[Federal Register Volume 84, Number 130 (Monday, July 8, 2019)]
[Proposed Rules]
[Pages 32371-32379]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-14343]


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DEPARTMENT OF HOMELAND SECURITY

Federal Emergency Management Agency

44 CFR Part 62

[Docket ID FEMA-2017-0025]
RIN 1660-AA90


National Flood Insurance Program (NFIP); Revisions to Methodology 
for Payments To Write Your Own (WYO) Companies

AGENCY: Federal Emergency Management Agency, DHS.

ACTION: Advance Notice of Proposed Rulemaking.

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SUMMARY: As directed by the Biggert-Waters Flood Insurance Reform Act 
of 2012, the Federal Emergency Management Agency (FEMA) intends to 
modify the way it pays private insurance companies participating in the 
Write Your Own (WYO) Program. FEMA seeks comment regarding possible 
approaches to incorporating actual flood insurance expense data into 
the payment methodology that FEMA uses to determine the amount of 
payments to WYO companies.

DATES: Comments must be submitted by September 6, 2019.

ADDRESSES: You may submit comments, identified by Docket ID FEMA-2017-
0025, by one of the following methods:
    Federal eRulemaking Portal: http://www.regulations.gov. Follow the 
instructions for submitting comments.
    Mail/Hand Delivery/Courier: Regulatory Affairs Division, Office of 
Chief Counsel, Federal Emergency Management Agency, 8NE, 500 C Street 
SW, Washington, DC 20472.

FOR FURTHER INFORMATION CONTACT: Sarah Ice, Federal Insurance and 
Mitigation Administration, FEMA, 400 C St. SW, Washington, DC 20472 
(mail); (202) 320-5577 (phone); or [email protected] 
(email).

SUPPLEMENTARY INFORMATION: 

I. Public Participation

    We encourage you to participate in this rulemaking by submitting 
comments and related materials. We will consider all comments and 
material received during the comment period.
    If you submit a comment, identify the agency name and the docket ID 
for this rulemaking, indicate the specific section of this document to 
which each comment applies, and give the reason for each comment. You 
may submit your comments and material by electronic means, mail, or 
delivery to the address under the ADDRESSES section. Please submit your 
comments and material by only one means.
    Regardless of the method used for submitting comments or material, 
all submissions will be posted, without change, to the Federal e-
Rulemaking Portal at http://www.regulations.gov, and will include any 
personal information you provide. Therefore, submitting this 
information makes it public. You may wish to read the Privacy and 
Security Notice that is available via a link on the homepage of 
www.regulations.gov.
    Viewing comments and documents: For access to the docket to read 
background documents or comments received, go to the Federal e-
Rulemaking Portal at http://www.regulations.gov. The public may also 
inspect background documents and submitted comments at FEMA, Office of 
Chief Counsel, 500 C Street SW, Washington, DC 20472-3100.

II. Glossary of Terms, Abbreviations, and Frequently Used Acronyms

    To aid the reader, the following glossary (Table 1) defines 
technical terms most commonly used throughout this notice.

[[Page 32372]]



          Table 1--Glossary of Frequently Used Technical Terms
------------------------------------------------------------------------
                  Term                              Definition
------------------------------------------------------------------------
Allocated Loss Adjustment Expense        A loss adjustment expense that
 (ALAE).                                  is assignable or allocable to
                                          a specific claim, usually
                                          adjuster fees.
Credibility............................  (1) An actuarial term
                                          describing the degree of
                                          accuracy in forecasting future
                                          events based on statistical
                                          reporting of past events. (2)
                                          The weight assigned or
                                          assignable to observed data in
                                          contrast to that assigned to
                                          an external or broader-based
                                          set of data. Credibility is
                                          used to provide a measure of
                                          the relative predictive value
                                          of the data being reviewed.
                                          Weights can be determined
                                          through detailed formulas or
                                          by judgment. The weight
                                          assigned should generally
                                          increase with the number of
                                          exposure bases in the observed
                                          data and should decrease with
                                          higher levels of variability
                                          in the observed data.
General Expenses.......................  An insurer's marketing,
                                          operating, and administrative
                                          expenses. Does not include
                                          loss adjustment expenses.
Incurred Loss..........................  Sustained losses, paid or not,
                                          during a specified time
                                          period. Incurred losses are
                                          typically found by combining
                                          losses paid during the period
                                          plus unpaid losses sustained
                                          during the time period minus
                                          outstanding losses at the
                                          beginning of the period
                                          incurred in the previous
                                          period.
Loss Adjustment Expense (LAE)..........  The cost of investigating and
                                          adjusting a loss.
Net Written Premium....................  Written premium less deductions
                                          for reinsurance premiums and
                                          any commissions resulting from
                                          the purchase of reinsurance.
Paid Losses............................  Losses and allocated loss
                                          adjustment expenses (ALAE)
                                          paid to policyholders during a
                                          financial reporting period.
Ratio..................................  Percent. For example, the
                                          percentage of ratio 2:4 is
                                          50%. (2:4 can be written as \2/
                                          4\; 2 divided by 4 equals .5,
                                          or 50%).
Special Allocated Loss Adjustment        A loss adjustment expense
 Expense (SALAE).                         assignable or allocable to a
                                          specific claim that is not
                                          covered as ALAE because the
                                          expense is not applicable in a
                                          standard claim. For example,
                                          an insurance company may need
                                          to hire an engineer to
                                          determine if flooding caused a
                                          covered loss or an expert to
                                          determine the extent of damage
                                          to a large piece of machinery.
                                          SALAE also includes litigation
                                          costs associated with a
                                          specific claim.
Unallocated Loss Adjustment Expense      All external, internal, and
 (ULAE).                                  administrative claims handling
                                          expenses, including
                                          determination of coverage,
                                          that are not included in
                                          allocated or special allocated
                                          loss adjustment expenses.
Written Premium........................  The premium registered on the
                                          books of an insurer or a
                                          reinsurer at the time a policy
                                          is issued and paid for. This
                                          also includes any changes to
                                          that premium due to
                                          cancellations or mid-term
                                          endorsements.
------------------------------------------------------------------------

    To further aid the reader, the following table (Table 2) provides 
abbreviations and acronyms frequently used in this notice.

