National Flood Insurance Program: Continued Attention Needed to Address Challenges
Published: 2013-09-18T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: NFIP, established in 1968, provides policyholders with insurance coverage for flood damage. FEMA, within the Department of Homeland Security, is responsible for managing the program. NFIP offers two types of flood insurance premiums to property owners: subsidized and full-risk. The subsidized rates are not based on flood risk and, according to FEMA, represent only about 40-45 percent of the full flood risk. GAO placed NFIP on its high-risk list in 2006 because of concerns about its long-term solvency and related operational issues. GAO was asked to testify about NFIP issues and its recent work on NFIP. This statement discusses (1) the reasons that NFIP is considered high-risk, (2) changes to subsidized policies and implications of potential additional program changes, and (3) additional challenges for FEMA to address. In preparing this statement, GAO relied on its past work on NFIP, including GAO-13-607 , GAO-13-568 , and GAO-13-283 .
section_title: What GAO Found
paragraphs: The National Flood Insurance Program (NFIP) was added to GAO's high-risk list in 2006 and remains high risk due to losses incurred from the 2005 hurricanes and subsequent losses, the financial exposure the program represents for the federal government, and ongoing management and operational challenges. As of July 31, 2013, the program owed approximately $24 billion to the U.S. Treasury (Treasury). NFIP's financial condition highlights structural weaknesses in how the program has been funded--primarily its rate structure. The annual amount that NFIP collects in both full-risk and subsidized premiums is generally not enough to cover its operating costs, claim payments, and principal and interest payments for the debt owed to Treasury, especially in years of catastrophic flooding, such as 2005. This arrangement results in much of the financial risk of flooding being transferred to the federal government and ultimately the taxpayer. Furthermore, weaknesses in NFIP management and operations, including financial reporting processes and internal controls, strategic and human capital planning, and oversight of contractors have placed the program at risk.
The Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act) mandated that GAO conduct a number of studies related to actual and potential changes to NFIP, including analyses of remaining subsidies and the effect of increasing coverage limits or adding coverage options. In a study of remaining subsidies, GAO estimated that with the changes in the Biggert-Waters Act approximately 438,000 policies no longer are eligible for subsidies, including about 345,000 policies for nonprimary residences, about 87,000 business policies, and about 9,000 policies for single-family properties that had severe-repetitive losses. Subsidies on most of the approximately 715,000 remaining subsidized policies are expected to be eliminated over time as properties are sold or coverage lapses, as are previous exemptions from rate increases after flood zone map revisions. Reducing the financial impact of remaining subsidized policies on NFIP generally could involve accelerating elimination of subsidies, targeting assistance for subsidies, or expanding mitigation efforts, or some combination. Each approach has advantages and disadvantages. In GAO's 2008 study about rate-setting, GAO noted that the losses generated by NFIP have created substantial financial exposure for the federal government and U.S. taxpayers--due in part to its rate-setting process. Partly because of these rate-setting issues, GAO concluded in a July 2013 report that the advantages and disadvantages to additional changes to the program, such as raising coverage limits or adding optional coverage types, would need to be carefully weighed.
The Federal Emergency Management Agency (FEMA) will require several years to fully implement the Biggert-Waters Act. FEMA officials acknowledged that they have challenges to resolve. These include updating and correcting information on whether a policy is for a primary or secondary residence, determining the fair market value of insured properties, and developing a definition of severe repetitive loss for multifamily properties. Further, FEMA must establish full-risk rates that reflect flood risk for active policies that no longer are eligible for subsidies; but it does not have a plan to do so. In an effort to update payment formulas to insurance companies, as GAO recommended, FEMA has begun receiving actual flood-related information from some insurance companies but all companies are not reporting the information consistently.
section_title: What GAO Recommends
paragraphs: GAO continues to support its previous recommendations made to FEMA that focus on the need to address management and operational challenges, ensure that the methods and data used to set NFIP rates accurately reflect the risk of losses from flooding, and that oversight of NFIP and insurance companies responsible for selling and servicing flood policies is strengthened. FEMA agreed with these recommendations and is taking steps to address them.

