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

Letter

NFIP Is Not Designed to Cover All Flood Losses

As a result of coverage limits, restrictions, and exclusions in NFIP policies, insurance payments for flood damage may not pay all of the costs of repairing or replacing flood-damaged property. Certain NFIP limitations are embedded in statute; others have been promulgated by FEMA pursuant to its statutory authority. FEMA officials said that the coverage limitations are necessary to keep the NFIP self-supporting and actuarially sound. Thus, the program is designed to strike a balance between premium prices and coverage.

The following are several examples of NFIP coverage limitations, restrictions, and exclusions that affect the premium and amount a claimant could expect to receive for flood damage: Homeowners are required to insure their homes for the amount of their federally backed mortgages. If a home is insured for less than 80 percent of its full replacement cost or the maximum coverage amount of $250,000, or it is not a primary residence, NFIP will pay the actual cash value for the damage. The actual cash value represents the original cost of the structure less depreciation and, in most cases, will not cover the full cost to repair damage to or replace the dwelling. The value of physical depreciation is based on the age and condition of the item.

If a home is insured for 80 percent or more of its full replacement cost or the maximum coverage amount of $250,000 and is a primary residence, NFIP will pay replacement costs for damage to the dwelling. The policy defines replacement cost as coverage to replace the damaged part of the dwelling with materials of like kind and quality to what was damaged. The policy will pay the amount actually spent for this repair or replacement up to its limit.

A homeowner may choose not to insure personal property under the program.

A deductible amount is applied against claims for dwellings and personal property.

Basements, which are defined as building areas below grade level on all sides, have limited coverage that does not include payment to repair or replace finished walls, floors, furniture, and other personal property.

The personal property limit paid for jewelry, artwork, and home business equipment is $2,500 for all items combined. No coverage is provided on these items if they are located in a basement.

Actual cash value, not replacement value, is paid on all covered furniture and other personal property. Thus, personal property is also depreciated.

A detached garage is covered by the dwelling policy only if it is used solely for vehicles and storage. If the garage is improved (e.g., a sink is installed), flood damage to the structure is not covered under the NFIP.

In a hypothetical property adjustment we developed with the assistance of FEMA’s director of claims, a poorly maintained 30-year-old home located in a designated flood zone had flood damage when a nearby river overflowed. The property was valued at $60,000. It was insured under the NFIP for $30,000. Although a contractor estimated it would cost $40,000 to repair damages to the structure and personal property losses totaled another $10,000, a NFIP adjuster determined that payment on the claim was $8,000.

The following circumstances reduced the amount of coverage: The homeowner had chosen not to insure his personal property.

Because the homeowner did not insure the structure for at least 80 percent of its value, actual cash value will be paid for repairs or replacement of damage to the dwelling. Since the condition is poor, the actual cash value will be low.

A $1,000 deductible will be applied.

The adjuster determined that some problems that needed to be addressed had not been caused by the flood (e.g., leaking pipes in the bathroom and preexisting mold in the basement).

Only limited coverage is allowed in the basement of the home, where the largest amount of damage occurred.

Private Insurers Sell, Service, and Adjust Claims under FEMA Management and Oversight

The work of selling, servicing, and adjusting claims on NFIP policies is carried out by thousands of private sector insurance agents and adjusters who work independently or are employed by insurance companies or vendors under subcontract to insurance companies to handle their flood business. In contrast, according to a FEMA official, about 40 FEMA employees are responsible for regulating, managing, and overseeing the program, which is expected to grow to about 4.7 million policies in 2005. FEMA is assisted in this effort by about 170 contractor employees.

According to FEMA, about 95 percent of the NFIP policies in force are written by agents who work for or represent 94 private insurance companies that issue policies and adjust flood claims in their own names. The companies, called write-your-own companies, receive an expense allowance from FEMA of about one-third of the premium amounts for their services and are required to remit premium income in excess of this allowance to the National Flood Insurance Fund. The insurance companies share the FEMA expense allowance with the agent selling and servicing the policy and a vendor, if the company has subcontracted with one to handle all or part of its flood insurance business.

Independent Agents Are the Main Point of Contact for Policyholders

It is clear that some agents do not understand the program. It is very complex and different from the other lines of insurance. Flood insurance is much more complex than automobile and homeowners insurance. Some items of specific concern are definitions of elevated buildings and basements.

Officials at FEMA, the four insurance companies, and the vendor said that they offered support to the insurance agents who sell and service NFIP policies. Reported support included training, help from telephone hotline customer service representatives, development of rate quotes, and Web sites with NFIP information. However, other than requiring that agents meet basic state insurance licensing requirements, neither FEMA nor the four insurance companies have historically required that agents complete training or demonstrate a basic level of knowledge of the NFIP to sell flood policies.

