benefit ....................................................................... 29 Design Characteristics .................................................................................................................. 29 Advantages and Disadvantages .................................................................................................... 30 Risk Communication .................................................................................................................... 31 Program Design 4: Mitigation Grants and Loans ............................................................................ 32 Design Characteristics .................................................................................................................. 32 Advantages and Disadvantages .................................................................................................... 33 Risk Communication .................................................................................................................... 33 Comparison of Program Design Options ..................................................................................... 33 IV. How Policymakers Can Assess the Design Options ............................................................... 36 Underlying Assumptions for Interpreting Example Findings ...................................................... 36 Design 1: Income-Based Premium Sharing ................................................................................. 37 Design 2: Premium Burden-Based Benefit .................................................................................. 39 Design 3: Housing Burden-Based Benefit ................................................................................... 41 V. Administrative and Funding Options ...................................................................................... 44 Administration Options ................................................................................................................ 44 Option 1: IRS Tax Credit ............................................................................................................. 45 Advantages and Disadvantages ....................................................................................................... 45 Option 2: FEMA through NFIP Direct ........................................................................................ 45 Advantages and Disadvantages ....................................................................................................... 46 Option 3: FEMA with Assistance from States and Small Business Administration .................... 46 Advantages and Disadvantages ....................................................................................................... 47 Comparison of Administration Options ....................................................................................... 47 Funding Options ........................................................................................................................... 48 Option 1: NFIP Funded Affordability Program .............................................................................. 49 Option 2: Congressionally Appropriated Affordability Program .................................................... 49 Option 3. Hybrid Funded Affordability Program ............................................................................ 50 VI. Conclusions ............................................................................................................................. 51 Appendix A. Data and Statistical Methods ................................................................................... 53 Limitations of ACS Data .............................................................................................................. 53 Matching NFIP and ACS Data ..................................................................................................... 55 Representativeness of Matched Sample ....................................................................................... 55 Income Differences between Different Groups ........................................................................... 57 Appendix B: Additional Information on Flood Insurance Cost and Household Income ............. 72 Number of NFIP Policyholders and Cost of NFIP Policies ......................................................... 72 Policyholder and Non-policyholder Income ................................................................................ 73 Appendix C: Methods Used to Estimate Program Costs .............................................................. 78 Cost of Income-Based Premium Sharing ..................................................................................... 78 Cost When Benefits Vary Continuously with Household Income .................................................. 78 Cost When Benefits Based on Income Bins .................................................................................... 78 Cost of Design 2: Premium Burden-Based Benefit ..................................................................... 79 Cost When Benefits Vary Continuously with Household Income .................................................. 79 Cost When Benefits Based on Income Bins .................................................................................... 