section_title: Letter
paragraphs: I am pleased to be here today to testify on the National Flood Insurance  Program (NFIP). As you know, the flood insurance program is a key  component of the federal government’s efforts to minimize the damage  and financial impact of floods. Created in 1968, it is administered by the  Federal Emergency Management Agency (FEMA) within the Department  of Homeland Security. As of the end of fiscal year 2012, the program had  more than 5.5 million policies with an insured value of about $1.3 trillion  and collected about $3.5 billion in annual premiums.
My statement today will discuss (1) the reasons that NFIP is considered  high risk, (2) changes to subsidized policies and implications of potential  additional program changes, and (3) additional challenges for FEMA to  address. This testimony is based on two reports we recently issued in  July 2013 on NFIP coverage limits and subsidized properties and other  prior GAO reports on various issues related to NFIP. In conducting work  for our July 2013 reports, we analyzed FEMA data on flood insurance  policies, claims, and repetitive losses, as well as historic data on claims  and premiums for policies with subsidized and full-risk rates. We also  interviewed industry experts, including representatives from FEMA,  insurance industry organizations, brokers, insurance companies, and  consumer advocacy organizations. Finally, we reviewed prior GAO  reports and testimonies and relevant studies conducted by RAND, the  Wharton Risk Management and Decision Processes Center, Deloitte  Consulting LLP, the Congressional Research Service, and academics.
We conducted the work on which this statement is largely based 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.
subsections: section_title: Background
paragraphs: The National Flood Insurance Act of 1968 established NFIP as an  alternative to providing direct disaster relief after floods. NFIP, which  makes federally backed flood insurance available to residential property  owners and businesses, was intended to reduce the government’s  escalating costs for repairing flood damage. Floods are the most common  and destructive natural disaster in the United States; however,  homeowners’ insurance generally excludes flooding. Because of the  catastrophic nature of flooding and the inability to adequately predict flood  risks, private insurance companies historically have been largely unwilling  to underwrite and bear the risk resulting from providing primary flood  insurance coverage. Under NFIP, the federal government assumes the  liability for the insurance coverage and sets rates and coverage  limitations, while the private insurance industry sells the policies and  administers the claims.
NFIP offers two types of flood insurance premiums to property owners  who live in participating communities: subsidized and full-risk. The  National Flood Insurance Act of 1968 authorized NFIP to offer subsidized  premiums to owners of certain properties. These subsidized rates are not  based on flood risk and, according to FEMA, represent only about 40-45  percent of the full flood risk. Congress originally mandated the use of  subsidized premiums to encourage communities to join the program and  mitigate concerns that charging rates that fully and accurately reflected  flood risk would be burdensome to some property owners. Even with  highly discounted rates, subsidized premiums are, on average, higher  than full-risk premiums. The premiums are higher because subsidized  structures built before Flood Insurance Rate Maps (FIRM) became  available generally are more prone to flooding (that is, riskier) than other  structures. In general, pre-FIRM properties were not constructed  according to the program’s building standards or were built without regard  to base flood elevation—the level relative to mean sea level at which  there is a 1 percent or greater chance of flooding in a given year.
Potential policyholders can purchase flood insurance to cover both  buildings and contents for residential and commercial properties. NFIP’s  maximum coverage for residential policyholders is $250,000 for building  property and $100,000 for contents. This coverage includes replacement  value of the building and its foundation, electrical and plumbing systems,  central air and heating, furnaces and water heater, and equipment  considered part of the overall structure of the building. Personal property  coverage includes clothing, furniture, and portable electronic equipment.  For commercial policyholders, the maximum coverage is $500,000 per  unit for buildings and $500,000 for contents (for items similar to those  covered under residential policies).