                   Table 2--Abbreviations and Acronyms
------------------------------------------------------------------------
                  Term                         Abbreviation/Acronym
------------------------------------------------------------------------
Allocated Loss Adjustment Expense.......  ALAE
Biggert-Waters Flood Insurance Reform     BW-12
 Act of 2012.
Federal Emergency Management Agency.....  FEMA
Federal Insurance and Mitigation          FIMA
 Administration.
Homeowner Flood Insurance Affordability   HFIAA
 Act of 2014.
Loss Adjustment Expense.................  LAE
National Association of Insurance         NAIC
 Commissioners.
National Flood Insurance Act of 1968....  NFIA
National Flood Insurance Program........  NFIP
Special Allocated Loss Adjustment         SALAE
 Expense.
Unallocated Loss Adjustment Expense.....  ULAE
Write Your Own..........................  WYO
------------------------------------------------------------------------

III. Background

A. The National Flood Insurance Program (NFIP) and the Write Your Own 
(WYO) Program

    The National Flood Insurance Act of 1968 (NFIA), as amended (42 
U.S.C. 4001 et seq.), authorizes the Administrator of the Federal 
Emergency Management Agency (FEMA) to establish and carry out the NFIP 
to enable interested persons to purchase insurance against loss 
resulting from physical damage to, or loss of, real or personal 
property arising from flood in the United States. See 42 U.S.C. 
4011(a). Congress intended the NFIP to be ``a program of flood 
insurance with large-scale participation of the Federal Government and 
carried out to the maximum extent practicable by the private insurance 
industry.'' See 42 U.S.C. 4001(b). Under the NFIA, FEMA may carry out 
the NFIP through the facilities of the Federal government, using, for 
the purposes of providing flood insurance coverage, insurance companies 
and other insurers, insurance agents and brokers, and insurance 
adjustment organizations, as fiscal agents of the United States. See 42 
U.S.C. 4071.
    Pursuant to this authority, FEMA works closely with the insurance 
industry to facilitate the sale and servicing of flood insurance 
policies. A person can purchase an NFIP flood insurance policy, also 
known as the Standard Flood Insurance Policy (SFIP), either: (1) 
Directly from the Federal government through a direct servicing agent, 
or (2) from a private insurance company (referred to as a WYO company) 
through the WYO Program. The SFIP sets out the terms and conditions of 
insurance. FEMA establishes terms of insurance and rates, which are the 
same whether purchased directly from the NFIP or through the WYO 
Program.
    FEMA enters into a standard Financial Assistance/Subsidy 
Arrangement (Arrangement) with the WYO companies, which addresses the

[[Page 32373]]

terms and conditions for administering the NFIP policies, including 
compensation. FEMA publishes the annual Arrangement in the Federal 
Register. See 44 CFR 62.23(a). FEMA published the Fiscal Year 2019 
Arrangement in March 2018, which became effective October 1, 2018. 83 
FR 11772 (Mar. 16, 2018).

B. Legislative Mandate To Revise the WYO Compensation Methodology

    Congress enacted the Biggert-Waters Flood Insurance Reform Act of 
2012 (BW-12) (Title II, Subtitle A of Public Law 112-141, 126 Stat. 
405) to extend the NFIP's authorities through September 30, 2017, and 
to adopt significant program reform. Section 100224 of BW-12 (42 U.S.C. 
4081 note) directs FEMA, the Government Accountability Office (GAO), 
and WYO companies to take a series of actions designed to improve the 
oversight of compensation provided to WYO companies under the WYO 
program.
    Subsection (b) directs FEMA to develop a methodology for 
determining the amount of reimbursements paid to WYO companies for 
selling, writing, and servicing NFIP policies and adjusting claims. 
FEMA must develop such methodology using ``actual expense data for the 
flood insurance line.'' FEMA can derive the methodology from either: 
(1) Flood insurance expense data provided by WYO companies; (2) flood 
insurance expense data collected by the National Association of 
Insurance Commissioners; or (3) a combination of previous two methods. 
This methodology is due 180 days following the enactment of BW-12.
    Subsection (d) instructs FEMA to ``issue a rule'' adopting a 
revised WYO payment methodology. Such methodology must specify 
compensation in both catastrophic and non-catastrophic loss years and 
be structured to ensure reimbursements track the actual expenses of WYO 
companies as closely ``as practicably possible.'' Based on the 
structure of section 100224, FEMA believes that Congress intended that 
the rule also align with the methodology FEMA is required to develop 
pursuant to subsection (b). FEMA intends to adopt a replacement WYO 
payment methodology via the notice-and-comment rulemaking process in 
order to comply with this direction.

C. Current WYO Payment Methodology

    As set forth in the FY 2019 Arrangement, FEMA currently pays WYO 
companies for their expenses by authorizing companies to retain a 
portion of the premiums they collect on behalf of the NFIP. Article III 
of the Arrangement describes the methodology for calculating the amount 
WYO companies may keep as compensation. This includes the methodology 
for paying WYO companies for their marketing, operating, and 
administrative expenses (collectively referred to as general expenses) 
(Article III.B of the Arrangement) and the methodology for compensating 
WYO companies for their loss adjustment expenses (LAE) (Article III.C 
of the Arrangement). Figure 1 illustrates this payment methodology.
[GRAPHIC] [TIFF OMITTED] TP08JY19.004

1. Marketing, Operating, and Administrative Expenses (General Expenses) 
(B in Figure 1)
    Article III.B of the Arrangement authorizes WYO companies to retain 
a certain percentage of the written premiums they collect for the NFIP 
as compensation for their general expenses, including the costs of 
marketing, selling, and servicing policies.
    FEMA calculates the Base WYO Expense Allowance Percentage (D in 
Figure 1) and then adds additional amounts, as described below. To 
determine the Base WYO Expense Allowance Percentage, FEMA begins with 
data from five non-flood insurance lines, namely Homeowners Multiple 
Peril, Fire, Allied Lines,\1\ Farmowners Multiple Peril, and Commercial 
Multiple Peril (non-liability portion).\2\ It

