Journal of Financial Planning: January 2025
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Russell L. Brockett, CFA, CFP®, is a vice president at Dimensional Fund Advisors and a Ph.D. student in financial planning at Kansas State University. He has a Master’s of Science in finance and is a CFA charterholder and CFP® practitioner.
Patrick L. Brockett, Ph.D., holds the Gus Wortham Chair in Risk Management and Insurance at the University of Texas. He was editor in chief of the Journal of Risk and Insurance and the North American Actuarial Journal. He served on three National Academy of Sciences research committees related to flood insurance.
About 90 percent of disasters in the United States involve flooding (DHS 2024), making floods the most common and costly type of natural disaster. Flooding affects homeowners, small businesses, non-profits, and tenants, many of whom are unaware of the flood risk they bear and who are unprepared when flooding occurs. Insurance is a common risk management solution for transferring various types of risk externally, however many are unaware that there is an insurance product designed to cover floods, whether they need this insurance, or where to buy it.
Financial planners, whether they sell insurance or not, should be informed about flood risks because of its dramatic potential impact on household net worth and financial resilience. For example, Hurricane Helene hit the southern United States in September 2024. It produced 42 trillion gallons of rainfall and winds of 140 miles per hour. AccuWeather estimates damages and economic losses between $225 billion and $250 billion, including damage to homes, infrastructure, businesses, and lost revenue (Ferrell 2024). In Western North Carolina, which was particularly hard hit by flooding, fewer than 1 percent of households had insurance that covered floods (Yang, Corkery, and Mufson 2024). If one is aware of flood risk and approaches to mitigate it, then one can make an informed decision on how the risk can be managed.
Sadly, awareness itself is often lacking. Many think if they are not in a coastal area or near a river, or not in a designated high-risk area, then they don’t have to be concerned about flood risk. This is not true. Since 1998, across the United States, a full 99 percent of all counties have experienced a flood (FEMA 2023). Additionally, about three-quarters of structures damaged by Hurricane Harvey were outside the significant flood risk area (Hunn 2018). Similarly, 78 percent of properties damaged by 2024 Hurricane Debby were outside the high-risk flood area (First Street 2024).
If a property does experience flood damage, homeowners’ insurance (or business property insurance) will typically not cover losses. Floods generally are excluded in insurance contracts. Insurance is typically defined in insurance as rising water from an external source that impacts at least two acres or at least two adjacent properties (FEMA 2019).
There is also a widespread (generally false) impression that if your property is damaged and property insurance does not cover losses, then the Federal Emergency Management Agency (FEMA) will fund recovery (FEMA 2019). They will generally not. Only when the county you live in obtains a presidential disaster declaration will you receive special federal funding, and even then, aid is usually in the form of a loan, which must be paid back with interest. In fact, many flood events are local or regional and not sufficiently widespread that a state’s governor requests a federal disaster declaration. Even when the governor does request a federal disaster declaration, only 9.1 percent of the requests result in a federal disaster declaration (Gasper 2015). This disastrous combination—not knowing they are at flood risk, being unaware that their insurance will not help with recovery, and falsely expecting federal flood disaster assistance—can have ruinous financial consequences to households and businesses (Sachdeva, Xu, and Ando 2024). Financial planners can add significant value by helping clients overcome flood risk misinformation and information insufficiency.
Flood Risk and Wealth Vulnerability
Whether they are aware of it or not, many financial planner clients have a substantial proportion of wealth in areas vulnerable to flood risk. The median of household wealth from primary residence equity is 68 percent (Ravikumar and Karson 2018). Another 10–15 percent of their wealth is in other real estate. Unincorporated small business ownership contributes another 17–20 percent to wealth (Wolff 2016, Table 3). These wealth components are all potentially vulnerable to costly flood damage. Additionally, as household wealth levels increase, so does the amount of wealth connected to businesses that themselves may have flood vulnerability. Headd (2021), using data from the Federal Reserve Board Survey of Consumer Finances, notes, “in 2019, 45 percent of families in the top 10 percent of net worth had business equity.” This is pertinent in the context of flood risk because according to FEMA, 40 percent of companies do not reopen after a flood disaster, and 90 percent fail within two years (Flood Defenders n.d.). Floods can wipe out a lifetime of savings, and financial planners can provide a source of guidance for how to avoid the potential wealth-destroying consequences. This is of growing relevance since flood risks are increasing in both frequency and severity with climate change. At the same time, more people are moving into flood vulnerable areas than are moving out of them (Shao et al. 2017).
