Before the Subcommittee on Housing and Community

Opportunity, Committee on Financial Services, House

of Representatives

United States General Accounting Office

GAO

For Release on Delivery

Expected at 10:00 a.m.

Thursday

July 19, 2001

FLOOD INSURANCE

Information on the

Financial Condition of the

National Flood Insurance

Program

Statement of Stanley J. Czerwinski

Director, Physical Infrastructure Issues

GAO-01-992T
Page 1 GAO-01-992T National Flood Insurance Program

Madam Chairwoman and Members of the Subcommittee:

We are here today to discuss the financial condition of the National Flood

Insurance Program administered by the Federal Emergency Management

Agency’s (FEMA) Federal Insurance and Mitigation Administration

(Administration). The program, along with low-interest loans provided by

the Small Business Administration and individual and family grants

provided by FEMA, is a major component of the federal government’s

efforts to provide flood-related disaster assistance. Floods have been, and

continue to be, the most destructive natural hazard in terms of economic

loss to the nation, according to FEMA. From fiscal years 1969 through

2000, the program paid about $10 billion in insurance claims, primarily

from premiums collected from program policyholders. The recent floods

in the Midwest, Louisiana, Texas, and West Virginia have again

demonstrated the destructive nature of this hazard to the nation.

Prior to the flood insurance program’s inception in 1968, flood insurance

was generally not available from private insurance companies. The

National Flood Insurance Act of 1968 (P.L. 90-448) established the

program to identify flood-prone areas, make flood insurance available to

property owners living in communities that joined the program, encourage

floodplain management efforts to mitigate flood hazards, and reduce

federal expenditures for disaster assistance. As you know Madam

Chairwoman, we last provided testimony to this Subcommittee on this

issue on October 27, 1999.1

Our statement today will provide information on (1) the financial results of

the program’s operations since fiscal year 1993, (2) the actuarial

soundness of the program, and (3) the impact of repetitive losses (multiple

loss properties) and FEMA’s strategies for reducing those losses.

The following summarizes our work:

• While the magnitude of flood damage varies considerably from year to

year, the program has operated “in the black” during the last 2 fiscal years

following a period of sustained losses to the program from severe

flooding. In March 1994, we reported that, while sufficient to cover flood

losses experienced at that time, overall income from the program’s

 1

Flood Insurance: Information on Financial Aspects of the National Flood Insurance

Program (GAO/T-RCED-00-23, Oct. 27, 1999).
Page 2 GAO-01-992T National Flood Insurance Program

premiums was not sufficient to build reserves to meet future expected

flood losses.2

 Therefore, we concluded that it was inevitable that losses

from claims and the program’s expenses would exceed the funds available

to the program in some years. During the 8-year period from fiscal years

1993 through 2000, the program experienced losses from floods that were

greater than the premiums collected from policyholders. Cumulative

operating losses to the program (program income less program costs)

totaled about $843 million during this 8-year period. During the first 6

years of that period, cumulative operating losses totaled about $1.56

billion and required FEMA to borrow from the U.S. Treasury to help

finance these losses. During fiscal years 1999 and 2000, however, program

revenues exceeded program costs by about $720 million, enabling the

Administration to repay the funds it had borrowed from the U.S. Treasury

to finance the program’s earlier losses.

• The program is not actuarially sound because it does not collect sufficient

premium income to build reserves to meet the long-term future expected

flood losses.3

 The program, by design, is not actuarially sound because the

Congress authorized subsidized insurance rates to be made available for

policies covering certain structures to encourage communities to join the

program. Because about 30 percent of the policies were subsidized as of

2000, overall premium income is not sufficient to build reserves to meet

future expected flood losses. The Administration’s annual target for the

program’s overall premium income is at least the amount of losses and

expenses in an average historical loss year, which approximates the

average annual losses experienced under the program since 1978. Since no

catastrophic loss years have occurred since 1978,4

 collecting premiums

that are based on an average historical loss year does not enable the

program to build sufficient reserves to cover a possible catastrophic loss

year in the future. Because the program does not collect sufficient

premium income to build reserves to meet the long-term future expected

flood losses, including catastrophic losses, it is inevitable that losses from

claims and the program’s expenses will exceed the funds available to the

program in some years and, cumulatively, over time.

