Flood Insurance: Challenges Facing the National Flood Insurance Program

Published by the Government Accountability Office on 2003-04-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                            United States General Accounting Office

GAO                         Testimony
                            Before the Subcommittee on Housing and
                            Community Opportunity, Committee on
                            Financial Services,
                            House of Representatives
Not to be Released before
2:00 p.m. EST
Tuesday, April 1, 2003      FLOOD INSURANCE
                            Challenges Facing the
                            National Flood Insurance
                            Statement for the Record by
                            JayEtta Z. Hecker, Director
                            Physical Infrastructure

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                                                April 1, 2003

                                                FLOOD INSURANCE

                                                Challenges Facing the National Flood
Highlights of GAO-03-606T, testimony for
the Subcommittee on Housing and                 Insurance Program
Community Opportunity, Committee on
Financial Services, House of

Floods have been, and continue to               The program faces the following challenges in operating the program
be, the most destructive natural                effectively and protecting property owners from loss from floods.
hazard in terms of economic loss to             • Improving information on the program’s financial condition.
the nation. The National Flood                      Cash-based budgeting, which focuses on the amount of funds that go in
Insurance Program is a key
component of the federal
                                                    and out of a program in a fiscal year, obscures the program’s costs and
government’s efforts to minimize                    does not provide information necessary to signal emerging problems,
the damage and financial impact of                  such as shortfalls in funds to cover the program’s risk exposure.
floods. The program identifies                      Accrual-based budgeting better matches revenues and expenses,
flood-prone areas of the country,                   recognizes the risk assumed by the government, and has the potential to
makes flood insurance available in                  overcome the deficiencies of cash-based budgeting.
the nearly 20,000 communities that              • Reducing losses to the program resulting from policy subsidies
participate in the program, and                     and repetitive loss properties. The program has lost money and is not
encourages flood-plain                              actuarially sound because about 29 percent of the policies in force are
management efforts. Since its                       subsidized but appropriations are not provided to cover the subsidies.
inception in 1969, the National
Flood Insurance has provided $12
                                                    Owners of structures built before the flood zone was included in the
billion in insurance claims to                      program pay reduced premiums that represent only about 35-40 percent
owners of flood-damaged                             of the true risk premium. Further, repetitive loss properties—properties
properties, and its building                        with two or more losses in a 10-year period—add to program losses as
standards are estimated to save $1                  they represent 38 percent of claims losses but account for 2 percent of
billion annually. The program has                   insured properties.
been managed by the Federal                     • Increasing property owner participation in the program. The
Emergency Management Agency,                        administration has estimated that less than 50 percent of eligible
but along with other activities of                  properties in flood plains participate in the program. Additionally, even
the agency, it was recently placed                  when the purchase of insurance is mandatory, the extent of
into the Department of Homeland
                                                    noncompliance with the mandatory purchase requirement is unknown
                                                    and remains a concern.
GAO has issued a number of                      Actions have been initiated or proposed by the administration or in the
reports on the flood insurance                  Congress to address some of the challenges. However, the affect of some
program and was asked to discuss                actions on the program is not clear. For example, reducing subsidies may
the current challenges to the                   cause some policyholders to cancel their policies, reducing program
widespread success of the                       participation and leaving them vulnerable to financial loss from floods.
program.                                        Further, placement of the program within the Department of Homeland
                                                Security has the potential to decrease the attention, visibility, and support
                                                the program receives.


