Federal Emergency Management Agency: Challenges for the National 
Flood Insurance Program (25-JAN-06, GAO-06-335T).		 
                                                                 
The National Flood Insurance Program (NFIP), established in 1968,
provides property owners with some insurance coverage for flood  
damage. The Federal Emergency Management Agency (FEMA) within the
Department of Homeland Security is responsible for managing the  
NFIP. The unprecedented magnitude and severity of the flood	 
losses from hurricanes in 2005 challenged the NFIP to process a  
record number of claims. These storms also illustrated the extent
to which the federal government has exposure for claims coverage 
in catastrophic loss years. FEMA estimates that Hurricanes	 
Katrina, Rita, and Wilma will generate claims and payments of	 
about $23 billion--far surpassing the total claims paid in the	 
entire history of the NFIP. This testimony provides information  
from past and ongoing GAO work on issues including: (1) NFIP's	 
financial structure; (2) the impact of properties with repetitive
flood losses on NFIP's resources; (3) proposals to increase the  
number of policies in force; and (4) the status of past GAO	 
recommendations.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-335T					        
    ACCNO:   A45677						        
  TITLE:     Federal Emergency Management Agency: Challenges for the  
National Flood Insurance Program				 
     DATE:   01/25/2006 
  SUBJECT:   Claims processing					 
	     Financial analysis 				 
	     Financial management				 
	     Flood insurance					 
	     Hurricane Katrina					 
	     Insurance losses					 
	     Performance measures				 
	     Program evaluation 				 
	     Program management 				 
	     Subsidies						 
	     Hurricanes 					 
	     Disaster recovery					 
	     Natural disasters					 
	     FEMA National Flood Insurance Program		 
	     Hurricane Rita					 

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GAO-06-335T

     

     * Major Program Issues -a Summary
     * The NFIP Pays Expenses and Claims with Premiums to the Exten
          * Premium Subsidies and Repetitive-Loss Properties Affect NFIP
     * Expansion of the NFIP Policyholder Base
          * Compliance with Mandatory Purchase Requirements Difficult to
          * Expansion of Mandatory Purchase Requirements Would Generate
          * FEMA Has a Marketing Campaign to Attract New Policyholders a
     * Accurate, Updated Flood Maps Are the Foundation of the NFIP
     * Monitoring and Oversight of NFIP Identifies Specific Problem
     * FEMA Has Not Fully Implemented NFIP Program Changes Mandated
     * Concluding Observations
     * GAO Contact and Staff Acknowledgments
     * GAO's Mission
     * Obtaining Copies of GAO Reports and Testimony
          * Order by Mail or Phone
     * To Report Fraud, Waste, and Abuse in Federal Programs
     * Congressional Relations
     * Public Affairs

Testimony

Before the Chairman, Committee on Banking, Housing and Urban Affairs,

U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 10:00 a.m. EST

Wednesday, January 25, 2006

FEDERAL EMERGENCY MANAGEMENT AGENCY

Challenges for the National Flood Insurance Program

Statement of David M. Walker, Comptroller General of the United States

GAO-06-335T

Mr. Chairman and Members of the Committee:

I appreciate the opportunity to participate in today's hearing on the
future of the National Flood Insurance Program (NFIP) to discuss issues
related to the future financial stability of the NFIP and recommendations
we have made for improvements to the management and oversight of the
program. The NFIP combines property insurance for flood victims, mapping
to identify the boundaries of the areas at highest risk of flooding, and
incentives for communities to adopt and enforce floodplain management
regulations and building standards to reduce future flood damage. The
effective integration of all three of these elements is needed for the
NFIP to achieve its goals of:

           o  providing property flood insurance coverage for a high
           proportion of property owners who would benefit from such
           coverage;
           o  reducing, through this insurance coverage, taxpayer-funded
           disaster assistance for property damage when flooding strikes; and
           o  reducing property flood damage through flood plain management
           based on accurate, useful flood maps and the enforcement of
           building standards (such as elevating structures).

Hurricanes Katrina and Rita represent a tragedy for hundreds of thousands
of our fellow Americans. Their lives have been turned upside down, and
many who would have benefited from flood insurance did not have it. This
tragedy offers an opportunity to fundamentally rethink the flood insurance
program and how it can best be structured to provide financial protection
from flooding for those who need and would benefit from flood insurance
while enhancing the program's financial foundation.

The Federal Emergency Management Agency (FEMA) within the Department of
Homeland Security (DHS) is responsible for the oversight and management of
the program.1 Under the program, the federal government assumes the
liability for the insurance coverage and sets rates and coverage
limitations, among other responsibilities.

Floods are the most common and destructive natural disaster in the United
States. According to NFIP statistics, 90 percent of all natural disasters
in the United States involve flooding. However, flooding is generally
excluded from homeowner policies that typically cover damage from other
losses, such as wind, fire, and theft. Because of the catastrophic nature
of flooding and the inability to adequately predict flood risks, private
insurance companies have largely been unwilling to underwrite and bear the
risk of flood insurance.

1In March 2003, FEMA and its approximately 2,500 staff became part of DHS.
FEMA retained its name and individual identity within the department.

The NFIP was established by the National Flood Insurance Act of 19682 to
provide policyholders with some insurance coverage for flood damage, as an
alternative to disaster assistance, and to try to reduce the escalating
costs of repairing flood damage. In creating the NFIP, Congress found that
a flood insurance program with "large-scale participation of the Federal
Government and carried out to the maximum extent practicable by the
private insurance industry is feasible and can be initiated."3 In keeping
with this purpose, FEMA has contractual agreements with 95 private
insurance company partners to sell policies and adjust and process claims.

