Federal Emergency Management Agency
Improvements Needed to Enhance Oversight and Management of the National Flood Insurance Program Gao ID: GAO-06-119 October 18, 2005In the wake of Hurricane Isabel in 2003, GAO was mandated by the Flood Insurance Reform Act of 2004 to report on issues related to the National Flood Insurance Program (NFIP) and its oversight and management by the Federal Emergency Management Agency (FEMA). Private insurance companies sell NFIP policies and adjust claims, while a private program contractor helps FEMA administer the NFIP. To address this mandate, this report assesses (1) the statutory and regulatory limitations on coverage for homeowners under the NFIP; (2) FEMA's role in monitoring and overseeing the NFIP; (3) FEMA's response to concerns regarding NFIP payments for Hurricane Isabel claims; and (4) the status of FEMA's implementation of provisions of the Flood Insurance Reform Act of 2004. Although impacts from Hurricane Katrina were not part of the report's scope, GAO recognizes that this disaster presents the NFIP with unprecedented challenges.
The amount of insurance coverage available to homeowners under the NFIP is limited by requirements set forth in statute and FEMA's regulations, which include FEMA's standard flood insurance policy. As a result of these limitations, insurance payments to claimants for flood damage may not cover all of the costs of repairing or replacing flood-damaged property. For example, homes that could sustain more than $250,000 in damage cannot be insured to their full replacement cost, thus limiting claims to this statutory ceiling. In addition, NFIP policies cover only direct physical loss by or from flood. Therefore, losses resulting primarily from a preexisting structural weakness in a home or losses resulting from events other than flood, such as windstorms, are not covered by NFIP policies. To meet its monitoring and oversight responsibilities, FEMA is to conduct periodic operational reviews of the 95 private insurance companies that participate in the NFIP, and FEMA's program contractor is to check the accuracy of claims settlements by doing quality assurance reinspections of a sample of claims adjustments for every flood event. FEMA did not use a statistically valid method for sampling files to be reviewed in these monitoring and oversight activities. As a result, FEMA cannot project the results of these reviews to determine the overall accuracy of claims settled for specific flood events or assess the overall performance of insurance companies and their adjusters in fulfilling responsibilities for the NFIP--actions necessary for FEMA to have reasonable assurance that program objectives are being achieved. In the months after Hurricane Isabel, FEMA took steps intended to address concerns that arose from that flood event. In April 2004, FEMA established a task force to review claims settlements from Hurricane Isabel claimants. As a result of task force reviews, almost half of the 2,294 policyholders who sought a review received additional payments. The additional payment amount averaged $3,300 more than the original settlement--for a total average settlement of about $32,400 per claimant. In most cases, the additional funds were for repairing or replacing buildings or property not included in the initial adjuster's loss determination, or to cover additional material or labor costs. FEMA has not yet fully implemented provisions of the Flood Insurance Reform Act of 2004 requiring the agency to provide policyholders with a flood insurance claims handbook that meets statutory requirements, to establish a regulatory appeals process, and to ensure that insurance agents meet minimum NFIP education and training requirements. The statutory deadline for implementing these changes was December 30, 2004. Efforts to implement the provisions are under way, but have not yet been completed. FEMA has not developed plans with milestones for assigning accountability and projecting when program improvements will be made, so that improvements are in place to assist victims of future flood events.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-06-119, Federal Emergency Management Agency: Improvements Needed to Enhance Oversight and Management of the National Flood Insurance Program
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
October 2005:
Federal Emergency Management Agency:
Improvements Needed to Enhance Oversight and Management of the National
Flood Insurance Program:
GAO-06-119:
GAO Highlights:
Highlights of GAO-06-119, a report to Congressional Committees:
Why GAO Did This Study:
In the wake of Hurricane Isabel in 2003, GAO was mandated by the Flood
Insurance Reform Act of 2004 to report on issues related to the
National Flood Insurance Program (NFIP) and its oversight and
management by the Federal Emergency Management Agency (FEMA). Private
insurance companies sell NFIP policies and adjust claims, while a
private program contractor helps FEMA administer the NFIP.
To address this mandate, this report assesses (1) the statutory and
regulatory limitations on coverage for homeowners under the NFIP; (2)
FEMA‘s role in monitoring and overseeing the NFIP; (3) FEMA‘s response
to concerns regarding NFIP payments for Hurricane Isabel claims; and
(4) the status of FEMA‘s implementation of provisions of the Flood
Insurance Reform Act of 2004.
Although impacts from Hurricane Katrina were not part of the report‘s
scope, GAO recognizes that this disaster presents the NFIP with
unprecedented challenges.
What GAO Found:
The amount of insurance coverage available to homeowners under the NFIP
is limited by requirements set forth in statute and FEMA‘s regulations,
which include FEMA‘s standard flood insurance policy. As a result of
these limitations, insurance payments to claimants for flood damage may
not cover all of the costs of repairing or replacing flood-damaged
property. For example, homes that could sustain more than $250,000 in
damage cannot be insured to their full replacement cost, thus limiting
claims to this statutory ceiling. In addition, NFIP policies cover only
direct physical loss by or from flood. Therefore, losses resulting
primarily from a preexisting structural weakness in a home or losses
resulting from events other than flood, such as windstorms, are not
covered by NFIP policies.
To meet its monitoring and oversight responsibilities, FEMA is to
conduct periodic operational reviews of the 95 private insurance
companies that participate in the NFIP, and FEMA‘s program contractor
is to check the accuracy of claims settlements by doing quality
assurance reinspections of a sample of claims adjustments for every
flood event. FEMA did not use a statistically valid method for sampling
files to be reviewed in these monitoring and oversight activities. As a
result, FEMA cannot project the results of these reviews to determine
the overall accuracy of claims settled for specific flood events or
assess the overall performance of insurance companies and their
adjusters in fulfilling responsibilities for the NFIP”actions necessary
for FEMA to have reasonable assurance that program objectives are being
achieved.
In the months after Hurricane Isabel, FEMA took steps intended to
address concerns that arose from that flood event. In April 2004, FEMA
established a task force to review claims settlements from Hurricane
Isabel claimants. As a result of task force reviews, almost half of the
2,294 policyholders who sought a review received additional payments.
The additional payment amount averaged $3,300 more than the original
settlement”for a total average settlement of about $32,400 per
claimant. In most cases, the additional funds were for repairing or
replacing buildings or property not included in the initial adjuster‘s
loss determination, or to cover additional material or labor costs.
FEMA has not yet fully implemented provisions of the Flood Insurance
Reform Act of 2004 requiring the agency to provide policyholders with a
flood insurance claims handbook that meets statutory requirements, to
establish a regulatory appeals process, and to ensure that insurance
agents meet minimum NFIP education and training requirements. The
statutory deadline for implementing these changes was December 30,
2004. Efforts to implement the provisions are under way, but have not
yet been completed. FEMA has not developed plans with milestones for
assigning accountability and projecting when program improvements will
be made, so that improvements are in place to assist victims of future
flood events.
What GAO Recommends:
GAO is recommending that FEMA use a statistically valid method to
select claims for review and establish milestones for meeting
provisions of the Flood Insurance Reform Act. FEMA reviewed a draft of
this report and expressed concerns about our findings related to NFIP
program management.
www.gao.gov/cgi-bin/getrpt?GAO-06-119.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact William O. Jenkins, Jr.
at (202) 512-8777 or jenkinswo@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Due to Statutory and Regulatory Limitations, NFIP Payments May Not
Cover All Costs to Repair or Replace Flood-Damaged Property:
Monitoring and Oversight of NFIP Identifies Specific Problems, but Does
Not Provide Comprehensive Information on Overall Program Performance:
FEMA Task Force Closed about Half of Hurricane Isabel Claims Reviewed
with Additional Payments:
FEMA Has Not Fully Implemented NFIP Program Changes Mandated by the
Flood Insurance Reform Act of 2004:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Federal Emergency Management Agency:
Appendix III: GAO Contact and Staff Acknowledgements:
Tables:
Table 1: NFIP Claims Payments on Flood Events in 2003:
Table 2: NFIP Claims Payments on Flood Events in 2004:
Table 3: Total Number of Operational Reviews of Write-Your-Own
Companies Conducted by FEMA (January 2000 to August 2005):
Figures:
Figure 1: NFIP Policies in Force, 1978-2005:
Figure 2: Total NFIP Payments to Claimants, 1972-2004:
Figure 3: Key Participants in the NFIP:
Figure 4: Disposition of Hurricane Isabel Claims Reviewed by the FEMA
Task Force:
Figure 5: Comparison of Claims Settlement Amounts for Hurricane Isabel
Claims Reviewed by the Task Force and All Claims Closed with Payment
(2002-2004):
Abbreviations:
FEMA: Federal Emergency Management Agency:
NFIP: National Flood Insurance Program:
OMB: Office of Management and Budget:
SFIP: Standard Flood Insurance Policy:
United States Government Accountability Office:
Washington, DC 20548:
October 18, 2005:
The Honorable Richard Shelby:
Chairman:
The Honorable Paul Sarbanes:
Ranking Minority Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Michael Oxley:
Chairman:
The Honorable Barney Frank:
Ranking Minority Member:
Committee on Financial Services:
House of Representatives:
Ninety percent of all natural disasters in the United States involve
flooding. Although homeowner insurance policies typically cover damage
and losses from fire or theft and often from wind-driven rain, they do
not cover flood damage because private insurance companies are largely
unwilling to bear the economic risks associated with the potentially
catastrophic impact of flooding. To provide some insurance protection
for flood victims, as well as incentives for communities to adopt and
enforce floodplain management regulations to reduce future flood
damage, Congress established the National Flood Insurance Program
(NFIP) in 1968. NFIP coverage is available to owners and occupants of
insurable property in flood-prone areas.[Footnote 1] The Federal
Emergency Management Agency (FEMA) within the Department of Homeland
Security is responsible for, among other things, oversight and
management of the NFIP.[Footnote 2]
To implement the NFIP, FEMA principally relies on private insurance
companies that sell flood insurance policies and adjust claims from
policyholders after floods occur. FEMA is assisted in its management
and oversight functions by a program contractor. As of August 2005, the
NFIP had about 4.6 million policyholders in about 20,000 communities.
As of August 2005, the program had paid a total of about $14.6 billion
in insurance claims financed primarily by policyholder premiums.
Without the NFIP, the costs to repair damage covered by these claims
would otherwise have been paid through taxpayer-funded disaster relief
or by the flood victims themselves.
Policyholders' concerns regarding the processing and payments of NFIP
claims after Hurricane Isabel in 2003 focused congressional attention
on the program. Specifically, some policyholders cited inadequate
payments for flood damages they incurred and a lack of clarity
regarding their insurance policies and the procedures for filing and
adjusting claims for flood damage.
The Flood Insurance Reform Act of 2004,[Footnote 3] which mandated that
FEMA implement new processes and requirements for selling NFIP policies
and adjusting flood insurance claims, also mandated that we study and
report on issues related to the processing of flood insurance claims
and FEMA's oversight and management of the program. To address this
mandate, this report assesses (1) the statutory and regulatory
limitations on homeowners' coverage under the NFIP; (2) FEMA's role in
monitoring and overseeing the NFIP; (3) FEMA's response to concerns
regarding NFIP payments for claims related to Hurricane Isabel; and (4)
the status of FEMA's implementation of provisions of the Flood
Insurance Reform Act of 2004.
As we finalized this report, the extent of the devastation from
Hurricanes Katrina and Rita in August 2005 and September 2005 was not
yet fully determined, as the nation struggled to respond to the
immediate needs of populations of entire cities and towns for food,
water, shelter, and basic health care. Although impacts from Hurricane
Katrina and Rita were not part of our mandate for this report, clearly
this disaster will challenge the NFIP with demands the program has
never before faced in its more than 30-year history. Already, a record
number of flood insurance claims have been filed in 2005, and Congress
has increased the program's authority to borrow from the United States
Treasury from $1.5 billion to $3.5 billion.