To view the full testimony, click on the link
above. For more information, contact
JayEtta Z. Hecker, (202) 512-2834,
Heckerj@gao.gov.                                Source: FEMA Photo Library.
    Mr. Chairman and Members of the Subcommittee:

    I appreciate the opportunity to submit this statement for the record on the
    National Flood Insurance Program and challenges to its success. Floods
    have been, and continue to be, the most destructive natural hazard in
    terms of economic loss to the nation. The flood insurance program, which
    has been administered by the Federal Emergency Management Agency
    (FEMA), has been a key component of the federal government’s efforts to
    minimize the impact of floods and to provide flood-related disaster relief.
    For example, the program has been credited by the administration with
    saving a billion dollars annually by improving flood plain management and
    setting building standards—such as one to elevate properties—that have
    reduced potential losses. Additionally, the approximately $12 billion paid
    in insurance claims from 1969 through 2002 to policyholders has been
    funded primarily by policyholders’ premiums, thus saving the federal
    government from paying all damage-related expenses in the aftermath of

    Nevertheless, the flood insurance program faces challenges. In reports
    published within the last few years, FEMA’s Inspector General and we
    have identified a number of concerns with the program’s financial viability
    and with the extent to which flood insurance policies have been purchased
    for structures in flood-prone areas. In addition, the administration noted in
    its fiscal year 2004 budget request that the program is only moderately
    effective; it and the Congress have proposed measures to improve the
    program’s effectiveness. With the creation of the Department of Homeland
    Security (DHS) and the inclusion of FEMA’s functions within it, the
    program—along with its associated problems and improvement
    measures—has now become the responsibility of the new department.

    My statement today is based primarily on our past work and on
    preliminary results from ongoing work that we are conducting for the
    Subcommittee examining flood zone remapping efforts. I will provide a
    perspective on (1) the program’s presentation of financial information, (2)
    the major causes of losses in the program, (3) the extent of property
    owner participation in the program, and (4) recent actions taken or
    proposed to improve the program. In summary:

•   The flood insurance program’s use of cash-based budgeting may present
    misleading information on the program’s financial condition. Cash-based
    budgeting, which focuses on the amount of funds into and out of the
    program in a fiscal year, can obscure the program’s costs because the time
    between the extension of insurance, the receipt of premiums, the

    Page 1                                                          GAO-03-606T
    occurrence of insured events, and payment of claims may extend over
    several fiscal years. Further, this form of budgeting may not provide the
    information necessary to signal emerging problems, such as shortfalls in
    funds to cover the program’s risk exposure. The use of accrual-based
    budgeting—which, among other things, better matches revenues and
    expenses and recognizes the liability for future insurance claim
    payments—has the potential to overcome a number of the deficiencies in
    cash-based budgeting.

•   Subsidies on certain policies and so-called repetitive loss properties—
    properties that have experienced two or more losses greater than $1,000 in
    a 10-year period—have been the principal causes of the flood insurance
    program’s long-term losses. About 29 percent of all policies in force are
    subsidized, and on average the premiums for these policies are only about
    35-40 percent of—and about $500 million annually less than—the true risk
    premium for those properties. Additionally, about 38 percent of all
    program claims have been the result of repetitive loss properties, at a cost
    of about $200 million annually.

•   Flood insurance program participation—the percentage of structures in
    designated flood zones that are insured—may be low, resulting in many
    property owners being at risk of financial loss due to flooding. The
    administration estimates that less than half of the eligible properties in
    flood plains participate in the program. Further, even when the purchase
    of flood insurance is mandatory—properties in flood zones with
    mortgages from federally regulated lenders are required to have flood
    insurance—the extent of noncompliance with this requirement is
    unknown and remains a concern.

•   Recent actions have been taken or proposed by the administration and the
    Congress that may affect the program. These include actions to eliminate
    the premium subsidy on properties that are second homes or vacation
    properties, to phase out coverage or begin charging full and actuarially
    based rates for repetitive loss properties, and to undertake an expanded
    program to update flood maps upon which the program bases its
    insurance rates and mandatory purchase requirements. While these
    actions will address some of the challenges in the program, certain actions
    may have adverse implications—for example, increasing premiums to
    subsidized policyholders may cause some to cancel their insurance and
    remapping flood zones may bring into the program more properties that
    could be subsidized. Moreover, action has not been taken to move the
    program to accrual-based budgeting. Finally, the placement of the
    program—which is not directly security related—into the new Department
    of Homeland Security may affect the amount of attention the program

    Page 2                                                          GAO-03-606T
                     receives as it pursues nonsecurity- related goals in a department that is
                     under tremendous pressure to succeed in its primary mission of securing
                     the homeland.

