Federal Emergency Management Agency: Ongoing Challenges Facing	 
the National Flood Insurance Program (02-OCT-07, GAO-08-118T).	 
                                                                 
The National Flood Insurance Program (NFIP), established in 1968,
provides property owners with some insurance coverage for flood  
damage. The Federal Emergency Management Agency (FEMA) within the
Department of Homeland Security is responsible for managing the  
NFIP. Given the challenges facing the NFIP and the need for	 
legislative reform to ensure the financial stability and ongoing 
viability of this program, GAO placed the NFIP on its high-risk  
list in March 2006. This testimony updates past work and provides
information about ongoing GAO work on issues including (1) NFIP's
financial structure, (2) the extent of compliance with mandatory 
requirements, (3) the status of map modernization efforts, and	 
(4) FEMA's oversight of the NFIP. Building on our previous and	 
ongoing work on the NFIP, GAO collected data from FEMA to update 
efforts, including information about claims, policies, repetitive
loss properties, and mitigation efforts.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-118T					        
    ACCNO:   A76928						        
  TITLE:     Federal Emergency Management Agency: Ongoing Challenges  
Facing the National Flood Insurance Program			 
     DATE:   10/02/2007 
  SUBJECT:   Claims processing					 
	     Claims settlement					 
	     Financial management				 
	     Flood insurance					 
	     Floods						 
	     Hurricane Katrina					 
	     Insurance claims					 
	     Insurance premiums 				 
	     Policy evaluation					 
	     Program evaluation 				 
	     Program management 				 
	     Property damage claims				 
	     Property losses					 
	     Reporting requirements				 
	     Risk assessment					 
	     Risk management					 
	     Policies and procedures				 
	     Program coordination				 
	     Program costs					 
	     FEMA National Flood Insurance Program		 
	     GAO High Risk Series				 

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GAO-08-118T

   

     * [1]In summary:
     * [2]Background
     * [3]The NFIP's Financial Structure is Not Designed to be Actuari

          * [4]Policy Subsidies Significantly Reduce NFIP's Income from Pre
          * [5]Repetitive Loss Properties Continue to be a Drain on the Pro
          * [6]Remapping Is Creating A New Generation of Properties That Ma

     * [7]FEMA Has Expanded Participation in the NFIP, but Ensuring Co
     * [8]FEMA Faces Challenges in Producing Accurate, Updated Flood M
     * [9]FEMA's Monitoring and Oversight Have Identified Specific Pro
     * [10]Concluding Observations
     * [11]GAO Contact and Staff Acknowledgments
     * [12]GAO's Mission
     * [13]Obtaining Copies of GAO Reports and Testimony

          * [14]Order by Mail or Phone

     * [15]To Report Fraud, Waste, and Abuse in Federal Programs
     * [16]Congressional Relations
     * [17]Public Affairs

Testimony

Before the Committee on Banking, Housing and Urban Affairs, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery
Expected at 10:30 a.m. EDT
Tuesday, October 2, 2007

FEDERAL EMERGENCY MANAGEMENT AGENCY

Ongoing Challenges Facing the National Flood Insurance Program

Statement of Orice Williams, Director
Financial Markets and Community Investments

GAO-08-118T

Mr. Chairman and Members of the Committee:

I appreciate the opportunity to participate in today's hearing on the
National Flood Insurance Program (NFIP) and the challenges facing the
Federal Emergency Management Agency (FEMA), which oversees it. As you
know, the NFIP has been on GAO's high-risk list since March 2006, and my
statement today focuses on the ongoing challenges facing the program. Over
the past three decades, we have identified numerous challenges to the
program that affect its day-to-day operations and future financial
stability. Recently, we reported on NFIP's unprecedented financial and
regulatory strains in the aftermath of the 2005 hurricane season.^1 As a
result, the program has had to borrow extensively from the U.S. Treasury
in order to pay claims and expenses. With the current program expiring
next September, this and other issues warrant review and debate, including
how best to structure the NFIP so that it provides financial protection
for those who need and would benefit from flood insurance while enhancing
the program's financial foundation.

My testimony today will revisit and update the four major challenges
facing the NFIP:

           o Reducing losses to the program from policy subsidies and
           repetitive loss properties--that is, properties in high-risk areas
           that flood repeatedly and that make repeated claims on the NFIP;

           o Increasing property owner participation in the program to
           include not only homeowners in high-risk areas, but also those who
           live in less flood-prone areas that are still at risk of
           experiencing losses from flooding;

           o Developing accurate, digital flood maps that can provide the
           information the program needs to determine which areas are most at
           risk of flooding; and

           o Providing effective oversight of flood insurance operations to
           ensure that the NFIP is making appropriate payments to the
           insurance companies, insurance agents, and claims adjusters
           responsible for the day-to-day process of selling and servicing
           flood insurance policies.