To determine the statutory and regulatory limitations on homeowners'
coverage under the NFIP, we researched The National Flood Insurance Act
of 1968, as amended,[Footnote 4] its legislative history, and FEMA's
implementing regulations, which include FEMA's "Standard Flood
Insurance Policy" (SFIP). We also discussed the results of our analysis
with officials of the DHS Office of General Counsel. To assess FEMA's
NFIP monitoring and oversight role, we examined program requirements
and reports and observed NFIP training programs for insurance agents
and adjusters. We also observed a FEMA review of an insurance company's
operations, and we analyzed reports of the results of all reviews of
insurance operations and follow-up visits at insurance companies where
FEMA identified critical errors over a 10-year period, from 1996 to
April 2005--a total sample of 15 reports. We interviewed officials of
FEMA and its program contractor about their oversight activities and
discussed aspects of the process with private-sector insurance
officials from four of the five largest insurance companies
participating in the NFIP based on the number of claims filed in 2004.
We also obtained documentation on how reviews of a sample of claims
adjustments are done after flood events and talked with staff employed
by FEMA's contractor about how they reinspect the work of private-
sector adjusters who prepare flood damage estimates and how they select
properties to visit for these reviews. We interviewed them because they
had performed quality reinspections of claims adjustments for damage
from Hurricane Isabel, as well as from hurricanes in Florida in 2004.
To determine FEMA's response to concerns about Hurricane Isabel claims
payments, we discussed the actions FEMA took to address concerns of
Hurricane Isabel claimants with FEMA officials, and we reviewed a
statistically valid sample of 100 files from claimants in Maryland,
Virginia, and North Carolina who were dissatisfied with their initial
claims settlements resulting from Hurricane Isabel and who had their
claims reviewed by a special FEMA task force. We based our analysis of
these claims on the information in the files we reviewed; we did not
independently verify the accuracy of the information in the claims
files. To test the overall reliability of the NFIP database, we
reviewed a statistically valid sample of 250 claims for all flood
events that occurred in 2003 and 2004. We conducted this reliability
testing to assure ourselves that information from the NFIP database was
sufficiently accurate for our reporting purposes. To determine the
extent to which FEMA implemented provisions of the Flood Insurance
Reform Act of 2004, we examined documentation of the agency's efforts
and interviewed officials. We conducted our work from December 2004
through August 2005 in accordance with generally accepted government
auditing standards. Our scope and methodology are discussed in greater
detail in appendix I.
Results in Brief:
The amount of insurance coverage available to homeowners under the NFIP
is limited by requirements set forth in statute and regulation. As a
result of these limitations, insurance payments to claimants for flood
damage may not cover all of the costs of repairing or replacing flood-
damaged property. For example, there is a $250,000 statutory ceiling on
the amount of flood insurance homeowners may purchase; thus, homes that
might sustain more than $250,000 in damage cannot be insured to their
full replacement cost. In addition, NFIP policies cover only direct
physical loss by or from flood. Therefore, losses resulting primarily
from a preexisting structural weakness defect in a home or prior water
damage, and losses resulting from events other than flood, such as
windstorms or earth movements, are not covered by the NFIP. Moreover, a
homeowner's personal property is covered, with certain limitations,
only if the homeowner has separately purchased NFIP personal property
insurance in addition to coverage for the building. Finally, the method
of settling losses affects the amount recovered. For example, homes
that qualify only for an actual cash value settlement--which represents
the cost to replace damaged property, less the value of physical
depreciation--would presumably receive payments that are less than
homes that qualify for a replacement cost settlement, which does not
deduct for depreciation.
To meet its monitoring and oversight responsibilities, FEMA is to
conduct periodic operational reviews of the 95 private insurance
companies that participate in the NFIP. In addition, FEMA's program
contractor is to check the accuracy of claims settlements by doing
quality assurance reinspections of a sample of claims adjustments for
every flood event. For operational reviews, FEMA examiners are to do a
thorough review of the companies' NFIP underwriting and claims
settlement processes and internal controls, including checking a sample
of claims and underwriting files to determine, for example, whether a
violation of policy has occurred, an incorrect payment has been made,
and if files contain all required documentation. Separately, FEMA's
program contractor is responsible for conducting quality assurance
reinspections of a sample of claims adjustments for specific flood
events in order to identify, for example, whether an insurer allowed an
uncovered expense or missed a covered expense in the original
adjustment. The operational reviews and follow-up visits to insurance
companies that we analyzed followed FEMA's internal control procedures
for identifying and resolving specific problems that may occur in
individual insurance companies' processes for selling and renewing NFIP
policies and adjusting claims. According to information provided by
FEMA, the number of operational reviews completed between 2000 and
August 2005 were done at a pace that allows for a review of each
participating insurance company at least once every 3 years, as FEMA
procedures require. In addition, the processes FEMA had in place for
operational reviews and quality assurance reinspections of claims
adjustments met our internal control standard for monitoring federal
programs. However, the process FEMA used to select a sample of claims
files for operational reviews and the process its program contractor
used to select a sample of adjustments for reinspections were not
randomly chosen or statistically representative of all claims. We found
that the selection processes used were, instead, based upon judgmental
criteria including, among other items, the size and location of loss
and complexity of claims. As a result of limitations in the sampling
processes, FEMA cannot project the results of these monitoring and
oversight activities to determine the overall accuracy of claims
settled for specific flood events or assess the overall performance of
insurance companies and their adjusters in fulfilling their
responsibilities for the NFIP--actions necessary for FEMA meet our
internal control standard that it have reasonable assurance that
program objectives are being achieved and that its operations are
effective and efficient.
In the months after Hurricane Isabel, FEMA took steps intended to
uniquely address concerns that arose from that flood event. In April
2004, FEMA established a task force to review claims settlements from
Hurricane Isabel claimants. This was the first time in the history of
the NFIP that a formal claims review process was established. As a
result of task force reviews, almost half of the 2,294 policyholders
who sought a claims review received additional payments. The additional
payment amount averaged $3,300 more than the original settlement--for a
total average settlement of about $32,400 per claimant. In most cases,
the additional funds were for repairing or replacing buildings or
personal property not included in the initial adjuster's loss
determination; or to cover additional material or labor costs. For
example, in one instance the original adjuster had not included
coverage for a kitchen countertop and a cable television outlet that
the task force added to the claims settlement. In other claims,
reviewers allowed higher prices for paint, dry wall, insulation, and
other building materials than had been allowed in the initial loss
report. An NFIP manager said that the original pricing was not an error
in many cases, but that the costs of the materials had increased
between the time of the initial loss and the final settlement offer.
Among reasons that claims reviewed by the task force were closed with
no additional payment were that the reviewer agreed with the original
determination that (1) flood damage to parts of a basement were not
covered and that (2) damage was not due to flood but to wind-driven
rain.
As of September 2005, FEMA had not yet fully implemented provisions of
the Flood Insurance Reform Act of 2004. The act requires FEMA to
provide policyholders a flood insurance claims handbook and other new
materials for explaining their coverage when they purchase and renew
policies; to establish a regulatory appeals process for claimants; and
to establish minimum education and training requirements for insurance
agents who sell NFIP policies. The 6-month statutory deadline for
implementing these changes was December 30, 2004. While FEMA advised us
that it finalized statutorily required informational materials in
September 2005, its flood insurance claims handbook does not yet fully
comply with statutory requirements. The handbook contains information
on anticipating, filing and appealing a claim, but does not include
information regarding the appeals process that FEMA is statutorily
required to establish through regulation. In its comments on our draft
report, FEMA stated that it was offering claimants an informal appeals
process pending the establishment of a regulatory process, and that the
handbook describes this informal appeals process. However, by statute,
the claims handbook must describe the regulatory process, which FEMA
has yet to establish. With respect to this appeals process, FEMA has
not stated how long rulemaking might take to establish the process by
regulation, or how the process might work, such as filing requirements,
time frames for considering appeals, and the composition of an appeals
board. With respect to minimum training and education requirements for
insurance agents who sell NFIP policies, FEMA published a Federal
Register notice on September 1, 2005, which included an outline of
training course materials. In the notice, FEMA stated that, rather than
establish separate and perhaps duplicative requirements from those that
may already be in place in the states, it had chosen to work with the
states to implement the NFIP requirements through already established
state licensing schemes for insurance agents. The notice did not
specify how or when states were to begin implementing the NFIP training
and education requirements. Thus, it is too early to tell the extent to
which insurance agents will meet FEMA's minimum standards. FEMA
officials said that, because changes to the program could have broad
reaching and significant effects on policyholders and private-sector
stakeholders upon whom FEMA relies to implement the program, the agency
is taking a measured approach to addressing the changes mandated by
Congress. Nonetheless, without plans with milestones for completing its
efforts to address the provisions of the act, FEMA cannot hold
responsible officials accountable or ensure that statutorily required
improvements are in place to assist victims of future flood events.
To strengthen and improve FEMA's monitoring and oversight of the NFIP,
we are recommending that FEMA use a methodologically valid approach for
sampling files selected for operational reviews and quality assurance
claims reinspections. To help ensure that actions are taken in a timely
manner to address legislative requirements established in the Flood
Insurance Reform Act of 2004, we are recommending that FEMA establish
documented plans with milestones for completing its efforts and hold
NFIP officials accountable for implementing these plans.
In commenting on a draft of this report, FEMA expressed concerns about
our findings related to NFIP program management and oversight.
Specifically, FEMA was concerned that we did not directly address the
issue of whether Congress intended the NFIP to restore flood-damaged
properties to their pre-flood conditions. We believe we have addressed
the issue consistent with our statutory mandate by explaining the
statutory and regulatory provisions that affect both dollar ceilings
and other coverage limitations. In other words, flood insurance
policies can only restore victims to pre-flood conditions within, but
not beyond, the dollar ceilings and other coverage limitations
established by law and regulation. FEMA also questioned our
characterization of its operational reviews and claims reinspection
processes in the context of FEMA's overall financial and management
control efforts. However, our focus was on overall NFIP program
management and oversight, not on FEMA's fiduciary responsibilities or
additional internal control measures. During our review, FEMA managers
described the operational reviews and claims inspections as the primary
methods FEMA used for monitoring and overseeing the NFIP.
FEMA also noted that its method of selecting its sample for operational
reviews was more appropriate than the statisticall y random probability
sample we recommended. We believe that, although FEMA's current
sampling strategy may provide an opportunity to focus on particular
areas of risk, it does not provide management with the information
needed to assess the overall performance of private insurance companies
and adjusters participating in the program--information that FEMA needs
to have reasonable assurance that program objectives are being
achieved:
In addition, FEMA disagreed with our characterization of the extent to
which FEMA has met provisions of the Flood Insurance Reform Act of
2004. We believe that our description of those efforts and our
recommendations with regard to implementing the Act's provisions remain
valid. FEMA's comments are contained in appendix II. In addition, FEMA
provided technical comments, which we incorporated into the report as
appropriate.
Background:
Nearly 20,000 communities across the United States and its territories
participate in the NFIP by adopting and agreeing to enforce state and
community floodplain management regulations to reduce future flood
damage. In exchange, the NFIP makes federally backed flood insurance
available to homeowners and other property owners in these communities.
