Flood Insurance: Information on Financial Aspects of the National Flood
Insurance Program (Testimony, 10/27/1999, GAO/T-RCED-00-23).

The flood insurance program run by the Federal Emergency Management
Agency paid about $7 billion in insurance claims from fiscal years 1986
through 1998. In recent years, claims paid by the program have risen as
a result of a series of storms, creating a greater drain on the program.
This testimony discusses the (1) financial results of the program's
operations since fiscal year 1993, (2) major factors contributing to the
financial difficulties faced by the program, and (3) actions taken by
and plans of the Federal Insurance Administration that may affect the
program's financial health.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-RCED-00-23
     TITLE:  Flood Insurance: Information on Financial Aspects of the
	     National Flood Insurance Program
      DATE:  10/27/1999
   SUBJECT:  Flood insurance
	     Property damages
	     Financial management
	     Emergency preparedness
	     Disaster relief aid
	     Property losses
	     Insurance premiums
	     Subsidies
IDENTIFIER:  FEMA National Flood Insurance Program

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GAO/T-RCED-00-23

Cover
================================================================ COVER

Before the Subcommittee on Housing and Community Opportunity,
Committee on Banking and Financial Services, House of Representatives

For Release
on Delivery
Expected at
10 a.m.  EDT
Wednesday
October 27, 1999

FLOOD INSURANCE - INFORMATION ON
FINANCIAL ASPECTS OF THE NATIONAL
FLOOD INSURANCE PROGRAM

Statement of Stanley J.  Czerwinski, Associate Director,
Housing and Community Development Issues,
Resources, Community, and Economic
Development Division

GAOT-RCED-00-23

GAO/RCED-00-23T

(385832)

Abbreviations
=============================================================== ABBREV

  FEMA -
  FIRM -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We are here today to discuss the financial condition of the National
Flood Insurance Program administered by the Federal Emergency
Management Agency's (FEMA) Federal Insurance Administration.  The
program, along with low-interest loans provided by the Small Business
Administration and individual and family grants provided by FEMA, is
a major component of the federal government's efforts to provide
flood-related disaster assistance.  Floods have been, and continue to
be, the most destructive natural hazard in terms of economic loss to
the nation, according to FEMA.  From fiscal years 1986 through 1998
the program paid about $7 billion in insurance claims primarily from
premiums collected from program policyholders.  In recent years,
claims paid by the program have increased as a result of a series of
storms, creating a greater drain on the cash reserves of the program. 

Prior to the flood insurance program's inception in 1968, flood
insurance was generally not available from private insurance
companies.  The National Flood Insurance Act of 1968 (P.L.  90-448)
established the program to identify flood-prone areas, make flood
insurance available to property owners living in communities that
joined the program, encourage floodplain management efforts to
mitigate flood hazards, and reduce federal expenditures on disaster
assistance. 

Our statement today will provide information on the (1) financial
results of the program's operations since fiscal year 1993, (2) major
factors contributing to the financial difficulties faced by the
program, and (3) actions taken by and plans of the Federal Insurance
Administration that may affect the program's financial health.  We
provided similar testimony at a field hearing of the Senate Committee
on Banking, Housing, and Urban Affairs on August 25, 1999. 

The following summarizes our work: 

  -- In March 1994, we reported that while sufficient to cover flood
     losses experienced at that time, overall income from the
     program's premiums was not sufficient to build reserves to meet
     future expected flood losses.\1 Therefore, we concluded that it
     was inevitable that losses from claims and the program's
     expenses would exceed the funds available to the program in some
     years.  In this regard, during the 6-year period from fiscal
     years 1993 through 1998, the program experienced losses from
     floods that were greater than the premiums collected from
     policyholders.  Cumulative operating losses to the program
     (program income less program costs) totaled about $1.56 billion
     during the 6-year period.  To finance these losses, the Federal
     Insurance Administration has periodically borrowed from the U.S. 
     Treasury.  According to FEMA, $541 million was owed by the
     program to the U.S.  Treasury as of August 31, 1999. 

