Flood Insurance: Potential Barriers Cited to Increased Use of Private Insurance
Published: 2016-07-14T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: NFIP was created, in part, because private insurers historically have been unwilling to insure against flood damage. The private flood insurance market remains small. The 2012 Biggert-Waters Act took steps to encourage private-sector participation by requiring regulators to direct lenders to accept private flood insurance to satisfy the mandatory purchase requirement—a federal requirement to purchase flood insurance on certain properties.
GAO was asked to examine if the regulatory environment posed barriers to private flood insurance. This report describes (1) lender and regulator implementation of provisions on private flood insurance; and (2) views on regulatory, or other, barriers to using private flood insurance to satisfy the mandatory purchase requirement. GAO reviewed laws, regulations and guidance and interviewed officials from FEMA, five federal regulators, government-sponsored enterprises, and the National Association of Insurance Commissioners. GAO interviewed various stakeholders, selected based on their flood insurance experience and size, among other factors: a nongeneralizable sample of eight lenders; 13 organizations; five state insurance regulators; and four private flood insurers.
section_title: What GAO Found
paragraphs: Lenders and their regulators have taken some action to implement provisions on private flood insurance in the Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act). Specifically, lenders told GAO they send notifications to borrowers that encourage borrowers to compare private and National Flood Insurance Program (NFIP) policies. Lenders with whom GAO spoke accepted private policies and generally said they used Federal Emergency Management Agency (FEMA) guidelines and interagency guidance to evaluate private policies. Federal regulators (Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, National Credit Union Administration, and Farm Credit Administration) issued interagency questions and answers on private insurance in 2009, which cite the FEMA guidelines. However, FEMA rescinded its guidelines in 2013, citing a lack of authority to rule on the acceptability of private insurance policies. Federal regulators have issued joint proposed rules to implement the Biggert-Waters Act definition of private flood insurance, but have not yet finalized them. Regulators stated that the information provided in the 2009 Questions and Answers remains in effect until final rules implementing the private flood insurance provisions of the Biggert-Waters Act are adopted.
Stakeholders cited a number of challenges as potentially inhibiting the use of private flood insurance to satisfy the mandatory purchase requirement.
Regulatory uncertainty . Without final regulations implementing the Biggert-Waters Act requirement to accept private flood insurance, there was uncertainty among stakeholders about which private policies would satisfy the mandatory purchase requirement. Many stakeholders, including some lenders, emphasized that lenders needed discretion when evaluating policies and that ensuring policies met the Biggert-Waters Act definition would be challenging for lenders, in part due to their lack of insurance expertise.
Recent NFIP changes . Stakeholders noted that a recent NFIP policy change could discourage consumers' use of private insurance. FEMA recently stopped allowing policyholders to obtain a refund of their unused NFIP premium if they obtained a non-NFIP policy. FEMA officials stated that, based on their recent review of NFIP cancellation policies, this practice was not explicitly permitted in the NFIP standard flood insurance policy terms and conditions. Due to this change, consumers who wish to obtain private coverage would forfeit any unused portion of their premium if they switched after the NFIP policy's effective date. While FEMA's standard policy terms do not specifically address refunds when a non-NFIP policy is obtained, FEMA could revise the standard policy to allow for such refunds. Allowing this type of refund would be in line with industry practice to allow refunds of paid premiums when cancelling insurance policies, as well as Congressional interest in transferring some of the federal government's exposure to flood insurance risk to the private sector.
Market challenges . Many stakeholders noted that low private sector participation in flood insurance was also due to market challenges, some citing the inability to compete with discounted NFIP rates as a primary barrier—a finding that GAO also reported in previous work (GAO-14-127).
section_title: What GAO Recommends
paragraphs: GAO recommends that FEMA reconsider allowing policyholders who cancel their NFIP policy to be refunded, on a prorated basis, when obtaining a non-NFIP policy and take any necessary steps to amend the NFIP standard policy to do so. FEMA agreed with our recommendation.

section_title: Letter
paragraphs: Floods are the most common and destructive natural disaster in the  United States. Created by the National Flood Insurance Act of 1968, the  National Flood Insurance Program (NFIP) is designed to protect  homeowners from flood losses, minimize the exposure of property to  flood damage, and alleviate taxpayers’ responsibility for flood losses paid  out in the form of postdisaster relief. NFIP—which is administered by the  Federal Emergency Management Agency (FEMA)—was created, in part,  because private insurers historically have been largely unwilling to insure  against flood damage. As of April 2016, NFIP collected about $3.4 billion  in annual premiums and insured about $1.2 trillion in property. Congress  passed the Flood Disaster Protection Act of 1973 (FDPA) to increase  flood insurance coverage among borrowers and encourage participation  in NFIP. FDPA, as amended, requires each federal entity for lending  regulation to direct regulated lending institutions to ensure that borrowers  with mortgages held by regulated lending institutions and secured by  properties located in special flood hazard areas (SFHA) in communities  participating in FEMA’s NFIP purchase and maintain flood insurance  (mandatory purchase requirement).
After several years of catastrophic losses, primarily from Hurricane  Katrina and other 2005 storms and Superstorm Sandy in 2012, NFIP’s  current debt to the Department of the Treasury (Treasury) was $23 billion  as of April 2016. Because of its premium structure, NFIP is unlikely to be  able to repay this debt in the near future, if ever. As a result of its  financial exposure and management challenges, the program has been  on GAO’s High-Risk list since 2006. Furthermore, some members of  Congress and others have shown increased interest in reducing the  federal role in flood insurance by transferring its exposure to the private  sector. In addition, new technologies and a better understanding of flood  risks may have increased the private sector’s willingness to offer flood  coverage. The Biggert-Waters Flood Insurance Reform Act of 2012  (Biggert-Waters Act) reauthorized NFIP through September 30, 2017, and  included changes related to the acceptance of private flood insurance to  satisfy the mandatory purchase requirement. In January 2014, we  reported on conditions needed for private-sector involvement in flood  insurance and strategies for increasing private-sector involvement.
You requested that we revisit the issue of the private-sector involvement  in flood insurance with a focus on the regulatory environment and  whether it posed any barriers to private flood insurance policies being  purchased by homeowners to satisfy the mandatory purchase  requirement. This report describes (1) regulated lending institutions’ and  federal regulators’ implementation of statutory provisions governing the  use of private flood insurance to satisfy the mandatory purchase  requirement; and (2) views on any regulatory, or other, barriers to the  increased use of private flood insurance to satisfy the mandatory  purchase requirement.
To address these objectives, we reviewed flood insurance laws and  regulations, related agency guidance, congressional hearings, and  studies, as well as past GAO reports on insurance markets and flood  insurance. To address the first objective, we reviewed relevant federal  flood insurance laws to identify the requirements for federal entities for  lending regulation (federal regulators) and how each regulator addresses  the use and acceptability of private flood insurance to fulfill the mandatory  purchase requirement. The federal regulators involved in implementing  the provisions of the flood insurance laws governing the mandatory  purchase requirement are the Office of the Comptroller of the Currency  (OCC), the Board of Governors of the Federal Reserve System (Federal  Reserve), the Federal Deposit Insurance Corporation (FDIC), the Farm  Credit Administration (FCA), and the National Credit Union Administration  (NCUA). We interviewed officials from each of these agencies, the  Federal National Mortgage Association (Fannie Mae), Federal Home  Loan Mortgage Corporation (Freddie Mac), and FEMA. We also obtained  information from the Department of Housing and Urban Development’s  (HUD) Federal Housing Administration (FHA).