NFIP largely has relied on the private insurance industry to sell and  service policies. In 1983, FEMA established the Write-Your-Own (WYO)  program. Private insurers become WYOs by entering into an  arrangement with FEMA to issue flood policies in their own name. WYOs  adjust flood claims and settle, pay, and defend claims but assume no  flood risk. Insurance agents from these companies are the main point of  contact for most policyholders. WYOs issue policies, collect premiums,  deduct an allowance for commission and operating expenses from the  premiums, and remit the balance to NFIP. In most cases, insurance  companies hire subcontractors—flood insurance vendors—to conduct  some or all of the day-to-day processing and management of flood  insurance policies. When flood losses occur, policyholders report them to  their insurance agents, who notify the WYOs. The companies review the  claims and process approved claims for payment. FEMA reimburses the  WYOs for the amount of the claims plus expenses for adjusting and  processing the claims, using rates that FEMA establishes. As of  September 2012, about 85 WYOs accounted for about 85 percent of the  more than 5.5 million policies in force.
section_title: NFIP Remains on GAO’s High-Risk List Due to Financial Instability and Other Challenges
paragraphs: NFIP was added to GAO’s High-Risk List in 2006 due to losses from the  2005 hurricanes and the financial exposure the program created for the  federal government. Until 2004, NFIP was able to cover most of its  claims with premiums it collected and occasional loans from the U.S.  Treasury (Treasury) that it repaid. However, after the 2005 hurricanes— primarily Hurricane Katrina—the program borrowed $16.8 billion from  Treasury to cover the unprecedented number of claims. In prior work we  found that NFIP, as it was then structured, was not likely to generate  sufficient revenues to repay this amount. NFIP since has received  additional borrowing authority in the amount of $9.7 billion to cover claims  for Superstorm Sandy. As of July 31, 2013, the program owed Treasury  approximately $24 billion.
NFIP’s financial condition highlights structural weaknesses in program  funding—primarily its rate structure. By design, NFIP does not operate for  profit. Instead, the program must meet a public policy goal—to provide  flood insurance in flood-prone areas to property owners who otherwise  would not be able to obtain it. NFIP generally is expected to cover its  claim payments and operating expenses with the premiums it collects.  However, subsidized policies have been a financial burden on the  program because of their relatively high losses and premium rates that  are not actuarially based. As discussed previously, subsidized policies  are associated with structures more prone to flood damage (either  because of the way they were built or their location). As a result, the  annual amount that NFIP collects in both full-risk and subsidized  premiums is generally not enough to cover its operating costs, claim  payments, and principal and interest payments to Treasury, especially in  years of catastrophic flooding. This arrangement results in much of the  financial risk of flooding being transferred to the federal government and  ultimately the taxpayer.
The Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters  Act) addressed some of the structural challenges that have contributed to  the program’s financial instability.policies will not receive subsidized premium rates, subsidies on existing   For example, new flood insurance  policies for many other properties will be phased out, and policies for  properties that are remapped to a higher risk level will be subject to  higher premium rates. In addition the Biggert-Waters Act requires FEMA  to implement other changes to its rate-setting process, including building  a reserve fund and updating maps used to set rates to reflect relevant  information on topography, long-term erosion of shorelines, future  changes in sea levels, and the intensity of hurricanes. While these  changes may help increase NFIP’s long-term financial stability, the  program still faces challenges in implementing the changes and their  ultimate effect is not yet known.
Furthermore, weaknesses in NFIP management and operations, including  financial reporting processes and internal controls, strategic and human  capital planning, and oversight of contractors, also have placed the  program at risk. For example, in 2011 we found that FEMA had not  developed goals, objectives, or performance measures for NFIP. In  addition, FEMA faces challenges modernizing NFIP’s insurance policy  and claims management system. As a result, we made recommendations  to improve the effectiveness of FEMA’s planning and oversight efforts for  NFIP; improve FEMA’s policies and procedures for achieving NFIP’s  goals; and increase the usefulness and reliability of NFIP’s flood  insurance policy and claims processing system. While FEMA agreed with  our recommendations and has taken some steps to address them,  continued attention to these issues is vital and additional steps are  needed to address the concerns we have identified in the past.
