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

Letter

Background

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.

Overview of Mandatory Purchase Requirement

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.

Overview of Insurance Regulation and Markets

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.

Admitted Insurance Market

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.

Nonadmitted Market and Surplus Lines Insurance

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.

Lenders’ and Regulators’ Implementation of Provisions Relating to Private Flood Insurance

Lenders Told Us They Rely on Existing Guidance and Criteria When Assessing Private Policies

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.

Lenders Told Us They Send Notifications to Borrowers That Include Language Encouraging Comparison of NFIP and Private Insurance

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).

Federal Regulators Have Jointly Implemented Flood Insurance Regulations

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.

Regulatory Uncertainty, Certain NFIP Changes, and Market Challenges Cited as Potentially Inhibiting Use of Private Flood Insurance

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.

Lack of Final Regulations and Scope of Statutory Definition of Private Flood Insurance Cited by Stakeholders as Potential Barriers for Lenders

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.

Recent NFIP Policy Changes May Discourage Consumers’ Use of Private Flood Insurance

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.

Limited Use of Private Flood Insurance Also Due to Market Challenges

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.

Recent Legislative Proposals to Amend the Biggert-Waters Act and State Actions to Help Increase Accessibility of Private Flood Insurance

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.

Conclusions

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.

Recommendation

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.

Agency Comments

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.

Appendix I: Objectives, Scope, and Methodology

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.

Regulator and Lender Implementation

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.

Regulatory and Other Barriers

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.

Appendix II: Private Flood Insurance Criteria in FEMA’s Guidelines (2007) and the Biggert-Waters Act Definition (2012)

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).

Appendix III: Sample Form of Notice of Special Flood Hazards and Availability of Federal Disaster Relief Assistance

The following sample notice is included as an appendix in the regulators’ respective flood insurance regulations.

Appendix IV: Comments from the Department of Homeland Security

Appendix V: Comments from the National Credit Union Administration

Appendix VI: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

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.