                     Before I discuss these issues in greater detail, I would like to briefly
                     explain the National Flood Insurance Program and its importance to the
                     federal flood management effort.

                     In 1968, in recognition of the increasing amount of flood damage, the lack
The National Flood   of readily available insurance for property owners, and the cost to the
Insurance Program    taxpayer for flood-related disaster relief, the Congress enacted the
                     National Flood Insurance Act (P.L. 90-448) that created the National Flood
Has Sought to        Insurance Program. Since its inception, the program has sought to
Minimize Flood-      minimize flood-related property losses by making flood insurance
                     available on reasonable terms and encouraging its purchase by people
Related Losses       who need flood insurance protection—particularly those living in flood-
                     prone areas known as special flood hazard areas. The program identifies
                     flood-prone areas in the country, makes flood insurance available to
                     property owners in communities that participate in the program,1 and
                     encourages floodplain management efforts to mitigate flood hazards. The
                     program has paid about $12 billion in insurance claims, primarily from
                     policyholder premiums that otherwise would, to some extent, have
                     increased taxpayer-funded disaster relief.

                     Under the program, flood insurance rate maps (FIRM) have been prepared
                     to identify special flood hazard areas—also known as 100-year
                     floodplains—that have a 1-percent or greater chance of experiencing
                     flooding in any given year. For a community to participate in the program,
                     any structures built within a special flood hazard area after the FIRM was
                     completed must be built according to the program’s building standards
                     that are aimed at minimizing flood losses. A key component of the
                     program’s building standards that must be followed by participating
                     communities is a requirement that the lowest floor of the structure be
                     elevated to or above the base flood level—the highest elevation at which
                     there is a 1-percent chance of flooding in a given year. The administration
                     has estimated that the program’s standards for new construction are
                     saving about $1 billion annually in flood damage avoided.

                      Nearly 20,000 communities across the United States currently participate in the program,
                     including Puerto Rico and the Virgin Islands.

                     Page 3                                                                      GAO-03-606T
When the program was created, the purchase of flood insurance was
voluntary. To increase the impact of the program, however, the Congress
amended the original law in 1973 and again in 1994 to require the purchase
of flood insurance in certain circumstances. Flood insurance was required
for structures in special flood hazard areas of communities participating in
the program if (1) any federal loans or grants were used to acquire or build
the structures or (2) the structures are secured by mortgage loans made by
lending institutions that are regulated by the federal government. Owners
of properties with no mortgages or properties with mortgages held by
unregulated lenders were not, and still are not, required to purchase flood
insurance, even if the properties are in special flood hazard areas.

The National Flood Insurance Reform Act of 1994 that amended the
program also reinforced the objective of using insurance as the preferred
mechanism for disaster assistance. The act expanded the role of federal
agency lenders and regulators in enforcing the mandatory flood insurance
purchase requirements. It prohibited further flood disaster assistance for
any property where flood insurance was not maintained even though it
was mandated as a condition for receiving prior disaster assistance.
Regarding the prohibition on further flood disaster assistance, the act
prohibits borrowers who have received certain disaster assistance, and
then failed to obtain flood insurance coverage, from receiving future
disaster aid.

FEMA’s Federal Insurance and Mitigation Administration has been
responsible for managing the flood insurance program. However, the
Homeland Security Act of 20022 transferred this responsibility to the
Department of Homeland Security (DHS). As part of the largest
reorganization of the federal government in over 50 years, the legislation
combined about 170,000 federal employees, 22 agencies, and various
missions—some that have not traditionally been considered security
related—into the new department. FEMA’s responsibilities, including the
flood insurance program, were placed in their entirety into DHS, effective
March 1, 2003. Responsibility for the flood insurance program now resides
in DHS’s Emergency Preparedness and Response Directorate.