section_title: Change to Subsidized Policies and Implications of Additional Program Changes
paragraphs: The Biggert-Waters Act mandates that GAO conduct a number of studies  related to actual and potential changes to NFIP, including analyses of  remaining subsidized properties, and the effect of increasing coverage  limits or adding coverage options. In one of our studies responding to  these mandates, of remaining subsidized properties, we estimated that  with the changes in the Biggert-Waters Act approximately 438,000  policies are no longer eligible for subsidies, including about 345,000  nonprimary residential policies, about 87,000 business policies, and about  9,000 single-family, severe-repetitive-loss policies.the approximately 715,000 remaining subsidized policies are expected to  be eliminated over time. Under the act, most remaining subsidized  policies no longer would be eligible for subsidies if NFIP coverage lapsed  or the properties were sold or substantially damaged. We estimated that  with implementation of the provisions addressing sales and coverage  lapses, the number of subsidized policies could decline by almost 14  percent per year. At that rate, the number of subsidized policies would be  reduced by 50 percent in approximately 5 years. After about 14 years,  fewer than 100,000 subsidized policies would remain. However, the  actual outcomes and time required for subsidies to be reduced could vary  depending on the behavior of policyholders and the actual rate of sales  and coverage lapses. In terms of characteristics, we found that the  geographic distribution of remaining subsidized policies was similar to the  distribution of all NFIP policies. Other characteristics we analyzed— indicators of home value and owner income—were different for the  policies that continue to be eligible for subsidized premium rates  compared to those with full-risk rates. In particular, counties with higher  home values and income levels tended to have larger percentages of  remaining subsidized policies than policies with full-risk rates.
In our July 2013 report on subsidized policies, we identified three broad  options that could help address the financial impact of remaining  subsidized policies on the program, but the advantages and  disadvantages of each would need to be considered and action would be  required from both Congress and FEMA. These options are not mutually  exclusive and may be used together to reduce the financial impact of  subsidized policies on NFIP. The way in which an option is implemented  (such as more aggressively or gradually) also can produce different  effects in terms of policy goals and thus change the advantages and  disadvantages.
Adjust the pace of eliminating subsidies. Accelerating the elimination  of subsidies could improve NFIP’s financial stability by more quickly  increasing the number of policies with premium rates that more  accurately reflect the full risk of flooding, but could exacerbate the  difficulty some policyholders may have in adjusting to new rates. In  contrast, delaying the elimination of subsidized policies or lengthening  the phase-in period would continue to expose the federal government  to increased financial risk over a longer time. Moreover, delaying the  elimination of subsidies would not represent a long-term fix for those  policyholders who could not afford the new premium rates, whenever  they came into effect.
Target assistance for remaining subsidies. Assistance or a subsidy  could be based on the financial need of the property owners, which  could help ensure that only those policyholders needing the subsidy  would have access to it and retain their coverage, with the rest paying  full-risk rates. Targeting subsidies based on need—through a means  test, for example—is an approach other federal programs use.  However, NFIP does not currently collect the policyholder data  required to assess need and determine eligibility and it could be  difficult for FEMA to develop and administer such an assistance  program in the midst of ongoing management challenges. Moreover,  unlike other agencies that provide—and are allocated funds for— traditional subsidies, NFIP does not receive an appropriation to pay  for shortfalls in collected premiums caused by its subsidized rates.  One approach to maintain subsidies but improve NFIP’s financial  stability would be to rate all policies at the full-risk rate and  appropriate subsidies for eligible policyholders.
Expand mitigation efforts such as elevation, relocation, and demolition  of properties. This would include making mitigation mandatory to  ensure that more homes were better protected. Mitigation efforts  could be used to help reduce or eliminate the long-term risk of flood  damage; especially if FEMA targeted the properties that were most  costly to the program, such as those with repetitive losses. However,  mitigation is expensive for NFIP, taxpayers, and communities.
In our October 2008 study of NFIP’s rate-setting, we found that the losses  generated by NFIP have created substantial financial exposure for the  federal government and U.S. taxpayers—due in part to the program’s  rate-setting process. We also found that FEMA’s rate-setting methods,  even for full-risk rates, do not result in rates that accurately reflect flood  risks. For example, FEMA’s rate-setting process does not fully take into  account ongoing and planned development, long-term trends in erosion,  or the effects of global climate change. Furthermore, FEMA sets rates  on a nationwide basis, combining and averaging many topographic  factors that are relevant to flood risks, and does not specifically account  for these factors when setting rates for individual properties.