To understand how lenders are fulfilling the requirements, we identified  and interviewed representatives from a nongeneralizable sample of eight  mortgage lenders based on their volume of loans in counties with a high  volume of NFIP policies, size and type of institution, and other factors.  To better understand how the federal regulators have implemented the  statutory requirements, we compared their regulations with the statutes.  We also reviewed guidance provided by the federal regulators and FEMA  related to the use of private flood insurance to satisfy the mandatory  purchase requirement. We reviewed and compared each of the  regulators’ examination manuals and flood insurance modules to  understand how each examined the regulated lending institutions they  supervise for compliance. Finally, we reviewed the policies of Fannie  Mae, Freddie Mac, the Department of Veterans Affairs (VA), and FHA to  understand their flood insurance requirements for mortgages they either  purchase or insure.
To address the second objective on any barriers, we interviewed various  stakeholders in the flood insurance industry: selected lenders (as  discussed above), organizations in the insurance and lending industries,  private flood insurance companies, and officials from selected state  insurance regulatory agencies. We selected 13 organizations to interview  based on the organization’s type, purpose and relevance to private flood  insurance, and membership. We identified these organizations based on  previous and ongoing GAO work on flood insurance, and comment letters  submitted by interested parties in response to federal regulators’  proposed rules on private flood insurance. We also selected and  interviewed representatives from a nongeneralizable sample of four  private insurance companies involved in the private market for flood  insurance. We identified and selected these companies through news  articles and our interviews with representatives of lenders and state  regulatory agencies. We also interviewed insurance regulators and their  representatives from Florida, Louisiana, Pennsylvania, Texas, and West  Virginia and reviewed selected laws from those states. We selected these  states based on the volume of NFIP policies written and flood insurance  regulatory activity in each state. Information provided by the selected  state insurance regulators is not generalizable to all states. In addition,  we reviewed 44 comment letters submitted in response to proposed rules  issued by the federal regulators in October 2013 on the acceptance of  private flood insurance to satisfy the mandatory purchase requirement in  order to identify comments pertaining to potential or actual regulatory  barriers to the use of private flood insurance and potential effects of the  proposed rules. We conducted a literature search for news articles and  studies to determine what is known about any regulatory, or other,  barriers to using private flood insurance to satisfy the mandatory  purchase requirement. We also interviewed representatives of the  National Association of Insurance Commissioners (NAIC) and the  Department of the Treasury’s Federal Insurance Office.
We conducted this performance audit from May 2015 to July 2016 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Flooding disasters of the 1920s and 1930s led to federal involvement in  protecting life and property from flooding, with the passage of the Flood  Control Act of 1936. Generally, the only available financial recourse to  assist flood victims was postdisaster assistance. When flood insurance  was first proposed in the 1950s, it became clear that private insurance  companies could not profitably provide flood coverage at a price that  consumers could afford, primarily because of the catastrophic nature of  flooding and the difficulty of determining accurate rates. In 1965,  Congress passed the Southeast Hurricane Disaster Relief Act that  provided financial relief for victims of flooding and mandated a feasibility  study of a national flood insurance program, which helped provide the  basis for the National Flood Insurance Act of 1968 that created NFIP.
FEMA, through its Federal Insurance and Mitigation Administration  (FIMA), manages the flood insurance program and sells and services  NFIP policies primarily through private insurance companies in the Write- Your-Own (WYO) program. Program participation takes place at the  community and the property-owner level. To participate, communities  must adopt and enforce land use and control measures to mitigate the  effects of flooding on new or existing homes in SFHAs. Participation for  property owners (borrowers) in participating communities initially was  voluntary; however, due in part to low levels of borrower participation;  Congress established the mandatory purchase requirement for properties  located in SFHAs in participating communities.
subsections: section_title: Overview of Mandatory Purchase Requirement
paragraphs: Regulated lending institutions and loan servicers acting on their behalf  must ensure that borrowers (1) purchase flood insurance for any building  or a mobile home located or to be located in an SFHA in a participating  community at the time a mortgage loan for that property is obtained, or at  the time of increasing, extending or renewing the loan, and (2) maintain  the insurance through the life of the loan, or add it if the property is  remapped into an SFHA and the borrower is then required to purchase  flood insurance under the mandatory purchase requirement. Regulated  lending institutions may not make, increase, extend, or renew any loan  secured by improved real estate or a mobile home located or to be  located in an SFHA community participating in NFIP unless the building  or mobile home and any personal property securing such loan is covered  by flood insurance for the term of the loan, subject to certain exceptions.  Although FDPA did not define “flood insurance” to specifically include or  exclude private insurance, guidance issued by the Federal Insurance  Administration in 1974 stated that private flood insurance policies could  satisfy the mandatory purchase requirement as long as they met specified  criteria.
The National Flood Insurance Reform Act of 1994 (1994 Act) further  amended the statutory framework for the mandatory purchase  requirement and its enforcement by federal regulators. The 1994 Act  directed that federal regulators issue regulations to require regulated  lending intuitions to notify borrowers in SFHAs about the availability of  flood insurance coverage under NFIP, and that such coverage is also  available from private insurers. Regulations implementing the 1994 Act  require that regulated lending institutions mail or deliver a written notice to  the borrower and servicer before completion of the transaction. The  notice must contain the following information: a warning that the building or the mobile home is or will be located in a description of the flood insurance purchase requirements under  FDPA, as amended; a statement, where applicable, that flood insurance coverage is  available under NFIP and also may be available from private insurers;  and a statement whether federal disaster relief assistance may be  available if flooding (from a federally declared disaster) causes  damage to the building or mobile home.
The 1994 Act also requires regulators to assess civil monetary penalties  against regulated lending institutions found to have a pattern or practice  of violating certain federal flood insurance requirements. It also required  Fannie Mae and Freddie Mac to implement procedures reasonably  designed to ensure that any mortgage they purchase (secured by  improved real estate or a mobile home in an SFHA) has flood insurance.
More recently, in 2012, the Biggert-Waters Act reauthorized NFIP through  September 30, 2017, and made some significant changes to FDPA. For  example, the Biggert-Waters Act increased the maximum penalties that  may be assessed against a regulated lending institution. The Biggert- Waters Act also required regulators to issue regulations directing lending  institutions to accept private flood insurance (as defined by the act) and  modified the required notification of borrowers of the availability of private  flood insurance.
In 2013, the federal regulators issued a joint notice of proposed  rulemaking to implement certain provisions of the Biggert-Waters Act,  including the modified notification and required acceptance of private  flood insurance. In July 2015, the regulators issued a final rule  implementing the modified notification provision and certain other  provisions from the Biggert-Waters Act and HFIAA. The July 2015 final  rule did not include implementation of the Biggert-Waters Act’s  requirements on private flood insurance; the agencies noted that they  planned to address those requirements in a separate rulemaking. See  figure 1 for a summary timeline of selected federal flood insurance  legislation.
section_title: Overview of Insurance Regulation and Markets
paragraphs: Insurance is primarily regulated by the states, unless federal law  specifically relates to the business of insurance (as in the cases of flood  and terrorism insurance). Federal regulators generally have authority  over the activities of regulated lending institutions that relate to the flood  insurance requirements under FDPA. The Federal Reserve, FDIC, OCC,  NCUA, and FCA are the regulators responsible for overseeing the federal  flood insurance requirements, including the mandatory flood insurance  purchase requirement, for their institutions (see table 1).
