National Flood Insurance Program: FEMA's Management and Oversight
of Payments for Insurance Company Services Should Be Improved	 
(05-SEP-07, GAO-07-1078).					 
                                                                 
Extraordinary recent flood events raise serious questions about  
the solvency of the National Flood Insurance Program (NFIP),	 
which is administered by the Federal Emergency Management Agency 
(FEMA). The NFIP is largely implemented by private insurance	 
companies that sell and service policies and adjust claims under 
the Write Your Own (WYO) Program. This report, prepared under the
authority of the Comptroller General, examines (1) how much FEMA 
paid the WYO companies in recent years for operating costs and	 
how FEMA determined payment amounts; (2) how FEMA's approach to  
determining operating costs assures that payments are reasonable 
estimates of companies' expenses; and (3) how FEMA assures that  
financial and management controls are in place for the WYO	 
program and operate as intended. To do these assessments, GAO	 
interviewed FEMA and insurance officials, and analyzed statutes, 
regulations, payment data, methodologies, and audits of WYO	 
companies.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-1078					        
    ACCNO:   A75672						        
  TITLE:     National Flood Insurance Program: FEMA's Management and  
Oversight of Payments for Insurance Company Services Should Be	 
Improved							 
     DATE:   09/05/2007 
  SUBJECT:   Claims processing					 
	     Claims processing costs				 
	     Claims settlement					 
	     Expense claims					 
	     Financial statement audits 			 
	     Flood insurance					 
	     Hurricane Katrina					 
	     Insurance claims					 
	     Insurance companies				 
	     Insurance premiums 				 
	     Internal controls					 
	     Operating expenses 				 
	     Policies and procedures				 
	     Program costs					 
	     Program goals or objectives			 
	     Program implementation				 
	     FEMA National Flood Insurance Program		 
	     FEMA Write Your Own Program			 

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GAO-07-1078

   

     * [1]Results in Brief
     * [2]Background

          * [3]Overview of the National Flood Insurance Program
          * [4]History and Goals of the WYO Program
          * [5]Roles of WYO Companies and Other Key Participants in the NFI

     * [6]Payments to WYO Insurance Companies Comprised Up to Almost T

          * [7]Overall Payments to WYO Insurance Companies
          * [8]Selling and Servicing NFIP Policies

               * [9]Selling and Servicing Policies: Agent Commissions
               * [10]Selling and Servicing Policies: Operating Expenses
               * [11]Selling and Servicing Policies: Bonuses
               * [12]While FEMA Officials Consider WYO Payments for Selling
                 and S

          * [13]After Flood Losses, FEMA Pays WYO Insurance Companies for Ad

               * [14]Claims Adjustment Fees
               * [15]Expense Payment for Claims Processing Activities
               * [16]Views Mixed on the Sufficiency of Payments for
                 Post-Flood Ac

     * [17]FEMA's Long-standing Approach for Establishing a Schedule of

          * [18]FEMA's Methodologies Cannot Ensure That the Schedule of Oper
          * [19]FEMA Has Legal Authority to Collect Data on Actual WYO Expen
          * [20]Other Federal Programs Collect Actual Cost Data to Help Dete

     * [21]Financial Management Controls Did Not Provide Assurance That

          * [22]FEMA Regulations and Guidance Require Biennial Financial Aud
          * [23]Most WYO Insurance Companies Did Not Meet the Biennial Finan
          * [24]Biennial Financial Statement Audits Identified One Company w
          * [25]FEMA Did Not Track or Review Financial Statement Audits

     * [26]Conclusions
     * [27]Recommendations for Executive Action
     * [28]Agency Comments and Our Evaluation
     * [29]GAO Contact
     * [30]Acknowledgments
     * [31]National Flood Insurance Program
     * [32]Federal Crop Insurance Corporation
     * [33]GAO's Mission
     * [34]Obtaining Copies of GAO Reports and Testimony

          * [35]Order by Mail or Phone

     * [36]To Report Fraud, Waste, and Abuse in Federal Programs
     * [37]Congressional Relations
     * [38]Public Affairs

Report to Congressional Committees

United States Government Accountability Office

GAO

September 2007

NATIONAL FLOOD INSURANCE PROGRAM

FEMA's Management and Oversight of Payments for Insurance Company Services
Should Be Improved

GAO-07-1078

Contents

Letter 1

Results in Brief 4
Background 8
Payments to WYO Insurance Companies Comprised Up to Almost Two-Thirds of
Total Premium Revenue in Recent Years Based on Payment Methodologies
Established in 1983 16
FEMA's Long-standing Approach for Establishing a Schedule of Operating
Costs Cannot Ensure That WYO Insurance Company Payments Are Based on
Reasonable Estimates of Actual Expenses 26
Financial Management Controls Did Not Provide Assurance That Payments to
WYO Insurance Companies Were Proper and in Accordance with Program
Requirements 34
Conclusions 40
Recommendations for Executive Action 41
Agency Comments and Our Evaluation 41
Appendix I Scope and Methodology 44
Appendix II Percentage Allowances FEMA Authorized WYO Insurance Companies
to Retain for Operating Expenses Incurred in Selling and Servicing NFIP
Policies (Fiscal Years 1984-2007) 46
Appendix III Comments from the Department of Homeland Security 47
Appendix IV GAO Contact and Staff Acknowledgments 51
Related GAO Products 52
National Flood Insurance Program 52
Federal Crop Insurance Corporation 52

Tables

Table 1: Payments to WYO Insurance Companies Received for Services
Rendered to the NFIP (Fiscal Years 2004-2006) 17
Table 2: Methodology for Calculating Payments to WYO Insurance Companies
for Selling and Servicing NFIP Policies and Actual Payments Made, Fiscal
Years 2004-2006 18
Table 3: Incentive Bonus Award Structure and Distribution to WYO
Companies, Fiscal Years 2004-2006 21
Table 4: Methodology for Calculating Payments to WYO Insurance Companies
for Adjusting and Processing Claims after a Flood-Loss Event, and Actual
Payments Made, Fiscal Years 2004-2006 23
Table 5: Excepts from the Adjuster Fee Schedule 24

Figures

Figure 1: NFIP Policies in Force, 1978-April 2007 9
Figure 2: NFIP Payments to Claimants for 2005 Compared to Other Years 11
Figure 3: Key Participants in the NFIP WYO Program 15
Figure 4: Biennial Financial Statement Audits of WYO Insurance Companies
Completed from Fiscal Years 2001 to 2006 37

Abbreviations

CPA certified public accountant
DHS Department of Homeland Security
FCIC Federal Crop Insurance Corporation
FEMA Federal Emergency Management Agency
NAIC National Association of Insurance Commissioners
NFIP National Flood Insurance Program
OIG Office of Inspector General
WYO Write Your Own

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United States Government Accountability Office
Washington, DC 20548

September 5, 2007

Congressional Requesters

The Federal Emergency Management Agency (FEMA), a component of the
Department of Homeland Security (DHS), provides insurance protection
against flood damage to homeowners, businesses, and others, and assumes
the risk for insured flood losses, through the National Flood Insurance
Program (NFIP). The NFIP is largely implemented by private insurance
companies that participate in FEMA's Write Your Own (WYO) program. Through
the WYO program, insurance companies enter into agreements with FEMA to
sell and service flood insurance policies and adjust claims after flood
losses. As of December 2006, 88 insurance companies were participating in
the WYO program.

While the NFIP, by design, is not actuarially sound because Congress
authorized subsidized insurance rates for some policyholders, the program
was largely successful until recent years in paying its expenses with
premium revenues--the funds paid by policyholders for their annual flood
insurance coverage. As a result, since its inception in 1968, in most
years the NFIP paid for flood losses and operating expenses with policy
premium revenues, rather than tax dollars. However, because the program's
premium rates have been set to cover losses in an average year based on
program experience that did not include any catastrophic losses, the
program has been unable to build sufficient reserves to meet future
expected flood losses.1 The series of extraordinary flood events in recent
years--including Hurricane Katrina in August 2005, which inflicted
extensive damage on the Gulf Coast--has raised serious questions about the
financial solvency of the NFIP and highlighted this known program
limitation. Collecting premiums that are based on an average historical
loss year does not enable the NFIP to build sufficient reserves to cover
losses that exceed the historic averages. As of April 2007, FEMA had paid
almost $16 billion in claims for flood damage as a result of Hurricane
Katrina, more than the $14.6 billion it had paid for the cumulative total
of all flood events from 1968 until Hurricane Katrina occurred. After
Katrina, FEMA was unable to cover all of the claims received for flood
losses and had to increase its borrowing authority from the U.S. Treasury
from $1.5 billion to more than $20 billion. In March 2006, we designated
the NFIP as a high-risk program,2 and Congress has been considering a
number of legislative changes to improve the program's financial solvency.

1See GAO, Flood Insurance: Information on the Financial Condition of the
National Flood Insurance Program, [39]GAO-01-992T (Washington, D.C.: July
2001).

Compounding the dramatic increase in the amount paid on flood insurance
claims have been increases in the amounts of money FEMA has been required
to pay for services to WYO insurance companies.3 This report, prepared
under the authority of the Comptroller General in order to contribute to
the discussion about ways to improve the NFIP's financial solvency,
addresses the following questions: (1) In recent years, how much in
operating costs did FEMA pay to the WYO insurance companies that sell and
service NFIP policies and adjust claims and how does FEMA determine the
amount of these operating costs? (2) How does FEMA provide assurance that
the approach it uses to determine operating costs is based on reasonable
estimates of WYO insurance companies' expenses? and (3) How does FEMA
provide assurance that financial and management controls in place for the
WYO program operate as intended and in accordance with program
requirements?

This is one of several reports and testimonies we have completed or have
under way related to the administration and management of the NFIP since
the unprecedented losses from Hurricane Katrina and other major flood
events in 2004 and 2005 illustrated the extent of the federal government's
exposure to losses in catastrophic flood years. Related work we recently
completed addressed issues including the NFIP's financing, oversight and
management, implementation of the program in the aftermath of Hurricanes
Katrina and Rita, the inventory of insured properties that suffer
repetitive flood losses, and the status of efforts to revise and improve
the nation's flood maps. (See the list of related GAO products on page 52
of this report.) In addition, we have reviews under way assessing how
insurance companies manage losses that may be covered by both wind and
flood insurance, the impact of subsidized properties on the NFIP, and
additional aspects of FEMA's financial oversight of WYO insurance
companies.

2See GAO, GAO's High-Risk Program, [40]GAO-06-497T (Washington, D.C.: Mar.
15, 2006). GAO has periodically identified for Congress high-risk areas
that are in need of broad-based transformations to address major economic,
efficiency, or effectiveness challenges.

3WYO insurance companies may retain premium revenues collected or receive
disbursements from the NFIP Fund as payment for services rendered.

To assess how much FEMA paid to WYO insurance companies in recent years
for operating costs and how FEMA determines the amount of these operating
costs, we interviewed FEMA officials, examined documentation such as
FEMA's financial subsidy arrangement with the WYO insurance companies, and
analyzed FEMA data on amounts paid to WYO insurance companies for fiscal
years 2004-2006. We examined internal controls FEMA had in place to ensure
the reliability of the data. We determined that the information was
sufficiently reliable for our purposes by discussing with officials the
internal control processes in place, observing the monthly process used by
FEMA's program contractor to reconcile cost information submitted by WYO
insurance companies, and reviewing audits of DHS financial statements. We
conducted semi-structured interviews with representatives of a judgmental
sample of five WYO insurance companies and the National Association of
Insurance Commissioners (NAIC)4 to obtain their perspectives on FEMA's
payment methodologies. We chose our sample to include representatives of
four of the five largest participating WYO insurance companies in terms of
their market share of NFIP policies in force in 2006 and one mid-sized WYO
insurance company. However, our sample is not a representative sample of
all participating WYO insurance companies, so the views expressed should
not be generalized to the universe of the 88 participating companies.

