FEMA's Rate-Setting Process Warrants Attention
GAO-09-12, Oct 31, 2008
Questions about the financial status of the National Flood Insurance Program (NFIP) have increased since the 2005 hurricanes, which left the program with an unprecedented $17.4 billion deficit--a debt that resulted in GAO placing NFIP on its high-risk list in March 2006. Among the concerns are the subsidized rates NFIP must provide for about 25 percent of the policies, mostly for older buildings in high-risk flood zones. And although fully risk-based rates are supposed to reflect actual flood risk, concerns have been raised that they do not. This report evaluates (1) the Federal Emergency Management Agency's (FEMA) process for setting full-risk rates to determine whether it produces rates that accurately reflect the risk of flooding and (2) the process that FEMA uses to set subsidized rates and their effect on the financial condition of NFIP. To do this work, GAO evaluated the NFIP rate model, examined data from FEMA, surveyed relevant literature, and interviewed other relevant agencies and risk-modeling firms.
FEMA's method for setting its full-risk rates may not ensure that the rates accurately reflect the actual risk of flood damage. The NFIP model combines estimated flood risk with expected flood damage, but a number of factors may affect the accuracy of the rates the model generates. First, some data inputs are outdated or inaccurate. FEMA relies on flood probabilities from the 1980s and damage estimates that do not fully reflect recent NFIP damage experience. Moreover, while FEMA has made updating its flood maps a priority, most of the maps used in rate setting have not yet been updated. Second, FEMA does not require all properties remapped into higher-risk areas to pay rates based on the new designation. This policy, known as grandfathering, erodes NFIP's ability to charge rates that reflect the risk of flooding. The policy is intended to increase participation, but FEMA does not track the number of grandfathered properties and cannot determine their financial impact on the program. Third, FEMA uses a nationwide rating system that combines flood zones across many geographic areas, so individual policies do not always reflect topographical features that affect flood risk. In fact, some patterns in historical claims and premium data suggest that NFIP's full-risk rates may not always reflect actual flood risk. Collectively, these factors increase the risk that premiums collected on full-risk policies may be insufficient to cover future losses, adding to concerns about NFIP's financial stability. FEMA's rate-setting process for subsidized properties depends in part on the accuracy of the full-risk rates, raising concerns about how these rates are calculated as well. To set subsidized rates, FEMA first subtracts the total amount it expects to collect in full-risk premiums from the average historical loss year--that is, the minimum (target) amount that the program needs to collect from all premiums to cover at least average annual losses, as determined by historical data. The remainder becomes the aggregate target amount the program must collect in subsidized premiums. To set individual subsidized rates, FEMA officials then consider their knowledge of flood risk, previous rate increases for various locations, and statutory limits on increases. The resulting subsidized premiums continue to be a financial strain on the NFIP and contribute to its ongoing financial instability. Evidence suggests that flooding is likely to become more severe in the future, resulting in increased risk exposure, the potential for more catastrophic losses, and ongoing financial instability for the program. Currently, the annual amount that NFIP collects in both full-risk and subsidized premiums is not enough to cover its operating costs, claim losses, and principal and interest payments to the Department of the Treasury, thereby exposing the federal government and ultimately taxpayers to ever-greater financial risks, especially in years of catastrophic flooding.
- Review Pending
- Closed - implemented
- Closed - not implemented
Recommendations for Executive Action
Recommendation: The Secretary of the Department of Homeland Security should direct FEMA to take steps to ensure that its rate-setting methods and the data it uses to set rates result in full-risk premiums rates that accurately reflect the risk of losses from flooding. These steps should include, for example, verifying the accuracy of flood probabilities, damage estimates, and flood maps; ensuring that the effects of long-term planned and ongoing development, as well as climate change, are reflected in the flood probabilities used; and reevaluating the practice of aggregating risks across zones.
Agency Affected: Department of Homeland Security
Comments: In an April 2010 meeting, FEMA officials described several actions they were planning to take to help improve the extent to which NFIP premium rates accurately reflect the risk of losses from flooding. These actions include (1) attempting to obtain better data on individual properties and topography from a 3rd party contractor; (2) working with contractors to obtain better flood probability data from updated flood maps; and (3) conducting coastal and riverine flood damage studies and incorporating the results into their pricing model. They added that they did use Army Corps of Engineers 2006 damage estimates to verify the accuracy of their own damage estimates. They also indicated that when map modernization efforts are complete, they will be able to use the results better estimate potential flood damages, which will in turn result in more accurate premium rates. We will await implementation of these plans before closing the recommendation.
Recommendation: The Secretary of the Department of Homeland Security should direct FEMA to ensure that information is collected on the location, number, and losses associated with existing and newly created grandfathered properties in NFIP and to analyze the financial impact of these properties on the flood insurance program.
Agency Affected: Department of Homeland Security
Comments: In April 2010, FEMA officials said that they were working on establishing contracts under which grandfathered properties and their impact on NFIP would be evaluated. They also indicated that they were talking with a 3rd party contractor about obtaining better information on individual properties. Such detailed information has recently become more affordable, and they were hopeful that it would help them in their evaluation of grandfathered properties. We will await implementation of these actions before closing the recommendation.