 2

See Flood Insurance: Financial Resources May Not Be Sufficient to Meet Future

Expected Losses (GAO/RCED-94-80, Mar. 21, 1994).

3

For the program to be actuarially sound, overall revenues from insurance premiums would

need to be sufficient to cover expected losses from claims and the program’s expenses.

4

Administration officials told us that a catastrophic year is defined as a year resulting in

$5.5 billion to $6 billion in claims losses, which has a 1 in 1,000 chance of occurring.
Page 3 GAO-01-992T National Flood Insurance Program

• Repetitive loss properties have a major disproportionate impact on the

National Flood Insurance Program, according to FEMA. The cost of

multiple-loss properties (two or more losses greater than $1,000 each on

the same property within a 10-year period) to the program is large—about

38 percent of all claims paid historically, currently about $200 million

annually. In a recent report on the Government Performance and Results

Act, we identified improving the financial condition of the flood insurance

program as a major management challenge and reported on FEMA’s

strategy for addressing this challenge, including reducing losses from

multiple loss properties.5

 In its fiscal year 2002 Performance Plan and

budget proposal, FEMA, among other things, has under way or is planning

actions aimed at (1) identifying a target group of properties suffering

multiple losses and transferring them to a special servicing facility for

better oversight and coordination of insurance and mitigation actions; (2)

developing a proposal to reduce the subsidy provided to older repetitive

loss properties; (3) terminating flood insurance coverage for the worst

offending repetitive loss properties; and (4) eliminating subsidies for

vacation homes, rental properties, and other nonprimary properties that

experience repetitive losses.

Before I discuss these issues in greater detail, let me briefly explain the

National Flood Insurance Program and other federal disaster assistance

related to this program.

About 19,600 communities have joined the flood insurance program.

Under the program, flood insurance rate maps (FIRM) were prepared to

identify special flood hazard areas. In order for a community to join the

program, any structures built within a special flood hazard area after the

FIRM was completed were required to be built according to the program’s

building standards that are aimed at minimizing flood losses. Special flood

hazard areas, also known as the 100-year floodplains, are areas subject to a

1-percent or greater chance of experiencing flooding in a given year. A key

component of the program’s building standards, that must be followed by

communities participating in the program, is a requirement that the lowest

floor of the structure be elevated to or above the base flood level—the

elevation at which there is a 1-percent chance of flooding in a given year.

 5

Federal Emergency Management Agency: Status of Achieving Key Outcomes and

Addressing Major Management Challenges (GAO-01-832, July 9, 2001).

The National Flood

Insurance Program

and Other FloodRelated Assistance
Page 4 GAO-01-992T National Flood Insurance Program

To encourage communities to join the program, thereby promoting

floodplain management and the widespread purchasing of flood insurance,

the Congress authorized FEMA to make subsidized flood insurance rates

available to owners of structures built before a community’s FIRM was

prepared. These pre-FIRM structures are generally more flood-prone than

later built structures because they were not built according to the

program’s building standards. Owners of post-FIRM structures pay

actuarial rates for national flood insurance. The average annual premium

for a subsidized policy is currently $610, and the average annual premium

for an actuarial policy is currently $310. The higher average premium for a

subsidized policy reflects the significantly greater risk of flood-prone preFIRM properties. The $610 average annual premium for a subsidized policy

represents about 38 percent of the true risk premium for these properties.

From 1968 until the adoption of the Flood Disaster Protection Act of 1973,

the purchase of flood insurance was voluntary. The 1973 act required the

mandatory purchase of flood insurance to cover structures in special flood

hazard areas of communities participating in the program if (1) any federal

loans or grants were used to acquire or build the structures and (2) the

loans were secured by improved properties and were made by lending

institutions regulated by the federal government. The owners of properties

with no mortgages or properties with mortgages held by unregulated

lenders were not, and still are not, required to buy flood insurance, even if

the properties are in special flood hazard areas.