To determine how FEMA provides assurance that its approach to determining
operating costs for WYO insurance companies results in reasonable
estimates of the companies' expenses, we reviewed the statutory and
regulatory framework for establishing a schedule of operating costs and
federal internal control standards, and we obtained the views of FEMA and
insurance industry officials on the effectiveness of the current payment
approach and the potential implications of implementing other payment
methodologies. We also assessed how the approach FEMA currently uses to
pay WYO insurance companies for their services compares to payment
methodologies used by two similar public-private insurance arrangements.
These are (1) the Federal Crop Insurance Corporation's (FCIC) arrangement
with private insurers for handling expenses associated with insuring
agricultural crop values; and (2) the NFIP's arrangement with its Direct
Servicing Agent, a FEMA contractor that sells and services policies and
adjusts claims on about 4 percent of flood insurance policies that are
not, for various reasons, handled through the WYO program.

4NAIC is the professional association of state insurance regulators.

To determine the extent to which FEMA's financial management controls for
WYO companies provide assurance that payments are proper and in accordance
with program requirements, we documented FEMA's regulations and procedures
for monitoring and overseeing payments of expenses to WYO insurance
companies for selling and servicing NFIP policies. We analyzed the
schedule and results of biennial financial statement audits conducted for
fiscal years 2001 to 2006. We also interviewed officials of FEMA and its
program contractor. In addition, we reviewed financial audits of the NFIP
done by the DHS Office of Inspector General (OIG) for fiscal years 2003 to
2006. We performed our work from June 2006 through July 2007, in
accordance with generally accepted government auditing standards.
Additional details on our scope and methodology are in appendix I.

Results in Brief

FEMA's total payments to WYO insurance companies for operating costs
ranged from $619.2 million to $1.6 billion (in current dollars, not
adjusted for inflation) or from more than a third to almost two-thirds of
the total premiums paid by policyholders to the NFIP for fiscal years 2004
through 2006. In fiscal years 2005 and 2006, payments were larger than for
fiscal year 2004 because the WYO insurance companies received payments in
these years for settling an unprecedented number and dollar amount of
claims for damages resulting from Hurricanes Charley, Ivan, Frances, and
Jeanne in Florida and other East Coast and Gulf Coast states in 2004 and
Hurricanes Katrina, Rita, Wilma, and other flood events in 2005. To
determine the amount of these payments, FEMA negotiated payment approaches
with insurance industry representatives when it established the current
WYO program in 1983 based on industry averages for operating expenses for
other lines of insurance (such as homeowners, commercial, and fire), past
practice, and discussion with WYO insurance company participants and other
insurance industry representatives. While FEMA has periodically adjusted
payment amounts since 1983, the underlying methodologies it uses to
calculate them have not significantly changed. FEMA pays WYO companies for
selling and servicing insurance policies and adjusting and processing
policyholders' claims after a flood event occurs. For selling and
servicing NFIP policies, FEMA pays WYO insurance companies (1) a flat 15
percent of premiums for agent commissions; (2) a percentage for operating
expenses, which historically also averages about 15 percent, based on
industry averages for other lines of insurance; and (3) bonuses of up to 2
percent of their total annual premium revenues for increasing the number
of NFIP policies they sell. After flood losses, FEMA pays WYO insurance
companies for adjusting and processing policyholders' claims according to
(1) an adjustment fee schedule used by the insurance industry for other
types of insurance claims and (2) an allowance of 3.3 percent of each
claim settlement amount to pay for their processing expenses. The WYO
insurance companies collect their operating costs from FEMA based on these
methodologies. Any portion of the premium revenues retained by the WYO
insurance companies that are not used to cover expenses may be retained as
profit.

The approach FEMA uses to determine operating costs for WYO insurance
companies, rooted in policies negotiated and established about 25 years
ago, cannot ensure that payments are based on reasonable estimates of
actual expenses because FEMA does not consider actual expenses incurred by
the companies for their services to the NFIP and does not collect actual
expense data from the WYO insurance companies. For example, the payment
formula FEMA uses to set a payment rate of 3.3 percent of claims
settlement amounts for claims processing expenses, such as setting up
operations in flood-damaged areas, has been in place since the program's
inception. Since it created the program in 1983, FEMA has had no basis,
other than discussion with WYO insurance companies, to determine whether
that payment rate is a reasonable estimate of expenses incurred. As a
result of the unprecedented number and cost of flood insurance claims
after Hurricane Katrina, the amount FEMA paid WYO insurance companies for
claims processing expenses based on this formula increased more than
tenfold from about $30 million in fiscal year 2004 to about $385 million
in fiscal year 2005 not adjusted for inflation. In response, FEMA
officials said they are considering a possible cap on the amount of
payments in this expense category in future catastrophic loss years. Under
the National Flood Insurance Act of 1968, insurance companies choosing to
participate in the WYO program must keep such records as FEMA prescribes
and provide access to these records for purpose of audit and examination.
Although it has the authority to do so, FEMA does not collect data on
actual WYO flood insurance expenses. FEMA's reluctance to impose
additional cost accounting requirements on WYO insurance companies is
based on concerns that the approach would (1) increase FEMA's cost of
administering the program and (2) result in a decline in the number of
insurance companies that choose to participate in the WYO program.
Nonetheless, there is some precedent in two similar public-private
insurance partnerships for considering actual expense data. The FCIC,
which pays insurance companies a percentage of premium revenue for costs
related to insuring agricultural crop values against financial losses by
events such as droughts and other natural disasters, requires the
companies to submit detailed expense reports in a consistent format. The
NFIP Direct Servicing Agent, a FEMA contractor that sells and services
policies and adjusts claims on about 4 percent of flood insurance policies
that are not, for various reasons, handled through the WYO program, has
also calculated its operating costs. Based on standards for internal
control in the federal government, FEMA is responsible for implementing
controls that serve as the first line of defense in safeguarding assets,
preventing and detecting errors and fraud, and helping to achieve desired
results through effective stewardship of public resources.5 FEMA has not
significantly changed the payment policies that are the foundation of the
WYO program in more than 2 decades, and because FEMA cannot ensure that
its approach to establishing a schedule of operating costs is based on a
reasonable estimate of actual expenses or that the amount paid was
reasonable, it may not have effectively implemented these controls.

Biennial financial statement audits--FEMA's primary management control
mechanism to provide assurance that it receives complete and accurate
financial management information from the WYO insurance companies--were
not performed as required by regulation. FEMA's regulations and WYO
Financial Control Plan require each participating WYO insurance company to
arrange and pay for biennial financial statement audits by independent
certified public accountants (CPA) that evaluate its financial statements
for activities related to the NFIP. The audits are to be funded by the WYO
insurance companies from the payments they receive from FEMA for selling
and servicing policies (about 15 percent of premium revenue). However,
many insurance companies participating in the WYO program received these
payments in full yet did not comply with the requirement to have biennial
audits done during the period from fiscal year 2001 to 2006. Specifically,
for fiscal years 2001 and 2002, 40 of the 98 participating companies had
financial audits performed by independent CPA firms. For fiscal years 2002
to 2003, 37 of the 103 participating companies had financial statement
audits performed by CPA firms. For fiscal years 2003 and 2004, 35 of 107
participating companies had the financial audits performed; for fiscal
years 2005 and 2006, 5 of 94 participating companies had biennial
financial statement audits performed. FEMA officials said that FEMA
granted 32 additional WYO insurance companies extensions to complete the
biennial financial audits for 2005 and 2006 by September 30, 2007. The
officials said that the extensions were allowed because the WYO insurance
companies were in the process of contracting with new vendors or
subcontractors to perform their financial reporting responsibilities and
conducting financial audits would have been particularly costly and
difficult. FEMA did not have a mechanism in place for tracking and
reviewing the results of the biennial financial statement audits that were
performed. FEMA officials were able to provide us with copies of only two
biennial audit reports until the conclusion of our audit when they asked
WYO insurance companies and their subcontractors to send copies of
additional reports that might have been prepared. Without the required
biennial audits, FEMA lacks an appropriate internal control mechanism for
effective program oversight to help ensure that payments made to WYO
insurance companies are proper and in accordance with program
requirements. According to the standards for internal controls within the
federal government, such control mechanisms are important in agencies like
FEMA where large amounts of data are processed; where audit techniques may
be used to identify inefficiencies, waste, or abuse; and where managers
should be able to promptly review and evaluate audit findings in order to
identify opportunities for improvements.

5See GAO, Standards for Internal Control in the Federal Government,
GAO-AIMD-00.21.3.1(Washington, D.C.: November 1999).

We are recommending that the Secretary of DHS direct the Under Secretary
of Homeland Security, FEMA to take two actions to strengthen and improve
its administration of the NFIP: (1) take steps to ensure that its approach
to establishing a schedule of operating costs is based on a reasonable
estimate of actual expenses by reviewing appropriate documentation of
expenses incurred by WYO insurance companies; and (2) ensure that biennial
financial statement audits of WYO insurance companies are conducted by
independent CPA firms as required by FEMA regulation, and that FEMA
reviews the audits to help ensure that payments made are proper and in
accordance with program requirements.

In commenting on a draft of this report, DHS generally agreed with our
recommendations to improve financial accountability over payments the NFIP
makes to the WYO insurance companies. However, FEMA said our presentation
in table 1 of payments to WYO insurance companies for all NFIP services
for fiscal years 2004 to 2006 as a percentage of total premium revenues
was "inappropriate and misleading" because it was most appropriate to
compare the costs of adjusting and processing claims to total losses in a
year, not premium revenue. We disagree. We believe it is appropriate to
summarize aggregate expense payment data as a percentage of premiums
collected because the NFIP is designed to pay for flood losses and
operating expenses to the extent possible with premium revenues rather
than tax dollars. FEMA's comments are contained in appendix III.

Background

Overview of the National Flood Insurance Program

Congress established the NFIP in the National Flood Insurance Act of 1968
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.6 FEMA, within DHS, administers the NFIP
and is responsible for its management and oversight. Floods are the most
common and destructive natural disaster in the United States. In fact,
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. Under the NFIP, the federal government assumes
the liability for the insurance coverage and sets rates and coverage
limitations, among other responsibilities. 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."7

As of May 2007, more than 20,300 communities across the United States and
its territories participated in the NFIP by adopting and agreeing to
enforce state and community floodplain management regulations to reduce
future flood damage. In exchange, the NFIP makes federally backed flood
insurance available to homeowners and other property owners in these
communities. Homeowners with mortgages from federally regulated lenders on
property in communities identified to be in special high-risk flood hazard
areas are required to purchase flood insurance on their dwellings for at
least the outstanding mortgage amount. Optional, lower-cost coverage is
also available under the NFIP to protect homes in areas of low to moderate
risk. To insure furniture and other personal property items against flood
damage, homeowners may purchase separate NFIP personal property coverage.
Although premium amounts vary according to the amount of coverage
purchased and the location and characteristics of the property to be
insured, the average yearly premium for a 1-year policy was $475, as of
February 2007.

6The National Flood Insurance Act of 1968, as amended, is codified at 42
U.S.C. S 4001 to 4129.

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

As shown in figure 1, the NFIP has grown from about 1.5 million policies
in 1978 to about 5.4 million policies in April 2007.

Figure 1: NFIP Policies in Force, 1978-April 2007

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 by tax dollars. FEMA has statutory authority to borrow funds
from the U.S. Treasury to keep the NFIP solvent in years when losses are
heavy.8 The NFIP, by design, is not actuarially sound because Congress
authorized subsidized insurance rates to be made available for policies
covering certain structures to encourage communities to join the program
and premiums are based on the average historical loss year; therefore the
NFIP does not build sufficient reserves to cover losses that exceed the
historic averages. The subsidized properties are generally referred to as
Pre-FIRM (Flood Insurance Rate Map) buildings. The legislative history of
the National Flood Insurance Act recognized that insurance for existing
buildings constructed before the NFIP was established would be extremely
expensive because many of them were flood prone and did not comply with
NFIP floodplain management standards that went into effect after they were
built.

842 U.S.C. S 4016.

Until the last several years, FEMA had been generally successful in paying
flood losses and expenses with premium revenue, exercising its borrowing
authority three times in the last decade when claims payments exceeded
available fund balances. In each instance, FEMA repaid the funds with
interest. Prior to Hurricane Katrina in August 2005, FEMA had also made
substantial progress in repaying the borrowing it had undertaken to pay
losses for the 2004 hurricane season during which Hurricanes Charley,
Ivan, Frances, and Jeanne caused heavy flood damage in Florida and other
East Coast and Gulf Coast states. However, because the program's premium
rates have been set to cover losses in an average year based on program
experience that did not include any catastrophic losses, the program has
been unable to build sufficient reserves to meet future expected flood
losses.