Adjusters Are the Eyes and Ears of the NFIP

When losses occur, flood adjusters employed by insurance companies or independent contractors become the eyes and ears of the NFIP. Claims adjusters are assigned to policyholders by their insurance companies after the policyholders have notified their agents of a flood loss and the agents have written loss reports. Adjusters are responsible for assessing damage; estimating losses; and submitting required reports, work sheets, and photographs to the claimants’ insurance company, where the claim is reviewed and, if approved, processed for payment. They work under the coordination of a general adjuster assigned to manage claims adjustments for the flood event.

Unlike agents who sell flood insurance policies, adjusters must be certified by FEMA to work on NFIP claims. To be approved to adjust residential flood losses, an adjuster must have at least 4 consecutive years of full-time property loss adjusting experience and have attended an adjuster workshop, among other requirements. To keep their certifications current, adjusters are required to take a 1-day refresher workshop each year and pass a written examination testing their knowledge each year.

FEMA’s program contractor maintains a database of independent adjusters who are qualified to adjust flood claims. A FEMA official said that 4,844 flood-certified adjusters are registered in the database, as of April 2005. A NFIP official noted that the adjuster community is stretched thin when a major flood event occurs.

Adjusters and insurance companies are paid for claims settlements from the National Flood Insurance Fund based on the size of the losses they settle. The write-your-own company receives about 3.3 percent of the incurred loss, according to FEMA’s NFIP claims director. Adjusters are to be paid at the time claims are settled based on a standard fee schedule. For example, an adjuster receives $1,000 for a claim of between $25,000 and $35,000.

FEMA Oversees Work of Insurance Companies and Adjusters

FEMA’s primary method of overseeing the work of write-your-own companies is to conduct an operational review of every participating company at least every 3 years. In addition, FEMA relies on about 10 general adjusters employed by its program contractor to check the work of claims adjusters in reinspections of a sample of adjustments done after every flood event.

According to the FEMA director of NFIP claims, one or two employees from FEMA’s NFIP Claims and Underwriting sections go on-site to review the operations of write-your-own companies at least every 3 years. They do reviews more frequently, if necessary, to follow up on any findings from a previous visit. The auditors are to request that a random sample of 100 files be pulled for them to review. Files that are closed without payment and those with particularly large settlements are to be included in the sample of files reviewed. Auditors are to check the files for completeness and accuracy. For example, they must make sure that there are photographs to document damage. Auditors are also to look at internal controls in place at the company.

If a write-your-own company does not pass an operational review, FEMA requires that it develop an action plan to correct the problems and schedules a follow-up review in 6 months to determine whether progress has been made, according to the NFIP director of claims. If the company continues to have problems and fails to implement an action plan, it can ultimately be withdrawn from the NFIP. According to FEMA officials, a company has been asked to withdraw from the NFIP once in the program’s history. About 3 years ago, a write-your-own company was withdrawn from the NFIP in part because of issues raised in operational reviews and in part to other financial problems.

Three of the four flood program managers for write-your-own companies whom we interviewed thought operational reviews were an effective way for FEMA to ensure that the NFIP is run according to established legislation and regulation. The fourth manager said that he had no opinion one way or the other. Interviewees noted that the reviews caught problems, and while FEMA had a small audit staff, the auditors were knowledgeable and provided about the right level of review. Two of the four flood program managers said that recent operational reviews had identified problems on policies they had recently purchased from other companies and that they were working to rewrite some policies and address other oversight issues.

General adjusters are to do reinspections of open claims. FEMA chooses a random sample of about 4 percent of the claims for every flood event to reinspect, according to the NFIP claims director. If the general adjuster determines that a company paid for an expense that should not have been covered, FEMA is to be reimbursed by the write-your-own company. If a general adjuster finds that an adjuster missed an item in the original inspection, the general adjuster is to add it back into the claims report so that the policyholder will be compensated for it.

The instructors at an adjuster refresher training session we attended noted the following as common errors identified in reinspections of claims: improper measurement of room dimensions; improper allocation of damage between wind and flood (homeowners’ policies cover wind damage, while the NFIP covers flood losses); poor communication with homeowners on the process they are following to inspect the property and settle the claim.

Stakeholders Said the NFIP Has Many Positive Aspects but Implementation Is Complex

“I am in the flood insurance business because I believe in the program. It does a lot of good. Floods are horrible occurrences. A homeowner sees the water coming but can do nothing to stop it. The smell is horrible. Whole communities are affected, and the emotional toll is tremendous. I have seen the NFIP do great good for many people.”