The National Flood Insurance Reform Act of 1994 reinforces the objective

of using insurance as the preferred mechanism for disaster assistance by

(1) expanding the role of federal agency lenders and regulators to enforce

the mandatory flood insurance purchase requirements and (2) prohibiting

further flood disaster assistance for any property where flood insurance is

not maintained, even though flood insurance was mandated as a condition

for receiving disaster assistance. Regarding the prohibition on further

flood disaster assistance, the act requires borrowers who have received

certain disaster assistance and then failed to obtain flood coverage to be

barred from receiving future disaster aid.

Other forms of flood disaster assistance include low-interest loans from

the Small Business Administration to flood victims who are creditworthy.

In addition, a flood victim who cannot obtain a Small Business

Administration loan may apply for an individual and family FEMA grant of

up to $14,400 or the amount of the loss, whichever is less.
Page 5 GAO-01-992T National Flood Insurance Program

Annual operating losses or net revenues from the National Flood

Insurance Program’s operations have varied significantly from year to

year. While revenues exceeded program costs in some years, cumulative

program costs exceeded income by about $843 million during the period

October 1, 1992, through September 30, 2000. As seen in Figure 1, during

the 8-year period from fiscal years 1993 through 2000, the program

incurred operating losses in 5 of these years and experienced net income

in the 3 remaining years.

Figure 1: Net Financial Status of the National Flood Insurance Program (Annual

Income Minus Costs)

Source: National Flood Insurance Program Operating Results by Fiscal Year

During fiscal years 1993 through 1998, the first 6 years of the 8-year period,

the flood insurance program generally experienced operating losses.6

 This

occurred because losses from flood claims were greater than premium

income collected from the program’s policyholders. The program’s annual

 6

Program income primarily consists of premium revenues paid by policyholders, but also

includes investments, fees, and other revenues. Program costs primarily consist of claims

and related expenses, but also include, among other things, operating and interest costs.

Severe Flooding Has

Sometimes Resulted

in Sustained Losses to

the Program

270

-536

132

588

-602 -576

-117 -0.6

-800

-600

-400

-200

0

200

400

600

800

1993 1994 1995 1996 1997 1998 1999 2000

Fiscal year

Net dollars in millions
Page 6 GAO-01-992T National Flood Insurance Program

losses during this period ranged from about $600,000 in fiscal year 1998 to

$602 million in fiscal year 1993. Cumulative operating losses experienced

by the program totaled about $1.56 billion during the 6-year period. To

help finance these losses, the Administration borrowed from the U.S.

Treasury during the 6-year period.7

 According to FEMA, as of August 31,

1999, the debt owed by the program to the U.S. Treasury totaled $541

million.8

Since fiscal year 1995, losses experienced by the program annually have

gradually declined, and in fiscal years 1999 and 2000 program revenues

exceeded program costs by a total of about $720 million. As a result, the

Administration was able to repay its debt owed the U.S. Treasury, and, as

of June 30, 2001, the program owes no debt to the U.S. Treasury.9

The financial improvement experienced by the program since fiscal year

1995 was primarily due to three reasons. First, claims and related

expenses declined.10 Second, the number of policyholders covered by the

program increased about 31 percent from 3.3 million policies in force in

fiscal year 1995 to 4.3 million policies in force by fiscal year 2000.

Accordingly, earned premium revenue on these policies increased during

the period. Third, according to Administration officials, the proportion of

generally more flood-prone pre-FIRM subsidized policies insured by the

program has declined, resulting in a less risky portfolio of policies in force.

The percentage of program policies that are subsidized has declined over

time as newer properties have joined the program and are charged

actuarial rates. While 41 percent of the 2.7 million policies in force in fiscal

 7

The Congress authorized the Administration to borrow up to $1 billion from the U.S.

Treasury, if necessary, to pay claims losses. Legislation enacted in 1996 provided a 1-year

increase in borrowing authority to $1.5 billion, later extended through 2001. No

appropriations have been made to the program since fiscal year 1986.

8

According to an Administration official, debt owed by the Administration to the U.S.

Treasury is not equivalent to the program’s cumulative losses because the amount of

borrowing needed depends on (1) the relative timing of payments on the program’s current

obligations and expected monthly premium receipts and (2) future insurance claims.