P.L. 107-296, Nov. 25, 2002.

Page 4                                                          GAO-03-606T
                       Historically, federal government programs, including the National Flood
Cash-Basis Budgeting   Insurance Program, report income and expenditures on a cash basis—
Does Not Provide All   income is recorded when received and expenditures are recorded when
                       paid. Over the years, the annual reporting of the program’s premium
Needed Information     revenues and its claims losses and expenses has shown wide fluctuations
on Flood Insurance     in cash-based operating net income or losses. For example, for fiscal year
                       2002, the program had a net income of $755 million, but in the previous
Program’s Financial    year it had a net loss of $518 million. For the life of the program, the
Condition              program has shown a net loss of $531 million. The program has, on
                       numerous occasions, borrowed from the U.S. Treasury to fund claims

                       This “cash-based” budgeting, although useful for many government
                       programs, may present misleading financial information on the flood
                       insurance program. In 1997 and again in 1998, 3 we reported that cash-
                       based budgeting has shortcomings for federal insurance programs.
                       Specifically, its focus on single period cash flows can obscure the
                       program’s cost to the government and thus may (1) distort the information
                       presented to policymakers, (2) skew the recognition of the program’s
                       economic impact, and (3) cause fluctuations in the deficit unrelated to
                       long-term fiscal balance. The focus on annual cash flows—the amounts of
                       funds into and out of a program during a fiscal year—may not reflect the
                       government’s cost because the time between the extension of the
                       insurance, the receipt of premiums, the occurrence of an insured event,
                       and the payment of claims may extend over several fiscal years.

                       For the flood insurance program, cash-based budgeting may not provide
                       the information necessary to signal emerging problems, make adequate
                       cost comparisons, or control costs. For example, under its current
                       practices, the program provides subsidized policies without explicitly
                       recognizing the potential cost to the government. Under current policy, the
                       Congress has authorized subsidies to be provided to a significant portion
                       of the total policies in force, without providing annual appropriations to
                       cover the potential cost of these subsidies. The program, as designed, does
                       not charge a premium sufficient to cover its multiyear risk exposure. As a
                       result, not only is the program actuarially unsound, but also the size of the
                       shortfall is unknown. This is a concern that the administration has

                        U.S. General Accounting Office, Budget Issues: Budgeting for Federal Insurance
                       Programs, GAO/AIMD-97-16 (Washington, D.C.: Sept. 30, 1997) and Budget Issues:
                       Budgeting for Federal Insurance Programs, GAO/T-AIMD-98-147 (Washington, D.C.: Apr.
                       23, 1998).

                       Page 5                                                                 GAO-03-606T
recognized and identified as a financial challenge to the flood insurance

The use of accrual-based budgeting for the flood insurance program has
the potential to overcome a number of the deficiencies in cash-based
budgeting. Accrual-based budgeting (1) recognizes transactions or events
when they occur, regardless of cash flows; (2) matches revenues and
expenses whenever it is reasonable and practicable to do so; (3)
recognizes the cost for future insurance claim payments when the
insurance is extended; and (4) provides a mechanism for establishing
reserves to pay those costs. In short, because of the time lag between the
extension of an insurance commitment, the collection of premiums, and
the payment of claims, measuring the financial condition of the flood
insurance program by comparing annual premium income and losses
creates a budgetary distortion. That distortion, together with the
misinformation it conveys, could be reduced or eliminated by accrual-
based budgeting.

