Background

The National Flood Insurance Act of 1968 created NFIP. According to  FEMA, NFIP was designed to address a number of policy objectives,  including offering affordable insurance premiums to encourage program  participation and community-based floodplain management and reducing  the reliance on federal disaster assistance. The act provided the federal  government with the authority to work with the private insurance industry,  and since its inception NFIP has largely relied on the private insurance  industry to sell and service flood policies.
In 1983, FEMA established the WYO program with the goals of increasing  the NFIP policy base and geographic distribution, improving service to  policyholders, and providing the insurance industry with direct operating  experience with flood insurance. FEMA also sells and services flood  insurance through the DSA, which a contractor operates. Private insurers  become WYO companies by signing a Financial Assistance/Subsidy  Arrangement with FEMA under which the insurers agree to issue flood  policies in their own name, adjust flood claims, and settle and defend all  claims arising from the flood policies. Private insurers must meet  FEMA’s established criteria for becoming a WYO company.  Requirements for a company to participate in the WYO program include,  among others, 5 years of experience in property and casualty insurance  lines, good standing with state insurance departments, and the ability to  meet NFIP reporting requirements to adequately sell and service flood  insurance policies.
Each year, FEMA publishes in the Federal Register the terms for  participation in the WYO program, including amounts WYO companies  will be paid to sell and service flood policies and adjust and pay claims.  The compensation FEMA pays WYO companies is one factor it considers  in setting premium rates for flood policies. This Federal Register notice  also states that WYO companies are to comply with the provisions of  NFIP’s WYO Financial Control Plan Requirements and Procedures  (Financial Control Plan). The Financial Control Plan outlines WYO  companies’ responsibilities for program operations, including  underwriting, claim adjustments, cash management, and financial  reporting, as well as FEMA’s responsibilities for management and  oversight.

		Other Parties Involved in Day-to-Day Processing of Policies and Claims

WYO companies employ, contract, or work with other parties to sell and  issue flood policies and receive, process, and pay claims. Insurance  agents for one or more WYO companies are the main point of contact for  most policyholders seeking to purchase an NFIP policy, find information  on coverage, or file a claim. Based on information the insurance agents  submit, the WYO companies issue policies, collect premiums from  policyholders, deduct an allowance for expenses from the premium, and  remit the balance to the National Flood Insurance Fund—into which  premiums are deposited and from which claims and expenses are paid.  WYO companies typically contract with flood insurance vendors to  conduct some or all of the day-to-day processing and management of  flood insurance policies.
WYO companies work with certified flood adjusters to settle NFIP claims.  When flood losses occur, policyholders report them to their insurance  agent, who notifies the WYO company. To assess damages, the WYO  company assigns a flood adjuster, who may be independent or employed  by an insurance or adjusting company. The adjuster is responsible for  assessing damage; estimating losses; and submitting required reports,  work sheets, and photographs to the WYO company, where the claim is  reviewed and, if approved, processed for payment. FEMA reimburses the  WYO company from the National Flood Insurance Fund for the amount of  the claims and expenses paid. Claim amounts may be adjusted after the  initial settlement is paid if claimants submit documentation that costs were  different than estimated.

		WYO Compensation

Current WYO compensation is structured primarily as allowances to pay  for policy sales and servicing, claims adjusting and processing, and other  services FEMA requires that participating companies provide. This  service-oriented compensation structure, with uniform rates generally  based on insurance industry average expense ratios (proxies) and fee  schedules, allows WYO companies to earn a profit to the degree that  compensation exceeds their actual expenses. Most of FEMA’s payments  to WYO companies under the current compensation structure are not  reimbursements of actual expenses incurred, but allowances on which  the companies can either make a profit or incur a loss. Since the  inception of the WYO program, FEMA has generally used proxies to  determine the rates at which it pays WYO companies, and the payments  FEMA makes are determined by applying these proxy rates to either  premiums written or claim losses (see table 1).
Commission and operating expenses are based on a proxy of a WYO  company’s net written premiums. FEMA established a commission  expense allowance at 15 percent in 1983 after consulting with industry  representatives. This percentage has not changed since and is written  into the Financial Assistance/Subsidy Arrangement. The percentage used  for calculating operating expenses is generally provided annually to WYO  companies as part of the compensation package (see table 1). The  percentage is determined annually based on A.M. Best Company’s  aggregates and average industry operating expenses for five lines of  property insurance—fire, allied lines, farm owners multiple peril,  homeowners multiple peril, and commercial multiple peril.
Further, WYO companies receive payment for three types of claim  adjustment expenses.
Allocated loss adjustment expenses (ALAE). These are claim  expenses to adjust specific claims. FEMA determines payment for  ALAE based on information it periodically collects from independent  adjusting firms on the cost of adjusting losses in other lines of  insurance business, and presents the payment amount to WYO  companies through a fee schedule.
Unallocated loss adjustment expenses (ULAE). These are claim  expenses that are incurred by the WYO company for routine  operations not associated with a specific claim such as salaries,  overhead, and maintenance. FEMA bases payment for ULAE on a  percentage of net written premiums and a percentage of claim losses.  Before May 2008, FEMA calculated the amount for ULAE as 3.3  percent of claim losses but changed its methodology to 1.5 percent of  claim losses plus 1 percent of net written premium, which was further  reduced to 0.9 percent in fiscal year 2013. According to FEMA’s  statements in the Federal Register, the flat rate of 3.3 percent of claim  losses resulted in payments far greater than expenses during  catastrophic loss years and payments below actual expenses during  low-loss years.
Special allocated loss adjustment expenses (SALAE). These are  claim expenses related to litigation, engineering, appraisals, other  experts, and additional claim adjustments. FEMA calculates SALAE  based on actual expenses. In March 2015, FEMA eliminated the  previous $2,500 approval threshold for SALAE expenses for experts  (Type 1) and required WYO companies to submit specific information  to FEMA, including information on the claim, policy limits, and an  explanation and justification for the reimbursement. FEMA staff must  review the information submitted and approve the expenditure before  the WYO is allowed to incur any Type 1 expenses. In July 2016,  FEMA removed the $5,000 threshold for Type 3 expenses (litigation- related) and required WYO companies to seek approval for  reimbursement of such expenses and pre-approval if they wished to  take more than three depositions in a case.
In addition, FEMA pays WYO companies that meet certain policy growth  goals a percentage of net written premiums as a marketing bonus. In  2009, we found that FEMA’s marketing goals were not aligned with  FEMA’s NFIP goals. As a result, FEMA changed the formula for how  WYO companies earn bonuses in the fiscal year 2013 compensation  arrangement. A growth bonus is intended to provide an incentive for WYO  companies to continue to grow the NFIP program by adding new policies.  FEMA officials told us that the agency changed the program’s growth  bonus to better link it to new business—if a WYO company acquires  another company’s business, the number of transferred policies is added  to the company’s beginning number of policies and the total merged  number of policies is used when calculating aggregate growth for the  purposes of the bonus. Therefore, the WYO company is receiving a  growth bonus based only on new business since the number of  transferred policies is added to the existing policies in place before the  percentage of growth is calculated. This allows FEMA to recognize WYO  companies for actual growth and not for transferring policies from one  company to another. With the new formula, WYO companies can receive  a higher percentage of net written premiums as a growth bonus when the  policy growth is tied to three supporting goals for selling policies: (1) in  underserved areas, (2) for residential preferred risk policies, and (3) for  nonresidential policies.

		FEMA Management and Oversight of WYO Companies

Within FEMA, the Federal Insurance and Mitigation Administration (FIMA)  manages NFIP. According to FEMA staff, about 70 staff within FIMA are  dedicated to managing and overseeing the WYO program and claim  processes. Their management responsibilities include establishing and  updating NFIP regulations, analyzing data to actuarially determine flood  insurance rates, and offering workshops and conferences to insurance  agents and adjusters to explain NFIP requirements. In addition, FEMA is  responsible for monitoring and overseeing the performance of the WYO  companies to ensure that NFIP is administered properly.
FEMA has processes for monitoring and providing oversight of NFIP  claims that are outlined in its Financial Control Plan. Under the current  plan, the processes include triennial claims operation reviews, biennial  financial statement audits, and underwriting reviews. The agency also is  responsible for reinspecting claims and monitoring company performance  as needed.
Claims operation reviews. FEMA is to conduct these reviews at  every WYO company on a 3-year rotating basis, according to the  Financial Control Plan. The stated purpose of these reviews is to  evaluate a WYO company’s processes for administering flood claims,  NFIP data reporting, and the accuracy and service the company  provides customers when handling claims. As part of the review  process, FEMA officials are to review the entire claim file including  coverage, policy compliance, and whether coverage limits are within  NFIP statutory allowances. FEMA notes findings as critical and  noncritical errors.
Improper payment reviews. DHS is required to conduct annual  reviews by the Improper Payments Information Act (IPIA), as  amended. Such reviews identify a statistically valid sample of  payments done annually to estimate the percentage of improper  payments.
Reinspection of claims. While the claims operation review is meant  to focus on transactions at WYO companies or groups of WYO  companies selected by FEMA for review, the selection for  reinspection of claims is to be based on specific events or large  losses. Until 2015, all claim files were subject to FEMA’s reinspection  process outlined in the Financial Control Plan, which included routine  reinspections as well as special assist reinspections, which are  inspections of claims requested by Congress, a policyholder, a WYO  company, or the DSA. Starting in 2015, FEMA discontinued routine  reinspections but continued special assist reinspections.
Biennial audits. According to the Financial Control Plan, the biennial  audit is to provide an independent assessment of a WYO company’s  financial controls relating to its participation in NFIP and the integrity  of the financial data it reports to FEMA. The audits provide an opinion  on the fairness of a WYO company’s financial statements, the  adequacy of its internal controls, and the extent of its compliance with  relevant laws and regulations, including reporting any discrepancies  found in the claims process.
Audits for cause. According to WYO Financial Control Plan  Monitoring procedures, FEMA can conduct these audits as a last  resort if other remedies in its oversight of WYO companies have been  exhausted, or at the request of OIG. The monitoring procedures also  state that there have been fewer than five such audits during the  program’s history.

		NAIC and FEMA WYO Company Reporting

Insurance is primarily regulated by the states, unless federal law  specifically relates to the business of insurance (as in the cases of flood  and terrorism insurance). Requirements and processes for regulating  insurance may vary from state to state, but state regulators generally  license insurance companies and agents, review insurance products and  premium rates, and examine insurers’ financial solvency and market  conduct. According to NAIC, state regulators monitor an insurers’  compliance with laws and regulations and a company’s financial condition  through solvency surveillance and examination mechanisms. Insurance  regulators use insurance companies’ financial statements and other  information as part of their continuous financial analysis, which is to be  performed at least quarterly, to identify issues that could affect solvency.
Through NAIC, the regulators also collect financial information from  insurers for ongoing monitoring of financial solvency, including  information on their federal flood line of insurance. NAIC’s statutory  accounting principles prescribe standards for insurer accounting and  reporting of financial information, which are intended to, among other  things, ensure the consistent reporting of financial information. NAIC  also issues instructions for completing annual statements and related  schedules and exhibits, including the Insurance Expense Exhibit, which  provides premium, loss, expense, reserve, and profit data for each line of  property and casualty business, including the federal flood line of  insurance, and is presented both for the direct insurance written by  insurers and net of reinsurance. The exhibit provides a statutory  allocation of income to lines of business and may be used to measure  underlying profitability of insurance operations. Each WYO company  determines its own method for allocating revenues and expenses, which  may vary from company to company. WYO companies have been  reporting this information to NAIC annually since 1997.
FEMA’s National Flood Insurance Program Write-Your-Own Accounting  Procedures Manual prescribes the financial reporting requirements for all  WYO companies. This manual is part of the NFIP WYO Program  Financial Control Plan, which also includes transaction record reporting  and reconciliation procedures. These procedures describe, among other  things, expectations for the timeliness of reporting and elements of the  quality review that FEMA performs on submitted data.

