National Flood Insurance Program: Oversight of Policy Issuance and Claims
Published: 2005-04-14T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: According to the National Flood Insurance Program (NFIP), 90 percent of all natural disasters in the United States involve flooding. Because of the catastrophic and unpredictable nature of floods, private insurance companies do not typically cover flood losses. Congress established the NFIP in 1968 to provide an insurance alternative to disaster assistance in response to the escalating costs of repairing flood damage. During congressional hearings on provisions of the Flood Insurance Reform Act of 2004, several legislators testified on NFIP shortcomings, as reported by constituents whose properties had been flooded by Hurricane Isabel in September 2003. The act required GAO to study coverage provided under the NFIP. It also required the Federal Emergency Management Agency (FEMA), the administrator of the NFIP, to take steps to address concerns about coverage and claims procedures. Today's testimony is based on work in progress to address this mandate. It provides preliminary information on (1) the types of coverage limits, restrictions, and exclusions under the NFIP; (2) how FEMA, in partnership with private insurers, manages and oversees the NFIP and the views of selected private sector program managers on how the program is working; and (3) the status of FEMA's efforts to comply with provisions of the Flood Insurance Reform Act.
section_title: What GAO Found
paragraphs: As a result of policy limits, restrictions, and exclusions, insurance payments to claimants for flood damage may not cover all of the costs of repairing or replacing damaged property. Some limitations are embedded in statute and others have been promulgated by FEMA pursuant to its statutory authority. FEMA officials said that the coverage limitations are necessary to keep the NFIP self-supporting and actuarially sound. Thus, the program is designed to strike a balance between premium prices and coverage. For example, homeowners may choose not to insure personal property under the program. If they do elect to have this coverage, the value of personal property is depreciated. Basement coverage does not include payment to repair or replace finished walls and floors. The work of selling, servicing, and adjusting claims on NFIP policies is carried out by thousands of private sector insurance agents and adjusters under the regulation, management, and oversight of about 40 FEMA employees assisted by about 170 contractor employees. Agents are the main point of contact for policyholders. Four private sector NFIP managers we interviewed said that the agents have varying levels of NFIP knowledge. While training and support are available, historically neither FEMA nor the insurance companies have required completion of training or demonstration of basic program knowledge. Flood-certified adjusters are responsible for assessing damage and estimating losses when flooding occurs. Unlike agents, adjusters have mandatory training requirements. FEMA has oversight mechanisms in place to review the operations of the insurance companies and the work of adjusters. The private sector NFIP managers GAO interviewed were generally supportive of the program. However, they said that FEMA should find ways to make it less complex than and more similar to other property insurance programs. FEMA has taken steps to address its mandates in the Flood Insurance Reform Act, but it did not meet the 6-month timeframe specified. For example, to establish an insurance agent training requirement, an official said FEMA is discussing options but has not developed an action plan. To meet the requirement to provide "simple and complete information" to NFIP policyholders, FEMA has drafted materials explaining coverage, deductibles, and claim- and appeals-related procedures that it expects to have finalized by October 2005.

section_title: Letter
paragraphs: I appreciate the opportunity to participate in today’s hearing to discuss the  National Flood Insurance Program (NFIP) and the Federal Emergency  Management Agency’s (FEMA) role in overseeing processes for issuing  policies and adjusting claims after floods occur. My testimony is based on  preliminary results to date of our ongoing review of the NFIP, as mandated  by the Flood Insurance Reform Act of 2004.
According to NFIP statistics, 90 percent of all natural disasters in the  United States involve flooding. However, flooding is generally excluded  from homeowner policies that typically cover damage from losses  including wind, fire, and theft. Because of the catastrophic nature of  flooding and the inability to adequately predict flood risks, private  insurance companies are largely unwilling to underwrite and bear the risk  of flood insurance.
Under the National Flood Insurance Act of 1968, Congress established the  NFIP to provide an insurance alternative to disaster assistance in response  to the escalating costs of repairing flood damage. In creating the NFIP,  Congress found that “a program of flood insurance with 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.” Under the NFIP, homeowners with mortgages insured by  federal lenders on property in communities identified to be in special high- risk flood hazard areas are required to purchase flood insurance on their  dwellings, up to a maximum of $250,000 in coverage for single-family  homes. Optional, lower-cost coverage is also available under the NFIP to  protect homes in areas of low to moderate risk. To insure furniture and  other contents against flood, property owners must purchase separate  NFIP personal property coverage for up to $100,000.
