I have made reference in previous posts to GAO reports on the National Flood Insurance Program, so it is past time for me to discuss the GAO findings and recommendations. In the four years after Hurricane Katrina, there were at least six significant GAO reports on NFIP that focused on problems in the management and oversight of insurance companies and contractors. I am going to focus on two of those reports:
Below I have copied and pasted the summary findings and recommendations from the reports themselves.
The December 2007 GAO report is the one that said insurance companies have an inherent conflict of interest when NFIP allows them to adjust both the federal flood claim and their own wind claim on a property that has both wind and flood damage from a hurricane. It also said that NFIP and its contractors performed very little oversight of those adjustments, did not require the insurance companies to explain how they distinguished between flood damage and wind damage, and did not even have access to information on the companies’ wind claims, so they did not even have the capacity to verify that the claims had been fairly apportioned between the flood and homeowners policies. It should be noted that with regard to NFIP the insurance companies are nothing more than contractors and have a fiduciary responsibility on behalf of the federal government and federal taxpayers. They do not bear any of the flood risk, so they are not acting as insurers.
The handful of us who actually read this report when it was released saw this as a strong indictment of the mismanagement of the flood program and an urgent call for reform of the relationship between the insurance company contractors and NFIP. Unfortunately, only a handful of us actually read GAO reports. As soon as the report was released, the insurance companies, FEMA, NFIP, and their allies in Congress and the Bush Administration all repeated the talking point that the GAO had concluded that there was no proof that the insurance companies had committed fraud by billing the flood program for wind damage. The national press, which also apparently never reads GAO reports, repeated this spin and declared the issue settled. (The only media exceptions were Becky Mowbray of the Times Picayune and Anita Lee of the Sun Herald, but their readers in New Orleans and on the Mississippi Gulf Coast already knew what insurance companies had done to them.) Of course, what GAO had found was that there was so little documentation contained in the flood claims files that it was not possible to determine at that point whether the adjustments had been fair or accurate.
The 2009 GAO report about the windfall subsidies paid by NFIP to the insurance companies was completely ignored by Congress, the Obama Administration, and the media. I am not sure whether anyone but me took the time to read it. Generally, when an insurance company’s agent sells a flood policy, the company keeps 30% of the premium to pay the agent’s commission and the company’s administrative expenses for handling the policy. GAO found that to be almost certainly an excessively generous administrative subsidy, but could not tell for sure because NFIP does not require insurance companies to report what they actually spend to administer flood policies. The 30% is based on an insurance industry formula for what insurers spend on their own policies, with another free percentage point gifted by the Bush Administration in 2001. As GAO explains, insurance companies have a lot of underwriting and marketing expenses on their own products that they do not have with NFIP policies. The overwhelming record shows that insurance companies and their agents do not independently promote flood policies – they write flood policies when the mortgage requires it or when the customer requests it but do not spend any more time or resources than absolutely necessary. For several years, the Congressional Budget Office’s annual Budget Options book has included the option of rescinding the extra one percent of premiums that was gifted to the insurance companies by NFIP in 2001. In 2010, I drafted an amendment that my boss Gene Taylor offered to that year’s House flood insurance bill to rescind the extra percent to drop the administrative subsidy from 30% to 29%, but the House Rules Committee would not make the amendment in order, so Taylor was not allowed to offer it on the floor. The Rules Committee acts on behalf of the party leaders, so it was clear that neither party leadership wanted its Members to have to vote on a cut in the subsidy to insurance companies.
GAO also found that the NFIP practice of paying bonuses to insurance companies for increasing the number of flood policies was commonly rewarding companies for something they had nothing to do with. After a major flood event there is an increase in flood policies because any uninsured disaster victim who receives FEMA assistance or an SBA disaster loan for flood damage is required to buy flood insurance as a condition of the assistance. In other cases, updates in the flood insurance maps often add more properties into the mandatory zones where flood insurance is required for a federally-backed mortgage. The great majority of new flood policies are because of these two factors, yet NFIP has been rewarding insurance companies that already keep 30% of the premiums with an additional bonus.