Homeowners with mortgages from federally regulated lenders on property
in communities identified to be in special high-risk flood hazard areas
are required to purchase flood insurance on their dwellings. Optional,
lower-cost coverage is also available under the NFIP to protect homes
in areas of low to moderate risk. To insure furniture and other
personal property items against flood damage, homeowners must purchase
separate NFIP personal property coverage. Although premium amounts vary
according to the amount of coverage purchased and the location and
characteristics of the property to be insured, the average yearly
premium for a 1-year policy was $446, as of June 2005.
The National Flood Insurance Act of 1968[Footnote 5] established the
NFIP. Congress mandated that the NFIP was to be implemented "based on
workable methods of pooling risks, minimizing costs, and distributing
burdens equitably among those who will be protected by flood insurance
and the general public."[Footnote 6] To make "flood insurance coverage
available on reasonable terms and conditions to persons who have need
for such protection,"[Footnote 7] the NFIP strikes a balance between
the scope of the coverage provided and the premium amounts required to
provide that coverage. Coverage limitations arise from statute and
regulation, including FEMA's standard flood insurance policy (SFIP),
which is incorporated in regulation and issued to policyholders when
they purchase flood insurance.
To the extent possible, the program is designed to pay operating
expenses and flood insurance claims with premiums collected on flood
insurance policies rather than by tax dollars. However, as we have
reported, the program, by design, is not actuarially sound because
Congress authorized subsidized insurance rates to be made available for
policies covering certain structures to encourage communities to join
the program. As a result, the program does not collect sufficient
premium income to build reserves to meet the long-term future expected
flood losses.[Footnote 8] FEMA has statutory authority to borrow funds
from the Treasury to keep the NFIP solvent.[Footnote 9] Following
Hurricane Katrina in August 2005, legislation was enacted that
increased FEMA's borrowing authority from a total of $1.5 billion to
$3.5 billion through fiscal year 2008.[Footnote 10] FEMA has exercised
its borrowing authority four times in the last decade when losses
exceeded available fund balances. For example, as of August 2005, FEMA
had borrowed $300 million in 2005 to pay an estimated $1.8 billion on
flood insurance claims resulting from the 2004 hurricane season. As it
has done when it has borrowed in the past, FEMA intends to repay these
funds with interest, according to agency officials, however, the
officials had not yet estimated NFIP claims amounts anticipated for
flood damage from Hurricane Katrina in August 2005.
Participation in the NFIP and Claims Payments Have Grown:
As shown in figure 1, the number of NFIP policies in force has grown
steadily over the past 27 years to a total of about 4.6 million
policies in force as of May 31, 2005.
Figure 1: NFIP Policies in Force, 1978-2005:
[See PDF for image]
[End of figure]
As shown in figure 2, NFIP claims payments have varied widely by year
over the life of the program depending on the number and severity of
flood events; however, as the number of policies in force increased
(see fig. 1), the claims payments have trended upward. Claims paid in
2004 were the highest amount in the history of the NFIP--more than $1.9
billion for all flood events.
Figure 2: Total NFIP Payments to Claimants, 1972-2004:
[See PDF for image]
[End of figure]
Tables 1 and 2 provide information on payments by flood event in 2003
and 2004. In 2003, the NFIP paid about $478 million on more than 21,000
claims from 5 named flood events and an additional $287 million on
15,232 claims filed for damage from unnamed floods. Of those claims,
more than half resulted from damage from Hurricane Isabel in six states
and Washington, D.C. Hurricane Isabel was a category 5 hurricane at its
peak with sustained winds in excess of 165 miles per hour. It made
landfall on September 18, 2003, near Drum Inlet, North Carolina, as a
category 2 storm. As it traveled across Virginia, Maryland, and
Pennsylvania, Isabel weakened to a tropical storm, but its heavy rains
caused storm surge flooding.
Table 1: NFIP Claims Payments on Flood Events in 2003:
Dollars in thousands:
Flood event/state(s): Hurricane Isabel (Delaware, Maryland, North
Carolina, Pennsylvania, South Carolina, Virginia, and Washington,
D.C.);
Number of paid losses: 19,523;
Amount paid: $455,869.
Flood event/state(s): Delaware flooding (Delaware);
Number of paid losses: 10;
Amount paid: $64.
Flood event/state(s): Torrential rain (Puerto Rico);
Number of paid losses: 261;
Amount paid: $1,366.
Flood event/state(s): Hurricane Claudette (Texas);
Number of paid losses: 1,035;
Amount paid: $10,884.
Flood event/state(s): Tennessee flood (Tennessee);
Number of paid losses: 309;
Amount paid: $9,759.
Flood event/state(s): Named flood event total;
Number of paid losses: 21,138;
Amount paid: $477,942.
Flood event/state(s): Unnamed flood total;
Number of paid losses: 15,232;
Amount paid: $287,317.
Total;
Number of paid losses: 36,370;
Amount paid: $765,259.
Source: GAO analysis of FEMA data.
[End of table]
For 2004 flood events, as of April 30, 2005, the NFIP paid more than
$1.9 billion on more than 52,785 NFIP claims from storms including
Hurricanes Charley, Frances, Ivan, and Jeanne that caused major damage
in Florida and other East Coast and Gulf Coast states.
Table 2: NFIP Claims Payments on Flood Events in 2004:
Flood event/state(s): Kentucky Flood (Kentucky);
Number of paid losses: 279;
Amount paid: $5,717.
Flood event/state(s): Hurricane Alex (North Carolina);
Number of paid losses: 249;
Amount paid: $2,436.
Flood event/state(s): Hurricane Charley (Florida and North Carolina);
Number of paid losses: 2,434;
Amount paid: $46,369.
Flood event/state(s): Hurricane Frances (Florida);
Number of paid losses: 4,737;
Amount paid: $139,866.
Flood event/state(s): Hurricane Ivan (Alabama, Florida, Georgia,
Louisiana, Mississippi, Ohio, Pennsylvania, Virginia, and West
Virginia);
Number of paid losses: 25,558;
Amount paid: $1,233,964.
Flood event/state(s): Hurricane Jeanne (Florida and Puerto Rico);
Number of paid losses: 3,994;
Amount paid: $78,355.
Flood event/state(s): Named flood event total;
Number of paid losses: 37,251;
Amount paid: $1,506,707.
Flood event/state(s): Unnamed flood total;
Number of paid losses: 15,534;
Amount paid: $442,678.
Flood event/state(s): Total;
Number of paid losses: 52,785;
Amount paid: $1,949,385.
Source: GAO analysis of FEMA data.
[End of table]
Private Insurers Sell Policies and Adjust NFIP Claims under FEMA
Oversight and Management:
The work of selling, servicing, and adjusting claims on NFIP policies
is carried out by thousands of private-sector insurance agents and
adjusters who work independently or are employed by insurance companies
or their designated subcontractors. According to FEMA, about 95 percent
of the NFIP policies in force are written by insurance agents who
represent 95 private insurance companies that issue policies and adjust
flood claims in their own names.[Footnote 11] The companies, called
write-your-own companies, receive an expense allowance from FEMA of
about one-third of the premium amounts for their services and are
required to remit premium income in excess of this allowance to the
National Flood Insurance Fund.[Footnote 12] The write-your-own
companies also receive a percentage fee--about 3.3 percent of the
incurred loss--for adjusting and settling claims. The insurance
companies share the FEMA expense allowance and fee for claims
settlements with insurance agents who sell and service the policies, a
vendor, or subcontractor, if the company has subcontracted with one to
handle all or part of its flood insurance business, and flood claims
adjusters.[Footnote 13]
Figure 3 shows the key participants in the process: a homeowner; an
insurance agent, an insurance company, and, in many cases, a flood
insurance vendor, or subcontractor, to assist with aspects of the NFIP
business; and a flood adjuster. FEMA and its program contractor manage
and oversee the NFIP and the National Flood Insurance Fund accounts
into which premiums are deposited and claims and expenses paid.
Figure 3: Key Participants in the NFIP:
[See PDF for image]
[End of figure]
Insurance agents under contract to one or more write-your-own insurance
company are the main point of contact for most policyholders to
purchase an NFIP policy, seek information on coverage, or file a claim.
In order to sell flood insurance, agents must meet basic state
insurance licensing requirements. Based on information the insurance
agents submit, the insurance companies issue policies, collect premiums
from policyholders, deduct an allowance for expenses from the premium,
and remit the balance to the National Flood Insurance Fund. In some
cases, insurance companies hire subcontractors--flood insurance
vendors--to conduct some or all of the day-to-day processing and
management of flood insurance policies.
Insurance companies work with certified flood adjusters to settle NFIP
claims. When flood losses occur, policyholders contact their insurance
agents to report the loss. The agent then contacts the write-your-own
company to report the loss and it assigns a flood adjuster to assess
damages. Flood adjusters may be independentor employed by an insurance
or adjusting company. These adjusters are responsible for assessing
damage, estimating losses, and submitting required reports, work
sheets, and photographs to the insurance company, where the claim is
reviewed and, if approved, processed for payment. Adjusters determine
prices for repairs by reviewing estimates of costs prepared by
policyholders and their contractors, consulting pricing software and
checking local prices for materials. Claims amounts may be adjusted
after the initial settlement is paid if claimants submit documentation
that some costs were higher than estimated. An adjuster must have a
least 4 consecutive years of full-time property loss adjusting
experience and have attended an adjuster workshop, among other
requirements, to be certified by FEMA to work on NFIP claims,. To keep
their certifications current, adjusters are required to take a 1-day
refresher workshop each year and pass a written examination testing
their knowledge each year.
Flood claims adjusters employed by write-your-own companies are paid
salaries and sometimes bonuses for working long hours after major flood
events from a percentage fee--about 3.3 percent of the incurred loss,
which the NFIP pays write-your-own companies for settling claims,
according to an NFIP official. Independent adjusters who work for
multiple insurance companies are also paid based on a standard NFIP fee
schedule that varies adjuster compensation according to the size of the
claim. For example, the fee schedule pays $1,000 for a claim settlement
of between $25,000 and $35,000. If the independent adjuster is
registered with an independent adjusting firm, a portion of the fee
goes to the adjusting firm.
About 40 FEMA employees, assisted by about 170 contractor employees,
are responsible for managing the NFIP. Management responsibilities
include establishing and updating NFIP regulations, administering the
National Flood Insurance Fund, analyzing data to actuarially determine
flood insurance rates and premiums, and offering training to insurance
agents and adjusters. In addition, FEMA and its program contractor are
responsible for monitoring and overseeing the quality of the
performance of the write-your-own companies to assure that the NFIP is
administered properly.
Due to Statutory and Regulatory Limitations, NFIP Payments May Not
Cover All Costs to Repair or Replace Flood-Damaged Property:
The amount of insurance coverage available to homeowners under the NFIP
is limited, based on requirements set forth in statute and
regulation.[Footnote 14] First, by statute, there are limitations on
the amount of insurance coverage homeowners may purchase for their
dwellings and personal property. In addition, FEMA has further defined
the general terms and conditions of flood insurance coverage pursuant
to a broad grant of congressionally delegated authority, issuing
regulations that include a SFIP. Because of these statutory and
regulatory limitations, insurance payments to claimants for flood
damage may not cover all of the costs of repairing or replacing damaged
property.
In terms of statutory limitations, there is a ceiling on the amount of
insurance coverage available for single-family homes, which is
$250,000.[Footnote 15] Because of this statutory ceiling, homes that
could sustain more than $250,000 in damage cannot be insured to reflect
full replacement costs. Furthermore, while homes whose full replacement
cost is less than $250,000 may be fully insured, this is not
statutorily required. There is a "mandatory purchase" requirement for
homeowners in special high-risk flood hazard areas who hold mortgages
from federally regulated lenders, but they are only required to insure
their homes for the amount of their mortgages, which may be less than
their homes' full replacement cost.[Footnote 16] For homeowners in
areas of low-to moderate-flood risk, the purchase and amount of
insurance is optional, up to the $250,000 statutory maximum.[Footnote
17] As a result of the $250,000 ceiling and the "mandatory purchase"
floor, insurance on a given home may be less than its full replacement
cost. Homeowners may also separately elect to insure the contents of
their homes under the NFIP, although they are not required to do so. As
with the $250,000 cap on building coverage, there is also a statutory
limit on the amount of personal property coverage homeowners can buy.