In our 1997 report, we pointed out that developing accrual-based budgets
would be challenging, requiring the development of models to generate
reasonably reliable cost estimates of the risks assumed by federal
insurance programs. Nevertheless, the potential benefits to the flood
insurance program, as well as other federal insurance programs, warrant
the effort to develop these risk-assumed cost estimates. We suggested that
the Congress consider encouraging the development and subsequent
reporting of annual risk-assumed cost estimates for all federal insurance
programs. At this time, the flood insurance program is still using cash-
based budgeting for reporting its financial performance. We continue to
believe that the development of accrual-based budgets for the flood
insurance program would be a valuable step in developing a more
comprehensive approach for reporting on the operations and real costs of
this program.

Page 6                                                          GAO-03-606T
                       The National Flood Insurance Program has raised financial concerns
Policy Subsidies and   because, over the years, it has lost money and at times has had to borrow
Payments for           funds from the U.S. Treasury.4 Two reasons—policy subsidies and
                       payments for repetitive losses—have been consistently identified in our
Repetitive Losses      past work and by FEMA to explain financial challenges in the National
Contribute to          Flood Insurance Program. First, the flood insurance program has
                       sustained losses, and is not actuarially sound, largely because many
Program Losses         policies in the program are subsidized. The Congress authorized the
                       program to make subsidized flood insurance rates available to owners of
                       structures built before a community’s FIRM was prepared.5 For a single-
                       family pre-FIRM property, subsidized rates are available for the first
                       $35,000 of coverage, although any insurance coverage above that amount
                       must be purchased at actuarial rates. These pre-FIRM structures are
                       generally more likely to sustain flood damage than later structures
                       because they were not built according to the program’s building standards.
                       The average annual premium for a subsidized policy is $637, representing
                       about 35-40 percent of the true risk premium for these properties.

                       According to flood insurance program officials, about 29 percent of the 4.4
                       million policies in force are currently subsidized. Although this percentage
                       of subsidized policies is substantially lower than it was in the past, it still
                       results in a significant reduction in revenues to the program. Program
                       officials estimate that the total premium income from subsidized
                       policyholders is currently about $500 million per year less than it would be
                       if these rates had been actuarially based and participation remained the
                       same. Originally, funds to support subsidized premiums were appropriated
                       for the flood insurance program; however, since the mid-1980s no funds
                       have been appropriated, and the losses resulting from subsidized policies
                       must be borne by the program.

                       As we reported in July 2001,6 increasing the premiums charged to
                       subsidized policyholders to improve the program’s financial health could
                       have an adverse impact. Elimination of the subsidy on pre-FIRM structures
                       would cause rates on these properties to rise, on average, to more than
                       twice the current premium rates. Program officials estimate that

                       At this time, all funds borrowed from the U.S. Treasury have been repaid.
                       Owners of post-FIRM structures pay actuarial rates for flood insurance.
                        U.S. General Accounting Office, Flood Insurance: Information on the Financial
                       Condition of the National Flood Insurance Program, GAO-01-992T (Washington, D.C.:
                       July 19, 2001).

                       Page 7                                                                      GAO-03-606T
elimination of the subsidy would result in an annual average premium of
about $1,300 for pre-FIRM structures. This would likely cause some pre-
FIRM property owners to cancel their flood insurance.7 Cancellation of
policies on these structures—which are more likely to suffer flood loss—
would in turn increase the likelihood of the federal government having to
pay increased costs for flood-related disaster assistance to these
properties. The effect on the total federal disaster assistance costs of
phasing out subsidized rates would depend on the number of
policyholders who would cancel their policies and the extent to which
future flood disasters affecting those properties occurred. Thus, it is
difficult to estimate whether the increased costs of federal disaster relief
programs would be less than, or more than, the cost of the program’s
current subsidy.

In addition to revenue lost because of subsidized policies, significant costs
to the program result from repetitive loss properties. According to FEMA,
about 38 percent of all claims historically, and about $200 million annually,
represent repetitive losses—properties having two or more losses greater
than $1,000 within a 10-year period. About 45,000 buildings currently
insured under the program have been flooded on more than one occasion
and have received flood insurance claims payments of $1,000 or more for
each loss. Over the years, the total cost of these multiple-loss properties to
the program has been about $3.8 billion.