First, here are the findings and recommendations in the GAO report on Wind/Flood Conflicts:
What GAO Found
Insurance coverage gaps and claims uncertainties can arise when coverage for hurricane damage is divided among multiple insurance policies. Coverage for hurricanes generally requires more than one policy because private homeowners policies generally exclude flood damage. But the extent of coverage under each policy depends on the cause of the damages, as determined through the claims adjustment process and the policy terms that cover a particular type of damage. This process is further complicated when the damaged property is subjected to a combination of high winds and flooding and evidence at the damage scene is limited. Other claims concerns can arise on such properties when the same insurer serves as both NFIP’s write-your-own (WYO) insurer and the property-casualty (wind) insurer. In such cases, the same company is responsible for determining damages and losses to itself and to NFIP, creating an inherent conflict of interest.
Differences in licensing and training requirements for insurance claims adjusters among states also create uncertainties about adjusters’ qualifications. Prior to the 2005 hurricane season, some coastal states had few or no requirements, while others had requirements for most types of adjusters. Further, states can waive their normal oversight requirements after a catastrophic event to help address demand, as they did after Hurricane Katrina. As a result, significant variations can exist in the qualifications of claims adjusters available after a catastrophic event. Strengthened and more uniform state requirements for adjusters could enhance the qualifications of the adjuster force in future catastrophes and improve the quality and consistency of claims adjustments.
NFIP does not systematically collect and analyze both wind and flood damage claims data, limiting FEMA’s ability to assess the accuracy of flood payments on hurricane-damaged properties. The claims data collected by NFIP through the WYO insurers—including those that sell and service both wind and flood policies on a property—do not include information on whether wind contributed to total damages or the extent of wind damage as determined by the WYO insurer. The lack of this data also limits the usefulness of FEMA’s quality assurance reinspection program to reevaluate the accuracy of payments. In addition, the aggregate claims data that state insurance regulators collectively gathered after Hurricanes Katrina and Rita were not intended to be used to assess wind and flood damage claims together on a property- or community-level basis.
Further, FEMA program contractors do not have access to WYO insurers’ policies, procedures, and instructions that describe to adjusters how wind and flood damages are to be determined when properties are subjected to both perils. FEMA
officials stated that they did not have the authority to collect wind damage claims data from insurers. But without the ability to examine claims adjustment information for both the wind and flood damages, NFIP cannot always determine the extent to which each peril contributed to total property damages and the accuracy of the claims paid for losses caused by flooding.
GAO Recommendations:
Matters for Congressional Consideration:
To strengthen and clarify FEMA’s oversight of WYO insurers, particularly those that service both wind and flood damage claims on the same property, we recommend the Congress consider giving FEMA clear statutory access to:
• both wind and flood damage claims information available from NFIP’s WYO insurers in cases in which it is likely that both wind and flooding contributed to any damage or loss to covered properties, enabling NFIP to match and analyze the wind and flood damage apportionments made on hurricane-damaged properties in a systematic fashion, as appropriate; and
• the policies, procedures, and instructions used by WYO insurers and their adjusters for both flood and wind claims to assess and validate insurers’ claims adjustment practices for identifying, apportioning, and quantifying damages in cases where there are combined perils.
Recommendation for Action
We recommend that state insurance commissioners, acting through NAIC, enhance the quality and consistency of standards and oversight for all types of claims adjusters among states through more stringent and consistent licensing and training requirements for adjusters, including, in those states where appropriate, training to assess and apportion damages due to wind, flooding, or both.