		FEMA Compensation and Oversight of the Direct Program

As previously discussed, FEMA’s DSA serves as the insurer of last resort  when a WYO company is unable or unwilling to write a flood insurance  policy. Through the Direct Program, the DSA services both standard  policies and other types of policies, including repetitive loss and group  flood policies. According to FEMA officials, as of August 2016, the DSA  administers 15 percent of FEMA flood insurance policies.
FEMA pays the DSA contractor for selling and servicing flood insurance  and for adjusting and processing claims after a flood event through a  competitively awarded predominantly fixed-price contract. The contractor  has calculated its cost to sell and service policies as well as adjust claims  following a noncatastrophic event based on its prior experience as a  vendor for WYO companies. Based on this experience, the contractor  charges a flat price per policy type that is not based on the premium  amount. The DSA contractor also has the ability to withdraw funds on  behalf of the agency from the Department of the Treasury to pay for  certain actual costs, such as overhead costs for mailing and printing.
FEMA oversees the DSA contractor and conducts operation reviews on  the DSA’s underwriting and claims operations annually versus triennially  for the WYO companies. According to FEMA officials, DSA financial- related information is subjected to the annual audit of the Department of  Homeland Security’s consolidated financial statements that an  independent certified public accountant performs.

	FEMA Still Relies on Insurance Industry Proxies for Setting Compensation and Has Not Yet Revised Its Practices in Response to the Biggert-Waters Act

FEMA continues to lack the information it needs to determine whether its  compensation payments are appropriate and how much profit is included  in what it pays WYO companies. Efforts by FEMA, NAIC, and WYO  companies have resulted in some improvements to federal flood financial  data reported to NAIC. But we found inconsistencies in how companies  reported federal flood data to NAIC, which limits the usefulness of the  data for setting compensation rates. Our analysis also shows that the  manner in which WYO companies operate has an effect on their  expenses and profits, which FEMA may find relevant when developing a  WYO compensation methodology and rates. However, FEMA has made  limited progress toward revising its WYO compensation methodology as  required by the Biggert-Waters Act.

		Efforts Have Resulted in Some Improvements to Federal Flood Financial Data Critical to Revising Compensation

Efforts by FEMA, NAIC, and WYO companies have resulted in some  improvements to federal flood financial data reported to NAIC that are  critical to a revised compensation methodology. FEMA officials told us  that since our 2009 report they have worked with NAIC and WYO  companies to help ensure that reasonable and accurate operating  expenses for the federal flood insurance line are being reported to NAIC.  In addition, FEMA officials told us that FEMA has analyzed WYO  company financial data since 2009 to monitor improvements in the  companies’ federal flood data, but has found mixed results.
A FEMA official told us that after issuance of our 2009 report, the agency  conducted site visits to four WYO companies to review the actual flood  insurance data the companies submitted to NAIC. The official said that  they found the visits helpful in understanding how the companies were  reporting the financial results of their flood insurance lines. However, this  official explained that it would require too many resources to meet with all  the WYO companies individually and FEMA has not made any further  company-specific inquiries or visits. As a result of these initial efforts,  NAIC amended its guidance in 2011 on the reporting of WYO commission  and fee allowances in response to FEMA’s request. According to FEMA,  this change was intended to address one issue we found during our 2009  engagement–-specifically, that WYO companies were subtracting  (netting) WYO compensation from expenses. Reporting expenses net of  compensation instead of reporting expenses gross for the flood insurance  they wrote resulted in higher calculated profits. We found that 2 of the 10  companies whose data we analyzed for this report changed from net to  gross expense reporting in the first year in which the NAIC guidance was  effective or at some point before 2014, and 7 WYO companies reported  expenses gross, not net, during the 2008–2014 period. Only one  company from those we selected to review continued to report a portion  of its expenses net of compensation in 2014.
In addition, WYO companies have made other improvements to the  federal flood insurance financial data they report to NAIC beyond  reporting expenses. For example, our analysis confirmed that one WYO  company revisited how certain expenses for servicing flood policies were  allocated and reported to NAIC. Two other companies made changes in  how they report losses—one changed its method for estimating losses  reported to NAIC to be consistent with the method it used to report such  losses to FEMA, while another said it changed its policy of reporting  certain loss adjustment expense reimbursements as an offset to incurred  losses reported to NAIC. These reporting changes collectively improved  the quality of the NAIC financial data necessary to ensure comparability  with financial data the WYO companies submit to FEMA, which is  important to determining the amounts to be built into compensation rates  for estimated expenses and profits.
To verify the accuracy of the NAIC data, FEMA officials told us that they  request and analyze the federal flood insurance data that WYOs report to  NAIC around April or May of each year. FEMA officials explained that the  benefit of using NAIC data is that the data are reported on WYO  companies’ annual statements and it is more cost efficient to get all the  data from one source than for FEMA to independently collect and verify  the data from each WYO company. WYO companies’ financial  statements are submitted to both NAIC and state regulators. A FEMA  official told us that its analysis, which it has periodically performed since  2009, has included comparing each WYO company’s premiums and  losses reported to NAIC to the figures the companies report on the  financial statements they submit to FEMA. FEMA has also compared the  aggregate homeowners’ underwriting and loss adjustment expense ratios  of the WYO companies to non-WYO companies. FEMA officials told us  that for the largest 8 to 10 WYO companies, FEMA has also compared  their underwriting and loss adjustment expense ratios (expenses  expressed as a percentage of written premiums) for flood to the same  ratios for their homeowners lines for a 5-year period to determine if a  correlation exists between the companies’ costs of operating these two  lines of business. FEMA has prepared a report showing underwriting  expenses and loss adjustment expenses grouped into various ranges,  such as negative expense ratios, “0-5 percent”, and “5-10 percent” to  assess the trend in WYO company expenses over time.
In September 2016, FEMA officials estimated that WYO companies that  make up about 80 percent of the net written premiums reported had  adequately improved the quality of the underwriting expense data  reported to NAIC. FEMA officials also said that these companies usually  have underwriting expenses between 20 percent and 30 percent of their  net written premium or an average expense ratio of 25 percent. By using  that information as a model and excluding WYO companies with  expenses that fall outside that range, FEMA officials stated that they may  be able to use data from these companies to set future commission and  operating expense allowances for all WYO companies. However, FEMA  officials noted that the loss adjustment expense ratios varied much more  significantly from company to company than did underwriting expense  ratios. They also observed negative loss adjustment expense ratios for  some WYO companies, although they added that such ratios can occur  as a result of changes in loss reserve estimates. FEMA officials also said  that they generally found great inconsistency in how WYOs were  reporting expenses between two categories of loss adjustment expenses,  which affected their ability to assess the reasonableness of the expense  ratios of a single year, but had greater success in doing so when the  ratios were calculated based on total loss adjustment expenses for a 5- year period.
According to an August 2016 WYO Bulletin, beginning with the fiscal year  2017 arrangement year, FEMA intends to require that WYO companies  provide to FEMA copies of all data submissions to NAIC related to their  flood insurance activities and to attest to the accuracy of those  submissions. FEMA stated in the bulletin that this requirement would be  aligned with the arrangement’s specification that, upon request, WYO  companies supply FEMA with a true and correct copy of a WYO  company’s property and casualty annual financial statement filed with  state insurance regulatory agencies and the arrangement’s requirement  that provides access to all records of WYO companies pertinent to the  arrangement. FEMA also stated in the bulletin that this requirement will  support FEMA’s efforts to pay WYO companies based on actual  expenses incurred by companies.

		Inconsistencies in WYO Company Reporting Continue to Limit Its Usefulness in Setting Compensation Rates

			Reporting Inconsistencies

We found that WYO companies were not consistently reporting their  federal flood financial data to NAIC. The inconsistencies we found in the  data WYO companies reported to NAIC resulted in unreported  underwriting and loss adjustment expenses of varying amounts and  significance by 8 of the 10 companies we reviewed. Further, we found  that some WYO companies reported different loss and related reserves to  NAIC and FEMA.
More than half of the companies we reviewed did not report to NAIC all of  their adjuster fees and other expenses incurred on the companies’ flood  losses and provided a variety of explanations for their accounting  practices. Nearly all of the WYO companies we reviewed told us that they  reported adjuster fees as a direct expense of the flood insurance line, but  one WYO company told us that their interpretation of the NAIC rules was  that adjuster fees should be reported as an expense ceded to FEMA and,  thus, not reported as a direct expense to its flood line. Similarly, four  WYO companies told us that they did not record reimbursable legal,  engineering, appraisal, and other adjuster fees as direct expenses of their  flood lines because, among other reasons, some viewed these as  FEMA’s expenses and not the company’s, although this was not the  practice for the remaining companies we reviewed. Still another WYO  company told us that it reports policy or claim-specific expenses to the  flood line, but does not report indirect expenses, such as claim handling  fees paid to their vendor. Collectively, based on our analysis, these  unreported loss adjustment expenses amounted to about $14 million.  Also, some companies did not report certain related operating expenses  for their federal flood line. These expenses included fees paid to flood  vendors, premium taxes, and internal company overhead expenses that  would normally be classified as a type of underwriting expense. However,  due to the WYO companies’ established practices at the time and their  interpretation of NAIC’s rules, these expenses were either not allocated to  the federal flood line or were reported on the books of an affiliated  company. Collectively, based on our analysis, these unreported operating  expenses amounted to approximately $52 million. As discussed below,  these unreported expenses had a significant effect on the combined  profits of these companies.
The inconsistencies we found in how premiums are reported to FEMA  and NAIC had little effect on individual company profit calculations. For  nearly all companies we reviewed, differences in premiums WYO  companies reported to FEMA and NAIC in 2014 were negligible (less  than plus or minus 1 percent) and had a negligible effect on reported  commission and underwriting expenses, and profit. Any differences that  existed were generally attributable to timing differences—linked to a lag in  WYO companies receiving financial data from vendors that, in turn,  affected the companies’ reporting to NAIC. Also, some of the differences  we identified in incurred losses reported to FEMA and NAIC were also  due to this reporting lag, but as the timing of floods and the payment of  claim losses are less predictable than premium payments, the lag in  reporting had a more significant effect on reported losses and loss  adjustment expenses. For example, we determined the effect of the lag  for one company was about 5 percent of incurred losses reported to  FEMA, whereas for another company the effect was greater than 25  percent of incurred losses.
However, the inconsistency with the greatest effect on individual  company-reported losses was related to how certain companies  estimated incurred but not reported losses and related adjustment  expenses. Three of the WYO companies told us that the actuarial  methodology they used to develop incurred but not reported loss  estimates for NAIC reporting purposes was different than the  methodology their vendor used to develop the estimates submitted to  FEMA. Another company told us it accounted for its federal flood activity  entirely on a cash basis and did not, therefore, report any unpaid loss and  loss adjustment expense reserves to NAIC. In order to compare loss  adjustment compensation with actual expenses, we adjusted these  companies’ reported expenses to remove the effect of these differences  and substituted expense estimates we developed based on the loss and  loss adjustment expense reserves the companies’ vendors reported to  FEMA. Collectively, the net effect of our adjusting for these differences in  reported losses and loss reserves (some companies reported significantly  higher losses and loss reserves to FEMA than to NAIC while others  reported significantly lower estimates) was a net increase in reported loss  adjustment expenses of more than $5 million. These adjustments are  reflected below along with the unreported expenses noted above.

			Effects of Inconsistent Reporting on Expenses and Profit for 10 WYO Companies

We performed additional analyses and comparisons for 10 selected WYO  companies to adjust for inconsistencies (discussed previously) and  determine the effect of the revised amounts on expenses and profits. The  10 companies we selected accounted for a majority of net written  premiums, net paid losses, and total compensation paid for calendar year  2014 (see table 2). For more details about our methodology and the  limitations of our analysis, see appendix I.
An initial comparison of selected WYO company compensation with the  expenses the companies reported to NAIC appears to show that the  companies collectively earned a profit of 25 percent in 2014 (as illustrated  in table 3). However, after we adjusted the reported expenses for the  effects of inconsistent reporting described previously, we estimated that  the companies earned a profit of approximately 15 percent on the flood  insurance line (see table 3).
While an aggregate measurement of profitability for all selected WYO  companies can be calculated, this calculation is significantly influenced by  a few WYO companies that dominate the flood insurance market and  whose business model and cost structure may be different from that of  the majority of insurers that participate in the WYO program. The 2014  flood insurance profits of the companies we reviewed, after our  adjustments, ranged from approximately 2 percent to 38 percent.  Removal of the two WYO companies that represent the outliers of this  range would result in total profit of approximately 18 percent and a profit  range that still varies significantly between 7 percent and 28 percent for  the remaining eight companies. Importantly, our analysis and ability to  estimate WYO company expenses and profit were subject to certain  limitations (see app. I for details on these limitations and their potential  effects), which included limiting our analysis to 1 year (2014). In addition,  our 2014 estimates of company expenses and profit are an outcome of  our effort to understand the issues surrounding the inconsistent financial  reporting by the selected WYO companies and the various factors that  can affect company expenses and profit. For these reasons, these  estimates should not be taken to be a static or predictable indicator of  WYO company profits.

