What's at Stake? Understanding the Role of Home Equity in Flood Insurance Demand
50 Pages Posted: 5 Feb 2021
Date Written: January 13, 2021
Millions of properties in the U.S. are exposed to increasing threats from natural disasters. Yet, a large majority of at-risk homes are uninsured against the costliest disaster: flooding. Floods cause elevated rates of mortgage delinquency and default that can impact the broader housing finance system. In this paper, we explore the connection between homeowners' stake in their homes and their demand for flood insurance. To isolate the causal effect of home equity on food insurance demand, we study the response of flood insurance take-up to sudden house price changes over the housing boom and bust in the 2000s. We find that flood insurance take-up follows the dynamics of house prices in each market over the boom-bust cycle, with a home price elasticity around 0.33. A series of heterogeneity and robustness checks suggest that the role of mortgage default as implicit insurance is the most plausible mechanism for the positive relationship. We conclude by discussing the implications of our results for the effects of climate change on real estate and financial markets as well as for optimal disaster insurance policy.
Keywords: disaster insurance, home equity, housing booms and busts, mortgage default
JEL Classification: G21, G52, Q54
Suggested Citation: Suggested Citation