79 Cost of Design 3: Housing Burden-Based Benefit ....................................................................... 79 Cost Design 4: Mitigation Grants and Loans Add-On ................................................................. 80 Appendix D: The Person Identification Validation System (PVS): Applying the Center for Administrative Records Research and Applications’ (CARRA) Record Linkage Software .. 81 iv An Affordability Framework for the National Flood Insurance Program April 17, 2018 List of Tables and Figures Table 2.1. Flood Insurance Policies by Extent and Source of Flood Risk...................................... 8 Table 2.2. Policyholder Costs for Single-Family Homes (for policies in effect in 2015) .......... 10 Table 2.3. Median Household Income of Policyholders and Non-policyholders (number of households in parentheses) ................................................................................................... 11 Table 2.4. Income Categories ....................................................................................................... 12 Table 2.5. Distribution of Income for Policyholders and Non-policyholders ............................. 13 Table 2.6. Income by Housing Tenure and Mortgage Status (number of households in parentheses)........................................................................................................................... 14 Table 2.7. Weighted Median Income by Source of Flood Risk in the SFHA ............................. 15 Table 2.8. Flood Insurance Costs as Percentage of Weighted Household Income for Residential Policyholders......................................................................................................................... 16 Table 2.9. Ratio of PITI to Household Income for Residential Policyholders ............................ 18 Table 2.10. Ratio of PITI to Household Income for Residential Non-policyholders .................. 19 Figure 3.1. Illustrative Example of Income-Based Premium Sharing .......................................... 25 Figure 3.2. Illustrative Example of Premium Burden-Based Benefit ........................................... 27 Figure 3.3. Illustrative Example of Housing Burden-Based Premium Benefit ............................ 30 Table 3.1. Comparison of Flood Insurance Affordability Program Design Options .................... 34 Table 4.1. Illustrative Scenarios for an Income-Based Premium Sharing Program .................... 38 Table 4.2. Illustrative Scenarios for Program Available Both Inside and Outside SFHA (for program beneficiaries only) .................................................................................................. 39 Table 4.3. Illustrative Scenarios for a Premium Burden-Based Benefit Program ....................... 40 Table 4.4. Illustrative Scenarios for Burden-Based Benefit Program When Program Available Both Inside and Outside SFHA (for program beneficiaries only) ........................................ 41 Table 4.5. Illustrative Scenarios for a Housing Burden-Based Benefit Program ........................ 42 Table 4.6. Illustrative Scenarios for Impact of Housing Burden-Based Benefit When Program Is Available to All Policyholders (for program beneficiaries only) ......................................... 43 Table 5.1. Summary of Advantages and Disadvantages of Administration Options ................... 48 Table A.1. Comparison of NFIP Portfolio of Residential Policies with Weighted Sample of Policyholders......................................................................................................................... 57 Table A.2. ACS Household Groups .............................................................................................. 58 Table A.3. Wilcoxon Rank Sum Tests Results, Difference in Income for Households Residing Inside versus Outside an SFHA (2015), using 95% Confidence Level ................................ 58 Table A.4. Wilcoxon Rank Sum Tests Results, Difference in Income between Policyholders and Non-policyholders within an SFHA (2015), using 95% Confidence Level ......................... 62 Table A.5. Wilcoxon Rank Sum Tests Results, Difference in Income between Policyholders and Non-policyholders Outside an SFHA (2015), using 95% Confidence Level ....................... 65 Table A.6. Wilcoxon Rank Sum Tests Results, Difference in Income between Policyholders and Non-policyholders (2015), using 95% Confidence Level .................................................... 68 Table B.1. Number of NFIP Policyholders by State, including residential, non-residential business, and other non-residential (2015) ........................................................................... 72 Table B.2. Average Premiums and Fees for Single Family Homes (for policies in effect in 2015) ..................................................................................................................................... 73 Figure B.1. Difference in Median Incomes of ACS Respondents Living In and Out of the SFHA (2014) .................................................................................................................................... 74 v An Affordability Framework for the National Flood Insurance Program April 17, 2018 Figure B.2. Map of Difference in Median Incomes of ACS Respondents Living In or Out of the SFHA (2015) ......................................................................................................................... 