FEMA, which is within the  Department of Homeland Security (DHS), is responsible for the oversight  and management of NFIP. NFIP’s Financial Challenges Have Increased the Federal Government’s and U.S. Taxpayers’ Financial Exposure from Flood Losses

By design, NFIP is not an actuarially sound program, in part because it does  not operate like many private insurance companies. As of August 2010, NFIP owed approximately $18.8  billion to Treasury, primarily as a result of loans that the program received  to pay claims from the 2005 hurricane season. For example, FEMA cannot deny insurance on the basis of  frequent losses. For example, as we have  pointed out in previous reports, NFIP provides subsidized and  grandfathered rates that do not reflect the full risk of potential flood losses  to some property owners, operates in part with unreliable and incomplete  data on flood risks that make it difficult to set accurate rates, and has not  been able to overcome the challenge of repetitive loss properties. Not accurately reflecting  the actual risk of flooding increases the risk that full-risk premiums may  not be sufficient to cover future losses and add to concerns about NFIP’s  financial stability. Despite Its Financial Challenges, NFIP Has Experienced Some Positive Developments

According to FEMA, expanded marketing efforts through its FloodSmart  campaign have contributed to an increase in NFIP policies. This increase, combined with a relatively low loss  experience in recent years, has enabled FEMA to make nearly $600 million  in payments to Treasury with no additional borrowing since March 2009. While these  are all encouraging developments, FEMA is still unlikely to ever pay off its  current $18.8 billion debt. FEMA’s Operational and Management Issues May Further Limit Progress in Achieving NFIP Goals

We have identified a number of operational issues that affect NFIP,  including weaknesses in FEMA’s oversight of WYO insurers, and  shortcomings in its oversight of other contractors, as well as new issues  from ongoing work. For example, we found that FEMA does not  systematically consider actual flood insurance expense information when  determining the amount it pays WYO insurers for selling and servicing  flood insurance policies and adjusting claims. FEMA’s Oversight of Non- WYO Contractor Activities Is Also Lacking

Also in a previous report, we pointed out that FEMA lacked records of  monitoring activities for other contractors, inconsistently followed its  procedures for monitoring these contractors, and did not coordinate  contract monitoring responsibilities for the two major contracts we  reviewed. FEMA Continues to Lack an Effective System to Manage Flood Insurance Policy and Claims Data

To manage the flood policy and claims information that it obtains from  insurance companies, NFIP’s Bureau and Statistical Agent (BSA) relies on  a flood insurance management system from the 1980s that is difficult and  costly to sustain and that does not adequately support NFIP’s mission  needs. As part of our ongoing review of FEMA’s management of NFIP, we found  that despite having invested roughly $40 million over 7 years, FEMA has  yet to implement NextGen. Addressing NFIP’s Challenges Would Require Actions from FEMA and Congress

To address the challenges NFIP faces, FEMA would have to address its  own operational and management challenges. For example, if Congress wants to structure NFIP as  an insurance company and limit borrowing from Treasury in future high-  or catastrophic loss years, NFIP would have to build a capital surplus  fund. Premium Rates Could Be Made More Reflective of Flood Risk

Making premium rates more reflective of flood risk would require actions  by FEMA and Congress. However, these options involve trade-offs. However, one option to maintain the subsidies but improve NFIP’s  financial stability would be to rate all policies at the full-risk rate and to  appropriate subsidies for qualified policyholders. FEMA Could Take Further Actions to Help Address Operational and Management Challenges

Over the last several years we have made many recommendations for  actions that FEMA could take to improve its management of NFIP. For example, we have recommended that FEMA:    Address challenges to oversight of the WYO program, specifically the lack  of transparency of and accountability for the payments FEMA makes to  WYO insurers, by determining in advance the amounts built into the  payment rates for estimated expenses and profit, annually analyzing the  amounts of actual expenses and profit in relation to the estimated  amounts used in setting payment rates, and by immediately reassessing  the practice of paying WYO insurers an additional 1 percent of written  premiums for operating expenses. Take steps to better oversee WYO insurers and ensure that they are in  compliance with statutory requirements for NFIP and that taxpayers’  funds are spent appropriately by consistently following the Financial  Control Plan and ensuring that each component is implemented; ensuring  that any revised Financial Control Plan covers oversight of all functions of  participating WYO insurers, including customer service and litigation  expenses; systematically tracking insurance companies’ compliance with  and performance under each component of the Financial Control Plan;  and ensuring centralized access to all audits, reviews, and data analyses  performed for each WYO insurer under the Financial Control Plan. Closing Comments