9

Administration officials noted that, beginning in fiscal year 1986, the Congress required all

program and administrative costs to be paid for by the program without a commensurate

rate increase. In 1991, the Congress authorized the Administration to charge policyholders

a federal policy fee to pay for these costs. Administration officials estimate the current

value of the resulting loss of funds and investment income to be about $436 million, making

the program more vulnerable to the need for exercising its borrowing authority.

10The magnitude of flood damage can vary considerably from year to year.
Page 7 GAO-01-992T National Flood Insurance Program

year 1993 were subsidized, 30 percent of the 4.3 million policies in force in

fiscal year 2000 were subsidized, according to an Administration official.

While the program incurred operating losses during the 8-year period, it

should be recognized that the value of the program in reducing federal

expenditures on disaster assistance should not be measured by net federal

expenditures alone. For example, the Administration estimated that the

program’s standards for new construction are now saving about $1 billion

annually in flood damage avoided. Also, from October 1, 1968, through

September 30, 2000, the program paid about $10 billion in insurance

claims, primarily from policyholder premiums that otherwise would, to

some extent, have increased taxpayer-funded disaster relief.

The program is not actuarially sound because about 30 percent of the 4.3

million policies in force are subsidized, according to an Administration

official. For a single-family pre-FIRM property, subsidized rates are

available for the first $35,000 of coverage, although any insurance

coverage above that amount must be purchased at actuarial rates.

Administration officials estimated that total premium income from

subsidized policyholders is currently about $500 million less than it would

be if these rates had been actuarially based and participation had

remained the same.

Pre-FIRM structures that are within an identified 100-year floodplain and

are covered by subsidized policies are, on average, not as elevated as the

post-FIRM structures in comparison with the base flood level.

Administration officials told us that, on average, pre-FIRM structures not

built to the program’s standards are three and a half to four times more

likely to suffer a flood loss. When these structures suffer a loss, the

damage sustained is, on average, about 40 percent greater than the damage

to flooded post-FIRM structures. According to the Administration, when

these two factors are combined, pre-FIRM structures suffer, on average,

about five times more damage than post-FIRM structures.

As an alternative to actuarial soundness, the Administration developed a

financial goal for the program to collect sufficient revenues to at least

meet the expected losses and expenses of the average historical loss year,

as well as to cover all non-loss-related program expenses, such as the

program’s administration. However, the average historical loss year is

based only on the program’s experiences since 1978. Since then, no

catastrophic year ($5.5 billion to $6 billion in claims losses) has occurred,

The Program Is Not,

by Design, Actuarially

Sound

Premium Income Is Not

Sufficient to Build

Reserves for Potential

Catastrophic Losses
Page 8 GAO-01-992T National Flood Insurance Program

and many years in the 1980s were characterized by fairly low actual loss

levels as compared to the historical average losses experienced in other

years. Therefore, the historical average loss year involves fewer losses

from claims than the expected annual claims losses in future years. As a

result, collecting premiums to meet the historical average loss year does

not realize the collections necessary to build reserves for potential

catastrophic years in the future.

For the program to be actuarially sound, its rate-setting process would

have to consider the monetary risk exposure of the program or the dollar

value of expected flood losses over the long run. Since the magnitude of

flood damage varies considerably from year to year, income from

premiums in many years would exceed actual losses. This circumstance

would enable the program to build reserves toward a possible catastrophic

year in the future.

As we reported in March 1994, increasing the premiums charged to

subsidized policyholders (thereby decreasing the subsidy) to improve the

program’s financial health could have an adverse impact on other federal

disaster-related relief costs. Increasing the rates of subsidized

policyholders would likely cause some policyholders to cancel their flood

insurance, and, if flooded in the future, these people might apply for Small

Business Administration loans or FEMA disaster assistance grants.

Because they were built before the program’s building standards became

applicable, pre-FIRM structures are generally not as elevated as post-FIRM

structures, and, if their owners were to be charged true actuarial rates,

these rates would be much higher than current subsidized rates.11 For

example, if the subsidy on pre-FIRM structures were eliminated, insurance

rates on currently subsidized policies would need to rise, on average,

approximately a little more than twofold, according to an Administration

official. This increase would result in an annual average premium of about

$1,300 for these pre-FIRM structures. Significant rate increases for

 11Also, Administration officials told us that making all rates actuarially based would not

make the program actuarially sound. They noted that an initial capitalization would be

necessary to establish some reserves in the event that a catastrophic year were to occur

before sufficient reserves had accumulated from income from premiums.