75 Figure B.3. Household Incomes for ACS Respondents Living inside the SFHA (2015, includes both policyholders and non-policyholders) .......................................................................... 76 Figure B.4. Household Income for ACS Respondents Living outside the SFHA (2015, includes both policyholders and non-policyholders) .......................................................................... 77 vi An Affordability Framework for the National Flood Insurance Program April 17, 2018 I. Introduction Background The Federal Emergency Management Agency (FEMA) administers the National Flood Insurance Program (NFIP), a federally operated insurance program created by the National Flood Insurance Act of 1968. The NFIP is a voluntary program that enables property owners in participating communities to purchase insurance protection against losses from flooding. The NFIP collects premiums and fees from its policyholders and pays claims to those policyholders for costs associated with covered flood damages.1 The NFIP provides discounts for some insured homes and the discounts are aimed at making flood insurance more affordable, but those discounts are not delivered based on need or ability to pay. These discounts, combined with several large loss years, contributed to revenue shortfalls and resulted in NFIP borrowing to pay claims in several instances. These factors caused the NFIP to be $20.525 billion in debt to the U.S. Treasury as of April, 2018. In response to the debt accumulated largely from Hurricanes Rita, Wilma and Katrina in 2005, Congress passed the Biggert-Waters Flood Insurance Reform Act of 2012, (BW-12).2 BW-12 focused on strengthening the NFIP’s fiscal soundness and required FEMA to eliminate subsidies for some types of policyholders and to move further toward risk-based pricing of policies.3 Through risk-based pricing, FEMA can communicate the risk of flooding by charging higher premiums in areas where the risk of flooding is greater. BW-12 also required FEMA to charge additional fees to policyholders to cover other program costs. As a result of this transition to higher rates and increased fees, premiums rose, and resulted in public concern that the prices stemming from BW-12 were unaffordable.4 Congress reevaluated the rate increases as a result of the public concern and subsequently passed the Homeowner Flood Insurance Affordability Act of 2014, (HFIAA).5 HFIAA rolled back some of the changes resulting from BW-12 and focused greater attention on the issue of flood insurance affordability. Congress was concerned that as NFIP rate discounts phased out, flood insurance premiums would become increasingly unaffordable and higher premiums would create financial hardship for some households, discouraging participation in the program. FEMA notes that despite higher fees, flood insurance claim payments may not cover the full replacement cost of housing damaged by flood disasters and those policyholders may have to rely on individual assistance and loans after a disaster. BW-12 directed FEMA to examine options to aid individuals so they could afford risk-based premiums under the NFIP utilizing targeted assistance for policyholders rather than generally 1As of May 31, 2017, there were approximately five million policies insuring approximately $1.2 trillion in assets. 2 Public Law 112-141, Div. F, Title II, Subtitle A. 3Prior to BW-12, approximately 80 percent of policies were risk-based. 4The HFIAA surcharge is $25 for primary residences and $250 for second homes. Under HFIAA, annual premium increases are capped at 18 percent for primary residences and 25 percent for secondary homes. On average, the increase was around 9 percent (Aon National Flood Service, 2016). 5 Public Law 114-89. 1 An Affordability Framework for the National Flood Insurance Program April 17, 2018 subsidized rates, including means-tested vouchers.6 In addition, HFIAA required FEMA to develop an affordability framework to help policymakers consider the impact of implementing risk-based premiums and determine how to provide targeted policyholder assistance rather than discounted rates across the entire NFIP portfolio. Section 9 of HFIAA required FEMA to examine options and consider the following criteria: 1. Accurate communication to consumers of the flood risk associated with their properties; 2. Targeted assistance to flood insurance policyholders based on their financial ability to continue their participation in the NFIP; 3. Individual or community actions that mitigate or lower the cost of flood insurance; 4. The impact of increases in risk premium rates upon participation in the NFIP; 5. The impact flood insurance rate map updates will have on the affordability of flood insurance.7 Objective This study’s objective is to respond to HFIAA’s direction for FEMA to develop an affordability framework proposing programmatic and regulatory changes that address affordability of flood insurance. As such, FEMA primarily focused on parts (1), (2), and (3) of the HFIAA statutory considerations cited above. FEMA retains a significant body of work focusing on considerations (4) and (5) cited above, and we incorporated knowledge gained from this work throughout the framework.8 In addition, for the purposes of this framework, FEMA did not consider the effect of future rate changes on affordability, as