FEMA, the agency responsible for coordinating the federal response to  disasters, administers the NFIP. FEMA has been generally successful in  keeping the NFIP on sound financial footing. FEMA reports that the NFIP  is self-supporting for the average historical loss year, which means that  operating expenses and flood insurance claims are not paid for by the  taxpayer, but through premiums collected on flood insurance policies.  FEMA has exercised its authority to borrow from the Treasury three times  in the last decade when losses were heavy. However, it has repaid all  borrowed funds with interest.
By 2005, the NFIP is projected to have approximately 4.7 million  policyholders in the nearly 19,000 participating communities, with   $699 billion of insurance in force. Since its inception, the program has paid  about $12 billion in insurance claims, primarily from policyholder  premiums that otherwise would have been paid through taxpayer-funded  disaster relief or been borne by the home and business owners themselves.
During congressional hearings held last year on the Flood Insurance  Reform Act of 2004, several legislators testified on NFIP concerns as  reported by constituents whose properties had been flooded by Hurricane  Isabel in September 2003. Problems they reported included inadequate  payments and unclear policies and procedures for filing and adjusting  damage claims. According to NFIP statistical data, NFIP policyholders  filed about 23,770 claims for $454.2 million for flood damage as a result of  this storm, primarily in Maryland, Virginia, and North Carolina.
Several months later, the hurricane season that began in August 2004  struck hard in Florida and other East and Gulf Coast states. In Florida  alone, more than one in five homes suffered wind, rain, flood, or other  damage from the hurricanes, according to FEMA. According to NFIP data,  the combined impact of Hurricanes Charley, Frances, Ivan, and Jeanne in  August and September 2004 made them the most costly catastrophes in  U.S. history, surpassing the costs of Hurricane Andrew in 1992 and the  World Trade Center and Pentagon terrorist attacks in 2001. FEMA  reported that these storms resulted in 59,125 NFIP claims for more than  $1.3 billion in payments as of March 2005 on claims that have been closed.
To meet our legislative mandate, as modified and expanded to include  information on the 2004 hurricane season, and as discussed with your  committee and the Senate Committee on Banking, Housing, and Urban  Affairs, we are reviewing several issues related to NFIP claims and  FEMA’s oversight role. Today, we are prepared to provide preliminary  information on (1) the types of limits, restrictions, and exclusions to  coverage that exist under the NFIP; (2) how FEMA, in partnership with  private insurers, manages and oversees the NFIP, and the views of  selected private sector NFIP program managers on how the program is  working; and (3) the current status of FEMA’s efforts to comply with  provisions of the Flood Insurance Reform Act that mandate it establish  insurance agent education and training requirements, new processes for  explaining coverage to policyholders when they purchase and renew  policies, and an appeals process for claimants. In addition, appendix I  presents data on policies in force and payments claimants received under  the NFIP for flood events over the life of the program through 2004.
To address these issues, we collected data from the NFIP management  information system, examined program documentation, and interviewed  officials of FEMA and its program contractor. We also interviewed four  private sector NFIP program managers for insurance companies and  managers at one vendor—a company that subcontracts with insurance  companies to handle all or part of their flood business. Using a  semistructured interview instrument, we asked these managers how their  operations are managed and reviewed, how they believe the program is  working, and what suggestions they have for improvements. In  consultation with FEMA officials, we selected the interviewees because  they are among the largest private sector partners for the NFIP. We  observed FEMA-sponsored training of insurance agents and adjusters and  a FEMA oversight review of the management of a private insurance  company’s NFIP business.
Our work that forms the basis of the preliminary observations presented in  our testimony today is still in progress. For example, we have not yet  completed our review of the NFIP program and the claims made after  Hurricane Isabel and the 2004 hurricane season. Among the ongoing work  to be completed prior to issuing our report later this year are (1) an  assessment of the reliability of FEMA’s management information system,  (2) interviews with the general adjusters who supervised claims  adjustments in Maryland after Hurricane Isabel and in Florida during the  2004 hurricane season, (3) observations of FEMA’s monitoring and  oversight activities, and (4) a review of the operational reviews FEMA has  done over the last several years. Our work is being done in accordance  with generally accepted government auditing standards.