		WYO Company Operations Can Affect Flood Line Expenses and Profits and Are Relevant When Developing Compensation Methodology and Rates

Aside from the inconsistencies in reporting financial data, other factors  specific to how WYO companies operate their flood line of business also  can affect a company’s expenses and profits. These company-specific  factors, coupled with the inherent uncertainty of the frequency and  severity of loss events, the overall market for flood insurance, and  changes to the flood insurance program’s design and requirements, can  present challenges in developing the WYO compensation methodology.  Further, these factors can also present challenges in setting rates that  appropriately compensate WYO companies over time for providing  services to policyholders.

			Effects of WYO Company Operations on Flood Line Expenses and Profit

Based on our analysis of the costs of operating their flood lines of  business in relation to expenses and profits, we found that companies’  operating characteristics could in part explain the significant variance in  expenses and profits. One way to understand the amount of WYO  company expenses and profits is in relation to the premiums paid by  policyholders. As noted in table 2, total compensation paid to the WYO  companies we reviewed represented approximately 35 percent of net  written premiums. That is, 35 cents of every premium dollar paid by  policyholders went toward compensation for the selected companies. As  shown in table 4, by breaking down compensation into expense and profit  components, slightly more than 5 percent of every dollar of premium  written by the 10 WYO companies went to their profit.
As demonstrated previously, WYO company expenses and profit vary  significantly and those variances can be explained in part by the  companies’ operating characteristics. For example, some WYO  companies we interviewed told us that they used independent agents and  generally paid these agents a commission higher than the 15 percent  allowance FEMA provides. Further, the companies we selected for review  had commission expenses of 17.7 percent of net written premiums on  average (see table 4). Some WYO companies attributed the higher  commission to stiff competition in writing new business or keeping current  policies in place in certain markets. Agent commissions can vary not only  from company to company, but also by volume of sales, across lines of  property and casualty insurance, and between new business and renewal  of existing policies. However, we did not determine whether agents’  commissions for selling NFIP policies were affected by how insurers  compensated agents for selling other lines of property and casualty  business. Also, nearly all of the WYO companies we reviewed told us that  they pay adjusters the same amount that FEMA provides as an adjuster  fee allowance and, thus, do not earn a profit on this category of  compensation.
The operating expense allowance, including policy growth incentive  bonuses, and the ULAE allowance are the remaining categories of  compensation on which WYO companies can earn a profit and, thus,  offset losses on agent compensation. The operating and ULAE  allowances compensate WYO companies for the expenses incurred to  operate and administer their flood lines and fulfill the companies’  obligations under their agreements with FEMA, but are not directly  associated with selling specific policies or adjusting specific claims. It is in  these areas that the companies’ operating characteristics and their  compensation of vendors can more directly affect the expenses they incur  and the profits they earn on the federal flood line. In addition to premium  taxes and fees, these allowances cover such insurer expenses as  salaries and benefits of company personnel, printing and postage,  advertising, equipment, training and travel, audit and legal services, and  other expenses. The expenses are incurred to fulfill company obligations,  such as to underwrite and issue policies; collect, remit, and account for  funds; submit financial and statistical reports; conduct audits and reviews;  and manage all aspects of the claims process.
All of the WYO companies we reviewed use vendors to some extent to  operate their flood lines. Most of the WYO companies used third-party  vendors, while the others used an affiliated company to provide various  services. Many of the companies that used third-party vendors told us  that they generally outsource policy, claims, reporting, and other functions  to their vendor, although some use a vendor’s systems software and  retain responsibility for underwriting policies and adjusting claims.  Vendors we interviewed said that they offer a variety of service levels that  WYO companies can choose from depending on the degree of control  they want over the underwriting and claims processes and, thus, the  customer service experience of their policyholders and agents.
WYO companies and vendors told us vendors are paid a percentage of  gross or net written premiums and ULAE allowances and may be paid for  additional expenses incurred in providing services above what is provided  for in the base contract. Third-party vendors with whom we spoke said  that the amount WYO companies pay depends on the nature and extent  of the services provided and the volume of premiums and losses. We  were not able to obtain information from all WYO companies about how  much they pay their vendor, but from the information we were able to  obtain from some WYO companies we were able to estimate the amount  paid. We noted that the difference between what the WYO companies  paid third-party vendors varied by 2 percent or more of net written  premium. In addition, we observed that some companies paid up to twice  the amount of incurred loss ULAE compensation to their vendors as  others. Such differences in vendor compensation can affect WYO  company flood line profits. And because vendor compensation is based in  large part on FEMA’s allowances or the written premiums and losses on  which those allowances are based, changes in those allowances will,  absent changes to the vendor contracts, carry through to the vendors.
We identified expenses of approximately $80 million in aggregate that  three WYO companies paid to their affiliated vendors in 2014; this amount  represents approximately 12 percent of total adjusted expenses (see  table 3 above). Company representatives told us that the affiliated  vendors provided policy administration, claims processing, cash  management, reporting, and other services that third-party vendors  typically offer and may include additional management, financial, and  legal and regulatory services commonly performed by an insurer’s  employees. Some companies told us that the fee charged was either  intended to cover only the affiliate’s expenses or was equivalent to what  they would expect to pay a third-party vendor for the same services. We  did not determine the amount of intercompany profits or losses reflected  in the expenses these WYO companies reported and one company told  us that this information is not made public. Without more specific  information on the affiliated vendors’ activities and intercompany profits  and losses, it would not be possible to determine how the fees charged  by these affiliated vendors compare to what a third-party vendor  otherwise would charge in an arms-length transaction. Excluding  intercompany profits and losses (or a portion thereof) from expenses  would increase or decrease, respectively, the profit shown in tables 3 and  4.
In addition to vendor fees, some of the WYO companies whose data we  analyzed allocate internal company overhead expenses for corporate- wide support functions to their flood lines. Companies told us that they  allocate overhead expenses in accordance with the methods prescribed  by NAIC. In some cases companies told us that expenses were allocated  based on the results of cost studies for those functions that support the  federal flood line or were allocated to each line of property and casualty  business in proportion to factors such as head count, salaries, and  premiums written or earned. In the cases in which we were able to obtain  sufficient information to determine how much of the WYO companies’  expenses were allocated to overhead, we observed that overhead as a  percentage of net written premium ranged from less than 1 percent to  almost 3 percent. The amount of overhead allocated to the flood line can  affect the company’s profit on this line and the variances we observed  may reflect the relative significance of the federal flood line to the WYO  companies’ total property business and the extent that certain activities  are performed by internal WYO company personnel versus their vendors.

			WYO Company Perspectives on Factors That Can Affect Their Expenses and Profit

Aggregate industry average expense ratios and WYO company flood line  expenses and profit are both historical in nature and, as such, may not  fully account for current conditions and the effects that changes to the  flood program’s design and requirements may have on WYO companies’  expenses and profits in the future. The 10 WYO companies whose  reporting we reviewed cited a number of factors that they consider when  evaluating the WYO arrangement in relation to their financial and  strategic goals. Some WYO companies told us that their goals can be met  as long as they are able to offer flood insurance as part of a full menu of  products that help meet the financial needs of their customers without  undue financial and reputational risks being placed on the company.  Some companies specifically cited as a concern the mandates imposed  by Congress and FEMA as part of recently enacted legislation (Biggert- Waters Act and the Homeowners Flood Insurance Affordability Act of  2014) that the companies said imposed significant unreimbursed costs on  them. Some WYO companies also stated that additional fees,  assessments, and surcharges imposed by this legislation added to  customers’ out-of-pocket costs. According to the WYO companies, these  additional costs to consumers resulted in some property owners dropping  their flood coverage and leaving the WYO companies with a smaller  policy base.

		FEMA Has Not Yet Revised Its Compensation Methodology

FEMA has not yet revised its compensation methodology in response to  section 224 of the Biggert-Waters Act or our prior recommendations and  continues to rely on insurance industry proxies for other lines of insurance  for setting compensation rates (see table 1 for FEMA’s compensation  practices). The Biggert-Waters Act built on our 2009 recommendations  and required that FEMA take into account actual expenses and determine  in advance the amount of profit built into its compensation rates when  determining compensation. FEMA officials told us that the agency  began the rulemaking process in late 2014 in response to the Biggert- Waters Act requirements, but that its progress had slowed as litigation  over Hurricane Sandy claims escalated and more resources were  assigned to that issue. As of September 2016, FEMA was unable to  provide a timeline for completing its rulemaking required under section  224. One FEMA official explained that it is difficult to determine a timeline  for rulemaking since some elements of the process, such as economic  analysis and the concurrence process through FEMA and DHS, are  beyond the agency’s control. In September 2016, FEMA officials told us  that an upcoming regulatory action in response to section 224 of the  Biggert-Waters Act would address FEMA’s new methodology for  compensating WYO companies, as well as fully address our open  recommendation from the 2009 report related to compensation and data  quality.
However, FEMA has not made clear whether its expense ratio analysis,  planned data requests, and WYO company attestations of the accuracy of  their financial data (as discussed previously) represent the entirety of the  agency’s plan to ensure the accuracy of the data WYOs submit to NAIC.  FEMA also has not made clear whether—in light of its own observations  on unusual expense ratios and our findings of inconsistent WYO  company reporting—it intends to make other inquiries and perform other  analyses that will fully address our recommendations. Among the 10  recommendations in the report, we made the following five relating to  compensation methodology and data quality that have not been fully  addressed:
We recommended that FEMA (1) determine in advance the amounts  built into the payment rates for estimated expenses and profit; (2)  annually analyze actual expenses and profit in relation to the  estimated amounts used in setting payment rates; and (3) consider  the results of the analysis of payments, actual expenses, and profit in  evaluating methods for paying WYO companies.
We also recommended that FEMA increase the usefulness of the data  WYO companies report to NAIC by (1) taking actions to obtain  reasonable assurance that expense data can be considered in setting  payment rates and (2) developing data analysis strategies to annually  test the quality of flood insurance data the companies report to NAIC.
Federal managerial cost accounting standards state that reliable cost  information is critical to the proper allocation and stewardship of federal  resources and that actual cost information is an important element  agency management should consider when setting payment rates.
Our 2009 recommendations to FEMA remain relevant as FEMA seeks to  develop a compensation methodology as required by the Biggert-Waters  Act. They included that the agency should determine whether data  reported to NAIC could be used to set WYO compensation rates and that  FEMA develop comprehensive analysis strategies to annually test the  quality of the data. Although FEMA has reported improvements to data  that WYO companies submit, FEMA stated that although it has compared  underwriting expense ratios to the related allowances it pays insurers, it  has not yet compared WYO companies’ reported expenses to the  payments it makes to the WYO companies and determined the  companies’ profits due to resource limitations. As a result, and as we  noted in 2009, FEMA does not have the information it needs to determine  whether its payments are appropriate and how much profit is included in  its compensation of the WYO companies. In addition to being helpful in  identifying potential inconsistencies in expense reporting, such a  comparison of compensation payments and actual expenses would help  FEMA to identify differences in how individual companies operate and the  related effects on company expenses and profit. As discussed previously,  we found that the manner in which a WYO company operates has an  effect on its expenses and profits and is thereby relevant for FEMA to  take into consideration as it develops its new compensation methodology.  FEMA’s completion of additional actions to improve data quality and  transparency and accountability over compensation will help it meet  Biggert-Waters Act requirements.

	Data and Views on Over- and Underpayment of NFIP Claims

Data on over- and underpayment of claims in fiscal years 2008–2015  varied in over- and underpayments identified, depending on the type of  review conducted as part of FEMA’s NFIP claims oversight. FEMA  officials, some WYO company representatives, and some stakeholders  agreed that over- and underpayment of NFIP claims were not widespread  and cited several factors that contributed to over- and underpayment  issues. A recent DHS OIG report found that, among other things, FEMA  was unable to ensure that WYO companies were properly implementing  NFIP and unable to identify systemic problems in the program. Currently,  a FEMA working group is developing a new WYO oversight plan to  address financial oversight, claims, underwriting, appeals, and litigation.

		FEMA Data on Over- and Underpayment of Claims

To obtain information about over- and underpayments of NFIP claims, we  reviewed available data from FEMA documenting triennial claims  operation reviews, improper payment reviews, claims reinspections,  biennial audits, and audits for cause for fiscal years 2008–2015. We  found that the extent of over- and underpayments varied, depending on  the type of review conducted.