Increasing Premiums for

Subsidized Policies or

Expanding Participation in

the Program Might Have

Adverse Financial Impacts
Page 9 GAO-01-992T National Flood Insurance Program

subsidized policies, including charging actuarial rates, would likely cause

some pre-FIRM property owners to cancel their flood insurance.12

If owners of pre-FIRM structures, which suffer the greatest flood loss,

canceled their insurance policies, the federal government would likely

face increased costs, as the result of future floods, in the form of lowinterest loans from the Small Business Administration or grants from

FEMA. The effect on total federal disaster assistance costs of phasing out

subsidized rates would depend on the number of the program’s current

policyholders who would cancel their policies. Thus, it is difficult to

estimate if the increased costs of other federal disaster relief programs

would be less than, or more than, the cost of the program’s current

subsidy.

On the other hand, expanding participation in the program by increasing

the rate of compliance with the mandatory purchase requirement, or by

extending the mandatory purchase requirement to property owners not

now covered, will likely increase the number of both subsidized and

unsubsidized policies. Although greater participation in the program is

likely to reduce the cost of FEMA grants and Small Business

Administration loans, the resulting increase in subsidized policyholders

will put greater financial stress on the flood insurance program, because

the premiums received from subsidized policyholders are not sufficient to

meet the future estimated losses on these policies.

Repetitive loss properties have a major disproportionate impact on the

National Flood Insurance Program, according to FEMA’s fiscal year 2000

performance report. About 38 percent of all program claims historically

(currently about $200 million annually) represent repetitive losses, even

though repetitive-loss structures make up a small percentage of all

program policies. About 45,000 buildings currently insured under the

program have been flooded on more than one occasion and have received

flood insurance claims payments of $1,000 or more for each loss. Over the

years, the total cost of these multiple-loss properties to the program has

been about $3.8 billion.

 12The National Flood Insurance Reform Act of 1994 expanded the mandatory flood

insurance purchase requirement on properties that are located in special flood hazard

areas and financed with any federal loan or grant or loans made by lending institutions

regulated by the federal government.

FEMA Has Developed

Strategies To Reduce

The Impact of

Repetitive Flood

Losses
Page 10 GAO-01-992T National Flood Insurance Program

A 1998 study by the National Wildlife Federation noted that repetitive loss

properties represent only 2 percent of all properties insured by the

program, but they tend to have damage claims that exceed the value of the

house and most are concentrated in special flood hazard areas. For

example, nearly one out of every ten repetitive loss homes has had

cumulative flood loss claims that exceeded the value of the house.

Furthermore, over half of all nationwide repetitive loss property insurance

payments have been made in Louisiana and Texas. About 15 states

account for 90 percent of the total payments made for repetitive loss

properties.

We, as well as FEMA’s Office of Inspector General, have identified

improving the financial condition of the National Flood Insurance Program

as one of FEMA’s major management challenges. In our July report on

FEMA’s performance under the Government Performance and Results Act,

we outlined FEMA’s accomplishments and plans to reduce the losses it

sustains from repetitive loss properties. Among other things, FEMA has

under way actions or plans aimed at (1) identifying target repetitive loss

properties and transferring their servicing to a special servicing facility

designed to better oversee claims and coordinate and facilitate insurance

and mitigation actions and (2) developing and implementing proposals to

reduce the subsidy provided to pre-FIRM repetitive loss properties.