^1GAO, National Flood Insurance Program: New Process Aided Hurricane
Katrina Claims Handling, but FEMA's Oversight Should Be Improved,
[18]GAO-07-169 (Washington, D.C.: Dec. 15, 2006).

My statement is based largely on completed work on the 2005 claims process
and subsequent payments to insurance companies for services rendered and
ongoing work on subsidized properties; the rate-setting process for flood
insurance premiums; financial and statistical information on the NFIP from
a variety of sources; and the Write-Your-Own (WYO) program, under which
insurance companies enter into agreements with FEMA to sell and service
flood insurance policies and adjust claims after flood losses; and FEMA's
oversight. In conducting our work, we collected relevant data from FEMA;
analyzed statutes, regulations, and payment data relevant to the NFIP; and
interviewed FEMA officials, FEMA contractors, insurance company officials,
and state and local officials to obtain information relevant to their
experience with NFIP. Some of the work was also based on interviews with
individual policyholders, insurance agents, and claims adjusters, and on
audits of private insurance companies that sell and service flood
insurance on behalf of FEMA. We performed our work in accordance with
generally accepted government auditing standards.

In summary:

One of the biggest challenges facing the NFIP is the actuarial soundness
of the program. As of August 2007, FEMA owed over $17.5 billion to the
U.S. Treasury, largely resulting from losses during the 2005 hurricanes.
FEMA is unlikely to be able to pay this debt primarily because many of the
program's premium rates have been set to cover losses in an average
historical year based on program experience that did not include any
catastrophic losses. To keep the cost of flood insurance affordable,
Congress included premium subsidies, and as a result the program does not
take in as much in premiums as it pays out in claims. With these
subsidies, some policyholders with structures that were built before
floodplain management regulations were established in their communities
pay premiums that represent about 35 to 40 percent of the true risk
premium. Moreover, about 1 percent of NFIP-insured properties that suffer
repetitive losses account for between 25 and 30 percent of all flood
claims. FEMA is also creating a new generation of "grandfathered"
properties that are mapped into higher-risk areas and that have an
existing policy or purchase a new flood insurance policy prior to the
adoption of new maps. The properties may be eligible to receive a
discounted or "grandfathered" premium rate equal to the nonsubsidized rate
for their old risk designation. Placing the program on more sound
financial footing will involve trade-offs in how best to balance the need
for charging higher premiums, which would put the program on a sounder
financial basis while continuing to encourage participation in the
program.

The NFIP also faces challenges expanding its policyholder base by
enforcing compliance with mandatory purchase requirements and promoting
voluntary purchase by other homeowners, some of whom live in areas that
are at less risk. While flood insurance is mandatory for homeowners who
live in certain high-risk areas and have mortgages held by federally
regulated financial institutions, determining the extent of compliance can
be complicated. One recent study estimated that compliance with the
mandatory purchase requirement was about 75 to 80 percent but that the
penetration elsewhere in the market was only 1 percent. Moreover, since
2004, FEMA has implemented a mass media campaign called "FloodSmart" to
educate the public about the risks of flooding and to encourage the
purchase of flood insurance. While the numbers of policyholders has
increased following Hurricane Katrina, it is unclear whether these
policyholders will remain in the program as time goes on.

The impact of the 2005 hurricanes highlighted the importance of having
accurate, up-to-date flood maps that identify areas that are at risk of
flooding and thus the areas where property owners would benefit from
purchasing flood insurance. While requirements for purchasing flood
insurance apply only to certain properties in high-risk areas, according
to FEMA about half of all flood damage occurs outside of areas currently
mapped as high-risk areas. In response to recommendations from Congress,
GAO, and others, FEMA has taken steps to adjust its map modernization
efforts by changing its mapping standards and guidelines and adjusting
risk-based mapping priorities. However, managing its relationship with its
contractor and with state and local partners--all with varying technical
capabilities and resources--to produce accurate digital flood maps is an
ongoing challenge. Likewise, assuring that map standards are consistently
applied across communities once the maps are created is a similar
challenge.

FEMA, which oversees the NFIP program, also faces significant challenges
in providing effective oversight over the insurance companies and
thousands of insurance agents and claims adjusters that are primarily
responsible for the day-to-day process of selling and servicing flood
insurance policies. In response to our recommendations an interim report
issued in September 2007, FEMA has agreed to take steps to ensure that it
has a reasonable estimate of the actual expenses the insurance companies
incur to help determine whether payments for services are appropriate and
to ensure that required financial audits are performed.^2

Background

The NFIP provides property insurance for flood victims, maps the
boundaries of the areas at highest risk of flooding, and offers incentives
for communities to adopt and enforce floodplain management regulations and
building standards to reduce future flood damage. The effective
integration of all three of these elements is needed for the NFIP to
achieve its goals. These include:

           o providing property flood insurance coverage for the many
           property owners who would benefit from such coverage;

           o reducing taxpayer-funded disaster assistance for property damage
           when flooding strikes; and

           o reducing flood damage to properties through floodplain
           management that is based on accurate, useful flood maps and the
           enforcement of relevant building standards.