By statute, homeowners can purchase no more than $100,000 in personal
property coverage, even if the value of their personal property exceeds
this amount.[Footnote 18]
In addition to the statutory limitations on coverage amounts, Congress
also gave FEMA broad authority to issue regulations establishing "the
general terms and conditions of insurability," including the classes,
types, and locations of properties that are eligible for flood
insurance; the nature and limits of loss that may be covered; the
classification, limitation, and rejection of any risks that FEMA
considers advisable; and the amount of appropriate loss
deductibles.[Footnote 19] Pursuant to this delegation of authority,
FEMA has issued regulations, including a "Standard Flood Insurance
Policy," that further delineate the scope of coverage.[Footnote 20] All
flood insurance made available under the NFIP is subject to the express
terms and conditions of the statute and regulations, including the
SFIP.[Footnote 21]
The SFIP is a contractual document that contains the terms of coverage
and is issued to homeowners when they purchase flood insurance. Some of
the principal SFIP limitations concern whether particular events,
losses, building property and personal property are covered, and what
deductible amounts and loss settlement methods apply when an insured
files a claim. While either FEMA or private write-your-own insurance
companies may issue flood insurance policies, FEMA's regulations
prohibit any change to the SFIP provisions without the express written
consent of the Federal Insurance Administrator, the FEMA official
responsible for administering the NFIP.[Footnote 22] The Administrator
is also charged with interpreting the scope of coverage under the
SFIP.[Footnote 23]
The SFIP covers only "direct physical loss by or from flood."[Footnote
24] It does not cover losses resulting from events other than flood,
such as windstorms or earth movements. Additionally, if the losses
primarily result from conditions inherent to the dwelling or within the
control of the insured, they are not covered by the SFIP.[Footnote 25]
Nor does the SFIP provide coverage if the flood is already in progress
when the policy begins or when the insured adds coverage. Finally, the
SFIP only covers direct, physical flood losses, not indirect losses
such as loss of revenue or profits, interruption of business, access to
and use of the insured property, or living expenses incurred while
property is uninhabitable.[Footnote 26]
The SFIP limits what type of building property is covered, considering
such things as the property's use, permanence, and degree of enclosure.
For coverage purposes, the SFIP defines a "building" as a manufactured
home; a travel trailer affixed to a permanent foundation; or a
"structure with two or more outside rigid walls and a fully secured
roof, that is affixed to a permanent site."[Footnote 27] A building
under construction may be covered even if not yet walled or roofed if
the construction is underway at the time the losses are
incurred.[Footnote 28] Detached garages may be covered, but not if the
garage is used for residential, business, or farming purposes,[Footnote
29] in which case it must be separately insured. Certain items of
property are considered part of the building. In general, these are
items built in or affixed to the building, for example, stoves, ovens,
refrigerators, central air conditioners, and permanently installed
cabinets and carpets. At the basement level, building coverage is more
limited and does not extend to finishing materials. For example,
whereas the SFIP covers permanently installed paneling and wallpaper
above the basement level, coverage in the basement is limited to
unfinished drywall.[Footnote 30]
The SFIP only insures for personal property if the homeowner purchases
personal property coverage and the personal property is inside a
building.[Footnote 31] Personal property includes movable items such as
portable microwaves, window-type air conditioning units, and carpets
that are not permanently installed. In a basement, coverage is limited
to certain items installed in their functioning location and, if
necessary for operation, connected to a power source, for example,
portable air conditioning units and clothes washers and dryers. Certain
types of personal property are specially limited to payment of no more
that $2,500, regardless of the magnitude of the loss. These objects
include artwork, collectibles, jewelry, furs, and property used in any
business.[Footnote 32] Personal property coverage does not extend to
such things as currency, postage, deeds, and other valuable
papers.[Footnote 33]
Certain types of property are wholly excluded from both building
property and personal property coverage. The first type of excluded
properties are those that are generally separate from the main
dwelling, such as recreational vehicles; self-propelled vehicles and
machines; land, plants, and animals; walkways, driveways, patios; and
hot tubs and swimming pools. The second type of excluded properties are
those with a close relationship with water or that are located below
ground, including buildings and personal property located entirely, in,
on, or over water; boathouses, wharves, piers, and docks; underground
structures or equipment; and buildings and contents where more than 49
percent of the actual cash value of the building is below
ground.[Footnote 34]
The amount recoverable under the SFIP is limited to the amount that
exceeds the applicable deductible.[Footnote 35] Applicable deductible
amounts are not listed in the SFIP itself, but are shown on the
Declarations Page, a computer-generated summary of the information
provided by the insured in the insured's application. The Declarations
Page is part of each insured's flood insurance policy. [Footnote 36]
The final type of limitation found in the SFIP derives from the methods
of settling losses. There are three loss settlement methods under the
SFIP: (1) "replacement cost," which homeowners may only purchase for
single-family dwellings in which they principally reside; (2) "special
loss settlement," which only applies to large manufactured
homes;[Footnote 37] and (3) "actual cash value," which applies to any
property that does not qualify for replacement cost or special loss
settlement.
The only difference between replacement cost and actual cash value is
the significance attached to the property's physical depreciation. An
actual cash value loss settlement represents what it would cost to
replace damaged property, less the value of its physical
depreciation.[Footnote 38] Because of depreciation, actual cash value
will presumably be less than the full cost to repair or replace the
damage.[Footnote 39] A replacement cost loss settlement, on the other
hand, does not deduct for physical depreciation. If replacement cost
coverage applies, the policy will pay the actual amount spent to repair
or replace the damage with materials of like kind and quality, subject
to the applicable deductible and the building's limit of
liability.[Footnote 40]
Homeowners can only obtain replacement cost coverage for their single-
family dwellings, not for multi-family dwellings or items of personal
property, which are subject to actual cash value coverage. In addition,
not all single-family dwellings are eligible for replacement cost
coverage. To qualify for such coverage, a home must be insured for 80
percent or more of its full replacement cost or the maximum coverage
amount of $250,000, and it must a principal residence. If a home does
not meet both criteria, the policy will pay the actual cash value for
the covered damage.
An additional limitation in replacement cost coverage applies when the
full cost of repair or replacement is greater than $1,000 or 5 percent
of the entire amount of insurance on the dwelling. In that case, the
SFIP provides that it "will not be liable for any loss unless and until
the actual repair or replacement is completed," unless the insured
foregoes a replacement cost settlement and makes a claim for actual
cash instead.[Footnote 41] If the insured eventually spends more on the
repair or replacement than the actual cash settlement, the individual
may file a claim for additional replacement cost liability, provided he
or she provides a notice of intent to do so within 180 days after the
date of loss. [Footnote 42]
We developed the following hypothetical property adjustment example
with the assistance of FEMA's director of NFIP claims to illustrate how
applicable limitations could reduce coverage for claimants whose
property is damaged by flood:
Hypothetical: A poorly maintained 30-year-old home located in a
designated flood zone was damaged when a nearby river overflowed. The
home's full replacement cost was $60,000. The homeowner purchased an
NFIP policy for $30,000 in coverage. Although a contractor estimated it
would cost $40,000 to repair damages to the structure and personal
property losses totaled another $10,000, a NFIP adjuster determined
that payment on the claim was $8,000 because:
* The homeowner had chosen not to insure his personal property.
* The adjuster determined that some problems that needed to be
addressed had not been caused by the flood (e.g., leaking pipes in the
bathroom and preexisting mold in the basement).
* The basement of the home, where the largest amount of damage
occurred, was finished, and coverage was limited to drywall damage.
* Actual cash value will be paid for repairs or replacement of damage
to the dwelling because the homeowner did not insure the structure for
at least 80 percent of its full replacement cost. Because the condition
of the home before the flood was poor, the actual cash value was low.
In this hypothetical case, the adjuster determined that the actual cash
value of damaged property covered by the policy was $9,000.
* A $1,000 deductible applied, reducing the $9,000 actual cash value
payment to $8,000.
Monitoring and Oversight of NFIP Identifies Specific Problems, but Does
Not Provide Comprehensive Information on Overall Program Performance:
FEMA's primary method to monitor and oversee the NFIP is to conduct
operational reviews of the 95 write-your-own insurance companies
participating in the NFIP. In addition, FEMA's program contractor is to
reinspect a sample of claims adjustments for every flood event to
identify errors, among other things. The operational reviews and follow-
up visits we analyzed followed FEMA's internal control procedures on
the processes for examiners to follow in conducting the reviews and for
doing the reviews at a pace that allows for a review of each write-your-
own company on at least a triennial basis. The processes FEMA followed
also met our internal control monitoring standard that requires federal
agencies to ensure that the findings of audits and other reviews are
promptly resolved. However, in doing these monitoring and oversight
activities, neither FEMA nor its program contractor used a
statistically valid method for sampling files selected for operational
reviews or claims reinspections. As a result, FEMA did not meet our
internal control standard that federal agencies have internal controls
in place to provide reasonable assurance that program objectives are
being achieved and that program operations are effective and efficient.
Without a statistically valid sampling methodology, the agency cannot
project the results of these monitoring and oversight activities to
determine the overall accuracy of claims settled for specific flood
events or assess the overall performance of insurance companies and
their adjusters in fulfilling their responsibilities for the NFIP.
FEMA's Operational Reviews of Insurers We Analyzed Identified and
Followed Up on Problems:
Operational reviews of flood insurance companies participating in NFIP
that are conducted by FEMA staff are FEMA's primary internal control
mechanism for monitoring, identifying, and resolving problems related
to how insurers sell and renew NFIP policies and adjust claims. Our
analysis of reports of all 15 operational reviews and follow up visits
at companies that were identified as having critical errors (e.g.,
incorrect payments) found that FEMA checked information and conducted
file reviews in accordance with the requirements and procedures
outlined in its Write Your Own Financial Control Plan.[Footnote 43] In
addition, our analysis found that FEMA followed up at all of the
companies where operational reviews had identified critical errors to
monitor the progress these companies made over time in addressing and
resolving critical errors. Monitoring the quality of performance over
time and ensuring that the findings of audits and other reviews are
promptly resolved is an internal control standard that we have
identified for the federal government.[Footnote 44]
According to the FEMA director of NFIP claims, one or two examiners
from FEMA's NFIP Claims and Underwriting sections go on-site to review
the operations of the 95 write-your-own companies. If vendors handle
all or part of a company's NFIP business, operational reviews are
conducted at the vendor locations and reviews of all of the companies
doing business with the vendor can be completed during one visit. Seven
FEMA staff in the Mitigation Division underwriting section and two
staff in the claims section have primary responsibility for conducting
operational reviews in addition to other responsibilities including
writing insurance manuals and regulations, providing technical
assistance, and responding to inquiries from policyholders, Members of
Congress and others. As discussed below, FEMA directs examiners to
conduct three steps for each operational review--a general underwriting
review, a specific underwriting review, and a claims operation review
of each insurance company's NFIP business. Requirements and procedures
for the operational review are outlined in FEMA's Write Your Own
Financial Control Plan.
In the general underwriting review, examiners are to review how the
company has handled applications for NFIP policies and how policies are
issued and cancelled among other items. The examiners are to check a
sample of files to determine, for example, whether NFIP policies were
renewed using correct payment rates and whether appropriate
documentation was included in the file. In the specific underwriting
review and the claims operation review, examiners are to conduct
detailed examinations of files to check for completeness and accuracy.