Hurricanes Katrina, Rita, and Wilma, in 2005, had a far-reaching impact on
the financial solvency of the NFIP. Legislation increased FEMA's borrowing
authority from a total of $1.5 billion prior to Hurricane Katrina to $20.8
billion by March 2006, and, as of May 2007, FEMA's outstanding debt to the
Treasury was $17.5 billion. As we have reported, it is unlikely that FEMA
can repay a debt of this size and pay future claims in a program that
generates premium income of about $2 billion a year.9 Legislation has been
introduced in Congress to increase FEMA's borrowing authority to pay
interest on the debt and attention has focused on the extent of the
federal government's exposure for claims payments in future catastrophic
loss years and ways to improve the program's financial solvency.

Figure 2 shows the magnitude of the loss payments for Hurricane Katrina
and other flood events in 2005 compared to claims payments over other
years.

9See GAO, Federal Emergency Management Agency: Challenges for the National
Flood Insurance Program, [41]GAO-06-335T (Washington, D.C.: Jan. 25,
2006).

Figure 2: NFIP Payments to Claimants for 2005 Compared to Other Years

In prior work, we have reported that FEMA and the WYO insurance companies
settled the unprecedented number of NFIP claims after Hurricane Katrina
reasonably quickly, reporting that over 95 percent of Gulf Coast claims
for damage from Hurricane Katrina followed closely by Hurricane Rita were
settled in May 2006, about 9 months after the storms.10

History and Goals of the WYO Program

Since its inception, the NFIP has relied to a large extent on the private
insurance industry to sell and service policies, as Congress envisioned
when it authorized the program in 1968. From 1969 through 1977, NFIP was
operated under Part A of the National Flood Insurance Act (the Act),
meaning that private insurers assumed a portion of the risk of financial
loss.11 In order to implement the program, the Department of Housing and
Urban Development, the agency that administered the NFIP at that time,
entered into an agreement with a consortium of private insurers known as
the National Flood Insurers Association. Under this agreement, the
department reimbursed the association for operating costs, and because the
association was a risk-sharing insurer, it received an additional annual
operating allowance equal to 5 percent of policyholder premiums. In 1977,
in part as a result of disagreements on issues of financial control
between the private insurers and the department, the relationship ended.

10See GAO, National Flood Insurance Program: New Processes Aided Hurricane
Katrina Claims Handling, but FEMA's Oversight Should Be Improved,
[42]GAO-07-169 (Washington, D.C.: Dec. 15, 2006).

1142 U.S.C. SS 4051-4056.

Since 1978, NFIP has operated under Part B of the Act, meaning that the
federal government bears the entire risk of loss.12 Because insurance
companies operating under Part B, such as WYO companies, are not
risk-sharing insurers, they are paid only for operating costs. The FEMA
director is to establish a current schedule of operating costs by
negotiating with representatives of the insurance industry. Under the Act,
operating costs include four components: (1) expense reimbursements
covering the direct, actual, and necessary expenses incurred in connection
with selling and servicing flood insurance coverage; (2) reasonable
compensation payable for selling and servicing flood insurance coverage,
or commissions or service fees paid to producers; (3) loss adjustment
expenses; and (4) other direct, actual, and necessary expenses that FEMA
finds are incurred in connection with selling or servicing flood insurance
coverage.13

In 1983, FEMA, still operating the NFIP under Part B, established the WYO
program to obtain more industry involvement in the NFIP. According to
FEMA, the goals of the WYO program are to increase the NFIP policy base
and the geographic distribution of policies, improve service to NFIP
policyholders through the infusion of insurance industry knowledge, and
provide the insurance industry with direct operating experience with flood
insurance. Over the years, insurance company participation has grown and
the WYO program has assumed a larger share of the total NFIP policies in
force. During the first year of the WYO arrangement, 48 insurance
companies agreed to participate. In 1986, WYO insurance companies
administered about 50 percent of a little over 2 million policies in
force. In February 2007, WYO insurance companies administered about 96
percent of the about 5.4 million policies in force at that time.

1242 U.S.C. SS 4071-4072.

1342 U.S.C. S 4018(b)(1).

Roles of WYO Companies and Other Key Participants in the NFIP

A private insurer becomes a WYO company by entering into an agreement with
FEMA known as the Financial Assistance/Subsidy Arrangement. Under the
arrangement, private insurers agree to issue flood policies in their own
name. In addition, the WYO companies adjust flood claims as well as
settle, pay, and defend all claims arising from the flood policies. To
enter into a WYO arrangement with the NFIP, private insurers must meet
FEMA's established criteria.14 Factors FEMA considers in determining
whether companies are accepted into the WYO program include their
experience in property and casualty insurance lines, standing with state
insurance departments, and the ability to meet NFIP reporting requirements
to adequately sell and service flood insurance policies.

Each year, FEMA is required to publish in the Federal Register the terms
for participation in the WYO program, including amounts WYO insurance
companies will be paid for expenses. Companies that agree to participate
in the program sign a financial assistance/subsidy arrangement and are to
comply with the provisions of FEMA's WYO Financial Control Plan, which
outlines WYO insurance companies' responsibilities for program operations
including underwriting, claims adjustments, cash management, and financial
reporting, as well as FEMA's responsibilities for management and
oversight.

Selling policies. Insurance agents under contract to one or more WYO
insurance companies are the main point of contact for most policyholders
to purchase an NFIP policy, seek information on coverage, or file a claim.
Based on information the insurance agents submit, the WYO insurance
companies issue policies, collect premiums from policyholders, deduct an
allowance for expenses from the premium, and remit the balance to the
National Flood Insurance Fund. In some cases, insurance companies hire
subcontractors--flood insurance vendors--to conduct some or all of the
day-to-day processing and management of flood insurance policies.

Adjusting claims. Insurance companies work with certified flood adjusters
to settle NFIP claims. When flood losses occur, policyholders report them
to their insurance agent, who notifies the WYO insurance company. The WYO
insurance company assigns a flood adjuster to assess damages. Flood
adjusters may be independent or employed by an insurance or adjusting
company. These adjusters are responsible for assessing damage, estimating
losses, and submitting required reports, work sheets, and photographs to
the WYO insurance company, where the claim is reviewed and, if approved,
processed for payment. WYO insurance companies are then reimbursed by FEMA
from the National Flood Insurance Fund for the amount of the claims and
expenses paid. Claims amounts may be adjusted after the initial settlement
is paid if claimants submit documentation that some costs were higher than
estimated.

1444 C.F.R. S 62.24.

FEMA Management and Oversight. About 68 FEMA employees, assisted by about
170 contractor employees manage and oversee the NFIP and the National
Flood Insurance Fund into which premiums are deposited and claims and
expenses paid. Their management responsibilities include establishing and
updating NFIP regulations, analyzing data to actuarially determine flood
insurance rates, and offering training to insurance agents and adjusters.
In addition, FEMA and its program contractor are responsible for
monitoring and overseeing the quality of the performance of the WYO
insurance companies to assure that the NFIP is administered properly.
Figure 3 provides an overview of the WYO companies' and others'
participation in the NFIP.

Figure 3: Key Participants in the NFIP WYO Program

Payments to WYO Insurance Companies Comprised Up to Almost Two-Thirds of Total
Premium Revenue in Recent Years Based on Payment Methodologies Established in
1983

FEMA's payments to WYO insurance companies for operating costs ranged from
more than a third to almost two-thirds of the total premiums paid by
policyholders to the NFIP for fiscal years 2004 through 2006. During the
3-year period from fiscal year 2004 through 2006, FEMA's payments to WYO
insurance companies ranged from $619.2 million to $1.6 billion in current
dollars that were not adjusted for inflation. FEMA establishes a schedule
of operating costs for WYO insurance companies participating in the NFIP
based on industry averages for operating expenses for other lines of
insurance, such as homeowners, commercial and fire; past practices; and
discussions with WYO insurance company participants and other insurance
industry representatives. FEMA negotiated these payment methodologies with
insurance industry representatives when it established the WYO program in
1983. While FEMA has periodically adjusted payment amounts since 1983, the
underlying methodologies it uses for determining them have not
significantly changed. FEMA pays WYO companies in two main categories (1)
for selling and servicing insurance policies and (2) adjusting and
processing policyholders' claims after a flood event occurs. Any portion
of the premium revenues retained by the WYO insurance companies that are
not used to cover expenses may be retained as profit. Because the WYO
insurance companies bear no risk for NFIP losses, the payments they
receive from FEMA are for work incurred in selling and servicing policies
and adjusting claims.

Overall Payments to WYO Insurance Companies

As shown in table 1, in the last 3 fiscal years, payments to WYO insurance
companies have consumed from over a third to almost two-thirds of the
total premiums paid by policyholders to the NFIP. In fiscal years 2005 and
2006, payments were larger than for fiscal year 2004 because the WYO
insurance companies received payments in these years for settling the
unprecedented number and amount of claims for damages resulting from flood
events including Hurricanes Charley, Ivan, Frances, and Jeanne in Florida
and other East Coast and Gulf Coast states in 2004 and Hurricanes Katrina,
Rita, Wilma, and other flood events in 2005.

Table 1: Payments to WYO Insurance Companies Received for Services
Rendered to the NFIP (Fiscal Years 2004-2006)

Dollars in millions
                                   Payments to WYO                            
               Premium revenue insurance companies Percent of premium revenue 
               received by the        for services     paid for WYO insurance 
Fiscal year       NFIP Fund            rendered           company services 
2004               $1,772.8              $619.2                       34.9 
2005                1,943.6               984.5                       50.7 
2006                2,439.9             1,583.5                       64.9 

Source: GAO analysis of FEMA data.

Note: Dollars are not adjusted for inflation.

Selling and Servicing NFIP Policies

WYO insurance companies retain premium revenues for selling and servicing
NFIP policies based on three different calculations: (1) a flat 15
percentage allowance for insurance agent sales commissions; (2) an average
of industry operating expenses for other lines of insurance to determine
the amount for operating expenses associated with processing and servicing
insurance policies, which historically also averages to about 15 percent;
and (3) incentive bonuses to WYO companies of up to 2 percent of the
premiums generated by selling and servicing flood insurance policies.
Table 2 summarizes the methods FEMA uses to calculate payments to WYO
companies for selling and servicing flood insurance policies and recent
payment amounts.

Table 2: Methodology for Calculating Payments to WYO Insurance Companies
for Selling and Servicing NFIP Policies and Actual Payments Made, Fiscal
Years 2004-2006

Dollars in    
millions      
                                           Calculation          
Type of                                 result       Actual  
payment                                 (actual or  payments 
calculationa  Calculation methodology   estimated)      FY04   FY05   FY06 
(1) Insurance Percentage amount         15% of        $524.9 $634.6 $687.3 
agent sales   established in the annual premium                            
commissions   financial                 revenue                            
                 assistance/subsidy        retained                           
                 arrangement between FEMA                                     
                 and participating                                            
                 insurance companies                                          
(2) Operating Based on a 5-year rolling About 15%                          
expensesb     average of direct         percent of                         
                 operating costs as        premium                            
                 reported by the industry  revenue                            
                 for other types of        retained                           
                 property and casualty                                        
                 insurance                                                    
(3) Incentive Awarded to companies that 0.5% -2% of     31.6   21.4   44.5 
bonus         achieve 2 to 5 percent or premium                            
                 more growth in the number revenue                            
                 of NFIP policies they     retained                           
                 have in force                                                

Source: GAO analysis of FEMA data.

Note: Dollars are not adjusted for inflation. In addition to these major
categories of payments related to selling and servicing policies that WYO
insurance companies receive for services to the NFIP, FEMA officials noted
two other smaller categories of payments that are available. First, WYO
insurance companies may receive special allocations if they need to hire
engineers to do studies necessary to underwrite policies or adjust claims.
Total payments are about $2 million a year. Second, in future years, FEMA
has proposed to pay WYO insurance companies  1/4 of 1 percent in
additional premium revenues for expenses they incur to comply with
provisions of the Flood Insurance Reform Act of 2004. The proposal is
currently under review by DHS. If approved, it could be effective in
fiscal year 2008. The 2004 Act mandated that NFIP policyholders receive
additional informational materials explaining their coverage, which
resulted in additional expenses to the WYO insurance companies for postage
and mailings, among other items. Total payments on premium revenues of $2
billion would be about $5 million.

aFEMA did not provide payment information for insurance agent sales
commissions and operating expenses as separate line items.

bIncludes state premium tax, which FEMA officials said averages 2 percent
of written premiums.