  -- Two major factors contribute to the financial difficulties faced
     by the program.  First, the program is not actuarially sound
     because it does not collect sufficient premium income to build
     reserves to meet the long-term future expected flood losses.\2
     Second, the cost of multiple-loss properties (two or more losses
     greater than $1,000 each within a 10-year period) to the program
     is large--about 36 percent of all claims paid historically,
     currently about $200 million annually.  The program, by design,
     is not actuarially sound because the Congress authorized
     subsidized insurance rates to be made available for policies
     covering certain structures to encourage communities to join the
     program.  Because about 30 percent of the policies were
     subsidized as of 1998, overall premium income is not sufficient
     to build reserves to meet future expected flood losses.  The
     Federal Insurance Administration's annual target for the
     program's overall premium income is at least the amount of loss
     and expenses in an historical average loss year, which
     approximates the average annual loss experienced under the
     program since 1978.  Since no catastrophic loss years\3 have
     occurred since 1978, collecting premiums that are based on an
     historical average loss year does not enable the program to
     build sufficient reserves to cover a possible catastrophic loss
     year in the future.  Because the program does not collect
     sufficient premium income to build reserves to meet the
     long-term future expected flood losses, including catastrophic
     losses, it is inevitable that losses from claims and the
     program's expenses will exceed the funds available to the
     program in some years. 

  -- The Federal Insurance Administration has studies under way and
     has taken other actions recently that may affect the program's
     financial health.  Among other things, it has studies under way
     assessing the (1) economic effects of eliminating subsidized
     flood insurance rates for policies covering certain structures
     and (2) program's underwriting and claims processes and
     controls.  The Federal Insurance Administration has also
     developed a strategy to mitigate flood losses (to prevent future
     losses or reduce the losses that might otherwise occur from
     floods) for currently insured multiple-loss properties posing
     the greatest risk of loss. 

Before I discuss these issues in greater detail, let me briefly
explain the National Flood Insurance Program and other federal
disaster assistance related to this program. 

--------------------
\1 See Flood Insurance:  Financial Resources May Not Be Sufficient to
Meet Future Expected Losses (GAO/RCED-94-80, Mar.  21, 1994). 

\2 For the program to be actuarially sound, overall revenues from
insurance premiums would need to be sufficient to cover expected
losses from claims and the program's expenses. 

\3 Federal Administration officials told us that a catastrophic year
is defined as a year resulting in $5.5 billion to $6 billion in
claims losses, which has a 1 in 1,000 chance of occurring. 

   THE NATIONAL FLOOD INSURANCE
   PROGRAM AND OTHER FLOOD-RELATED
   ASSISTANCE
---------------------------------------------------------- Chapter 0:1

Over 19,000 communities have joined the flood insurance program. 
Under the program, flood insurance rate maps (FIRM) were prepared to
identify special flood hazard areas.  In order for a community to
join the program, any structures built within a special flood hazard
area after the FIRM was completed were required to be built to the
program's building standards that are aimed at minimizing flood
losses.  Special flood hazard areas, also known as the 100-year
floodplains, are areas subject to a 1-percent or greater chance of
experiencing flooding in a given year.  A key component of the
program's building standards, that must be followed by communities
participating in the program, is a requirement that the lowest floor
of the structure be elevated to or above the base flood level--the
elevation at which there is a 1-percent chance of flooding in a given
year. 

To encourage communities to join the program, thereby promoting
floodplain management and the widespread purchasing of flood
insurance, the Congress authorized the Federal Insurance
Administration to make subsidized flood insurance rates available to
owners of structures built before a community's FIRM was prepared. 
These pre-FIRM structures are generally more flood-prone than
later-built structures because they were not built according to the
program's building standards.  Owners of post-FIRM structures pay
actuarial rates for national flood insurance.  Despite subsidized
premiums, the average annual premium for a subsidized policy is
currently $580 and the average annual premium for an actuarial policy
is currently $290.  The higher average premium for a subsidized
policy reflects the significantly greater riskiness of flood-prone
pre-FIRM properties.  The $580 average annual premium for a
subsidized policy also represents about 38 percent of the true risk
premium for these properties. 