In fiscal year 2000, FEMA implemented a repetitive loss initiative to target

the 10,000 worst repetitive loss properties, those currently insured

properties that had four or more losses, or two to three losses where the

cumulative flood insurance claims payments exceeded the building’s

value. According to FEMA, the initiative is designed to eliminate or shortcircuit the cycle of flooding and rebuilding for properties suffering

multiple losses due to flooding. The initiative includes identifying

repetitive loss properties and transferring their insurance policies to a

central, special servicing facility designed to better oversee claims. FEMA

believes that this special servicing will help coordinate insurance activities

and mitigation grant programs. FEMA reported that it had identified

repetitive loss properties and would make this information available to

state and local governments to help them target repetitive loss properties

for mitigation actions. FEMA also reported that it planned to mitigate

1,938 target properties over the next 4 years.

In addition, in its fiscal year 2002 annual performance plan, FEMA outlined

several strategies to reduce the subsidy provided to repetitive loss

properties as well as several business improvement process actions to

reduce the program’s costs. FEMA stated it would use Flood Mitigation
Page 11 GAO-01-992T National Flood Insurance Program

Assistance funds and Hazard Mitigation Grants Program funds in

conjunction with flood insurance program funds to acquire properties,

relocate residents, or otherwise mitigate future losses. FEMA also plans to

provide incentives to communities to reduce repetitive flood losses.

In its fiscal year 2002 budget proposal, FEMA requested to transfer $20

million in fees from the National Flood Insurance Program to increase the

number of buyouts of properties that suffer repetitive losses. This

proposal also includes a proposal for two major reforms to the flood

insurance program. FEMA proposes to terminate flood insurance coverage

for the worst offending repetitive loss properties. FEMA also proposes to

eliminate subsidized premiums for vacation homes, rental properties, and

other nonprimary properties that experienced repetitive losses. FEMA

estimates these two reforms will generate savings of about $12 million in

fiscal year 2002 and additional funds in subsequent years.

- - - - -

In closing, Madam Chairwoman, the Administration is helping the nation

avoid the costs of flood damage through the premiums it collects from,

and the claim payments it makes to, program policyholders as well as the

building standards it has promoted for new construction that minimize

flood damage. However, at times, heavy flooding has produced annual

flood insurance losses that exceeded the premiums collected from

policyholders. As a result, the program has had to borrow funds from the

U.S. Treasury to cover its operating losses, which it subsequently repaid.

Two major factors underlie these financial difficulties—the program, by

design, is not actuarially sound and it experiences repetitive losses. These

factors are not easy to overcome because they have been an integral part

of the program since its inception, and they are related to the promotion of

floodplain management and widespread purchasing of flood insurance.

Madam Chairwoman, this completes our prepared statement. We would be

happy to respond to any questions that you or Members of the

Subcommittee might have.

For further information on this testimony, please contact Mr. Stanley

Czerwinski at (202) 512-2834. Mark Abraham, Martha Chow, Kerry

Hawranek, Signora May, Lisa Moore, and Robert Procaccini made key

contributions to this testimony.

Contact and

Acknowledgments
Page 12 GAO-01-992T National Flood Insurance Program

Federal Emergency Management Agency: Status of Achieving Key

Outcomes and Addressing Major Management Challenges (GAO-01-832,

July 9, 2001).

Flood Insurance: Emerging Opportunity to Better Measure Certain

Results of the National Flood Insurance Program (GAO-01-736T, May 16,

2001).

Disaster Assistance: Issues Related to the Development of FEMA’s

Insurance Requirements (GAO/GGD/OGC-00-62, Feb. 25, 2000).

Flood Insurance: Information on Financial Aspects of the National

Flood Insurance Program (GAO/T-RCED-00-23, Oct. 27, 1999).

Flood Insurance: Information on Financial Aspects of the National

Flood Insurance Program (GAO/T-RCED-99-280, Aug. 25, 1999).

Disaster Assistance: Opportunities to Improve Cost-Effectiveness

Determinations for Mitigation Grants (GAO/RCED-99-236, Aug. 4, 1999).

Disaster Assistance: FEMA Can Improve Its Cost-Effectiveness

Determinations for Mitigation Grants (GAO/T-RCED-99-274, Aug. 4,

1999).

Disaster Assistance: Improvements Needed in Determining Eligibility

for Public Assistance (GAO/RCED-96-113, May 23, 1996).

Flood Insurance: Financial Resources May Not Be Sufficient to Meet

Future Expected Losses (GAO/RCED-94-80, Mar. 21, 1994).

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