In summary, we found:    The NFIP is not designed to cover all flood losses. Some limitations are  embedded in statute and others have been promulgated by FEMA  pursuant to its statutory authority to keep the program self-supporting and  actuarially sound. For example, the limited coverage allowed for  basements does not include payment to repair or replace finished walls,  floors, furniture, and other personal property.
The work of selling, servicing, and adjusting claims on NFIP policies is  carried out by thousands of private sector insurance agents, adjusters, and  other employees. The private sector effort is regulated, managed, and  overseen by about 40 FEMA employees with the assistance of about   170 contractor employees. The private sector program managers we  interviewed said that the NFIP has many positive aspects, but its  implementation is complex for policyholders, agents, and adjusters. Each  of the four interviewees, when asked how the NFIP could be improved,  said that FEMA should look for ways to make the program less complex  and more similar to other property insurance programs.
Although its 6-month deadline elapsed in December 2004, FEMA continues  its efforts to comply with mandates of the Flood Insurance Reform Act  that it establish (1) insurance agent education and training requirements,  (2) new processes for explaining coverage to policyholders when they  purchase and renew policies, and (3) an appeals process for claimants  who are dissatisfied with the settlement of their claims. FEMA officials  said that the rule-making process required for two of the initiatives takes  more than 6 months to complete. On the third initiative, FEMA is awaiting  DHS approval of materials it has prepared to explain coverage to  policyholders. A FEMA official estimated that it would be after October  2005 before it has fully complied with the mandates.
subsections: section_title: NFIP Is Not Designed to Cover All Flood Losses
paragraphs: As a result of coverage limits, restrictions, and exclusions in NFIP policies,  insurance payments for flood damage may not pay all of the costs of  repairing or replacing flood-damaged property. Certain NFIP limitations  are embedded in statute; others have been promulgated by FEMA  pursuant to its statutory authority. FEMA officials said that the coverage  limitations are necessary to keep the NFIP self-supporting and actuarially  sound. Thus, the program is designed to strike a balance between  premium prices and coverage.
The following are several examples of NFIP coverage limitations,  restrictions, and exclusions that affect the premium and amount a  claimant could expect to receive for flood damage:    Homeowners are required to insure their homes for the amount of their  federally backed mortgages. If a home is insured for less than 80 percent  of its full replacement cost or the maximum coverage amount of $250,000,  or it is not a primary residence, NFIP will pay the actual cash value for the  damage. The actual cash value represents the original cost of the structure  less depreciation and, in most cases, will not cover the full cost to repair  damage to or replace the dwelling. The value of physical depreciation is  based on the age and condition of the item.
If a home is insured for 80 percent or more of its full replacement cost or  the maximum coverage amount of $250,000 and is a primary residence,  NFIP will pay replacement costs for damage to the dwelling. The policy  defines replacement cost as coverage to replace the damaged part of the  dwelling with materials of like kind and quality to what was damaged. The  policy will pay the amount actually spent for this repair or replacement up  to its limit.
A homeowner may choose not to insure personal property under the  program.
A deductible amount is applied against claims for dwellings and personal  property.
Basements, which are defined as building areas below grade level on all  sides, have limited coverage that does not include payment to repair or  replace finished walls, floors, furniture, and other personal property.
The personal property limit paid for jewelry, artwork, and home business  equipment is $2,500 for all items combined. No coverage is provided on  these items if they are located in a basement.
Actual cash value, not replacement value, is paid on all covered furniture  and other personal property. Thus, personal property is also depreciated.
A detached garage is covered by the dwelling policy only if it is used solely  for vehicles and storage. If the garage is improved (e.g., a sink is installed),  flood damage to the structure is not covered under the NFIP.
In a hypothetical property adjustment we developed with the assistance of  FEMA’s director of claims, a poorly maintained 30-year-old home located  in a designated flood zone had flood damage when a nearby river  overflowed. The property was valued at $60,000. It was insured under the  NFIP for $30,000. Although a contractor estimated it would cost $40,000 to  repair damages to the structure and personal property losses totaled  another $10,000, a NFIP adjuster determined that payment on the claim  was $8,000.
