Background

The NFIP provides property insurance for flood victims, maps the  boundaries of the areas at highest risk of flooding, and offers incentives  for communities to adopt and enforce floodplain management regulations  and building standards to reduce future flood damage. The effective  integration of all three of these elements is needed for the NFIP to achieve  its goals. These include:    providing property flood insurance coverage for the many property  owners who would benefit from such coverage;  reducing taxpayer-funded disaster assistance for property damage  when flooding strikes; and  reducing flood damage to properties through floodplain management  that is based on accurate, useful flood maps and the enforcement of  relevant building standards.
Floods are the most common and destructive natural disaster in the  United States. According to NFIP statistics, 90 percent of all natural  disasters in the United States involve flooding. Our analysis of FEMA data  found that over the past 25 years, about 97 percent of the U.S. population  lived in a county that had at least one declared flood disaster, and 45  percent lived in a county that that had six or more flood disaster  declarations. However, flooding is generally excluded from homeowner  insurance policies that typically cover damage from other losses, such as  wind, fire, and theft. Because of the catastrophic nature of flooding and  the difficulty of adequately predicting flood risks, as well as the fact that  those who are most at risk are the most likely to buy coverage, private  insurance companies have largely been unwilling to underwrite and bear  the risk of flood insurance.
The NFIP was established by the National Flood Insurance Act of 1968 to  provide policyholders with some insurance coverage for flood damage, as  an alternative to disaster assistance, and to try to reduce the escalating  costs of repairing flood damage. In creating the NFIP, Congress found that  a flood insurance program with the “large-scale participation of the  Federal Government and carried out to the maximum extent practicable  by the private insurance industry is feasible and can be initiated.” In  keeping with this purpose, 92 private insurance companies were  participating in the WYO program as of September 2007. NFIP pays these  insurers fees to sell and service policies and adjust and process claims.  FEMA, which is within the Department of Homeland Security (DHS), is  responsible for the oversight and management of the NFIP. We reported in  September 2007 that about 68 FEMA employees, assisted by about 170  contract employees, manage and oversee the NFIP and the National Flood  Insurance Fund, into which premiums are deposited and claims and  expenses are paid. As of April 2007, the NFIP was estimated to have over  5.4 million policies in about 20,300 communities. To ensure that NFIP can  cover claims after catastrophic events, FEMA has statutory authority to  borrow funds from the Treasury to keep the program solvent.
According to FEMA, an estimated $1.2 billion in flood losses are avoided  annually because communities have implemented the NFIP’s floodplain  management requirements. Flood maps identify the boundaries of the  areas that are most at risk of flooding. Property owners whose properties  are within special flood hazard areas and who have mortgages from a  federally regulated lender are required to purchase flood insurance for the  amount of their outstanding mortgage balance, up to the maximum policy  limit of $250,000 for single-family homes. According to FEMA, Excess  Flood Protection coverage above these amounts is available in the private  insurance markets. Personal property coverage is available for contents,  such as furniture and electronics, for an additional $100,000. Business  owners may purchase up to $500,000 of coverage for buildings and  $500,000 for contents. The owners of properties with no mortgages or  properties with mortgages held by lenders who are not federally regulated  are not required to buy flood insurance, even if the properties are in a  special flood hazard area. Optional lower-cost coverage is available under  the NFIP to protect homes in areas of low to moderate risk.