FEMA faces a number of ongoing challenges in managing and  administering NFIP that, if not addressed, will continue to work against  improving the program’s long-term financial condition. As we noted when placing NFIP on the high-risk list in 2006,  comprehensive reform will likely be needed to address the financial  challenges facing the program. This statement was prepared under  the direction of Patrick Ward. Federal Emergency Management Agency: Ongoing Challenges Facing the  National Flood Insurance Program.
Why GAO Did This Study

The National Flood Insurance Program (NFIP), established in 1968, provides policyholders with insurance coverage for flood damage. The Federal Emergency Management Agency (FEMA) within the Department of Homeland Security is responsible for managing NFIP. Unprecedented losses from the 2005 hurricane season and NFIP's periodic need to borrow from the U.S. Treasury to pay flood insurance claims have raised concerns about the program's long-term financial solvency. Because of these concerns and NFIP's operational issues, NFIP has been on GAO's high-risk list since March 2006. As of August 2010, NFIP's debt to Treasury stood at $18.8 billion. This testimony discusses (1) NFIP's financial challenges, (2) FEMA's operational and management challenges, and (3) actions needed to address these challenges. In preparing this statement, GAO relied on its past work on NFIP and GAO's ongoing review of FEMA's management of NFIP, particularly data management and contractor oversight issues.

What GAO Found

While Congress and FEMA intended that NFIP be funded with premiums collected from policyholders rather than with tax dollars, the program is, by design, not actuarially sound. NFIP cannot do some of the things that private insurers do to manage their risks. For example, NFIP is not structured to build a capital surplus, is likely unable to purchase reinsurance to cover catastrophic losses, cannot reject high-risk applicants, and is subject to statutory limits on rate increases. In addition, its premium rates do not reflect actual flood risk. For example, nearly one in four property owners pay subsidized rates, "full-risk" rates may not reflect the full risk of flooding, and NFIP allows "grandfathered" rates that allow some property owners to continue paying rates that do not reflect reassessments of their properties' flood risk. Further, NFIP cannot deny insurance on the basis of frequent losses and thus provides policies for repetitive loss properties, which represent only 1 percent of policies but account for 25 to 30 percent of claims. NFIP's financial condition has improved slightly due to an increase in the number of policyholders and moderate flood losses, and since March 2009, FEMA has taken some encouraging steps toward improving its financial position, including making $600 million in payments to Treasury without increasing its borrowings. However, it is unlikely to pay off its full $18.8 billion debt, especially if it faces catastrophic loss years. Operational and management issues may also limit efforts to address NFIP's financial challenges and meet program goals. Payments to write-your-own (WYO) insurers, which are key to NFIP operations, represent one-third to two-thirds of the premiums collected. But FEMA does not systematically consider actual flood insurance expense information when calculating these payments and has not aligned its WYO bonus structure with NFIP goals or implemented all of its financial controls for the WYO program. GAO also found that FEMA did not consistently follow its procedures for monitoring non-WYO contractors or coordinate contract monitoring responsibilities among departments on some contracts. Some contract monitoring records were missing, and no system was in place that would allow departments to share information on contractor deficiencies. In ongoing GAO work examining FEMA's management of NFIP, some similar issues are emerging. For example, FEMA still lacks an effective system to manage flood insurance policy and claims data, despite investing roughly 7 years and $40 million on a new system whose development has been halted. However, FEMA has begun to acknowledge its management challenges and develop a plan of action. Addressing the financial challenges facing NFIP would likely require actions by both FEMA and Congress that involve trade-offs, and the challenges could be difficult to remedy. For example, reducing subsidies could increase collected premiums but reduce program participation. At the same time, FEMA must address its operational and management issues. GAO has recommended a number of actions that FEMA could take to improve NFIP operations, and ongoing work will likely identify additional issues. In past work, GAO recommended, among other things, that FEMA take steps to help ensure that premium rates are more reflective of flood risks; strengthen its oversight of NFIP and insurance companies responsible for selling and servicing flood policies; and strengthen its internal controls and data quality.