The following circumstances reduced the amount of coverage:    The homeowner had chosen not to insure his personal property.
Because the homeowner did not insure the structure for at least 80 percent  of its value, actual cash value will be paid for repairs or replacement of  damage to the dwelling. Since the condition is poor, the actual cash value  will be low.
A $1,000 deductible will be applied.
The adjuster determined that some problems that needed to be addressed  had not been caused by the flood (e.g., leaking pipes in the bathroom and  preexisting mold in the basement).
Only limited coverage is allowed in the basement of the home, where the  largest amount of damage occurred.
section_title: Private Insurers Sell, Service, and Adjust Claims under FEMA Management and Oversight
paragraphs: The work of selling, servicing, and adjusting claims on NFIP policies is  carried out by thousands of private sector insurance agents and adjusters  who work independently or are employed by insurance companies or  vendors under subcontract to insurance companies to handle their flood  business. In contrast, according to a FEMA official, about 40 FEMA  employees are responsible for regulating, managing, and overseeing the  program, which is expected to grow to about 4.7 million policies in 2005.  FEMA is assisted in this effort by about 170 contractor employees.
According to FEMA, about 95 percent of the NFIP policies in force are  written by agents who work for or represent 94 private insurance  companies that issue policies and adjust flood claims in their own names.  The companies, called write-your-own companies, receive an expense  allowance from FEMA of about one-third of the premium amounts for  their services and are required to remit premium income in excess of this  allowance to the National Flood Insurance Fund. The insurance  companies share the FEMA expense allowance with the agent selling and  servicing the policy and a vendor, if the company has subcontracted with  one to handle all or part of its flood insurance business.
subsections: section_title: Independent Agents Are the Main Point of Contact for Policyholders
paragraphs: It is clear that some agents do not understand the program. It is very complex and different  from the other lines of insurance. Flood insurance is much more complex than automobile  and homeowners insurance. Some items of specific concern are definitions of elevated  buildings and basements.
Officials at FEMA, the four insurance companies, and the vendor said that  they offered support to the insurance agents who sell and service NFIP  policies. Reported support included training, help from telephone hotline  customer service representatives, development of rate quotes, and Web  sites with NFIP information. However, other than requiring that agents  meet basic state insurance licensing requirements, neither FEMA nor the  four insurance companies have historically required that agents complete  training or demonstrate a basic level of knowledge of the NFIP to sell  flood policies.
section_title: Adjusters Are the Eyes and Ears of the NFIP
paragraphs: When losses occur, flood adjusters employed by insurance companies or  independent contractors become the eyes and ears of the NFIP. Claims  adjusters are assigned to policyholders by their insurance companies after  the policyholders have notified their agents of a flood loss and the agents  have written loss reports. Adjusters are responsible for assessing damage;  estimating losses; and submitting required reports, work sheets, and  photographs to the claimants’ insurance company, where the claim is  reviewed and, if approved, processed for payment. They work under the  coordination of a general adjuster assigned to manage claims adjustments  for the flood event.
Unlike agents who sell flood insurance policies, adjusters must be certified  by FEMA to work on NFIP claims. To be approved to adjust residential  flood losses, an adjuster must have at least 4 consecutive years of full-time  property loss adjusting experience and have attended an adjuster  workshop, among other requirements. To keep their certifications current,  adjusters are required to take a 1-day refresher workshop each year and  pass a written examination testing their knowledge each year.
FEMA’s program contractor maintains a database of independent  adjusters who are qualified to adjust flood claims. A FEMA official said  that 4,844 flood-certified adjusters are registered in the database, as of  April 2005. A NFIP official noted that the adjuster community is stretched  thin when a major flood event occurs.