Although repetitive loss properties represent about one-third of the
historical claims, these properties make up a small percentage of all
program policies. A 1998 study by the National Wildlife Federation noted
that repetitive loss properties represented only 2 percent of all properties
insured by the program, but they tended to have damage claims that
exceeded the value of the insured structure and most were concentrated
in special flood hazard areas. For example, nearly 1 out of every 10
repetitive loss homes has had cumulative flood loss claims that exceeded
the value of the house. Furthermore, over half of all nationwide repetitive
loss property insurance payments had been made in Louisiana and Texas.
About 15 states accounted for 90 percent of the total payments made for
repetitive loss properties.

 Owners of pre-FIRM properties required to maintain flood insurance (i.e. properties with
mortgages made or held by federally regulated lending institutions) would not be able to
cancel their policies.

Page 8                                                                      GAO-03-606T
                           Not only does the National Flood Insurance Program face challenges with
Participation in the       its financial condition, but also in achieving one of the purposes for which
Program May Be Low         it was created—to make flood insurance the mechanism for property
                           owners to cover flood losses. Participation rates—the percentage of
                           structures in special flood hazard areas that are insured—provide a
                           measure to indicate the degree to which the owners of properties
                           vulnerable to flooding are protected from financial loss through insurance,
                           the financial risk to the government from flood-related disaster assistance
                           is decreasing, and the program is obtaining high levels of premium income.
                           The rate of participation in the program, however, may be low. In its fiscal
                           year 2004 budget request, the administration noted that less than half of
                           the eligible properties in flood areas participate in the program, a
                           participation rate that was significantly lower than the nearly 90 percent
                           participation rate for wind and hurricane insurance in at-risk areas.

                           No comprehensive data are available to measure nationwide participation
                           rates. However, various studies have identified instances where low levels
                           of participation existed. For example:

                       •   A 1999 DeKalb County, Georgia, participation study determined that of
                           over 17,000 structures in the special flood hazard areas, about 3,100—18
                           percent—had flood insurance.

                       •   A 1999 FEMA post-disaster study of 11 counties in Vermont found that 16
                           percent of homes sampled in the special flood hazard areas had flood

                       •   A 1999 study by the Strategic Advocacy Group of two counties in
                           Kentucky that had experienced flood disasters found that flood insurance
                           was in force for 52 percent of homes mortgaged since 1994 and was in
                           force for 30 percent of homes mortgaged before 1994.

                       •   An August 2000 FEMA Inspector General study that noted that statistics
                           from North Carolina showed that of about 150,000 structures in special
                           flood hazard areas, 33 percent were covered by flood insurance.

                           FEMA estimates that one-half to two-thirds of those structures in special
                           flood hazard areas do not have flood insurance coverage, because the
                           uninsured owners either are not aware that homeowner’s insurance does
                           not cover flood damage or do not perceive the serious flood risk to which
                           they are exposed.

                           Page 9                                                          GAO-03-606T
One area of flood insurance participation that should not be of concern,
yet is, are those properties for which the purchase of flood insurance is
mandatory. Flood insurance is required for properties located in flood-
prone areas of participating communities for the life of mortgage loans
made or held by federally regulated lending institutions, guaranteed by
federal agencies, or purchased by government-sponsored enterprises.8 No
definitive data exist on the number of mortgages meeting these criteria;
however, according to program officials, most mortgages made in the
country meet the criteria, and for those in a special flood hazard area, the
property owners would have to purchase and maintain flood insurance
over the life of the loan.

The level of noncompliance with this mandatory purchase requirement is
unknown. As we reported in June 2002,9 federal banking regulators and
government-sponsored enterprises believe noncompliance is very low on
the basis of their bank examinations and compliance reviews. Conversely,
flood insurance program officials view noncompliance with the mandatory
purchase requirement to be significant, based on aggregate statistics and
site-specific studies that indicate that noncompliance is occurring. Neither
side, however, is able to substantiate its differing claim with statistically
sound data that provide a nationwide perspective on noncompliance.