Background of Flood Insurance
Catastrophic events do not occur regularly enough for an actuary to estimate frequency and severity using past data. Additionally, for flood insurance, when a river overflows or a hurricane hits, an insurer experiencing flooding in one property would likely experience a multitude of adjacent properties with damage, making losses highly correlated.
Any early attempt at flood insurance by private insurers in the 1920s fell apart due to the destructive 1927 Great Mississippi River Flood (Daniel 1977). Whereas recovery efforts following the flood were primarily performed by private charities, such as the American Red Cross, as time passed, pressure for the government to step in and assist in recovery increased (Moss 1999). It also became increasingly apparent that in the long run, it would be cheaper, and more humanitarian, to proactively address the flood risk costs ex-ante rather than deal with post-loss disaster relief and rebuilding aid. Research has shown that recovery after a disaster is most effective when funds are allocated rapidly (Chakravarty 2014, Regnier 2020), and insurance payments are more rapid and efficient than charities or governmental assistance.
Following Hurricane Betsy, Congress in 1968 passed the National Flood Insurance Act, creating the public National Flood Insurance Program (NFIP). This act also addressed floodplain management issues and made it so businesses and property owners in a community that participated in the NFIP could purchase NFIP insurance and receive federal relief funds. To encourage participation, NFIP even sold insurance at discounted subsidized rates (compared to the actual risk-based actuarially fair rates).
The U.S. Army Corp of Engineers (USACE) wanted to set the standard for property being in a high-risk flood zone if it had an annual probability of flooding of 0.2 percent, or an expected flood return time of 1 / 0.002 = 500 years. On the other hand, the real estate industry wanted a much lower standard, a once in 50 years or 2 percent annual flood probability (Flood Defenders n.d.). A 1973 meeting of the USACE and real estate lobbyists arrived at a compromise: the so-called “100-year flood plain.” A “high-risk” or special flood hazard area (SFHA) that needed additional treatment was defined to be an area having a 1 percent annual chance of flooding or a once in 100 years chance of a flood occurring.
Thus began the National Flood Insurance Program. It was not, however, immediately enthusiastically embraced. To address the low percentage of people buying flood insurance, Congress passed the Flood Disaster Protection Act of 1973 (PL 93-234), which contained a mandatory purchase requirement for property owners in the SFHA who had a mortgage from a lender that received federal support (such as banks, savings and loans, or credit unions with federal deposit guarantee insurance, or Fannie Mae-backed loans). Additionally, households and businesses without an NFIP policy were ineligible to receive federal or federally related financial assistance or disaster assistance for rebuilding. This carrot-and-stick approach to encouraging enrollment did increase participation. Today, there are more than 4.5 million NFIP flood policies.
Return of Private Insurers
NFIP outreach to consumers remained difficult. While property owners were familiar with automobile and homeowners’ insurance, and knew agents and how to get these policies, they were generally unaware of flood insurance. This kept enrollment levels low. To expand exposure and tap into the existing networks of private insurance agents already selling to the same target market, an agreement was reached in 1983 whereby private insurers would sell NFIP policies and service claims but would not bear financial risk, as responsibility for funding losses would remain with the NFIP. This opened the door for the reentry of private insurers into flood insurance as administrative service providers. This program, known as the “write your own” (WYO) approach for selling NFIP policies, created new awareness of flood insurance to customers previously unaware of their need for protection. Customers could also now deal with flood risk through agents and insurance companies they already knew.