Adjusters and insurance companies are paid for claims settlements from  the National Flood Insurance Fund based on the size of the losses they  settle. The write-your-own company receives about 3.3 percent of the  incurred loss, according to FEMA’s NFIP claims director. Adjusters are to  be paid at the time claims are settled based on a standard fee schedule.  For example, an adjuster receives $1,000 for a claim of between $25,000  and $35,000.
section_title: FEMA Oversees Work of Insurance Companies and Adjusters
paragraphs: FEMA’s primary method of overseeing the work of write-your-own  companies is to conduct an operational review of every participating  company at least every 3 years. In addition, FEMA relies on about   10 general adjusters employed by its program contractor to check the  work of claims adjusters in reinspections of a sample of adjustments done  after every flood event.
According to the FEMA director of NFIP claims, one or two employees  from FEMA’s NFIP Claims and Underwriting sections go on-site to review  the operations of write-your-own companies at least every 3 years. They  do reviews more frequently, if necessary, to follow up on any findings  from a previous visit. The auditors are to request that a random sample of  100 files be pulled for them to review. Files that are closed without  payment and those with particularly large settlements are to be included in  the sample of files reviewed. Auditors are to check the files for  completeness and accuracy. For example, they must make sure that there  are photographs to document damage. Auditors are also to look at internal  controls in place at the company.
If a write-your-own company does not pass an operational review, FEMA  requires that it develop an action plan to correct the problems and  schedules a follow-up review in 6 months to determine whether progress  has been made, according to the NFIP director of claims. If the company  continues to have problems and fails to implement an action plan, it can  ultimately be withdrawn from the NFIP. According to FEMA officials, a  company has been asked to withdraw from the NFIP once in the program’s  history. About 3 years ago, a write-your-own company was withdrawn  from the NFIP in part because of issues raised in operational reviews and  in part to other financial problems.
Three of the four flood program managers for write-your-own companies  whom we interviewed thought operational reviews were an effective way  for FEMA to ensure that the NFIP is run according to established  legislation and regulation. The fourth manager said that he had no opinion  one way or the other. Interviewees noted that the reviews caught  problems, and while FEMA had a small audit staff, the auditors were  knowledgeable and provided about the right level of review. Two of the  four flood program managers said that recent operational reviews had  identified problems on policies they had recently purchased from other  companies and that they were working to rewrite some policies and  address other oversight issues.
General adjusters are to do reinspections of open claims. FEMA chooses a  random sample of about 4 percent of the claims for every flood event to  reinspect, according to the NFIP claims director. If the general adjuster  determines that a company paid for an expense that should not have been  covered, FEMA is to be reimbursed by the write-your-own company. If a  general adjuster finds that an adjuster missed an item in the original  inspection, the general adjuster is to add it back into the claims report so  that the policyholder will be compensated for it.
The instructors at an adjuster refresher training session we attended noted  the following as common errors identified in reinspections of claims:  improper measurement of room dimensions; improper allocation of damage between wind and flood (homeowners’  policies cover wind damage, while the NFIP covers flood losses);   poor communication with homeowners on the process they are following  to inspect the property and settle the claim.
section_title: Stakeholders Said the NFIP Has Many Positive Aspects but Implementation Is Complex
paragraphs: “I am in the flood insurance business because I believe in the program. It does a lot of  good. Floods are horrible occurrences. A homeowner sees the water coming but can do  nothing to stop it. The smell is horrible. Whole communities are affected, and the emotional  toll is tremendous. I have seen the NFIP do great good for many people.”
Each of the interviewees, when asked how the NFIP could be improved,  said that FEMA should look for ways to make the program less complex  and more similar to other property insurance programs. For example, a  vendor manager noted, “if the customers, the agents, and the adjusters all  have difficulty understanding the program, it is too complicated.” “As FEMA has tried to make the flood program more actuarily sound, it has made it more  complex. FEMA has required of us more information, more forms, and more photos to be  scanned into files. Those requirements cost money to implement. As an industry, we are  looking at how the flood line might be more compatible with other lines of insurance  business to be more cost-efficient. Now the flood business is so unique that it requires  special handling.”