From 1968 until the adoption of the Flood Disaster Protection Act of
1973, the purchase of flood insurance was voluntary.  The 1973 act
required the mandatory purchase of flood insurance to cover
structures in special flood hazard areas of communities participating
in the program if (1) any federal loans or grants were used to
acquire or build the structures and (2) the loans were secured by
improved properties and were made by lending institutions regulated
by the federal government.  The owners of properties with no
mortgages or properties with mortgages held by unregulated lenders
are not required to buy flood insurance, even if the properties are
in special flood hazard areas. 

The National Flood Insurance Reform Act of 1994 reinforced the
objective of using insurance as the preferred mechanism for disaster
assistance by (1) expanding mandatory flood insurance purchase
requirements and (2) effecting a prohibition on further flood
disaster assistance for any property where flood insurance is not
maintained, after having been mandated as a condition for receiving
disaster assistance.  The act requires federal agency lenders and
regulators to develop regulations to direct their federally regulated
lenders not to make, increase, extend, or renew any loan on
applicable property unless flood insurance is purchased.  The act
also requires borrowers who have received certain disaster assistance
and then failed to obtain flood coverage to be barred from receiving
future disaster aid. 

Other forms of flood disaster assistance include Small Business
Administration low-interest loans to flood victims who are
creditworthy.  In addition, a flood victim who cannot obtain a Small
Business Administration loan may apply for an individual and family
FEMA grant of up to $13,600 or the amount of the loss, whichever is
less. 

   SUSTAINED LOSSES TO THE PROGRAM
   FROM SEVERE FLOODING
---------------------------------------------------------- Chapter 0:2

While the National Flood Insurance Program's costs exceeded program
revenues in some years, cumulative program income exceeded program
costs by about $90 million during the period October 1, 1968, through
September 30, 1992.\4 However, since fiscal year 1993, the flood
insurance program has generally experienced operating losses because
program costsï¿½driven by losses and related expensesï¿½were greater than
program income.\5 This occurred because losses from flood claims were
greater than what could be paid by premium income collected from the
program's policyholders.  As seen in Figure 1, during the 6-year
period from fiscal years 1993 through 1998, the program incurred
operating losses in 5 of these years--the exception was fiscal year
1994, when net income was about $270 million. 

   Figure 1:  Net Financial Status
   of the National Flood Insurance
   Program (Annual Income Minus
   Costs)

   (See figure in printed
   edition.)

Source:  National Flood Insurance Program Flood Insurance Rate
Review. 

The program's annual losses during this period ranged from about
$600,000 in fiscal year 1998 to $602 million in fiscal year 1993. 
Cumulative operating losses experienced by the program totaled about
$1.56 billion during the 6-year period, of which about $1.47 billion
was outstanding as of September 30, 1998 (the $1.56 billion loss less
the $90 million in revenues as of September 30, 1992).  To finance
these losses, the Federal Insurance Administration borrowed from the
U.S.  Treasury during the 6-year period.\6

According to FEMA, as of August 31, 1999, the debt owed by the
program to the U.S.  Treasury totaled $541 million.\7 Interest
expense incurred by the Federal Insurance Administration on the
program's borrowings totaled about $115 million during the 3 fiscal
years 1996 through 1998.\8

While the program has incurred substantial operating losses in recent
years, it should be recognized that the value of the program in
reducing federal expenditures on disaster assistance is not limited
to its financial status.  For example, the Federal Insurance
Administration estimated that the program's standards for new
construction are now saving about $1 billion annually in flood damage
avoided.  Also, during the 13-year period from October 1, 1985,
through September 30, 1998, the program paid about $7 billion in
insurance claims primarily from policyholder premiums that otherwise
would, to some extent, have increased taxpayer-funded disaster
relief. 

It should also be recognized that losses experienced by the program
annually have gradually declined since fiscal year 1995.  Total
operating losses declined from $576 million in fiscal year 1995 to
$600,000 in fiscal 1998.  This decline was primarily due to three
reasons.  First, claims and related expenses declined from $1.1
billion in fiscal year 1995 to $719 million in fiscal year 1998.\9
Second, the number of policyholders covered by the program increased
about 24 percent from 3.3 million policies in force in fiscal year
1995 to 4.1 million policies in force by fiscal 1998.  Accordingly,
earned premium revenue on these policies increased from $814 million
to $1.2 billion during the period.  Third, according to Federal
Insurance Administration officials, the proportion of generally more
flood-prone pre-FIRM subsidized policies insured by the program has
declined, resulting in a less risky portfolio of policies in force. 
The percentage of program policies that are subsidized declines over
time as newer properties join the program and are charged actuarial
rates.  While 41 percent of the 2.7 million policies in force in
fiscal year 1993 were subsidized, 30 percent of the 4.1 million
policies in force in fiscal year 1998 were subsidized, according to a
Federal Insurance Administration official. 