[[Page 32374]]

uses these five insurance lines because (1) data on flood insurance 
expenses has only recently become widely available; (2) current 
reporting of flood insurance expenses has limited reliability; and (3) 
these non-flood lines are the most similar to flood insurance.\3\ FEMA 
obtains data for these five insurance lines from A.M. Best Company's 
Aggregates and Averages publication.\4\ Each of these five insurance 
lines has various expense categories. FEMA uses three expense 
categories that fit most closely with flood insurance expenses. These 
include ``General Expenses,'' ``Other Acquisition Expenses,'' and 
``Taxes, Licenses, and Fees.'' For each expense category, FEMA divides 
actual expenses by the written premium to come up with an expense 
ratio. For example, if the General Expenses are $50 and the written 
premiums are $5,000, FEMA divides $50 by $5,000 to come up with an 
expense ratio of 1%, meaning General Expenses equaled 1% of the written 
premium.
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    \1\ ``Allied Lines'' are coverages which are generally included 
with property insurance, such as glass, tornado, windstorm and hail; 
sprinkler and water damage; explosion, riot, and civil commotion; 
growing crops; flood; rain; and damage from aircraft and vehicle. 
See http://www.naic.org/consumer_glossary.htm.
    \2\ The non-liability portion is the portion that deals with 
property insurance; the liability portion covers non-property based 
risks, such as civil liability for libel, slander, negligence, and 
unlawful employment practices. The property side is the side most 
akin to flood insurance and so FEMA uses that side for its 
calculation.
    \3\ As explained later in this notice, in December 2016, the 
Government Accountability Office (GAO) found that insurers were not 
consistently reporting flood insurance expense data to the National 
Association of Insurance Commissioners, resulting in underreporting 
of certain underwriting and loss expenses for their flood insurance 
lines. See GAO, Flood Insurance: FEMA Needs to Address Data Quality 
and Consider Company Characteristics When Revising Its Compensation 
Methodology (Jan. 9, 2017), at http://www.gao.gov/products/GAO-17-36.
    \4\ A.M. Best is an independent rating agency that focuses on 
the insurance industry. See http://www.ambest.com. A.M. Best obtains 
their data from financial statements submitted to the National 
Association of Insurance Commissioners (NAIC) by insurers in order 
to comply with State insurance regulator reporting requirements.
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    After FEMA calculates the expense ratio for each of the three 
expense categories, it adds them together to come up with the total 
expense ratio for each of the five insurance lines identified above. 
For example, if the expense ratio for General Expenses is 1%, for Other 
Acquisition Expenses is 5%, and for Taxes, Licenses, and Fees is 2%, 
FEMA then adds all three together (1 + 5 + 2) to come up with the total 
expense ratio for that insurance line (1 + 5 + 2=8%), which in this 
scenario is 8%. FEMA does this calculation for each of the five 
insurance lines. Once it has the total expense ratio for each of the 
five insurance lines, it weight averages them (using written premiums 
as weights) to determine the average expense ratio for all five lines 
of insurance combined. For example, if the expense ratios for each of 
the five insurance lines is: 2.6%, 9%, 11%, 13%, and 5%, and each line 
expressed as a portion of the total premiums of all five lines is: 25%, 
25%, 25%, 15%, and 10%, respectively, FEMA multiplies each expense 
ratio by its portion of total premiums. FEMA then adds the products to 
get an annual weighted average expense ratio for the non-flood 
insurance lines of insurance of 8.1% 
((2.6x0.25)+(9x0.25)+(11x0.25)+(13x0.15)+(5x0.1)=8.1%).
    To account for variability from year to year, FEMA then takes the 
annual weighted average expense ratio that it calculated for each of 
the previous 4 years, plus the weighted average expense ratio for the 
current year and averages them. For example, if the current year 
expense ratio is 8.1%, the previous year 1 ratio is 6%, the previous 
year 2 ratio is 4%, the previous year 3 ratio is 8%, and the previous 
year 4 ratio is 3%, then FEMA would add these ratios together (8.1 + 6 
+ 4 + 8 +3 = 29.1%), and then divide 29.1% by 5 to get an average 
expense ratio of 5.82%. The Base WYO Expense Allowance Percentage would 
then be 5.82%.
    FEMA then adds an additional 15 percentage points to pay WYO 
companies for commissions or salaries of insurance agents, brokers, or 
other entities producing qualified flood insurance applications and 
other related expenses (E in Figure 1). See Arrangement III.B.2. Prior 
to the Fiscal Year 2019 Arrangement, FEMA also added an additional 1 
percentage point to the Base WYO Expense Allowance Percentage to 
account for the additional complexity associated with selling and 
servicing NFIP policies. See FY 2018 Arrangement, Art. III.B.1, 82 FR 
17017, 17020 (Apr. 4, 2017); Arrangement, 44 CFR 62, App. A, Art. III.B 
] 2 (Arrangement applicable prior to FY 2018).\5\
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    \5\ See 81 FR 84483 (Nov. 23, 2016) (removing the Arrangement 
from regulation).
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    From 2009 to 2017, the percentages of written premium for each year 
(which include the Base WYO Expense Allowance Percentage, the extra 1 
percentage point for years prior to FY 2019, and the 15 percentage 
points for agent commissions), were as follows:
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    \6\ Percentage reflects the FY 2019 Arrangement's one percent 
reduction in compensation for general expenses. The rate would have 
been 31 percent without FY19 Arrangement's 1 percent reduction.