Floods are the most common and destructive natural disaster in the United
States. According to NFIP statistics, 90 percent of all natural disasters
in the United States involve flooding. Our analysis of FEMA data found
that over the past 25 years, about 97 percent of the U.S. population lived
in a county that had at least one declared flood disaster, and 45 percent
lived in a county that that had six or more flood disaster declarations.^3
However, flooding is generally excluded from homeowner insurance policies
that typically cover damage from other losses, such as wind, fire, and
theft. Because of the catastrophic nature of flooding and the difficulty
of adequately predicting flood risks, as well as the fact that those who
are most at risk are the most likely to buy coverage, private insurance
companies have largely been unwilling to underwrite and bear the risk of
flood insurance.^4

^2GAO, National Flood Insurance Program: FEMA's Management and Oversight of
Payments for Insurance Company Services Should Be Improved,
[19]GAO-07-1078 (Washington D.C.: Sept. 5, 2007).

^3GAO, Natural Hazard Mitigation: Various Mitigation Efforts Exist, but
Federal Efforts Do Not Provide a Comprehensive Strategic Framework,
[20]GAO-07-403 (Washington, D.C.: Aug. 22, 2007).

The NFIP was established by 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.^5 In creating the NFIP, Congress found
that a flood insurance program with the "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."^6 In
keeping with this purpose, 92 private insurance companies were
participating in the WYO program as of September 2007. NFIP pays these
insurers fees to sell and service policies and adjust and process claims.
FEMA, which is within the Department of Homeland Security (DHS), is
responsible for the oversight and management of the NFIP. We reported in
September 2007 that about 68 FEMA employees, assisted by about 170
contract employees, manage and oversee the NFIP and the National Flood
Insurance Fund, into which premiums are deposited and claims and expenses
are paid. As of April 2007, the NFIP was estimated to have over 5.4
million policies in about 20,300 communities.^7 To ensure that NFIP can
cover claims after catastrophic events, FEMA has statutory authority to
borrow funds from the Treasury to keep the program solvent.^8

According to FEMA, an estimated $1.2 billion in flood losses are avoided
annually because communities have implemented the NFIP's floodplain
management requirements. Flood maps identify the boundaries of the areas
that are most at risk of flooding. Property owners whose properties are
within special flood hazard areas and who have mortgages from a federally
regulated lender are required to purchase flood insurance for the amount
of their outstanding mortgage balance, up to the maximum policy limit of
$250,000 for single-family homes. According to FEMA, Excess Flood
Protection coverage above these amounts is available in the private
insurance markets. Personal property coverage is available for contents,
such as furniture and electronics, for an additional $100,000. Business
owners may purchase up to $500,000 of coverage for buildings and $500,000
for contents. The owners of properties with no mortgages or properties
with mortgages held by lenders who are not federally regulated are not
required to buy flood insurance, even if the properties are in a special
flood hazard area. Optional lower-cost coverage is available under the
NFIP to protect homes in areas of low to moderate risk.

^4According to FEMA, many private insurers offer Excess Flood Protection,
which provides higher limits of coverage than the NFIP, in the event of
catastrophic loss by flooding.

^5The National Flood Insurance Act of 1968, as amended, is codified at 42
U.S.C. SS 4001 et seq.

^642 U.S.C.S 4001(b).

^7FEMA defines a community as, any state or area or political subdivision
thereof, or any Indian tribe or authorized tribal organization, which has
authority to adopt and enforce floodplain management regulations for the
areas within its jurisdiction. 44 C.F.R. S 59.1 . In most cases, a
community is an incorporated city, town, township, borough, or village, or
an unincorporated area of a county or parish.

^8See 42 U.S.C. 4016.

The NFIP's Financial Structure is Not Designed to be Actuarially Sound

To the extent possible, the NFIP is designed to pay operating expenses and
flood insurance claims with premiums collected on flood insurance policies
rather than with tax dollars. However, as we have reported, the program,
by design, is not actuarially sound because Congress authorized subsidized
insurance rates for policies covering some properties in order to
encourage communities to join the program.^9 As a result, the program does
not collect sufficient premium income to build capital to cover long-term
future flood losses. Moreover, the premiums collected are often not
sufficient to pay for losses even in years without catastrophic flooding.
This shortfall is exacerbated by repetitive loss properties that file
repeated claims with NFIP.

