Implementing a Combined Federal Flood and Wind Insurance Program Would Require FEMA to Address Several Management Challenges

To implement a combined federal flood and wind insurance program,  FEMA would need to complete a number of steps, similar to those  undertaken to establish the NFIP, which would require the agency to  address several challenges. First, FEMA would need to undertake studies  in order to determine appropriate building codes that communities would  be required to adopt in order to participate in the combined program. Fourth, promoting the  combined federal flood and wind insurance program in communities  would require that FEMA staff raise awareness of the combined program’s  availability and coordinate enforcement of the new building codes. FEMA Would Need to Adapt Existing NFIP Processes for Wind Coverage

While some of the NFIP’s current processes could be leveraged to  implement a combined federal flood and wind program, they would need  to be revised, an action that could pose further challenges for FEMA. H.R. FEMA Would Need to Set Premium Rates for the Flood and Wind Program Adequate to Cover All Future and Catastrophic Losses without Borrowing

Setting premium rates that would adequately reflect all expected costs  without borrowing from the Treasury would require FEMA to make a  number of sophisticated determinations. This determination could be  particularly difficult because it is unclear whether the program might be  able to purchase reinsurance, and because attempting to build up a  sufficient surplus to pay for catastrophic losses would require high  premium rates compared to the size of expected claims and an unknown  number of years without larger than average losses, over which FEMA has  no control. As a result, in setting rates FEMA would  need to determine how much the program would be required to pay,  including in years with catastrophic losses, and use this amount in setting  rates, as is done by private sector insurers. H.R. FEMA Would Need to Account for Likely Adverse Selection and Limited Participation

In determining a premium rate for a federal flood and wind program that  was adequate to pay all future costs, FEMA would also need to take into  account the adverse selection—the tendency to insure primarily the  highest risks—and limited participation the program would likely  experience. 3121 would require the new program  to charge rates adequate to cover all future costs, potentially precluding  any subsidies. Second, a federal flood and wind policy would have lower coverage limits  than the flood and wind coverage currently available in high-risk coastal  areas, further limiting participation. A Federal Flood and Wind Insurance Program Could Benefit Some but Would Involve Trade- offs

While a combined federal flood and wind program would entail costs, it  could benefit some property owners and market participants. While H.R. For example, losses from Hurricane Katrina and other hurricanes were  beyond what NFIP could pay with the premiums it had collected. As of  December 2007, FEMA still owed approximately $17.3 billion to the  Treasury, an amount it is unlikely able to repay. 3121 to stop renewing or selling new polices until such  losses are repaid could actually increase the cost to the federal  government. FEMA also  generally agreed with our findings and emphasized the challenges it would  face in addressing several key issues. Finally, FEMA provided technical  comments, which we incorporated as appropriate. In addition, we stated that termination of the program due  to the borrowing restriction could potentially leave some property owners  uninsured following a catastrophic event and limit FEMA’s ability to repay  any borrowed funds. 3121, the Flood Insurance Reform and  Modernization Act of 2007, in terms of (1) the program’s potential effects  on policyholders, insurance market participants, and the federal  government; (2) what would be required for Federal Emergency  Management Agency (FEMA) to determine and charge actuarially sound  premium rates; and (3) the steps FEMA would have to take to implement  the program. To evaluate the program’s potential effects on policyholders, insurance  market participants, and the federal government, we interviewed officials  from the FEMA, the National Flood Insurance Program (NFIP), state  insurance regulators, the National Association of Insurance  Commissioners (NAIC), state wind insurance program operators, primary  insurers, reinsurers,  insurance and reinsurance associations, insurance agent associations, risk- modeling organizations, actuarial consultants, the American Academy of  Actuaries (AAA), the Association of State Flood Plain Managers (ASFPM),  the National Flood Determination Association (NFDA), and others.
Why GAO Did This Study

Disputes between policyholders and insurers after the 2005 hurricanes highlight the challenges of determining the cause and extent of damages when properties are subject to both high winds and flooding. Additionally, insurers want to reduce their exposure in high-risk areas, and state wind insurance programs have grown significantly. H.R. 3121, the Flood Insurance Reform and Modernization Act of 2007, would create a combined federal insurance program with coverage for both wind and flood damage. GAO was asked to evaluate this potential program in terms of (1) what would be required to implement it; (2) the steps the Federal Emergency Management Agency (FEMA) would need to take to determine premium rates that reflect all future costs; and (3) how it could affect policyholders, insurance market participants, and the federal government. To address these questions, GAO analyzed state and federal programs, examined studies of coastal wind insurance issues, and interviewed federal and state regulatory officials as well as industry participants and analysts. FEMA and the National Association of Insurance Commissioners generally agreed with GAO's report findings. FEMA emphasized the challenges it would face in addressing several key issues. FEMA also provided technical comments, which were incorporated as appropriate.

What GAO Found

To implement a combined federal flood and wind insurance program, FEMA would need to complete certain challenging steps. First, FEMA would need to determine wind hazard prevention standards that communities would have to adopt in order to receive coverage. Second, FEMA would need to adapt existing programs to accommodate wind coverage--for example, the Write Your Own program. Third, FEMA would need to create a new rate-setting process, as the process for setting flood insurance rates is different from what is needed for wind coverage. Fourth, promoting the new program in communities would require that FEMA staff raise awareness of the combined program's availability and coordinate enforcement of the new building codes. Finally, FEMA would need to put staff and procedures in place to administer and oversee the new program while it faces current management and oversight challenges with the National Flood Insurance Program (NFIP). Setting premium rates adequate to cover all the expected costs of flood and wind damage would require FEMA to make sophisticated determinations. For example, FEMA would need to determine how the program would pay claims in years with catastrophic losses without borrowing from the Department of the Treasury. H.R. 3121 would require the program to stop renewing or selling new policies if it needed to borrow funds, effectively terminating the program. It is also unclear whether the program could obtain reinsurance to cover such losses, and attempting to fund losses by building up a surplus would potentially require high premium rates and an unknown number of years without large losses, something over which FEMA has no control. Further, FEMA would need to account for the likelihood that participation would be limited and only the highest-risk properties would be insured. These factors would further increase premium rates and make it difficult to set rates adequate to cover future costs. A federal flood and wind insurance program could benefit some policyholders and market participants but would also involve trade-offs. For example, not requiring adjusters to distinguish between flood and wind damage could reduce both delays in reimbursing participants and the potential for litigation. However, borrowing restrictions could also leave property owners without coverage after a catastrophic event. In addition, the proposed coverage limits are relatively low compared with the coverage that is currently available, potentially leaving some properties underinsured. The program could also reduce the exposure of some insurers by insuring high-risk properties that currently have private sector coverage. However, an unknown portion of the exposure currently held by state wind programs--nearly $600 billion in 2007--could be transferred to the federal government. While H.R. 3121 would require premium rates to be adequate to cover any exposure and restrict borrowing by the program, the potential exists for losses to greatly exceed expectations, as happened with Hurricane Katrina in 2005. This could increase FEMA's total debt, which as of December 2007 was about $17.3 billion.