                TABLE 3--WYO EXPENSE ALLOWANCE PERCENTAGE
------------------------------------------------------------------------
                                                           Percent of
                                                        written premium
                  Arrangement  year                     paid to WYO for
                                                        general expenses
------------------------------------------------------------------------
2009.................................................              29.8
2010.................................................              30.0
2011.................................................              30.2
2012.................................................              30.4
2013.................................................              30.7
2014.................................................              30.7
2015.................................................              30.8
2016.................................................              30.9
2017.................................................              30.9
2018.................................................              30.9
2019.................................................            \6\ 30
------------------------------------------------------------------------

    In addition to these amounts, FEMA also provides for the 
possibility of a growth bonus. (F in Figure 1). See Arrangement 
III.B.3. The actual bonus varies by the extent a WYO company meets 
certain marketing goals. The total growth bonus paid to all WYO 
companies may not exceed 2 percent of aggregate written premium for all 
companies. Prior to the 2019 Arrangement, an individual company could 
not receive a growth bonus of more than 2 percent of such individual 
company's written premium. See, e.g. FY 2018 Arrangement, Art. III.B.3.
2. Loss Adjustment Expenses (LAE) (C in Figure 1)
    LAE are expenses incurred in the course of adjusting insurance 
claims.\7\ There are three categories of LAE in the Arrangement: (1) 
unallocated loss adjustment expenses (ULAE), (2) allocated loss 
adjustment expenses (ALAE), and (3) special allocated loss adjustment 
expenses (SALAE).
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    \7\ Adjusting an insurance claim is a determination of the 
amount payable by the insurer to the insured on a claim under an 
insurance policy.
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    ULAE (H in Figure 1) are expenses a WYO company incurs while 
adjusting flood insurance claims but cannot attribute to a specific 
claim. Examples of ULAE include general overhead, adjuster supervision 
expenses, and catastrophic response resources, such as mobile claim 
response units. FEMA reimburses ULAE based on a ``ULAE Schedule.'' 
Arrangement III.C.1. The Fiscal Year 2017 schedule provides for 0.9 
percent of net written premium and 1.5 percent of incurred loss.\8\ 
FEMA

[[Page 32375]]

calculates incurred loss based on claims that have been reported to the 
WYO company. FEMA excludes any estimate by the WYO company for 
additional dollars the WYO company will pay on claims from flooding 
events that have already happened but have not yet been reported to the 
company. Further, in calculating incurred loss for those claims already 
reported to the company, FEMA includes both amounts already paid on 
those claims and the estimate by the company of amounts remaining to be 
paid on those claims.
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    \8\ Prior to Hurricane Katrina, FEMA reimbursed ULAE based on 
3.3 percent of incurred losses, as that was the number FEMA 
determined was required to maintain sufficient WYO company 
participation in the NFIP program. Katrina, however, revealed that 
in a high-severity localized event, a payment of 3.3 percent of 
incurred losses resulted in significant overpayments to WYO 
companies. For this reason, FEMA removed the percentage from the 
Arrangement and instead communicated it on an annual basis. See 73 
FR 18182, 18184-5 (April 3, 2008). Following this change FEMA 
altered its ULAE reimbursement method to decrease variations between 
low and high-payout years. Accordingly, it decreased its payment of 
incurred losses to 1.5 percent, and began reimbursing 1 percent of 
net written premiums, eventually reaching today's level at .9 
percent of net written premiums. (The net written premium percentage 
was designed to cover expenses that are more fixed; as such, it is 
more static and thus avoids overcompensation during disaster years.)
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    ALAE (I in Figure 1) are adjustment expenses attributable to 
specific claims, such as fees to adjusters. FEMA pays for ALAE for 
adjuster expenses according to a fee schedule, but only after the claim 
has been closed. Arrangement III.C.2. The NFIP published the current 
ALAE fee schedule in 2017. See NFIP Claims Manual, Appendix A.\9\ The 
schedule provides for a range of flat rate fees varying according to 
the disposition of a claim and the amount of the gross paid loss.\10\ 
The ALAE schedule is reproduced in part below:
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    \9\ https://www.fema.gov/media-library-data/1535556801689-ef2b1232f884cc6e4396a8cc7e7526b3/Appendix_A_Adjuster_Fee_Schedule.pdf.
    \10\ ``Gross Loss'' is the agreed cost to repair before 
application of depreciation or the applicable deductible(s), but 
subject to policy limitations (such as those dollar amounts 
specified in Coverage B -- Personal Property Special Limits and 
Coverage C -- Other Coverages, Loss Avoidance Measures and Property 
Removed to Safety) and exclusions.

                       Table 4--ALAE Fee Schedule
------------------------------------------------------------------------
                Claim Range                              Fee
------------------------------------------------------------------------
Erroneous Assignment......................  $95.00.
Claim Withdrawn...........................  $95.00.
Closed Without Payment (CWOP).............  $395.00.
.01-$1,000.00.............................  $525.00.
$1,000.01-$5,000.00.......................  $800.00.
$5,000.01-$10,000.00......................  $1,035.00.
$10,000.01-$15,000.00.....................  $1,175.00.
$15,000.01-$25,000.00.....................  $1,275.00.
$25,000.01-$35,000.00.....................  $1,475.00.
$35,000.01-$50,000.00.....................  $1,750.00.
$50,000.01-$100,000.00....................  3.4% but not less than
                                             $1,750.
$100,000.01-$250,000.00...................  2.6% but not less than
                                             $4,250.
$250,000.01-$1,000,000.00.................  2.4% but not less than
                                             $7,800.
$1,000,000.01 and up......................  2.2% but not less than
                                             $24,000.
------------------------------------------------------------------------

    The current ULAE and ALAE schedules have resulted in payments equal 
to 6.7 percent of the total losses paid (the amount actually paid for 
claims) during the last 5 years for which data is available. However, 
annual paid losses and the annual amount of LAE payments that are 
incurred to service them vary widely in that period, as seen in the 
Table 5:

                                Table 5--Amount FEMA Paid for ALAE and ULAE \11\
                                                  [$ Thousands]
----------------------------------------------------------------------------------------------------------------
                                                                                                    D. Payment
                                                                                                   for LAE/Paid
                Arrangement year                   A. Paid  Loss   B. ALAE  Paid   C. ULAE  Paid    Loss Ratio
                                                                                                    (B+C)/A = D
                                                                                                     (percent)
----------------------------------------------------------------------------------------------------------------
2013............................................      $7,463,580        $295,439        $137,529            5.80
2014............................................         741,729          33,205          37,803            9.57
2015............................................         687,407          28,116          36,358            9.38
2016............................................       1,864,887          61,930          73,571            7.27
2017............................................       3,376,735         107,296         141,216            7.36
    5-Yr Total/Avg..............................      14,134,338         525,986         426,476            6.74
----------------------------------------------------------------------------------------------------------------

