Subsidized Premium Rates

NFIP policies have what FEMA describes as either subsidized or full-risk  premiums. Third, private insurers would need adequate consumer  participation in order to manage and diversify their risk. NFIP was created in part because the catastrophic  nature of flooding made it difficult for private insurance companies to  develop an actuarial rate structure that could adequately reflect the risks  to flood-prone properties. Private Insurers Would Need Freedom to Charge Adequate Rates and Manage Risk

Stakeholders said that private insurers would also need to be able to  charge adequate rates that would reflect the full estimated risk of flood  loss and allow for profit. For example,  stakeholders said that state by state approval of flood insurance rates  might impede insurers’ ability to obtain adequate rates. Based on our analysis of stakeholder views and other information, many  property owners may also have an inaccurate perception of their risk of  flooding and thus do not buy flood insurance. Several Strategies Could Encourage Private Sector Involvement, but a Governmental Role Would Likely Be Required

Stakeholders with whom we spoke or who participated in our roundtable  discussion identified several strategies that could be used to help transfer  some of the responsibility of providing flood insurance from the federal  government to the private sector. Several Strategies Could Help Create Conditions for Private Sector Involvement

One strategy stakeholders identified, which we have also mentioned in  previous reports, would be for Congress to eliminate subsidized rates,  charge full-risk rates to all policyholders, and appropriate funding for a  direct means-based subsidy to some policyholders. A second strategy  that stakeholders identified would be for the federal government to  provide only residual insurance, serving as the insurer of last resort for  properties that the private sector is unwilling to insure. Finally, charging full-risk rates to all policyholders  would demonstrate a property’s actual flood risk to property owners,  discourage further development in high-risk areas, and encourage  property owners to invest in mitigation to lower their exposure to flood risk  as well as their premium rate. To address private sector  concerns about being able to accurately set rates, FEMA could grant  private insurers access to historical claims data. Further, because these  residual policies would have the highest risk, they would require high  premium rates to cover their full risk of loss, potentially reducing  consumer participation. Some  stakeholders said that the private reinsurance industry might be able to  provide some reinsurance to private insurers, reducing the federal  government’s potential role in reinsurance. However, the costs of these reinsurance  premiums would likely be passed onto the policyholder, and the resulting  higher rates could reduce consumer participation. Mandatory coverage. Other stakeholders discussed NFIP purchasing  reinsurance from the private sector to cover exposure to catastrophic  losses rather than relying on borrowing from Treasury. Catastrophe bonds. As  the private sector increases its role in providing flood coverage, various  government entities could collaborate on other important roles. Delaying or repealing rate increases in the Biggert-Waters Act may  address affordability concerns but would likely continue to increase  NFIP’s long-term burden on taxpayers. As we have suggested previously, Congress could eliminate  subsidized rates, charge full-risk rates to all policyholders, and  appropriate funds for a direct means-based subsidy to eligible  policyholders. The movement to full-risk rates would encourage private  sector participation, and the explicit subsidy would address affordability  concerns, raise awareness of the risks associated with living in harm’s  way, and decrease costs to taxpayers, depending on the extent and  amount of the subsidy. Appendix I: Objectives, Scope, and Methodology

The Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters  Act) mandated that GAO conduct a number of studies, including this  study on assessing a broad range of options, methods, and strategies for  privatizing the National Flood Insurance Program (NFIP). This report  discusses (1) conditions needed for private sector involvement in flood  insurance and (2) strategies for increasing it. The roundtable discussion focused on four broad themes that included: a policy goals framework for evaluating options for increasing private  sector involvement in flood insurance, barriers to private sector involvement that would need to be options for private sector involvement and associated benefits and  challenges, and  the governmental role that would remain in a private flood insurance  market.
Why GAO Did This Study

NFIP has accrued $24 billion in debt, highlighting structural weaknesses in the program and increasing concerns about its burden on taxpayers. As a result, some have suggested shifting exposure to the private sector and eliminating subsidized premium rates, so individual property owners--not taxpayers--would pay for their risk of flood loss. NFIP was created, in part, because private insurers were unwilling to insure against flood damage, but new technologies and a better understanding of flood risks may have increased their willingness to offer flood coverage.
The Biggert-Waters Flood Insurance Reform Act of 2012 moves NFIP toward charging more full-risk rates. It also mandates that GAO conduct a study on increasing private sector involvement in flood insurance. This report addresses (1) the conditions needed for private sector involvement in flood insurance and (2) strategies for increasing private sector involvement. To do this work, GAO reviewed available documentation and hosted a roundtable in August 2013 that included stakeholders from FEMA, the insurance and reinsurance industries, and state insurance regulators, among others. GAO also interviewed other similar stakeholders.

What GAO Found

According to stakeholders with whom GAO spoke, several conditions must be present to increase private sector involvement in the sale of flood insurance. First, insurers need to be able to accurately assess risk to determine premium rates. For example, stakeholders told GAO that access to National Flood Insurance Program (NFIP) policy and claims data and upcoming improvements in private sector computer modeling could enable them to better assess risk. Second, insurers need to be able to charge premium rates that reflect the full estimated risk of potential flood losses while still allowing the companies to make a profit, as well as be able to decide which applicants they will insure. However, stakeholders said that such rates might seem unaffordable to many homeowners. Third, insurers need sufficient consumer participation to properly manage and diversify their risk, but stakeholders said that many property owners do not buy flood insurance because they may have an inaccurate perception of their risk of flooding.
Stakeholders identified several strategies that could help create conditions that would promote the sale of flood insurance by the private sector. For example,
NFIP charging full-risk rates . Congress could eliminate subsidized rates, charge all policyholders full-risk rates, and appropriate funding for a direct means-based subsidy to some policyholders. Stakeholders said full-risk NFIP rates would encourage private sector participation because they would be much closer to the rates private insurers would need to charge. The explicit subsidy would address affordability concerns, increase transparency, and reduce taxpayer costs depending on the extent and amount of the subsidy. The Biggert-Waters Act eliminates some subsidized rates, but some have proposed delaying these rate increases. Doing so could address affordability concerns, but would also delay addressing NFIP's burden on taxpayers.
NFIP providing residual insurance . The federal government could also encourage private sector involvement by providing coverage for the highest-risk properties that the private sector is unwilling to insure. Providing residual coverage could increase the program's exposure relative to the number of properties it insured, but NFIP would be insuring fewer properties, and charging adequate rates could reduce taxpayer costs.
NFIP as reinsurer . Alternatively, the federal government could serve as a reinsurer, charging a premium for assuming the risk of catastrophic losses. However, the cost of reinsurance premiums would likely be passed on to consumers, with higher rates potentially decreasing consumer participation.
Stakeholders identified other strategies including mandatory coverage requirements to ensure broad participation, NFIP purchasing reinsurance from the private sector rather than borrowing from the U.S. Treasury, and NFIP issuing catastrophe bonds to transfer risk to private investors. As the private sector increases its role in providing flood coverage, the federal government could collaborate with state and local governments to focus on other important roles, including promoting risk awareness among consumers, encouraging mitigation, enforcing building codes, overseeing land use agreements, and streamlining insurance regulations.

What GAO Recommends

While GAO makes no new recommendations in this report, GAO reiterates its previous suggestion from a June 2011 report ( GAO-11-297 ) that Congress consider eliminating subsidized rates, charge full-risk rates to all policyholders, and appropriate funds for premium assistance to eligible policyholders to address affordability issues.