DOCUMENT RESUK! OU289 - [&10517251 [Veaknesses in the Financial Controls of the National Flood Insurance Program]. B-114860; CSD-77-47. March 21, 1977. 9 pp. Report to Patricia Parris, Secretary, Department of Housing and Urban Development; by Henry Eschwege, Director, Community and Economic Development Div. Issue Area: Accounting and Financial Reporting (100); Automatic Data Processing (103);Automatic Data Processing: Using Results of ADP Systems (2600). Contact: Community and Rconomic Development Div. Budget Function: Miscellaneous: Financial Management and Information Systems (1002). Organization Concerned: rational Flood Insurers Association. Congressional Relevance: House Committee on Banking, Currency and Housing; Senate Committee on Banking, Housing and Urban Affairs. Authority. National Flood Insurance Act of 1968 (42 U.S.C. 4011; 42 U.S.C. 4071). Flood Disaster ProtecticL Act of 1973. Government Corporation Control act. There are numerous weaknesses in the ability of the National Flood Insurers Association (NFIA) to generate accurate financial data on its operations relating to the National F.ood Insurance Program. Findings/Conclusions: These weaknesses could adversely affect the Governmentes ability to determine reasonable amounts payable to NFIA under the program; determine flood insurance premium rates; prepare financial statements of the program's condition and results of its operations; and make management decisions. Both accuracy of financial data and timeliness of such data ame seriously lacking in the National Flood Insurance Program. J:ecormendations: Every effort should be made tc assure that adequate financial control over the flood insurance program is established as quickly as possible. The Secretar7 of Housing and Urban Development should: 1) direct the Federal Insurance Administration (FIA) to review financial control problems with NFIA with the objective of establishing a plan that will result in the receipt from NFIA of reliable financial and statistical data necessary to manage the program; 2) direct the Inspector General to review the plan developed to make sure such data will meet FIA's needs; and 3) give consideration to a partial or full assumption by the Government of necessary functions as permitted under Part B of the National Flood Insurance Act of 1968. if adequate financial control cannot be established through arrangements with FIA. (SC) CO UNITED STATES GENERAL.ACCOUNTING OFFICE WASHINGTON, D.C. 20548 COh:MUNITY AND ECONOMIC DEVELOPMENT DIVISION MAR 2 1 1977 MAR 2 ! 1977 B-114860 The Honorable The Secretary of Housing and . Urban Development Dear Mrs. Harris: We have reviewed the National Flood Insurers Association's (NFIA) financial controls over its operations relating to the National Flood Insurance Program. We found numerous weaknesses in NFIA's ability to generate accurate financial data. These weaknesses could adversely affect the Government's ability to -- determine reasonable amounts payable to 1NIA, under the program; -- determine flood insurance premium rrtes; -- prepare financial statements of the program's condition and results of its operations; and -- make management decisions. The purpose of this letter is to bring these weaknesses to your attention so that timely corrective action can be taken. .The National Flood Insurance Program was established under authority of the National Flood Insurance Act of 1968 (42 U.S.C. 4011). It is a subsidized, Government-sponsored program designed to help owners of real or personal property, in areas designated as eligible for flood insurance, purchase such insurance. The program is administered by your Federal Insurance Administration (FIA). The 1968 act authorized the Secretary of Housing and Urban Development to encourage and assist insurance companies to form a pool for the purpose of providing the flood insur- ance coverage authorized by law. On June 6, 1969, NFIA, CED-77-47 B-114860 th..-ough its member companies, began providing the authorized insurance coverage. Membership in NFIA is open to all com- panies licensed under the laws of any State to write prnperty insurance. AiIA acts as a liaison between member companies and FIA, makes ~se public aware of the flood insurance program through advertising, and conducts educational seminars for insurance agents. Further, it is responsible for maintaining accounting and administ.t"ive records of the program's opera- tions and fo£-reporting on :ts financial condition to the Administrator, FIA, at least qIarterly. FIA sets policy; establishes premium rates; desigi.ates areas eligible for insurance; ar.d reinsures, for a fee, the insurers that sell flood insurance. q> The 1.973 Flood Disaster Protection AcL provided for a mandatory rather than voluntary flood insurance program. FIA concluded that the impact of this legislation on the program would be massive. In March 1974, to avoid operating obstacles resulting frcm accelerating program growth, the administrator of FIA ordered the development of a computerized accounting system for the