Partly because of the rate-setting issues, in our July 2013 report on  raising coverage limits or adding optional coverage types, we found that  the advantages and disadvantages to making more changes to the  program, such as these, would need to be carefully weighed. To  determine the financial impact on NFIP of increasing coverage limits, we  estimated the potential financial effect on NFIP if coverage limits had  been raised in 2002–2011. Higher coverage limits would have been  associated with increased net revenue in all fiscal years from 2002  through 2011, except for fiscal years 2004 and 2005 when the program  experienced catastrophic losses. The overall results were the same when  we conducted the analyses using variations in our assumptions to (1)  decrease the premiums by 20 percent below the baseline estimate; (2)  decrease the claims by 20 percent below the baseline estimate; and (3)  estimate that only 25 percent, 50 percent, or 75 percent of all  policyholders increased their coverage. Overall, the financial impact on  the program of raising coverage limits would depend on the adequacy of  the rates charged for the additional coverage. We also found that adding  business interruption coverage to NFIP could be particularly challenging.  For example, properly pricing risk, underwriting, and claim processing can  be complex. Similarly, offering optional coverage for additional living  expenses would have many of the same potential effects on NFIP,  although this coverage generally is less complex to administer.
section_title: Additional Challenges for FEMA to Address
paragraphs: In July 2013, we reported that FEMA will require several years to fully  implement the Biggert-Waters Act and FEMA officials acknowledged that  they have data limitations and other challenges to resolve before  eliminating some subsidies as required in the act. The following points  highlight some of the challenges we identified:
The act eliminated subsidies for residential policies that covered  nonprimary residences and business policies. FEMA has data on  whether a policy covers a primary residence, but officials stated that  the data may be outdated or incorrect. In addition, FEMA categorizes  policies as residential and nonresidential rather than residential and  business. As a result, FEMA does not have the information to identify  nonresidential properties such as schools or churches that are not  businesses and continue to be eligible for a subsidy. Beginning in  October 2013, FEMA will require applicants for new policies and  renewals to provide property status (residential or business).
The act states that subsidies will be eliminated for policies that have  received cumulative payment amounts for flood-related damage that  equaled or exceeded the fair market value of the properties, and for  policies that experience damage exceeding 50 percent of the fair  market value of properties after enactment. Currently, FEMA is unable  to make this determination as it does not maintain data on the fair  market value of properties insured by subsidized policies. FEMA  officials said that they have been in the process of identifying a data  source.
The act eliminates subsidies for severe repetitive loss policies and  provides a definition of severe repetitive loss for single-family homes.  However, it requires FEMA to define severe repetitive loss for  multifamily properties and FEMA has not yet developed this definition.
The act also requires FEMA to phase in full-risk rates on active policies  that no longer are eligible for subsidies, but we found that FEMA  generally lacks information needed to establish full-risk rates that reflect  flood risk for the properties involved and also lacks a plan for proactively  obtaining such information. Federal internal control standards state that  agencies should identify and analyze risks associated with achieving  program objectives, and use this information as a basis for developing a  plan for mitigating the risks. In addition, these standards state that  agencies should identify and obtain relevant and needed data to be able  to meet program goals. However, in July 2013 we reported that FEMA  does not have key information used in determining full-risk rates from all  policyholders. According to FEMA officials, not all policyholders have  elevation certificates, which document their property’s risk of flooding.  Information about elevation is a key element in establishing premium  rates on certain properties. Elevation certificates are required for some  properties, but optional for others. According to FEMA officials, consistent  with the act they are phasing in rate increases (of 25 percent per year) for  policyholders who no longer are eligible for subsidies. The increase will  continue until the rates reach a specific level or until policyholders supply  an elevation certificate that indicates the property’s risk, allowing FEMA to  determine the full-risk rate.