    SALAE include specialized claims handling expenses attributable to 
a specific claim, such as for legal, surveying, or engineering support. 
Unlike ULAE and ALAE, FEMA does not use a schedule to reimburse SALAE, 
but rather pays for SALAE on a dollar-for-dollar reimbursement 
basis.\12\
---------------------------------------------------------------------------

    \11\ Data were based on annual end of year financial statements 
for the National Flood Insurance Program and expenses paid 
exclusively for the Write Your Own program. All amounts shown in 
this table track payments to the Arrangement Year (Oct 1 through Sep 
30) in which they were made. This is in contrast to other methods of 
tracking payments (see, e.g., Table 7) to the year the flood 
occurred.
    \12\ The basic SALAE guideline is WYO Bulletin W-10039 (April 1, 
2010), available at https://bsa.nfipstat.fema.gov/wyobull/2010/w-10039.pdf.
---------------------------------------------------------------------------

    SALAE represents a very small portion of the National Flood 
Insurance Program's expenses and overall claims process. In 2015, 
FEMA's internal data indicates that 8.10 percent of claims involved 
SALAE payments, which cost 0.47 percent of losses incurred for that 
year. In 2016, 2.57 percent of claims involved SALAE payments, which 
cost 0.18 percent of losses incurred for that year. However, 
administering this small portion on a dollar-for-dollar reimbursement 
basis requires significant administrative oversight on the part of 
FEMA. FEMA program staff review each reimbursement request to ensure 
fair pricing and reasonable use of professional services. Specific for 
reimbursement of litigation of claims, FEMA employs several dedicated 
program and legal staff members to oversee reimbursement of WYO 
companies for their legal expenses.

D. Findings of Inadequacies in Current Methodology

    Relevant to this discussion, the GAO has issued two reports 
outlining its concerns with FEMA's methodology for calculating the 
amount FEMA pays WYO companies. In August 2009, GAO issued a report 
entitled, ``Flood Insurance: Opportunities Exist to Improve Oversight 
of the WYO Program'' (2009 GAO Report).\13\ In the report, GAO 
criticized the NFIP for not considering actual flood insurance expense 
information when it determines the amount it pays the WYO company for 
selling and servicing flood insurance policies and adjusting claims. 
2009 GAO Report, 5-6. As part of the review, GAO examined the expense 
payments FEMA made to six WYO companies for their actual expenses for 
calendar years 2005 through 2007. Id. at 6. GAO found

[[Page 32376]]

that the payments exceeded the WYO companies' actual expenses by $327.1 
million, or 16.5 percent of total payments made. Id.
---------------------------------------------------------------------------

    \13\ GAO-09-455 (Sept. 21, 2009), available at http://www.gao.gov/products/GAO-09-455.
---------------------------------------------------------------------------

    However, the 2009 GAO report also found inconsistencies in the 
actual flood expenses data obtained by the National Association of 
Insurance Commissioners (NAIC). Id. at 5-6. GAO found that some 
companies reported their flood insurance expenses to NAIC after 
offsetting them with the payments they received from FEMA. Id. In other 
instances, it found that companies included payments made under service 
agreements with affiliated companies that may have included profit 
distributions that should not have been included. Id. Accordingly, GAO 
found that the consistency of WYO companies' reporting to NAIC needs to 
be improved in order for data on the companies' expenses to be fully 
utilized. See id. at 5-6.
    In December 2016, GAO issued another report entitled, ``Flood 
Insurance: FEMA Needs to Address Data Quality and Consider Company 
Characteristics When Revising Its Compensation Methodology'' (2016 GAO 
Report).\14\ In this report, GAO affirmed its 2009 recommendations and 
found that FEMA has yet to revise its WYO compensation methodology to 
reflect actual expenses, due in large part to a lack of quality data on 
actual expenses.
---------------------------------------------------------------------------

    \14\ GAO-17-36 (Dec. 8, 2016), available at http://www.gao.gov/products/GAO-17-36.
---------------------------------------------------------------------------

E. WYO Expenses Reported to NAIC Compared to WYO Compensation

    FEMA has examined the difference between payments made under the 
current methodology and the actual expenses reported by WYO companies 
to the NAIC between 2009 and 2013, the latest year data is available 
for either methodology.\15\ The results appear in Table 6. FEMA found 
that the reimbursement rate for general expenses under the current 
methodology exceeded the actual flood expense ratio calculated using 
NAIC data.
---------------------------------------------------------------------------

    \15\ In order to control for non-credible data in some NAIC 
reports, FEMA only used data from participating WYO companies 
reporting expense ratios of 10 percent and above.

     Table 6--General Expenses: Reported Flood Insurance Expenses Ratio (i.e., Reported General Expenses as
                      Percentage of Reported Written Premium) vs. Current Methodology \16\
----------------------------------------------------------------------------------------------------------------
                                                                                      C. NAIC
                                                                                     Reported        Table 3.
                                                                                      General       Percent of
                                                     A. NAIC         B. NAIC        Expenses as       Written
                Arrangement year                    Reported         Reported     Percentage  of   Premium Paid
                                                     General         Written         Reported       to WYO for
                                                    Expenses         Premium          Written         General
                                                                                  Premium  A/B =     Expenses
                                                                                         C
----------------------------------------------------------------------------------------------------------------
2013...........................................     697,027,000    2,937,809,000            23.7            30.7
2014...........................................     719,039,000    2,911,660,000            24.7            30.7
2015...........................................     684,714,000    2,756,173,000            24.8            30.8
2016...........................................     723,487,000    2,759,584,000            26.2            30.9
2017...........................................     746,587,000    2,744,213,000            27.2            30.9
5-Yr Total/Avg.................................   3,570,854,000   14,109,439,000            25.3            30.8
----------------------------------------------------------------------------------------------------------------

    FEMA also analyzed LAE and found similar results, i.e., the 
reimbursement rate under the current methodology exceeded the actual 
flood expense ratio using NAIC data. Both the actual expense data from 
the NAIC and the amounts FEMA pays under the current methodology show 
variation from year to year; some years have lower LAE/loss ratios 
while other years have higher ratios. However, as seen in Table 7, the 
NAIC actual expense data indicates consistently lower ratios (i.e., 
lower LAE relative to paid loss) (column C of Table 7) than what FEMA 
pays under the current LAE methodology (last column of Table 7, which 
lists data from Table 5).
---------------------------------------------------------------------------

    \16\ These reported figures for flood insurance expense data are 
the latest available as of November 2018. FEMA notes that the future 
differences between NAIC reported expenses and the corresponding WYO 
Expense Allowances will be slightly different than the historical 
difference shown here because of the FY19 Arrangement's 1 percent 
reduction in compensation for general expenses.