program's activities. NFIA entered into a contract with Bradford Computer & Systems, Inc. (Bradford), for the development and implementation of the computerized system. The contract became effective in August 1974, but was terminated in November 1976 because many problems developed between NFIA and Bradford. Subsequently, NFIA began operating the system on its own. The flood insurance program has grown considerably since its inception. = By December 31, 19'., an estimated 680,000 policies, representing about $18.6 billion of insurance, were in force. During calendar year 1975, about $48 million in premiums was collected and about 23,000 claims were settled for almost $97 millioin. LOSS OF FINANCIAL CONTROL OVER FLOOD INSURANCE PROGRAM Our review of the financial controls of the National Flood i..surance Program showed that NFIA has been unable to generate accurate financial and statistical data. As a result, it can neither produce its own financial statements nor supply FIA with the kind of data it needs to make program decisions, determine subsidy amounts and premium rates, or produce the financial statements for the program. - 2- B-114860 NFIA's-financial statements at June 0SO,1975, were audited and certified by Arthur Andersen & Co. The company's repre- sentatives informed us that the certification was possible because necessary financial information wiz qenerated by 41) mechanized procedures in place throughout the year at NF A and (2) manual procedures used and special analyses provided by NFIA. However, since October 1975, NFIA has been unable to prepare financial statements on the results of its operations or to prepare proper billings to the Department of Housing and Urban Development (HUD) for 'its share of NFIA's costs and flood losses. Arthur Anderson & to. concluded, after a review of the status of NFIA's records as of June 30, 1976, that, if an audit is at all feasible, the scope of the work would necessarily be so extensive that the cost would make it Prohibitive. The audit firm suggested that a 2,.-month ,udit be made at June 30, 19'7, since it believed that the current problems could be solved by that time. The Controller, NFIA, informed us chat NF[A's inability to prepare financial statements was caused by the failure of Bradford to properly meet its contractual obligations and that such failure create& ~ultip]e financial and statistical problems during the period Bradford was responsible for the NFIA system, Bradfoid, in a March 1976 letter to NFIA, stated tiat all significant difficulties in performance clearlv have been caused by NFIA's failure to fulfill its own obligations, by the serious deficiencies in the data made available to Bradford, and by NFIA's lack of cooperation. System development problems bec:ame evident during the first contract year, and by the lat':er part of 1975, NFIA became increasingly concerned because of what it considered to be a lack of progress. In October 1975, NFIA stopped making payments to Bradford under tne contract. FIA was cogni:,ant of the system development problems since at least January 1975. However, by February 1976, FIA considered that the situation had deteriorated to the point that NFIA no longer wanted to solve the contractual problems but, rather, wanted to terminate the Bradford contract. NFIA concluded that Bradford was in default under the contract and offered a settlement agreement to Bradford to terminate it. Bradford, in March 1976, rejected the settlement, choosing instead to formally arbitrate their differences as provided f - in the contract. Arbitration began in September 1976. T'.e arbitrators were dismissed in November 1976, however, because Bradford and NFIA agreed to terminate the contract. - 3- B-114860 We were informed by the Controller, NFIA, that NFIA has taken over operation of the Bradford system. In so doing they have hired clerical personnel from Bradford and are utilizing the services of several other Bradford people during a transitional period. The NFIA Controller informed us also that NFIA paid aoout $4.3 million of about $5.7 million billed by Bradford since payment to Bradford was stopped in October 1975. Extent of financial control problems In November 1975, NFIA engaged Arthur Andersen & Co. to reviaw th.a system's problems relative to the Bradford con- tract, In February 1976 Arthur Andersen & Co. reported that the Bradford system did not meet the criteria established by FIA and NFIA for accountability of the flood insurance opera- tions. They cited about 75 deficiencies covering 22 major system requirements. Examples o - deficiencies included prob- lems in the areas of premium calculations, error editing, processing of agent commissions, pol!cy statistics, policy servicing, financial statements, policy master files, claims administration, a~nd system controls. In 'ebruary i976 Arthur Andersen & Co. was retained by NFIA to develop support for potential legal proceedings pursuant to the Bradford contract, to develcp a Dlan to purify data files and implement effective file maintenance, and