Flood Insurance: Review of FEMA Study and Report on Community-Based Options
Released: 2016-08-24T00:00:00

Letter

Background

Overview of Key NFIP Legislation

In 1968, Congress created NFIP to address the increasing cost of federal disaster assistance by providing flood insurance to property owners in flood-prone areas, where such insurance was either not available or prohibitively expensive. The 1968 law also authorized premium subsidies to encourage property owner participation. To participate in the program, communities must adopt and agree to enforce floodplain management regulations to reduce future flood damage. In exchange, federally backed flood insurance is offered to residents in those communities.

NFIP was subsequently modified by various amendments to strengthen certain aspects of the program. The Flood Disaster Protection Act of 1973 made the purchase of flood insurance mandatory for properties in special flood hazard areas—areas that are at high risk for flooding—that are security for loans from federally regulated lenders and located in NFIP participating communities. This requirement expanded the overall number of insured properties, including those that qualified for subsidized premiums. The National Flood Insurance Reform Act of 1994 expanded the purchase requirement for federally backed mortgages on properties located in special flood hazard areas.

Congress has passed two key pieces of legislation designed to reform NFIP. The Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert- Waters Act), enacted in July 2012, instituted provisions to help strengthen NFIP’s future financial solvency and administrative efficiency. For example, it required FEMA to phase out almost all discounted insurance premiums and establish a reserve fund. As implementation proceeded, however, affected communities raised concerns about some Biggert- Waters Act requirements. The Homeowner Flood Insurance Affordability Act of 2014 was enacted in March 2014 and sought largely to address affordability concerns by repealing or altering some Biggert-Waters Act requirements. In this context, HFIAA included provisions that FEMA produce a study and submit a report that assess and recommend options, methods, and strategies for making voluntary CBFI available through NFIP.

NFIP Data on the Number of Policies in Force and Communities Participating

According to FEMA, as of March 2016 there were more than 5 million NFIP policies in force, which were spread across more than 22,000 communities throughout the United States and its territories (see figs. 1 and 2). FEMA defines a community as a political entity that has the authority to adopt and enforce floodplain ordinances for the area under its jurisdiction which is—in most cases—an incorporated city, town, township, borough, village, or an unincorporated area of a county or parish. While FEMA could potentially modify this definition to include other types of communities for a CBFI option, using the number of communities currently participating in NFIP provides one measure of how many communities could hypothetically pursue a CBFI option.

Policy Goals for Federal Involvement in Natural Catastrophe Insurance

In 2007, we identified four broad policy goals for federal involvement in natural catastrophe insurance: (1) charging premium rates that fully reflect actual risks; (2) encouraging private markets to provide natural catastrophe insurance; (3) encouraging broad participation in natural catastrophe insurance programs; and (4) limiting costs to taxpayers before and after a disaster. We identified these goals by drawing insights from a variety of sources: past GAO work, legislative histories of laws that changed the roles of state governments and the federal government after disasters, bills considered by Congress, interviews with public and private sector officials, and articles written by experts in insurance economics. We believe that the four goals we identified accurately capture the essential concerns of the federal government. We have previously used these policy goals to evaluate potential changes to NFIP. We believe that they are still relevant and could also be used to evaluate a CBFI option.

FEMA’s Study and Report Provided Relevant Information and Concluded that FEMA Should Not Implement CBFI

The Design of FEMA’s Study Was Reasonable, with Methodology Supporting Study Objectives

We determined that the CBFI study objectives and methodology agreed upon by FEMA and NAS were reasonable. The objectives were clearly stated and designed to provide relevant, high-level considerations that could help FEMA decide whether CBFI should be implemented before determining how it should be implemented, which FEMA officials said was an important step. The methodology was consistent with the study’s objectives and was reasonable given the limitations identified by FEMA: short time frames, the need to obtain informed opinions, and unavailable data. As a result, the study included findings that helped FEMA draw conclusions about whether and how to implement CBFI, if it chose to do so.

FEMA and NAS took several steps to design the objectives and methodology of the CBFI study. FEMA initially provided NAS with documents that included background information on the purpose of the study and proposed a methodology and objectives. Then, NAS officials responded with minor modifications that reflected what NAS could do to meet FEMA’s needs. FEMA and NAS officials told us that they held two meetings and communicated via email before agreeing to the methodology, objectives, and time frames (see fig. 3).

According to FEMA and NAS officials, FEMA and NAS agreed that the study’s objectives were to examine future prospects for CBFI by identifying and discussing issues that would require further evaluation in order for FEMA and others to better evaluate CBFI’s strengths and weaknesses. According to FEMA officials, the agreed-upon objectives met their needs.

To execute the CBFI study, NAS convened an expert committee to produce a report using a consensus report process. The committee was composed of 12 members that represented academia, the private sector, and state and federal government. The committee met twice: the January 2015 meeting featured guest presentations, and the March 2015 meeting was convened in a workshop-type format with multiple panels of external speakers. Following these meetings, the NAS study director, committee chair, and other committee members developed sections of the study and all committee members signed off on the full study. Prior to publication, NAS conducted an independent external peer review by experts who NAS recruited based on their technical expertise and breadth of perspectives.