FEMA's current debt to the Treasury--over $17.5 billion--is almost
entirely for payment of claims from the 2005 hurricanes. Legislation
increased FEMA's borrowing authority from a total of $1.5 billion prior to
Hurricane Katrina to $20.8 billion in March 2006. As we have testified
previously, it is unlikely that FEMA will be able to repay a debt of this
size and cover future claims, given that the program generates premium
income of about $2 billion a year, which must first cover ongoing loss and
expenses.^10

To date, the program has gone through almost two full seasons without a
major hurricane, and according to FEMA about $524 million of premium
income has been used to pay interest on the debt owed to the Treasury in
2006. FEMA officials also noted that because fiscal year 2007 had been a
relatively low flood loss year, the agency should be able to pay its next
scheduled interest payment from premium income and would not have to borrow
additional funds from Treasury to pay interest on its outstanding debt.^11
Attention has been focused on the extent of the federal governmentï¿½s exposure
for claims payments in future catastrophic loss years and on ways to improve
the programï¿½s financial solvency.^12 For example, some in Congress have
recommended phasing in actuarial rates for vacation homes and nonresidential
properties.^13

Policy Subsidies Significantly Reduce NFIP's Income from Premiums

About 25 percent of NFIP's over 5.4 million policies have premiums that
are substantially less than the true risk premiums. Properties constructed
before their communities joined the NFIP and were issued a Flood Insurance
Rate Map (or FIRM), which shows the community's flood risk, are eligible
for subsidized rates. These policyholders typically pay premiums that
represent about 35 to 40 percent of the true risk premium.

In January 2006, FEMA estimated a shortfall in annual premium income
because of policy subsidies at $750 million. In response to concerns about
the historical basis for the subsidies and questions about the
characteristics of the homes receiving subsidies, we were asked by the
Ranking Member of this committee to collect certain demographic
information about the portfolio of subsidized properties and property
owners. This work will provide information on residential pre-FIRM
subsidized properties in selected counties of the country.^14 To the extent
that reliable data is available, we plan to capture the variations that
exist by type of flooding (e.g., coastal or riverine), fair market values
for subsidized and nonsubsidized properties in each location, average
income levels for each county, claims data for subsidized and nonsubsidized
properties in each location, and the mitigation efforts being used. Our
work will build upon the work of the Congressional Budget Office on values
of properties in the NFIP.^15

^9GAO, Flood Insurance: Information on the Financial Condition of the
National Flood Insurance Program, [21]GAO-01-992T  (Washington, D.C.: July
2001).

^10GAO, Federal Emergency Management Agency: Challenges for the National
Flood Insurance Program, [22]GAO-07-335T (Washington, D.C.: Jan. 25,
2006).

^11According to FEMA officials, the next scheduled payment is October 1,
2007.

^12See, e.g., S. 3589, S 11, 109th Cong. (2006).

^13H.R.3121, S121,110th Cong. (2007).

^14Our key criteria for selecting the case study counties include high
number and/or percent of subsidized policies, repetitive loss properties,
and number of claims paid; the type of flooding experienced by the
community (e.g., coastal, riverine); geographic location (urban/rural,
east and west coast, inland/coastal); population demography (racial/ethnic
groups and income levels); availability of digitally enhanced-FIRM maps to
enable us to overlay on Census maps; and availability of electronic county
tax assessment data to enable us to match with NFIP database by property.

As part of this review, we are also examining the extent to which FEMA's
nonsubsidized rates are truly actuarially based. We will assess how NFIP
sets rates for its nonsubsidized and subsidized premiums, determine the
total premiums the NFIP collects, and compare that amount to claims and
related costs. Our analysis of FEMA's premiums and claims data should help
provide insights into how FEMA sets rates.

We also have work under way that will provide a description of financial
and statistical trends, by flood zone, for the past 10 years.
Specifically, we have been asked to describe average premium and claim
amounts by flood zone, FEMA's estimates of likely losses, and the extent
to which losses are attributable to repetitive loss properties or
hurricanes. We will also describe the extent to which flood-damaged
properties have been purchased through NFIP-funded mitigation programs.
However, our ability to report on these issues will depend on the quality
of FEMA's claims data. Finally, we are evaluating the adequacy of FEMA's
procedures for monitoring selected contracts that support the NFIP.

Repetitive Loss Properties Continue to be a Drain on the Program

In reauthorizing the NFIP in 2004, Congress noted that repetitive loss
properties--those that had resulted in two or more flood insurance claims
payments of $1,000 or more over 10 years--constituted a significant drain
on the resources of the NFIP.^16 These repetitive loss properties are
problematic not only because of their vulnerability to flooding, but also
because of the costs of repeatedly repairing flood damages.^17 Although
these properties account for only about 1 percent of NFIP-covered
properties, they account for between 25 and 30 percent of claims. As of
September 2007 over 70,000 repetitive loss properties were insured by the
NFIP.