As of November 2005, the NFIP was estimated to have approximately 4.8
million policyholders in about 20,000 communities. According to FEMA,
every $3 in flood insurance claims payments saves about $1 in disaster
assistance payments, and the combination of flood plain management and
mitigation efforts save about $1 billion in flood damage each year.

Flood maps identify the boundaries of the areas at the greatest risk of
flooding. These areas are called special high-risk flood hazard areas,
often referred to as the 100-year flood plain, that area in which there is
a 1 percent chance of flooding each year, or a 30 percent chance of
flooding over the period of a 30-year mortgage. Property owners whose
properties are within the 100-year flood plain, as identified on the flood
maps, and whose mortgages are from a federally regulated lender, are
required to purchase flood insurance for the amount of their outstanding
mortgage balance, up to the maximum policy limit of $250,000 in coverage
for single family homes. The owners of properties with no mortgages or
properties with mortgages held by lenders who are not federally regulated
were not, and still are not, required to buy flood insurance, even if the
properties are in the 100-year flood plain. Optional, lower-cost coverage
is available under the NFIP to protect homes in areas of low to moderate
risk that are outside the 100-year flood plain, but owners of properties
in these lower-risk areas are not required to purchase flood insurance.

2The National Flood Insurance Act of 1968, as amended, is codified at 42
U.S.C. 4001 to 4129.

342 U.S.C. 4001(b)(2).

The unprecedented magnitude and severity of the flood losses in 2005
placed unprecedented challenges on the NFIP to process a record number of
claims, many in properties flooded by Hurricanes Katrina and Rita that
were inaccessible for weeks after the flooding occurred. These storms also
illustrated the extent to which the federal government has exposure for
claims coverage in catastrophic loss years. From its inception in 1968
until August 2005, the NFIP paid about $14.6 billion in insurance claims,
primarily from policyholder premiums that otherwise would have been paid
through taxpayer-funded disaster relief or borne by home and business
owners themselves. As shown in figure 1, FEMA estimates that Hurricanes
Katrina, Rita, and Wilma are likely to generate claims and associated
payments of about $23 billion- far surpassing the total about $15 billion
in claims paid in the entire history of the NFIP up to those events.

Figure 1: NFIP Claims Payments from 1968 to 2004 and Estimated for
Hurricanes Katrina, Rita, and Wilma

The NFIP cannot absorb the total costs of paying these claims. On November
21, 2005, FEMA's authority to borrow from the Treasury was increased from
$1.5 billion to $18.5 billion through fiscal year 2008.4 The acting
director of FEMA's Mitigation Division said this borrowing authority will
pay NFIP claims and expenses into February 2006, when additional
legislative action to increase the borrowing authority will likely be
required. He also said that it is highly unlikely that the program could
generate sufficient revenues to cover a debt of this size. FEMA estimates
that given its current income-about $2 billion annually---and average
historical loss levels, it could expect to handle up to about $1.5 billion
in debt and still have a reasonable chance to repay it within a 3- to
5-year time period.

GAO has a body of work underway on the preparation for, response to, and
recovery from Hurricanes Katrina and Rita, including how the NFIP was
implemented. We have had teams in the Gulf Coast states since the weeks
immediately following the hurricanes collecting data and observations from
hurricane victims and federal, state, local, and private participants in
the preparation for, response to, and recovery from the extensive damages.
I have also visited the region and spoken with governors in some of the
affected states, military and civilian officials leading the recovery
efforts, and others to help inform our work. One objective of the work we
have underway on the NFIP is to assess what changes, if any, could be made
to strengthen the NFIP's fiscal solvency. To this end, we will review
proposals to increase revenues, reduce costs, or otherwise make the NFIP
more actuarially sound. We expect to report on this matter later this
year.

As GAO moves forward with this work, we will continue to coordinate with
this and other congressional committees and the accountability
community-federal inspector generals, state and city auditors-regarding
the scope of our future work on emergency management issues, including the
NFIP. Our goal is to apply our resources and expertise to address
long-term concerns, such as those we are discussing today, and to avoid
duplicating the work of others.

Past experience can provide context for considering future policy options.
In this spirit, my testimony today is based on a body of work that GAO has
done over the past several years before the nation began the struggle to
respond to the devastating effects of Hurricanes Katrina and Rita in our
Gulf Coast states, as well as some preliminary results of interviews and
review of documentation for work in progress on how the NFIP was
implemented for these storms. Our prior work has addressed the issues of
the program's structure and financing, oversight and management,
repetitive loss properties, mandatory and voluntary purchase of flood
insurance, and revising and improving the nation's flood maps. Together
the prior work and work in process provide information useful in assessing
efforts over the NFIP's history to enhance the program's financial
stability and effectiveness. Most recently, we issued a report in October
2005 on FEMA's management and oversight of the flood insurance program
that includes several recommendations for improvement.5 This report was
mandated by the Flood Insurance Reform Act of 2004.6 It includes
recommendations on two pre-Hurricane Katrina flood-insurance related
issues that pose a challenge for FEMA. These are (1) improving FEMA's
management and oversight of the NFIP and (2) improving FEMA's
implementation of provisions of the Flood Insurance Reform Act of 2004 to
provide policyholders a flood insurance claims handbook that meets
statutory requirements, to establish a regulatory appeals process, and to
ensure that flood insurance agents meet minimum NFIP education and
training requirements.

4National Flood Insurance Program Further Enhanced Borrowing Authority Act
of 2005, Pub. L. No. 109-106, 119 Stat. 2288 (2005).