NAS and FEMA officials explained that they decided to use the consensus report process because it offered several benefits and did not face the same limitations that other methodologies would have faced. According to NAS officials, because consensus reports modulate different perspectives and identify new concepts and approaches, this approach was appropriate to meet the study’s objectives. FEMA officials explained that they requested a consensus report methodology because it would provide independent, creative, and unbiased ideas from experts who already had a deep contextual knowledge of NFIP. Further, FEMA officials said that alternative approaches they considered would have faced various limitations. They stated that community-based surveys or listening sessions, for example, would have taken more time and might not have reached audiences that could provide well-informed opinions. Data analysis was not considered a viable option because FEMA does not have the data it would need to determine hypothetical costs for participating communities, homeowners, and FEMA. For example, as we have previously reported, FEMA does not collect all information necessary to determine flood risk, which is a key factor for determining NFIP premiums for individual policyholders or, potentially, communities.

FEMA’s Study Provided Relevant Information for Evaluating the Advisability of Implementing CBFI

We determined that FEMA’s study provided relevant information for evaluating the advisability of implementing CBFI. The study identified and discussed seven main areas for further consideration in designing a CBFI option for potential implementation.

Risk bearing and sharing—A CBFI option could conceivably shift risk- bearing to communities, private insurers, or individuals depending on how it is structured.

Responsibilities for writing policies and loss adjustments— Participating insurance agents write policies and collect premiums under NFIP, but CBFI policies could be written at the community level.

Coverage limits, standards, and compliance—Movement to a CBFI policy option could provide a community with an opportunity to reconsider flood exposures, such as extending the exposure beyond individual homes to public infrastructure.

Underwriting, pricing, and allocation of premium costs—Several complex considerations could fall under this topic, including methods used in setting premiums, the extent to which catastrophic losses would be reflected, and the allocation of premium costs among homeowners.

Administrative capabilities—Communities would likely not have expertise for undertaking the administration of CBFI policies, but depending on how a community is defined, it could have the means for collecting funds to pay for CBFI premiums.

Confirming compliance with mandatory purchase requirements—A community-based policy might have to maintain some aspect of individual property coverage in order to satisfy mandatory flood insurance purchase requirements, which could be administratively burdensome.

Pricing expertise, including valuation of mitigation measures—Pricing of CBFI policies would need to account for the risk underwritten and the savings expected from mitigation measures.

The study also provided other relevant information related to CBFI, such as discussion of potential benefits and challenges, a conceptual rationale for identifying cases in which CBFI may or may not be a good option, and considerations for defining “community” in the context of CBFI. For example, the study reports that benefits could include reduced administrative and transaction costs, increased take-up rates, and promotion of mitigation efforts and floodplain management. The study also reports that challenges could include lack of community interest; limited implementation capability; likely need to create many approaches given variation in population size, geography, and authority to regulate land use and collect revenue; and political obstacles. Additionally, the study developed a conceptual rationale for identifying cases in which CBFI may or may not be desirable, and also identified several factors that could make CBFI more or less desirable than individual flood insurance policies. In addition, the study notes that FEMA may want to consider broadening the current definition of “community” because it may be too narrow in the context of CBFI. Specifically, the study noted that while a town or city would clearly be considered as a community under FEMA’s current definition, the status of areas such as business districts or gated communities would be unclear and, as a result, it is difficult to say whether or not these kinds of areas would be eligible to purchase CBFI policies.

To further assess FEMA’s study, we evaluated relevant elements of its findings against the four public policy goals for federal involvement in natural catastrophe insurance that we have previously identified. The public policy goals, along with examples of elements from the study, follow. 1. Charging premium rates that fully reflect actual risks. Our prior work has shown that charging rates that do not fully reflect actual risks makes it difficult for FEMA to maintain the financial stability of NFIP, sends policyholders inaccurate price signals about their chances of incurring losses, and reduces incentives for policyholders to undertake mitigation efforts. FEMA’s study identified areas for further consideration, including several related to charging premium rates that fully reflect risks; responsibility for bearing and sharing risk; responsibility for writing policies and loss adjustments; underwriting, pricing, and allocation of premium costs; and pricing expertise, including valuation of mitigation measures. The study also outlined concepts for innovative uses of CBFI that could help NFIP charge full- risk rates, such as requiring communities interested in CBFI to provide comprehensive analysis of flood risk in their communities, which would enhance NFIP’s knowledge of flood risk at the community level. 2. Encouraging private markets to provide natural catastrophe insurance. Our prior work has shown that covering flood-related losses through NFIP involves significant federal expense, and Congress has shown interest in reducing the federal government’s role in flood insurance by transferring its exposure to the private sector. While the private sector has not historically been willing to participate in the flood insurance market, facilitating certain conditions could help increase private sector involvement. FEMA’s study discusses ways in which CBFI could encourage or discourage private market participation in flood insurance markets. For example, the study suggests that CBFI could encourage private sector involvement if NFIP offered it in either of two forms. First, CBFI could be offered as a way to insure all properties at a base level of coverage, providing the private sector with an opportunity to offer supplementary insurance above this base level of coverage. Second, CBFI could be offered as coverage for residual risk properties—the highest-risk properties that the private sector would not want to insure—allowing the private sector to insure all other properties.