  Selling and Servicing Policies: Agent Commissions

WYO insurance companies retain a flat fee of 15 percent of premium
revenues for agent commissions. The WYO insurance companies, however,
determine the actual amount of commission they pay to agents. The amount
varies from one WYO insurance company to another and may be more or less
than 15 percent. For example, one WYO insurance company flood program
manager said that agents for his company receive a commission of 15
percent of the policy amount and may also receive other incentives during
special flood marketing campaigns. Another flood program manager said that
her company's agents received a commission that was larger than 15 percent
of the policy amount. In the insurance industry, many independent agents
are paid by commission only, whereas sales workers who are employees of an
agency or an insurance carrier may be paid in one of three ways--salary
only, salary plus commission, or salary plus bonus. In general,
commissions are the most common form of compensation, especially for
experienced agents.15

The amount of work involved in selling and servicing NFIP policies varies
based on the flood risk of the insured property, according to a
representative of the NAIC. For example, the representative said that NFIP
policy sales for properties located in special flood hazard areas require
the greatest amount of work because of the need to develop information on
the elevation of the property, take photographs, and create other
documentation that is required to determine the premium amount. They said
that policy sales and renewals that require lesser amounts of work include
(1) renewals where information has not changed; (2) sales of policies on
properties that were built before NFIP floodplain management standards
went into effect (because they qualify for subsidized premiums and do not
require extensive documentation to determine flood risk); and (3) sales of
policies for properties that are not located in special flood hazard areas
(because they do not require extensive documentation to assess flood
risk).

  Selling and Servicing Policies: Operating Expenses

In addition to the 15 percent allowance for agent commissions, WYO
insurance companies retain about 15 percent of the premium revenues for
ongoing operating expenses related to administering the NFIP and providing
services to policyholders. This payment amount is based on an annual
agreement between FEMA and the WYO insurance companies. See appendix III
for the percentage allowances FEMA authorized WYO insurance companies to
retain for operating expenses incurred in selling and servicing NFIP
policies for fiscal years 1984 to 2007. According to the agreement, the
WYO insurance companies may withhold, as operating and administrative
expenses (other than agent commissions), an amount equal to the average
industry expenses ratios for A.M. Best Company's Aggregates and Averages
for the following five property coverages: Fire, Allied Lines, Farmowners
Multiple Peril, Homeowners Multiple Peril, and Commercial Multiple Peril
(non-liability portion).16 According to the agreement, this amount is to
be increased by 1 percentage point to reimburse expenses "beyond regular
property/casualty expenses."17

15Bureau of Labor Statistics, U.S. Department of Labor, Occupational
Outlook Handbook, 2006-07 Edition, Insurance Sales Agents, on the Internet
at http://www.bls.gov/oco/ocos118.htm (visited Apr. 26, 2007).

16A.M. Best is an insurance industry rating and information agency that
compiles and publishes data submitted by insurance companies to their
state regulatory authorities.

The payment for administrative and operating expenses is intended to cover
a variety of expenses WYO insurance companies incur in servicing NFIP
policies. WYO insurance company managers said examples of expenses they
incurred included fees for services of a vendor or subcontractor (if one
is retained to handle all or part of the flood insurance business),
payment of salaries and expenses for employees with full or part-time
responsibilities for the NFIP work, payment of fees to independent public
accounting firms to conduct biennial audits of financial systems for the
NFIP, and payment of state taxes on the funds received from the NFIP.
Other expenses reported by WYO insurance companies include costs of
marketing NFIP policies, training agents to sell and service NFIP
policies, and creating or modifying computer and accounting systems to
report financial and statistical information required by the NFIP.

  Selling and Servicing Policies: Bonuses

According to FEMA officials, the agency has used annual bonuses for WYO
insurance companies since 199518 as an incentive to increase the number of
NFIP policies in force. Under the bonus incentive program, FEMA provides
WYO insurance companies with opportunities to earn additional percentages
of premium revenue above the levels established annually if they increase
the number of flood insurance policies they sell and service. FEMA
officials said that they established bonus percentage amounts through
discussions with WYO insurance company officials, noting that, as of May
2007, the NFIP had experienced 36 continuous months of policy growth.19
One official attributed the growth to "a new American consciousness" of
the importance of having flood insurance in the aftermath of Hurricane
Katrina and other major flood events in 2004 and 2005. This growth in
policies accounts for the recent parallel growth in bonuses. Table 3
provides information on how bonuses have been awarded and distributed. As
the table shows, most participating WYO insurance companies received bonus
payments in each of the fiscal years, and in fiscal year 2006, 67 percent
of the companies received the highest bonus amount of 2 percent of premium
revenues.

17Federal Emergency Management Agency, Federal Insurance Administration,
Financial Assistance/Subsidy Agreement (Washington, D.C.: Oct. 1, 2006).

18FEMA also provided annual incentive bonuses in 1989-1991.

19In addition to the marketing incentive bonuses, FEMA helps WYO insurance
companies pay for their NFIP marketing efforts through the NFIP
cooperative advertising program, which provides WYO companies and
insurance agents the opportunity to split their advertising costs for any
approved flood insurance print or Yellow Pages display ads with the NFIP
as well as the development of public relations and of collateral materials
such as brochures.

Table 3: Incentive Bonus Award Structure and Distribution to WYO
Companies, Fiscal Years 2004-2006

                     Actual    Number and  
                      bonus    percentage  
                    payments     of WYO    
Policy     Bonus (dollars   companies   
growth  level (%    in      receiving   
level     of all millions)    bonus     
(%)    premiums)      FY04         FY05   FY06 FY04 FY05 FY06 
<2.0           0         0            0      0   22  22%   37  40% 21  24% 
2.0          0.5         0        $1.63 $0.023    3   3%    4   4%  1   1% 
3.0          1.0     $0.48         3.04  0.104    4   4%    7   8%  2   2% 
4.0          1.5      2.07         6.02    2.4   26  26%    6   7%  5   6% 
5.0          2.0     29.04        10.72   42.1   44  44%   39  40% 59  67% 
Total               $31.58       $21.42  $44.5   99  99%   93 100% 88 100% 

Source: GAO analysis of FEMA data.

Note: The number of insurance companies participating in the WYO program
fluctuates; numbers for ends of fiscal years are reported. Dollars are not
adjusted for inflation. Percentages within each fiscal year do not total
100% due to rounding. WYO companies that achieved policy growth of less
than 2 percent for any fiscal year were not eligible to receive bonuses.
For 2004, FEMA officials advised that bonuses were based on overall growth
and retention; therefore, although three companies achieved overall growth
of 2.0 to 3.0 percent, they were not awarded bonuses.

  While FEMA Officials Consider WYO Payments for Selling and Servicing Policies
  to Be Fair, Insurance Industry Stakeholder Views Were Mixed

FEMA officials said that the methodologies they use for paying WYO
companies for selling and servicing flood insurance are fair for both the
government and the insurance industry. The officials noted that because
the methodologies approximate the expenses incurred for insurance policy
sales and servicing on an industrywide basis, they result in fair
compensation for the WYO insurance companies. According to FEMA officials,
many of the traditional operating costs associated with other lines of
insurance are also incurred in selling and servicing flood insurance for
the NFIP (i.e., commissions to agents, staff salaries, taxes, and building
and equipment costs). Moreover, FEMA officials considered the payment of
the same percentage of premium revenue to WYO insurance companies for more
and less time-consuming sales and renewals to be a reasonable approach
because it results in a reasonable overall compensation rate for the
services the companies perform. They said that because the method for
paying companies to sell and service policies has worked well over the
years, FEMA has not deemed it necessary to significantly change its
approach since it was put into place at the inception of the WYO program
in 1983.20

Of the five WYO companies we interviewed (including four of the five
largest participating in the NFIP), views on the sufficiency of FEMA's
payment structure were mixed. Three WYO company officials stated that the
expense percentage was generally sufficient, while two stated that it was
too low. In addition, one NAIC representative we interviewed said that the
methodology was generally fair to the insurance companies and taxpayers,
and another noted that expense allowance percentages are probably too high
for some renewals and too low for new business but overall work out to a
reasonable amount of compensation.

After Flood Losses, FEMA Pays WYO Insurance Companies for Adjusting Claims and
Providing Claims Processing Services

In addition to paying WYO companies for selling and servicing NFIP flood
insurance policies, FEMA also provides payments after a flood loss occurs.
WYO companies are paid both for adjusting claims and for processing claims
and providing certain claims-related services, such as setting up
temporary flood insurance claims processing centers. Table 4 provides
information on the methodologies FEMA uses to calculate these payments and
recent payment amounts.

20FEMA has never relied on actual flood insurance expense data to
determine operating costs. However, in 1998 to 1999, FEMA reviewed its
methodology for paying WYO insurance companies and, as a result, slightly
modified the way in which it calculated payments for selling and servicing
flood insurance policies based on average expenses of other lines of
property and casualty insurance. Specifically, FEMA began using direct, as
opposed to net, expense information for the property and casualty
insurance lines, meaning that FEMA no longer reimbursed WYO insurance
companies for reinsurance expenses, which are not relevant for flood
insurance because the federal government through the Treasury is
ultimately responsible for program losses that exceed program funds. As a
result, FEMA reduced the operating expense allowance by one percent. See
64 Fed. Reg. 27,705 (May 21, 1999). However, 2 years later, FEMA
determined that the operating expense allowance should be increased by
about 1 percent for expenses beyond regular property/casualty expenses,
effectively negating the reduction made in 1999. See 66 Fed. Reg. 40,916
(Aug. 6, 2001).

Table 4: Methodology for Calculating Payments to WYO Insurance Companies
for Adjusting and Processing Claims after a Flood-Loss Event, and Actual
Payments Made, Fiscal Years 2004-2006

Dollars in      
millions        
                                   Calculation result   Actual  
Type of payment Calculation     (actual or          payments 
calculation     methodology     estimated)              FY04   FY05   FY06 
(1) Claims      Dollar or       Ranges from $60 to     $32.4  $97.2 $466.5 
adjustments     percentage of   $1,250 in flat fees                        
                   incurred loss   for claims up to                           
                   based on        $50,000                                    
                   adjuster fee                                               
                   schedule        Fees for claims                            
                                   above $50,000, fees                        
                                   range from 2.1% to                         
                                   3% of the claims                           
                                   settlement amount.                         
(2) Claims      Based on actual 3.3% per incurred       30.3  231.3  385.1 
processing      incurred loss   loss                                       
Total                                                  $62.7 $328.5 $851.6 

Source: FEMA.

Note: Dollars are not adjusted for inflation. WYO insurance companies also
process claims that fall into other categories, such as "erroneous
assignment" or "closed without payment" and receive fees of $60 and $225,
respectively. For claims of $50,000-$100,000, the fee equals 3%; for
claims up to $250,000, the fee is 2.3% with a $3,000 minimum; and for
claims above $250,000, the fee is 2.1% with a minimum of $5,750.

  Claims Adjustment Fees

FEMA pays WYO insurance companies for adjuster fees based on a fee
schedule that FEMA periodically negotiates with WYO insurance company
representatives. Using the fee schedule, FEMA, through the WYO insurance
companies, pays adjuster fees based on the amount of each claim settled,
with higher fees for larger claims settlement amounts. While some WYO
insurance companies use adjusters who are company employees, other WYO
insurance companies hire and pay claims adjusting firms that employ their
own workforces. These adjusting firms may keep a percentage of the fee for
expenses and profit and pay a portion to independent adjusters they
engage. For example, while one adjusting firm we visited paid independent
adjusters 40 percent of the amount on the adjuster fee schedule, FEMA
officials said that independent adjusters typically received 70 percent of
the amount on the adjuster fee schedule.