^15CBO, Value of Properties in the National Flood Insurance Program
(Washington, D.C.: June 2007).

^16Flood Insurance Reform Act of 2004, Pub. L. No. 108-264, section
2(3),(4), (5), 118 Stat. 712, 713 (2004).

^17GAO, National Flood Insurance Program: Actions to Address Repetitive
Loss Properties,  [23]GAO-04-401T  (Washington, D.C.: Mar. 25, 2004).

The 2004 Flood Insurance Reform Act authorized a 5-year pilot program to
encourage mitigation efforts on severe repetitive loss properties in the
NFIP.^18 According to FEMA, as of September 2007 about 8,100 properties
i0nsured by the NFIP were categorized as severe repetitive loss properties.
Under the pilot, FEMA is required to adjust its rules and rates to ensure
that homeowners pay higher premiums if they refuse an offer to mitigate
the property. The pilot program was funded in fiscal year 2006, and
according to FEMA officials, FEMA has not yet developed the regulations,
guidance, and administrative documents necessary for implementation.

Remapping Is Creating A New Generation of Properties That May Not Pay Risk-based
Premiums

FEMA is also creating a new generation of properties that may not pay
risk-based premiums. Properties that are remapped into higher flood risk
areas may be able to keep or "grandfather" the nonsubsidized rates
associated with their risk level prior to being remapped into a higher
flood risk area. As a result, eligible property owners who have an
existing policy or who purchase new flood insurance policies before they
are mapped into higher-risk areas will go on paying the same nonsubsidized
premium rate.^19 Moreover, these grandfathered rates can be permanent.
Although this option is a major selling point of encouraging broader
participation in the program, such actions may further erode the actuarial
soundness and financial stability of the program.

^18A severe repetitive loss property is defined as a single family
property or a multifamily property that is covered under flood insurance
by the NFIP and has incurred flood-related damage for which 4 or more
separate claims payments have been paid under flood insurance coverage,
with the amount of each claim payment exceeding $5,000 and with cumulative
amount of such claims payments exceeding $20,000; or for which at least 2
separate claims payments have been made with the cumulative amount of such
claims exceeding the reported value of the property. 42 U.S.C. S 4102a(b)

^19Generally, post-Flood Insurance Rate Map (Post-FIRM) buildings built in
compliance with the floodplain management regulations will continue to
have favorable rate treatment even though higher base flood elevations or
more restrictive, greater risk zone designations result from Flood
Insurance Rate Map revisions. Property owners can also purchase policies
after they are remapped by proving that the property was previously
mapped.

FEMA Has Expanded Participation in the NFIP, but Ensuring Compliance with
Requirements Need Ongoing Attention

From 1968 until the adoption of the Flood Disaster Protection Act of 1973,
buying flood insurance was voluntary. However, voluntary participation in
the NFIP was low, and many flood victims did not have insurance to repair
damages from floods in the early 1970s. In 1973 and again in 1994,
Congress enacted laws requiring that some property owners in special flood
hazard areas buy NFIP insurance. The owners of properties with no
mortgages or properties with mortgages held by lenders that were not
federally regulated were not, and still are not, required to buy flood
insurance, even if the properties are in special flood hazard areas.

As we have reported in the past, viewpoints differ about whether lenders
were complying with the flood insurance purchase requirements, primarily
because the officials we spoke with did not use the same types of data to
reach their conclusions.^20 For example, federal bank regulators and
lenders based their belief that lenders were generally complying with the
NFIP's purchase requirements on regulators' examinations and reviews that
were conducted to monitor and verify lender compliance. In contrast, FEMA
officials believed that many lenders frequently were not complying with
the requirements, an opinion that they based largely on estimates computed
from data on mortgages, flood zones, and insurance policies; limited
studies on compliance; and anecdotal evidence indicating that insurance
was not always purchased when it was required. At the time of our report
in 2002, neither side was able to substantiate these claims with
statistically sound data. However, a FEMA-commissioned study of compliance
with the mandatory purchase requirement estimated that compliance with
purchase requirements, under plausible assumptions, was 75 to 80 percent
in special flood hazard areas for single-family homes that had a high
probability of having a mortgage.^21 The analysis conducted did not
provide evidence that compliance declined as mortgages aged. At the same
time, the study showed that about half of single-family homes in special
flood hazard areas had flood insurance.

^20GAO, Flood Insurance: Extent of Noncompliance with Purchase
Requirements Is Unknown, [24]GAO-02-396  (Washington, D.C: June 21, 2002).