Data we collected and analyzed for our June 2002 report help address
some concerns with the issue of noncompliance, but the issue remains
unresolved. We analyzed available flood insurance, mortgage purchase,
and flood zone data to determine whether noncompliance was a concern
at the time of loan origination. Our analysis of mortgage and insurance
data for 471 highly flood-prone areas in 17 states showed that, for most
areas, more new insurance policies were purchased than mortgages
issued, which suggests noncompliance was not a problem in those areas at
the time of loan origination.

However, data to determine whether insurance is retained over the life of
loans are unavailable, and this issue remains unresolved. There are
indications that some level of noncompliance exists. For example, an
August 2000 study by FEMA’s Office of Inspector General examined

 A government-sponsored enterprise is a privately owned, federally chartered corporation
that serves a public purpose.
 U.S. General Accounting Office, Flood Insurance: Extent of Noncompliance with
Purchase Requirements Is Unknown, GAO-02-396 (Washington, D.C.: June 21, 2002).

Page 10                                                                    GAO-03-606T
                       noncompliance for 4,195 residences in coastal areas of 10 states and found
                       that 416—10 percent—were required to have flood insurance but did not.
                       Flood insurance program officials continue to be concerned with required
                       insurance policy retention and are working with federal banking
                       regulatory organizations and government-sponsored enterprises to identify
                       actions that can be taken to better ensure borrowers are required to renew
                       flood insurance policies annually.

                       The administration and the Congress have recognized the challenges
The Administration     facing the flood insurance program and have proposed actions to improve
and the Congress       it. These actions include the following:
Have Proposed and •    Reducing or eliminating subsidies for certain properties. In the fiscal
Initiated Actions to   year 2004 budget request, the administration proposed ending premium
                       subsidies for second homes and vacation properties. According to flood
Improve the Program    insurance program officials, this change would affect 30 percent of the
                       properties currently receiving subsidized premiums and would increase
                       revenue to the program by $200 million annually. Additionally, program
                       officials plan to increase the rates on all subsidized properties by about 2
                       percent in May 2003.

                   •   Changing premium rates for repetitive loss properties. Two bills—H.R.
                       253 and H.R. 670—have been introduced to amend the National Flood
                       Insurance Act of 1968 that would, among other things, change the
                       premiums for repetitive loss properties. Under these bills, premiums
                       charged for such properties would reflect actuarially based rates if the
                       property owner has refused a buyout, elevation, or other flood mitigation
                       measure from the flood insurance program or FEMA.

                   •   Improving efforts to increase program participation. The administration
                       has identified three strategies it intends to use to increase the number of
                       policies in force: expanded marketing, program simplification, and
                       increasing lender compliance. With regard to lender compliance, DHS
                       plans to conduct an education effort with financial regulators about the
                       mandatory flood insurance requirements for properties with mortgages
                       from federally regulated lenders. Additionally, DHS plans to evaluate the
                       program’s incentive structure to attract more participation in the program.

                   •   Conducting a remapping of the nation’s flood zones. Many of the nation’s
                       FIRMs are old and outdated, and for some communities FIRMs have never
                       been developed. The administration has initiated a multiyear, $1 billion
                       effort to map all flood zones in the country and reduce the average age of
                       FIRMs from 13 to 6 years.

                       Page 11                                                          GAO-03-606T
While we have not fully analyzed these actions, on the basis of a
preliminary assessment, they appear to address some of the challenges to
the flood insurance program, including two of the key challenges—the
program’s financial losses and the perceived low level of participation in
the program by property owners in flood-prone areas. Reducing subsidies
and repetitive loss properties has the potential to help improve the
program’s financial condition, and increasing program participation would
better protect those living in at-risk areas and potentially lower federal
cost for disaster assistance after flood events. However, as mentioned
earlier, actions such as increasing premiums to subsidized policyholders
could cause some of these policyholders to cancel their flood insurance,
resulting in lower participation rates and possibly raising federal disaster
assistance costs.