	The NFIP’s Financial Structure is Not Designed to be Actuarially Sound

To the extent possible, the NFIP is designed to pay operating expenses  and flood insurance claims with premiums collected on flood insurance  policies rather than with tax dollars. However, as we have reported, the  program, by design, is not actuarially sound because Congress authorized  subsidized insurance rates for policies covering some properties in order  to encourage communities to join the program. As a result, the program  does not collect sufficient premium income to build capital to cover long- term future flood losses. Moreover, the premiums collected are often not  sufficient to pay for losses even in years without catastrophic flooding.  This shortfall is exacerbated by repetitive loss properties that file repeated  claims with NFIP.
FEMA’s current debt to the Treasury—over $17.5 billion—is almost  entirely for payment of claims from the 2005 hurricanes. Legislation  increased FEMA’s borrowing authority from a total of $1.5 billion prior to  Hurricane Katrina to $20.8 billion in March 2006. As we have testified  previously, it is unlikely that FEMA will be able to repay a debt of this size  and cover future claims, given that the program generates premium  income of about $2 billion a year, which must first cover ongoing loss and  expenses.
To date, the program has gone through almost two full seasons without a  major hurricane, and according to FEMA about $524 million of premium  income has been used to pay interest on the debt owed to the Treasury in  2006. FEMA officials also noted that because fiscal year 2007 had been a  relatively low flood loss year, the agency should be able to pay its next  scheduled interest payment from premium income and would not have to  borrow additional funds from Treasury to pay interest on its outstanding  debt. Attention has been focused on the extent of the federal  government’s exposure for claims payments in future catastrophic loss  years and on ways to improve the program’s financial solvency. For  example, some in Congress have recommended phasing in actuarial rates  for vacation homes and nonresidential properties.

		Policy Subsidies Significantly Reduce NFIP’s Income from Premiums

About 25 percent of NFIP’s over 5.4 million policies have premiums that  are substantially less than the true risk premiums. Properties constructed  before their communities joined the NFIP and were issued a Flood  Insurance Rate Map (or FIRM), which shows the community’s flood risk,  are eligible for subsidized rates. These policyholders typically pay  premiums that represent about 35 to 40 percent of the true risk premium.
In January 2006, FEMA estimated a shortfall in annual premium income  because of policy subsidies at $750 million. In response to concerns about  the historical basis for the subsidies and questions about the  characteristics of the homes receiving subsidies, we were asked by the  Ranking Member of this committee to collect certain demographic  information about the portfolio of subsidized properties and property  owners. This work will provide information on residential pre-FIRM  subsidized properties in selected counties of the country. To the extent  that reliable data is available, we plan to capture the variations that exist  by type of flooding (e.g., coastal or riverine), fair market values for  subsidized and nonsubsidized properties in each location, average income  levels for each county, claims data for subsidized and nonsubsidized  properties in each location, and the mitigation efforts being used.  Our  work will build upon the work of the Congressional Budget Office on  values of properties in the NFIP.
As part of this review, we are also examining the extent to which FEMA’s  nonsubsidized rates are truly actuarially based. We will assess how NFIP  sets rates for its nonsubsidized and subsidized premiums, determine the  total premiums the NFIP collects, and compare that amount to claims and  related costs. Our analysis of FEMA’s premiums and claims data should  help provide insights into how FEMA sets rates.
We also have work under way that will provide a description of financial  and statistical trends, by flood zone, for the past 10 years. Specifically, we  have been asked to describe average premium and claim amounts by flood  zone, FEMA’s estimates of likely losses, and the extent to which losses are  attributable to repetitive loss properties or hurricanes. We will also  describe the extent to which flood-damaged properties have been  purchased through NFIP-funded mitigation programs. However, our ability  to report on these issues will depend on the quality of FEMA’s claims data.  Finally, we are evaluating the adequacy of FEMA’s procedures for  monitoring selected contracts that support the NFIP.

		Repetitive Loss Properties Continue to be a Drain on the Program

In reauthorizing the NFIP in 2004, Congress noted that repetitive loss  properties—those that had resulted in two or more flood insurance claims  payments of $1,000 or more over 10 years—constituted a significant drain  on the resources of the NFIP. These repetitive loss properties are  problematic not only because of their vulnerability to flooding, but also  because of the costs of repeatedly repairing flood damages. Although  these properties account for only about 1 percent of NFIP-covered  properties, they account for between 25 and 30 percent of claims. As of  September 2007 over 70,000 repetitive loss properties were insured by the  NFIP.
The 2004 Flood Insurance Reform Act authorized a 5-year pilot program to  encourage mitigation efforts on severe repetitive loss properties in the  NFIP. According to FEMA, as of September 2007 about 8,100 properties  insured by the NFIP were categorized as severe repetitive loss properties.  Under the pilot, FEMA is required to adjust its rules and rates to ensure  that homeowners pay higher premiums if they refuse an offer to mitigate  the property. The pilot program was funded in fiscal year 2006, and  according to FEMA officials, FEMA has not yet developed the regulations,  guidance, and administrative documents necessary for implementation.