The 2006 study also found that while one-third of NFIP policies were
written outside of special flood hazard areas, the market penetration rate
was only about 1 percent. Yet according to FEMA about half of all flood
damage occurs outside of high risk areas. FEMA has efforts under way to
increase participation by improving the quality of information that is
available on the NFIP and on flood risks and by marketing to retain
policyholders currently in the program. In October 2003, FEMA contracted
for a new integrated mass marketing campaign called "FloodSmart" to
educate the public about the risks of flooding and to encourage the
purchase of flood insurance. Marketing elements being used include direct
mail, national television commercials, print advertising, and Web sites
that are designed for communities, consumers, and insurance agents.
According to FEMA officials, in the little more than 3 years since the
contract began, net policy growth has been almost 24 percent, and policy
retention has improved from 88 percent to almost 92 percent. However, the
success of the program will be measured by retention rates as
policyholders' memories of the devastation from Hurricane Katrina begin to
fade over time.

^21RAND Corporation, The National Flood Insurance Program's Market
Penetration Rate: Estimates and Policy Implications, 2006. This range is
based on calculations, using estimates from a stratified random sample of
data from 2004. Given the nature of the sample the estimates cannot be
extrapolated to communities excluded from NFIP, New York City, and
communities in Puerto Rico, Virgin Islands, Guam, and American Samoa.
Assumptions made in calculating compliance rate were: (1) The number of
policies underwritten by private insurers is 7 percent of the number in
Special Flood Hazard Areas (SFHA) by NFIP; (2) 85 percent of mortgages in
SFHAs are subject to the mandatory purchase requirement; and (3) The
market penetration rates for homes that have mortgages but are not subject
to the mandatory purchase requirement is 38 percent (the market
penetration rate for homes where the probability of a mortgage is low or
uncertain). As with any statistical sample there is error associated with
the estimates. Certain regions included estimates with considerable
uncertainty, and a larger sample size would be needed to make more
definitive conclusions.

FEMA Faces Challenges in Producing Accurate, Updated Flood Maps

Accurate flood maps that identify the areas that are at greatest risk of
flooding are the foundation of the NFIP. These maps, which show the extent
of flood risk across the country, allow the program to determine high-risk
areas for designation both as special hazard zones and as areas that can
benefit the most from mitigation. Flood maps must be periodically updated
to assess and capture changes in the boundaries of floodplains resulting
from community growth, development, erosion, and other factors that affect
the boundaries of areas at risk of flooding. The maps are principally used
by (1) the communities participating in the NFIP, to adopt and enforce the
program's minimum building standards for new construction within the maps'
identified floodplains; (2) FEMA, to develop flood insurance policy rates
based on flood risk; and (3) federal regulated mortgage lenders, to
identify those property owners who are statutorily required to purchase
federal flood insurance. As we reported in 2004, FEMA has embarked on a
multiyear effort to update the nation's flood maps at a cost in excess of
$1 billion.^22 At that time we noted that NFIP faced major challenges in
working with its contractor and state and local partners to produce
accurate digital flood maps.

FEMA has taken steps to improve these working relationships by developing
a number of guidelines and procedures. According to FEMA, the agency has
developed a plan for prioritizing and delivering modernized maps
nationwide, including developing risk-based mapping priorities. Moreover,
FEMA has recognized that a maintenance program will be needed to keep the
maps current and relevant. For example, several strategies are under
consideration for maintaining map integrity, including reviewing the flood
map inventory every 5 years, as required by law; updating data and maps
more regularly, as needed; addressing any unmet flood mapping needs and
assessing the quality and quantity of maps; and examining risk management
more broadly.^23 However, the effectiveness of these strategies will
depend on available funding and FEMA's ongoing commitment to ensuring the
integrity of the maps. As of September 2007 FEMA had remapped 34 percent
of its maps.^24

^22GAO, Flood Map Modernization: Program Strategy Shows Promise, but
Challenges Remain, [25]GAO-04-417 (Washington, D.C.: Mar. 31, 2004).

^23National Flood Insurance Reform Act of 1994, S 575. 42 U.S.C. S4101.

^24According to FEMA, the almost 34 percent includes both new preliminary
and effective maps.

FEMA's Monitoring and Oversight Have Identified Specific Problems but Have Not
Produced Comprehensive Information on Overall Program Performance