			Claims Operation Reviews

The vast majority of WYO companies received satisfactory ratings in  FEMA’s recent claims operation reviews and overpayments by  companies and the DSA ranged from 2.7 percent to 6.7 percent of claim  amounts reviewed. Between fiscal years 2008 and 2015, the number of  WYO companies that received unsatisfactory ratings on their claims  operation reviews ranged from zero to three each year. Under the current  Financial Control Plan, FEMA reviews samples of WYO claim files during  claims operation reviews. FEMA reviewers note findings as critical and  noncritical errors and allow a 19 percent error rate under the current  Financial Control Plan; an overall error percentage of 20 percent or higher  is a basis for an unsatisfactory rating. According to an August 2016  WYO bulletin, FEMA planned to reduce the acceptable error percentage  for claims operation reviews to 10 percent starting in fiscal year 2017 to  better encourage WYO companies to adopt policies and practices  designed to more accurately handle flood insurance claims and ensure  that WYO companies pay all claims authorized by the Standard Flood  Insurance Policy. Examples of critical errors in files include claim  payments that exceed the policy terms, incorrect payments, and  significant payment delays. FEMA’s review steps provide an opportunity  for WYO companies to respond to and resolve errors before the agency  issues a final report.
In fiscal year 2015, FEMA’s claims operation review of 866 claims found  23 overpayments totaling $80,202 and 15 underpayments totaling  $93,256. The percentage of overpayments in 2015 was lower than in  previous years, while the number and percentage of underpayments was  higher than in previous years (see table 5). FEMA officials said that for  2013, the particular companies selected for review or lower losses overall  might have contributed to fewer overpayments compared to other years.  FEMA officials noted that although claims operation reviews required  identifying a selection of claim files for review, results were not  generalizable to the larger population of claim files for a WYO company or  across NFIP.
Under the current Financial Control Plan, FEMA can refer WYO  companies with unacceptable performance to the Standards Committee,  which can recommend appropriate remedial actions for companies with  performance issues. For example, the committee can require WYO  company managers to address performance issues at a committee  meeting, require a WYO company to develop and satisfy a plan to  remedy its performance issues, monitor performance until the WYO  company achieves acceptable levels of performance, and recommend  that FEMA not renew a company’s WYO arrangement. In 2002, the  Standards Committee recommended that FEMA not renew one  company’s WYO arrangement. According to FEMA officials, the  company’s inability to resolve underwriting errors contributed to its  departure from the WYO program. Since 2008, five WYO companies  have appeared before the Standards Committee to address performance  issues.
One WYO company appeared in 2011 to address unsatisfactory  underwriting and claims operation reviews.
Three other WYO companies appeared between 2008 and 2010 to  address unsatisfactory underwriting operation reviews; one of these  companies was among the largest group of writers of flood insurance  from 2008 to 2014.
The other company, also among the largest group writers of flood  insurance from 2008 to 2014, appeared before the Standards  Committee in 2014 to address its administrative processes for debt  collection.

			Improper Payment Reviews

According to FEMA officials, DHS’s Office of the Chief Financial Officer  conducts improper payment reviews annually. These reviews examine  NFIP policies written by WYO companies as well as those written by the  DSA. Under IPIA, an improper payment is any payment that should not  have been made or that was made in an incorrect amount (including  overpayments and underpayments) under statutory, contractual,  administrative, or other legally applicable requirements. According to  FEMA officials, improper payment reviews identify a statistically valid  sample and the results are generalizable to the entire population,  whereas FEMA’s claims operation review results, as discussed  previously, are not generalizable. They said another difference is that  the claims operation reviews select entire claim files for review, while the  improper payment review tests individual payments; a claim file can  include multiple payments.
FEMA’s most recent improper payment reviews found that improper  payments in NFIP claims for fiscal years 2012–2014 occurred less than  0.2 percent of the time, well below FEMA’s threshold of 1.5 percent (see  table 6). For example, the fiscal year 2014 review of 338 payments  found two improper payments (one overpayment and one underpayment),  for an error rate of approximately 0.16 percent. According to a recent IPIA  audit report, errors can be typographical such as inconsistencies in  recording payment amounts across building estimates, final reports,  claims summaries, or checks issued. Errors can also derive from the  estimation of recoverable depreciation. For example, an adjuster might  not have included replacement cost value in the final claims payment  calculations.
As previously discussed, until 2015, FEMA conducted routine  reinspections of claims files, randomly selected by flood event, size of  loss, or class of business. In addition, FEMA selected claims for  reinspection in response to requests from within the agency, WYO  companies, appeals from policyholders, and requests from Congress  (special assist reinspections).
Starting in 2015, FEMA discontinued the routine reinspections. According  to agency officials, they discontinued this type of review because the  annual IPIA review provided comparable information. In August 2016,  FEMA officials confirmed that the agency planned to continue conducting  special assist reinspections, and also was piloting a random claims  quality check to review and analyze NFIP claims early in the claims  process to identify any systemic claims processing issues associated with  particular flood events. From 2010 to 2015, the agency reviewed from  around 50 to more than 2,400 claim files each year through a combination  of routine reinspections and special assist reinspections. In this period,  FEMA’s reinspections identified underpayments totaling more than $5.95  million and overpayments of about $2.34 million (see table 7). According  to FEMA officials, heightened interest in claim underpayments following  Hurricane Sandy might have led to an increased interest in reviewing for  possible underpayments in recent years.
The total number of claims reinspected increased in 2013, after Tropical  Storm Isaac and Hurricane Sandy in 2012, which as of July 31, 2016,  caused more than $555 million and $8.3 billion in NFIP losses,  respectively. The number of claims FEMA reinspected generally declined  between 2013–2015. A FEMA official noted that the decline was due to  the fact that FEMA bases the number of reinspections it conducts on the  number of claims received as a result of flooding events and that there  were no significant flooding events during this time period. Table 8 shows  the numbers and types of claims reinspections initiated from fiscal years  2010 through 2015.
No WYO companies received unsatisfactory biennial financial audit  ratings during fiscal years 2010–2015; prior to that, two WYO companies  received unsatisfactory ratings in 2009. Most recently, in fiscal year 2015,  FEMA conducted 37 biennial audits, which resulted in 36 satisfactory  ratings and 1 nonrating for which FEMA planned to follow up in its 2016  review. According to FEMA officials, a WYO company receives a  satisfactory rating from FEMA when it receives an unqualified opinion  from the auditor. Normally, every company receives a rating but might  receive a nonrating if a company was exempt from the biennial audit in  the reporting year.
According to the current Financial Control Plan, FEMA’s biennial audits of  WYO companies include claims, underwriting, and financial reviews. For  the claims portion of the audits, FEMA identifies a random sample of a  WYO company’s claim files for an independent auditor to verify, among  other things, that adjuster reports contain adequate evidence to  substantiate the payment or denial of claims, including the amount of  losses and that building and contents allocations are correct. DSA  financial-related information is handled differently. It is subject to the  annual audit of DHS’s consolidated financial statements performed by an  independent certified public accountant. FEMA officials told us that, as of  December 2015, the contract officer responsible for managing the DSA  contract met with the DSA contractor biweekly to discuss any issues with  the company’s data submissions to the agency.

			Audits for Cause

In addition to the oversight processes described above, according to the  current Financial Control Plan, FEMA can conduct audits for cause on its  own initiative or upon the recommendation of the Standards Committee or  OIG when certain criteria are met. According to FEMA’s Financial Control  Plan Monitoring procedures, an audit for cause is a last resort if other  remedies available to the Standards Committee are exhausted, OIG  requests one, or agency officials believe immediate action is necessary.  For example, FEMA could determine an audit for cause was necessary  based on claims reinspection results showing consistent overpayments or  biennial audits showing significant problems.
According to agency officials, FEMA has not conducted any audits for  cause as a result of biennial audits since 2007. The officials also were  unaware of any audits for cause having been conducted as a result of  claims reinspections.

		FEMA, WYO Company, and Stakeholder Views on Over- and Underpayment of Claims

FEMA officials, some WYO company representatives, and some  stakeholders agreed that over- and underpayment of NFIP claims were  not widespread. We asked stakeholders about their perspectives on any  over- or underpayment of NFIP claims and none who responded on this  issue described NFIP over- or underpayments as widespread. Some  WYO company representatives said companies do not typically consider  claim over- and underpayments a significant issue because companies or  their vendors have procedural safeguards to help ensure they pay claims  appropriately. Some WYO company representatives said over- and  underpayments of NFIP claims were caused by similar factors as over-  and underpayments in other property and casualty lines.
According to FEMA officials, lack of documentation was the main cause  of overpayments. For example, they said overpayments could happen  when the contents of a policyholder’s home were not adequately  documented or an adjuster did not correctly calculate losses (use of  actual cash value and incorrect depreciation figures). According to FEMA  officials, WYO companies generally have reimbursed FEMA for any  overpayments they identified, and the companies would request  reimbursement from the insured in cases of large or potentially fraudulent  overpayments. For example, FEMA recovered the $61,439 overpayment  from fiscal year 2014 identified in the IPIA review. The officials said that  when the DSA has identified overpayments, it also has sought to recoup  the money from the recipient insureds.
Representatives of several WYO companies and two stakeholders said  that companies lacked incentives for underpayments and FEMA officials  said underpayments were generally small and typically resulted from  mathematical errors. Representatives from most WYO companies with  whom we spoke said that companies typically did not track  underpayments. According to FEMA officials, representatives of two WYO  companies, and two stakeholders including a vendor, some policyholders  lack an understanding of the terms of NFIP coverage. They said  policyholders sometimes expect to be made whole after a flood event, but  the NFIP standard flood insurance policy coverage is limited to direct  physical losses by or from flood, depending on the type of insured  property and the amount of coverage obtained. In a 2014 report, we  found that homeowners may not understand their insurance coverage  well enough to know what is covered, what is excluded, and what loss  events and circumstances might result in paid, partially paid, or denied  claims, and disaster events could highlight differences between  consumers’ expectations for insurance and their actual coverage,  resulting in added frustrations.
Representatives of some WYO companies and a few stakeholders said  factors related to the nature of the claims process and large loss events  contributed to over- and underpayment issues, including the following:
Nature of the claims adjustment process. The claims adjustment  process can lead to differences across claims. Representatives of one  WYO company said that claim adjusters must make judgment calls  with respect to calculating depreciation. For example, three  experienced adjusters might calculate three slightly different estimates  for the same claim, according to representatives of another WYO  company.
Large claims volume. According to two stakeholders, processing a  large volume of claims can contribute to claims processing errors and  lead to increased perceptions that over- and underpayments are an  issue.
Inexperienced adjusters. Lack of qualified adjusters after large  storms can lead to claims processing errors. Representatives of a  WYO company said public adjusters often lacked NFIP experience.  To meet immediate needs for assessing damage caused by recent  large storm events, FEMA provided a limited waiver of claim adjuster  certification. According to a stakeholder, this practice led to hiring  claim adjusters who otherwise would not have met FEMA’s  qualifications. Representatives of the WYO company said  inexperienced adjusters might give claimants false hope for the  amount of claims they might receive, leading to perceptions of  underpayments. A representative from another WYO company said  adjusters learn on the job, and having a few errors was not unusual  for a complex line of business like NFIP. In addition, representatives  of the WYO company said streamlining adjusting software could help  address this issue. The WYO company representatives and a  stakeholder said training and additional oversight of adjusters was  needed.
Changes by FEMA to the Standard Flood Insurance Policy claims  process. In the 4 years following Hurricane Sandy, FEMA issued  several bulletins outlining processing changes for claims associated  with the loss event, which may have further complicated what some  described as already a complex process. Among these changes,  FEMA allowed WYO companies to pay claims after receiving an  adjuster’s estimate but before a policyholder provided all necessary  paperwork, with the expectation that additional payouts would be  required once the losses were fully documented. FEMA issued three  extensions to the 60-day filing window for policyholders to submit  proof of loss information to their WYO insurer, extending the filing  window to 1 year, then 18 months, and finally, 24 months after the  event.
Market fluctuations. Replacement cost calculations in the data might  change between the time an adjuster develops an estimate and a  contractor begins repairs.