		Remapping Is Creating A New Generation of Properties That May Not Pay Risk-based Premiums

FEMA is also creating a new generation of properties that may not pay  risk-based premiums. Properties that are remapped into higher flood risk  areas may be able to keep or “grandfather” the nonsubsidized rates  associated with their risk level prior to being remapped into a higher flood  risk area. As a result, eligible property owners who have an existing policy  or who purchase new flood insurance policies before they are mapped into  higher-risk areas will go on paying the same nonsubsidized premium rate.  Moreover, these grandfathered rates can be permanent. Although this  option is a major selling point of encouraging broader participation in the  program, such actions may further erode the actuarial soundness and  financial stability of the program.

	FEMA Has Expanded Participation in the NFIP, but Ensuring Compliance with Requirements Need Ongoing Attention

From 1968 until the adoption of the Flood Disaster Protection Act of 1973,  buying flood insurance was voluntary. However, voluntary participation in  the NFIP was low, and many flood victims did not have insurance to repair  damages from floods in the early 1970s. In 1973 and again in 1994,  Congress enacted laws requiring that some property owners in special  flood hazard areas buy NFIP insurance. The owners of properties with no  mortgages or properties with mortgages held by lenders that were not  federally regulated were not, and still are not, required to buy flood  insurance, even if the properties are in special flood hazard areas.
As we have reported in the past, viewpoints differ about whether lenders  were complying with the flood insurance purchase requirements, primarily  because the officials we spoke with did not use the same types of data to  reach their conclusions. For example, federal bank regulators and  lenders based their belief that lenders were generally complying with the  NFIP’s purchase requirements on regulators’ examinations and reviews  that were conducted to monitor and verify lender compliance. In contrast,  FEMA officials believed that many lenders frequently were not complying  with the requirements, an opinion that they based largely on estimates  computed from data on mortgages, flood zones, and insurance policies;  limited studies on compliance; and anecdotal evidence indicating that  insurance was not always purchased when it was required. At the time of  our report in 2002, neither side was able to substantiate these claims with  statistically sound data. However, a FEMA-commissioned study of  compliance with the mandatory purchase requirement estimated that  compliance with purchase requirements, under plausible assumptions,  was 75 to 80 percent in special flood hazard areas for single-family homes  that had a high probability of having a mortgage. The analysis conducted  did not provide evidence that compliance declined as mortgages aged.  At  the same time, the study showed that about half of single-family homes in  special flood hazard areas had flood insurance.
The 2006 study also found that while one-third of NFIP policies were  written outside of special flood hazard areas, the market penetration rate  was only about 1 percent. Yet according to FEMA about half of all flood  damage occurs outside of high risk areas.  FEMA has efforts under way to  increase participation by improving the quality of information that is  available on the NFIP and on flood risks and by marketing to retain  policyholders currently in the program. In October 2003, FEMA contracted  for a new integrated mass marketing campaign called “FloodSmart” to  educate the public about the risks of flooding and to encourage the  purchase of flood insurance. Marketing elements being used include direct  mail, national television commercials, print advertising, and Web sites that  are designed for communities, consumers, and insurance agents.  According to FEMA officials, in the little more than 3 years since the  contract began, net policy growth has been almost 24 percent, and policy  retention has improved from 88 percent to almost 92 percent. However,  the success of the program will be measured by retention rates as  policyholders’ memories of the devastation from Hurricane Katrina begin  to fade over time.