FEMA officials said that some documentation (i.e., elevation certificates)  is required because the NFIP is part of FEMA’s broader flood plain  management strategy that combines insurance protection with hazard  mitigation to reduce future flood damage to homes. The officials noted  that, while the NFIP has different requirements than homeowners  insurance, it is not necessarily more complex and that the more familiar  agents become with the requirements of the NFIP, the easier it becomes  for them to routinely handle documentation requirements.
section_title: FEMA Continues Efforts to Comply with Legislative Mandates
paragraphs: Congress mandated that within 6 months of the enactment of the Flood  Insurance Reform Act, FEMA establish (1) insurance agent education and  training requirements, (2) new processes for explaining coverage to  policyholders when they purchase and renew policies, and (3) an appeals  process for claimants who are dissatisfied with the settlement of their  claims. The 6-month mandated deadline elapsed on December 30, 2004,  but FEMA is still working to complete these mandated efforts. According  to FEMA officials, in order to address the requirements to establish  insurance agent education and training and for explaining coverage to  policyholders, the agency must go through the rule-making process. FEMA  officials also said to address the requirement for explaining policy  coverage, they are waiting for DHS approval before finalizing the draft  materials that will accompany the flood insurance policy. When DHS  approves the draft materials, they will be published in the Federal Register  as part of the rule-making process. Regarding the requirement for an  appeals process, the agency must initiate and complete formal rule  making. FEMA officials said that this process takes more than 6 months  and could not be completed within the mandated time frame.
subsections: section_title: FEMA Is Coordinating with the States to Establish Training and Education Requirements
paragraphs: To address the requirement in the Flood Insurance Reform Act of 2004 to  establish insurance agent education and training requirements, FEMA is  working with state insurance commissions. An official said FEMA is still in  the planning stages of meeting the requirement and is discussing options  with state insurance commissions, but has not yet developed an action  plan.
section_title: FEMA Has Drafted New Materials on Consumer Policy Information
paragraphs: When a customer purchases a flood insurance policy, the main document  he or she is to receive from the insurance agent is the policy. A  congressional report accompanying the Flood Insurance Reform Act  stated that the NFIP did not provide “simple” forms or claims guidelines  for flood victims to follow, making access to information about flood  insurance policies difficult to obtain. To address this concern, the act  requires FEMA to provide simplified forms and a flood insurance claims  handbook to policyholders at the time of purchase or renewal and at the  time of flood loss. FEMA has drafted new materials that would be  provided to the policyholder at the time of purchase or renewal of the  flood insurance policy. The draft material includes:    a supplemental form that would explain the policy, such as the amount of  deductibles, the exact coverage being purchased, exclusions from  coverage, and an explanation of how lost items and damages will be  valued under the policy at the time of loss;   a flood insurance handbook to describe procedures to be followed to file a  claim and provide detailed information on an appeals process that FEMA  is to develop; and   an acknowledgment form that the policyholder has received the flood  insurance policy and that the policy only covers building property for the  dwelling and does not provide coverage for contents or personal property.
Before the materials are finalized, FEMA must go through rule making and  publish them in the Federal Register. FEMA expects to have these forms  and handbook finalized by October 2005.
section_title: FEMA Is Establishing a Formal Appeals Process to Address Consumer Complaints
paragraphs: If a policyholder has a grievance about a flood insurance claim, proof of  loss, or loss estimate, he or she may informally appeal to the insurance  agent, to the insurance adjustor’s supervisor, or to a hotline where a  customer representative is to provide assistance. There is currently no  official recourse for the policyholder. To provide official recourse to  policyholders, section 205 of the Flood Insurance Reform Act requires that  FEMA establish a formal appeals process through which policyholders  may appeal decisions on their claims. FEMA is developing a formal  appeals process for a policyholder to follow if he or she has a grievance.  The proposed new appeals process must go through the rule-making  process with publication of a draft and a final set of procedures in the  Federal Register. A FEMA official was uncertain when the process would  be completed, but said that it would be after October 2005.
Mr. Chairman and Members of the Committee, this concludes my prepared  statement. I would be pleased to answer any questions you and the  Committee members may have.
section_title: Contacts and Staff Acknowledgments
paragraphs: For further information about this statement, please contact William O.  Jenkins, Jr. Director, Homeland Security and Justice Issues, on (202)   512-8777 or jenkinswo@gao.gov or Christopher Keisling, Assistant  Director, Homeland Security and Justice, on (404) 679-1917 or at  keislingc@gao.gov.
Major contributors to this testimony included Christine Davis, Pawnee  Davis, and Deborah Knorr.