		Recent OIG Report Identified NFIP Oversight Deficiencies

In March 2016, a DHS OIG report found that although FEMA performed  the required oversight reviews of WYO companies in accordance with the  agency’s Financial Control Plan, it could improve its processes. For  example, the OIG report stated that FEMA was not using the results from  its Financial Control Plan reviews—including claims operation reviews,  biennial audits, and claims reinspections—to make WYO program  improvements because the agency lacked adequate guidance, resources,  or internal controls. Among other findings, OIG found that FEMA was  unable to ensure that WYO companies were properly implementing NFIP  and unable to identify systemic problems in the program. FEMA  management acknowledged that NFIP lacked a consistent or reliable  method to identify systemic problems or recognize patterns or warning  signs. The OIG report recommended that FEMA develop and implement  procedures to evaluate the results of the oversight under the Financial  Control Plan and determine the overall effectiveness of established NFIP  internal controls. In response, the agency planned to evaluate the  Financial Control Plan review process and make recommendations to  improve its oversight of WYO companies, which are expected by  December 30, 2016.
As of August 2016, a FEMA working group was developing a new WYO  oversight plan to address financial oversight, claims, underwriting,  appeals, and litigation, to be completed by January 2017. According to  FEMA officials, the working group would update the Financial Control  Plan after developing the WYO oversight plan. They said FEMA  planned to monitor WYO company error rates on claims and underwriting  operation reviews as part of its WYO company oversight, and its  oversight would include performance measures.
Prior to the issuance of the OIG report, FEMA had begun evaluating the  customer experience to further identify ways to align NFIP and FEMA’s  processes around the policyholder. For example, according to agency  officials, in 2015 FEMA surveyed approximately 2,000 policyholders to  understand customers’ priorities and found, among other things, that  customers would prefer a simplified program and more coverage  choices.
Furthermore, FEMA has begun reorganizing FIMA, including separating  the department into two branches—one to oversee the WYO program  and the other to oversee the DSA—and establishing separate claims and  claims appeals processes. To improve claims processing, FEMA planned  to gather more real-time claim data from WYO companies and the DSA to  enhance the customer experience and detect problems or errors as they  occur. To improve the claims appeals process, the agency established a  new appeals branch within FIMA’s Policyholder Services Division devoted  to redesigning and overseeing the appeals process and planned to  implement changes by December 30, 2016. According to FEMA officials,  these changes would help address a March 2016 OIG recommendation  that the agency properly document and update existing procedures for  the claims appeal process. In addition, in an effort to understand how  policyholders move through the claims process after flood events and  possible issues with that process, FEMA began obtaining detailed claims  information from WYO companies on a weekly basis. According to  agency officials, the data, while unverified and unedited, provided insights  into the claims process not previously available to FEMA following large  loss events.

	Current WYO Arrangement and Potential Alternatives Involve Trade-offs

According to our analysis and interviews, the current WYO arrangement  provides advantages to consumers and insurers but disadvantages to  FEMA in overseeing a large number of companies. While potential  alternatives involving fewer participating WYO companies could ease  oversight for FEMA, these alternatives could lead to reduced market  penetration, among other trade-offs. Most WYO companies we  interviewed preferred the current WYO arrangement over any of the three  potential alternatives we identified. All the potential alternatives involve  FEMA contracting with participating companies, a status that most WYO  company representatives cited as creating more regulatory burden  because of federal contract requirements.

		Trade-offs of Current Arrangement Include Advantages for Consumers and Insurers from WYO Company Competition but Disadvantages for FEMA Oversight

Based on our analysis and interviews with FEMA, WYO companies, and  stakeholders (relevant organizations and vendors), the current WYO  arrangement has trade-offs (see table 9). For example, while competition  among the approximately 75 companies under the current arrangement  may lead to improvements in customer service, the large number of  companies increases the amount of oversight FEMA must provide.  Representatives of most WYO companies and several stakeholders with  whom we spoke preferred the current arrangement over adopting an  alternative structure for the program. Representatives of some WYO  companies said the current approach is predictable. This stability could  continue to encourage WYO participation.
However, a few stakeholders and representatives of a few WYO  companies said costs for WYO companies had increased with recent  legislation, which could discourage WYO participation in the future. Under  the DSA contract, FEMA may direct changes within the general scope of  the contract regarding the description of services to be performed, time of  performance, and the place of performance of the services, but it must  compensate the contractor for these changes. For example, if there is a  change in law or regulation after the execution date of the contract that  affects the contractor’s performance of the services, FEMA must  compensate the contractor, through an equitable adjustment, for the  changes. We discuss federal contract requirements and differences  between the DSA contract and the WYO arrangement in more detail in  appendix II. While FEMA uses proxies to compensate WYO companies, it  compensates the DSA based on a predominantly fixed-price contract (tied  to a fixed-price per policy, based on policy type). Our review of contract  modifications showed an example in which the DSA sought equitable  adjustments from FEMA for changed work caused by implementation of  the Biggert-Waters Act and the Homeowner Flood Insurance Affordability  Act of 2014 (HFIAA). In the modifications we reviewed, the DSA generally  was compensated for its estimated additional costs imposed by the  change if it could prove the changes affected the work under the terms of  the original contract. For example, in December 2014 FEMA equitably  adjusted the DSA contract to pay an additional $830,070 to implement the  Biggert-Waters Act and $125,531 to implement HFIAA, which repealed  and modified certain provisions of the Biggert-Waters Act. WYO  companies also were affected by these changes but representatives of  two WYO companies and a stakeholder said WYO companies were not  able to request additional compensation to recoup additional costs.
In other comments about the current arrangement, FEMA officials and  representatives of one WYO company said FEMA oversight of vendors  that administer policies was needed. FEMA’s current oversight processes  do not include direct oversight of vendors. According to FEMA officials,  nine vendors serviced about 85 percent of NFIP policies as of May 2015.  One stakeholder—a vendor—noted that FEMA auditors frequently visited  the vendor to conduct triennial claims operation reviews and biennial  financial audits of the WYO companies that the vendor serviced. FEMA  officials noted that the agency’s relationship is with the WYO company  and, therefore, its oversight was specific to WYO companies and did not  include any requirements for vendors.

		Potential Alternatives to the Current WYO Arrangement Each Involve Trade-offs

Three potential alternatives to the current structure for the WYO program  each involve trade-offs, although WYO company representatives and  stakeholders generally preferred the third alternative that would maintain  a WYO network. All three potential alternatives involve FEMA contracting  with participating companies (WYO companies or vendors), a status that  most WYO company representatives cited as creating more regulatory  burden because of federal contract requirements. (We discuss federal  contract requirements and the views of WYO companies about the  program being premised on contracting in more detail in app. II.)
More specifically, we identified the following three potential alternatives  (see fig. 1):
Alternative 1: FEMA contracts with one or more insurance  companies. FEMA would solicit offers for a contract with one or more  insurance companies to sell and service flood policies and adjust  claims.
Alternative 2: FEMA contracts with one vendor. FEMA would  solicit offers for a contract with a flood insurance vendor to service  flood policies. The arrangement would be similar to the NFIP Direct  program. The vendor would sell flood insurance policies through  independent insurance agents, and insurance companies would not  be involved.
Alternative 3: FEMA contracts with multiple vendors and  maintains the WYO network. The WYO companies would sell flood  policies, while one or more vendors would service the policies. FEMA  would solicit offers for contracts from multiple flood insurance vendors  to service flood policies. Insurance companies that wanted to sell  flood insurance would contract with one or more of the vendors to  service flood policies sold by insurance company agents. Because  FEMA would pay vendors to administer the flood policies, participating  insurance companies would not incur any operational expenses for  their flood line; rather, FEMA would pay the insurance companies a  sales bonus for performance.
We previously reported that the three alternatives had advantages and  disadvantages in terms of the potential impact on the basic operations of  administering flood insurance policies and adjusting claims, as well as on  FEMA’s oversight of the program and its contractors. In the following  analysis, we discuss the trade-offs of each alternative based on four  factors that we identified: the cost to WYO companies, oversight by  FEMA, market penetration, and WYO company participation.
Alternative 1, in which FEMA would contract with one or more insurance  companies to sell and service flood policies and adjust claims, would  maintain the WYO company network to some extent but likely would  involve fewer participating WYO companies (see table 10).
Some stakeholders said that many current WYO companies would  elect not to participate in a bid process because they opposed  becoming federal contractors. However, representatives of one WYO  company said that by not participating, these companies would lose a  competitive advantage. That is, offering flood insurance in addition to  home, life, and automobile insurance allows participating multiline  insurers to address multiple insurance needs of their customers.  Representatives of another WYO company said that WYO companies  with in-house servicing capabilities would have a competitive  advantage over other companies that use third-party vendors.
Fewer WYO companies could or could not represent an advantage for  FEMA. Oversight might be easier than that required for the  approximately 75 WYO companies in the current arrangement as of  September 2016. Representatives of one WYO company said FEMA  could collaborate more closely with WYO companies if fewer were  involved in the program. However, one stakeholder said overseeing  federal contracts could require expanded oversight processes and  additional resources from the agency.
Responding to large loss events could be more challenging with fewer  WYO companies. Furthermore, a change in the composition of WYO  companies could affect market penetration. (We discuss geographic  concentration of market share for WYO companies later in this report.)
Alternative 2, in which FEMA would contract with one vendor to service  policies and sell them via independent insurance agents, similar to the  NFIP Direct program, largely would eliminate insurance companies’  involvement in NFIP (see table 11).
Representatives of one WYO company said transitioning to this model  would be a step backward for the WYO program, which evolved from  a single entity in the 1980s. In addition, representatives of another  WYO company pointed out that no single insurer or vendor had the  infrastructure needed to deliver NFIP coverage on such a large scale.
Similar to Alternative 1, in which FEMA would contract with one or  more insurance companies, representatives of a few WYO companies  and a stakeholder said handling a large storm event could be even  more challenging for a single entity and could have a negative effect  on the customer experience generally, and after large-loss events.
Furthermore, according to representatives of another WYO company  and a few stakeholders, selling policies through independent agents  only, rather than through independent agents and the network of  agents affiliated with WYO companies currently in the program, could  adversely affect market penetration.
Lastly, representatives of some WYO companies said competition  could be an issue under this option. For example, if one vendor won a  long-term contract, the companies not selected might not maintain the  ability to service the flood business, which could create a cycle in  which the same vendor has a competitive advantage and is  repeatedly selected.
Many stakeholders generally said that Alternative 3, in which FEMA  would contract with multiple vendors (to service NFIP policies) and  maintain the WYO network (to sell NFIP policies), was the most appealing  option of the three alternatives we identified because it would involve  multiple vendors and maintain the existing WYO network (see table 12).  However, this option also has significant trade-offs.
This arrangement would maintain competition among vendors and  WYO companies, but could lead to declines in customer service.  Representatives of a few WYO companies said that by having FEMA  set requirements for vendors that deliver customer service—rather  than having WYO companies contract with vendors as is the current  practice—WYO companies would have less control over customer  service quality and could face reputational risks.
However, according to representatives of two WYO companies and a  stakeholder, competition among participating vendors could drive  down program costs or improve customer service quality.
Some WYO companies and stakeholders considered the possible impact  on responses to large loss events and effects on customer service quality  as important factors in evaluating potential changes to the WYO program.  As mentioned previously, each alternative we identified could involve a  decrease in the number of participating WYO companies.  Representatives of some WYO companies and a few stakeholders said  decreasing the number of WYO companies could negatively affect  customer service and market penetration.