According to FEMA's director for NFIP claims, the adjuster fee schedule
system is based on fee schedules used by independent adjusting firms for
claims on other lines of insurance (i.e., homeowners).21 According to the
director, rates paid on the fee schedule have been adjusted periodically
since 1983 and were last revised in 2004 based on discussions with the WYO
insurance companies and independent adjusting firms.22 Table 5 shows
excerpts from the adjuster fee schedule effective as of May 2007 for
claims with loss dates of September 2004 and later.

21Like other WYO payment agreements, this payment method was implemented
in 1983, about the same time other lines of insurance moved to implement
fee schedules based on claims settlement amounts rather than paying for
claims adjustments based on the adjusters' time and expense.

Table 5: Excepts from the Adjuster Fee Schedule

Claim range            Fee                                                 
Closed without payment $225                                                
$225.01 to 1,000       425                                                 
$2,500.01 to 5,000     500                                                 
$5,000.01 to 7,500     575                                                 
$7,500.01 to 10,000    650                                                 
$10,000.01 to 15,000   750                                                 
$15,000.01 to 25,000   850                                                 
$25,000.01 to 35,000   1,000                                               
$35,000.01 to $50,000  1,250                                               
$50,000.01 to $100,000 3 percent of the loss settlement amount             
$100,000.01 to 250,000 2.3 percent of the loss settlement amount but not   
                          less than $3,000                                    
$250,000.01 and up     2.1 percent of the loss settlement amount but not   
                          less than $5,750                                    

Source: FEMA.

Note: Based on gross loss.

  Expense Payment for Claims Processing Activities

After a flood loss, in addition to claims adjustment payments, FEMA pays
WYO insurance companies for processing claims at a rate of 3.3 percent of
the flood insurance property settlement. According to FEMA officials, this
allowance is provided to WYO insurance companies to set up operations to
process claims in flood-damaged areas. For example, WYO insurance
companies may set up disaster recovery centers to organize their claims
processing efforts on behalf of the NFIP and special telephone hotlines to
provide service, and pay travel expenses for employees and salaries of
temporary workers to staff recovery centers. According to FEMA officials,
the rate of payment for these expenses was initially determined by FEMA
based on data on expenses incurred to adjust losses for other lines of
insurance provided by A.M. Best, the insurance industry rating and
information agency. However, during the 1980s, the insurance industry
changed its requirements for reporting expenses incurred for loss
adjustments; therefore, comparison information for other lines of
insurance was no longer available, according to a FEMA official. Since
that time, the official said that FEMA has not changed the claims expense
allowance percentage because of discussions with representatives of the
insurance industry who consider the percentage to be reasonable.

22In addition, FEMA authorized payments of $750 per expedited claims
adjustment, a process that did not require site visits by certified flood
claims adjusters, to settle about 17,200 claims for damage from Hurricanes
Katrina and Rita in 2005.

  Views Mixed on the Sufficiency of Payments for Post-Flood Activities

The views of the five WYO insurance company managers we interviewed were
mixed on whether the 3.3 percent claims adjustment expense allowance FEMA
pays is sufficient in relation to the costs they incur. One WYO insurance
company manager thought the expense percentage was sufficient. Three WYO
company managers said that the expense percentage was generally reasonable
in catastrophic loss years but not in average loss years, and another WYO
insurance company manager said the expense percentage was reasonable in
noncatastrophic loss years but not in catastrophic loss years when prices
charged by adjusters for their services increase and resources are not as
readily available to manage claims adjustment operations. NAIC
representatives said that they were not able to comment on whether the
amount paid was generally reasonable for the insurance companies and
taxpayers because they did not have data necessary to form an opinion.

A senior FEMA official said that while FEMA has discussed the
reasonableness of the payments for claims processing expenses with
representatives of the WYO insurance companies, FEMA has not, since 1983,
assessed the amount of the payments based on either expenses incurred by
the WYO companies for processing of NFIP claims or actual costs incurred
by insurance companies for processing claims on other lines of insurance.
The official said that some consideration was being given to capping the
amount of the claims expense allowance paid in catastrophic loss years.
The official said that a draft proposed rule is being discussed with WYO
insurance company officials and action could be taken as early as fiscal
year 2008.

FEMA's Long-standing Approach for Establishing a Schedule of Operating Costs
Cannot Ensure That WYO Insurance Company Payments Are Based on Reasonable
Estimates of Actual Expenses

FEMA's methodologies for determining WYO's operating costs, rooted in
policies established about 25 years ago, cannot provide assurance that
payments are based on reasonable estimates of actual expenses because
actual expenses incurred by the companies for their services to the NFIP
are not considered. It is important that FEMA be able to rely on a
methodologically sound approach for making decisions about NFIP operating
costs, given both the program's growth and rise in payouts in recent
years. Although FEMA has the authority to collect expenses information and
FEMA officials said that they have considered alternative methodologies
for paying WYO insurance companies, the officials raised concerns about
collecting expense information from WYO insurance companies. Nevertheless,
there is a precedent for doing so since two other public-private insurance
partnerships with similarities to the WYO program use information on the
actual costs incurred by participating insurance companies as one basis
for determining how much to pay for services.

FEMA's Methodologies Cannot Ensure That the Schedule of Operating Costs Is Based
on Reasonable Estimates of Actual Expenses

While the WYO program has operated without interruption since 1983 in both
catastrophic and noncatastrophic flood years, FEMA has not determined
whether payments it makes reasonably reflect the actual expenses WYO
insurance companies have incurred in selling and servicing NFIP policies
and settling claims for flood losses. The methodologies FEMA currently
uses to determine payment amounts for the WYO insurance companies for
services rendered do not meet the federal internal control standard that
agencies be held accountable for, among other things, stewardship of
government resources. For example, as noted earlier, FEMA allows the WYO
insurance companies to retain a percentage of premium revenue it collects
based on average expenses for five property/casualty lines of insurance;
this amount is increased by 1 percentage point to reimburse expenses for
the NFIP beyond regular property/casualty expenses. However, without
obtaining and considering audited data on the actual costs incurred by the
WYO companies, FEMA has no assurance that the additional 1 percentage
point--about $20 million annually programwide--is an accurate reflection
of the expenses WYO companies actually incur beyond regular
property/casualty expenses. Nor can FEMA determine, based on current
payment methodologies, how WYO insurance company costs might have changed
over time because its payment approach is rooted in policies established
in 1983, when the WYO program began. For example, the payment formula FEMA
used to set the 3.3 percent payment rate for claims processing expenses
incurred by WYO insurance companies has been in place since the program's
inception, and FEMA has no basis, other than discussion with WYO insurance
company officials, for determining that the 3.3 percent claims processing
payment is a reasonable estimate of expenses incurred.

It is important that FEMA be able to rely on a methodologically sound
approach for making decisions about NFIP operating costs, given both the
program's growth and rise in payouts. As shown earlier in figure 1,
participation in the NFIP has steadily increased over time from
approximately 2 million to over 5 million policies in force. Annual
premium revenue, which is the basis for calculating payments to WYO
insurance companies for selling and servicing policies, has increased as
well, from $385 million in 1983 to more than $2 billion in 2007. And costs
of claims settlements have trended upward, as the costs of labor and
materials to repair flood-damaged properties have increased, resulting in
larger payment amounts to WYO insurance companies for adjusting claims. As
a result of the unprecedented number and cost of flood insurance claims
after Hurricane Katrina, the amount FEMA paid the WYO insurance companies
based on its formula for claims processing (i.e., setting up temporary
flood insurance claims processing centers) was $385.1 million in fiscal
year 2005--a more than tenfold increase from the $30.3 million, not
adjusted for inflation, paid for such expenses in fiscal year 2004.

FEMA officials said that they are in the process of discussing with WYO
insurance company officials a proposed cap on the amount WYO insurance
companies will be paid for claims processing expenses in future
catastrophic loss years that could become effective in fiscal year 2008,
as noted above. FEMA officials also said that they believed the insurance
companies participating in the WYO program generally had lower expenses
than other companies that choose not to participate in the WYO program.
They cited their analysis of 2004 operating expenses, which compared the
expenses for homeowner policies for insurance companies that participated
in the WYO program to companies that did not participate and found that
companies that did not participate in the WYO program generally reported
higher expenses. Nevertheless, because FEMA does not collect actual data
from WYO insurance companies specific to their flood insurance expenses,
it cannot ensure payments are based on reasonable estimates of actual
flood insurance expenses.

FEMA officials said that they have considered methodologies other than the
current approach for paying WYO insurance companies, including having the
companies submit information on their actual expenses for reimbursement
for services rendered to the NFIP. However, they said that such an
approach could create a number of additional challenges that might have a
negative impact on the program. For example, because the costs of doing
business vary from one WYO insurance company to another, according to the
business models they have developed for carrying out their services to the
NFIP and the amount of their flood insurance business, the NFIP would, in
the agency's view, have to pay different companies at different levels,
which could result in higher FEMA administrative costs and could also fail
to reward WYO insurance companies with the most efficient operations. The
officials also said that compensation based on actual expenses could also
result in inefficient companies entering the WYO program because there is
no incentive for them to control expenses. In addition, FEMA officials
stated that they would likely have to hire additional staff and provide
resources to review and validate WYO expense data, further increasing
program costs. However, FEMA could choose, for example, to use data on
actual expenses to establish payment rates based on an average of expenses
WYO insurance companies incur, similar to its current approach. Thus, WYO
insurance companies would continue to have an incentive to perform
efficiently.

FEMA Has Legal Authority to Collect Data on Actual WYO Expenses to Determine If
Payments Are Based on Reasonable Estimates of Expenses, but Officials Cited
Concerns about Potential Implications

Under the National Flood Insurance Act of 1968, insurance companies
choosing to participate in the WYO program must keep such records as FEMA
prescribes and provide access to these records for purpose of audit and
examination. Although it has authority to do so, FEMA does not collect
data on actual WYO flood insurance expenses that could provide a basis for
ensuring that the WYO schedule of operating costs is based on a reasonable
estimate of expenses. FEMA's reluctance to impose additional cost
accounting requirements on WYO insurance companies is based on concerns
that the number of companies choosing to participate in the WYO program
would decline if FEMA did so.

The National Flood Insurance Act of 1968 mandated that FEMA negotiate with
representatives of the insurance industry to establish a current schedule
of operating costs.23 Operating costs include:

           o expense reimbursements covering the direct, actual, and
           necessary expenses incurred in connection with selling and
           servicing flood insurance coverage;
           o reasonable compensation payable for selling and servicing flood
           insurance coverage;
           o loss adjustment expenses; and
           o other direct, actual, and necessary expenses incurred in
           connection with selling or servicing flood insurance coverage.

2342 USC S 4018(a).

In addition, the act provides FEMA with broad audit and access authority
to the records of insurance companies choosing to participate in the WYO
program. In particular, WYO insurance companies must "keep such records as
the [FEMA] Director shall prescribe, including records which fully
disclose the total costs of the program undertaken or the services being
rendered, and such other records as will facilitate an effective audit."24
Any WYO records pertinent to program costs and services rendered are
subject to audit and examination by FEMA (and GAO).25 While these
provisions provide a legal basis for FEMA to collect cost data from WYO
insurance companies to ensure that the schedule of operating costs
reasonably reflects actual WYO insurance company expenses, FEMA officials
expressed concerns that new cost accounting requirements would drive
insurance companies out of the WYO program.

Under its agreement with participating WYO insurance companies, FEMA can
request that the companies provide "a true and correct copy of the
Company's Fire and Casualty Annual Statement, and Insurance Expense
Exhibit," which the companies are required to file with their respective
state insurance authorities. The Insurance Expense Exhibit provides a
statutory allocation of income to lines of business, thereby measuring the
underlying profitability of the insurance operations. According to NAIC
officials, all revenues and expenditures, whether or not they are
associated with particular policies, are allocated to lines of business,
including flood insurance, and various sets of operating returns are
calculated in the Exhibit, so that profitability by line of business may
be measured. They said that WYO companies allocate costs related to their
flood insurance business based on a reporting requirement established by
the NAIC in 1997 and that companies determine their own allocation
methods, which according to NAIC procedures, must be "reasonable."

2442 U.S.C.  at S 4084(a).

2542 U.S.C.  at S 4084(b). The statutory audit and access rights provided
under this section are codified in regulation as part of the Financial
Assistance/Subsidy Agreement between FEMA and all participating WYO
insurance companies. 44 C.F.R. pt. 62, app. A, art. XIV.