Although subsidized policies have been identified as a risk to the program  because of the financial drain they represent, FEMA does not have a plan  to expeditiously and proactively obtain the information needed to set full- risk rates for all of them. Instead, FEMA will rely on certain policyholders  to voluntarily obtain elevation certificates, which can be expensive for the  property owner. Those at lower risk levels have an incentive to do so  because they may then be eligible for lower rates. However, policyholders  may not know their risk level, and policyholders with higher risk levels  have a disincentive to voluntarily obtain an elevation certificate because  they then could pay a higher premium. In our July 2013 report, we  concluded that without a plan to expeditiously obtain property-level  elevation information, FEMA will continue to lack basic information  needed to accurately determine flood risk and continue to base full-risk  rate increases for previously subsidized policies on limited estimates. As  a result, FEMA’s phased-in rates for previously subsidized policies still  may not reflect a property’s full risk of flooding; with some policyholders  paying premiums that are below and others paying premiums that exceed  full-risk rates. We recommended that FEMA develop and implement a  plan, including a timeline, to obtain needed elevation information as soon  as practicable. FEMA agreed with this recommendation and plans to  evaluate the appropriate approach to obtain or require the submittal of  this information.
The Biggert-Waters Act also requires a number of other changes that the  agency has been starting to implement. For example FEMA must adjust  rates to accurately reflect the current risk of flood to properties when an  area’s flood map is changed, subject to any other statutory provision in  chapter 50 of Title 42 of the Unites States Code. 2013, FEMA has been determining how this provision would affect  properties exempted from rate increases when they were remapped.
42 U.S.C. § 4015(e). agency deems appropriate) over a number of years beginning October 1,  2013.
We continue to monitor the status of FEMA’s actions related to  recommendations we have made in prior reports. In 2008, we  recommended that FEMA develop a rate-setting methodology that uses  data that results in full-risk premiums that accurately reflect the risk of  losses from flooding. account the effects of long-term planned and ongoing development,  including climate change. In response to our continued support of this  recommendation as well as requirements in the Biggert-Waters Act,  FEMA officials stated that they have made progress. For example, FEMA  stated they already have revised damage calculations for flooding events  that only reach the foundation of the structure, and performed a study to  assess the long-term impacts of climate change. FEMA’s ongoing efforts  include analyzing water-depth probability curves for the various zones  and piloting studies to determine structure elevation and flood depths for  various return periods.
GAO-09-12.
National Association of Insurance Commissioners (NAIC) and conducting  other analyses to ensure that WYOs accurately report this information.  However, FEMA officials stated that the agency cannot take action that  completely addresses our recommendations until the WYOs reliably  report to NAIC and that it might take several years before all companies  consistently report such information. The agency also has been  considering how to best introduce the WYOs’ actual flood-related  expenses into payment formulas over the next several years, when FEMA  expects to have more reliable financial information and less variation in  reported expense ratios.
In 2011, we recommended that FEMA improve strategic planning,  performance management, and program oversight within and related to  NFIP. FEMA agreed with our recommendations and has addressed  some of them, such as strategic planning, but it still needs to continue to  address the management and operational weaknesses we identified,  including human capital planning, acquisition management, policy and  claims management systems, financial management, collaboration, and  records management. Unless these management issues are addressed,  FEMA risks ongoing challenges in effectively and efficiently managing  NFIP, including its management and use of data and technology.
In conclusion, when we placed NFIP on the high-risk list in 2006, we  noted that comprehensive reform likely would be needed to address the  financial challenges facing the program. Since passage of the Biggert- Waters Act, FEMA is taking some important first steps toward  implementing the reforms the act requires, but the extent to which the  changes included in the act and FEMA’s implementation will reduce the  financial exposure created by the program is not clear and the program’s  long-term financial condition is not yet assured. In addition, our previous  work has identified many of the necessary actions that FEMA should take  to address a number of ongoing challenges in managing and  administering the program. Getting NFIP on a sound footing, both  financially and operationally, is important to achieving its goals and at the  same time reducing its burden on the taxpayer.
Chairman Merkley, Ranking Member Heller, and Members of the  Subcommittee, this concludes my prepared statement. I would be happy  to answer any questions that you may have at this time.
section_title: Contact and Staff Acknowledgments
paragraphs: If you or your staff have any questions about this testimony, 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 statement. Other staff who made key contributions  to this testimony include Jill Naamane and Patrick Ward (Assistant  Directors); Isidro Gomez; Karen Jarzynka-Hernandez; Barbara  Roesmann; Rhonda Rose; and Jessica Sandler.
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