Insurance Information

December 9, 2008

In a recent report released by the U.S. Government Accountability Office (GAO), it is cited that premiums charged by the National Flood Insurance Program (NFIP) are insufficient to cover the risk. The report advises that the methods for rate setting be reconsidered.

The GAO report recently submitted to the U.S. Senate Committee on Banking and Housing and Urban Affairs, says that the 2005 hurricane season left the NFIP with a never before heard of deficit of $17.4 billion. The report brings together findings of a study undertaken as a response to concerns over the financial status of the NFIP, which is operated by the Federal Emergency Management Agency (FEMA).

By statute the NFIP was not designed to be actuarially sound. The GAO report notes that up until 2004, the program dealt with most of its losses through its collected premiums and with the help of occasional loans from the Treasury that were either repaid or retired by Congress.

It is the intent of premium rates to fully reflect the risk of flooding, in the case at least for about 75% of properties. The remaining 25 percent are subsidized in order to encourage participation in the program.

In addition to this, the NFIP permits some properties, to remain at lower premium levels that do not reflect the true flood risk. These are these properties which through the re-mapping process have been allocated to riskier flood zones. But the GAO discovered that FEMA does not collect data on these properties. Nor does it measure their financial impact on the program. In fact FEMA does not even know how many of these properties exist, their precise location, or how much they create in losses.

As a part of their study, the GAO evaluated FEMA's processes for establishing both full-risk and subsidized rates. It discovered that in general the amount the NFIP collects in annual premiums, both full-risk and subsidized, is not sufficient to cover its operating costs, claim losses, and principal and interest payments to the Department of Treasury. This therefore has the affect of exposing the federal government and therefore taxpayers, to ever-greater financial risk. This would be especially true during years of catastrophic flooding.

An additional feature of the report is its mention that some of FEMA's data is outdated or inaccurate. The report notes that that damage estimates and flood probabilities based on data from the 1980s do not reflect recent flood damage experience. Also many of the flood maps used in rate setting were found to be in need of updating.

The study found that there is a basic problem in the rate structure and that is that policyholders in states with frequent high-loss years pay the same rates as policyholders with similar properties in states with less losses. This results in low-loss states ending up subsidizing states with high losses.