  Table 7--Loss Adjustment Expenses (LAE) as a Percent of Paid Losses: Reported by NAIC vs. Paid Under Current
                                                   Methodology
                                                [In $ Thousands]
----------------------------------------------------------------------------------------------------------------
                                                                                      C. NAIC
                                                                                   Reported LAE   D. From  Table
                                                      A. NAIC         B. NAIC      as Percentage  5  Payment for
       Calendar year/Arrangement year \1\         Reported  Paid   Reported  LAE      of NAIC         LAE/Paid
                                                       Loss          Paid \2\     Reported  Paid  Loss Ratio \3\
                                                                                  Loss  (B / A =     (percent)
                                                                                        C)
----------------------------------------------------------------------------------------------------------------
2013............................................      $6,393,676        $334,276            5.23            5.80
2014............................................         588,622          61,435           10.44            9.57
2015............................................         829,042          65,192            7.86            9.38
2016............................................       3,091,250         141,377            4.57            7.27
2017............................................       7,189,144         347,127            4.83            7.36

[[Page 32377]]

 
    5-Yr Average................................       3,618,347         189,882            5.25            6.74
----------------------------------------------------------------------------------------------------------------
\1\ Both ``Calendar Year'' and ``Arrangement Year'' are presented in one column for user ease. Although there is
  a calendar year and an arrangement year for each year of data, FEMA's definitions of the two differ.
  Specifically, here the calendar year represents January 1 through December 31. The arrangement year represents
  the time frame (generally the 365 days) covered in the standard Financial Assistance/Subsidy Arrangement with
  private sector property insurers, also known as Write Your Own (WYO) companies, to sell NFIP flood insurance
  policies under their own names and adjust and pay claims arising under the Standard Flood Insurance Policy
  (SFIP). See 42 U.S.C. 4081(a).
\2\ In column B, the LAE values listed are the sum of both ULAE and ALAE for each year. SALAE is not included in
  the values.
\3\ In column D, the values include only payments made for ULAE and ALAE for each arrangement year. SALAE is not
  included in the values, as reported in Table 5.

IV. Possible Methodologies

    FEMA is considering three possible methodologies for calculating 
payments to WYO companies. The three methodologies only address 
payments for general and loss adjustment expenses incurred by WYO 
companies. FEMA is considering additional regulatory actions to address 
the possibility of additional non-expense related payments, such as for 
profit or performance-based incentives.
    FEMA presents these possible methodologies in order to solicit 
comments from the public. FEMA intends to use these comments to inform 
the publication of a notice of proposed rulemaking that will propose a 
new WYO payment methodology in the future.

A. Credibility Weighting Methodology: Incorporating Actual Expense Data 
Into Current Methodology

    FEMA is considering a payment approach that uses credibility 
weighting procedures \17\ to incorporate actual flood expense data into 
FEMA's current methodology (described in section III.C of this ANPRM). 
Credibility weighting combines two or more values. In this case, the 
values would be the expense compensation ratios under the current 
methodology and those yielded by flood insurance expense data. However, 
a weight is applied to each value to introduce a greater influence of 
one over the other in the final result. The weights are based on 
actuarial opinion of the quality, robustness, and representative nature 
of the available data, and can differ from year to year. How these 
factors are considered will vary based on the specific procedure or 
procedures used to incorporate credibility. Such procedures include 
Bayesian credibility procedures, empirical credibility procedures, and 
classical credibility procedures.\18\
---------------------------------------------------------------------------

    \17\ The Actuarial Standard Board defines ``credibility 
procedure'' as: ``A process that involves the following: (a) The 
evaluation of subject experience for potential use in setting 
assumptions without reference to other data; or (b) the 
identification of relevant experience and the selection and 
implementation of a method for blending the relevant experience with 
the subject experience.'' Actuarial Standards Board, Actuarial 
Standard of Practice No. 25: Credibility Procedures, 2 (Dec. 2013), 
available at http://www.actuarialstandardsboard.org/wp-content/uploads/2014/02/asop025_174.pdf. ``Subject experience'' means ``[a] 
specific set of data drawn from the experience under consideration 
for the purpose of predicting the parameter under study.'' Id. 
``Relevant experience'' means ``[s]ets of data, that include data 
other than the subject experience, that, in the actuary's judgment, 
are predictive of the parameter under study (including but not 
limited to loss ratios, claims, mortality, payment patterns, 
persistency, or expenses). Relevant experience may include subject 
experience as a subset.'' Id.
    \18\ See Actuarial Standards Board, Actuarial Standard of 
Practice No. 25: Credibility Procedures, 5-6 (Dec. 2013), available 
at http://www.actuarialstandardsboard.org/wp-content/uploads/2014/02/asop025_174.pdf.
---------------------------------------------------------------------------