Requirements and processes for regulating insurance may vary from  state to state, but state regulators generally license insurance companies  and agents, review insurance products and premium rates, and examine  insurers’ financial solvency and market conduct. According to NAIC, state  regulators monitor an insurers’ compliance with laws and regulations, and  a company’s financial condition through solvency surveillance and  examination mechanisms. Insurance regulators use insurance  companies’ financial statements and other information as part of their  continuous financial analysis, which is performed at least quarterly, to  identify issues that could affect solvency. State insurance regulators  typically conduct on-site financial solvency examinations every 3–5 years,  although they may do so more frequently for some insurers, and may  perform additional examinations as needed. Through NAIC, the  regulators also collect financial information from insurers for ongoing  monitoring of financial solvency.
subsections: section_title: Admitted Insurance Market
paragraphs: Admitted insurers can sell insurance in one or more states but must be  licensed to operate in every state in which they sell coverage. Admitted  insurers can be licensed to sell several lines or types of coverage to  individuals or families, including personal lines (such as homeowners,  renters, and automobile insurance) and commercial lines (such as  general liability, commercial property, and product liability insurance).  Their activities are regulated primarily by the states. State regulators  require admitted insurance companies to maintain specific levels of  capital to continue to conduct business.
Admitted insurers provide coverage for numerous risks, but they may not  be willing to cover some risks. These include risks that are difficult to  assess, occur too frequently to be acceptable to admitted insurers, are  specialized or unusual, or require coverage that exceeds the capacity of  admitted carriers. In these cases, potential insureds may turn to the  nonadmitted market.
section_title: Nonadmitted Market and Surplus Lines Insurance
paragraphs: The nonadmitted market offers insurance products for risks for which  coverage is unavailable in the admitted market. Among the nonadmitted  insurers are surplus lines insurers. These insurers provide coverage for  general, management, and professional liabilities and commercial,  automobile, environmental, and property risks, among other things, and  tailor their products to meet the needs of the insured. For example, they  may write policies to cover personal lines of insurance such as  homeowners insurance in flood-prone areas. In 2014, the total surplus  lines direct premiums written in the U.S. market totaled more than $40  billion.
While admitted insurers must be licensed in the states in which they sell  insurance, surplus lines insurers must be licensed in only one state but  may sell in others in which they are not licensed, provided they are  eligible according to the states’ surplus lines laws. Surplus lines insurers  also must sell their insurance through a state-licensed broker. The  brokers typically represent insurance buyers and place coverage with  surplus lines insurers. According to NAIC, on a surplus lines placement,  the insurance regulator of the policyholder's home state has authority  over the placement of the insurance by a surplus lines broker and can  sanction the surplus lines broker, revoke their license, and hold them  liable for the full amount of the policy. To place coverage in the surplus  lines market, brokers must follow state due diligence requirements.  Although they vary from state to state, according to an association  representing surplus lines insurers and brokers, these requirements  generally call for a “diligent search” of the admitted market before turning  to a surplus lines insurer. The diligent search generally requires brokers  to establish that three admitted companies licensed to write the kind and  type of insurance being requested had declined to provide it.
section_title: Lenders’ and Regulators’ Implementation of Provisions Relating to Private Flood Insurance
subsections: section_title: Lenders Told Us They Rely on Existing Guidance and Criteria When Assessing Private Policies
paragraphs: All eight of the lenders with whom we spoke stated that they accept or  would accept private flood insurance as satisfaction of the mandatory  purchase requirement. Moreover, all but one stated that they have  policies and procedures that use one or more sources of guidance when  determining if a private policy satisfies the mandatory purchase  requirement. All but one of the lenders referenced the criteria in FEMA’s  (now rescinded) Mandatory Purchase of Flood Insurance Guidelines  (Guidelines) as one set of guidance—the Guidelines provided lenders  with six criteria to evaluate private flood insurance policies for compliance  with the mandatory purchase requirement. The Guidelines also provided  that to the extent the policy differs from the NFIP standard policy, the  differences should be examined before the policy is accepted. (See table  2 and app. II for more detailed information on the criteria.) Half of the  lenders with whom we spoke also referenced the July 2009 Interagency  Questions and Answers Regarding Flood Insurance (2009 Questions and  Answers) provided by the federal regulators, which cite FEMA’s  Guidelines as criteria for evaluating private flood insurance policies.  One lender cited the requirements of Fannie Mae and Freddie Mac as a  primary source of guidance. The same lender also added that when  working with loans insured by FHA and VA, they use their requirements  and guidance on the use of private flood insurance.
FEMA issued Guidelines in 1989 to promote greater uniformity and  understanding of the requirements of mandatory purchase provisions  among federal regulators of lenders, government-sponsored enterprises  (such as Fannie Mae or Freddie Mac), federal agency lenders, and  applicable lending institutions. In February 2013, FEMA rescinded the  Guidelines, stating that the six elements listed in the guidance were  intended to provide assistance to regulated lending institutions in  determining the acceptability of private flood insurance and were not  meant to be exclusive. Furthermore, FEMA stated, as it had in the  Guidelines, that it had no authority to rule on the acceptability of private  insurance policies.
However, federal regulators told us that until they finalize regulations  requiring regulated lending institutions to accept private flood insurance  under the Biggert-Waters Act, regulated lending institutions should  continue to use the 2009 Questions and Answers as guidance when  determining if a private flood insurance policy satisfies the purchase  requirement. In these Questions and Answers, the regulators state that  a private flood insurance policy may be an adequate substitute for an  NFIP policy if it meets the criteria set forth by FEMA in its Guidelines.  The 2009 Questions and Answers also state that regulated lending  institutions may rely on a private policy that does not meet the FEMA  criteria only in limited circumstances. Officials for each of the regulators  acknowledged that the 2009 Questions and Answers cite the rescinded  FEMA Guidelines but stated that the overall guidance remains in effect.  They noted that regulated lending institutions continue to have discretion  in determining whether a private flood insurance policy meets regulated  lending institutions’ obligations under the mandatory purchase  requirement.
Furthermore, in their interagency statement as well as their 2013 joint  notice of proposed rulemaking, the regulators stated that the Biggert- Waters Act provision requiring the acceptance of private flood insurance,  as defined by the act, will be implemented through rulemaking. Both  documents noted that the regulators considered this provision not  effective until final regulations are issued. The 2013 joint notice of  proposed rulemaking further stated that regulated lending institutions  currently continue to have the discretion to accept flood insurance issued  by private insurers. According to federal regulators, while they are  working on finalizing these regulations, they currently do not have a  timetable for issuing final regulations implementing these requirements.
According to most of the lenders with whom we spoke, each exercises  some level of discretion when determining whether a private policy meets  the guidance they currently follow. For example, two lenders stated that if  a private policy does not exactly match the FEMA criteria, they use their  judgement in determining if the policy provides sufficient protection under  the law. Four lenders stated that if a policy does not meet the criteria they  may determine not to accept the policy or ask the borrower to obtain a  policy that more closely meets the criteria. Most lenders described  currently having procedures for evaluating a private flood insurance policy  that generally require greater judgement and resources than required  when the borrower presents an NFIP policy. For example, half of the  lenders stated that procedures for assessing a private flood insurance  policy generally include obtaining the entire policy and evaluating it  against the FEMA Guidelines. In contrast, one lender stated that the  company only obtains the NFIP policy declaration page. A representative  of another lender said the company has specialists to conduct reviews of  private flood insurance policies and a centralized flood insurance function  that reviews NFIP policies.
Finally, according to most of the lenders with whom we spoke, they deal  with a relatively small number of private policies. For example, while most  of the lenders did not specifically track data on the use of private flood  insurance, six of the eight lenders roughly estimated that less than 5  percent of the residential mortgages in their portfolios that require flood  insurance were insured by a private policy. While stakeholders with whom  we spoke did not have data on the use of private flood insurance, they  generally agreed that most private flood insurance written is in the surplus  lines market for commercial properties or for coverage in excess of what  NFIP offers. We were not able to identify any currently available  information on the amount of flood insurance written by admitted carriers.  According to NAIC officials, NAIC has begun to collect information on  private flood insurance from various associations to inform state  insurance regulators of the current interest and activity in the private  market for flood insurance. NAIC also has been developing a requirement  for insurance companies to include a line item in their annual financial  statements that highlights their private flood insurance activity.
section_title: Lenders Told Us They Send Notifications to Borrowers That Include Language Encouraging Comparison of NFIP and Private Insurance
paragraphs: According to all of the lenders we interviewed, their notices to borrowers  include language that encourages the comparison of NFIP and private  insurance policies. More specifically, they said they use sample language  provided in the final rule that implemented Biggert-Waters Act changes to  the notification requirement, or something generally similar. (The statutory  requirements and the sample language are described in more detail  below.)