Private insurers can now legally write in multiple business lines, allowing them a form of internal diversification. Importantly, technology has significantly improved so satellite imaging, lidar, etc., allow for more precise determination of building elevation, a critical factor for flood losses. Modern private flood insurers use technology to customize policies to client needs while simultaneously being better able to compute risk. Being for-profit entities, private insurers can also choose to cherry pick properties they want to underwrite and charge actuarially based individualized rates to their clients. Using mathematical and technological expertise, they can offer broader coverage, sometimes at lower premiums than the NFIP, and they can diversify or transfer excessive risk externally. Also important to the development of private flood insurance markets was the legislative directive in 2019 that private insurance could be used to satisfy the mandatory flood insurance requirement for lenders to properties in the SFHA.
The private market is now a growing alternative for flood insurance. According to AM Best (2023), the number of private flood insurers more than quadrupled from 47 in 2016 to 198 in 2022 and private direct premiums written by private insurers increased by 24 percent while NFIP direct premiums went down by about 12 percent. These insurance evolutions mean greater choice for consumers and financial professionals in managing flood risks.
Implications for Financial Planners
Understanding disaster risk is difficult for many consumers due to opaque insurance policy exclusions and the confusing disaster insurance landscape (Lim and Fee 2023). Nevertheless, the stakes are high with floods, as just an inch of water can cause $25,000 or more in damages (FEMA 2023). While 88–91 percent of all homeowners carry homeowners’ insurance (Vukelich 2024), only 4 percent of homeowners have flood insurance (Floodsmart 2024). This is a prime opportunity for financial planners to add value to the families they serve by evaluating clients’ flood insurance coverage options regardless of whether clients live inside or outside of a 100-year floodplain. Homeowners insure against house fires in most homeowners’ insurance policies, but they may not know that over a 30-year period, they are five times more likely to experience a flood than a fire (Vukelich 2024) and 27 times more likely to experience a flood event than a fire over 30 years if they reside in the higher risk special flood hazard area (USACE n.d.). Of course, despite these figures, buying flood insurance is ultimately a personal decision based on risk tolerance, price, and accessibility.
Planners should get familiar with federal flood-related resources like SBA loans or FEMA grants, how options will interact with existing insurance coverage, and whether excess flood insurance is needed beyond the NFIP limits. It is also useful to familiarize oneself with state, municipality, and charitable organizations that may provide additional emergency relief funding in the event of a flood. The planner can use the unexpected events recently in the news to remind clients to continually maintain an emergency fund buffer for more of the inevitable costs, like flooding, which can impact job security, health, and housing needs.
Financial planners can help reduce or eliminate certain client expenses after a natural disaster. Creditors frequently make hardship accommodations for individuals impacted by a flood if informed of the incident. Additionally, under the SECURE 2.0 Act of 2022, individuals impacted by federally declared major disasters can take qualified disaster recovery distributions of up to $22,000 from their retirement accounts without the usual 10 percent early withdrawal penalty (TRG Advisors 2024). From a tax perspective, the IRS may extend deadlines for affected taxpayers, and additional deductions are possible for unreimbursed losses.
Lastly, planners should make sure clients are periodically documenting their physical assets and not just their financial assets. Check out FEMA’s FloodSmart.gov for more information on managing flood risks. There is a wealth of information on this website regarding appropriate steps to share with clients before and after a flood.
References
AM Best. 2023. “Best’s Market Segment Report: US Private Flood Market Growing, Especially Commercial Property.” https://news.ambest.com/newscontent.aspx?refnum=252182.
Chakravarty, A. 2014. “Humanitarian Relief Chain: Rapid Response Under Uncertainty.” International Journal of Production Economics 151 (May): 146–157.
Daniel, Pete.1977. Deep’n as It Come: The 1927 Mississippi River Flood. University of Arkansas Press.
DHS (Department of Homeland Security). 2024. “Natural Disasters: Floods.” www.dhs.gov/natural-disasters.
FEMA. 2019. “Fact Sheet: Myths and Facts About Flood Insurance.” www.fema.gov/press-release/20230425/fact-sheet-myths-and-facts-about-flood-insurance.
FEMA. 2023. “FEMA Fact Sheet May 2023: Everyone Needs Flood Insurance.” https://agents.floodsmart.gov/sites/default/files/fema_nfip-everyone-needs-flood-insurance-fact-sheet-05-2023.pdf.