    Credibility weighting procedures allow FEMA to incorporate flood 
expense data in WYO compensation, while adjusting the impact of such 
data to account for its shortcomings. As data from the NAIC becomes a 
more credible indicator of actual flood expenses, this methodology will 
allow FEMA to give it greater weight. Under this approach, FEMA would 
steadily increase usage of actual flood expense data over time, as that 
data increases in credibility, while continuing to draw from the non-
flood insurance expense data currently in use in the near term.
1. General Expenses
    For general expenses, FEMA would credibility weight two sources of 
expense data: The actual flood insurance expense ratio and the non-
flood insurance expense ratio. FEMA would obtain this data from A.M. 
Best Company's Aggregates and Averages publication, as FEMA does under 
its current methodology. The actual flood insurance expense ratio would 
cover the ``General Expenses,'' ``Other Acquisition Expenses,'' 
``Taxes, Licenses, and Fees,'' and ``Agent Commission'' expense 
categories incurred by insurance companies, averaged over the previous 
five years for which reliable and complete data are available. FEMA 
projects that, based on data reported by WYO companies to the NAIC for 
FY 2013 through FY 2017, this would yield an expense ratio of 25.3 
percent of written premium (i.e., actual expenses are 25.3 percent of 
the written premiums) before credibility weighting.\19\
---------------------------------------------------------------------------

    \19\ 25.3 percent is estimated based on a 5-year average of 
NAIC-reported data of WYO companies who reported expenses within the 
10 percent and above range. FEMA limited analysis of NAIC data to 
this specific range because it deemed WYO-reported expenses below 10 
percent to be less than credible, based on number of firms reporting 
and general experience with the WYO program and the NFIP.
---------------------------------------------------------------------------

    The non-flood insurance industry expense ratio would be the expense 
ratios for the five non-flood property/casualty insurance lines used in 
the current methodology. The ratios would cover the ``General 
Expenses,'' ``Other Acquisition Expenses,'' and ``Taxes, Licenses, and 
Fees'' expense categories, averaged over the previous five years, then 
adding the static 15 percent agent commission percentage of the current 
general expense scheme (discussed in section III.C.1. of this ANPRM). 
FEMA expects this would yield an expense ratio of 30 percent of written 
premium before credibility weighting.\20\
---------------------------------------------------------------------------

    \20\ 30 percent is based on data from FY 2014 through FY 2016 
(which were factored into the WYO compensation rates between FY 2017 
and FY 2019).

---------------------------------------------------------------------------

[[Page 32378]]

    Based on the current NAIC actual flood expense data, FEMA estimates 
that the credibility-weighted general expense ratio for FY 2019 would 
be approximately 28.8 percent of written premium (based on preliminary 
estimates that assume an initial credibility weighting of only 25 
percent for the self-reported NAIC data). This would represent 
approximately a $36.63 million decrease in general expense payments to 
WYO companies in FY 2019, as compared to the current compensation 
baseline in 2019. As the flood expense data collected by the NAIC 
becomes more credible, this approach would assign greater weight to the 
flood insurance expense ratio.
2. LAE
    As noted above, FEMA currently reimburses ULAE and ALAE using 
different methods. It reimburses ULAE based on 0.9 percent of written 
premium and 1.5 percent of incurred loss, and ALAE according to a 
schedule based on a range of flat-rate fees. Under the credibility 
weighting approach, FEMA would no longer reimburse ULAE and ALAE 
separately using these different methods. Instead, FEMA would use one 
new fee schedule (modeled after the current ALAE schedule) to determine 
reimbursements for both. Because FEMA would use the same reimbursement 
schedule for both, it would no longer need to differentiate between 
ULAE and ALAE; as such, this new fee schedule would depict the overall 
LAE payment rate. FEMA's reimbursement for SALAE would remain unchanged 
because FEMA currently pays for SALAE on a dollar-for-dollar 
reimbursement basis, and would continue to do so.
    FEMA would revise this LAE fee schedule annually to minimize the 
difference from year to year between actual LAE that WYO companies 
incur as reported by NAIC and what FEMA pays to cover those incurred 
expenses. FEMA would minimize this difference by adjusting the previous 
annual LAE fee schedule by applying a certain calculated percentage. 
FEMA would calculate this percentage by credibility weighting (1) the 
payment amounts that FEMA would have made if the most recent LAE fee 
schedule had been in place during recent years and (2) the payment 
amounts that FEMA would have paid under the current LAE fee schedule, 
revised to yield the actual reported LAE expenses for the same period. 
In essence, FEMA would incorporate actual reported expenses incurred by 
WYO companies by regularly examining the validity of the current LAE 
fee schedule and revising that LAE fee schedule using historical LAE 
payment experience.
    Using this approach, FEMA's preliminary calculations indicate that 
LAE under the unified fee schedule in FY 2019 would result in a payment 
rate of 7.63 percent of paid losses (the dollar amount of claims paid 
by the NFIP), which is a reduction of 0.66 percentage points from the 
FY 2019 compensation rate of 8.29 percent under the current LAE 
compensation methodology.\21\ This would represent an approximately 
$20.28 million decrease in LAE payments to WYO companies in the first 
year. Over time, the LAE payment rate would better align with the year-
to-year LAE expenses because FEMA would likely assign an increasing 
credibility to the NAIC flood expense data and each year's experience 
would inform and improve the next year's rates. FEMA expects an 
increase in credibility because of FEMA's ongoing collaboration with 
the NAIC to improve data quality and the NAIC's issuance of guidance on 
the proper accounting of reimbursements to Write Your Own companies. 
FEMA has also improved its monitoring of WYO expenses related to 
litigation, see WYO Bulletin W-16045 (July 19, 2016), engineering 
inspections, see WYO Bulletins W-15010 (Mar. 9, 2015), and overall 
expense reporting, see WYO Bulletin W-16048 (Aug. 4, 2016). See, e.g., 
N.C. Gen. Stat. Sec.  58-2-180 (willful misstatement of information in 
certain financial or other statements); Va. Code Ann. Sec.  38.2-2027 
(withholding of certain information and giving false or misleading 
information to the Commissioner of Insurance, statistical rating 
agencies, or any other insurer).
---------------------------------------------------------------------------

    \21\ As a reference point, the average historical compensation 
rate for ALAE and ULAE from 2013-2017 was 6.74 percent of total paid 
losses.
---------------------------------------------------------------------------