FEMA officials said the requirement for insurance companies to provide
information on costs allocated to their flood insurance business was
established at FEMA's request, and FEMA has reviewed the data annually
since 2004. However, the officials said they could not use the information
to help determine the reasonableness of payments to WYO insurance
companies for the services they perform for the NFIP because the methods
WYO companies use to report their flood insurance-related expenses in the
Insurance Expense Exhibit vary by company. They said that FEMA has not
required that WYO insurance companies report their flood- related expenses
separately because of their reluctance to increase federal reporting
requirements on their WYO partners in the NFIP.

FEMA officials expressed concern that the number of companies that choose
to participate in the WYO program would decline dramatically if additional
cost accounting requirements were established for them. The officials said
that potential impacts of less private-sector participation include a
reduced ability to respond quickly to catastrophic flood events and more
difficulty for policyholders in locating agents to sell and service NFIP
policies. That concern notwithstanding, however, more specific and
relevant information on actual expenses allocated by the WYO insurance
companies to their flood insurance business could help FEMA determine the
reasonableness of its expense estimates if the flood insurance data
already maintained by participating WYO insurance companies were
consistently reported.

Based on the standards for internal control in the federal government,
FEMA is responsible for implementing controls that serve as the first line
of defense in safeguarding assets, preventing and detecting errors and
fraud, and helping to achieve desired results through effective
stewardship of public resources. Moreover, internal controls are integral
to ensuring the reliability of financial reporting and the effectiveness
and efficiency of operations, including the use of resources. FEMA has not
significantly changed the payment policies that are the foundation of the
WYO program in more than 2 decades, and because FEMA cannot ensure that
its approach to establishing a schedule of operating costs is based on a
reasonable estimate of actual expenses, it has not effectively implemented
these internal controls. A review of the WYO insurance companies'
operating costs would be prudent and timely.

Other Federal Programs Collect Actual Cost Data to Help Determine Payments for
Insurance Industry Services

While FEMA has not elected to collect actual cost data from WYO companies,
it has the legal authority to do so, as noted above, and there is
precedent within the federal government for doing so. Two public-private
insurance partnerships similar to the NFIP's arrangement with WYO
insurance companies collect information on the actual costs incurred by
participating insurance companies as a basis to help determine how much to
pay for services.

The first is the FCIC, which bears the risk for insuring agricultural crop
values under the auspices of the U.S. Department of Agriculture's Risk
Management Agency.26 The FCIC protects farmers who participate in the
program against financial losses caused by events such as droughts and
other natural disasters.

Like FEMA does for the NFIP, the Risk Management Agency pays insurance
companies a percentage of premium revenue for expense allowances for
services to the FCIC. Unlike the NFIP, however, beginning in 1994, the
FCIC began to require companies to submit detailed expense reports in a
consistent format following standard industry guidelines, including the
NAIC guidelines for allocating expenses among lines of business. While the
FCIC does not use these reports as a direct basis for reimbursing
individual insurance companies, the actual expense information contained
in the reports informs the agency's methodology for establishing future
reimbursement rates for expenses related to insurance services. FCIC
requires that companies submit documentation of their expenses and uses
this information to determine the appropriate percentage as a basis for
compensation. This documentation is intended to provide a basis for
program oversight to ensure that payments made to private insurance
companies for their expenses in providing insurance services are
reasonable--documentation that is currently lacking in the NFIP.

One potential advantage that results from FCIC's direct access to expense
data is that this information may be used to enhance program oversight.
For example, in reviewing actual expense data submitted by the insurance
companies participating in the FCIC in 1997, we found that some expenses
reimbursed by FCIC were excessive.27 Among the expenses reported were
those associated with profit-sharing bonuses and lobbying. In addition,
even within the expense categories reasonably associated with the sale and
service of crop insurance, we found expenses that appeared excessive for
reimbursement under a taxpayer-supported program, suggesting an
opportunity to further reduce future reimbursement rates. These expenses
included agents' commissions that exceeded the industry average,
unnecessary travel-related expenses, and questionable entertainment
activities. Currently, comparable oversight activities cannot be performed
on NFIP's WYO program participants because the data needed for such
analysis have not been obtained.

26In 2007, 16 private-sector insurance companies sold and serviced
policies for the FCIC. The program insured crops valued at about $44.3
billion in fiscal year 2005, with about 1.3 million policies in force.

The second public-private partnership comparable to the NFIP is an entity
that participates in the flood insurance program, but not as a WYO
insurance company. This entity is the NFIP Direct Servicing Agent--a FEMA
contractor that sells, services, and adjusts claims on about 4 percent of
flood insurance policies that are not, for various reasons, handled
through the WYO program.28 FEMA pays the NFIP Direct Servicing Agent for
selling and servicing flood insurance and for adjusting and processing
claims after a flood event through a competitively awarded contract at a
fixed cost. The contractor has calculated its cost to sell and service
policies as well as adjust claims following a non-catastrophic event based
on prior experience as a vendor for several WYO insurance companies. Based
on these calculations, the contractor charges a flat price per policy that
is not based on the premium amount. For example, a flood insurance policy
with a $400 premium would cost the NFIP Direct Servicing Agent the same to
service as a policy with $800 in premiums, based on a flat fee paid per
policy per month. For catastrophic flood events, such as Hurricane
Katrina, the NFIP Direct Servicing Agent submits receipts to the NFIP and
is reimbursed for expenses related to setting up a catastrophe center and
hiring additional staff.29

27See GAO, Crop Insurance: Opportunities Exist to Reduce Government Costs
for Private-Sector Delivery, RCED-97-70 (Washington, D.C.: April 1997).

28The NFIP Direct Servicing Agent services all policies not covered by WYO
insurance companies. Among the reasons an NFIP policy would be serviced by
the direct servicing agent are (1) the WYO insurance company that sold the
policy withdrew from the WYO program or went out of business or (2) the
policies are on a special class of properties that have suffered
repetitive losses that FEMA has chosen to administer through its servicing
agent. The NFIP Servicing Agent does not pay state premium taxes that WYO
insurance companies must pay on flood insurance premiums.

While the approach used to compensate the NFIP Direct Servicing Agent for
its services illustrates that information on actual costs incurred can be
developed by private sector entities participating in the NFIP, FEMA
officials have cautioned that differences in compensation approaches are
based on a different role for the contractor in the NFIP than that of the
WYO insurance companies. While the WYO insurance companies are paid on a
percentage basis to provide incentives for them to increase the number of
NFIP policies they have in force, the NFIP Direct Servicing Agent does not
market the NFIP; rather, it services the specialized group of policies it
is assigned in its contract with FEMA. Nevertheless, the financial
arrangement with the Direct Servicing Agent shows that cost information
can be collected and is useful in determining reasonable payments.

Although public-private partnerships for federal insurance programs such
as these include considerations of actual expense information and FEMA has
the legal authority to obtain such information from WYO insurance
companies, FEMA's current methodologies for determining payment amounts
are not based on an assessment of actual expenses the WYO insurance
companies incur and do not require that WYO insurance companies maintain
or report their expenses. As a result, FEMA does not know whether the
payments it makes to the WYO insurance companies reasonably reflect the
expenses they incur in selling and servicing NFIP policies and
establishing operations in flood-damaged areas.

29These activities are paid for through a Letter of Credit with the U.S.
Treasury and the Direct Servicing Agent is reimbursed for its actual
expenses.

Financial Management Controls Did Not Provide Assurance That Payments to WYO
Insurance Companies Were Proper and in Accordance with Program Requirements

Biennial financial statement audits--FEMA's primary management control
mechanism to provide assurances that it receives complete and accurate
financial management information from the WYO insurance companies--were
not performed on a consistent basis as required by regulation. FEMA's
regulations and the WYO Financial Control Plan require each participating
WYO insurance company to arrange for biennial financial audits that assess
its financial statements for activities related to the NFIP; audit costs
are covered by the expense allowance received from FEMA for selling and
servicing policies. However, many insurance companies participating in the
WYO program did not comply with the schedule. In addition, FEMA did not
have a mechanism in place for tracking and reviewing the results of the
biennial financial statement audits that were performed. Because the
biennial financial statement audits were not consistently completed and
reviewed, FEMA lacks assurance that it is making proper payments for the
services of the WYO insurance companies and that financial information is
being properly presented.

FEMA Regulations and Guidance Require Biennial Financial Audits of WYO Insurance
Companies to Assess the Quality of Financial Controls over NFIP-Related
Activities

FEMA regulations as implemented through its WYO Financial Control Plan
require each participating WYO insurance company to arrange for biennial
financial audits by independent CPA firms that assess its financial
statements for activities and controls related to the NFIP.30 The biennial
financial statement audits are intended to provide FEMA with an
independent assessment of the quality of financial controls over
activities related to WYO companies' participation in the NFIP and the
integrity of the financial data they report. Biennial financial statement
audits provide assurance that WYO insurance companies report complete and
accurate information on their NFIP activities, which are necessary to
ensure that payments made from the NFIP fund for services rendered are
proper and in accordance with program requirements. The third-party
financial audits are intended to reduce or eliminate the need for FEMA to
conduct on-site visits to WYO insurance companies to oversee their
financial activities.31 The audits provide opinions and report on the
fairness of the WYO insurance companies' financial statements, the
adequacy of internal controls, and the extent of the WYO insurance
companies' compliance with applicable laws and regulations. Some WYO
insurance companies conduct in-house financial management operations while
others subcontract with a flood insurance vendor, or subcontractor, to
handle financial reporting requirements and operations. When a vendor is
involved, WYO insurance companies that have contracted with the same
vendor generally hire an independent CPA firm to audit the vendor's
financial operations and provide an opinion on the quality of the
financial systems for all of the WYO insurance companies that subcontract
with the vendor.

30The financial control requirements applicable to WYO insurance companies
appear at 44 C.F.R.S62.23(j) and 44 C.F.R. pt. 62, app. B, which
incorporates by reference a separate document, "The Write Your Own Program
Financial Control Plan Requirements and Procedures."

Under FEMA regulation, WYO insurance companies are responsible for
selecting CPA firms to conduct their audits in accordance with generally
accepted auditing standards and generally accepted government auditing
standards issued by the Comptroller General. The audits are to be funded
by the WYO companies from the expense allowance (about 15 percent of
premium revenue) they receive for selling and servicing policies.

FEMA has several other methods for managing and overseeing the quality of
work performed by WYO insurance companies including monthly
reconciliations and manual validation and recalculation of the amounts
retained by the WYO insurance companies, reviews of the operations of the
WYO insurance companies at least once every 3 years, and quality assurance
reinspection of a sample of claims adjusted after each flood event. Our
review of these other methods of management and oversight determined that
they did not provide direct information about the propriety and accuracy
of payments made to the WYO insurance companies for their NFIP-related
activities. In addition, when FEMA has concerns regarding the propriety of
a WYO insurance company's financial reporting, the agency may conduct
audits "for cause." However, according to NFIP officials, FEMA has not
conducted any audits for cause during the 7-year period we reviewed.

31An exception to the requirement is allowed for WYO insurance companies
that were audited by a CPA firm under contract with the FEMA or DHS Office
of Inspector General (OIG) during the 2-year period. For those WYO
insurance companies, biennial financial audits are required to cover only
1 year of the 2-year period. In March 2003, when FEMA became part of DHS,
the DHS OIG assumed responsibility for financial audits of the NFIP.
However, FEMA's WYO Financial Control Plan was last revised in December
1999 and did not reflect the change in responsibility. FEMA provided two
DHS OIG audit reports for the NFIP--a 2002 audit that included tests of
controls related to the financial activities of six WYO insurance
companies and a 2004 audit that included tests of controls related to five
WYO insurance companies. According to an official of the DHS OIG, in 2005,
no official audit report was issued because the independent CPA firm that
conducted the audit submitted the results late. Instead of issuing an
audit report, the independent CPA firm provided a copy of the audit
results to the NFIP. As of May 2007, the 2006 DHS OIG audit of the NFIP
was still in process, according to the official.