All of the lenders with whom we spoke also stated that other than  providing the required notice to borrowers, they generally did not  communicate with borrowers about flood insurance, either private or  NFIP. A few lenders stated that borrowers likely make insurance  decisions with their insurance agent.
As noted previously, the Biggert-Waters Act amended the notification  requirement in the 1994 Act to revise and add information pertaining to  private flood insurance. The Biggert-Waters Act requires that regulated  lending institutions disclose to a borrower that  flood insurance is available from private insurance companies that  issue standard flood insurance policies on behalf of NFIP or directly  from NFIP;  flood insurance that provides the same level of coverage as a  standard flood insurance policy under NFIP may be available from a  private insurance company that issues policies on behalf of the  company; and  the borrower is encouraged to compare the flood insurance coverage,  deductibles, exclusions, conditions, and premiums associated with  flood insurance policies issued on behalf of NFIP and policies issued  on behalf of private insurance companies and to direct inquiries on the  availability, cost, and comparisons of flood insurance coverage to an  insurance agent.
In July 2015, the federal regulators issued a final rule that provides that  the revised and additional disclosures be included in the notification to  borrowers. The regulators also amended an existing sample form  (Sample Form of Notice of Special Flood Hazards and Availability of  Federal Disaster Relief Assistance) with language to reflect the additional  disclosures (see app. III). Since the sample form was first provided in  1996, regulations have provided that a regulated lending institution will be  considered in compliance with the notice requirement if the regulated  lending institution provides a written notice to the borrower containing the  language found in the sample form (within a reasonable time before the  completion of the transaction).
section_title: Federal Regulators Have Jointly Implemented Flood Insurance Regulations
paragraphs: Our review of the regulations issued to implement the various flood  insurance statutes found that since the passage of the 1994 Act, as  amended, the federal regulators have issued joint regulations  implementing most of the statutory requirements.
Most recently, in July 2015 the regulators issued final rules implementing  numerous provisions of the Biggert-Waters Act and the Homeowner  Flood Insurance Affordability Act of 2014 (HFIAA) related to the escrow of  flood insurance payments on residential properties, exemptions from the  mandatory purchase requirement, and, as stated earlier, revised  disclosures in the notification to borrowers, among other provisions. The  regulators did not implement the Biggert-Waters Act provision requiring  the acceptance of private flood insurance, as defined by the act.
The federal regulators in our review—FDIC, Federal Reserve, NCUA,  OCC, and FCA—also have developed consistent examination guidance  for regulated lending institutions’ activities related to flood insurance. All  five of the federal regulators currently responsible for lending regulation  use risk-based examinations in their oversight of their institutions. When  examining institutions, each has procedures for reviewing a regulated  lending institution’s compliance with the requirements of the National  Flood Insurance Act, as amended. To assist examiners in executing  these examinations, each federal regulator has developed a general  examination manual that details examination policies and procedures as  well as flood insurance examination procedures that were developed on  an interagency basis under the direction of the Federal Financial  Institutions Examination Council. According to federal regulators’  examination guidance, an examination team is to review a regulated  lending institution’s policies, procedures, and controls for ensuring  compliance with the flood insurance requirements. Two federal regulators  stated and the other three regulators’ examination guidance states that  examiners generally review a sample of loans to determine compliance  with regulatory requirements, potentially including flood insurance  requirements.
We reviewed the examination manuals and flood insurance modules or  checklists for each of the federal regulators and found that the relevant  flood insurance portions of each manual were substantially similar and  addressed the flood insurance-related requirements for the regulated  lending institutions. For example, all five regulators’ modules or  checklists include, reviewing loan documentation to ensure that a flood  zone determination was made, notices were provided to the borrower and  servicer, premiums were properly escrowed, and the property was  covered by an insurance policy in the appropriate amount. Based on our  review, the flood insurance examination procedures did not differentiate  between private flood insurance policies and NFIP policies. The focus of  the manuals was to assist examiners in assessing regulated lending  institutions’ compliance with flood insurance requirements, including  notice and mandatory purchase of flood insurance.
section_title: Regulatory Uncertainty, Certain NFIP Changes, and Market Challenges Cited as Potentially Inhibiting Use of Private Flood Insurance
paragraphs: Stakeholders cited regulatory uncertainty, such as the lack of final  implementing regulations and the scope of the definition of private flood  insurance in the Biggert-Waters Act, as some of the potential barriers  lenders may face in fulfilling their responsibilities regarding private flood  insurance and the mandatory purchase requirement. Stakeholders also  cited recent changes made by FEMA to certain NFIP policies as potential  barriers to consumers’ use of private flood insurance. Finally,  stakeholders identified certain market challenges as barriers to increased  use of private insurance. Congress has been considering legislation to  address some of the concerns raised by stakeholders and some states  have enacted legislation to make private flood insurance more accessible.
subsections: section_title: Lack of Final Regulations and Scope of Statutory Definition of Private Flood Insurance Cited by Stakeholders as Potential Barriers for Lenders
paragraphs: Stakeholders cited the lack of final implementing regulations, the scope of  the Biggert-Waters Act definition of private flood insurance, and limited  insurance expertise as potential barriers lenders face to evaluating and  accepting private policies in satisfaction of the mandatory purchase  requirement. The Biggert-Waters Act requires regulators to issue  regulations requiring that regulated lending institutions accept private  flood insurance, as defined in the statute, to meet the mandatory  purchase requirement; however, regulators have yet to issue the final  regulations to make this provision effective.
Lack of final rules. Various stakeholders with whom we spoke cited the  lack of final rules as creating regulatory uncertainty among lenders and  insurers about the use of private flood insurance to satisfy the mandatory  purchase requirement. For example, one association noted that while a  law has been passed requiring regulated lending institutions to accept  private flood insurance, without final rules implementing this requirement,  it is unknown what the regulations will be and how lenders and private  insurers will comply. Officials from two lenders also stated that the lack of  final regulations and the lenders’ reliance on FEMA guidance puts them in  an uncertain and uncomfortable position, as this guidance has been  rescinded and is not current. Furthermore, according to a private insurer  with whom we spoke, there is uncertainty about whether private policies  that lenders have accepted as satisfying the mandatory purchase  requirement, may retroactively be deemed noncompliant if they do not  meet the requirements of the new regulations, after they are finalized.  This insurer added that the issuance of final rules on the acceptance of  and definition of private flood insurance would lead to more clarity. They  added that public acceptance and use of private flood insurance also may  increase. Finally, a state insurance regulator and federal regulator noted  that the lack of final rules has led to uncertainty among lenders about  which private policies should be accepted.
Scope of definition and flexibility. Stakeholders we interviewed, as well  as many comment letters in response to the regulators’ October 2013  proposed rules on private flood insurance, expressed concerns about the  scope of the definition of private flood insurance in the Biggert-Waters  Act, also discussed later in this section. They also noted the need for  regulated lending institutions to retain some discretion when evaluating  private flood policies. The Biggert-Waters Act codified the rescinded  FEMA criteria (which the regulators and lenders considered as guidance),  into law as the definition of private flood insurance. See app. II for a side- by-side comparison of the FEMA criteria and the Biggert-Waters Act  definition.