	FEMA Faces Challenges in Producing Accurate, Updated Flood Maps

Accurate flood maps that identify the areas that are at greatest risk of  flooding are the foundation of the NFIP. These maps, which show the  extent of flood risk across the country, allow the program to determine  high-risk areas for designation both as special hazard zones and as areas  that can benefit the most from mitigation. Flood maps must be periodically  updated to assess and capture changes in the boundaries of floodplains  resulting from community growth, development, erosion, and other factors  that affect the boundaries of areas at risk of flooding. The maps are  principally used by (1) the communities participating in the NFIP, to adopt  and enforce the program’s minimum building standards for new  construction within the maps’ identified floodplains; (2) FEMA, to develop  flood insurance policy rates based on flood risk; and (3) federal regulated  mortgage lenders, to identify those property owners who are statutorily  required to purchase federal flood insurance. As we reported in 2004,  FEMA has embarked on a multiyear effort to update the nation’s flood  maps at a cost in excess of $1 billion. At that time we noted that NFIP  faced major challenges in working with its contractor and state and local  partners to produce accurate digital flood maps.
FEMA has taken steps to improve these working relationships by  developing a number of guidelines and procedures. According to FEMA,  the agency has developed a plan for prioritizing and delivering modernized  maps nationwide, including developing risk-based mapping priorities.  Moreover, FEMA has recognized that a maintenance program will be  needed to keep the maps current and relevant. For example, several  strategies are under consideration for maintaining map integrity, including  reviewing the flood map inventory every 5 years, as required by law;  updating data and maps more regularly, as needed; addressing any unmet  flood mapping needs and assessing the quality and quantity of maps; and  examining risk management more broadly. However, the effectiveness of  these strategies will depend on available funding and FEMA’s ongoing  commitment to ensuring the integrity of the maps. As of September 2007  FEMA had remapped 34 percent of its maps.

	FEMA’s Monitoring and Oversight Have Identified Specific Problems but Have Not Produced Comprehensive Information on Overall Program Performance

