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. 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. 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. 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’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.