For example, they must make sure that elevations are calculated
correctly on new policies and that photographs document damage on flood
claims.
For all aspects of the operational reviews, the examiners are to
determine whether files are maintained in good order, whether current
forms are used and whether staff has a proficient knowledge of
requirements and procedures to properly underwrite and process flood
claims. Examiners are also to look at internal controls in place at
each company. When problems are identified, examiners are to classify
the severity of the errors. Each file reviewed is to be classified as
satisfactory or unsatisfactory. Unsatisfactory files contain either a
critical error (e.g., a violation of policy or an incorrect payment) or
three non-critical errors (e.g., violations of procedures that did not
delay actions on claims).
Write-your-own companies with error rates of 20 percent or higher of
the total number of files reviewed for the specific underwriting or
claims operation review would always receive an unsatisfactory
designation. If a company receives an unsatisfactory designation, FEMA
requires that it develop an action plan to correct the problems
identified and is to schedule a follow-up review in 6 months to
determine whether progress has been made. The action plans developed by
the companies generally must contain a timetable for addressing
deficiencies, including a plan for making progress reports to FEMA and
developing more stringent internal quality control procedures. If a
company continues to have problems and fails to implement an action
plan, it can ultimately be withdrawn from the NFIP. According to FEMA
officials, a company has been required to withdraw from the NFIP once
in the program's history in part because of issues raised in
operational reviews and in part due to other financial problems.
In our analysis of reports of all 15 operational reviews and follow-up
visits done at insurance companies that were identified as having
critical errors, we found that examiners checked information and did
file reviews in accordance with the requirements and procedures
outlined in the Write Your Own Financial Control Plan. We also
determined that FEMA followed up to monitor the progress the companies
made in addressing and resolving critical errors. For example, in one
instance after a write-your-own company received two unsatisfactory
designations, it was directed by FEMA to rewrite all of its policies to
be sure that the correct premiums were being charged to policyholders.
In another instance, FEMA required a write-your-own company to take
more extensive action than was proposed in its plan to address
deficiencies.
In addition, according to information provided by FEMA, operational
reviews completed since 2000 were on pace to meet FEMA's policy that
each of the 95 write-your-own companies be operationally reviewed at
least once every 3 years. Table 3 shows the number of operational
reviews reported by FEMA from January 2000 through August 2005. FEMA
has scheduled a review of 31 write-your-own companies at a large vendor
location for later in 2005.
Table 3: Total Number of Operational Reviews of Write-Your-Own
Companies Conducted by FEMA (January 2000 to August 2005):
Year: 2000;
Number of companies reviewed: 43.
Year: 2001;
Number of companies reviewed: 10.
Year: 2002;
Number of companies reviewed: 33.
Year: 2003;
Number of companies reviewed: 9.
Year: 2004;
Number of companies reviewed: 42.
Year: January to August 2005;
Number of companies reviewed: 11.
Total;
Number of companies reviewed: 148.
Source: FEMA.
[End of table]
Reinspections of NFIP Claims Conducted by Program Contractor:
In addition to operational reviews done by FEMA staff, FEMA's program
contractor conducts quality assurance reinspections of claims for
specific flood events. The program contractor employs nine general
adjusters who conduct quality assurance reinspections of a sample of
open claims for each flood event.[Footnote 45] Procedures for the
general adjusters to follow in conducting these reinspections are
outlined in FEMA's Write Your Own Financial Control Plan. According to
the general adjusters we interviewed, in addition to preparing written
reports of each reinspection, general adjusters discuss the results of
the reinspections they perform with officials of the write-your-own
companies that process the claims. If a general adjuster determines
that the insurance company allowed an expense that should not have been
covered, the company is to reimburse the NFIP. If a general adjuster
finds that the private-sector adjuster missed a covered expense in the
original adjustment, the general adjuster will take steps to provide
additional payment to the policyholder. An instructor at an adjuster
refresher training session, while observing that adjusters had
performed very well over all during the 2004 hurricane season, cited
several errors that he had identified in reinspections of claims,
including improper measurement of room dimensions and improper
allocation of costs caused by wind damage (covered by homeowners'
policies) versus costs caused by flood damage. In addition, the
instructor identified a problem that arose, namely, poor communication
with homeowners on the process followed to inspect the homeowner's
property and settle the claim. Overall error rates for write-your-own
companies are monitored. Procedures require additional monitoring,
training, or other action if error rates exceed 3 percent. According to
the general adjusters we interviewed and FEMA's program contractor,
quality assurance reinspections are forwarded from general adjusters to
the program contractor where results of reinspections are to be
aggregated in a reinspection database as a method of providing for
broad-based oversight of the NFIP as its services are delivered by the
write-your-own companies, adjusting firms and independent flood
adjusters.
Sampling Methods Used to Conduct Operational Reviews and Quality
Assurance Reinspections Do Not Provide Management Information on
Overall Performance:
FEMA used nonprobability sampling processes rather than random sampling
to select files for operational reviews and claims for quality
assurance reinspections. In nonprobability sampling, staff select a
sample based on their knowledge of the population's characteristics.
The major limitation of this type of sampling is that the results
cannot be generalized to a larger population, because there is no way
to establish, by defensible evidence, how representative the sample is.
A nonprobability sample is therefore not appropriate to use if the
objective is to generalize about the population from which the sample
is taken.[Footnote 46]
For the operational reviews, specific guidance on how to select files
for review is not documented, although guidance is provided on the
number of files to review based on the size of the write-your-own
companies' volume of NFIP business. The process used to select claims
for review, as it is described by FEMA managers who oversee operational
reviews, identifies problems at the write-your-own companies, but it is
not designed to assess overall performance. For the specific
underwriting portion of the review, examiners use a process described
by a FEMA official as adverse selection, or selection of files for
review that include the most difficult new policies that the company
underwrote in the period since the last operational review under the
assumption that if the company addresses difficult underwriting issues
correctly, it will also be able to do routine underwriting issues
correctly. According to this official, some examples of the most
difficult underwriting issues are policies covering properties in the
flood hazard areas closest to bodies of water and elevated buildings
that have enclosures underneath them. For the claims operation portion
of the operational review, like the underwriting portion, an examiner
said that FEMA attempts to select the more difficult or potentially
troublesome claims files to review. In addition, files that are closed
without payment and those with particularly large settlements are to be
included in the sample of files reviewed. Thus, the operational reviews
provide FEMA with management information on specific problems that
occur at write-your-own companies but, by design, do not assess the
overall performance of the companies.
For quality assurance reinspections, procedures are included in the
written FEMA guidance on the number of claims to sample, but not on the
sample selection process. General adjusters employed by FEMA's
contractor are to reinspect a sample of properties based on the total
number of claims the write-your-own company is processing for the flood
event. A FEMA official said that this number is up to about 4 percent
of claims for each flood event based on the total number of claims
filed for the flood event. Although the two general adjusters we
interviewed said their inspection sample selection process was random,
the selection process they described involved choosing properties to
reinspect based upon criteria they considered to be important. The
general adjusters said that they generally reinspected the adjustments
done on properties from a variety of neighborhoods that represented
different types (i.e., single family and condominium) and values of
houses, and varying flood loss claims amounts. A FEMA manager said that
this process was comparable to the approach used by all nine of the
general adjustors. While these criteria, if properly applied, would
lead to some variety in the selection of claims to review, the
selection process is not random or statistically valid for purposes of
projecting results to overall performance. By exercising a more
rigorous sample selection process, without incurring additional costs
or selecting larger sample sizes, FEMA would improve its internal
control processes.
Because FEMA's primary means of providing oversight are its operational
reviews and quality assurance reinspections, statistically-valid
information from these oversight activities is essential. However,
FEMA's use of an approach that lacks statistical validity for selecting
files for operational reviews and claims for reinspections does not
provide management with the information needed to assess the overall
performance of the write-your-own companies, including the overall
accuracy of the underwriting of NFIP policies and the adjustment of
claims--information that FEMA needs to have reasonable assurance that
program objectives are being achieved. Without a statistically valid
sampling methodology, FEMA did not meet our internal control standard
that federal agencies provide reasonable assurance that program
objectives are being achieved and that program operations are effective
and efficient.[Footnote 47]
FEMA Task Force Closed about Half of Hurricane Isabel Claims Reviewed
with Additional Payments:
FEMA took unique actions to respond to concerns regarding NFIP payments
for Hurricane Isabel flood claims. In April 2004, about 7 months after
Hurricane Isabel, FEMA established a task force to review claims
settlements based on requests by Hurricane Isabel claimants.[Footnote
48] It was the first time in the history of the NFIP that a formal
review process was established for NFIP claimants who were not
satisfied with actions taken on their claims. According to an NFIP
official, the task force was comprised of about 50 current and former
certified flood adjusters from various private sector flood insurance
adjusting firms, the nine general adjusters employed by FEMA's program
contractor, and three FEMA staff. Adjusters were assigned to review
claims outside of states where they had previously adjusted claims for
Hurricane Isabel damage, according to the official.
As shown in figure 4, FEMA officials said they sent notifications to
23,770 Isabel claimants in six states[Footnote 49] and Washington,
D.C., to advise claimants that they could have their claims reviewed by
a special FEMA task force if they were unhappy with actions taken to
settle them. Claimants could request a review by the FEMA task force in
person at a community meeting, by telephone, mail, or fax. About 10
percent of the claimants who were notified (2,294)--all with property
in Maryland, Virginia, and North Carolina--responded. In reviewing
those claims, the task force determined that 1,229 of the claims should
be closed with no additional payment and that 1,065 claims should be
closed with additional payments.
Figure 4: Disposition of Hurricane Isabel Claims Reviewed by the FEMA
Task Force:
[See PDF for image]
[End of figure]
Based on our review of a statistically representative sample of claims
files selected from the 2,294 claimants that responded to FEMA that
they wanted a task force review of their claims, the task force closed
claims with no additional payment for a variety of reasons. For
example:
* Task force agreed with the original determination that flood damage
to parts of a basement were not covered.
* Task force agreed with the original determination that damage was not
due to flood but to wind-driven rain.
* Task force agreed with the original determination that a claimant did
not have coverage for personal property.
Based on our analysis, reviewers allowed additional payments most
frequently to:
* Repair or replace building or personal property items that the
initial adjuster did not include in the loss report.
* Pay a higher amount for materials, labor, or personal property items
than the original adjuster had allowed.
In more than 90 percent of claims closed by the task force with
additional payment, the reviewer determined that additional payments
were due for one of these two reasons.[Footnote 50] In 48 percent of
the claims, additional payments were allowed for items that the initial
adjuster did not include in the loss report, and in 43 percent of
claims, additional payments were allowed to pay a higher amount for
costs than the original adjuster had allowed. For example, in one claim
we reviewed, the original estimate did not include coverage for a
kitchen countertop and a cable television outlet that the reviewer
included in the final claim settlement. In other claims, reviewers
allowed higher prices for paint, dry wall, insulation, base molding,
ceramic floor tile, and window trim, among other items, than had been
allowed in the initial loss report. One general adjuster for FEMA's
program contractor said that the original pricing was not an error in
many cases, but that the costs of the materials had increased between
the time of the initial loss and the final settlement offer.