FEMA is generally reconsidering the rating structure of the NFIP under its Risk Rating Redesign effort. After implementing Risk Rating Redesign, the 6Section 100236 of Biggert-Waters Flood Insurance Reform Act of 2012, Pub. L. 112-141 (July 6, 2012) directed the Administrator to conduct a study of “(1) methods to encourage and maintain participation in the National Flood Insurance Program; (2) methods to educate consumers about the National Flood Insurance Program and the flood risk associated with their property; (3) methods for establishing an affordability framework for the [NFIP], including methods for individuals to afford risk-based premiums under the [NFIP] through targeted assistance rather than generally subsidized rates, including means-tested vouchers; and (4) the implications for the [NFIP] and the Federal budget of using each such method”. See Id. at (a)(3)-(4). Under subsection (b), to inform the Administrator in the conduct of the study under subsection (a)’s study, Congress directed the Administrator “to enter into a contract under which the National Academy of Sciences, in consultation with the Comptroller of the United States, shall conduct and submit to the Administrator an economic analysis of the costs and benefits to the Federal Government of a flood insurance program with full risk-based premiums, combined with means-tested Federal assistance to aid individuals who cannot afford coverage, through an insurance voucher program. The analysis shall compare the costs of a program of risk-based rates and means-tested assistance to the current system of subsidized flood insurance rates and federally funded disaster relief for people without coverage.” The Administrator was directed to report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives. 7 Section 9 of the Homeowner Flood Insurance Affordability Act of 2014, Pub. L. 113-89 (Mar. 21, 2014) directed the Administrator to prepare a draft affordability framework and to submit the draft affordability framework to the full Committee on Banking, Housing, and Urban Affairs and the Committee on Appropriations of the Senate and the full Committee on Financial Services and the full Committee on Appropriations of the House of Representatives. 8 Our data indicates that when prices of insurance increase, participation in the NFIP will decline, regardless of whether this price change is because of map updates or premium and fee increases. 2 An Affordability Framework for the National Flood Insurance Program April 17, 2018 NFIP will be able to determine risk-based premiums more accurately; some rates will increase while others may decrease. Rate increases could cause additional affordability challenges for policyholders who are already burdened by the cost of their flood insurance, as well as for potential policyholders. These challenges will be particularly salient for policyholders who currently receive discounts and subsidies. Considerations in Developing the Affordability Framework Affordability is a general concept used to address the concern that policyholders may not be able to afford their flood insurance premiums from rate increases—neither BW-12 nor HFIAA provided a definition of flood insurance affordability.9 Thus, in the process of developing the affordability framework, FEMA solicited guidance from other federal agencies in late 2016 on how to define affordability in the flood insurance context. Based upon their feedback and our insights, we defined the concept of affordability from a cost burden or “ability to pay” perspective. Therefore, households applying for assistance face a means test to determine whether they qualify for benefits. We included several other key considerations as we developed the framework:  Flood insurance is the best way for a household to recover from a flood. Insured survivors recover more quickly and more fully than uninsured survivors, who often rely on federal disaster assistance and charity in order to recover;  Targeting potential policyholders in addition to current policyholders for assistance could increase the number of property owners who want to purchase Federal flood insurance;  Price is one of the best signals of risk that a consumer receives; any affordability assistance should be delivered with communication of the policyholder’s full-risk, non- discounted rate;  Any affordability program developed based on the framework that is funded by NFIP’s current premiums and fees reduce the NFIP’s ability to cover the cost of certain flood events, while creating additional affordability challenges, and work counter to our goal of creating a sound financial framework; and  We discuss the definitions of affordability emerging from our work at the end of Chapter 2, and apply those definitions in developing the options in Chapter 3, and quantitatively illustrate the impacts of those options on affordability in Chapter 4. 9HFIAA suggests that premiums are unaffordable if the premium exceeds 1 percent of the policy coverage limit. However, the premium-to-coverage ratio has no means test associated with it. For example, a $100,000 property with $100,000 of coverage paying $1,000 for insurance would appear to be equally burdened as a $1,000,000 property with $250,000 of coverage paying $2,500 for insurance. The latter property owner may not face a cost burden when deciding whether to purchase $2,500 per year flood insurance policy. 3