The National Flood Insurance Act of 1968 established NFIP as an alternative to providing direct disaster assistance after floods. NFIP, which provides government-guaranteed flood insurance to homeowners and businesses, was intended to reduce the federal government’s escalating costs for repairing flood damage after disasters. FEMA, which is within the Department of Homeland Security (DHS), is responsible for the oversight and management of NFIP. Since the program’s inception, Congress has enacted several pieces of legislation to strengthen it. The Flood Disaster Protection Act of 1973 made flood insurance mandatory for owners of properties in vulnerable areas who had mortgages from federally regulated lenders and provided additional incentives for communities to join the program. The National Flood Insurance Reform Act of 1994 strengthened the mandatory purchase requirements for owners of properties located in special flood hazard areas (SFHA) with mortgages from federally regulated lenders. Finally, the Bunning- Bereuter-Blumenauer Flood Insurance Reform Act of 2004 authorized grant programs to mitigate properties that experienced repetitive flood losses. Owners of these repetitive loss properties who do not mitigate face higher premiums. To participate in NFIP, communities agree to enforce regulations for land use and new construction in high-risk flood zones and to adopt and enforce state and community floodplain management regulations to reduce future flood damage. Currently, more than 20,000 communities participate in NFIP. NFIP has mapped flood risks across the country, assigning flood zone designations based on risk levels, and these designations are a factor in determining premium rates. NFIP offers two types of flood insurance premiums: subsidized and full-risk. The National Flood Insurance Act of 1968 authorizes NFIP to offer subsidized premiums to owners of certain properties. These subsidized premium rates, which represent only about 35 to 40 percent of the cost of covering the full risk of flood damage to the properties, account for about 22 percent of all NFIP policies. To help reduce or eliminate the long-term risk of flood damage to buildings and other structures insured by NFIP, FEMA has used a variety of mitigation efforts, such as elevation, relocation, and demolition. Despite these efforts, the inventories of repetitive loss properties and policies with subsidized premium rates have continued to grow. In response to the magnitude and severity of the losses from the 2005 hurricanes, Congress increased NFIP’s borrowing authority from the Department of the Treasury (Treasury) to $20.775 billion. As of April 2010, FEMA owed Treasury $18.8 billion, and the program as currently designed will likely not generate sufficient revenues to repay this debt. By design, NFIP is not an actuarially sound program, in part because it does not operate like many private insurance companies. As a government program, its primary public policy goal is to provide flood insurance in flood-prone areas to property owners who otherwise would not be able to obtain it. Yet NFIP is also expected to cover its claims losses and operating expenses with the premiums it collects, much like a private insurer. In years when flooding has not been catastrophic, NFIP has generally managed to meet these competing goals. In years of catastrophic flooding, however, and especially during the 2005 hurricane season, it has not. NFIP’s operations differ from those of most private insurers in a number of ways. First, it operates on a cash-flow basis and has the authority to borrow from Treasury. As of April 2010, NFIP owed approximately $18.8 billion to Treasury, primarily as a result of loans that the program received to pay claims from the 2005 hurricane season. NFIP will likely not be able to meet its interest payments in most years, and the debt may continue to grow as the program may need to borrow to meet the interest payments and potential future flood losses. Also unlike private insurance companies, NFIP assumes all the risk for the policies it sells. Private insurers typically retain only part of the risk that they accept from policyholders, ceding a portion of the risk to reinsurers (insurance for insurers). This mechanism is particularly important in the case of insurance for catastrophic events, because the availability of reinsurance allows an insurer to limit the possibility that it will experience losses beyond its ability to pay. NFIP’s lack of reinsurance, combined with the lack of structure to build a capital surplus, transfers much of the financial risk of flooding to Treasury and ultimately the taxpayer. NFIP is also required to accept virtually all applications for insurance, unlike private insurers, which may reject applicants for a variety of reasons. For example, FEMA cannot deny insurance on the basis of frequent losses. As a result, NFIP is less able to offset the effects of adverse selection—that is, the phenomenon that those who are most likely to purchase insurance are also the most likely to experience losses. Adverse selection may lead to a concentration of policyholders in the riskiest areas. This problem is further compounded by the fact that those at greatest risk are required to purchase NFIP insurance if they have a mortgage from a federally regulated