Put Banks' Skin In Flood Program Game, Study Suggests

WASHINGTON--One way to reduce the government subsidy for flood insurance would be to pass legislation requiring that bank mortgages on homes hit by a deluge be considered paid in full, according to proposals by two academics.

Another proposal made by Mark J. Browne, an actuarial science professor at University of Wisconsin School of Business, and Martin Halek, assistant professor at the University of Georgia Terry College of Business risk management and insurance department, would be to require all homeowners purchase flood insurance.

By putting the banks at risk, they suggested, lenders faced with the risk would price it into the interest rate charged for a mortgage.

Regarding the second proposal mandating flood coverage, if it was implemented, enough capital would enter the insurance industry to meet the demand without the need for public subsidy, they argued.

The advantage of putting the flood risk on mortgage bankers, Mr. Browne and Mr. Halek said, is that the financial markets have significantly greater capacity to assume losses than the property-casualty insurance industry.

"Both proposals would result in those deriving the benefits of homeownership in areas exposed to the flood peril bearing the cost of the risk," they wrote in their analysis.

The paper was presented at a recent symposium on "Private Markets and Public Insurance Programs" held by the American Enterprise Institute.

The issue is important because the authorization for the National Flood Insurance Program runs out March 6, and no talks have as yet been held by Congress to discuss an extension.

The House and Senate both passed different bills reauthorizing and reforming the NFIP last year, but could not resolve the considerable differences between the two bills, leading to a decision in October to extend the program until early March.

Another extension of the current program, which is running a $17 billion deficit, mainly tied to losses suffered during Hurricane Katrina in 2005, is seen as likely.

Under the Brown/Halek proposal to have the banks shoulder the risk, a Congress unwilling to subsidize the program any longer could pass legislation saying that following a flood of a particular size in a specified area, the outstanding balance on all mortgages in the affected area would be considered paid in full.

According to this scenario, the loss arising from the unpaid value of the mortgages would revert to the credit markets--the banks that underwrote the loans or those that bought the loans from the banks in the secondary market.