According to some stakeholders, to be compliant with the Biggert-Waters  Act provisions, regulated lending institutions only may be able to accept  private policies meeting all the criteria in the law. They added that  evaluating private policies to meet all elements of the statutory definition  would reduce the discretion regulated lending institutions currently have  when evaluating and accepting private policies. As discussed previously,  some lenders stated that they currently use their judgement in  determining whether to accept a private policy even if it does not meet all  the criteria but still covers their risk. Furthermore, two lenders stated that,  under the Biggert-Waters Act requirement, their evaluation of private  policies would focus on compliance with the statutory definition, as  opposed to focusing on ensuring the policies met the lender’s own risk  requirements. These lenders, as well as associations and lenders that  submitted comment letters, emphasized the need for regulated lending  institutions to have a certain level of flexibility and discretion in evaluating  and accepting policies.
Importance of guidance. Comment letters and representatives of  banking trade associations with whom we spoke also stated their desire  for additional guidance on how to evaluate private flood insurance policies  once the final rule is implemented. Some stakeholders want additional  guidance because regulated lending institutions could face civil monetary  penalties (for noncompliance) for policies that did not meet the statutory  criteria. A few lenders we interviewed and comment letters to the  proposed rules also noted that additional guidance that clearly states  what is required of private flood insurance policies to comply with the  Biggert-Waters Act would make lenders more comfortable in reviewing  and accepting such policies. Citing a need for clear and comprehensive  guidance, several stakeholders urged the federal regulators and FEMA to  work together to update and reinstate FEMA’s rescinded Guidelines to  reflect changes from the Biggert-Waters Act. In addition, in their comment  letters, a few stakeholders noted that additional guidance would help  promote uniformity across mortgage lenders and the private flood  insurance industry.
Lender expertise. Some lenders and other stakeholders from the  insurance and banking industries stated their concern about evaluating  policies for compliance with one criterion in particular: that private flood  insurance provide coverage be “at least as broad as” the coverage NFIP  offers. A lender, two insurers, FEMA officials, and a regulatory official all  noted that matching the elements of a private policy to an NFIP policy  would be difficult. For example, FEMA officials said that NFIP’s policy  terms and rates do not reflect prior flood losses and that private insurers  likely would not be able to develop their rates without taking prior losses  into consideration. Two private insurers told us that in their experience,  some lenders find it difficult to compare private policies with NFIP  policies. One insurer added that if a lender was not familiar with private  flood insurance, the company would need to educate the lender on their  policy’s coverage and show how it matched that of an NFIP policy. More  generally, some lenders and banking associations with whom we spoke,  as well as many comment letters on the proposed rule, noted that lenders  might not have the expertise to evaluate private flood policies against the  statutory criteria. In addition, a FEMA-commissioned study on  privatization concluded that an increased use of private insurance would  necessitate increased resources on the part of regulated lending  institutions to assess whether private policies complied with the  mandatory purchase requirement and met their needs.
In their October 2013 proposed rule, the federal regulators acknowledged  concerns about the ability of regulated lending institutions to evaluate  whether private policies met the statutory definition because some  regulated lending institutions lacked the necessary technical expertise.  Recognizing that regulating insurance is generally the domain of state  regulators, the regulators suggested that the state regulators might be the  appropriate parties to determine whether a flood insurance policy met all  the criteria in the statutory definition of private flood insurance. Therefore,  the proposed rule includes a safe harbor to allow regulated lending  institutions to rely on a written determination of the state insurance  regulator that a policy issued by a private insurer met the federal statutory  definition of private flood insurance.
Concerns about state interpretations. While some comment letters and  stakeholders with whom we spoke acknowledged that state insurance  regulators have authority and experience in approving and overseeing  property/casualty insurance, and can do the same with private flood  insurance, some also noted challenges with the proposed safe harbor.  Specifically, in their comment letters, NAIC and other stakeholders  questioned the authority and ability of state insurance regulators to be  solely responsible for interpreting or enforcing federal law generally, and  in particular, the federal statutory definition of private flood insurance.  Representatives of one state insurance regulator with whom we spoke  noted that even with their experience and regulatory structure for  approving insurance policies, state regulators would find it challenging to  determine if private policies were at least as broad as NFIP policies.
FEMA’s report on privatization acknowledges that with greater use of  private flood insurance, state insurance regulators would have an  increased role and need to become more familiar with how flood  insurance is modeled, priced, and managed. The FEMA report also noted  that the involvement of different state regulators could result in many  different regulatory systems. Some comment letters also raised this  concern, and added that varying state laws could result in inconsistencies  in states’ determinations of acceptable flood insurance policies. Due to  the challenges with the statutory definition of private flood insurance  described earlier, comment letters from some lenders and banking  associations, and a few lenders with whom we spoke, noted the need for  an additional option for a safe harbor provision (that is, in addition to the  one discussed in the proposed rule), which they could rely on for  approving private policies as meeting the statutory criteria. They  suggested that insurance companies provide their own written  determination that their policy complies with the definition of private flood  insurance in the Biggert-Waters Act. One private insurer we interviewed  has been asked by lenders to attest in writing that its flood insurance  policy meets the requirements in the Biggert-Waters Act.
section_title: Recent NFIP Policy Changes May Discourage Consumers’ Use of Private Flood Insurance
paragraphs: Stakeholders cited certain changes made by FEMA to NFIP policies on  flood insurance, which may affect consumers financially, as potential  barriers to consumers’ ability or willingness to switch from NFIP and use  private flood insurance to satisfy the mandatory purchase requirement.
Continuous coverage. NAIC and stakeholders cited FEMA’s  interpretation of the continuous coverage requirement in connection with  private flood insurance and the effect on consumers’ ability to qualify for  NFIP discounted rates. Effective April 1, 2016, FEMA prohibits the use of  discounted rates (subsidized or “grandfathered” rates) for policies when  there has been a lapse in NFIP coverage of more than 90 days (see   fig. 2). FEMA officials noted that excluding non-NFIP policies from  constituting continuous coverage was due to FEMA’s interpretation of the  HFIAA provision on policy lapses.
Some stakeholders, including private insurers, noted that FEMA’s  decision to exclude private flood insurance policies from constituting  continuous coverage could have financial repercussions for consumers  seeking to reinstate their previously discounted NFIP coverage (after  using a private policy to insure their properties from flood losses). So, if a  NFIP policyholder who qualified for subsidized rates switched to a private  flood policy, and then switched back to an NFIP policy, the policyholder  would no longer qualify for subsidized rates and would be charged full- risk rates based on the elevation of the property. A single-family primary  residence with $200,000 in building coverage and $50,000 in contents  coverage would pay a subsidized premium of $2,880, but their full-risk  rate would be based on elevation. For example if this building’s elevation  was 1 foot below base flood elevation, the full-risk premium would be  $4,650. If it was 2 feet below, the full-risk premium would be $6,890.  Two private insurers and an association representing insurers told us that  due to the risk of losing their discounted NFIP rates, consumers may  avoid the private market as an option to insure against flood losses.