Each of the interviewees, when asked how the NFIP could be improved, said that FEMA should look for ways to make the program less complex and more similar to other property insurance programs. For example, a vendor manager noted, “if the customers, the agents, and the adjusters all have difficulty understanding the program, it is too complicated.” “As FEMA has tried to make the flood program more actuarily sound, it has made it more complex. FEMA has required of us more information, more forms, and more photos to be scanned into files. Those requirements cost money to implement. As an industry, we are looking at how the flood line might be more compatible with other lines of insurance business to be more cost-efficient. Now the flood business is so unique that it requires special handling.”

FEMA officials said that some documentation (i.e., elevation certificates) is required because the NFIP is part of FEMA’s broader flood plain management strategy that combines insurance protection with hazard mitigation to reduce future flood damage to homes. The officials noted that, while the NFIP has different requirements than homeowners insurance, it is not necessarily more complex and that the more familiar agents become with the requirements of the NFIP, the easier it becomes for them to routinely handle documentation requirements.

FEMA Continues Efforts to Comply with Legislative Mandates

Congress mandated that within 6 months of the enactment of the Flood Insurance Reform Act, FEMA establish (1) insurance agent education and training requirements, (2) new processes for explaining coverage to policyholders when they purchase and renew policies, and (3) an appeals process for claimants who are dissatisfied with the settlement of their claims. The 6-month mandated deadline elapsed on December 30, 2004, but FEMA is still working to complete these mandated efforts. According to FEMA officials, in order to address the requirements to establish insurance agent education and training and for explaining coverage to policyholders, the agency must go through the rule-making process. FEMA officials also said to address the requirement for explaining policy coverage, they are waiting for DHS approval before finalizing the draft materials that will accompany the flood insurance policy. When DHS approves the draft materials, they will be published in the Federal Register as part of the rule-making process. Regarding the requirement for an appeals process, the agency must initiate and complete formal rule making. FEMA officials said that this process takes more than 6 months and could not be completed within the mandated time frame.

FEMA Is Coordinating with the States to Establish Training and Education Requirements

To address the requirement in the Flood Insurance Reform Act of 2004 to establish insurance agent education and training requirements, FEMA is working with state insurance commissions. An official said FEMA is still in the planning stages of meeting the requirement and is discussing options with state insurance commissions, but has not yet developed an action plan.

FEMA Has Drafted New Materials on Consumer Policy Information

When a customer purchases a flood insurance policy, the main document he or she is to receive from the insurance agent is the policy. A congressional report accompanying the Flood Insurance Reform Act stated that the NFIP did not provide “simple” forms or claims guidelines for flood victims to follow, making access to information about flood insurance policies difficult to obtain. To address this concern, the act requires FEMA to provide simplified forms and a flood insurance claims handbook to policyholders at the time of purchase or renewal and at the time of flood loss. FEMA has drafted new materials that would be provided to the policyholder at the time of purchase or renewal of the flood insurance policy. The draft material includes: a supplemental form that would explain the policy, such as the amount of deductibles, the exact coverage being purchased, exclusions from coverage, and an explanation of how lost items and damages will be valued under the policy at the time of loss; a flood insurance handbook to describe procedures to be followed to file a claim and provide detailed information on an appeals process that FEMA is to develop; and an acknowledgment form that the policyholder has received the flood insurance policy and that the policy only covers building property for the dwelling and does not provide coverage for contents or personal property.

Before the materials are finalized, FEMA must go through rule making and publish them in the Federal Register. FEMA expects to have these forms and handbook finalized by October 2005.

FEMA Is Establishing a Formal Appeals Process to Address Consumer Complaints

If a policyholder has a grievance about a flood insurance claim, proof of loss, or loss estimate, he or she may informally appeal to the insurance agent, to the insurance adjustor’s supervisor, or to a hotline where a customer representative is to provide assistance. There is currently no official recourse for the policyholder. To provide official recourse to policyholders, section 205 of the Flood Insurance Reform Act requires that FEMA establish a formal appeals process through which policyholders may appeal decisions on their claims. FEMA is developing a formal appeals process for a policyholder to follow if he or she has a grievance. The proposed new appeals process must go through the rule-making process with publication of a draft and a final set of procedures in the Federal Register. A FEMA official was uncertain when the process would be completed, but said that it would be after October 2005.

Mr. Chairman and Members of the Committee, this concludes my prepared statement. I would be pleased to answer any questions you and the Committee members may have.

Contacts and Staff Acknowledgments

For further information about this statement, please contact William O. Jenkins, Jr. Director, Homeland Security and Justice Issues, on (202) 512-8777 or jenkinswo@gao.gov or Christopher Keisling, Assistant Director, Homeland Security and Justice, on (404) 679-1917 or at keislingc@gao.gov.

Major contributors to this testimony included Christine Davis, Pawnee Davis, and Deborah Knorr.