That report was based on interviews with FEMA officials, documentation of
its monitoring and oversight processes, and our field observations of
FEMA's monitoring and oversight activities. In addition, we analyzed the
National Flood Insurance Act of 1968, as amended, its legislative history,
and FEMA's implementing regulations, and we examined documentation and
interviewed officials about FEMA's efforts to comply with provisions of
the 2004 Flood Insurance Reform Act. We did our work from December 2004 to
August 2005 in accordance with generally accepted government auditing
standards.

5GAO, Federal Emergency Management Agency: Improvements Needed to Enhance
Oversight and Management of the National Flood Insurance Program,
GAO-06-119 (Washington, D.C.: Oct. 18, 2005).

6Bunning-Bereuter-Blumenauer Flood Insurance Reform Act of 2004, Pub. L.
No. 108-264, 118 Stat. 712, 727 (2004).

                        Major Program Issues -a Summary

A key characteristic of the NFIP is the extent to which FEMA must rely on
others to achieve the program's goals. FEMA's role for the NFIP is
principally one of establishing policies and standards that others
generally implement on a day-to-day basis and providing financial and
management oversight of those who carry out those day-to-day
responsibilities. These responsibilities include ensuring that property
owners who are required to purchase flood insurance do so, enforcing flood
plain management and building regulations, selling and servicing flood
insurance policies, and updating and maintaining the nation's flood maps.
In our prior work, we have identified several major challenges facing the
NFIP:

           o  Reducing losses to the program resulting from policy subsidies
           and repetitive loss properties.7 The program is not actuarially
           sound because of the number of policies in force that are
           subsidized-about 29 percent at the time of our 2003 report. As a
           result of these subsidies, some policyholders with dwellings that
           were built before flood plain management regulations were
           established in their communities pay premiums that represent about
           35 to 40 percent of the true risk premium. In January 2006, FEMA
           estimated a shortfall in annual premium income because of policy
           subsidies at $750 million. Moreover, at the time of our 2004
           report, there were about 49,000 repetitive loss properties-those
           with two or more losses of $1,000 or more in a 10-year
           period-representing about 1 percent of the 4.4 million buildings
           insured under the program. From 1978 until March 2004, these
           repetitive loss properties represented about $4.6 billion in
           claims payments.

           o  Increasing property owner participation in the program. The
           extent of noncompliance with current mandatory purchase
           requirements by affected property owners is unknown. Some interest
           has been expressed in Congress in assessing the feasibility of
           expanding mandatory purchase requirements beyond current special
           high-risk flood hazard areas. FEMA and its private insurance
           partners also have efforts underway to increase participation in
           the NFIP by marketing flood insurance policies in areas where
           purchase is not mandatory.

           o  Developing accurate, digital flood maps.8 The impact of
           Hurricanes Katrina, Rita, and Wilma on homeowners has highlighted
           the importance of having accurate, up-to-date flood maps that
           identify the areas at risk of flooding and, thus, the areas in
           which homeowners would benefit from purchasing flood insurance. In
           our report on the NFIP's flood map modernization program, we
           discussed the multiple uses and benefits of accurate, digital
           flood plain maps. However, the NFIP faces a major challenge in
           working with its contractor and state and local partners of
           varying technical capabilities and resources to produce accurate,
           digital flood maps. In developing those maps, we recommended that
           FEMA develop and implement data standards that will enable FEMA,
           its contractor, and its state and local partners to identify and
           use consistent data collection and analysis methods for developing
           maps for communities with similar flood risk.

           o  Providing effective oversight of flood insurance operations. In
           our October 2005 report, we said that FEMA faces a challenge in
           providing effective oversight of the 95 insurance companies and
           thousands of insurance agents and claims adjusters who are
           primarily responsible for the day-to-day process of selling and
           servicing flood insurance policies.

7GAO, Flood Insurance: Challenges Facing the National Flood Insurance
Program, ( GAO-03-606T (Washington, D.C.: Apr. 1, 2003); National Flood
Insurance Program: Actions to Address Repetitive Loss Properties, (
GAO-04-401T (Washington, D.C.: Mar. 25, 2004).

The NFIP Pays Expenses and Claims with Premiums to the Extent Possible, but Its
          Financial Structure Is Not Designed to Be Actuarially Sound

To the extent possible, the NFIP is designed to pay operating expenses and
flood insurance claims with premiums collected on flood insurance policies
rather than with tax dollars. However, as we have reported, the program,
by design, is not actuarially sound because Congress authorized subsidized
insurance rates to be made available for policies covering some properties
to encourage communities to join the program. As a result, the program
does not collect sufficient premium income to build reserves to meet the
long-term future expected flood losses.9 FEMA has statutory authority to
borrow funds from the Treasury to keep the NFIP solvent.10

Until the 2004 hurricane season, FEMA had been generally successful in
keeping the NFIP on sound financial footing, exercising its borrowing
authority three times in the last decade when losses exceeded available
fund balances. In each instance, FEMA repaid the funds with interest.
According to FEMA officials, as of August 31, 2005, FEMA had outstanding
borrowing of $225 million with cash on hand totaling $289 million. FEMA
had substantially repaid the borrowing it had undertaken to pay losses
incurred for the 2004 hurricane season that, until Hurricane Katrina
struck, was the worst hurricane season on record for the NFIP. FEMA's
current debt with the Treasury is almost entirely for payment of claims
from Hurricanes Katrina and Rita and other flood events that occurred in
2005.

8GAO, Flood Map Modernization: Program Strategy Shows Promise, but
Challenges Remain, GAO-04-417 (Washington, D.C.: Mar. 31, 2004).

9GAO, Flood Insurance: Information on the Financial Condition of the
National Flood Insurance Program, GAO-01-992T (Washington, D.C.: July
2001).