However, the study also suggests several challenges that may outweigh these potential benefits. For example, private insurers would need to acquire the information and expertise to price CBFI policies in line with actuarial standards and would have difficulty diversifying their risk pool—issues we have previously identified as key private sector concerns about offering flood insurance. Additionally, CBFI may discourage private sector participation because servicing CBFI policies after a disaster could be difficult, as the damage would be concentrated in a set geographic area. 3. Encouraging broad participation in natural catastrophe insurance programs. Our prior work has shown that nationwide flood insurance penetration rates are estimated to be low and information on compliance with the mandatory purchase requirement is limited. The study provided some discussion of how potential benefits and challenges of CBFI could relate to increasing NFIP participation. For example, the study notes that CBFI could help increase take-up rates and encourage compliance with mandatory purchase requirements, but it also noted that there may be challenges related to requiring all community members to participate in CBFI and some communities would not be able to oversee compliance with mandatory purchase requirements (unless that responsibility remained with the lender). 4. Limiting costs to taxpayers before and after a disaster. Our prior work has shown that the losses already generated by NFIP, as well as the potential for future losses, have created substantial financial exposure for the federal government and NFIP likely will not generate sufficient premium revenue to repay the billions of dollars borrowed from Treasury. The study provided some discussion of how CBFI could potentially limit costs to taxpayers by encouraging communities to pursue mitigation options that reduce risk of flood damage and result in lower premiums, or by potentially reducing administrative and transaction costs. However, the study also said that—given administrative costs required to design and set up the program— these cost savings could be limited if few communities decide to enroll.

Finally, FEMA officials said that the CBFI study’s findings met their needs. According to the officials, the study’s broad discussion of areas for further research as well as potential benefits and challenges of CBFI informed their opinion on the prospects for CBFI.

FEMA’s Report Concludes that CBFI Should Not Be Implemented

The FEMA report, which included the study, provides a brief set of related conclusions from FEMA, including that FEMA should not implement CBFI. FEMA officials explained that, after reviewing the results of the study, they concluded that FEMA should not conduct further related research or implement CBFI for several reasons:

The challenges outlined in the study—such as administrative burden on communities and FEMA, unavailable data, unclear cost distribution among community members, and potential legislative requirements— are significant and likely outweigh the benefits.

A limited number of communities would be likely to participate in a CBFI option, as only one community expressed positive interest in CBFI after FEMA presented the idea during previous NFIP reform listening sessions.

Dedicating FEMA’s resources to other potential NFIP reforms and strengthening existing programs would be a better use of these resources.

Based on the factors cited by FEMA officials and our prior work, we agree that FEMA’s conclusion that it was not advisable to implement CBFI at this time was reasonable. We have previously reported on how some of the challenges that the CBFI study outlined apply to NFIP more broadly. For example, we have previously reported that FEMA’s resource constraints may jeopardize potential NFIP reform efforts. In 2008, we reported that implementing a combined federal flood and wind program could make addressing existing management challenges even more difficult, given the resources that would be required to administer and oversee a new program. In 2015 we reported that while FEMA had begun taking some actions to improve its capacity to administer NFIP, it was unclear whether FEMA had the resources required to complete its efforts to implement both the Biggert-Waters Act and HFIAA reforms. Also, starting in 2013, we have stated in multiple reports that FEMA does not collect some data necessary to determine flood risk—a key factor for determining NFIP premiums for individual policyholders or, potentially, communities. In addition, we have reported that some communities may face challenges administering NFIP and flood mitigation programs. In 2013, we reported that communities such as Indian tribes may lack the resources and administrative capacity needed to administer NFIP requirements, and in 2014 we reported that experts claim that some communities—especially rural ones—may lack the expertise and administrative capabilities to apply for and administer grants for mitigation activities.

Agency Comments

We provided a draft of this report to FEMA for its review. FEMA did not provide formal comments, and did not have any technical comments.

If you or your staff have any questions concerning 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 major contributions to this report are listed in appendix I.

Appendix I: GAO Contact and Staff Acknowledgments

Contact

Alicia Puente Cackley, (202) 512-8678 or cackleya@gao.gov.

Acknowledgments

In addition to the contact named above, Patrick Ward (Assistant Director); Chloe Brown and Tarik Carter (Analysts-in-Charge); Namita Bhatia- Sabharwal; and Jennifer Schwartz made key contributions to this report. Also contributing to this report were David Dornisch; Jessica Sandler; and Jena Sinkfield.