Narrowed opportunities for premium refunds. According to NAIC and  the private flood insurance companies with whom we spoke, another  recent regulatory change—a FEMA guidance revision related to policy  cancellations—could discourage the use of private flood insurance by  consumers. FEMA allows NFIP coverage to be terminated in accordance  with its stated cancellation reasons. If coverage is terminated for a valid  cancellation reason, the insured may be entitled to a full or partial refund  of the paid NFIP premium. Effective November 1, 2015, FEMA no longer  allows policyholders to cancel their NFIP policy and obtain a refund if they  obtained a non-NFIP policy (private flood insurance policy). However,  FEMA had allowed for refunds under this scenario previously (see fig. 3).  According to NAIC officials, if the reason for cancellation of an insurance  policy is the request of the policyholder, the policyholder generally would  receive a refund of the paid premium, which may be less than the  prorated premium, if stipulated by the insurance policy. Two organizations  that represent private insurers also stated that policyholders generally  would receive a refund of their paid premium when cancelling a policy  after the effective date of the policy. FEMA officials told us that this  change came about due to a review of cancellation allowances conducted  to incorporate any necessary changes from flood insurance legislation  (Biggert-Waters Act and HFIAA). Specifically, FEMA officials said that  FEMA only can allow cancellation of policies and refunds according to the  terms and conditions of NFIP’s Standard Flood Insurance Policy (SFIP).  They stated that while the NFIP policy allows for the cancellation of a  policy and refund of a premium, on a prorated basis, when a duplicate  NFIP policy is obtained on the same property, there is not a similar  provision when a non-NFIP policy is obtained. FEMA did not provide any  additional analysis or offer further explanation for this change. However,  FEMA could have taken steps to revise the SFIP to allow for such  refunds. Allowing this type of refund would be in line with industry practice  to allow for refunds of paid premiums as well as Congress’s interest in  transferring some of the federal government’s exposure to flood  insurance risk to the private sector.
According to most of the private flood insurers with whom we spoke, this  change to the cancellation policy further complicates the situation for  consumers who wish to opt for private flood insurance when coupled with  the requirement that regulated lending institutions establish escrow  accounts for flood insurance premiums and fees for loans made after  January 1, 2016. Generally, according to some insurers with whom we  spoke, lenders will use escrow accounts to pay for flood insurance from  30 to 90 days in advance of the effective date of insurance policies. The  combination of factors may present a challenge to consumers because  they may not know when escrowed payments are made or because of the  limited time frame in which they could cancel their NFIP policies to avoid  forfeiting their premium, which could result in the following scenarios.
According to one private insurer, policyholders may not be aware that  the bank already renewed their NFIP policy and made the payment  from the escrow account. Because FEMA will no longer refund  premiums to policyholders who switch to a non-NFIP policy,  consumers must cancel their NFIP policy in advance of their NFIP  renewal date to avoid forfeiting their premium.
A representative of another private insurer added that consumers who  wish to obtain a private insurance policy must consider making this  change well in advance of the NFIP policy effective date (or renewal  date) and that generally consumers do not address their insurance  needs that far in advance or realize when their insurance has been  paid from their escrow account.
section_title: Limited Use of Private Flood Insurance Also Due to Market Challenges
paragraphs: Many stakeholders with whom we spoke said that low private-sector  participation in the flood insurance market also was due to certain market  challenges that presented barriers to the private sector such as NFIP’s  discounted rates, a topic on which we reported previously and also have  ongoing work. For example, in our January 2014 report, we noted that  according to stakeholders, insurers needed to be able to charge premium  rates that reflect the full risk of potential flood losses, but with NFIP  charging rates that were not actuarially sound, private companies found it  difficult to compete in the market. Stakeholders with whom we spoke for  this report (including insurance trade associations, several state  insurance regulatory agencies, and another organization with flood  insurance expertise) also noted this concern. Several stakeholders,  including private insurers, and NAIC emphasized that having to compete  with NFIP’s discounted rates is one of the primary barriers to increased  use of private flood insurance rather than any regulatory issues. Similarly,  our review of literature related to the involvement of the private sector in  flood insurance found that the ability to charge actuarially sound rates  was a strong factor in market participation.
Many stakeholders (including insurance trade associations, a private  insurer, and officials from two state regulatory agencies) also noted the  lack of access to NFIP data on flood losses and claims as a barrier to  more private companies offering flood insurance. Stakeholders added  that access to such data would allow private insurance companies to  better estimate losses and price flood insurance premiums. In our  previous work, stakeholders told us that access to NFIP policy and claims  data would help private insurers assess flood risks and determine which  properties they might be willing to insure.
However, in our previous report we also noted that according to FEMA  officials, the agency would need to address privacy concerns to provide  property-level information to insurers, because the Privacy Act prohibits  the agency from releasing detailed NFIP policy and claims data. The  Privacy Act governs how federal agencies may use the personal  information that individuals supply when obtaining government services or  fulfilling obligations. FEMA officials said that while the agency could  release data in the aggregate, some information could not be provided in  detail. For example, FEMA could provide ZIP code-level information to  communities but would need to determine how to release property-level  information while protecting the privacy of individuals. FEMA officials  added that recent data breaches in the federal government’s information  technology controls have led to additional concerns about the secure  storage and sharing of NFIP data. According to NAIC officials, after  receiving a request from a state insurance regulator for NFIP data on  flood losses and claims in their state, FEMA officials approached NAIC to  discuss options for sharing such data. NAIC officials told us that its  catastrophe insurance working group is coordinating with FEMA actuaries  to determine how FEMA could share specific data with states, without  disclosing personally identifiable information.
Our previous work on private-sector involvement in flood insurance also  cited other concerns raised by stakeholders. Stakeholders we  interviewed for that work noted several conditions that must be present to  increase private-sector involvement in the sale of flood insurance,  including that insurers need sufficient consumer participation to properly  manage and diversify their risk. They also identified several strategies  that could help create conditions that would promote the sale of flood  insurance by the private sector, such as Congress eliminating discounted  rates and NFIP charging full-risk rates, or NFIP providing residual  insurance. In addition, we have an ongoing review examining the policy  goals that have led to NFIP’s debt to Treasury—for example, providing  subsidies to certain policyholders—and how the program can be reformed  under different circumstances (for example, if there is increased  participation in flood insurance by the private sector.)
Finally, some stakeholders also told us that certain FEMA restrictions on  WYOs may be an impediment to increasing the availability of private flood  insurance in the market. Specifically, the NFIP Financial  Assistance/Subsidy Arrangement (Arrangement) with WYOs restricts  WYOs from selling stand-alone flood insurance coverage outside of  NFIP. Officials from two state insurance agencies and one insurance  trade association said that the FEMA restriction limits companies with the  most experience in flood insurance from entering the private market.  FEMA officials stated that, despite this restriction, a number of companies  have found ways to offer flood insurance while remaining compliant with  the Arrangement. For example, if a subsidiary of a large insurance  company is a WYO, the parent company could offer stand-alone flood  coverage. Alternatively the WYO could offer flood coverage as part of a  multiperil policy.
section_title: Recent Legislative Proposals to Amend the Biggert-Waters Act and State Actions to Help Increase Accessibility of Private Flood Insurance
paragraphs: Since the passage of the Biggert-Waters Act, new legislation has been  introduced in Congress that could help address some of the regulatory  issues and a recent change made to NFIP that stakeholders cited as  barriers. The proposed legislation would amend the statutory definition of  private flood insurance that would satisfy the mandatory purchase  requirement. That is, the definition of private flood insurance in the  proposed legislation would replace the specific criteria in the Biggert- Waters Act and instead define private flood insurance as an insurance  policy that   (1) is issued by an insurance company that is   (I) licensed, admitted, or otherwise approved to engage in the  business of insurance in the state in which the insured building is located,  by the insurance regulator of that state; or   (II) eligible as a nonadmitted insurer to provide insurance in the  home state of the insured;   (2) is issued by an insurance company that is not otherwise disapproved  as a surplus lines insurer by the insurance regulator of the state in which  the property to be insured is located; and   (3) provides flood insurance coverage that complies with the laws and  regulations of that state.