To meet its monitoring and oversight responsibilities, FEMA is required to  conduct periodic operational reviews of the private insurance companies  that participate in the WYO program. In addition, FEMA’s program  contractor is required to check the accuracy of claims settlements by  doing quality assurance reinspections of a sample of claims adjustments  for every flood event. For operational reviews, FEMA examiners must  thoroughly examine the companies’ NFIP underwriting and claims  settlement processes and internal controls, including checking a sample of  claims and underwriting files to determine, for example, whether a  violation of procedures has occurred, an incorrect payment has been  made, or a file does not contain all required documentation. Separately,  FEMA’s program contractor is responsible for conducting quality  assurance reinspections of a sample of claims adjustments for specific  flood events in order to identify, among other things, expenses that were  paid that were not covered and covered expenses that were not paid. In  our December 2006 report, we found that a new claims handling process  aided the claims handling following the 2005 hurricane season and  resulted in few complaints. As a result, 95 percent of claims were closed  by May 2006, a time frame that compared favorably with those of other,  smaller recent floods. However, we noted that FEMA had not  implemented a recommendation from a prior report that it do quality  reinspections based on a random sample of all claims. We also found that  FEMA had not analyzed the overall results of the quality reinspections  following the 2005 hurricane season. In response, FEMA has agreed to (1)  analyze the overall results of the reinspection reports on the accuracy of  claims adjustments for future events, and (2) plan its reinspections based  on a random sample of claims.
FEMA faces challenges in providing effective oversight of the insurance  companies and thousands of insurance agents and claims adjusters that  are primarily responsible for the day-to-day process of selling and  servicing flood insurance policies. For example, as we reported in  September 2007, 94 WYO insurance companies had written 96 percent of  the flood insurance policies for the NFIP as of December 2006, up from the  48 companies that were writing 50 percent of the policies in 1986. We also  reported that for fiscal years 2004 through 2006, total operating costs that  FEMA paid to the WYO insurance companies ranged from $619 million to  $1.6 billion, or from more than a third to almost two-thirds of the total  premiums paid by policyholders to the NFIP, as a result of unprecedented  flood losses caused by the 2005 hurricanes. FEMA regulations require each  participating company to arrange and pay for audits by independent  certified public accounting firms. However, many WYO insurance  companies have not complied with the schedule in recent years. For  example, for fiscal years 2005 and 2006, 5 of 94 participating companies  had biennial financial statement audits performed. In response to our  recommendations, FEMA has agreed to take steps to ensure that it has  reasonable estimates of the actual expenses that WYO insurance  companies incurred to help determine whether payments for services are  appropriate and that required financial audits are performed.
Building on this body of work, we are beginning a follow-up engagement  that will analyze the expenses WYO insurance companies incur from  selling and servicing NFIP policies and determine whether the total  operating costs paid to the companies are equitable relative to those costs.  We will also examine how FEMA oversees the WYO program, including  reinspecting claims and performing operational reviews. Finally, we will  evaluate alternatives for selling and servicing flood insurance policies and  processing claims.
We are also completing an engagement that looks at the inherent conflict  of interest that exists when a WYO insurance company sells both property- casualty and flood policies to a single homeowner who is subject to a  multiple peril event such as a hurricane. We testified before the House  Committees on Financial Services and Homeland Security in June 2007  about our preliminary views on the sufficiency of data available to and  collected by FEMA to ensure the accuracy of claims payments. FEMA has  determined that it does not have the authority to collect wind damage  claims data from WYO insurance companies, even when the insurer  services both the wind and flood policies on the same property. Hence,  FEMA generally does not know the extent to which wind may have  contributed to total property damages. However, FEMA officials do not  believe that the agency needs to know the dollar amount of wind damages  paid by a WYO insurance company to verify the accuracy of a flood claim.  While they may not need this information for many flood claims, the  inherent conflict of interest that exists when a single WYO insurance  company is responsible for adjusting both the wind and flood claim on a  single property calls for the institution of strong internal controls to  ensure the accuracy of FEMA’s claims payments. Without internal controls  that include access to the entire claim file for certain properties (both  wind and flood), FEMA’s ability to confirm the accuracy of certain flood  claims may be limited. While the DHS Inspector General is currently  examining this issue by reviewing both wind and flood claims on selected  properties. Its interim report, issued in July 2007, was generally  inconclusive.

	Concluding Observations

As our prior work reveals, FEMA faces a number of ongoing challenges in  managing the NFIP that, if not addressed, will continue to threaten the  program’s financial solvency even if the program’s current debt is forgiven.  As we noted when we placed the NFIP on the high-risk list in 2006,  comprehensive reform will likely be needed to stabilize the long-term  finances of this program. Our ongoing work is designed to provide FEMA  and Congress with useful information to help assess ways to improve the  sufficiency of NFIP’s financial resources and its current funding  mechanism, mitigate expenses from repetitive loss properties, increase  compliance with mandatory purchase requirements, and expedite FEMA’s  flood map modernization efforts.
As you well know, placing the program on more sound financial footing  involves a set of highly complex, interrelated issues that are likely to  involve many trade-offs. For example, increasing premiums to better  reflect risk would put the program on a sounder financial footing but  could also reduce voluntary participation in the program or encourage  those who are required to purchase flood insurance to limit their coverage  to the minimum required amount (i.e., the amount of their outstanding  mortgage balance). As a result, taxpayer exposure for disaster assistance  resulting from flooding could increase. As we have said before, meeting  the NFIP’s current challenges will require sound data and analysis and the  cooperation and participation of many stakeholders.
Mr. Chairman and Members of the Committee, this concludes my prepared  statement. I would be pleased to respond to any questions you and the  Committee Members may have.

