should the flood insurance program continue?

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NFIP Issues: Individual Decisions and Flood/Disaster Risks

Economic viewpoint: individuals should base decisions on prices that

accurately reflect the costs of their activities (private and social).

Chivers and Flores (2001)

o prices are not performing this function in the NFIP

o authors don’t focus on prices distorted by subsidies

o broader problem: when is the information about flood risk

known?

Background

An argument in favor of the NFIP was that premiums would be a useful

price signal.

“Premiums proportional to risk and equal to both the private and

social cost of flood plain occupance will serve as a rationing

device, eliminating economically unwarranted uses of flood plain

lands on one hand, while not prohibiting uses for which a flood

plain location has merit on the other hand.”

(Krutilla, 1966 quoted in Chivers & Flores, p. 515)

Therefore

• mandatory flood insurance should make people face full social

cost of locating in a flood plain

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• property in flood risk area should ‘sell at a discount’

Literature review

• Results from property value studies mixed

• Property values of flooded properties fall immediately after event

• Properties that have not flooded see no ‘flood risk discount’ even

when the risk exists (in SFHA and require flood insurance)

Suggests that compulsory insurance is not leading to correct prices to efficiently “ration flood plain occupancy or ...incorporate the social cost...into the decision calculus of home buyers” (Chivers & Flores, p. 516)

Argue that for economically efficient decisions to be made

“potential purchasers of properties subject to flood risk must have information on the cost of compulsory flood insurance, otherwise we have one of the classic forms of market failure, imperfect information for buyers relative to sellers” (Chivers & Flores, p. 518)

Look at how the real estate market actually worked in Boulder, CO

Discussion with banker:

“in his experience, buyers usually did not learn of the actual NFIP premium until closing. At this point, it is difficult to back out of the purchase on account of an unexpectedly high NFIP premium...everyone at the closing is making money with the exception of the buyer. The pressure to close the deal is intense…he observed only two buyers [in

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30 years] who backed out of a sale on account of an unexpectedly high NFIP premium” (Chivers & Flores, pp. 518-19)

Discussion with realtor:

“flood risk is disclosed on the MLS listing, though sometimes incorrectly…for properties requiring flood insurance under NFIP, potential buyers are supposed to be notified prior to closing that they must purchase flood insurance… real estate agents do not have the precise premium information either and so they are not in a position to provide NFIP premium information to their clients” (Chivers & Flores, p. 519)

Hypothesis

flood discounts are not found in property value studies because buyers

do not have sufficiently complete information when negotiating a

purchase

Data

• Random sample of owners of property in the floodplain

• Recently applied for flood rating certificate (necessary for

transaction)

• Survey (general flood risk in Boulder; flood risk for own property;

demographics)

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Results (Chivers & Flores, pp. 519-20)

“How did you learn your home was located in a special flood hazard

area?

• Flood certification: 58%

• MLS information: 30%

• FIRM: 2%

• Lender 7%

“When did you first learn of the potential flood risk associated with

your home?”

• Prior to the offer: 8%

• Prior to the closing: 6%

• During closing: 60%

• After moving: 4%

• After being flooded: 6%

• Other: 16%

“When did you first learn of the cost of flood insurance associated with

this house?”

• Prior to the offer: 0%

• Prior to the closing: 2%

• During closing: 70%

• After moving: 16%

• After being flooded: 5%

• Other: 7%

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“At the time of the purchase of your home did you find that the cost of

insurance was

• higher than expected: 84%

• lower than expected: 2%

• as expected: 14%

“Do you think your decision to purchase or the amount offered would

have been different if you had known the exact cost of flood insurance

at the time of making an offer?”

• yes: 69%

• no: 31%

Conclusion

Information is acquired late in the purchase process. For the social cost

of floodplain activity to affect behavior, potential buyers need to

understand the nature of flood risk and the cost of insuring against it

before making an offer.

How do consumers get the information they need?

FEMA gives advice to real estate agents (FEMA)

Why should I talk to my clients about flood insurance?

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How much will flood insurance cost?

In order to obtain a flood insurance quote, your client may need to obtain an

Elevation Certificate (EC). Do you know where an existing EC may be found? Try

the local building permit or planning and zoning office, the current owner, or

flood insurance agent. If all else fails, the buyer may need to purchase a new EC

from a licensed land surveyor, engineer, or architect.

How will I know if a building is in an SFHA?

Your clients can check with their local community or visit www.floodsmart.gov to

learn more about their flood risk… Lenders will notify borrowers if flood insurance

is required as a condition of their mortgage loan.

Am I legally liable if I do not disclose the fact that a structure is in a

high-risk flood area?

Many states have disclosure laws for real estate professionals that address all

natural hazards, including flood. Check with your local Board of Realtors for

disclosure laws.

You can better help your client understand flood risk by learning more

about it yourself. Go the extra mile.

Property values may not reflect flood risks because individuals lack

information when making offers. Information can be difficult to obtain;

requires initiative by realtor or buyer.

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Property values may not reflect flood risks accurately because people’s

perceptions of flood risk can change.

Bin and Landry (2013)

Sales prices can capitalize risk factors. All things being equal, properties

facing a lower risk of flooding should sell at a premium. Buyers should

be prepared to pay more to be out of a flood zone.

Looking at residential housing sales data in North Carolina before and

after two significant hurricanes

• Hurricane Fran (1996)

• Hurricane Floyd (1999)

Want to measure the effects of the storm events on property values in

the flood zones.

Argument:

• FEMA maps indicate the probability of a flood.

• Intuitively, expect the ‘flood premium’ (higher price if lower risk)

to be consistent.

• It isn’t. It increases after a flooding event and changes over time.

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Hurricane Floyd (1999)

• Affected 2 million people

• Damaged or destroyed 60,000 homes

• $6 billion in damage

How did people react?

Purchase of flood insurance

Prior to the floods, most people did not know they were in a flood

zone; many had no flood insurance.

After Floyd, sales of flood insurance policies in North Carolina increased

24%.

Housing prices

Prior to these two events

• 40 years of relative calm

• No significant difference in property values across flood zones

After major flooding events

• differences in prices depending on risk

o lower risk has higher price

• risk premiums increase with repeated occurrence and damage

levels of storms

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As calm returns

• premium diminishes

• disappears 5-6 years after Floyd

Conclusion:

When storm impacts are easily remembered and visualized,

subjective risk probabilities are relatively high and influence

housing market transactions, but as flooding impacts become

more difficult to retrieve and more distant in memory, subjective

risk probabilities wane and potentially disappear, no longer

affecting housing market transactions.

Note: authors point out other factors could affect housing market

• Increased population growth (migrants w/limited storm

experience)

• Flood mitigation efforts

• Coastal flood zones may have location premiums

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Sources

Bin, O. and Landry, C. (2013). Changes in Implicit Flood Risk Premiums: Empirical

Evidence from the Housing Market. Retrieved from

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1850671

Chivers, J. and Flores, N. (2002, November). “Market Failure in Information: The

National Flood Insurance Program.” Land Economics, 78 (4), 515-521.

FEMA (2015). National Flood Insurance Program. Questions and Answers for Real

Estate Professionals. Retrieved from https://www.fema.gov/media-library-

data/1421170404334.../F-435_508_9Jan15.pdf

Krutilla, J. V. (1966). “An Economic Approach to Coping with Flood Damage.” Water Resources Research 2(2): 183-190.