10See 42 U.S.C. 4016.

Premium Subsidies and Repetitive-Loss Properties Affect NFIP's Actuarial
Soundness

As the destruction caused by horrendous 2004 and 2005 hurricanes are a
driving force for improving the NFIP today, devastating natural disasters
in the 1960s were a primary reason for the national interest in creating a
federal flood insurance program. In 1963 and 1964, Hurricane Betsy and
other hurricanes caused extensive damage in the South, and, in 1965, heavy
flooding occurred on the upper Mississippi River. In studying insurance
alternatives to disaster assistance for people suffering property losses
in floods, a flood insurance feasibility study found that premium rates in
certain flood-prone areas could be extremely high. As a result, the
National Flood Insurance Act of 1968, which created the NFIP, mandated
that existing buildings in flood-risk areas would receive subsidies on
premiums because these structures were built before the flood risk was
known and identified on flood insurance rate maps.11 Owners of structures
built in flood-prone areas on or after the effective date of the first
flood insurance rate maps in their areas or after December 31, 1974, would
have to pay full actuarial rates.12 Because many repetitive loss
properties were built before either December 31, 1974, or the effective
date of the first flood insurance rate maps in their areas, they were
eligible for subsidized premium rates under provisions of the National
Flood Insurance Act of 1968.

The provision of subsidized premiums encouraged communities to participate
in the NFIP by adopting and agreeing to enforce state and community
floodplain management regulations to reduce future flood damage. In April
2005, FEMA estimated that floodplain management regulations enforced by
communities participating in the NFIP have prevented over $1.1 billion
annually in flood damage.

1142 U.S.C. 4014(a)(2), 4015(a), (b).

1242 U.S.C. 4014(a)(1), 4015(c).

However, the policy subsidies reduce premium income and add risk to the
NFIP. In January 2006, FEMA estimated an annual shortfall in premium
income of $750 million because of policy subsidies. FEMA estimated that
phasing out subsidized rates for non-primary residences and nonresidential
properties alone would affect about 400,000 properties currently insured
by the NFIP. Some have questioned whether providing flood insurance for
second homes in high risk areas-such as barrier islands-encourages
development in areas at high risk of flooding.

In addition, some of the properties that had received the initial rate
subsidy are subject to repetitive flood losses, placing added financial
strain on the NFIP. In reauthorizing the NFIP in 2004, Congress noted that
"repetitive-loss properties"-those that had resulted in two or more flood
insurance claims payments of $1,000 or more over 10 years-constituted a
significant drain on the resources of the NFIP. 13 These repetitive loss
properties are problematic not only because of their vulnerability to
flooding but also because of the costs of repeatedly repairing flood
damages. While these properties make up only about 1 percent of the
properties insured under the NFIP, they account for 25 to 30 percent of
all claims losses. At the time of our March 2004 report on repetitive loss
properties, there were about 49,000 repetitive loss properties,
representing about $4.6 billion in claims payments from 1978 until March
2004. As of March 2004, nearly half of all nationwide repetitive loss
property insurance payments had been made in Louisiana, Texas, and
Florida. According to a recent Congressional Research Service report, as
of December 31, 2004, FEMA had identified 11,706 "severe repetitive loss"
properties, defined as those with four or more claims or two or three
losses that exceeded the insured value of the property.14 Of these 11,706
properties almost half (49 percent) were in three states-3,208 (27
percent) in Louisiana, 1,573 (13 percent) in Texas, and 1,034 (9 percent)
in New Jersey. A significant number of repetitive loss properties were
affected by Hurricanes Katrina and Rita. According to NFIP statistical
data through November 30, 2005, 4,835 repetitive loss properties,
including 3,183 in Louisiana, had substantial damage from Hurricane
Katrina.15 Two hundred and forty-three repetitive loss properties had
substantial damage from Hurricane Rita. Of these properties, 213 were
located in Louisiana and 30 were located in Texas.

13Flood Insurance Reform Act of 2004, Pub. L. No. 108-264, section
2(3),(4), (5), 118 Stat. 712, 713 (2004).

14Congressional Research Service, Federal Flood Insurance: The Repetitive
Loss Problem, RL32972 (Washington, D.C.: June 30, 2005).

15The term "substantial damage" means the cost of repairing the damaged
building exceeds 50 percent of its market value (or a lower trigger if
adopted locally).

For over a decade, FEMA has pursued a variety of strategies to reduce the
number of repetitive loss properties in the NFIP inventory. In a 2004
testimony, we noted that congressional proposals have been made to phase
out coverage or begin charging full and actuarially based rates for
repetitive loss property owners who refuse to accept FEMA's offer to
purchase or mitigate the effect of floods on these buildings.16 The 2004
Flood Insurance Reform Act created a 5-year pilot program to deal with
repetitive-loss properties in the NFIP. In particular, the act authorized
FEMA to provide financial assistance to participating states and
communities to carry out mitigation activities or to purchase "severe
repetitive loss properties."17 During the pilot program, policyholders who
refuse a mitigation or purchase offer that meets program requirements will
be required to pay increased premium rates. Specifically, the premium
rates for these policyholders would increase by 150 percent following
their refusal and another 150% following future claims of more than
$1,500.18 However, the rates charged cannot exceed the applicable
actuarial rate.

Because of the financial drain that repetitive loss properties have posed
for the program, it will be important in future studies of the NFIP to
continue to analyze data on progress being made to reduce the inventory of
subsidized NFIP properties, particularly those with repetitive losses; how
the reduction of this inventory contributes to the financial stability of
the program; and whether additional FEMA regulatory steps or congressional
actions could contribute to the financial solvency of the NFIP, while
meeting commitments made by the authorizing legislation.