Most WYO Insurance Companies Did Not Meet the Biennial Financial Statement Audit
Schedule Required by FEMA

As shown in figure 4, for biennial audits done during the period from
fiscal year 2001 to 2006, the majority of participating WYO insurance
companies did not comply with FEMA's requirement for biennial audits of
their financial operations to be conducted. The officials also said that
34 additional WYO insurance companies were granted extensions by FEMA to
complete their fiscal year 2005-2006 biennial financial statement audits
by September 30, 2007.

Figure 4: Biennial Financial Statement Audits of WYO Insurance Companies
Completed from Fiscal Years 2001 to 2006

Note: Numbers for participating WYO insurance companies are those at the
end of fiscal years 2002, 2003, 2004, and 2006.

Thirty-nine of the 40 biennial financial statement audits that were
completed for fiscal years 2001 to 2002 were the results of a review by
one independent CPA firm at a vendor for the 39 WYO insurance companies.
Similarly, 23 of the 37 biennial financial statement audits completed for
fiscal years 2002 to 2003 and all 35 of the biennial financial statement
audits that were completed for fiscal years 2003 to 2004 were the results
of reviews of two vendors and resulting reports by two independent CPA
firms. In these cases, the CPA firm visited a single flood insurance
vendor or subcontractor with which the audited WYO insurance companies
subcontracted to handle aspects of their NFIP business.

According to the Deputy Assistant Administrator for Insurance of FEMA's
Mitigation Division with responsibility for management and oversight of
the NFIP, FEMA did not require all WYO insurance companies to meet the
schedule for completing biennial financial statement audits during the
period we reviewed because some companies were in the process of
contracting with new vendors, or subcontractors, to do their financial
reporting so doing financial audits would have been particularly costly
and difficult. In addition, the Deputy Assistant Administrator said that
FEMA had no indication that the WYO insurance companies that did not have
biennial financial statement audits performed had any financial management
weaknesses. Nonetheless, without having the biennial audits conducted as
required by regulation, FEMA lacks assurance that WYO insurance companies
have financial systems in place to ensure that proper payments are made
and controls are in place for the services of the WYO insurance companies.
This assurance is necessary for FEMA to meet the internal control standard
for federal government agencies that they have reasonable assurance
program objectives are being achieved and operations are effective and
efficient. In addition, according to standards for internal controls
within the federal government, such a control mechanism is important in
agencies like FEMA where large amounts of data are processed; where audit
techniques may be used to identify inefficiencies, waste, or abuse; and
where managers should be able to promptly review and evaluate audit
findings in order to identify opportunities for improvements.

The Deputy Assistant Administrator also said that FEMA did not seek to
recoup the portion of the allowance paid from the NFIP fund for biennial
financial statement audits from the companies that did not have them
performed. He said that reimbursement was not requested because the
public-private partnership depends upon a level of cooperation without a
constant exchange of dollars.

Biennial Financial Statement Audits Identified One Company with Material
Weaknesses and Some Noncompliance and Internal Control Weaknesses

For the biennial financial statement audits that were completed from
fiscal year 2001 through fiscal year 2006, the independent CPA firms
identified material weaknesses in one instance and they identified some
other internal control weaknesses and instances of noncompliance with
financial reporting requirements.32 In all but one of the audit reports
completed, the independent CPA firm issued an unqualified opinion that for
the WYO insurance companies it audited, the financial statements fairly
presented, in all material respects, the WYO program assets, liabilities,
and accumulated deficit. The various audit opinions also stated that the
results of operations and cash flows of the companies' participation in
the WYO program for the 2-year periods audited conformed with generally
accepted accounting principles in the United States.

32The American Institute of Certified Public Accountants standard defines
a material weakness as a reportable condition in which the design or
operation of one or more of the internal control components does not
reduce to a relatively low level the risk that misstatements caused by
error or fraud in amounts that would be material in relation to the
financial statements being audited may occur and not be detected within a
timely period by employees in the normal course of performing their
assigned functions.

The audit in which material weaknesses were identified involved one WYO
insurance company during fiscal years 2002 to 2003. The independent CPA
firm that conducted the audit found significant deficiencies in design or
operation of internal controls over financial reporting that could affect
the company's ability to record, process, summarize, and report financial
data. Actions by the WYO insurance company to resolve the weaknesses
identified were documented and included engaging a new vendor for its
financial management functions. According to the Deputy Assistant
Administrator, as of July 2007, the company did not participate in the WYO
program.

Among the instances in which internal control weaknesses and instances of
noncompliance were identified, a CPA firm noted in its fiscal year 2001 to
2002 audit report that it considered a vendor's lack of internal control
procedures over its financial reporting to be a significant deficiency
that could adversely affect its ability to record, process, summarize, and
report financial data for the 39 WYO insurance companies with which it had
contracted to perform financial management activities. The audit report
also found that accounting department and executive staff did not have the
appropriate accounting expertise to adequately review and identify errors
in the financial reporting process. The vendor disagreed with the audit
report recommendation that it develop formalized procedures or controls
over financial reporting but indicated that it would evaluate and document
future procedures as necessary. A FEMA official said that FEMA did not
follow up on the audit recommendations because the vendor went out of
business shortly after the audit was completed. An audit report for fiscal
year 2003 to 2004 covering another vendor's financial management
activities for 35 WYO insurance companies cited instances of noncompliance
such as documentation missing from policy files and reports from claims
adjusters not being filed within specified time frames. WYO insurance
companies agreed to take action to address the audit recommendations.

FEMA Did Not Track or Review Financial Statement Audits

FEMA did not have a mechanism in place for tracking and reviewing the
results of the biennial financial statement audits that were performed.
FEMA officials were able to provide us with copies of only two biennial
audit reports until the conclusion of our audit when they asked WYO
insurance companies and their subcontractors to send copies of additional
reports that might have been prepared. Thus, it was apparent that the
results of the financial audits were not considered and used by FEMA to
identify opportunities for program improvements.

Conclusions

The NFIP was structured more than 25 years ago as a public-private
partnership between the government and private insurance companies that
agree to sell and service flood insurance policies on the government's
behalf. Over the years, the program has made flood insurance widely
available to consumers, while FEMA and the taxpayers have assumed all of
the financial risks for the program, should premiums be insufficient to
cover claims. In the aftermath of the catastrophic flood events of 2005,
which tested all aspects of the federal government's response to
large-scale natural disasters, FEMA and the WYO insurance companies worked
together to settle an unprecedented number of flood insurance claims
reasonably quickly. Moreover, the partnership has, over time, relieved
FEMA of the need to develop, hire, and train an in-house corps of sales
agents, adjusters, and others to administer flood insurance. However,
while the WYO program has been beneficial, FEMA runs the risk of not being
able to ensure that it is able, as time goes on, to manage and control the
program's costs. In fiscal year 2006--the catastrophic year that included
payments for claims resulting from Hurricane Katrina--FEMA paid almost 65
cents of every dollar collected in premiums to the WYO insurance
companies.

Two factors account for the operating cost-related risks FEMA incurs
through the WYO program. First, because FEMA cannot ensure that the
schedule of operating costs it pays to WYO insurance companies is based on
reasonable estimates of their expenses, FEMA does not know whether the
operating costs it pays appropriately reflect the expenses the WYO
insurance companies incur in selling and servicing NFIP policies and
adjusting claims. This is primarily because FEMA has not significantly
changed its methodologies for determining the schedule of operating costs
for WYO insurance companies since 1983, when the current structure was
created. As a result, the underlying methodologies may not take into
account factors that have changed over the life of the program. For
example, costs of claims settlements have trended upward as the costs of
labor and materials to repair flood-damaged properties have increased,
resulting in larger payment amounts to WYO insurance companies for
adjusting claims. Information on costs WYO insurance companies allocate to
their federal flood business has been collected and reported by the NAIC
since 1997 and reviewed by FEMA since 2004. Such information could be
helpful to FEMA officials in determining appropriate payments to WYO
insurance companies for the services they perform for the NFIP; however,
FEMA officials said that they do not use the information to help determine
a schedule of operating expenses because the WYO insurance companies are
inconsistent in the ways they allocate costs to flood insurance and report
the data.

Second, a lack of sufficient oversight of WYO insurance companies'
financial management processes limits FEMA's ability to ensure that
payments made to the WYO insurance companies participating in the NFIP
were proper and in accordance with program requirements--and ensure that
its operations are effective and efficient. Biennial financial statement
audits were not completed as required by FEMA regulation.

Recommendations for Executive Action

To improve financial accountability over payments the NFIP makes to the
WYO insurance companies, to strengthen controls over expenditures of
policyholders' and taxpayers' dollars, and to provide assurance that
payments made to the WYO insurance companies are proper and in accordance
with program requirements, we are recommending that the Secretary of
Homeland Security direct the Under Secretary of Homeland Security, FEMA,
to take the following two actions:

           1. Ensure that its approach to establishing a schedule of
           operating costs is based on a reasonable estimate of actual
           expenses by taking such actions as FEMA deems necessary such as
           working with NAIC to ensure consistency in the way all WYO
           insurance companies compile and report data on expenses allocated
           to their federal flood business.
           2. Ensure that biennial financial statement audits of WYO
           insurance companies are conducted by independent CPA firms as
           required by FEMA regulation, and that FEMA reviews the audits to
           ensure that payments made are proper and in accordance with
           program requirements.

Agency Comments and Our Evaluation

On August 29, 2007, DHS provided written comments on a draft of this
report dated August 14, 2007. DHS generally agreed with our
recommendations to improve financial accountability over payments the NFIP
makes to the WYO insurance companies. However, DHS said our presentation
in table 1 of payments to WYO insurance companies for all NFIP services
for fiscal years 2004 to 2006 as a percentage of total premium revenues
was "inappropriate and misleading" because it was most appropriate to
compare the costs of adjusting and processing claims to total losses in a
year, not premium revenue. We disagree. We believe it is appropriate to
summarize aggregate expense payment data as a percentage of premiums
collected because, as noted in the report, the NFIP is designed to pay for
flood losses and operating expenses to the extent possible with premium
revenues rather than tax dollars. Our report also provides detailed
information on the types of WYO payments made each year separately for
claims and other costs, including agent commissions and expenses for
selling and servicing policies.

DHS concurred with our recommendation to work with NAIC to improve the
consistency in the way WYO insurance companies compile and report this
data so that it is useful as an estimate of the WYO companies' actual
expenses for selling and servicing flood insurance policies. As progress
is made, it will be incumbent upon FEMA to determine whether the data
already collected on flood insurance program expenses are reliable and
sufficiently comprehensive for FEMA to make a reasonable estimate of WYO
insurance companies' actual expenses. DHS also concurred with our
recommendation that financial statement audits be conducted and the
results reviewed.

We are sending copies of this report to the Secretary of the Department of
Homeland Security, the Administrator of the Federal Emergency Management
Agency, selected congressional committees, and other interested parties.
In addition, the report will be available at no charge on the GAO Web site
at http://www.gao.gov. Please contact William Jenkins at (202) 512-8757 or
[43][email protected] if you or your staff have any questions concerning
this report. Contact points for our Offices of Congressional Relations and
Public Affairs may be found on the last page of this report. Key
contributors to this report are listed in appendix IV.