--------------------
\4 During this period, FEMA received $1.2 billion in appropriations
for the flood insurance program.  Without this appropriation, a $1.1
billion deficit would have resulted rather than a $90 million
surplus. 

\5 Program income primarily consists of premium revenues paid by
policyholders, but also includes investment, fees, and other
revenues.  Program costs primarily consist of claims and related
expenses, but also include, among other things, operating and
interest costs. 

\6 The Congress authorized the Federal Insurance Administration to
borrow up to $1 billion from the U.S.  Treasury if necessary to pay
claims losses.  Legislation enacted in 1996 provided a 1-year
increase in borrowing authority to $1.5 billion later extended
through 1999.  However, no appropriations have been made to the
program since fiscal year 1986. 

\7 According to a Federal Insurance Administration official, debt
owed by the Federal Insurance Administration to the U.S.  Treasury is
not equivalent to the program's cumulative losses because the amount
of borrowing needed depends on (1) the relative timing of payments on
the program's current obligations and expected monthly premium
receipts and (2) future insurance claims. 

\8 Federal Insurance Administration officials noted that beginning in
fiscal year 1986, the Congress required all program and
administrative costs to be paid for by the program without a
commensurate rate increase.  In 1991, the Congress authorized the
Federal Insurance Administration to charge policyholders a federal
policy fee to pay for these costs.  Federal Insurance Administration
officials estimate the current value of the resulting loss of funds
and investment income to be about $436 million, making the program
more vulnerable to the need for exercising its borrowing authority. 

\9 The magnitude of flood damage can vary considerably from year to
year. 

   MAJOR FACTORS CONTRIBUTING TO
   THE FINANCIAL DIFFICULTIES
   FACED BY THE PROGRAM
---------------------------------------------------------- Chapter 0:3

Two major factors contribute to the financial difficulties faced by
the program.  First, the program is not actuarially sound because, by
design, it does not collect sufficient premium income to build
reserves to meet future expected flood losses.  Second, the cost to
the program of multiple-loss properties is large--about $200 million
annually. 

      THE PROGRAM IS NOT, BY
      DESIGN, ACTUARIALLY SOUND
-------------------------------------------------------- Chapter 0:3.1

The program is not actuarially sound because about 30 percent of the
4.1 million policies in force are subsidized, according to a Federal
Insurance Administration official.  For a single-family pre-FIRM
property, subsidized rates are available for the first $35,000 of
coverage, although any insurance coverage above that amount must be
purchased at actuarial rates.  Federal Insurance Administration
officials estimated that total premium income from subsidized
policyholders are currently about $500 million less than they would
be if these rates had been actuarially based and participation had
remained the same. 

Pre-FIRM structures that are within an identified 100-year floodplain
and are covered by subsidized policies are, on average, not as
elevated as the post-FIRM structures in comparison with the base
flood level.  Federal Insurance Administration officials told us
that, on average, pre-FIRM structures not built to the program's
standards are three and a half to four times more likely to suffer a
flood loss.  When these structures suffer a loss, the damage
sustained is, on average, about 40 percent greater than the damage to
flooded post-FIRM structures.  According to the Federal Insurance
Administration, when these two factors are combined, pre-FIRM
structures suffer, on average, about five times more damage than
post-FIRM structures. 

         PREMIUM INCOME NOT
         SUFFICIENT TO BUILD
         RESERVES FOR POTENTIAL
         CATASTROPHIC LOSSES
------------------------------------------------------ Chapter 0:3.1.1

As an alternative to actuarial soundness, the Federal Insurance
Administration developed a financial goal for the program to collect
sufficient revenues to at least meet the expected losses and expenses
of the historical average loss year, as well as to cover all
non-loss-related program expenses, such as the program's
administration.  However, the historical average loss year is based
only on the experience under the program since 1978.  Since that
time, no catastrophic year ($5.5 billion to $6 billion in claims
losses) has occurred, and many years in the 1980s were characterized
by low actual loss levels as compared to the historical average
losses experienced in other years.  Therefore, the historical average
loss year involves less losses from claims than the expected annual
claims losses in future years.  As a result, collecting premiums to
meet the historical average loss year does not reflect the
collections necessary to build reserves for potential catastrophic
years in the future. 