To meet its monitoring and oversight responsibilities, FEMA is required to
conduct periodic operational reviews of the private insurance companies
that participate in the WYO program. In addition, FEMA's program
contractor is required to check the accuracy of claims settlements by
doing quality assurance reinspections of a sample of claims adjustments
for every flood event. For operational reviews, FEMA examiners must
thoroughly examine the companies' NFIP underwriting and claims settlement
processes and internal controls, including checking a sample of claims and
underwriting files to determine, for example, whether a violation of
procedures has occurred, an incorrect payment has been made, or a file
does not contain all required documentation. Separately, FEMA's program
contractor is responsible for conducting quality assurance reinspections
of a sample of claims adjustments for specific flood events in order to
identify, among other things, expenses that were paid that were not
covered and covered expenses that were not paid. In our December 2006
report, we found that a new claims handling process aided the claims
handling following the 2005 hurricane season and resulted in few
complaints. As a result, 95 percent of claims were closed by May 2006, a
time frame that compared favorably with those of other, smaller recent
floods.^25 However, we noted that FEMA had not implemented a
recommendation from a prior report that it do quality reinspections based
on a random sample of all claims.^26 We also found that FEMA had not
analyzed the overall results of the quality reinspections following the
2005 hurricane season. In response, FEMA has agreed to (1) analyze the
overall results of the reinspection reports on the accuracy of claims
adjustments for future events, and (2) plan its reinspections based on a
random sample of claims.

FEMA faces challenges in providing effective oversight of the insurance
companies and thousands of insurance agents and claims adjusters that are
primarily responsible for the day-to-day process of selling and servicing
flood insurance policies. For example, as we reported in September 2007,
94 WYO insurance companies had written 96 percent of the flood insurance
policies for the NFIP as of December 2006, up from the 48 companies that
were writing 50 percent of the policies in 1986.^27 We also reported that
for fiscal years 2004 through 2006, total operating costs that FEMA paid
to the WYO insurance companies ranged from $619 million to $1.6 billion,
or from more than a third to almost two-thirds of the total premiums paid
by policyholders to the NFIP, as a result of unprecedented flood losses
caused by the 2005 hurricanes. FEMA regulations require each participating
company to arrange and pay for audits by independent certified public
accounting firms. However, many WYO insurance companies have not complied
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. In response to our recommendations, FEMA has agreed to
take steps to ensure that it has reasonable estimates of the actual
expenses that WYO insurance companies incurred to help determine whether
payments for services are appropriate and that required financial audits
are performed.

^25 [26]GAO-07-169 .

^26GAO, Federal Management Emergency Management Agency: Improvements
Needed to Enhance Oversight and Management of the National Flood Insurance
Program, [27]GAO-06-119 (Washington, D.C.: Oct. 18, 2005).

^27 [28]GAO-07-1078 .

Building on this body of work, we are beginning a follow-up engagement
that will analyze the expenses WYO insurance companies incur from selling
and servicing NFIP policies and determine whether the total operating
costs paid to the companies are equitable relative to those costs. We will
also examine how FEMA oversees the WYO program, including reinspecting
claims and performing operational reviews. Finally, we will evaluate
alternatives for selling and servicing flood insurance policies and
processing claims.

We are also completing an engagement that looks at the inherent conflict
of interest that exists when a WYO insurance company sells both
property-casualty and flood policies to a single homeowner who is subject
to a multiple peril event such as a hurricane. We testified before the
House Committees on Financial Services and Homeland Security in June 2007
about our preliminary views on the sufficiency of data available to and
collected by FEMA to ensure the accuracy of claims payments.^28 FEMA has
determined that it does not have the authority to collect wind damage
claims data from WYO insurance companies, even when the insurer services
both the wind and flood policies on the same property. Hence, FEMA
generally does not know the extent to which wind may have contributed to
total property damages. However, FEMA officials do not believe that the
agency needs to know the dollar amount of wind damages paid by a WYO
insurance company to verify the accuracy of a flood claim. While they may
not need this information for many flood claims, the inherent conflict of
interest that exists when a single WYO insurance company is responsible
for adjusting both the wind and flood claim on a single property calls for
the institution of strong internal controls to ensure the accuracy of
FEMA's claims payments. Without internal controls that include access to
the entire claim file for certain properties (both wind and flood), FEMA's
ability to confirm the accuracy of certain flood claims may be limited.
While the DHS Inspector General is currently examining this issue by
reviewing both wind and flood claims on selected properties. Its interim
report, issued in July 2007, was generally inconclusive.^29

^28GAO, National Flood Insurance Program: Preliminary Views on FEMA's
Ability to Ensure Accurate Payments on Hurricane-Damaged Properties,
[29]GAO-07-991T (Washington, D.C.: June 2007).

Concluding Observations

As our prior work reveals, FEMA faces a number of ongoing challenges in
managing the NFIP that, if not addressed, will continue to threaten the
program's financial solvency even if the program's current debt is
forgiven. As we noted when we placed the NFIP on the high-risk list in
2006, comprehensive reform will likely be needed to stabilize the
long-term finances of this program. Our ongoing work is designed to
provide FEMA and Congress with useful information to help assess ways to
improve the sufficiency of NFIP's financial resources and its current
funding mechanism, mitigate expenses from repetitive loss properties,
increase compliance with mandatory purchase requirements, and expedite
FEMA's flood map modernization efforts.