16GAO, National Flood Insurance Program: Actions to Address Repetitive
Loss Properties, GAO-04-401T (Washington, D.C.: Mar. 25, 2004).

17Flood Insurance Reform Act of 2004, Pub. L. No. 108-264, section 102,
118 Stat. 712, 714-721 (2004). The act defines a "severe repetitive loss
property" to mean single-family properties that have received at least
$20,000 in flood insurance payments based on four or more claims of at
least $5,000 each. The act requires FEMA to define in future regulation
which multi-family properties constitute "severe repetitive loss
properties."

18Id., 118 Stat. 712, 717-718 (2004).

                    Expansion of the NFIP Policyholder Base

Compliance with Mandatory Purchase Requirements Difficult to Determine

In 1973 and 1994, Congress enacted requirements for mandatory purchase of
NFIP policies by some property owners in high-risk areas. From 1968 until
the adoption of the Flood Disaster Protection Act of 1973, the purchase of
flood insurance was voluntary. However, because voluntary participation in
the NFIP was low and many flood victims did not have insurance to repair
damages from floods in the early 1970s, the 1973 act required the
mandatory purchase of flood insurance to cover some structures in special
flood hazard areas of communities participating in the program. Homeowners
with mortgages held by federally-regulated lenders on property in
communities identified by FEMA to be in special flood hazard areas are
required to purchase flood insurance on their dwellings for the amount of
their outstanding mortgage balance, up to a maximum of $250,000 in
coverage for single family homes. The owners of properties with no
mortgages or properties with mortgages held by lenders who are not
federally regulated were not, and still are not, required to buy flood
insurance, even if the properties are in special flood hazard areas-the
areas NFIP flood maps identify as having the highest risk of flooding.

FEMA determines flood risk and actuarial ratings on properties through
flood insurance rate mapping and other considerations, including the
elevation of the lowest floor of the building, the type of building, the
number of floors, and whether or not the building has a basement, among
other factors. FEMA flood maps designate areas for risk of flooding by
zones. For example, areas subject to damage by waves and storm surge are
in the zone with the highest expectation for flood loss.

Between 1973 and 1994, many policyholders continued to find it easy to
drop policies, even if the policies were required by lenders. Federal
agency lenders and regulators did not appear to strongly enforce the
mandatory flood insurance purchase requirements.19 According to a recent
Congressional Research Service study,20 the Midwest flood of 1993
highlighted this problem and reinforced the idea that reforms were needed
to compel lender compliance with the requirements of the 1973 Act. In
response, Congress passed the National Flood Insurance Reform Act of 1994.
Under the 1994 law, if the property owner failed to get the required
coverage, federally-regulated lenders were required to purchase flood
insurance on their behalf and then bill the property owners. Lenders
became subject to civil monetary penalties for not enforcing the mandatory
purchase requirement.

19The federal entities for lending regulation are the Board of Governors
of the Federal Reserve System, the Office of the Comptroller of the
Currency, the Office of Thrift Supervision, the Federal Deposit Insurance
Corporation, the National Credit Union Administration, and the Farm Credit
Administration.

In June 2002, we reported that the extent to which lenders were enforcing
the mandatory purchase requirement was unknown. Officials involved with
the flood insurance program developed contrasting viewpoints about whether
lenders were complying with the flood insurance purchase requirements
primarily because the officials used differing types of data to reach
their conclusions. Federal bank regulators and lenders based their belief
that lenders were generally complying with the NFIP's purchase
requirements on regulators' examinations and reviews conducted to monitor
and verify lender compliance. In contrast, FEMA officials believed that
many lenders frequently were not complying with the requirements, which
was an opinion based largely on noncompliance estimates computed from data
on mortgages, flood zones, and insurance policies; limited studies on
compliance; and anecdotal evidence indicating that insurance was not
always in place where required. Neither side, however, was able to
substantiate its differing claims with statistically sound data that
provide a nationwide perspective on lender compliance. 21

Expansion of Mandatory Purchase Requirements Would Generate More Premiums, but
Implementation Could Be Problematic

Under FEMA's current Mandatory Purchase of Flood Insurance Guidelines,
properties in a 100-year flood plain with a statistical 1 in 100 chance of
flooding in any given year or a 30 percent chance of flooding during the
period of a 30-year mortgage are designated to be in special flood hazard
areas. Within the boundaries of these areas, homeowners with mortgages
from federal regulated lenders are required to purchase flood insurance
for an amount equal to their outstanding mortgage balance, up to the
maximum policy limit of $250,000 for a single-family home. To expand the
NFIP policyholder base, there has been some congressional interest in the
feasibility of extending the current mandatory purchase requirement to
properties in a 500-year flood plain, which statistically have a 1 in 500
chance of flooding in any given year.22 FEMA has estimated that expanding
NFIP mandatory purchase requirements to include structures in the 500-year
flood plain would generate up to $700 million in additional premiums. The
current annual premium for a structure in the 500-year flood plain is
about $280. However, a FEMA official cautioned that the rate of compliance
is an important component of any estimate of the amount of increase in
NFIP premiums that would result from expanding mandatory purchase
requirements.

20Congressional Research Service, Federal Flood Insurance: The Repetitive
Loss Problem (June 30, 2005).

21GAO, Flood Insurance: Extent of Noncompliance with Purchase Requirements
Is Unknown, GAO-02-396 (Washington, D.C: June 21, 2002).

It would be difficult to effectively assess the impacts, effectiveness,
and feasibility of such a change in the structure of the NFIP. We share
FEMA's concerns related to enforcing and assessing compliance. We also
believe that it would be difficult to assess the impacts an expansion in
the mandatory purchase requirements would have upon a range of
stakeholders, including not only home and business owners, but lenders,
mortgage servicers, builders, and local governments, among others.