The remapping of flood zones could potentially affect both participation
rates and the program’s financial condition. Remapping could identify
additional properties in special flood hazard areas that do not participate
in the program and for which DHS will need to undertake efforts to
encourage their participation in the program. Further, these additional
properties may not meet the program’s building standards since they were
built before the FIRM that included properties in the special flood hazard
area was developed. This could cause the program to offer subsidized
insurance rates for these properties, potentially exacerbating the losses to
the program resulting from subsidized properties. At the Subcommittee’s
request, we have begun a review to examine the remapping effort and its
effects, and will report on the results later this year.

None of these proposals, however, addresses the need to move the
program’s current cash-based budgeting for presenting the program’s
financial condition to accrual-based budgeting. As we noted earlier, the
current method of budgeting does not accurately portray the program’s
financial condition and does not allow the program to create reserves to
cover catastrophic losses and be actuarially sound. If a catastrophic loss
occurs, this may place the program in the position of again having to
borrow substantial sums from the Treasury in order to satisfy all claims

One additional challenge facing the flood insurance program relates to its
placement in DHS. As we discussed in a January 2003 report on FEMA’s

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                  major management challenges and program risks,10 the placement in DHS
                  of FEMA and programs such as flood insurance that have missions not
                  directly related to security represents a significantly changed environment
                  under which such programs will be conducted in the future. DHS is under
                  tremendous pressure to succeed in its primary mission of securing the
                  homeland, and the possibility exists that the flood insurance program may
                  not receive adequate attention, visibility, and support as part of the
                  department. For the flood insurance program to be fully successful, it will
                  be important for DHS management to ensure that sufficient management
                  capacity and accountability are provided to achieve the objectives of the
                  program. In this regard, the President’s fiscal year 2004 budget request
                  notes that additional reforms to the flood insurance program are being
                  deferred until the program is incorporated into DHS. This incorporation
                  has now occurred, and congressional oversight—such as through hearings
                  like this one today—should help to ensure that DHS maintains appropriate
                  focus on managing and improving the flood insurance program and
                  championing the reforms necessary to achieve the program’s objectives.

                  For further information on this testimony, please contact JayEtta Z.
Contacts and      Hecker at (202) 512-2834 or William O. Jenkins at (202) 512-8777.
Acknowledgments   Individuals making key contributions to this testimony included Christine
                  E. Bonham, Lawrence D. Cluff, Kirk Kiester, John T. McGrail, and John R.

                   U.S. General Accounting Office, Major Management Challenges and Program Risks:
                  Federal Emergency Management Agency, GAO-03-113 (Washington, D.C.: January 2003).

                  Page 13                                                               GAO-03-606T
Related GAO Products

             Major Management Challenges and Program Risks: Federal Emergency
             Management Agency. GAO-03-113. Washington, D.C.: January 2003.

             Flood Insurance: Extent of Noncompliance with Purchase Requirements
             Is Unknown. GAO-02-396. Washington, D.C.: June 21, 2002.

             Flood Insurance: Information on the Financial Condition of the
             National Flood Insurance Program. GAO-01-992T. Washington, D.C.: July
             19, 2001.

             Flood Insurance: Emerging Opportunity to Better Measure Certain
             Results of the National Flood Insurance Program. GAO-01-736T.
             Washington, D.C.: May 16, 2001.

             Budget Issues: Budgeting for Federal Insurance Programs. GAO/T-AIMD-
             98-147. Washington, D.C.: April 23, 1998.

             Budget Issues: Budgeting for Federal Insurance Programs. GAO/AIMD-
             97-16. Washington, D.C.: September 30, 1997.

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