Based on our analysis of the statistically representative sample of 100
claims files reviewed by the FEMA task force, the average amount paid
on claims closed with payments and for which claimants requested a
review by the task force was $32,438.[Footnote 51] The average
additional payment amount determined by the task force for claims that
were closed with an additional payment was $3,340. In comparison, as
illustrated in figure 5, the average closed payments for 2002, 2003,
and 2004 for claims closed with payment were $16,878, $19,980, and
$30,668, respectively[Footnote 52].:
Figure 5: Comparison of Claims Settlement Amounts for Hurricane Isabel
Claims Reviewed by the Task Force and All Claims Closed with Payment
(2002-2004):
[See PDF for image]
[End of figure]
FEMA Has Not Fully Implemented NFIP Program Changes Mandated by the
Flood Insurance Reform Act of 2004:
As of September 2005, FEMA had not fully implemented NFIP program
changes mandated by the Flood Insurance Reform Act of 2004 to (1)
develop supplemental materials for explaining coverage and the claims
process to policyholders when they purchase and renew policies and (2)
establish, by regulation, an appeals process for claimants. The 6-month
statutory deadline for implementing these changes was December 30,
2004. The act also required FEMA to establish minimum training and
education requirements for flood insurance agents and to publish the
requirements in the Federal Register by December 30, 2004. Although
FEMA published a Federal Register notice of its requirements on
September 1, 2005, the notice explained that FEMA intended to work with
the states to implement the minimum NFIP standards through existing
state licensing schemes for insurance agents. Thus, it is too early to
tell the extent to which insurance agents will meet FEMA's minimum
requirements.
For purposes of explaining coverage and the claims process to
policyholders, the Flood Insurance Reform Act of 2004 required FEMA to
develop three types of informational materials. The required materials
are: (1) supplemental forms explaining in simple terms the exact
coverage being purchased; (2) an acknowledgement form that the
policyholder received the SFIP and any supplemental explanatory forms,
as well as an opportunity to purchase coverage for personal property;
and (3) a flood insurance claims handbook describing the process for
filing and appealing claims.[Footnote 53] FEMA officials said they had
drafted an acknowledgement form and new insurance program forms to
explain coverage to policyholders when they purchase and renew their
insurance. FEMA officials said that these forms were final as of
September 2005, and that they expected distribution to policyholders to
begin in October 2005. While FEMA appears to have completed its
implementation efforts with respect to the supplemental and
acknowledgement forms, its flood insurance claims handbook does not yet
fully comply with statutory requirements. FEMA posted a flood insurance
claims handbook, dated July 2005, on its website in September 2005. The
handbook contains information on anticipating, filing and appealing a
claim, but does not include information regarding the appeals process
that FEMA is statutorily required to establish through regulation. In
its comments on our draft report, FEMA stated that it was offering
claimants an informal appeals process pending the establishment of a
regulatory process, and that the handbook describes this informal
appeals process. However, by statute, the claims handbook must describe
the regulatory process, which FEMA has yet to establish.
The establishment of a regulatory appeals process is required by
section 205 of the Flood Insurance Reform Act of 2004. To address this
requirement, FEMA officials said they had discussed the feasibility of
maintaining a permanent task force to consider appeals--like the one
created to review Hurricane Isabel claims. In commenting on a draft of
this report, the acting director of FEMA's Emergency Preparedness and
Response Directorate said that FEMA had rejected this plan, but he did
not disclose any alternative plan detailing key elements of an appeals
process such as how to initiate an appeal, time frames for considering
appeals, the size of an appeals board, and the qualifications for
membership, or how long the rulemaking process to provide for appeals
by regulation might take. Therefore, it remains unclear how or when
FEMA will establish the regulatory appeals process, as directed by the
Flood Insurance Reform Act of 2004.
Finally, section 207 of the Flood Insurance Reform Act of 2004 required
FEMA, in cooperation with the insurance industry, state insurance
regulators, and other interested parties, to establish minimum training
and education requirements for all insurance agents who sell flood
insurance policies and to publish the requirements in the Federal
Register. On September 1, 2005, FEMA published a Federal Register
notice in response to this requirement.[Footnote 54] In the notice,
FEMA provided a course outline for flood insurance agents, which
consisted of eight sections: an NFIP Overview; Flood Maps and Zone
Determinations; Policies and Products Available; General Coverage
Rules; Building Ratings; Claims Handling Process; Requirements of the
Flood Insurance Reform Act of 2004; and Agent Resources. FEMA further
stated that, rather than establish separate and perhaps duplicative
requirements from those that may already be in place in the states, it
had chosen to work with the states to implement NFIP requirements
through already established state licensing schemes for insurance
agents. However, the notice did not specify how or when states were to
begin implementing the NFIP training and education requirements. Given
the recent publication of the Federal Register notice, and the states'
eventual role in implementing FEMA's training and education
requirements, it is too early to tell the extent to which insurance
agents will meet FEMA's minimum standards.
FEMA officials said that developing and implementing changes to the
NFIP can have broad reaching and significant impacts for the millions
of NFIP policyholders, as well as the private sector stakeholders upon
whom FEMA relies to implement the program. As a result, the agency is
taking a measured approach to making the mandated changes to ensure
that it achieves results and minimizes any negative effects on
policyholders and NFIP stakeholders. Nonetheless, without plans with
milestones for completing its efforts to provide policyholders with a
flood insurance claims handbook that meets statutory requirements, to
establish a regulatory appeals process, and to ensure that insurance
agents meet minimum NFIP education and training requirements, FEMA
cannot hold responsible officials accountable and track progress to
ensure that these management improvements are in place to assist
victims of future flood events.
Conclusions:
A key challenge that FEMA faces in its role as coordinator of the
federal disaster response efforts, including the NFIP, is to ensure
through its monitoring and oversight efforts that programs are
implemented in accordance with statutory and regulatory requirements
across the nation. It is a difficult challenge to meet, as services are
delivered primarily through a decentralized system of private-sector
contractors, their employees, and their subcontractors. However, it is
increasingly important that FEMA have assurances that program
requirements are followed in light of the growing participation and
increasing costs of its programs.
While FEMA's NFIP monitoring and oversight processes have identified
specific problems with the delivery of services, the lack of
statistically representative samples for processes to assess the
accuracy of claims and adjustments limits FEMA's ability to project the
results of its analyses in order to provide management information on
the private sector's overall implementation of the program. Without
such information, the value of FEMA's monitoring processes--operational
reviews and quality assurance reinspections--as critical internal
control activities is limited. Such information could also help the
agency better identify potential needs for such things as additional
training requirements or clarification of NFIP coverage and claims
guidance, as identified in the Flood Insurance Reform Act of 2004.
FEMA officials have been working to address the consequences of the
most devastating hurricane season on record, and these efforts have
understandably put pressure on FEMA's resources, particularly since
claims began to be filed for the damage from Hurricane Katrina.
Nonetheless, the agency may continue to face challenges like those
posed by Hurricane Isabel in implementing the NFIP until plans for
addressing some of the key legislative requirements of the Flood
Insurance Reform Act of 2004 are developed and implemented. Without
establishing a roadmap and a schedule for meeting mandated time frames
that have already elapsed, FEMA is limited in its ability to project
when program improvements will be made.
Recommendations for Executive Action:
To improve FEMA's oversight and management of the NFIP, we recommend
that the Secretary of the Department of Homeland Security direct the
Under Secretary of Homeland Security for Emergency Preparedness and
Response to take the following two actions:
* use a methodologically valid approach to draw statistically
representative samples of claims for underwriting and claims portions
of operational reviews and for quality assurance reinspections of
claims by general adjusters; and:
* develop documented plans with milestones for implementing
requirements of the Flood Insurance Reform Act of 2004 to provide
policyholders with a flood insurance claims handbook that meets
statutory requirements, to establish a regulatory appeals process, and
to ensure that insurance agents meet minimum NFIP education and
training requirements.
Agency Comments and Our Evaluation:
On October 12, 2005, the Acting Director of FEMA's Mitigation Division
provided written comments on a draft of this report. FEMA offered
substantive comments on three issues (App. II). FEMA offered comments
principally in three areas: (1) its disappointment that we had not
directly addressed the issue of whether Congress intended the flood
insurance program to restore damaged property to its pre-flood
condition; (2) its view that the method of choosing its sample for
operational reviews was appropriate and that its financial and internal
controls are wide-ranging and include processes that we did not
address; and (3) its view that contrary to the impression given in our
draft report, FEMA has worked diligently to implement the requirements
of the Flood Insurance Reform Act of 2004.
* FEMA expressed disappointment that our report made no explicit,
unambiguous statement regarding whether Congress intended flood
insurance to restore damaged property to its pre-flood condition. We
believe we have addressed the issue consistent with our statutory
mandate by explaining the statutory and regulatory provisions that
affect both dollar ceilings and other coverage limitations. Section 208
of the Flood Insurance Reform Act of 2004 mandated GAO to conduct a
study of aspects of the National Flood Insurance Program (NFIP),
including "the adequacy of the scope of coverage provided under flood
insurance policies in meeting the intended goal of Congress that flood
victims be restored to their pre-flood conditions, and any
recommendations to ensure that goal is being met." To address this
mandate, it was necessary to consider the legal framework of flood
insurance coverage established by the National Flood Insurance Act of
1968, as amended, and FEMA's implementing regulations. The amounts and
limitations of flood insurance policy coverage are affected by both the
statute and the regulations. In other words, flood insurance policies
can only restore victims to pre-flood conditions within, but not
beyond, the limits established by law and regulation. To address our
mandate, we therefore explained the statutory and regulatory provisions
that placed limitations on the amount claimants could recover under
their flood insurance policies. Our April 2005 testimony[Footnote 55]
and this report make clear that the statutory ceilings on the maximum
amount of coverage that can be purchased and the policy limitations
that result from FEMA regulations may result in a policyholder's
insured structure not being restored to its pre-flood condition.
* FEMA highlights a number of oversight and management procedures for
the program, including those for financial management. It also noted
that its method of selecting its sample for operational reviews was
more appropriate than the statistically random probability sample we
recommended. Most of the additional oversight and management processes
and controls FEMA noted in its comments are for financial management--
an area not included in the scope of our work. Our work focused on
program implementation and oversight. During our review, FEMA managers
described the operational reviews and claims inspections as the primary
methods FEMA used for monitoring and overseeing the NFIP.
* In support of its current sampling strategy for its operational
reviews, FEMA cites a report it had commissioned in 1999---a report
FEMA had not previously mentioned or provided to us. Thus, we cannot
comment on that report or its recommendations. Nevertheless, although
FEMA's current sampling strategy may provide an opportunity to focus on
particular areas of risk, it does not provide management with the
information needed to assess the overall performance of the write-your-
own companies, including the overall accuracy of the underwriting of
NFIP policies and the adjustment of claims--information that FEMA needs
to have reasonable assurance that program objectives are being
achieved:
* With respect to FEMA's implementation of program changes mandated by
the Flood Insurance Reform Act of 2004, we described several actions
FEMA had taken in its efforts to comply with the Act, while noting that
it had not fully implemented the Act's requirements. In its comments on
our draft report, FEMA said that it had been working diligently to meet
the Act's requirements and had made further progress on certain
initiatives, for example, by finalizing "Summary of Coverage" forms
required by section 202 of the act and distributing them to
policyholders purchasing or renewing their coverage after September 21,
2005. We have updated our draft report to reflect the new status
information, but work remains to be done before FEMA fully implements
other requirements of the Flood Insurance Reform Act of 2004. As we
noted in our report, section 205 of the Act requires FEMA to establish
a claim appeals process by regulation, and section 204 of the Act
requires FEMA to describe this regulatory appeals process in its flood
insurance claims handbook. Although FEMA commented that it was offering
claimants an informal appeals process pending the establishment of a
regulatory process, it must establish the regulatory process to be in
compliance with the informational requirements of section 204 and the
procedural requirements of section 205 of the act. Finally, although
FEMA published minimum education and training requirements for flood
insurance agents in the Federal Register in September 2005, FEMA has
not established how or when states are to begin imposing these
requirements on flood insurance agents. Thus, we believe our
recommendation that FEMA develop documented plans with milestones for
implementing the requirements of the Flood Insurance Reform Act of 2004
remains appropriate.