We also recognize that it would be difficult and costly to determine the
additional geographic area that would be encompassed in an expanded
special flood hazard area. Current flood mapping focuses on the boundaries
of the 100-year flood plain, and FEMA has not estimated the additional
cost and time required to complete detailed, digitalized maps of areas
outside of the current 100-year special flood hazard area.

FEMA Has a Marketing Campaign to Attract New Policyholders and Improve Rates of
Renewal

In recent years, the number of NFIP policyholders did not grow
substantially. FEMA officials reported a pattern in which at the start of
each hurricane season, the number of polices in force was the same or less
than the number of policies in previous years. During the hurricane
season, the number of polices in force would increase slightly and then
level off or decline again at the end of the season.

FEMA has efforts underway to increase NFIP participation by improving the
quality of information that is available on the NFIP and flood risks and
by marketing to retain policyholders currently in the program. In October
2003, FEMA let a contract for a new integrated marketing campaign called
"FloodSmart." Marketing elements being used include direct mail, national
television commercials, print advertising, and websites designed for
consumers and insurance agents. According to FEMA officials, in a little
more than 2 years since the contract began, net policy growth was a little
more than 7 percent and policy retention improved from 88 percent to 91
percent.

22National Flood Insurance Program Commitment to Policyholders and Reform
Act of 2005, H.R. 4320, 109th Conress, section 3 (2005).

          Accurate, Updated Flood Maps Are the Foundation of the NFIP

Accurate flood maps that identify the areas at greatest risk of flooding
are the foundation of the NFIP. Flood maps must be periodically updated to
assess and map changes in the boundaries of floodplains that result from
community growth, development, erosion, and other factors that affect the
boundaries of areas at risk of flooding. FEMA has embarked on a multi-year
effort to update the nation's flood maps at a cost in excess of $1
billion. The maps are principally used by (1) the approximately 20,000
communities participating in the NFIP to adopt and enforce the program's
minimum building standards for new construction within the maps'
identified flood plains; (2) FEMA to develop accurate flood insurance
policy rates based on flood risk; and (3) federal regulated mortgage
lenders to identify those property owners who are statutorily required to
purchase federal flood insurance.

FEMA expects that by producing more accurate and accessible digital flood
maps, the NFIP and the nation will benefit in three ways. First,
communities can use more accurate digital maps to reduce flood risk within
floodplains by more effectively regulating development through zoning and
building standards. Second, accurate digital maps available on the
Internet will facilitate the identification of property owners who are
statutorily required to obtain or who would be best served by obtaining
flood insurance. Third, accurate and precise data will help national,
state, and local officials to accurately locate infrastructure and
transportation systems (e.g., power plants, sewage plants, railroads,
bridges, and ports) to help mitigate and manage risk for multiple hazards,
both natural and man-made.

Success in updating the nation's flood maps requires clear standards for
map development; the coordinated efforts and shared resources of federal,
state, and local governments; and the involvement of key stakeholders who
will be expected to use the maps. In developing the new data system to
update flood maps across the nation, FEMA's intent is to develop and
incorporate flood risk data that are of a level of specificity and
accuracy commensurate with communities' relative flood risks. Not every
community may need the same level of specificity and detail in its new
flood maps. However, it is important that FEMA establish standards for the
appropriate data and level of analysis required to develop maps for all
communities of a similar risk level. In its November 2004 Multi-Year Flood
Hazard Identification Plan, FEMA discussed the varying types of data
collection and analysis techniques the agency plans to use to develop
flood hazard data in order to relate the level of study and level of risk
for each of 3,146 counties.

FEMA has developed targets for resource contributions (in-kind as well as
dollars) by its state and local partners in updating the nation's flood
maps. At the same time, it has developed plans for reaching out to and
including the input of communities and key stakeholders in the development
of the new maps. These expanded outreach efforts reflect FEMA's
understanding that it is dependent upon others to achieve the benefits of
map modernization.

As I have discussed, it is important when considering any expansion of
mandatory purchase requirements for NFIP policies to understand that
implementation would require the development of additional detailed flood
maps. According to a FEMA official, digital mapping of areas outside of
special flood hazard areas is currently being considered on only a
selective basis for reasons such as potential changes in risk level or
population growth.

  Monitoring and Oversight of NFIP Identifies Specific Problems, but Does Not
        Provide Comprehensive Information on Overall Program Performance

To meet its monitoring and oversight responsibilities, FEMA is to conduct
periodic operational reviews of the 95 private insurance companies that
participate in the NFIP. In addition, FEMA's program contractor is to
check the accuracy of claims settlements by doing quality assurance
reinspections of a sample of claims adjustments for every flood event. For
operational reviews, FEMA examiners are to do a thorough review of the
companies' NFIP underwriting and claims settlement processes and internal
controls, including checking a sample of claims and underwriting files to
determine, for example, whether a violation of policy has occurred, an
incorrect payment has been made, and if files contain all required
documentation. Separately, FEMA's program contractor is responsible for
conducting quality assurance reinspections of a sample of claims
adjustments for specific flood events in order to identify, for example,
whether an insurer allowed an uncovered expense or missed a covered
expense in the original adjustment.

