On average, the premium for a  subsidized policy in a high-risk flood zone is higher than the premium on a  full-risk policy in the same zone because properties with full-risk rates  have either been built to newer flood-resistant building codes or have been  mitigated to reduce flood risks and thus are generally less flood prone  than properties that are eligible for subsidized rates. While the percentage of policies  receiving subsidies has dropped since 1978 to 23 percent of all policies as  of December 2007, the number of subsidized properties has continued to  increase. Further, because of current low NFIP participation rates, there appears to  be room for substantial growth in the number of NFIP policies, many of  which are likely to receive subsidized premium rates. The properties  receiving subsidized rates have been a financial burden on the program  because of their relatively high loss experience and subsidized rates that  do not reflect the actual risk of flooding. 1). FEMA officials also told us  that since the 1973 act, the increase in the number of mortgages subject to the flood insurance requirement, coupled with greater enforcement of this  requirement by financial regulators in recent years, had resulted in an  increased number of flood insurance policies, including policies with  subsidized rates. Approximately 70 percent (3.69 million) of the total policies were  concentrated in five states: California, Florida, Louisiana, New Jersey, and  Texas. Subsidized Properties Have Contributed to NFIP’s Historical Operating Deficits and Account for the Majority of Repetitive Loss Properties

The large number of subsidized properties has contributed to NFIP’s  historical operating losses through its relatively high loss experience and  rates that do not reflect the actual risk of flooding. Several Options Exist for Addressing the Financial Impact of Subsidized Properties on NFIP, but Each Option Involves Trade-offs

Because of the financial condition of NFIP and mounting losses, the  negative financial impact that subsidized premium rates have on the  program continues to be an area warranting ongoing attention, as we  pointed out when placing NFIP on the high-risk list in 2006. Options Exist That Could Help Reduce the Number of Subsidized Properties and Their Financial Impact on NFIP

Reducing the financial impact of subsidized properties on NFIP would  generally involve either reducing the number of properties receiving  subsidized premium rates, reducing the losses associated with these  properties, reducing the amount of the subsidy, or some combination of  these approaches. Whether maintaining the current program or making  changes to NFIP subsidies, Congress will be faced with balancing often- competing public policy goals, which include charging premium rates that  more fully reflect actual flood risks and help better ensure NFIP solvency,  encouraging broad participation in natural catastrophe insurance  programs by offering affordable rates, and limiting taxpayer costs before  and after a disaster. First, it could reduce flood losses by  ensuring that more homes were better protected from flooding through  mitigation, whether it was through elevation, relocation, or demolition. And  as we have seen, participation from local communities is critical for  successful mitigation efforts. Second, substantially increasing mitigation efforts would be costly  and would require increased funding for FEMA’s mitigation programs. Depending on how the option was implemented, a potential advantage to  this option would be that more policyholders would have to pay the full- risk rate and that those eligible for the subsidy would be made aware of  the full-risk rate before applying for the subsidy. However, this option has several disadvantages. This option also would involve certain implementation challenges in the  midst of other ongoing management challenges for NFIP. As  we have seen in 2008, flood losses are volatile and highly unpredictable,  and estimating future losses and determining premium rates adequate to  cover those losses is an inherently difficult process. In addition, even if  subsidized rates were eliminated, the potential for catastrophic losses  could still result in NFIP needing to borrow from the Treasury to pay  losses. Absent a change in the NFIP’s use of subsidized premium rates,  however, the subsidies will continue to hinder the financial stability of the  program, and the potential further increases in the number of properties  receiving subsidies could make the situation worse. Therefore,  implementing any or a combination of these options could significantly  reduce the adverse financial impact of subsidies on NFIP. Agency Comment and Our Evaluation