to provide system specifications and planning. When the parties entered into the arbitration proceedings, NFIA engaged Arthur Andersen & Co. to assist it and its attorneys in preparing for the case. NFIA paid Arthur Andersen & Co. over $1 million in fees and expenses for its services as follows. -- Review of Bradford system resulting in February 1976 .eport on system deficiencies $ 169,400 -- Arbitration support 447,000 -- File testing 60,600 -- System specifications and planning 351,500 $1,028,500 - 4 - B-114860 As of January 1977, Arthur Andersen & Co. was assisting NFIA in the assumption of the Bradford system, evaluation of system deficiencies, and correction of problems. Payment for these services is at the audit firm's standard biting rates, plus expenses. FIA also reviewed problems associated with the contractual relationship between NFIA and Bradford. The prim.ary purpose of its review was to determine whether problems with the sys- tem were having an adverse impact on policyholders. The review was also intended to identify particularly annoying problems so FIA could work with the parties and seek solutions to them. FIA's report identified numerous problems relating to poor financial control. Our review was conducted to determine whether the controls over computer operations could be relied upon to make sure that automated accounting and administrative records contain accu- rate and reliable information. We did not perform a follow-ur examination of control deficiencies to determine specific ef- fects. We did, however, observe control weaknesses that could directly affect the accuracy and reliability of data reccrd-d in the automated general ledger and reported in the annual financial statements. Because of these control weaknesses, incorrect information could be entered into accounting records, and financial statements prepared from these records could be misleading. Specifically, our review indicated that controls over NFIA's automated accour.ting system were not adequate to make sure that all -- cash receipts were deposited in banks and properly recorded in the general ledger, -- flood insurance information received by NFIA from servicing companies was properly entered into the financial records, and -- flood insurance forms containing incorrect or missing information were identified and rejected before final computer processing. We discussed these control weaknesses with the Controller, NFIA, on December 9, 1976. He stated that the problems re- sulted from deficiencies in the computerized accounting system and that corrections to the system were being made with the aid of specialists from Arthur Andersen & Co. He stated that cash - 5- B-114860 controls have been improved; however, improvement. 'Cere still being developed to make sure that (1) all data rect ived from the various member insurance companies is ultimatel' recorded in the accounting records and (2) editing proceourei' a-e adequate to identify incorrect or missing information. Effects of inadeauate financial controls One effect of inadequate financial control is that the Federal Gcvernment cannot properly calculate subsidy payments due insurers. Premium rates for flooc insurance are estab- lished on an actuarial basis and, insofar as practicable, at a level sufficient to cover the estimated full cost of insurance claims a'd to help in the accumulation of reserves to pay anticipated losses. To encourage the purchase of flood insurance, the Administrator established lower than full-c,,st ra ss, referred to as chargeable rates. The difference be- tweer, chargeable rates and full-cost actuarial rates provided the basls for a Federal Government subsidy. 1/ The subsidy, referred to as a premium equalization payment, is made to the insurer after flood losses covered by chargeable rate policies are paid. During the 3-year period ending June 30, 1975, NFIA was paid equalization payments of about $22 million, S37 million, and $47 million, respectively. On June 2, 1976, FIA requested NFIA to submit, for budget purposes, an estimate of certain financial data including the equalization payment due NFIA. On June 11, 1976, NFIA sub- mitted the data requested with the qualification that the estimates were based on numerous assumptions and projections, due to the problems with Bradford, and should be used accord- ingly. The estimates included $41 million (about $62 million less credits of about $21 million) due NFIA for equalization payment. Without accurate financial statements and statis- tical program data, FIA has little assurance that subsidy payments to NFIA are proper. 