For the program to be actuarially sound, its rate-setting process
would have to consider the monetary risk exposure of the program or
the dollar value of expected flood losses over the long run.  Since
the magnitude of flood damage varies considerably from year to year,
income from premiums in many years would exceed actual losses.  This
circumstance would enable the program to build reserves toward a
possible catastrophic year in the future. 

         INCREASING PREMIUMS FOR
         SUBSIDIZED POLICIES OR
         EXPANDING PARTICIPATION
         IN THE PROGRAM MAY HAVE
         ADVERSE FINANCIAL IMPACTS
------------------------------------------------------ Chapter 0:3.1.2

As we reported in March 1994, increasing the premiums charged to
subsidized policyholders (thereby decreasing the subsidy) to improve
the program's financial health could have an adverse impact on other
federal disaster-related relief costs.  Increasing subsidized rates
would likely cause some policyholders to cancel their flood
insurance, and if flooded in the future, these people might apply for
Small Business Administration loans or FEMA disaster assistance
grants. 

Because they were built before the program's building standards
became applicable, pre-FIRM structures are generally not as elevated
as post-FIRM structures, and if their owners were to be charged true
actuarial rates, these rates would be much higher than current
subsidized rates.\10 For example, if the subsidy on pre-FIRM
structures were eliminated, insurance rates on currently subsidized
policies would need to rise, on average, approximately a little more
than twofold, according to a Federal Insurance Administration
official.  This increase would result in an annual average premium of
about $1,300 for these pre-FIRM structures.  Significant rate
increases for subsidized policies, including charging actuarial
rates, would likely cause some pre-FIRM property owners to cancel
their flood insurance.\11

If owners of pre-FIRM structures, which suffer the greatest flood
loss, canceled their insurance policies, the federal government would
likely face increased costs, as the result of future floods, in the
form of low-interest loans from the Small Business Administration or
grants from FEMA.  The effect on total federal disaster assistance
costs of phasing out subsidized rates would depend on the number of
the program's current policyholders who would cancel their policies. 
Thus, it is difficult to estimate if the increased costs of other
federal disaster relief programs would be less than, or more than,
the cost of the program's current subsidy. 

On the other hand, expanding participation in the program by
increasing the rate of compliance with the mandatory purchase
requirement, or by extending the mandatory purchase requirement to
property owners not now covered, will likely increase the number of
both subsidized and unsubsidized policies.  Although greater
participation in the program is likely to reduce the cost of FEMA
grants and Small Business Administration loans, the resulting
increase in subsidized policyholders will put greater financial
stress on the flood insurance program, because the premiums received
from subsidized policyholders are not sufficient to meet the future
estimated losses on these policies. 

--------------------
\10 Also, Federal Insurance Administration officials told us that
making all rates actuarially based would not make the program
actuarially sound.  They noted that an initial capitalization would
be necessary to establish some reserves in the event that a
catastrophic year were to occur before sufficient reserves were
accumulated from income from premiums. 

\11 The National Flood Insurance Reform Act of 1994 expanded the
mandatory flood insurance purchase requirement on properties financed
with any federal loan or grant or loans made by lending institutions
regulated by the federal government that are located in special flood
hazard areas.  However, lenders have not always imposed this
requirement. 

      REPETITIVE FLOOD LOSSES
-------------------------------------------------------- Chapter 0:3.2

Another major factor contributing to the financial difficulties
facing the National Flood Insurance Program is repetitive flood
losses.\12 About 36 percent of all program claims historically
(currently about $200 million annually) represent repetitive losses
even though repetitive-loss structures make up a small percentage of
all program policies.  About 40,000 buildings currently insured under
the program have been flooded on more than one occasion and have
received flood insurance claims payments of $1,000 or more for each
loss.  The cost of these multiple-loss properties over the years to
the program has been $2 billion. 