As you well know, placing the program on more sound financial footing
involves a set of highly complex, interrelated issues that are likely to
involve many trade-offs. For example, increasing premiums to better
reflect risk would put the program on a sounder financial footing but
could also reduce voluntary participation in the program or encourage
those who are required to purchase flood insurance to limit their coverage
to the minimum required amount (i.e., the amount of their outstanding
mortgage balance). As a result, taxpayer exposure for disaster assistance
resulting from flooding could increase. As we have said before, meeting
the NFIP's current challenges will require sound data and analysis and the
cooperation and participation of many stakeholders.

^29Department of Homeland Security, Office of Inspector General, Interim
Report: Hurricane Katrina: A Review of Wind Versus Flood Issues,
OIG-07-62. (Washington, D.C.: July 2007).

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

GAO Contact and Staff Acknowledgments

Contact point for our Office of Congressional Relations and Public Affairs
may be found on the last page of this statement. For further information
about this testimony, please contact Orice M. Williams at (202) 512-8678
or [30][email protected] . This statement was prepared under the direction
of Andy Finkel. Key contributors were Emily Chalmers, Martha Chow, Nima
Patel Edwards, Grace Haskins, Lisa Moore, and Roberto Pinero.

(250371)

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Highlights of [38]GAO-08-118T , a testimony before the Committee on
Banking, Housing and Urban Affairs, U.S. Senate

October 2, 2007

FEDERAL EMERGENCY MANAGEMENT AGENCY

Ongoing Challenges Facing the National Flood Insurance Program

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

Given the challenges facing the NFIP and the need for legislative reform
to ensure the financial stability and ongoing viability of this program,
GAO placed the NFIP on its high-risk list in March 2006. This testimony
updates past work and provides information about ongoing GAO work on
issues including (1) NFIP's financial structure, (2) the extent of
compliance with mandatory requirements, (3) the status of map
modernization efforts, and (4) FEMA's oversight of the NFIP.

Building on our previous and ongoing work on the NFIP, GAO collected data
from FEMA to update efforts, including information about claims, policies,
repetitive loss properties, and mitigation efforts.

[39]What GAO Recommends

In past work, GAO recommended that FEMA strengthen its oversight of the
NFIP and insurance companies responsible for selling and servicing flood
policies, among other things. FEMA generally agreed with our
recommendations.

The most significant challenge facing the NFIP is the actuarial soundness
of the program. As of August 2007, FEMA owed over $17.5 billion to the
U.S. Treasury. FEMA is unlikely to be able to pay this debt, primarily
because the program's premium rates have been set to cover an average loss
year, which until 2005 did not include any catastrophic losses. This
challenge is compounded by the fact that some policyholders with
structures that were built before floodplain management regulations were
established in their communities generally pay premiums that represent
about 35 to 40 percent of the true risk premium. Moreover, about 1 percent
of NFIP-insured properties that suffer repetitive losses account for
between 25 and 30 percent of all flood claims. FEMA is also creating a new
generation of "grandfathered" properties--properties that are mapped into
higher-risk areas but may be eligible to receive a discounted premium rate
equal to the nonsubsidized rate for their old risk designation. Placing
the program on a more sound financial footing will involve trade-offs,
such as charging more risk-based premiums and expanding participation in
the program.

The NFIP also faces challenges expanding its policyholder base by
enforcing compliance with mandatory purchase requirements and promoting
voluntary purchase by homeowners who live in areas that are at less risk.
One recent study estimated that compliance with the mandatory purchase
requirement was about 75 to 80 percent but that penetration elsewhere in
the market was only 1 percent. Since 2004, FEMA has implemented a massive
media campaign called "FloodSmart" to increase awareness of flooding risk
nationwide by educating everyone about the risks of flooding and
encouraging the purchase of flood insurance. While the numbers of
policyholders increased following Hurricane Katrina, it is unclear whether
these participants will remain in the program as time goes on.

The impact of the 2005 hurricanes highlighted the importance of up-to-date
flood maps that accurately identify areas at greatest risk of flooding.
These maps are the foundation of the NFIP. In 2004 FEMA began its map
modernization efforts, and according to FEMA, about 34 percent of maps
have been remapped. Completing the map modernization effort and keeping
these maps current is also going to be an ongoing challenge for FEMA.

Finally, FEMA also faces significant challenges in providing effective
oversight over the insurance companies and thousands of insurance agents
and claims adjusters who are primarily responsible for the day-to-day
process of selling and servicing flood insurance policies. As GAO
recommended in a an interim report issued in September 2007, FEMA needs to
take steps to ensure that it has a reasonable estimate of actual expenses
that the insurance companies incur to help determine whether payments for
services are appropriate and that required financial audits are performed.
GAO, in its ongoing work, plans to further explore FEMA oversight of the
private insurance companies and the cost of selling and servicing NFIP
flood policies.

References

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