1/ Pursuant to an amendment in the Flood Disaster Protection Act of 1973, the Secretary changed the formula for deter- mining the subsidy payment to one based on actual premiums collected and actual losses incurred. - 6- B-134860 A second effect is chat the amount of the operating allowance to be retained by NFIA cannot be properly deter- mined. NFIA may retain as an operating allowance a part of the operating profit earned in an accounting period in an amou-t not to exceed 5 percent of the policyholders' pre- miums applicable to the period. Operating profit in excess of 5 percent of the policyholders' premiums is to be paid to the Administrator and held in the U.S. Treasury for the payment of future NFIA losses, operating costs, and operating allowances. The inability of NFIA to provide accurate income and expense statements has a direct effect on the determination of the operating allowance. A third effect concerns the setting of premium rates. Under section 1307 of the National Flood Insurance Act, the Secretary is required to estimate the premium rates necessary to nover the estimated full cost of insurance claims. How- ever, NFIA does not have its claim payment process under adequate financial control. Thousands of claims nave been paid since September 1975, but because claims processing had not yet been computerized these clai;ns have not been entered into the finas.,al records. One FIA official informed us that FIA has not received adequate gl.. on which to deteri:ine such premium rates. A fourth effect concerns FIA's financial statements. Under the provisions of the Government Corporation Control Act, FIA is required to prepare annually a statement of financial condition, an income and expense statement, an analysis of surplus or deficit, and a statement of sources and application of funds. FIA cannot prepare accurate finan- cial statements required by the act because it depends on reliable financial data from NFIA to reasonably state part of the financial data in its statements. The weaknesses in financial control over the flood insurance operations discussed in this report could, in our opinion, result in other serious program deficiencies. Ac- curate financial statements and statistical reports are essential to enable management to make proper decisions in many of their programs and to keep the Congress informed on program activities. Not only is accuracy of financial data required, but also timeliness. Both are seriously lacking in the National Flood Insurance Program. -7- B-114860 CONCLUSIONS AND RECOMMENDATIONS is essential to FIA Accurate financial data from NFIA in performing tasks applicable to the National Flood Insur- have such data, it cannot ance Program. Because FIA does not showing the financial properly prepare budgets and statementsdetermine premium rates, condition of the program, accurately operating allowances or calculate accurate subsidies and to make proper management payable to NFIA. Also, the ability without accurate statistical and finan- decisions is limited has existed for over a year; cial reports. This condition should be made to therefore, we believe that every effort over the.flood insur- assure that adequate financial control as possible. ance program is established as quickly Accordlngly, we recommend that you: problems with -- Direct FIA to review financial control a plan that NF[A with the objective of establishing NFIA of reliable will result in the receipt fromn to manage financial and statistical data necessary the program. the plan -- Direct the In3pector General to review meet FIA's develoPed to make sure such data will needs. full assumption by -- Give consideration to a partial or as permitted the Government of necessary functions National Flood Insurance Act of under Part B of the 4071), if adequate financial control 1969 (42 U.S.C. with NFIA. cannot be established through arrangements with BUD We discussed our findings and recommendations General's office. The officials of FIA and the Inspector official at FIA generally agreed with our findings and recom- Inspector General's mendations, and the official of the review of FIA plans. office concurred with our proposal for Reorganization As you know, section 236 of the Legislative agency to submit a Act of 1970 requires the bead of a Federal to written statement on our recommendations on actions taken Operations and the Senate the House Committee on Government not later than 60 days after Committee on Governmental Affairs and Senate Committees the date of the report and to the House for appro- on Appropriations with the agency's first request date of the report. after the priations made more than 60 days B-114860 We are sending copies of this report to the House Committee on Government Operations, the Senate Committee on Governmental Affairs, the House and Senate Committees on Appropriations; the Bzuse Committee on Banking, Currency and Housing; and the S.nate Committee on Banking, Housing, and Urban Affairs. Lopies are also being sent to the Director, Office of Management and Budget. We would be pleased to discuss the matters included in this report with you or your representatives, and we request that you advise us of any corrective action you ·plan to take. Sincerely yours, Henry;schwege Director -9-
Weaknesses in the Financial Controls of the National Flood Insurance Program
Published by the Government Accountability Office on 1977-03-21.
Below is a raw (and likely hideous) rendition of the original report. (PDF)