	GAO Contact and Staff Acknowledgments

Contact point for our Office of Congressional Relations and Public Affairs  may be found on the last page of this statement. For further information  about this testimony, please contact Orice M. Williams at (202) 512-8678 or  williamso@gao.gov. This statement was prepared under the direction of  Andy Finkel. Key contributors were Emily Chalmers, Martha Chow, Nima  Patel Edwards, Grace Haskins, Lisa Moore, and Roberto Pinero.
This is a work of the U.S. government and is not subject to copyright protection in the  United States. The published product may be reproduced and distributed in its entirety  without further permission from GAO. However, because this work may contain  copyrighted images or other material, permission from the copyright holder may be  necessary if you wish to reproduce this material separately.

Summary:
Why GAO Did This Study

The National Flood Insurance Program (NFIP), established in 1968, provides property owners with some insurance coverage for flood damage. The Federal Emergency Management Agency (FEMA) within the Department of Homeland Security is responsible for managing the NFIP. Given the challenges facing the NFIP and the need for legislative reform to ensure the financial stability and ongoing viability of this program, GAO placed the NFIP on its high-risk list in March 2006. This testimony updates past work and provides information about ongoing GAO work on issues including (1) NFIP's financial structure, (2) the extent of compliance with mandatory requirements, (3) the status of map modernization efforts, and (4) FEMA's oversight of the NFIP. Building on our previous and ongoing work on the NFIP, GAO collected data from FEMA to update efforts, including information about claims, policies, repetitive loss properties, and mitigation efforts.

What GAO Found

The most significant challenge facing the NFIP is the actuarial soundness of the program. As of August 2007, FEMA owed over $17.5 billion to the U.S. Treasury. FEMA is unlikely to be able to pay this debt, primarily because the program's premium rates have been set to cover an average loss year, which until 2005 did not include any catastrophic losses. This challenge is compounded by the fact that some policyholders with structures that were built before floodplain management regulations were established in their communities generally pay premiums that represent about 35 to 40 percent of the true risk premium. Moreover, about 1 percent of NFIP-insured properties that suffer repetitive losses account for between 25 and 30 percent of all flood claims. FEMA is also creating a new generation of "grandfathered" properties--properties that are mapped into higher-risk areas but may be eligible to receive a discounted premium rate equal to the nonsubsidized rate for their old risk designation. Placing the program on a more sound financial footing will involve trade-offs, such as charging more risk-based premiums and expanding participation in the program. The NFIP also faces challenges expanding its policyholder base by enforcing compliance with mandatory purchase requirements and promoting voluntary purchase by homeowners who live in areas that are at less risk. One recent study estimated that compliance with the mandatory purchase requirement was about 75 to 80 percent but that penetration elsewhere in the market was only 1 percent. Since 2004, FEMA has implemented a massive media campaign called "FloodSmart" to increase awareness of flooding risk nationwide by educating everyone about the risks of flooding and encouraging the purchase of flood insurance. While the numbers of policyholders increased following Hurricane Katrina, it is unclear whether these participants will remain in the program as time goes on. The impact of the 2005 hurricanes highlighted the importance of up-to-date flood maps that accurately identify areas at greatest risk of flooding. These maps are the foundation of the NFIP. In 2004 FEMA began its map modernization efforts, and according to FEMA, about 34 percent of maps have been remapped. Completing the map modernization effort and keeping these maps current is also going to be an ongoing challenge for FEMA. Finally, FEMA also faces significant challenges in providing effective oversight over the insurance companies and thousands of insurance agents and claims adjusters who are primarily responsible for the day-to-day process of selling and servicing flood insurance policies. As GAO recommended in a an interim report issued in September 2007, FEMA needs to take steps to ensure that it has a reasonable estimate of actual expenses that the insurance companies incur to help determine whether payments for services are appropriate and that required financial audits are performed. GAO, in its ongoing work, plans to further explore FEMA oversight of the private insurance companies and the cost of selling and servicing NFIP flood policies.