lender. Finally, by law, FEMA is prevented from raising rates on each flood zone by more than 10 percent each year. While most states regulate premium prices for private insurance companies on other lines of insurance, they generally do not set limits on premium rate increases, instead focusing on whether the resulting premium rates are justified by the projected losses and expenses. As we have seen, NFIP does not charge rates that reflect the full risk of flooding. NFIP could be placed on a sounder fiscal footing by addressing several elements of its premium structure. For example, as we have pointed out in previous reports, NFIP provides subsidized and grandfathered rates that do not reflect the full risk of potential flood losses to some property owners, operates in part with unreliable and incomplete data on flood risks that make it difficult to set accurate rates, and has not been able to overcome the challenge of repetitive loss properties. Subsidized rates, which are required by law, are perhaps the best-known example of premium rates that do not reflect the actual risk of flooding. These rates, which were authorized from when the program began, were intended to help property owners during the transition to full-risk rates. But today, nearly one out of four of NFIP policies continue to be based on a subsidized rate. These rates allow policyholders with structures that were built before floodplain management regulations were established in their communities to pay premiums that represent about 35 to 40 percent of the actual risk premium. Moreover, FEMA estimates that properties covered by policies with subsidized rates experience as much as five times more flood damage than compliant new structures that are charged full- risk rates. As we have pointed out, the number of policies receiving subsidized rates has grown steadily in recent years and without changes to the program will likely continue to grow, increasing the potential for future NFIP operating deficits. Further, potentially outdated and inaccurate data about flood probabilities and damage claims, as well as outdated flood maps, raise questions about whether full-risk premiums fully reflect the actual risk of flooding. First, some of the data used to estimate the probability of flooding have not been updated since the 1980s. Similarly, the claims data used as inputs to the model may be inaccurate because of incomplete claims records and missing data. Further, some of the maps FEMA uses to set premium rates remain out of date despite recent modernization efforts. For instance, as FEMA continues these modernization efforts, it does not account for ongoing and planned development, making some maps outdated shortly after their completion. Moreover, FEMA does not map for long-term erosion, further increasing the likelihood that data used to set rates are inaccurate. FEMA also sets flood insurance rates on a nationwide basis, failing to account for many topographic factors that are relevant to flood risk for individual properties. Some patterns in historical claims and premium data suggest that NFIP’s rates may not accurately reflect individual differences in properties’ flood risk. Not accurately reflecting the actual risk of flooding increases the risk that full-risk premiums may not be sufficient to cover future losses and add to concerns about NFIP’s financial stability. Further contributing to NFIP’s financial challenges, FEMA made a policy decision to allow certain properties remapped into riskier flood zones to keep their previous lower rates. Like subsidized rates, these “grandfathered” rates do not reflect the actual risk of flooding to the properties and do not generate sufficient premiums to cover expected losses. FEMA officials told us that the decision to grandfather rates was based on considerations of equity, ease of administration, and goals of promoting floodplain management. However, FEMA does not collect data on grandfathered properties or measure their financial impact on the program. As a result, it does not know how many such properties exist, their exact location, or the volume of losses they generate. As FEMA continues its efforts to modernize flood maps across the country, it has continued to face resistance from communities and homeowners when remapping places properties into higher-risk flood zones with higher rates. As a result, FEMA has often grandfathered in previous premium rates that are lower than the remapped rates. However, homeowners who are remapped into high-risk areas and do not currently have flood insurance may be required to purchase it at the full-risk rate. In reauthorizing NFIP in 2004, Congress noted that repetitive loss properties—those that have had two or more flood insurance claims payments of $1,000 or more over 10 years—constituted a significant drain on NFIP resources. These properties account for about 1 percent of all policies but are estimated to account for up to 30 percent of all NFIP losses. Not all repetitive loss properties are part of the subsidized property inventory, but a high proportion receive subsidized rates, further contributing to NFIP’s financial risks. While Congress has made efforts to target these properties, the number of repetitive loss properties has continued to grow, making them an ongoing challenge to NFIP’s financial stability.