Some stakeholders with whom we spoke supported the proposed  legislation because it relies on the expertise of state insurance regulators  rather than individual regulated lending institutions. According to these  stakeholders, the changes to the statutory definition of private flood  insurance clarify that flood insurance approved by state insurance  regulators is acceptable in satisfying the mandatory purchase  requirement. But according to a consumer advocate’s January 2016  testimony to Congress, facilitating the sale of flood insurance by surplus  lines carriers could create problems for consumers because surplus lines  policies are subject to fewer consumer protections than admitted policies.  For example, surplus lines policies are not backed by state guaranty  funds and states do not regulate surplus lines policy forms, which may  contain exclusions that regulators would not approve for an admitted  carrier. At the same hearing, NAIC stated its support for the proposed  legislation and noted that as the private flood insurance market grew, they  expected state insurance regulation would continue to evolve to meet the  size of the market as well as the needs of consumers. NAIC officials  also told us that the proposed legislation would alleviate their concerns  that the Biggert-Waters Act allows federal regulators to regulate the  solvency of private flood insurers. However, Fannie Mae officials stated  that the proposed legislation (H.R. 2901 as adopted by the House on April  28, 2016) would weaken its risk-management practices to the extent that  it would impair Fannie Mae from maintaining or taking prudent actions to  protect homeowners and collateral. Furthermore, while noting that  creating a viable private flood insurance market is in the interest of the  housing finance system and taxpayers, Freddie Mac officials stated that  they have concerns that the proposed legislation could shift the risk of  flood loss to Freddie Mac; they have been addressing these concerns  with the Federal Housing Finance Agency.
The proposed legislation also would amend the flood insurance statute to  explicitly allow for private flood insurance coverage to satisfy any  continuous coverage requirements, reversing a recent change that FEMA  made to NFIP (coverage is not considered continuous if supplied through  a non-NFIP policy for more than 90 days). As discussed earlier, some  stakeholders cited FEMA’s change to this policy as a potential barrier to  the use of private insurance. Specifically, the proposed legislation states  that any period during which a property was continuously covered by  private flood insurance, as defined by the proposed legislation, should be  considered to be a period of continuous coverage for purposes of  applying any statutory, regulatory, or administrative continuous coverage  requirement. However, the proposed legislation does not directly address  NFIP’s recent change in cancellation reasons, which can preclude  refunds of premiums when coverage was supplied by a non-NFIP policy,  or the restriction on WYOs offering stand-alone flood insurance products.
Whether a state permits a particular private flood insurance policy to be  offered to consumers is a different question from whether the regulated  lending institution or federal regulator finds the private policy sufficient to  satisfy the mandatory purchase requirement. More specifically, regulated  lending institutions and federal regulators, rather than states, are  responsible for ensuring compliance with the mandatory purchase  requirements under federal law. However, according to the state officials  with whom we spoke, states have the authority to regulate the flood  insurance offered by private insurance companies in their states and  some have taken steps to try to make private flood insurance more  accessible.
For example, Florida and West Virginia recently passed legislation that  outlines the regulatory structure for insurance companies that choose to  sell private flood insurance in those states. Specifically,
Both states allow insurance companies to write flood insurance  policies in a more customized way and charge rates in accordance  with state laws.
Both state laws reduce the barriers to accessing the surplus lines  market for some flood insurance by not requiring an agent to attempt  to place a policy with an admitted company or attempt to find a  comparable admitted product. Before the enactment of these laws,  the agent would have had to make a “diligent effort” to seek such  coverage in the admitted market before placing a flood insurance  policy with a surplus lines carrier.
According to officials from both states, these laws were not necessarily  needed to allow private insurers to offer flood insurance as officials from  both states believed prior statutes permitted the state insurance regulator  to allow for flood insurance. However, officials noted that these laws  publicly encourage private companies to sell flood insurance in these  states, with the intent of offering consumers more options.
Similarly, according to the National Association of Professional Surplus  Lines Offices (NAPSLO), 18 states have made private flood insurance  more accessible by providing for easier access to the surplus lines  insurance market. Furthermore, 12 of these states allow direct access to  the surplus lines market with no restrictions for flood, which means that  generally an insurance agent would not need to perform a diligent search.  According to representatives of NAPSLO, this generally includes not  having to first seek coverage with NFIP. NAPSLO officials also stated that  the other six states allow for access to the surplus lines insurance market  under specific circumstances, such as when a community does not  participate in NFIP.
section_title: Conclusions
paragraphs: The Biggert-Waters Act took steps to encourage greater participation by  the private sector in flood insurance, but aspects of the act’s provisions  on private flood insurance have created some regulatory uncertainty  among insurers and lenders. As a result, Congress has been considering  some steps designed to address potential regulatory barriers to the use of  private-sector insurance to satisfy the mandatory purchase requirement,  including considering legislation that would amend the statutory definition  of private flood insurance. The proposed legislation also would explicitly  allow for private flood insurance coverage to satisfy any continuous  coverage requirements, reversing a recent change that FEMA made to  NFIP cited by some stakeholders as a potential barrier to the use of  private insurance.
However, a recent policy change made by FEMA might discourage the  use of private flood insurance. FEMA no longer allows policyholders to  cancel their NFIP policy and obtain a refund, on a prorated basis, if they  obtained a non-NFIP policy (private flood insurance policy). FEMA made  the change based on a review of its policies brought about by the  enactment of the Biggert-Waters Act and HFIAA. FEMA officials stated  that FEMA can only allow the cancellation of policies and refunds  according to the terms and conditions of NFIP’s standard policy, which  does not directly address the refunds of premiums when a non-NFIP  policy is obtained. However, FEMA could have taken steps to revise the  SFIP to allow for such refunds. It is generally industry practice to refund  policyholders a portion of premium that is unused if they decide to cancel  their insurance policies. Allowing this type of refund would be in line with  congressional interest in transferring some of the federal government’s  exposure to flood insurance risk to the private sector.
section_title: Recommendation
paragraphs: To address a potential challenge for consumers who wish to opt for  private flood insurance and who must have insurance under the  mandatory purchase requirement, we recommend that the FEMA  Administrator should consider reinstating the cancellation reason code  allowing policyholders to cancel their NFIP policy and be eligible for  premium refunds, on a prorated basis, if they obtain a non-NFIP policy  after their NFIP policy became effective. If changes are needed to NFIP’s  standard flood insurance policy to allow such refunds, FEMA should take  the necessary steps to amend its standard flood insurance policy.
section_title: Agency Comments
paragraphs: We provided a draft of this report to FCA, FDIC, Federal Reserve, FEMA  within the Department of Homeland Security, HUD, NCUA, OCC,  Treasury, Fannie Mae, Freddie Mac, and NAIC for review and comment.
FCA, FDIC, Federal Reserve, OCC, Fannie Mae, Freddie Mac, and NAIC  provided technical comments, which we incorporated, as appropriate.  DHS provided a written response, reproduced in appendix IV, in which  FEMA agreed with our recommendation and plans to reinstate their  previous policy allowing policyholders to cancel their NFIP policy and  obtain a prorated refund if they obtain a comparable non-NFIP policy. The  response also stated that the policy change will be included in an April  2017 program bulletin, with an effective date of October 1, 2017, and  followed up with a subsequent rulemaking. NCUA also provided written  comments, reproduced in appendix V, in which agency officials stated  that the agency plans to, as noted in the report, update examination  policies and procedures to reflect recent changes in flood insurance  regulation and work with the other regulators to finalize private flood  insurance regulations.
We are sending copies of this report to the appropriate congressional  committee, and other interested parties. In addition, the report is available  at no charge on the GAO website at http://www.gao.gov.