		WYO Companies and Stakeholders Suggested Possible Improvements to the Current Arrangement and Other Potential Alternatives

Most WYO company representatives we interviewed preferred the current  arrangement to any of the potential alternatives, while most stakeholders  did not state a preference between the current arrangement and the  alternatives we identified. Many WYO company representatives and  several stakeholders provided suggestions for improving the current  arrangement.
Improve guidance for WYO companies. Representatives of several  WYO companies said better communication was needed from FEMA,  including following large loss events. For example, representatives of  one WYO company and a stakeholder said that FEMA should post  questions from the companies and the agency’s responses online.  This would help standardize information that WYO companies  received, and address the problem of getting different answers from  different FEMA officials through more informal communication  channels. According to FEMA officials, the agency plans to create  standards-based guidance for WYO companies and reduce the  amount of prescriptive guidance FEMA provided to WYO companies.
Simplify the program. Some WYO company representatives and  some stakeholders said NFIP coverage is more complicated to write  and adjust than other property and casualty insurance coverage.  Several suggested that FEMA take steps to make it easier for agents  to write policies and adjust claims. According to agency officials,  FEMA planned to enhance the consistency and simplicity of the NFIP  product and simplify NFIP policy language within the current  legislative framework, among other changes, during 2016.
Reconsider agent commissions. As discussed previously, based on  our data analysis and interviews with WYO companies, some WYO  companies pay more to agents than the 15 percent of net written  premiums that FEMA provides in compensation. Some WYO  company representatives and two stakeholders said increases in  agent commissions led to higher costs for WYO companies. Among  these stakeholders, one vendor said that FEMA should develop better  incentives for insurance agents to address this issue and increase  market penetration. For example, representatives said that FEMA  could establish agent compensation based on the percentage of  homeowners insurance policyholders that have flood insurance or  other metrics. In addition, they said FEMA could standardize agent  commissions so independent agents would focus more on selling new  policies rather than transferring NFIP policies from one WYO to  another that pays higher commission. As previously discussed, FEMA  is currently in the process of developing a new compensation  methodology through rulemaking but could not provide a timeline on  when this rulemaking would be complete.
Provide vendor oversight. FEMA officials said it was widely  acknowledged that FEMA must address its lack of vendor oversight,  and said the agency was taking steps to determine how to address  this issue in any changes to its WYO program oversight. In July 2015,  the agency began requesting WYO companies to submit, through  their vendors when applicable, sample files demonstrating the  implementation of NFIP program changes 30 days before a program  change became effective.  While not direct oversight of vendors,  FEMA officials stated that this change was part of its efforts to better  ensure that system updates for implementing NFIP program changes  were properly implemented. As of July 2016, FEMA officials did not  identify any other plans for addressing vendor oversight.
Other suggestions. In addition to suggestions on ways to improve  the WYO program, two WYO companies and some stakeholders  suggested other ways to improve NFIP. For example, representatives  of two WYO companies and some stakeholders suggested  encouraging private-sector participation in flood insurance (including  eliminating a noncompete clause for WYO companies from the  current arrangement, discussed later). In addition, one stakeholder  suggested making flood coverage a mandatory component of  homeowners insurance, establishing a different scale for quantifying  flood risk, expanding policy choices through NFIP or private-sector  coverage, and more closely coordinating NFIP and disaster  assistance.
FEMA officials told us they plan to reexamine and improve the WYO  arrangement to allow for greater flexibility in the relationship between  FEMA and WYO companies. In May 2016, FEMA issued a proposed rule  to remove the WYO arrangement from regulation to make operational  adjustments and corrections to the arrangement more efficiently. FEMA  officials told us that the agency does not plan to make changes to the  arrangement for fiscal year 2017.
Additionally, several stakeholders and WYO company representatives  with whom we spoke suggested other possible alternative structures for  the WYO program. These included increasing requirements for WYO  companies, removing a noncompete clause in the WYO arrangement,  and adopting the federal crop insurance program model, which shares  some similarities with NFIP but has some notable differences.
Limiting WYO participation or increasing WYO company  requirements. Representatives of several WYO companies  suggested that maintaining the current WYO arrangement but limiting  the number of WYO companies allowed to participate was another  option. Under this option, according to WYO representatives, WYO  companies would not necessarily become federal contractors, but  would compete, in a sense, for available spots in the program. FEMA  officials said adding other requirements for WYO companies—rather  than determining the number of WYO companies allowed to  participate—would be another way to achieve fewer participating  companies.
Removing noncompete clause. Three stakeholders, including two  industry groups representing insurance companies and a vendor, said  removing a noncompete clause from the arrangement (which  generally prevents WYO companies from selling private flood policies)  would encourage continued participation in the program and also  encourage greater private-sector involvement in insuring flood risk.  The noncompete clause was also cited as a potential barrier to  increased use of private flood insurance by various industry  stakeholders with whom we spoke as part of work we completed in  July 2016 on private sector involvement in flood insurance.
Adopting crop insurance model. One stakeholder suggested the  federal crop insurance model as a possible alternative structure for  the WYO program. Similar to the agreements between FEMA and  WYO companies, companies participating in the crop insurance  program—17 as of September 2016—have a 1-year agreement with  the Federal Crop Insurance Corporation to sell and service policies.  The crop insurance agreement is not considered a contract for the  purposes of the Federal Acquisition Regulation. But unlike in the WYO  program, these companies share a percentage of the risk of loss (and  opportunity for gain), and the Department of Agriculture reinsures their  losses, a significant structural difference between the two programs.  The Federal Crop Insurance Corporation accounted for about 1.1  million policies and $9.26 billion in premiums written as of October  2016, whereas according to the most recent data available, NFIP  accounted for 5.1 million policies and about $3.4 billion in federal flood  earned premiums. Similar to the WYO arrangement, companies in  the crop insurance program receive a percentage of the premium on  policies sold to cover the administrative costs of selling and servicing  these policies. In turn, insurance companies use this money to pay  commissions to their agents who sell the policies and fees to  adjusters when claims are filed. Unlike NFIP, the Federal Crop  Insurance Corporation requires that companies submit expense  amounts on a standard form, but these amounts are not audited. The  Department of Agriculture considers the expense information when it  renegotiates its standard agreement with insurers.

		Large WYO Companies Wrote the Majority of NFIP Residential Policies at the State and County Levels

Our analysis of three potential alternatives to the current WYO  arrangement found that each alternative could decrease the number of  participating WYO companies. We analyzed NFIP policy data to  understand the geographic concentration of WYO company market share  under the current arrangement. Specifically, we analyzed residential  policy data to understand the geographic concentration of residential  NFIP coverage and the role that large and small writers of NFIP coverage  and the DSA played in different states and counties. We found that  large WYO companies wrote the majority of NFIP residential policies  across states and counties (see fig. 2). We considered large WYO  companies as the top 10 companies in terms of NFIP market share in  2014.
Overall, large WYO companies accounted for the largest share of  written NFIP residential policies across states, territories, and the  District of Columbia (70 percent), while small WYO companies and  the DSA accounted for smaller shares of the market (16 and 14  percent, respectively).
At the state level, large WYO companies wrote more than half of all  NFIP residential policies in every state, while the share of policies  written by small WYO companies (2 percent–38 percent) and the DSA  (4 percent –28 percent) varied more.
At the county level, we found that large WYO companies wrote more  than half of all NFIP residential policies in 83 percent of counties  across the states, territories, and the District of Columbia.
See appendix III for additional analysis.

	Conclusions

FEMA has yet to implement Biggert-Waters act requirements to develop a  methodology for compensating WYO companies using actual flood  insurance expenses. For example, FEMA has not completed the  rulemaking process and we found the flood insurance financial data WYO  companies reported to NAIC are inconsistent, which limits the data’s  usefulness to FEMA in setting compensation rates. Additionally, FEMA  currently does not systematically consider actual flood expenses and  profit when establishing WYO compensation, and has yet to compare  WYO companies’ actual expenses and compensation. As recommended  in 2009, FEMA should (1) determine in advance the amounts built into the  payment rates for estimated expenses and profit; (2) annually analyze  actual expenses and profit in relation to the estimated amounts used in  setting payment rates; and (3) consider the results of the analysis of  payments, actual expenses, and profit in evaluating methods for paying  WYO companies. Additionally, FEMA should (4) take actions to obtain  reasonable assurance that flood insurance expense data reported to  NAIC can be considered in setting payment rates and (5) develop data  analysis strategies to annually test the quality of flood insurance data the  companies report to NAIC. Fully addressing these recommendations will  help FEMA meet the Biggert-Waters Act requirement to develop a  methodology for determining appropriate compensation for WYO  companies that uses the companies’ actual flood expenses.
FEMA is still in the process of revising its compensation methodology.  Based on our analysis, how a WYO company operates has an effect on  its expenses and profits. For example, company-specific factors such as  compensating independent agents to sell policies or third-party vendors to  service policies, and the manner in which a company allocates overhead  expenses, can result in varying expenses and profit. Gaining such an  understanding of the WYO companies’ operations, which can contribute  to year-to-year fluctuations in expenses and profit, would allow FEMA to  more effectively revise its compensation methodology. Moreover, this  understanding, coupled with improved data on WYO company expenses,  also would facilitate any future consideration that FEMA might make of  alternative structures for the WYO program. Finally, considering that the  compensation of WYO companies is a significant part of the total  premiums policyholders pay, FEMA may seek to achieve the program’s  objective of making flood insurance available at affordable rates in part by  establishing reasonable compensation rates that appropriately consider  WYO company expenses, profits, and operating characteristics.

	Recommendations for Executive Action

To improve the transparency and accountability over the compensation  paid to WYO companies and set appropriate compensation rates, the  FEMA administrator should take into account WYO company  characteristics that may impact companies’ expenses and profits when  developing the new compensation methodology and rates.

	Agency Comments

We provided a draft of this report to FEMA within the Department of  Homeland Security, NAIC, and FIO within the Department of the Treasury  for review and comment.
DHS and NAIC provided technical comments, which we incorporated, as  appropriate. DHS also provided a written response, reproduced in  appendix IV, in which FEMA concurred with our recommendation and  agreed that fully understanding the characteristics of the insurance  companies that participate in the WYO program can help in determining  compensation. FEMA responded that it intends to comply with the  rulemaking requirement of section 224 of the Biggert-Waters Act and,  when completed, will implement a new compensation methodology to  track, as closely as practicably possible, the actual expenses of the WYO  companies. Agency officials noted that as FEMA must implement this  recommendation via rulemaking, it is unable to provide more specific  information or a time frame at this time.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to DHS, NAIC, and  Treasury, and interested congressional committees and members. In  addition, the report will be available at no charge on the GAO website at  http://www.gao.gov.
If you or your staff have any questions about this report, please contact  me at (202)-512-8678 or cackleya@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on   the last page of this report. GAO staff who made key contributions to this  report are listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

Our objectives in this report were to describe the (1) Federal Emergency  Management Agency’s (FEMA) current compensation practices for Write- Your-Own (WYO) companies and the extent to which FEMA revised its  practices in response to the Biggert-Waters Flood Insurance Reform Act  of 2012 (Biggert-Waters Act); (2) information on over- and  underpayments of National Flood Insurance Program (NFIP) policy  claims; and (3) the trade-offs of selected potential alternatives to FEMA’s  current arrangement with WYO companies for selling and servicing flood  insurance policies.
To address all three reporting objectives, we reviewed our prior reports  and reports from the Office of Inspector General (OIG) of the Department  of Homeland Security; relevant laws and regulations; and FEMA  documentation and guidance. We also interviewed officials from FEMA  and representatives from 10 WYO companies with varying NFIP premium  bases. Specifically, we selected a non-generalizable, purposive sample of  10 WYO companies, selected based on net premiums written to capture  companies with a large market share of premiums written, as well as to  obtain the opinions of different sized WYO companies on their  involvement in NFIP. Also, to obtain a broader range of perspectives, we  included two WYO companies in this group of 10 because they did not  use subcontractors (vendors) to service policies. This is the first group of  10 WYO companies we selected. We later identified a second and third  group of 10 WYO companies to address other aspects of our reporting  objectives.