FEMA also offered a number of technical comments that we incorporated
as appropriate.
We are sending copies of this report to the Secretary of the Department
of Homeland Security. We will also make copies available to others upon
request. In addition, the report will be available at no charge on
GAO's Web site at http://www.gao.gov.
If you have any questions, please contact me at (202) 512-8777 or
jenkinswo@gao.gov or Christoper Keisling, assistant director at (404)
679-1917 or keislingc@gao.gov. Contact points for our offices of
Congressional Relations and Public Affairs may be found on the last
page of this report. GAO staff who made major contributions to this
report are listed in appendix III.
Signed by:
William O. Jenkins, Jr.:
Director, Homeland Security and Justice Issues:
[End of section]
Appendix I: Scope and Methodology:
To address provisions in the Flood Insurance Reform Act of 2004 for a
GAO study and report on issues related to the processing of flood
insurance claims and the Federal Emergency Management Agency's (FEMA)
oversight and management of the program, we assessed (1) the statutory
and regulatory limitations on homeowners' coverage under the National
Flood Insurance Program (NFIP); (2) FEMA's role in monitoring and
overseeing the NFIP; (3) FEMA's response to concerns regarding NFIP
payments for Hurricane Isabel claims; and (4) the status of FEMA's
implementation of requirements of the Flood Insurance Reform Act of
2004.
To determine the statutory and regulatory limitations on homeowners'
coverage under the NFIP, we reviewed the National Flood Insurance Act
of 1968, as amended, its legislative history, and FEMA's implementing
regulations, including its "Standard Flood Insurance Policy." We also
discussed our review with officials of DHS Office of General Counsel.
To assess FEMA's role in monitoring and overseeing the NFIP, we
examined program requirements and reports. We analyzed the results of
15 operational reviews and follow-up visits FEMA completed from 2001
through February 2005 to determine whether they were done in accordance
with requirements and procedures outlined in FEMA's Write Your Own
Financial Control Plan and GAO's Standards for Internal Control in the
Federal Government. To determine whether FEMA met the standard for
assessing the quality of performance over time and ensuring that
findings of its operational reviews were addressed, we analyzed reports
of the results of all reviews of insurance operations and follow-up
visits at insurance companies where FEMA identified critical errors
over a 10-year period, from 1996 to April 2005--a total of 15 reports.
All of the reviews and visits for this 10-year period occurred from
2001 to April 2005 because for several years prior to 1999, FEMA did
not conduct operational reviews. The reviews were restarted on a
"practice" basis in 1999 and a regular basis in 2000. We also observed
FEMA examiners as they conducted a portion of an operational review at
a flood insurance vendor location and obtained information on the
schedule of operational reviews from 2000 to June 2005. We obtained
documentation on how quality assurance reinspections of claims
adjustments are done after flood events and reviewed copies of several
reinspection reports and examples of data maintained in the NFIP
reinspection database, as well as aggregate information on the number
of quality assurance reinspections done from 2000 to June 2005. We
interviewed officials of FEMA and its program contractor about their
oversight activities, and we discussed aspects of the process with
private-sector insurance officials from four of the five largest write-
your-own companies in terms of the number of claims filed in 2004. For
example, we talked with FEMA officials about how claims files were
selected for each operational review to examine write your own
companies' claims underwriting and adjustment activities and talked
with two of the nine general adjusters employed by FEMA's program
contractor about how they reinspect the work of adjusters who prepare
flood damage estimates and how they select properties to visit. We
interviewed these two general adjusters because they had performed
reinspections of claims adjustments for damage from Hurricane Isabel
and from hurricanes in Florida in 2004. We did not evaluate FEMA's
methodology for selecting sample sizes for its monitoring and oversight
activities.
To determine FEMA's response to concerns about Hurricane Isabel claims
payments, we reviewed a statistically valid sample of 100 claims files
of claimants in Maryland, Virginia, and North Carolina who were not
satisfied with their initial claims settlements and had their claims
reviewed by a special FEMA task force. The claims files included
documentation of actions taken on the claims by the write-your-own
companies and the FEMA task force, as well as correspondence and
documentation provided by the claimants. For this representative sample
of claims, we determined the average additional amount paid on claims
that were closed with an additional payment; the average amount of
claims reviewed by the task force; and reasons claims were closed by
the task force with and without additional payments. We based our
analysis on the information in the files we reviewed; we did not verify
the accuracy of the information in the claims files. We tested the
reliability of claims payments amounts for the NFIP database on a
statistically valid sample of 250 claims for all flood events in 2003
and 2004. We determined that the NFIP database was sufficiently
reliable for our reporting purposes. We discussed the actions FEMA took
to address concerns of Hurricane Isabel claimants with FEMA officials,
as well as the two general adjusters we interviewed, other officials of
FEMA's program contractor, and private-sector insurance officials. We
did not interview NFIP policyholders who filed claims for flood damage
after Hurricane Isabel because (1) such interviews would have provided
anecdotal information that could not be used to make judgments about
Hurricane Isabel claimants as a group or any subset of the group; and
(2) we started our review more than a year after Hurricane Isabel
occurred; thus, testimonial information would have been dated.
To determine the extent to which FEMA had implemented provisions of the
Flood Insurance Reform Act of 2004, we examined documentation of the
agency's efforts, including draft materials FEMA had prepared for
distribution to policyholders. We also interviewed officials to
determine what progress had been made and what milestones, if any, had
been established to meet the legislative mandates.
We conducted our work in accordance with generally accepted government
auditing standards between December 2004 and August 2005.
[End of section]
Appendix II: Comments from the Federal Emergency Management Agency:
U.S. Department of Homeland Security:
500 C Street, SW:
Washington, DC 20472:
FEMA:
October 12, 2005:
William O. Jenkins, Jr.:
Director:
Homeland Security and Justice:
441 G St., NW:
Washington, DC 20548:
Dear Mr. Jenkins:
Thank you for providing the draft GAO report entitled, "Improvements
Needed to Enhance Oversight and Management of the National Flood
Insurance Program" for FEMA's review and comment. Based on FEMA's
review, I am providing general and specific comments on this report.
FEMA's primary comments fall in three areas, as follows:
As I indicated to the GAO in my letter of September 23, 2005, to Norman
J. Rabkin, I am disappointed that the issue regarding restoration of
policyholders to their "pre-flood" condition and Congressional intent
has not been directly addressed as FEMA would have expected based on
the language in the Reform Act of 2004 and the GAO letter dated October
1, 2004 that DHS received prior to the initiation of this study. The
GAO was instructed to investigate and report with regard to this issue
and should provide an unambiguous statement as to its findings. Since
in the subject report it is stated that the legislative history of the
National Flood Insurance Program (NFIP) as well as the authorizing
statute were examined, it would seem that the GAO found no expression
of intent to restore properties completely to pre-flood condition.
A relevant, similar issue was addressed by the GAO for Congress in 1986
when FEMA implemented certain limitations to basement coverage under
the Standard Flood Insurance Policy. In that report, the GAO stated
that:
"Under Section 1306, FEMA's Director is authorized to provide, by
regulation, the general terms and conditions of insurability. This
Section includes authority to specify the nature and limits of loss or
damage in any areas covered by flood insurance; the classification,
limitation, and rejection of risks; and any other terms and conditions
relating to insurance coverage or exclusion which may be needed to
carry out the program.
FIA said its decision to limit flood insurance coverage of basement
contents is authorized under several provisions of the act, including
those cited above. We concur with this position." (Appendix I, page 8,
"Flood Insurance - Federal Emergency Management Agency's Basement
Coverage Limitations," GAO/RCED-86-10FS, January 1986).
The basement coverage changes went through a public comment process as
well as Congressional scrutiny and were sustained.
* The GAO has given prominence to a concern that is not the main issue
and is based on only partial review of Program controls. With its
report title and "highlights" section GAO has chosen to emphasize a
rather arcane recommendation with regard to statistical sampling
without noting, as the report itself states on Page 5 that "..the
processes that FEMA had in place for operational reviews and quality
assurance reinspections of claims adjustments met our internal control
standard for monitoring federal programs" and later on page 21 that
"The processes FEMA followed also met our internal control monitoring
standard that requires federal agencies ensure that the findings of
audits and other reviews are promptly resolved." Further, the report
does not put operational reviews and claims reinspections in the
appropriate context within the entirety of what FEMA does to provide
oversight of the NFIP and the Write Your Own (WYO) Companies. It is
misleading to characterize the operational reviews as "FEMA's primary
method to monitor and oversee the NFIP." (Page 27) While very
important, these operational reviews, as well as the claims
reinspections, are only parts of a comprehensive Financial Control Plan
that has effectively provided oversight and control of the WYO
insurance operations of the NFIP as discussed below. Biennial audits by
CPA firms, annual Inspector General financial audits, monthly editing
of policy and claims transactions along with the statistical and
financial reconciliations provide an abundant amount of random sampling
and thorough review of WYO transactions. This information does not
appear to have been considered by the GAO in its study. However, these
monitoring and control mechanisms do have a bearing on the design and
use of operational reviews and claims reinspections. It is difficult to
understand how the GAO can reach a conclusion that FEMA is not meeting
an internal control standard without a thorough consideration of all
the controls and processes that FEMA has in place to provide oversight
of the Program.
* FEMA is pleased to find that in one of its primary areas of inquiry,
the GAO does not criticize FEMA's handling of the extensive review
process of the loss settlements resulting from the devastating impact
of Hurricane Isabel.
FEMA's Oversight and Management of the NFIP:
The WYO Financial Control Plan was developed as part of the original
implementation of the WYO Program in 1983. All WYO companies must
adhere to it. The Plan consists of the following elements including the
operation reviews and the claims reinspection program:
* Part 1 requires companies to have a CPA firm, on a biennial basis,
conduct independent financial, underwriting and claims audits following
GAO "yellow book" requirements. As part of these audits, random
sampling of claims and underwriting files is required. The audit
results are provided to FEMA.
* Part 2 provides the procedures for the monthly reconciliation and
review of financial statement and detailed policy and claim
transactions submitted by the WYO companies.
* Part 3 is the claims reinspection program reviewed by the GAO.
* Part 4 requires monthly company certifications of the reconciled
financial and statistical data submitted by the WYO companies.
* Part 5 incorporates the Transaction Record Reporting and Processing
Plan (TRRP Plan) that requires the companies' monthly submissions of
detailed policy and claims transactions. As already mentioned, these
statistical records are reconciled each month with company financial
statements. Routine system editing of the statistical transactions
allows for reviews of such things as the proper rating of policies and
whether claims have been submitted for valid policies in force and
claim settlements being within policy limits. This requirement is for
all records, not for only a sample.
* Part 6 incorporates the WYO Accounting Procedures Manual.
* Part 7 lays out the procedures for the Underwriting and Claims
Operational Reviews that the GAO focused on in the report.
* A Standards Committee comprised of both insurance industry and
Federal executives assists in providing oversight of WYO companies in
meeting the requirements of the Financial Control Plan and provides
recommendations to the FEMA Mitigation Division Director on actions
that should be taken when a WYO company is failing to meet its
responsibilities.
It is important to note that FEMA also continues to fund and
participate with the Office of the Inspector General's annual financial
statement and operations audit. Each year six WYO companies and the
NFIP Direct business contractor are audited. This audit includes random
sampling of policy and claims files as well as auditing of system
transactions and financial statements.
As a result of the WYO Financial Control Plan activities, and
conscientious follow up by FEMA with regard to various audit findings,
the NFIP portion of the Inspector General's financial audit has always
received a clean, unqualified audit opinion.