If you or your staff have any questions about this report, please contact  me at (202) 512-8678 or cackleya@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix VI.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: We were asked to revisit the issue of the private-sector involvement in  flood insurance with a focus on the regulatory environment and whether it  posed any barriers to private flood insurance policies being purchased by  homeowners to satisfy the mandatory purchase requirement. This report  describes (1) regulated lending institutions’ and federal regulators’  implementation of statutory provisions governing the use of private flood  insurance to satisfy the mandatory purchase requirement; and (2) views  on any regulatory, or other barriers, to the increased use of private flood  insurance to satisfy the mandatory purchase requirement. To address  these objectives, we reviewed flood insurance laws and regulations,  related agency guidance, congressional hearings, and studies, as well as  past GAO reports on insurance markets and flood insurance.
subsections: section_title: Regulator and Lender Implementation
paragraphs: We reviewed relevant federal flood insurance laws, including the Flood  Disaster Protection Act, National Flood Insurance Reform Act, Biggert- Waters Flood Insurance Reform Act, and the Homeowner Flood  Insurance Affordability Act, to identify requirements placed on federal  entities responsible for lending regulation (federal regulators) and how  each has addressed the use and acceptability of private flood insurance  to fulfill the mandatory purchase requirement. The federal regulators  involved in implementing the provisions of the flood insurance laws  governing the mandatory purchase requirement are the Office of the  Comptroller of the Currency (OCC), Board of Governors of the Federal  Reserve System (Federal Reserve), Federal Deposit Insurance  Corporation (FDIC), Farm Credit Administration (FCA), and National  Credit Union Administration (NCUA). We also reviewed the rules  implementing these statutes to determine what requirements are placed  on regulated lending institutions.
To understand how lenders have been fulfilling the requirements, we  interviewed representatives from eight lending institutions consisting of  banks and nonbanks. To identify lenders likely to have experience with  private flood insurance, we used National Flood Insurance Program  (NFIP) and SNL’s Mortgage Market Share data to identify the largest  lenders (by volume of mortgages originated) in those counties with the  largest number of NFIP flood insurance policies. To further categorize the  lending institutions, we then used criteria such as the type of institution,  regulatory agency responsible for supervising the institution, and size by  total assets (selecting lenders from large, medium, and small asset  categories). We selected a purposive sample of eight lenders with one or  two institutions supervised by each regulator and took care to ensure a  balanced representation of the different types and sizes of institutions.  For the purposes of this report we use the term “lenders” to refer to the  eight lenders with whom we spoke. Our sample included two nonbank  mortgage lenders that are not directly subject to the requirements of the  Flood Disaster Protection Act as they do not fit within the statutory  definition of regulated lending institutions. We spoke with these nonbank  lenders to better understand practices related to private flood insurance  among the full scope of mortgage market participants. This selection of  mortgage lenders is not generalizable to all mortgage lenders. We  determined that the data used were reliable for the purpose of identifying  and selecting mortgage lenders for a nongeneralizable sample.
To better understand how the federal regulators have implemented the  statutory requirements, we compared their regulations with the statutes.  We also reviewed guidance provided by the federal regulators and the  Federal Emergency Management Agency (FEMA) related to the use of  private flood insurance to satisfy the mandatory purchase requirement.  We reviewed and compared each of the regulator’s examination manuals  and flood insurance modules to understand how they examined the  regulated lending institutions they supervise for compliance. For example,  we reviewed each regulator’s flood insurance examination module to  determine what specific aspects of the regulations examiners were  reviewing. We also interviewed officials from OCC, Federal Reserve,  FDIC, FCA, NCUA, and FEMA. Finally, we reviewed the policies of the  Federal National Mortgage Association (Fannie Mae), Federal Home  Loan Mortgage Corporation (Freddie Mac), Department of Veterans  Affairs, and Federal Housing Administration to understand their flood  insurance requirements for mortgages they either purchase or insure. We  also followed up with the Department of Housing and Urban  Development’s Federal Housing Administration to understand any  potential changes to its policies.
section_title: Regulatory and Other Barriers
paragraphs: We interviewed various stakeholders—including selected lenders,  organizations in the insurance and lending industries, private flood  insurance companies, and state insurance regulatory agencies—about  any regulatory barriers to the increased use of private flood insurance.  We interviewed representatives of the eight selected lenders on barriers  they encounter in evaluating and accepting private flood insurance  policies and their views on enacted and proposed legislation on private  flood insurance. To obtain other views on private flood insurance, we  selected a diverse group of 13 organizations to interview based on the  type of organization, the organization’s purpose and relevance to private  flood insurance, and membership. We identified these organizations  based on previous and ongoing GAO work on flood insurance and  comment letters submitted in response to federal regulators’ proposed  rules on private flood insurance.
We also selected and interviewed representatives of four private  insurance companies involved in the private market for flood insurance.  To identify these companies, we reviewed news articles; interviewed  selected lenders, state insurance officials, and other industry  stakeholders; reviewed comment letters submitted in response to  proposed rules issued by the federal regulators on private flood  insurance; and reviewed prior GAO work. To select the insurance  companies to interview, we focused on those that were identified as  currently writing flood insurance in the admitted or nonadmitted insurance  markets. This selection of private insurance companies is not  generalizable to all private insurance companies.
To understand selected states’ regulation of flood insurance and obtain  the perspectives of state insurance regulators on regulatory barriers  related to private flood insurance, we interviewed insurance regulators  and their representatives from Florida, Louisiana, Pennsylvania, Texas,  and West Virginia and reviewed selected laws from Florida and West  Virginia. We selected these states based on the volume of NFIP policies  written and flood insurance regulatory activity in each state. The  information provided by the representatives of the state insurance  regulators is not generalizable to how all states oversee flood insurance.
We also reviewed comment letters submitted to the regulators (OCC,  Federal Reserve, FDIC, FCA, and NCUA) in response to proposed  federal rules on the acceptance of private flood insurance. We obtained  these comment letters by downloading each from www.regulations.gov,  docket ID OCC-2013-0015. We analyzed 44 comment letters submitted  by interested parties regarding the regulators’ joint proposed rules as of  May 2016. We reviewed each comment letter to identify comments  pertaining to potential or actual regulatory barriers to the use of private  flood insurance and effects of the proposed rules. One analyst created a  summary of common themes from the comment letters, which were  verified by a second analyst.
We also conducted a literature search for news articles and studies to  determine what is known about any regulatory barriers to using private  flood insurance to satisfy the mandatory purchase requirement. To  identify news articles and studies, we conducted searches of various  databases, such as EconLit and ProQuest, using search terms such as  “private” and “flood insurance.” From these searches, we identified and  reviewed 19 studies and articles since 2005 that were relevant to barriers  to private flood insurance. We reviewed these studies and articles to  identify regulatory barriers to the use of private flood insurance. We found  that these studies and articles generally did not identify regulatory barriers  but identified other relevant barriers related to increasing involvement of  the private sector in flood insurance.
We also interviewed representatives from the Department of the  Treasury’s Federal Insurance Office and the National Association of  Insurance Commissioners (NAIC) to obtain their views on regulatory  barriers, enacted and proposed legislation and regulations, and NAIC’s  views on states’ laws and regulations related to private flood insurance.
section_title: Appendix II: Private Flood Insurance Criteria in FEMA’s Guidelines (2007) and the Biggert-Waters Act Definition (2012)
paragraphs: Appendix II: Private Flood Insurance Criteria in  FEMA’s Guidelines (2007) and the Biggert- Waters Act Definition (2012)
The following table compares the guidance provided by Federal  Emergency Management Agency (FEMA) in the 2007 Mandatory  Purchase of Flood Insurance Guidelines (rescinded in February 2013) for  use of private flood insurance to satisfy the mandatory purchase  requirement with the statutory definition of private flood insurance in the  Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act).
section_title: Appendix III: Sample Form of Notice of Special Flood Hazards and Availability of Federal Disaster Relief Assistance
paragraphs: The following sample notice is included as an appendix in the regulators’  respective flood insurance regulations.
section_title: Appendix IV: Comments from the Department of Homeland Security
section_title: Appendix V: Comments from the National Credit Union Administration
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Allison Abrams (Assistant  Director), Anar Jessani (Analyst-in-Charge), Pamela Davidson, Matthew  Keeler, Marc Molino, Patricia Moye, and Barbara Roesmann made key  contributions to this report.