	Status of FEMA Revisions to Compensation Methodology

For our first objective, we reviewed the Biggert-Waters Act, other laws  and regulations relevant to FEMA’s compensation practices, and FEMA  documentation, such as WYO Bulletins (which FEMA publishes to inform  WYO companies, and the public, of updates or changes to NFIP,  including compensation practices). To identify any changes FEMA made  to its compensation methodology since our August 2009 report, we  reviewed WYO Company Bulletins issued between January 2008 and  August 2016. We also obtained and reviewed FEMA’s compensation  packages for WYO companies for fiscal years 2010–2016. To understand  the status of FEMA’s implementation of recommendations from our 2009  report and section 224 of the Biggert-Waters Act, which built on our  recommendations, we interviewed FEMA officials on any steps the  agency had taken to improve the quality of WYO company expense data  and on its progress in implementing related Biggert-Waters Act  requirements. We also interviewed National Association of Insurance  Commissioners (NAIC) officials about expense data WYO companies  report to NAIC. In addition, we interviewed the first group of 10 WYO  companies (discussed at the start of this appendix) on compensation  issues, including how expenses were incurred and reported.
To compare FEMA compensation paid to WYO companies to actual  expense data WYO companies reported to NAIC, we obtained and  analyzed premium, loss, and compensation data for all WYO companies  for fiscal years 2008–2014 from FEMA and premium, loss and expense  data for all WYO companies from SNL Financial and NAIC for calendar  years 2008–2014.  For purposes of our analysis, we retrieved federal  flood line data reported to NAIC from SNL Financial. To make the FEMA  and NAIC data comparable, we converted FEMA’s fiscal year data to a  calendar-year basis to match the period for reporting to NAIC. We also  converted FEMA reported paid losses and loss adjusted expenses to an  accrual basis to be able to appropriately compare loss adjustment  compensation and actual expenses. We then calculated estimated profit  for each WYO company as the difference between the calendar year  compensation reported to FEMA and calendar year expenses reported to  NAIC. The estimated profits, calculated using the data provided by FEMA  and NAIC data obtained from SNL Financial, did not correspond to our  expectations of profits from our 2009 work.
To better understand WYO companies’ accounting and reporting of  federal flood data, we made another (second) selection of 10 WYO  companies that comprised the majority of net written premiums (about 60  percent), paid losses (about 52 percent), and total compensation (about  60 percent) during 2008–2014. Specifically, we selected a  nongeneralizable, purposive sample of 10 WYO companies, selected  based on net premiums written during 2008–2014. We overselected WYO  companies with a larger share of the market because of their relevance in  the flood insurance market. We interviewed these WYO companies and  requested and examined additional information and data they provided.
We used this additional information and data to evaluate the causes of  differences in reported premiums and losses and estimate the effect  those differences had on the companies’ compensation and expenses.  We also used this information and data to estimate various underwriting  and loss adjustment expenses to corroborate statements the companies  made to us regarding the amount they pay their vendors and adjusters.  We analyzed the companies’ commission, underwriting, and loss expense  ratios, profits as a percentage of total compensation, and reported loss  and loss adjustment expense reserves to corroborate statements the  companies made regarding changes in their accounting and reporting  practices between 2008 and 2014. Based on the additional information  and data provided and our analyses, we made adjustments to the  expenses reported to NAIC for unreported expenses, reclassifications of  expenses, and the effects of different loss adjustment expense estimates  and recalculated estimated profit (on a pre-tax basis) for these 10 WYO  companies for calendar year 2014.
Our analysis and ability to estimate WYO company expenses and profit  were subject to a number of limitations.
First, the adjustments we made to the companies’ reported expenses  were based on information provided by the WYO companies. WYO  company representatives provided supplemental financial data and  made various representations to us, and while we reviewed the data  and representations for reasonableness in relation to other  information we had, we did not obtain all evidence necessary to fully  validate this additional information.
Second, we initially sought information from the 10 selected WYO  companies that would allow us to compare compensation and actual  expenses and estimate profit for each company for the years 2008-– 2014. However, due to challenges in obtaining sufficient information  and documentation from all companies to support their accounting  and reporting practices for each of those years and assess the  consistency of such reporting from company to company and year to  year, we limited our calculation of profit to a single year—2014.  Further, as our 2014 estimates of company expenses and profits are  an outcome of our effort to understand the issues surrounding the  inconsistent financial reporting by selected WYO companies and the  various factors that can affect company expenses and profit, these  estimates should not be taken to be a static or predictable indicator of  WYO company profits.
Third, two WYO companies stated that only expenses that could be  specifically identified as flood-related, including vendor fees, were  reported to NAIC on their Insurance Expense Exhibits. One WYO  company said that overhead expenses were not allocated to the  federal flood line because this line of business was not considered as  significant relative to the company’s other property insurance lines.  We did not obtain information from the companies that would allow us  to assess the significance of these unallocated overhead expenses to  our estimates of flood line profits.
Fourth, some of the companies we reviewed use affiliated companies  as vendors to service flood policies. As information on the affiliated  companies’ activities and profits was not available to us, we could not  determine the extent to which intercompany profits were reflected in  the expenses reported by these WYO companies and the extent to  which fees charged by these affiliated vendors might have exceeded  what otherwise would be charged by a third-party vendor.
We assessed the reliability of the FEMA data by reviewing audit  documentation from prior GAO engagements; and audit documentation  from and related reports issued by the Department of Homeland  Security’s external auditor supporting its work on WYO program financial  data included in the department’s fiscal year 2014 financial statements. In  addition, we performed electronic and manual data testing for missing  data, outliers, and other obvious errors, recalculated various types of  WYO compensation paid to WYO companies, and spoke with  knowledgeable agency officials about the data. For the NAIC data, we  reviewed related documentation and interviewed knowledgeable officials.  We assessed the reliability of the SNL Financial data by comparing it to  NAIC data to ensure its accuracy and consistency. We confirmed the  accuracy of the FEMA and NAIC data for the 10 selected companies by  requesting additional information from the companies. However, we did  not audit whether the FEMA and NAIC data were in accordance with  financial reporting standards and requirements. We determined that these  data were sufficiently reliable for the purpose of assessing the alignment  of compensation amounts with actual expenses and for estimating the  profits of a selection of WYO companies.

	Information on Over- and Underpayments

For our second objective, we reviewed data from FEMA documenting its  WYO company oversight processes. The data we reviewed pertain to the  triennial claims operation reviews, improper payment reviews (which the  agency conducts as required by the Improper Payments Information Act  of 2002, as amended), reinspection of claims, and biennial audits. We  assessed the reliability of the data by reviewing related FEMA  documentation on the data and interviewing knowledgeable agency  officials. We determined that these data were sufficiently reliable for the  purpose of reporting on FEMA’s oversight of claims and the results of  these reviews. We also reviewed other FEMA documentation on its  oversight of the claims process (such as FEMA’s Financial Control Plan  and Financial Control Plan Monitoring Procedures) to understand FEMA’s  oversight processes; a recent Senate Banking Committee investigation  report; and an OIG report that discussed issues associated with over- and  underpayment of claims. We interviewed FEMA officials about the  agency’s oversight of the claims process, potential causes for over- and  underpayments, and how they are resolved. We also interviewed the first  group of 10 selected WYO companies as well as stakeholders on their  views about the over- and underpayment of claims. Specifically, we  selected and interviewed 14 stakeholders representing a variety of  organization types with knowledge of flood insurance and the WYO  program. These stakeholders included three vendors with whom WYO  companies contract, and officials from 11 organizations comprised of  industry groups representing insurance companies and agents, and  academics. We interviewed officials from these entities to obtain diverse  perspectives on the possible extent and potential causes of over- and  underpayments of claims. Our work focused on over- and underpayments  and did not examine specific claims related to any specific event.

	Trade-offs of Potential Alternatives to WYO Arrangement

For our third objective, we reviewed a prior GAO report and conducted a  literature review to identify potential alternative approaches to FEMA’s  agreements with WYO companies for selling and servicing flood  insurance policies and examine trade-offs for these approaches. We  targeted our literature review to identify academic research and published  studies on flood insurance, broadly, and those that discussed alternatives  to the WYO arrangement. Our query identified around 60 document  summaries, from which we identified 19 for further analysis. Of the 19, all  provided background information on flood insurance and the NFIP  program, but none presented clear alternatives to the WYO arrangement.  From our prior work, we identified three potential alternative approaches  to the current WYO arrangement: (1) FEMA contracts with one or more  insurance companies; (2) FEMA contracts with one vendor; or (3) FEMA  contracts with multiple vendors and maintains the WYO network.
After initial interviews with WYO company representatives and  stakeholders indicated that alternatives to the current arrangement could  decrease the number of participating WYO companies, we analyzed  FEMA NFIP policy data to understand the geographic concentration of  NFIP policies written for homeowners by WYO companies. Our analysis  looked at policy data for residential policies under the current WYO  arrangement and the geographic concentration of market share for large  and small writers of NFIP coverage and the Direct Servicing Agent (DSA)  in different states and counties. As part of the analysis, we reviewed the  proportion of residential policies written by WYO companies and the DSA  in counties by population, based on county population categories used by  the Department of Agriculture’s Economic Research Service. For  purposes of this analysis, we considered large companies as those  among the 10 insurance groups whose members wrote the greatest  amount of NFIP coverage in 2014, the most recent year of available data  (our third group of 10 WYO companies selected). The methodology for  selecting these 10 WYO companies differed from the methodologies for  the previous two selections discussed. This third group of 10 insurers we  identified as large WYO companies accounted for an 80 percent  cumulative share of the federal flood market in 2014 (not including DSA  policies), with individual market shares ranging from approximately 2  percent to 20 percent. We considered all other insurers as small WYO  companies, with market shares ranging from 0 to 1.5 percent and a  cumulative market share of 20 percent. We tested the reliability of the  NFIP policy data by reviewing related documentation, conducting  electronic and manual data testing, and reviewing prior GAO  assessments of the data. We included only residential NFIP policies in  our analysis to focus our analysis on the market penetration related to  homeowners. In addition, we excluded from our analysis 1,506 policies  the geographic location of which could not be determined from FEMA’s  data. These policies accounted for 0.03 percent of the total number of  policies in the data set. We found these data reliable for the purpose of  identifying the geographic location of policies written by WYO companies  and the DSA.
In addition, we analyzed the proportion of NFIP residential policies written  by WYO companies and the DSA on a statewide basis for five states with  the highest total NFIP payments since 1978. Based on FEMA data as of  June 30, 2016, the five states with the highest total loss payments were  (in order of magnitude) Louisiana, Texas, New Jersey, New York, and  Florida. We assessed the reliability of these data by reviewing FEMA  data definitions and previous GAO assessments of the data. We  determined that these data were sufficiently reliable for the purpose of  identifying states with the highest total NFIP loss payments.
We also compared requirements of NFIP’s WYO arrangement and  FEMA’s DSA with some federal contract requirements. As previously  noted, we included several vendors among the 14 stakeholders with flood  insurance expertise we selected and interviewed to understand the trade- offs for the program being run by one vendor (the second alternative  approach we previously identified). Furthermore, we compared the  general structure of the insurance arrangement under the Department of  Agriculture’s Federal Crop Insurance Corporation with the WYO  arrangement, based on our prior work reviewing the crop insurance  program. We obtained perspectives from FEMA officials, representatives  of WYO companies (those selected based on net premiums written),  stakeholders with flood insurance expertise, and the Federal Insurance  Office of the Department of the Treasury on potential alternative  structures for the WYO program. We analyzed the tradeoffs of the  alternatives based on four primary factors: potential costs to participating  insurers, FEMA oversight, market penetration, and WYO company  participation. We identified these four factors based on our prior work  evaluating these arrangements and initial interviews with industry  participants. We also obtained their perspectives on other possible  improvements to NFIP.
We conducted this performance audit from April 2015 to December 2016  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Appendix II: Federal Contract Requirements and Write-Your-Own (WYO) Company and Stakeholder Views