William O. Jenkins, Jr.
Director, Homeland Security and Justice Issues

Listd of Congressional Committees:

The Honorable Christopher J. Dodd
Chairman
The Honorable Richard C. Shelby
Ranking Member
Committee on Banking, Housing, and Urban Affairs
United States Senate

The Honorable Joseph I. Lieberman
Chairman
The Honorable Susan M. Collins
Ranking Member
Committee on Homeland Security and Governmental Affairs
United States Senate

The Honorable Barney Frank
Chairman
The Honorable Spencer Bachus
Ranking Member
Committee on Financial Services
House of Representatives

The Honorable Bennie G. Thompson
Chairman
The Honorable Peter T. King
Ranking Member
Committee on Homeland Security
House of Representatives

The Honorable Henry A. Waxman
Chairman
The Honorable Tom Davis
Ranking Member
Committee on Oversight and Government Reform
House of Representatives

Appendix I: Scope and Methodology

To assess how much the Federal Emergency Management Agency (FEMA) paid in
recent years to the Write Your Own (WYO) insurance companies that sell and
service NFIP policies and adjust claims and how FEMA determines the amount
of these operating costs, we analyzed data on amounts paid to WYO
insurance companies for fiscal years 2004-2006. We also interviewed FEMA
officials on how FEMA set the payment levels and how the agency reviews
the methodologies in place to determine that they remain appropriate over
time, and we examined available documentation on FEMA's payment
methodologies. The data we examined included the amounts FEMA paid to WYO
companies for selling and servicing policies, for growth incentive
bonuses, and for expenses related to adjusting flood claims and paying
flood claims adjusters. We discussed with FEMA officials the internal
control processes in place and observed the monthly process used by FEMA's
program contractor to reconcile cost information submitted by WYO
insurance companies. We also reviewed audits of Department of Homeland
Security (DHS) financial statements prepared for the DHS Office of
Inspector General. We determined that the information was sufficiently
reliable for our purposes. We conducted semi-structured interviews with
representatives of a judgmental sample of five WYO insurance companies and
National Association of Insurance Commission (NAIC) officials to obtain
their perspective on FEMA's payment methodologies. Our sample included
representatives of four of the five largest participating WYO insurance
companies in terms of their market share of NFIP policies in force in 2006
and one mid-sized WYO insurance company. Our sample is not a
representative sample of all participating WYO insurance companies, so the
views expressed should not be generalized to the universe of the 88
participating companies.

To determine how the approach FEMA uses to establish a schedule of
operating costs provides assurance that it is based on reasonable
estimates of WYO insurance companies' expenses for the services rendered,
we reviewed the statutory and regulatory framework for establishing a
schedule of operating costs and obtained the views of FEMA and insurance
industry officials on the effectiveness of the current payment approach
and the potential implications of implementing other payment
methodologies. We also assessed how the approach FEMA currently uses to
pay WYO insurance companies for their services compares to payment
methodologies used by two similar public-private insurance arrangements.
To compare other public-private insurance partnerships, we first
identified the universe of similar arrangements with which to compare the
NFIP. We reviewed literature including prior GAO reports on federal
government insurance programs. We determined and confirmed with NFIP
officials that the only other federal insurance program with similar
public-private partnership arrangements was the Federal Crop Insurance
Corporation (FCIC), an insurance program that protects participating
farmers against the financial losses caused by events such as droughts,
floods, hurricanes, and other natural disasters. In addition, we
determined that FEMA's contract with the NFIP Direct Servicing Agent, the
contractor that administers four percent of NFIP policies on behalf of
FEMA, used methods for calculating and paying for activities to sell and
service policies and adjust claims that should be included in our scope.
We then interviewed officials and reviewed contract and budget information
on these two arrangements. Our analysis was designed to compare and
contrast the arrangements to the NFIP's WYO program. We did not make
determinations on which programs had the best practices because
information was not available on the expenses incurred by WYO insurance
companies for their services to the NFIP. Our review was limited to the
structure of the financial arrangements between the federal government and
the FCIC and NFIP Direct Servicing Agent to compensate the private
entities for selling and servicing government insurance policies and
adjusting claims. We did not assess the overall performance of the FCIC
and the NFIP Direct Servicing Agent.

To determine the extent to which FEMA's financial management controls for
WYO companies provide assurance that payments are proper and in accordance
with program requirements, we reviewed FEMA's regulations and procedures
for monitoring and overseeing payments of expenses to WYO insurance
companies for selling and servicing NFIP policies. We analyzed the
schedule and results of biennial financial audits conducted for fiscal
years 2001 to 2006. In addition, we reviewed financial audits of the NFIP
done by the DHS Office of Inspector General for fiscal years 2003 to 2006.
In addition to biennial financial audits, we also reviewed other FEMA
oversight mechanisms. We analyzed the results of 15 operational reviews
and follow-up visits FEMA performed at WYO insurance companies from 2001
through February 2005, and we reviewed a statistically valid sample of
quality assurance reinspections of claims adjustments for Hurricanes
Katrina and Rita, and we determined that these oversight mechanisms did
not provide direct information about the propriety and accuracy of
payments made to the WYO insurance companies for their NFIP-related
activities. We performed our work from June 2006 through July 2007, in
accordance with generally accepted government auditing standards.

Appendix II: Percentage Allowances FEMA Authorized WYO Insurance Companies
to Retain for Operating Expenses Incurred in Selling and Servicing NFIP
Policies (Fiscal Years 1984-2007)

Fiscal year Expense allowance percentage 
2007                                30.2 
2006                                30.8 
2005                                31.2 
2004                                31.8 
2003                                31.8 
2002                                32.3 
2001                                31.0 
2000                                31.7 
1999                                31.7 
1998                                31.6 
1997                                32.6 
1996                                32.6 
1995                                32.6 
1994                                32.6 
1993                                32.0 
1992                                31.8 
1991                                30.3 
1990                                30.5 
1989                                30.1 
1988                                30.4 
1987                                32.2 
1986                                32.7 
1985                                32.0 
1984                                29.5 

Source: FEMA.

Appendix III: Comments from the Department of Homeland Security

Appendix IV: GAO Contact and Staff Acknowledgments

GAO Contact

William O. Jenkins, Jr. (202) 512-8777 or [44][email protected]

Acknowledgments

In addition to the contact named above, Christopher Keisling, Assistant
Director; Amy Bernstein; Christine Davis; Dewi Djunaidy; Wilfred Holloway;
Tracey King; Deborah Knorr; and Jesus Ramoz made significant contributions
to this report.

Related GAO Products

National Flood Insurance Program

National Flood Insurance Program: New Processes Aided Hurricane Katrina
Claims Handling, but FEMA's Oversight Should Be Improved. [45]GAO-07-169 .
Washington, D.C.: December 15, 2006.

GAO's High-Risk Program. [46]GAO-06-497T . Washington, D.C.: March 15,
2006.

Federal Emergency Management Agency: Challenges for the National Flood
Insurance Program. [47]GAO-06-335T . Washington, D.C.: January 25, 2006.

Federal Emergency Management Agency: Improvements Needed to Enhance
Oversight and Management of the National Flood Insurance Program.
[48]GAO-06-119 . Washington, D.C.: October 18, 2005.

Flood Insurance: Challenges Facing the National Flood Insurance Program.
[49]GAO-03-606T . Washington, D.C.: April 1, 2003.

Major Management Challenges and Program Risks: Federal Emergency
Management Agency. [50]GAO-03-113 . Washington, D.C.: January 1, 2003.

Flood Insurance: Extent of Noncompliance with Purchase Requirements Is
Unknown. [51]GAO-02-396 . Washington, D.C.: June 21, 2002.

Flood Insurance: Information on the Financial Condition of the National
Flood Insurance Program. [52]GAO-01-992T . Washington, D.C.: July 19,
2001.

Flood Insurance: Emerging Opportunity to Better Measure Certain Results of
the National Flood Insurance Program. [53]GAO-01-736T . Washington, D.C.:
May 15, 2001.

Flood Insurance: Private Companies' Participation in the Write Your Own
Program. RCED-87-108. Washington, D.C.: May 29, 1987.

Federal Crop Insurance Corporation

Crop Insurance: Opportunities Exist to Reduce Government Costs for
Private-Sector Delivery. RCED-97-70. Washington, D.C.: April 17, 1997.

Crop Insurance: Participation in and Costs Associated with the Federal
Program. RCED-88-171BR. Washington, D.C.: July 6, 1988.

(440539)

[54]www.gao.gov/cgi-bin/getrpt?GAO-07-1078 .

To view the full product, including the scope
and methodology, click on the link above.

For more information, contact William O. Jenkins, (202) 512-8757 or
[email protected].

Highlights of [55]GAO-07-1078 , a report to congressional committees

September 2007

NATIONAL FLOOD INSURANCE PROGRAM

FEMA's Management and Oversight of Payments for Insurance Company Services
Should Be Improved

Extraordinary recent flood events raise serious questions about the
solvency of the National Flood Insurance Program (NFIP), which is
administered by the Federal Emergency Management Agency (FEMA). The NFIP
is largely implemented by private insurance companies that sell and
service policies and adjust claims under the Write Your Own (WYO) Program.
This report, prepared under the authority of the Comptroller General,
examines (1) how much FEMA paid the WYO companies in recent years for
operating costs and how FEMA determined payment amounts; (2) how FEMA's
approach to determining operating costs assures that payments are
reasonable estimates of companies' expenses; and (3) how FEMA assures that
financial and management controls are in place for the WYO program and
operate as intended. To do these assessments, GAO interviewed FEMA and
insurance officials, and analyzed statutes, regulations, payment data,
methodologies, and audits of WYO companies.

[56]What GAO Recommends

GAO recommends that FEMA take steps to ensure that it has a reasonable
estimate of actual expenses WYO companies incur to help determine payments
for services and that financial audits are performed. The Department of
Homeland Security reviewed a draft of this report and generally agreed
with our recommendations.

FEMA's payments to WYO insurance companies for operating costs ranged from
more than a third to almost two-thirds of the total premiums paid by
policyholders to the NFIP for fiscal years 2004 through 2006. In fiscal
years 2005 and 2006, larger payments to WYO insurance companies were the
result of settling an unprecedented number and dollar amount of claims for
damages resulting from major hurricanes and flood events including
Hurricane Katrina. To determine the amount of these payments, FEMA
negotiated payment approaches with insurance industry representatives when
it established the current WYO program in 1983 based on industry averages
for operating expenses for other lines of insurance (such as homeowners,
commercial, and fire), past practice, and discussion.

The approach FEMA uses to determine operating costs for WYO insurance
companies, rooted in policies negotiated and established about 25 years
ago, cannot ensure that payments are based on reasonable estimates of
actual expenses because actual expenses incurred by the companies for
their services to the NFIP are not considered. Although it has authority
to do so, FEMA does not collect data on actual WYO flood insurance
expenses that could provide a basis for insuring that the WYO payments are
based on a reasonable estimate of actual expenses. FEMA officials said
that they have not asked WYO insurance companies to provide expense
information due to concerns that the approach would increase FEMA's
administrative costs and cause a decline in WYO program participation.
However, some data on expenses WYO insurance companies allocate to flood
insurance are available. FEMA officials said that they cannot use this
information due to reporting inconsistencies. Also, there is some
precedent in two similar public-private insurance partnerships for
collecting actual expense information. FEMA's decision to rely on
long-standing practices does not meet federal internal control standards
that agencies be held accountable for, among other things, stewardship of
government resources.

Biennial financial statement audits--FEMA's primary mechanism to provide
assurance that it receives complete and accurate financial management
information from the WYO insurance companies--were not performed
consistently as required by regulation. FEMA regulations require each
participating company to arrange and pay for these audits by independent
certified public accounting firms. However, many WYO insurance companies
did not comply with the schedule in recent years. For example, for fiscal
years 2005 and 2006, 5 of 94 participating companies had biennial
financial statement audits performed. FEMA officials said they allowed
some companies to delay having the audits done because they were in the
process of contracting with new subcontractors to perform their financial
reporting responsibilities. Nonetheless, without the required biennial
audits, FEMA lacks an appropriate internal control mechanism for effective
program oversight.

References

Visible links
  39. http://www.gao.gov/cgi-bin/getrpt?GAO-01-992T
  40. http://www.gao.gov/cgi-bin/getrpt?GAO-06-497T
  41. http://www.gao.gov/cgi-bin/getrpt?GAO-06-335T
  42. http://www.gao.gov/cgi-bin/getrpt?GAO-07-169
  43. mailto:[email protected]
  44. mailto:[email protected]
  45. http://www.gao.gov/cgi-bin/getrpt?GAO-07-169
  46. http://www.gao.gov/cgi-bin/getrpt?GAO-06-497T
  47. http://www.gao.gov/cgi-bin/getrpt?GAO-06-335T
  48. http://www.gao.gov/cgi-bin/getrpt?GAO-06-119
  49. http://www.gao.gov/cgi-bin/getrpt?GAO-03-606T
  50. http://www.gao.gov/cgi-bin/getrpt?GAO-03-113
  51. http://www.gao.gov/cgi-bin/getrpt?GAO-02-396
  52. http://www.gao.gov/cgi-bin/getrpt?GAO-01-992T
  53. http://www.gao.gov/cgi-bin/getrpt?GAO-01-736T
  54. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1078
  55. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1078
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