Ferrell, Jesse. 2024, October 1. “Helene is 2nd-deadliest U.S. Hurricane in 50 years, Could Cost $250 Billion.” AccuWeather. www.accuweather.com/en/hurricane/helene-is-2nd-deadliest-u-s-hurricane-in-50-years-could-cost-250-billion/1698452.
First Street. 2024. “Review of Hurricane Debby: First Street Recreation Finds Majority of Damaged Homes Outside of FEMA Flood Zones.” First Street. https://firststreet.org/research-library/first-street-recreation-of-hurricane-debby-finds-majority-of-damaged-homes-outside-of-fema-flood-zones.
Flood Defenders. n.d. “America’s Most Frequent and Expensive Disaster.” FloodDefenders.org. https://www.flooddefenders.org/problem.
Gasper, John T. 2015.”The Politics of Denying Aid: An Analysis of Disaster Declaration Turndowns.” Journal of Public Management & Social Policy 22 (2). https://digitalscholarship.tsu.edu/cgi/viewcontent.cgi?article=1027&context=jpmsp.
Headd, Brian. 2021. “The Importance of Business Ownership to Wealth.” U.S. Small Business Administration. https://advocacy.sba.gov/wp-content/uploads/2021/08/Small-Business-Facts-Business-Owner-Wealth.pdf.
Hunn, David, Matt Dempsey, and Mihir Zaveri. 2018. “In Harvey’s Deluge, Most Damaged Homes Were Outside the Flood Plain, New Data Show.” Houston Chronicle. www.houstonchronicle.com/news/article/In-Harvey-s-deluge-most-damaged-homes-were-12794820.php.
Lim, H. and Fee, B. 2023. “Risk Management and Insurance Planning Against Natural Disasters.” Journal of Financial Planning 36 (8): 64–67.
Moss, David A. 1999. “Courting Disaster? The Transformation of Federal Disaster Policy Since 1803.” In The Financing of Catastrophe Risk, edited by Kenneth Froot. University of Chicago Press. www.nber.org/system/files/chapters/c7954/c7954.pdf.
Yang, John, Andrew Corkery, and Claire Mufson. 2024, October 6. “Helene’s Destruction Puts Spotlight on Costly Gaps in Homeowners Insurance.” PBS. www.pbs.org/newshour/show/helenes-destruction-puts-spotlight-on-costly-gaps-in-homeowners-insurance.
TRG Advisors. 2023. “Withdrawals for Qualified Disaster Distributions.” Rand Group. https://rand.hightoweradvisors.com/blogs/insights/withdrawals-for-qualified-disaster-distributions.
Ravikumar, B., and Evan Karson. 2018. “Who Has Equity in Their Homes? Who Doesn’t?” Federal Reserve Bank of St. Louis. www.stlouisfed.org/on-the-economy/2018/october/who-equity-their-homes-who-doesnt.
Regnier, Eva D. 2020. “What Is Six Hours Worth? The Impact of Lead Time on Tropical-Storm Preparation Decisions.” Decision Analysis 17 (1): 9–23. https://pubsonline.informs.org/doi/pdf/10.1287/deca.2019.0396?casa_token=ggvWFaNH-0AAAAA:pZpPp9C1crWvQoiP2bgdUyk8sPYgBFlKJz0shrls5BVceUtqqY1XZU4XTYQk6qXquS7CcmHVT8m.
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Shao, Wanyun, Siyuan Xian, Ning Lin, Howard Kunreuther, Nida Jackson, and Kirby Goidel. 2017. “Understanding the Effects of Past Flood Events and Perceived and Estimated Flood Risks on Individuals’ Voluntary Flood Insurance Purchase Behavior.” Water Research 108 (January): 391–400.
USACE (U.S. Army Corps of Engineers). n.d. “Understanding Flood Risk.” www.mvr.usace.army.mil/Missions/Flood-Risk-Management/Understanding-Flood-Risk/.
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Wolff, Edward N. 2016. “Household Wealth Trends in the United States, 1962 to 2013: What Happened over the Great Recession?” The Russell Sage Foundation. Journal of the Social Sciences 2 (6): 24–43. https://doi.org/10.7758/RSF.2016.2.6.02.