Now, here are the GAO findings and recommendations about the generous NFIP administrative subsidies to insurance companies:
What GAO Found
FEMA does not systematically consider actual flood insurance expense information when it determines the amount it pays the WYO for selling and servicing flood insurance policies and adjusting claims. Rather, since the inception of the WYO program, FEMA has used various proxies for determining the rates at which it pays the WYOs. Consequently, FEMA does not have the information it needs to determine (1) whether its payments are reasonable and (2) the amount of profit to the WYOs that are included in its payments. When GAO compared expense payments FEMA made to six WYOs to the WYOs’ actual expenses for calendar years 2005 through 2007, we found that the payments exceeded actual expenses by $327.1 million, or 16.5 percent of total payments made. Considering actual expense information would provide transparency and accountability over payments to the WYOs.
FEMA has not aligned its bonus structure with its long-term goals for the program. The WYOs generally offered flood insurance when requested but did not strategically market the product as a primary insurance line. FEMA has not set explicit marketing goals beyond a 5 percent goal of increasing policy growth each year, and the WYO program primarily rewards companies that are new to NFIP for sales increases that may result from external factors, including flood events. The Government Performance and Results Act states that when results could be influenced by external factors, agencies can use intermediate goals to measure contributions to specific goals. Paying bonuses based on such intermediate targeted goals could bring the bonus structure more in line with FEMA’s goals for the NFIP program.
FEMA has explicit financial control requirements and procedures for the WYO program but has not implemented all aspects of its Control Plan. FEMA provides guidance for WYOs that is intended to ensure compliance with the statutory requirements for the NFIP and contains checks and balances to help ensure that taxpayer funds are spent appropriately. FEMA did most of the required biennial audits and underwriting and claims reviews but did not do most of the required audits for cause; state insurance department audits; and marketing, litigation, and customer service operational reviews. In addition, FEMA did not systematically track the outcomes of the various audits, inspections, and reviews that it performed for the 10 WYOs included in this review of FEMA’s oversight of the program. Because FEMA does not implement all aspects of the Control Plan, it cannot ensure that the WYOs are fully complying with program requirements.
Recommendations for Executive Action
To provide transparency and accountability over the payments FEMA makes to WYOs for expenses and profits, we recommend that the Secretary of Homeland Security direct the Under Secretary of Homeland Security, FEMA, to
• determine in advance the amounts built into the payment rates for estimated expenses and profit;
• annually analyze the amounts of actual expenses and profit in relation to the estimated amounts used in setting payment rates;
• consider the results of the analysis of payments, actual expenses, and profit in evaluating the methods for paying WYOs; and
• in light of the findings in this report, immediately reassess the practice of paying WYOs an additional 1 percent of written premiums for operating expenses.
To increase the usefulness of the data reported by WYOs to NAIC and to institutionalize FEMA’s use of such data, we recommend that the Secretary of Homeland Security direct the Under Secretary of Homeland Security, FEMA, to
• take actions to obtain reasonable assurance that NAIC flood insurance expense data can be considered in setting payment rates that are appropriate, including identifying affiliated company profits in reported flood insurance expenses, and
• develop comprehensive data analysis strategies to annually test the quality of flood insurance data that WYOs report to NAIC.
If FEMA continues to use the WYO bonus program, we recommend that the Secretary of Homeland Security direct the Under Secretary of Homeland Security, FEMA, to improve it by considering the use of more targeted marketing goals that are in line with FEMA’s NFIP goals.
To improve oversight of the WYO program and compliance with program requirements, we recommend that the Secretary of Homeland Security direct the Under Secretary of Homeland Security, FEMA, to
• consistently follow the Control Plan and ensure that each component is implemented;
• ensure that any revised Control Plan include oversight of all functions of participating WYOs, including customer service and litigation expenses; and
• systematically track insurance companies’ compliance with and performance under each component of the Control Plan and ensure centralized access to all the audits, reviews, and data analyses performed for each participating insurance company under the Control Plan.
[...] the companies to keep 30% of the premiums for commissions and administrative expenses – an amount that GAO found to be far more than their actual expenses. Even with that windfall, we cannot get the insurers to diligently comply with the mandatory [...]