WASHINGTON — Legislation that would authorize the use of private flood insurance on Fannie Mae and Freddie Mac mortgages was overwhelmingly approved by the House late last month, but concerns about its potential impact are beginning to crop up.

The Consumer Mortgage Coalition is arguing that the bill has serious flaws by allowing private insurers to undercut pricing on federal flood insurance policies by offering high deductibles and exclusions to homeowners with mortgages guaranteed by the government-sponsored enterprises.

"It displaces the uniform security instrument's flood insurance protections for GSE loans by preventing the GSEs from rejecting private flood insurance policies that do not provide appropriate protection for the collateral backing the loan," Anne Canfield, the group's executive director, said in an interview.

The bill would also override existing mortgage contract requirements that name mortgage servicers as loss payees. It would allow private insurers to pay insurance proceeds directly to the homeowner to repair flood damage instead of the servicer. That gives homeowners the option of pocketing the insurance monies and leaving the GSEs with flood-damaged homes, some said.

"It doesn't make sense that the lender or servicer is not named as an additional loss payee. That's ridiculous," said Laurie Goodman, director of the Housing Policy Center at the Urban Institute.

The bill would encourage borrowers that make a minimum down payment to take out high deductible flood insurance policies. If a flood hits, they would have little to lose. But Fannie or Freddie could be left to cover the losses if the borrower abandons the property.

"Nobody focused on how this can be very detrimental to the GSEs," Goodman said. "There are a lot of ways to bring private capital into the flood insurance market, but this legislation seems to be the worst."

Canfield first raised the issue earlier this month in a paper warning of hidden dangers to the bill.

Under the bill, "if a private insurer were to issue low-cost policies that have unreasonably high deductibles, or that exclude some probable flood risks, the GSEs or servicers would not have the ability to reject the private flood policy," according to a May 2 report. In addition, "the GSEs or GSE servicers could not reject a private policy on which the servicers are not named as additional loss payees."

The bill is supported by the vast majority of the industry and few wanted to comment on the issues raised by Canfield.

But one industry source, who spoke on condition of anonymity, said "the concerns raised by the report are all on target."

These issues will likely to be considered when the Senate Banking Committee holds hearings on the flood bill. Sens. Dean Heller, R-Nev., and Jon Tester, D- Mont., have co-sponsored a similar private flood insurance bill.

Fannie and Freddie declined to comment on the concerns, as did their regulator, the Federal Housing Finance Agency.

But Canfield warns there could be dire consequences if the bill is not changed.

"This legislation is being considered at a time when the GSEs' capital is heading toward zero and experts are projecting that both the frequency and severity of floods is increasing as the nation's weather patterns change," Canfield wrote in a separate May 5 paper.

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