According to FEMA, these monitoring and oversight mechanisms will be in
place to assess the implementation of the NFIP after Hurricanes Katrina
and Rita. In addition, FEMA plans to do additional oversight of claims for
these storms that were handled using expedited procedures. To try to
assist NFIP policyholders despite obstacles in communicating with
claimants, reaching flooded properties, and locating records, FEMA allowed
expedited claims processing procedures that were unique to these storms.
In some circumstances, claims were settled without site visits by
certified flood claims adjusters. For flooding caused by the failure of
the levees in the New Orleans area, resulting in flooding from Lake
Pontchartrain, FEMA allowed the use of flood depth data to identify
structures that had been severely affected. If data on the depth and
duration of the water in the building showed that it was likely that
covered damage exceeded policy limits, claims could be settled without a
site visit by a claims adjuster. Similarly, losses in other areas of
Louisiana and Mississippi were handled without a site visit where
structures were washed off their foundations by flood waters and
square-foot measurements of the dwellings were known.

The operational reviews and follow-up visits to insurance companies that
we analyzed during 2005 followed FEMA's internal control procedures for
identifying and resolving specific problems that may occur in individual
insurance companies' processes for selling and renewing NFIP policies and
adjusting claims. According to information provided by FEMA, the number of
operational reviews completed between 2000 and August 2005 were done at a
pace that allows for a review of each participating insurance company at
least once every 3 years, as FEMA procedures require. In addition, the
processes FEMA had in place for operational reviews and quality assurance
reinspections of claims adjustments met our internal control standard for
monitoring federal programs.

However, the process FEMA used to select a sample of claims files for
operational reviews and the process its program contractor used to select
a sample of adjustments for reinspections were not randomly chosen or
statistically representative of all claims. We found that the selection
processes used were, instead, based upon judgmental criteria including,
among other items, the size and location of loss and complexity of claims.
As a result of limitations in the sampling processes, FEMA cannot project
the results of these monitoring and oversight activities to determine the
overall accuracy of claims settled for specific flood events or assess the
overall performance of insurance companies and their adjusters in
fulfilling their responsibilities for the NFIP-actions necessary for FEMA
to meet our internal control standard that it have reasonable assurance
that program objectives are being achieved and that its operations are
effective and efficient.

To strengthen and improve FEMA's monitoring and oversight of the NFIP, we
recommended that FEMA use a methodologically valid approach for sampling
files selected for operational reviews and quality assurance claims
reinspections. We also plan to follow up on the results of the monitoring
and oversight efforts for claims processed using expedited processes in
our review of the implementation of the NFIP after Hurricanes Katrina and
Rita.

FEMA did not agree with our recommendation. It noted that its current
sampling methodology of selecting a sample based on knowledge of the
population to be sampled was more appropriate for identifying problems
than the statistically random probability sample we recommended. Although
FEMA's current nonprobability sampling strategy may provide an opportunity
to focus on particular areas of risk, it does not provide management with
the information needed to assess the overall performance of private
insurance companies and adjusters participating in the program-information
that FEMA needs to have reasonable assurance that program objectives are
being achieved.

FEMA Has Not Fully Implemented NFIP Program Changes Mandated by the Flood
                          Insurance Reform Act of 2004

As of January 2006, FEMA had not yet fully implemented provisions of the
Flood Insurance Reform Act of 2004. Among other things, the act requires
FEMA to provide policyholders a flood insurance claims handbook; to
establish a regulatory appeals process for claimants; and to establish
minimum education and training requirements for insurance agents who sell
NFIP policies.23 The 6-month statutory deadline for implementing these
changes was December 30, 2004.

In September 2005, FEMA posted a flood insurance claims handbook on its
Web site. The handbook contains information on anticipating, filing and
appealing a claim through an informal appeals process, which FEMA intends
to use pending the establishment of a regulatory appeals process. However,
because the handbook does not contain information regarding the appeals
process that FEMA is statutorily required to establish through regulation,
it does not yet meet statutory requirements.

With respect to this appeals process, FEMA has not stated how long
rulemaking might take to establish the process by regulation, or how the
process might work, such as filing requirements, time frames for
considering appeals, and the composition of an appeals board. In January
2006, the acting director of FEMA's Mitigation Division said that FEMA had
submitted a draft rule to DHS. However, milestones for future actions were
not established. Claimants who wish to appeal decisions made on their
claims for damage from Hurricanes Katrina and Rita can follow a process
described by FEMA as an "informal" appeals process. As outlined in the
Flood Insurance Claims Handbook, to appeal, policyholders are to submit
statements of their concerns and supporting documentation to the director
of claims in FEMA's Mitigation Division, Risk Insurance Branch.

23 Flood Insurance Reform Act of 2004, Pub. L. No. 108-264, sections 204,
205, and 207.

With respect to minimum training and education requirements for insurance
agents who sell NFIP policies, FEMA published a Federal Register notice on
September 1, 2005, which included an outline of training course materials.
In the notice, FEMA stated that, rather than establish separate and
perhaps duplicative requirements from those that may already be in place
in the states, it had chosen to work with the states to implement the NFIP
requirements through already established state licensing schemes for
insurance agents. The notice did not specify how or when states were to
begin implementing the NFIP training and education requirements. Thus, it
is too early to tell the extent to which insurance agents will meet FEMA's
minimum standards. FEMA officials said that, because changes to the
program could have broad reaching and significant effects on policyholders
and private-sector stakeholders upon whom FEMA relies to implement the
program, the agency is taking a measured approach to addressing the
changes mandated by Congress. Nonetheless, without plans with milestones
for completing its efforts to address the provisions of the act, FEMA
cannot hold responsible officials accountable or ensure that statutorily
required improvements are in place to assist victims of future flood
events.

We recommended that FEMA develop documented plans with milestones for
implementing requirements of the Flood Insurance Reform Act of 2004 to
provide policyholders a flood insurance claims handbook that meets
statutory requirements, to establish a regulatory appeals process, and to
ensure that flood insurance agents meet minimum NFIP education and
training requirements. We will continue to monitor progress being made.