We provided a draft of this report to the Department of Homeland Security  (DHS) for comment. In its written comments, DHS expounded upon several topics  discussed in the report. We also reviewed relevant FEMA reports and analysis on these  factors. To evaluate NFIP’s existing structure and identify and evaluate options for  reducing or eliminating the costs of properties insured at subsidized  premium rates and the advantages and disadvantages of these options, we  analyzed NFIP’s legislative history, which described the objectives of NFIP  overall and NFIP subsidies in particular, and original expectations about  the subsidized inventory.
Why GAO Did This Study

The Federal Emergency Management Agency (FEMA), the Department of Homeland Security (DHS) agency that administers the National Flood Insurance Program (NFIP), estimates that subsidized properties--those that receive discounted premium rates that do not fully reflect the properties' actual flood risk--experience as much as five times the flood damage as properties that do not qualify for subsidized rates. Almost one in every four residential policies has subsidized rates that are on average 35-40 percent of the full-risk rate. Unprecedented losses from the 2005 hurricane season and NFIP's periodic need to borrow from the Department of the Treasury to pay flood insurance claims has raised concerns about the impact that subsidized premium rates have on the longterm financial solvency of NFIP. GAO designated NFIP as high-risk in March 2006; as of June 2008, NFIP's debt stood at $17.4 billion. This report (1) provides information on NFIP's inventory of subsidized properties and (2) examines NFIP's current approach to subsidized properties and the advantages and disadvantages of options for reducing the costs associated with these properties. To do this work, GAO analyzed data on policies and claims and collected available data about subsidized properties. GAO also reviewed applicable reports and interviewed relevant agency, state, and private sector officials. In its written comments, DHS expounded upon several topics discussed in this report.

What GAO Found

While it constitutes a declining percentage of all NFIP policies, the number of properties receiving subsidized premium rates has grown since 1985; by 2007 it was at its highest point in almost 30 years. According to FEMA, this growth resulted from several factors, including a growing number of mortgages with mandatory flood insurance purchase requirements and greater enforcement of these requirements, the longer-than-expected life of the structures that are eligible for subsidies, and increased awareness of the dangers of floods from several major recent disasters and increased NFIP marketing efforts. To date, more than half of the subsidized policies are concentrated in five states with relatively high flood risk--California, Florida, Louisiana, New Jersey, and Texas. Current low participation rates--around 50 percent of single-family homes in high-risk areas--leave room for substantial growth in the number of NFIP policies, many of which would be likely to receive subsidized rates. Because of their relatively high loss experience and lower premium rates, the policies receiving subsidized rates have been a financial burden on the program, with total claims exceeding premiums by $962 million over the period from 1986 through 2004, before the large losses from the 2005 hurricanes. Without changes to the program, the number of subsidized properties will likely continue to grow, increasing the potential for future NFIP operating deficits. As Congress evaluates the impact of subsidized premium rates, it is faced with balancing the public policy goals of charging premium rates that fully reflect actual risks, encouraging broad program participation through affordable rates, and limiting costs to taxpayers. While the current program of propertybased subsidies and voluntary mitigation efforts--steps taken to reduce a property's flood risk such as relocation or elevation--encourages broad program participation, it is unlikely to substantially reduce the adverse financial impact of subsidized properties. GAO identified three options for addressing the financial impact of subsidized properties on the NFIP, each with advantages and disadvantages. One option would be to increase mitigation efforts, including making mitigation mandatory. Mitigation could help reduce flood losses, but the increased funding for such efforts could be high. A second option, eliminating or reducing subsidies, could improve NFIP's financial stability by increasing the number of policies that more accurately reflect the risk of flooding. However, the resulting higher premium rates could reduce NFIP participation and could meet resistance from local communities. A third option would be to target subsidies based on financial need, which could help ensure that only those in need receive subsidies, with the rest paying full-risk rates. However, it could be challenging for FEMA to develop and administer such a program in the midst of ongoing management challenges. While the inherent difficulty in determining premium rates adequate to cover potentially volatile and at times catastrophic flood losses means that the potential for the program to incur future operating deficits will always exist, implementing any or a combination of these options could significantly reduce the adverse financial impact of subsidies on NFIP.