B. Methodology Based Completely on Flood Expense Data

    FEMA is also considering a methodology that uses solely actual 
flood insurance expense data, meaning it would no longer use industry 
expense ratios as part of the calculation. Under this approach, FEMA 
would use reported flood expense data to determine reasonable flood 
expense payment ratios by dividing previous years' general expenses by 
the associated written premium. Setting payment rates entirely on 
publicly available expense data collected from the NAIC would likely be 
the simplest approach for FEMA to administer, but would depend entirely 
on the credibility of flood expense data obtained from the NAIC. While 
the credibility of this data continues to improve, it is not likely 
fully credible at this time. See GAO-17-36 (Dec. 8, 2016). Any approach 
that depends entirely on the use of flood expense data would, at least 
in the short term, suffer from the same deficiencies as the current 
methodology, in that it would not be an accurate representation of the 
actual expenses incurred by WYO companies in carrying out their 
obligations under the WYO Program.
    Over the long term, this approach could result in payments that 
closely align with the actual reported flood expenses. However, relying 
solely on flood expense data would very likely result in wide gaps in 
what FEMA would pay year-to-year. This is because unlike expenses for 
non-flood lines, which tend to be evenly distributed and thus 
relatively stable, flooding tends to occur all at one time. Because 
flooding is not an evenly distributed hazard, it is difficult to 
insure. FEMA could continue its practice of averaging expense data over 
5 years in order to smooth sudden changes in expenses. Tailoring 
payments to WYO companies to their actual expenses in the long term, 
therefore, would place the methodology solely on a self-reported basis, 
which is not immune from manipulation and other potential 
irregularities. FEMA would be required to rely entirely on data 
provided by the NAIC, regardless of its credibility, which, as noted 
above, GAO identified as a source of concern.
    Based on the current NAIC actual flood expense data, FEMA projects 
that the general expense ratio for FY 2019 would be approximately 25.3 
percent of written premium (based on preliminary estimates that average 
the most recent three years of expense ratios based on self-reported 
NAIC data). This would represent approximately a $146.51 million 
decrease in general expense payments to WYO companies in FY 2019.
    In addition, using this approach, FEMA's preliminary calculations 
indicate that LAE under the unified fee schedule in FY 2019 would 
result in a payment rate of 5.67 percent of paid losses (the dollar 
amount of claims paid by the NFIP), which is a reduction of 2.62 
percentage points from the FY 2019 compensation rate of 8.29 percent 
under the current LAE compensation methodology in FY 2019.\22\ This 
would have represented an approximately

[[Page 32379]]

$81.11 million decrease in LAE payments to WYO companies in FY 2018.
---------------------------------------------------------------------------

    \22\ As a reference point, the average historical compensation 
rate for ALAE and ULAE from 2013-2017 was 6.74 percent of total paid 
losses.
---------------------------------------------------------------------------

C. Methodology Based on Invoices

    In a third possible methodology, FEMA would pay WYO companies on a 
direct, invoice-supported, dollar-for-dollar reimbursement basis, 
similar to how FEMA currently pays for SALAE. This approach would be 
based on the actual expenditures of WYO companies and would allow FEMA 
to collect detailed expenditure data. This would give FEMA more 
monitoring and control over WYO expenditures while ensuring that 
payments directly reflect an individual WYO company's incurred 
expenses. It would also avoid the consequences associated with the 
year-to-year variability of expenses discussed above. However, this 
approach would likely create significant administrative burdens for the 
NFIP and WYO companies. FEMA employs several legal and program staff 
members in order to oversee current SALAE reimbursements, and an 
expansion of direct reimbursements to cover all loss adjustment 
expenses would entail expanded cost burdens, given the volume of losses 
and the number of claims against which compensation would be tied. The 
timely processing of each claim's related expenses from each WYO 
company would not be possible given current staff and administrative 
capacity of FEMA and as a result, expansion of the reimbursement 
concept would likely require hiring numerous new staff members. Without 
such an increase in FEMA processing staff, a direct reimbursement 
methodology for all LAE expenses would result in reimbursement delays 
and disruption to both the policyholders and WYO companies. WYO 
companies would likely incur significant additional administrative 
expenses.

V. Public Comment

    FEMA seeks public comment on all aspects of a revised WYO payment 
methodology, with particular interest in better understanding the 
implication of the three methodologies described above. FEMA will use 
the received comments to inform future rulemaking on the subject. 
Comments accompanied by supporting data and analysis of the issues 
addressed in those comments would provide the greatest assistance to 
FEMA. Additionally, FEMA would derive particular benefit from 
commenters addressing one or more of the following questions:
    1. What are the limitations with the current WYO expense 
compensation methodology that you believe FEMA needs to address in the 
revised methodology?
    2. What recommendations do you have for improving the current WYO 
expense compensation methodology?
    3. What credibility weighting procedures should FEMA consider 
using, if any?
    4. Do the five non-flood property/casualty lines of insurance act 
as a good approximation of flood insurance general expenses in the 
credibility weighting-based approach? If FEMA continues to use non-
flood property/casualty lines of insurance, what lines should FEMA 
consider adding or subtracting from this list?
    5. Should FEMA merge payments for ULAE into the existing ALAE fee 
schedule so that ULAE payments are better tailored to the severity of a 
flood event?
    6. Does NAIC flood expense data accurately reflect the actual 
expenses incurred by WYO companies? What are the challenges of ensuring 
accurate data are provided to the NAIC and how can they best be 
overcome?
    7. What, if any, alternative data sources can provide WYO company 
expense data that are more accurate than what the NAIC captures?
    8. What, if any, additional costs would WYO companies incur if 
required to submit all NFIP-related expenses for reimbursement as they 
are incurred (i.e., the third alternative referenced above)?
    9. Does the structure of the current ALAE fee schedule adequately 
take into account the differences in incurred expenses between 
catastrophic and non-catastrophic loss years?
    10. What changes to the current methodology would allow FEMA to 
better distinguish between catastrophic and non-catastrophic years in 
paying out LAE?
    11. What individual characteristics of WYO companies could be used 
to better tailor a payment methodology to the actual expenses of 
individual companies?
    12. What additional data may help FEMA better understand actual 
expenses of WYO companies?

    Authority: 42 U.S.C. 4081 note.

Pete Gaynor,
Acting Administrator, Federal Emergency Management Agency.
[FR Doc. 2019-14343 Filed 7-5-19; 8:45 am]
 BILLING CODE 9111-52-P