FEMA disagreed with our recommendation and characterization of the extent
to which FEMA has met provisions of the Flood Insurance Reform Act of
2004. We believe that our description of those efforts and our
recommendations with regard to implementing the act's provisions are
valid. For example, although FEMA commented that it was offering claimants
an informal appeals process in its flood insurance claims handbook, it
must establish regulations for this process, and those are not yet
complete.

                            Concluding Observations

The most immediate challenge for the NFIP is processing the flood
insurance claims resulting from Hurricanes Katrina and Rita. Progress is
being made in that area. In December 2005, according to FEMA, more than 70
percent of Hurricane Katrina claims had been paid, totaling more than $11
billion, some of them using expedited procedures to assist policyholders
who were displaced from their homes.

In the longer term, Congress and the NFIP face a complex challenge in
assessing potential changes to the program that would improve its
financial stability, increase participation in the program by property
owners in areas at risk of flooding, reduce the number of repetitive loss
properties in the program, and maintain current and accurate flood plain
maps. These issues are complex, interrelated, and are likely to involve
trade-offs. For example, increasing premiums to better reflect risk may
reduce voluntary participation in the program or encourage those who are
required to purchase flood insurance to limit their coverage to the
minimum required amount (i.e., the amount of their outstanding mortgage
balance). This in turn can increase taxpayer exposure for disaster
assistance resulting from flooding. There is no "silver bullet" for
improving the current structure and operations of the NFIP. It will
require sound data and analysis and the cooperation and participation of
many stakeholders.

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

                     GAO Contact and Staff Acknowledgments

Contact point for our Office of Congressional Relations and Public Affairs
may be found on the last page of this statement. For further information
about this testimony, please contact Norman Rabkin at (202) 512-8777 or
[email protected] , or William O. Jenkins Jr. at (202) 512-8757 or
[email protected] . This statement was prepared under the direction of
Christopher Keisling. Key contributors were John Bagnulo, Christine Davis,
and Deborah Knorr.

(440477)

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Highlights of GAO-06-335T , a testimony to the Chairman, Committee on
Banking, Housing and Urban Affairs, U.S. Senate

January 25, 2006

FEDERAL EMERGENCY MANAGEMENT AGENCY

Challenges for the National Flood Insurance Program

The National Flood Insurance Program (NFIP), established in 1968, provides
property owners with some insurance coverage for flood damage. The Federal
Emergency Management Agency (FEMA) within the Department of Homeland
Security is responsible for managing the NFIP.

The unprecedented magnitude and severity of the flood losses from
hurricanes in 2005 challenged the NFIP to process a record number of
claims. These storms also illustrated the extent to which the federal
government has exposure for claims coverage in catastrophic loss years.
FEMA estimates that Hurricanes Katrina, Rita, and Wilma will generate
claims and payments of about $23 billion-far surpassing the total claims
paid in the entire history of the NFIP.

This testimony provides information from past and ongoing GAO work on
issues including: (1) NFIP's financial structure; (2) the impact of
properties with repetitive flood losses on NFIP's resources; (3) proposals
to increase the number of policies in force; and (4) the status of past
GAO recommendations.

What GAO Recommends

In past work, GAO recommended that FEMA strengthen its oversight of the
NFIP and develop plans to implement requirements of the Flood Insurance
Reform Act of 2004. FEMA disagreed with those recommendations.

The NFIP, by design, is not actuarially sound. The program does not
collect sufficient premium income to build reserves to meet long-term
future expected flood losses. In November 2005, FEMA's authority to borrow
from the Treasury was increased from $1.5 billion to $18.5 billion through
fiscal year 2008 to help pay claims from the 2005 hurricane season. It is
highly unlikely that the NFIP as presently funded could generate
sufficient revenues to repay a debt of this size.

One reason the NFIP is not actuarially sound is because a number of its
policies on dwellings that were built before flood plain management
regulations were established in their communities are subsidized and pay
premiums of 35-40 percent of the true risk premium. In January 2006, FEMA
estimated an annual shortfall in premium income of $750 million because of
such policy subsidies. Some subsidized properties, called repetitive loss
properties, also suffer repetitive flood losses, which accounted for about
$4.6 billion in claims payments from 1978 to March 2004. We need to
analyze the progress made to reduce the inventory of subsidized
repetitive-loss properties and determine whether additional regulatory or
congressional action is needed.

A challenge for FEMA is to expand the NFIP policyholder base by enforcing
mandatory purchase requirements and encouraging voluntary purchase by
homeowners who live in areas at lower risk of flooding. The extent of
noncompliance with current mandatory purchase requirements for property
owners in special flood hazard areas is unknown. There has been some
congressional interest in the feasibility of expanding mandatory purchase
requirements beyond the current special high-risk areas, however, there
are a number of difficulties to assessing the impacts, effectiveness, and
feasibility of such a change in the structure of the NFIP, as well as
concerns related to enforcing and assessing compliance. For example, more
precise flood mapping of areas outside the current high-risk areas would
be required to accurately identify affected property owners. FEMA and its
private insurance partners also have efforts underway to increase NFIP
participation by marketing policies in areas where purchase is not
mandatory.

FEMA has not yet fully implemented provisions of the Flood Insurance
Reform Act of 2004 requiring the agency to develop new materials to
explain coverage and the claims process to policyholders, establish an
appeals process for claimants, and provide insurance agent education and
training requirements. The statutory deadline for implementing these
changes was December 30, 2004, and, as of January 2006, FEMA had not
developed documented plans with milestones for meeting the provisions of
the act, as recommended by GAO.
*** End of document. ***