--------------------
\12 A repetitive-loss property is one that has two or more losses
greater than $1,000 each within any 10-year period. 

   ACTIONS UNDER WAY TO ADDRESS
   THE PROGRAM'S FINANCIAL
   PROBLEMS
---------------------------------------------------------- Chapter 0:4

The Federal Insurance Administration has studies under way and has
taken other actions recently that may have an affect on the financial
health of the program.  The Federal Insurance Administration has
studies under way assessing the economic effects of eliminating
subsidized flood insurance rates for pre-FIRM construction and the
program's underwriting and claims processes and controls.  It has
also developed a repetitive loss strategy that would target, for
mitigation assistance, currently insured multiple-loss properties
posing the greatest risk of loss.  The Federal Insurance
Administration also initiated a ï¿½Call for Issuesï¿½ inviting program
stakeholders and the public to make recommendations about ways to
make the program more effective. 

In line with requirements of the National Flood Insurance Reform Act
of 1994, FEMA awarded a contract to study the economic effects of
eliminating subsidized flood insurance rates for pre-FIRM
construction.  The study is aimed at determining, among other things,
the (1) number and types of properties that would be affected by an
increase in premium rates, (2) number of policyholders who would
likely cancel their flood insurance policies if premium rates were
increased, and (3) effects of increased premiums on land values and
property taxes.  The study has been delivered to the Federal
Insurance Administration which is developing recommendations based on
the study, which will be released by the first of next year. 

The improper underwriting of flood insurance policies and adjustments
of flood insurance losses have an adverse effect on the financial
health of the program.  In light of the growth in the number of
policyholders and losses experienced by the program, the Federal
Insurance Administration initiated an evaluation of its underwriting
and claims processes and controls.  This study will focus on, among
other things, how well the program's underwriting and claims
requirements are being met and the nature and adequacy of program
controls over these processes.  The final report is expected by the
end of the calendar year. 

Under its repetitive-loss strategy, the Federal Insurance
Administration intends to target for mitigation the most flood-prone
repetitive-loss properties, such as those that are currently insured
and have had four or more losses.  The Federal Insurance
Administration is considering a regulatory change proposing that if a
target property is offered mitigation assistance and the offer is
declined, flood insurance for the property will only be renewed or
rewritten at a full-risk premium.  Currently, about $20 million has
been authorized to address repetitive losses, and the Federal
Insurance Administration is exploring other options for funding. 

Lastly, the Federal Insurance Administration continues to categorize
600 issues suggested by lenders, bankers, individuals, and other
stakeholders in response to its ï¿½Call for Issuesï¿½ to make the program
more effective.  Due to the large number of issues, the Federal
Insurance Administration does not expect to report on the issues
until the end of the calendar year. 

-------------------------------------------------------- Chapter 0:4.1

In closing Mr.  Chairman, the Federal Insurance Administration is
helping the nation avoid the costs of flood damage through the
premiums it collects from, and the claim payments it makes to,
program policyholders as well as the building standards it has
promoted for new construction that minimize flood damage.  However,
in recent years, heavy flooding has produced annual flood insurance
losses that exceeded the premiums collected from policyholders.  As a
result, the program has had to borrow funds from the U.S.  Treasury
to cover its operating losses.  Two major factors underlie these
financial difficulties--the program, by design, is not actuarially
sound and it experiences repetitive losses.  These factors are not
easy to overcome because they have been an integral part of the
program since its inception, and they are related to the promotion of
floodplain management and widespread purchasing of flood insurance. 
The Federal Insurance Administration has studies under way and has
taken other actions that may enhance the financial soundness of the
program. 

Mr.  Chairman, this completes our prepared statement.  We would be
happy to respond to any questions that you or Members of the
Subcommittee may have. 

   CONTACT AND ACKNOWLEDGMENT
---------------------------------------------------------- Chapter 0:5

For future contacts regarding this testimony, please contact Mr. 
Stanley J.  Czerwinski at (202) 512-7631.  Mr.  Robert S.  Procaccini
and Mr.  R.  Tim Baden made key contributions to this testimony. 

*** End of document. ***