In 2009 and again for this report, we identified potential alternative  administrative structures for the National Flood Insurance Program’s  (NFIP) Write-Your-Own program, which, if possible, could replace the  WYO arrangement, each of which involve participating companies (WYO  companies or vendors) becoming federal contractors. In the WYO  program, private insurers sell and service flood insurance policies and  adjust claims for NFIP under an arrangement with the Federal Emergency  Management Agency (FEMA). In general, executive agencies must award  contracts using full and open competition. In addition, contracts generally  must include certain clauses related to contract administration, such as  those that provide the government the ability to terminate contracts, as  well as those required by statute and executive orders that implement  U.S. policy.
The following analysis discusses requirements that generally apply to  contracts under the Federal Acquisition Regulation (FAR) and how they  compare to the WYO arrangement and FEMA’s contract with the Direct  Servicing Agent (DSA). The DSA is a FEMA contractor that writes NFIP  policies and provides an alternative when a WYO company is unable or  unwilling to write a flood insurance policy. The analysis also includes the  views of WYO companies about changing the WYO program  arrangement to a contract subject to the FAR.
Open competition. Executive agencies generally must seek to obtain  “full and open competition” in the contract award process (subject to  exception). This means that all responsible sources are permitted to  compete. The DSA selection process includes full and open  competition, but insurance companies do not compete to participate in  the WYO program. Instead, companies must apply to participate, and  FEMA approves the participation of companies that meet certain  criteria, rather than selecting companies based on their bids for a  contract. Requirements for a company to participate in the WYO  program include their experience in property and casualty insurance  lines, good standing with state insurance departments, and ability to  meet NFIP reporting requirements to adequately sell and service flood  insurance policies. FEMA officials told us that the agency does not  track how many companies failed to gain approval to participate in the  program, but noted that many companies failed to obtain approval  because they did not meet the requirement for having 5 years of  experience as a property and casualty insurer.
Bid protests and dispute processes. Federal acquisition regulations  and statutes provide for bid protests—where interested parties can,  for example, protest the award of a contract (e.g., if company A wins  the contract, company B can challenge the award). In addition, federal  acquisition statutes and regulations provide procedures and  requirements for resolving claims and disputes that arise during  contract performance. DSA contract awards can be thus protested.  The current WYO arrangement does not include a process to protest  FEMA’s selection of WYO companies, but if any misunderstanding or  dispute arises between a WYO and FEMA about any factual issue  under the arrangement or in relation to FEMA’s nonrenewal of a WYO  company’s participation in the program, the company can submit the  dispute to arbitration.
Government as a party to a contract. Federal contracts generally  provide an agency the right to unilaterally terminate the contract— either for the convenience of the government or for the default of the  contractor. Under a termination for convenience, the government can  completely or partially terminate the work under a contract when it is  in the government’s interest. Agencies generally can make certain  unilateral modifications to a contract during performance as long as  those changes fall within the contract’s scope. The DSA contract  allows the Department of Homeland Security to terminate the contract  if it would be in the best interest of the government in the event that a  contractor discovers a conflict of interest, or in the event a contractor  intentionally did not disclose a conflict of interest. In contrast, the  WYO arrangement does not explicitly provide agency control over  termination, but in the event that a company is unable or otherwise  fails to carry out its obligations under the arrangement, the company  must transfer the NFIP policies it issued to FEMA or propose that  another WYO company assume responsibility for those policies.
Contract type and contractor costs. Depending on the contract  type, the government may or may not have insight into contractor  costs. For example, a cost reimbursement type contract—where the  government pays for allowable incurred costs to the extent prescribed  in the contract—can only be used if the contractor’s accounting  system is adequate for determining costs applicable to the contract.  For fixed-price-type contracts, where full responsibility for all costs is  placed on the contractor, the government would not have visibility into  contract costs. For example, the DSA has a hybrid firm-fixed-price  and time-and-materials contract with FEMA with a 1-year base period  and 4 one-year option terms. FEMA pays a fixed price per policy on a  monthly basis based on the type and number of policies the company  services (standard, group flood, and severe repetitive loss), as long as  the company meets the performance requirements included in the  contract. FEMA also pays the DSA for line items based on the  amount of time and materials the company spends on certification and  accreditation activities. The contract allows the contractor to recoup  cost increases stemming from changes to the contract. For example,  the DSA sought and obtained a series of payments from FEMA for  extra work the contractor conducted as part of implementing the  Biggert-Waters Act and the Homeowner Flood Insurance and  Affordability Act. As discussed in more detail in the report, the WYO  arrangement does not prescribe detailed cost and pricing guidance to  companies but generally compensates WYO companies using proxies  to determine rates at which it pays them. For example, the  arrangement provides that WYO companies may retain 15 percent of  net written premiums as the allowance for insurance agent  commissions.
Ethical practices and statutory compliance. Depending on the type  of contract, there are also a variety of requirements imposed under  statutes and executive orders that can have major effects on business  practices. These include provisions related to bribery, false claims,  false statements, conflicts of interest, and kickbacks; lobbying  restrictions; equal opportunity and affirmative action requirements;  subcontracting and sourcing; small business and veteran  participation; and compliance with labor standards and drug-free  workplace requirements. For example, the DSA contract requires the  company to use Department of Labor wage determinations and  outlines the types of benefits employees must receive, including  health and welfare benefits, paid vacation, and paid holidays. The  current WYO arrangement does not speak to all of the factors outlined  above, but provides that a WYO shall not discriminate against any  applicant for insurance because of race, color, religion, sex, age,  handicap, marital status, or national origin.
Representatives of seven of 10 WYO companies we interviewed (for all  three objectives, as described in app. I) opposed WYO companies  becoming federal contractors, citing burdensome requirements. Of the  other three, one said the costs of becoming a federal contractor would  depend on the structure of the contract, and the other two did not  comment. Representatives of one WYO company said a positive aspect  of having a contract is that it could provide a mechanism for establishing  an annual maximum to FEMA’s possible changes to the contract for NFIP  regulatory changes. This could allow WYO companies or vendors to  recoup some costs of implementing unexpected changes to the program.  The DSA contractor has the ability to recoup the expenses it incurs in  response to changes, for example to law or regulation, which affect its  performance of the services under the contract.
FEMA officials said WYO companies historically had opposed structuring  the WYO program as a federal contractual relationship between FEMA  and WYO companies since the WYO program was established and said a  federal contract might not be compatible with the structure of the  insurance industry and how WYO companies deliver coverage. In  addition, they said that as a federal contractor, a WYO company or  vendor would need to convert its information technology systems to  accommodate new federal security requirements, which would be time  consuming and costly.
Stakeholders who commented about the use of a federal contract for the  WYO program had mixed perspectives. We selected and interviewed 14  stakeholders with flood insurance expertise, based on their knowledge of  flood insurance and the WYO program. One stakeholder said FEMA’s  oversight might improve because the agency would have more authority  to direct how WYO companies administered claims. One stakeholder—a  vendor—said that although the current arrangement is not a federal  contract, it can feel like a contractual agreement for WYO companies  because the financial control plan outlines requirements for participating  companies. Another stakeholder said that use of a federal contract for the  WYO program could create more stringent requirements for WYO  companies and could lead to declines in their participation and NFIP  market penetration, and result in the DSA having to administer more  policies.

Appendix III: Geographic Concentration of National Flood Insurance Program (NFIP) Residential Policies Written by Write-Your- Own (WYO) Companies

Our analysis of three potential alternatives to the current WYO  arrangement found that each alternative could decrease the number of  participating WYO companies. We analyzed NFIP policy data to  understand the geographic concentration of WYO company market share  under the current arrangement, including what proportion of NFIP  residential coverage large and small WYO companies and the Direct  Servicing Agency (DSA) wrote in counties and in states with high NFIP  losses. We included only residential NFIP policies in our analysis to focus  on market share related to homeowners. We classified WYO companies  as large or small, with large companies being the top 10 WYO companies  in terms of NFIP market share in 2014. The DSA is a Federal  Emergency Management Agency (FEMA) contractor that writes NFIP  policies and provides an alternative when a WYO company is unable or  unwilling to write a flood insurance policy.
We compared the share of NFIP residential policies written by WYO  companies nationwide to those written by the DSA. As shown in figure 3,  in more than 83 percent of counties where residential NFIP coverage was  present, WYO companies wrote more than half of all policies.
In contrast, the DSA wrote at least 50 percent of NFIP residential policies  in 1.8 percent of counties, as shown in figure 4. In 17 counties across 11  states, the DSA wrote 100 percent of the NFIP residential policies, which  accounted for 21 policies total.
As shown in table 13, 81 percent of NFIP residential policies were written  for properties in metropolitan counties (areas with populations of 250,000  or more). Large WYO companies accounted for the majority of the  policies in states, territories, and the District of Columbia (70 percent),  while small WYO companies and the DSA accounted for smaller shares  of the market (16 percent and 14 percent, respectively). We also  analyzed the proportion of residential policies written in counties by  different categories (population and urban and rural). Large WYO  companies wrote more than half of all policies in each category. The  share for small WYOs ranged from 15 percent to 23 percent (with the  highest share in sparsely populated rural counties) and the DSA’s share  ranged from 13 percent to 18 percent in the different areas.
In addition to reviewing the data on a nationwide basis, we analyzed the  proportion of NFIP residential policies written by WYO companies and the  DSA for five states with the highest total NFIP payments according to  FEMA historical claims data since 1978. Based on FEMA data as of June  30, 2016, the five states with the highest total loss payments were (in  order of magnitude) Louisiana, Texas, New Jersey, New York, and  Florida.
In each of these states, at least 95 percent of NFIP residential policies  were located in metropolitan areas, with the majority of policies located in  counties in metropolitan areas with a population of 1 million or more.
In Louisiana, large WYO companies had 55 percent market share of  residential policies, the DSA had 27 percent (its highest share among  the five states), and small WYO companies had 18 percent.
In New York and New Jersey, large WYO companies achieved their  highest market share of NFIP residential policies among the five  states—78 percent and 81 percent respectively. Additionally, county- level shares for large WYO companies in New York ranged from 60  percent to 93 percent (small WYO companies had 3 percent–21  percent and the DSA had 4 percent–27 percent).
In Florida, large WYO companies had 70 percent of the NFIP  residential market and small WYOs had 22 percent (their highest  share among the five states). Large WYO companies wrote NFIP  residential coverage in all Florida counties, with county-level shares  ranging from 39 percent to 88 percent, (and from 11 percent to 50  percent for small WYO companies and from 2 percent to 20 percent  for the DSA).

Appendix IV: Comments from Department of Homeland Security

Appendix V: GAO Contacts and Staff Acknowledgments

	GAO Contacts

	Staff Acknowledgments

In addition to the contact named above, Allison Abrams (Assistant  Director); Rhonda Rose (Analyst-in-Charge); Christina S. Cantor; Heather  Chartier; Pamela R. Davidson; May M. Lee; Scott E. McNulty; John  Mingus; Marc W. Molino; Patricia Moye; and Barbara Roesmann made  key contributions to this report.

Summary:
Why GAO Did This Study

Private insurers (WYO companies) sell and service flood policies and adjust claims for NFIP under an arrangement with FEMA. In GAO-09-455 , GAO made recommendations on FEMA's WYO compensation methodology and data quality. The Biggert-Waters Act built on these recommendations and required FEMA to develop a methodology for determining appropriate amounts WYO companies should be reimbursed. GAO was asked to review the status of FEMA efforts. This report examines, among other issues, (1) the extent to which FEMA revised compensation practices, and (2) trade-offs of potential alternatives to the WYO arrangement. GAO reviewed laws and regulations, analyzed FEMA data and data on expenses reported to NAIC for 2008–2014 (most recent available), and interviewed FEMA and NAIC officials, stakeholders (11 organizations with flood insurance expertise, three vendors), and 10 selected WYO companies with varying NFIP premium bases. To compare FEMA compensation with actual expenses, GAO examined information on accounting and reporting practices from a second selection of 10 WYO companies (in this case, insurers wiithin10 insurance groups) that received about 60 percent of compensation in 2008–2014.

What GAO Found

The Federal Emergency Management Agency (FEMA) has yet to revise its compensation practices for Write-Your-Own (WYO) companies to reflect actual expenses as required by the Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act), and as GAO recommended in 2009. FEMA continues to rely on insurance industry expense information for other lines of property insurance to set compensation rates for WYO companies. Efforts by FEMA, the National Association of Insurance Commissioners (NAIC)—which collects data by line of insurance from insurance companies—and the WYO companies have resulted in some improvements to financial data on National Flood Insurance Program (NFIP) expenses that WYO companies report to NAIC. But GAO found inconsistencies among how 10 selected WYO companies (which received about 60 percent of the compensation FEMA paid in 2008–2014) reported federal flood data to NAIC that limit the usefulness of these data for determining expenses and setting compensation rates. For example, GAO analysis showed that adjusting for inconsistencies due to unreported expenses significantly reduced WYO company profits. Consequently, without quality data on actual expenses, FEMA continues to lack the information it needs to incorporate actual flood expense data into its compensation methodology as well as determine how much profit WYO companies make and whether its compensation payments are appropriate. FEMA has not clarified what other analyses it will undertake to address GAO 2009 recommendations concerning data quality. GAO also found the ways in which WYO companies operate, including how companies compensate agents and third-party vendors (with which some companies contract to conduct some or all of the management of their NFIP policies) can affect a company's expenses and profits. Considering company characteristics would allow FEMA to more effectively develop its compensation methodology and determine the appropriate amounts to reimburse WYO companies as required by the Biggert-Waters Act.
According to WYO companies and stakeholders, the current WYO arrangement and three potential alternatives GAO identified all involve trade-offs. Private insurers become WYO companies by signing a Financial Assistance/Subsidy Arrangement with FEMA and FEMA annually publishes terms for participation in the WYO program, including amounts companies will be paid for expenses. The current arrangement includes benefits for consumers from competition among approximately 75 WYO companies, but poses oversight challenges for FEMA due to the large number of companies. The three potential alternatives involve FEMA contracting with (1) one or more insurance companies to sell and service flood policies; (2) one vendor that would sell policies through agents and insurance companies would not be involved; or (3) multiple vendors to service policies while maintaining the WYO network to market and sell flood policies. All three potential alternatives would involve FEMA contracting with either WYO companies or vendors as federal contractors, a status that most WYO company representatives cited as creating more regulatory burden because of federal contract requirements. Representatives of most WYO companies and several stakeholders GAO interviewed preferred the current arrangement because of its predictability and noted that this characteristic would continue to encourage WYO company participation.

What GAO Recommends

GAO maintains that its 2009 recommendations remain valid and will help FEMA meet Biggert-Waters Act requirements. In this report, GAO recommends that FEMA take into account company characteristics when developing the new WYO compensation methodology. FEMA agreed with the recommendation.