In 1999, prior to FEMA's reinstituting the underwriting and claims
operational reviews, Deloitte and Touche, in a report commissioned by
FEMA, recommended that the operational reviews should be largely based
on the findings of their study to target certain areas. They further
recommended that a broad based general operational review would not be
effective to improve file handling weaknesses, but that there should
instead be a focused approach. Additionally, they recommended that the
intent of the operational reviews should not be assessment oriented.
These recommendations, along with FEMA's risk assessment and
determination of resource availability for this aspect of management
and program control led to the current design of the operational
reviews. This design is oriented to keying on certain higher risk and
higher consequence aspects of underwriting and claims that might not be
ferreted out through the variety of other Financial Control Plan
mechanisms. Thus, there is a bias in the sampling of files. However,
this affords the best opportunities to provide immediate feedback to
companies on proper procedures and to rapidly effect changes.
In summary, regarding FEMA's operations review and claims reinspection
process, the draft report does state that FEMA follows the requirements
of the Financial Control Plan (Page 21). The report also states that
FEMA's process meets the GAO's internal control standard in that "the
findings of audits and other reviews are promptly resolved" (p. 21).
However, it also states that the GAO's standards are not met because
FEMA does not use a statistically valid sampling technique to select
files for the operations reviews or for the claims reinspections
(introduction and Pages. 5, 21, 25, 26, 27, 34). In response, FEMA
comments that the operations reviews do include a random sampling
technique but were never intended to be based on statistically valid
samples. Instead, they are used to select the more difficult cases
based upon the judgment of FEMA's professional staff for the purposes
of correcting improper handling by the WYO Companies and for training
purposes. The claims reinspections and financial reviews are components
of a more comprehensive financial control plan.
FEMA's Actions in Carrying Out the Mandates of FIRA 2004:
Contrary to the impression conveyed by the draft report's other primary
criticism, FEMA has worked diligently to meet the requirements of FIRA
2004. The materials required by Sections 202 (Supplemental form), 203
(Acknowledgement form), and 204 (Flood Insurance Claims Handbook) have
been developed and distribution began September 21. The WYO Companies
are now sending out the Supplemental (Summary of Coverage) form and at
claim time the Claims Handbook. In connection with policy issuance the
Bureau and Statistical Agent will begin sending out the Claims
Handbook, the prior loss history required by Section 202 and the
Acknowledgement form in December based on the NFIP statistical system
reports for the month of October. The appeals process required by
Section 205 to be established by regulation will be placed in the
FEMA/DHS concurrence process this month, after which it will go to OMB
for concurrence. The report to Congress on the use of Increased Cost of
Compliance (ICC) coverage required by Section 206 is being prepared and
will be placed in the FEMA/DHS concurrence process by the end of
November 2005. The minimum training and education requirements for
flood insurance agents in Section 207 have been established and
published as a notice in the Federal Register on September 1, 2005, as
required. A bulletin providing for the charging of additional premium
only prospectively was been issued on May 23, 2005 in accordance with
Section 209. In the next revision to the Standard Flood Insurance
Policy, which requires regulatory action, these changes will be made in
the policy.
Thank you for giving FEMA the opportunity to provide input on the draft
report.
Sincerely,
Signed by:
David I. Maurstad,
Acting Director/Federal Insurance Administrator:
Mitigation Division:
Emergency Preparedness and Response Directorate:
[End of section]
Appendix III: GAO Contact and Staff Acknowledgements:
GAO Contact:
William O. Jenkins, Jr. (202) 512-8777:
Acknowledgments:
Amy Bernstein, Christine Davis, Pawnee Davis, Wilfred Holloway, Deborah
Knorr, and Raul Quintero made significant contributions to this report.
FOOTNOTES
[1] Our report focuses on homeowners' NFIP coverage; NFIP coverage is
also available for other structures such as apartment buildings,
schools, churches, businesses, cooperative associations, and
condominium associations.
[2] In March 2003, FEMA and its approximately 2,500 staff became part
of the Department of Homeland Security (DHS). Most of FEMA--including
its Mitigation Division, which is responsible for administering the
NFIP--is now part of the department's Emergency Preparedness and
Response Directorate. However, FEMA has retained its name and
individual identity within the department. The Secretary of DHS has
proposed a reorganization of DHS in which FEMA would report directly to
the Secretary and Undersecretary of DHS.
[3] Bunning-Bereuter-Blumenauer Flood Insurance Reform Act of 2004,
Pub. L. No. 108-264, 118 Stat. 712 (2004).
[4] The National Flood Insurance Act of 1968, as amended, is codified
at 42 U.S.C. 4001 to 4129.
[5] The National Flood Insurance Act of 1968, as amended, is codified
at 42 U.S.C. 4001 to 4129.
[6] 42 U.S.C. 4001(d).
[7] Id. 4001(a)(4).
[8] GAO, Flood Insurance: Information on the Financial Condition of the
National Flood Insurance Program, GAO-01-992T (Washington, D.C.: July
2001).
[9] See 42 U.S.C. 4016.
[10] The National Flood Insurance Program Enhanced Borrowing Authority
Act of 2005, Pub. L. No. 109-65 (Sept. 20, 2005).
[11] The other 5 percent of policies are sold and serviced by state-
licensed insurance agents and brokers who deal directly with FEMA.
[12] The fund, which was established in the Treasury by the 1968
legislation authorizing the NFIP, is the account into which premiums
are deposited and from which losses and operating and administrative
costs are paid. See 42 U.S.C. 4017.
[13] For example, the flood program manager from one insurance company
said that agents receive a commission of 15 percent of the policy
amount as an incentive to write flood insurance and may receive other
incentives during special flood marketing campaigns.
[14] As with homeowners' coverage, statutory and regulatory limitations
apply to NFIP coverage for other types of property. See 44 C.F.R. Part
61, appendix A(1), "Standard Flood Insurance Policy Dwelling Form,"
appendix A(2), "Standard Flood Insurance Policy General Property Form,"
and appendix A(3), "Standard Flood Insurance Policy Residential
Condominium Building Association Form."
[15] 42 U.S.C. 4013(b)(2).
[16] Id. 4012a(a), (b)(1).
[17] See id. 4012.
[18] Id. 4013(b)(3).
[19] Id. 4013(a).
[20] The insurance coverage regulations appear at 44 C.F.R. Part 61,
and the SFIP is an appendix to these regulations, set forth at 44
C.F.R. Part 61, appendix A(1), "Standard Flood Insurance Policy
Dwelling Form."
[21] 44 C.F.R. 61.4.
[22] Id. 61.13(d), (f).
[23] Id. 61.4(b), 61.14.
[24] The SFIP defines a flood as "[a] general and temporary condition
of partial or complete inundation of two or more acres of normally dry
land area or of two or more properties" caused by specified events such
as the overflow of inland or tidal waters. SFIP section II, Definitions
("Flood").
[25] SFIP section V, Exclusions. For example, the SFIP would not cover
water damage that primarily resulted from a structural defect in the
insured's dwelling.
[26] SFIP section V, Exclusions.
[27] SFIP section II, Definitions ("Building").
[28] SFIP section III, Property Covered (Coverage A - Building
Property). However, if the building under construction does not have at
least two walls and a roof, the deductible amount is twice that which
would otherwise apply. SFIP section VI, Deductibles.
[29] SFIP section III, Property Covered (Coverage A - Building
Property). Coverage for a detached garage is limited to no more than 10
percent of the building's limit of liability. Use of this insurance is
optional but reduces the building's limit of liability.
[30] SFIP section III, Property Covered (Coverage A - Building
Property).
[31] SFIP section III, Property Covered (Coverage B - Personal
Property).
[32] SFIP section III, Property Covered (Coverage B - Personal
Property).
[33] SFIP section IV, Property Not Covered.
[34] SFIP, section IV, Property Not Covered.
[35] SFIP section VI, Deductibles.
[36] SFIP section II, Definitions ("Declarations Page").
[37] "Special Loss Settlement" combines elements of replacement cost
and actual cash value settlements. Under the "Special Loss" rules,
totally destroyed dwellings receive either replacement cost coverage or
1.5 times the actual cash value, whichever is less, up to the
dwelling's limit of liability. Partially damaged dwellings are entitled
to replacement cost coverage.
[38] SFIP section II, Definitions ("Actual Cash Value").
[39] An actual cash settlement may be increased to reflect a greater
proportion of the costs of repairing or replacing damaged property,
without deduction for depreciation. The SFIP provides a formula for
calculating the proportion of the repair or replacement costs an
insured with actual cash coverage is eligible to receive. The SFIP will
pay this proportional amount if it is greater than the actual cash
settlement.
[40] SFIP section VII, General Conditions, subsection V, Loss
Settlement.
[41] SFIP section VII, General Conditions, subsection V, Loss
Settlement.
[42] FEMA officials told us that the agency did not require Hurricane
Isabel claimants to wait until after making repairs to obtain the full
replacement cost. They also said that FEMA plans to amend its
regulations to delete the requirement from the SFIP.
[43] National Flood Insurance Program, The Write Your Own Program
Financial Control, Plan Requirements and Procedures, revised December
1, 1999.
[44] See GAO, Standards for Internal Control in the Federal Government
(Washington, D.C.: Nov. 1999)
[45] In addition to doing reinspections, these general adjustors are
responsible for estimating damage from flood events, coordinating
claims adjustment activities at disaster locations, and conducting
adjuster training.
[46] GAO, Policy Manual (Washington, D.C.: Jan.1, 2004).
[47] In addition, the Improper Payments Information Act of 2002, Pub.
L. No. 107-300, 116 Stat. 2350, (2002), requires each executive agency
to review all of its programs and activities annually and identify
those that may be susceptible to significant improper payments. If DHS
determines during the annual review that the NFIP is susceptible to
significant improper payments, it will be required, in accordance with
Office of Management and Budget (OMB) guidance, to report statistically
valid estimates of improper NFIP payments to Congress before March 31
of the following applicable year.
[48] After the task force was created, the Senate Committee on Banking,
Housing, and Urban Affairs affirmed the need for an independent review
of Hurricane Isabel claims. See S. Rep. No. 108-262, at 5 (2004).
[49] Maryland, North Carolina, Virginia, Delaware, Pennsylvania, and
South Carolina.
[50] In 9 percent of the cases, the task force allowed recoverable
depreciation not allowed in the original settlement or determined that
the claim should be paid for a primary residence at replacement cost
value rather than for a seasonal residence at actual cash value. Some
claimants received additional payments for more than one reason.
[51] This information was current at the time of the review of the
claim by the task force and does not reflect any subsequent actions
taken on the claim by the write-your-own companies. FEMA's program
contractor reported that about 3,866 Hurricane Isabel claims were
closed without any payment. Most frequently Hurricane Isabel claims
were closed without payment because the adjuster report determined that
the damages did not exceed the amount of the deductible on the NFIP
policy. In other instances, policyholders filed a claim but failed to
follow up by providing appropriate documentation of loss. In several
instances, claims were filed for damage to seawalls, which are
specifically excluded from coverage under the NFIP.
[52] For claims in our file review, the median settlement amount--the
point at which half of the cases were settled at higher amount and half
were settled at a lower amount--was $15,583 before the task force
review and $19,826 after the task force review. Data on median
settlement amounts for 2002, 2003, and 2004 was not available.
[53] Sections 202, 203 and 204 of the Flood Insurance Reform Act of
2004 contain these requirements.
[54] See Flood Insurance Training and Education Requirements for
Insurance Agents, 70 Fed. Reg. 52,117 (2005).
[55] See GAO, National Flood Insurance Program: Oversight of Policy
Issuance and Claims, GAO-05-523T (Washington, D.C.: April 14, 2005).
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