Study: Flood Program Premiums Do Not Adequately Reflect Flood Risk

Premiums charged by the National Flood Insurance Program (NFIP) are inadequate to cover the risk and the program should re-examine its methods for setting rates, according to the U.S. Government Accountability Office (GAO).

The 2005 hurricanes left the NFIP with an “unprecedented” $17.4 billion deficit, the GAO says in a report recently submitted to the U.S. Senate Committee on Banking, Housing and Urban Affairs. The report, “FEMA’s Rate-Setting Process Warrants Attention,” summarizes the findings of a study undertaken in response to concerns over the financial status of the NFIP, which is operated by the Federal Emergency Management Agency (FEMA).

While by statute the NFIP was not designed to be actuarially sound, until 2004 the program covered most of its losses with collected premiums and occasional loans from the Treasury that were either repaid or retired by Congress, the GAO noted.

Premium rates for most properties – around 75 percent – are intended to fully reflect the risk of flooding, but in order to encourage participation in the program the remaining 25 percent are subsidized.

In addition the NFIP allows some properties, which through the re-mapping process have been assigned to riskier flood zones, to remain at lower premium levels that do not reflect the true flood risk. But the GAO found that “FEMA does not collect data on these properties – known as grandfathered properties – or measure their financial impact on the program and does not know how many of these properties exist, their exact location, or how much they generate in losses.”

The GAO evaluated FEMA’s processes for setting both full-risk and subsidized rates. It generally found that the amount the NFIP collects in annual premiums, both full-risk and subsidized, “is not enough to cover its operating costs, claim losses, and principal and interest payments to the Department of Treasury, thereby exposing the federal government and ultimately taxpayers to ever-greater financial risk, especially in years of catastrophic flooding.”

The report also noted that some of FEMA’s data is outdated or inaccurate; that damage estimates and flood probabilities based on data from the 1980s do not reflect recent flood damage experience; and that most of the flood “maps used in rate setting have not yet been updated.”

The GAO said one problem with the rate structure is that “policyholders in states with frequent high-loss years are paying the same rates as policyholders with similar properties in states with fewer losses.” Thus low-loss states end up subsidizing states with high losses.

It identified states where claims exceeded premiums from 1978 through 2007. Missouri topped the list followed by West Virginia; NFIP claims from those states exceeded premiums in 11 years during the time period. The following 18 states, in which claims exceeded premiums for multiple years, in descending order are: Mississippi (10), Louisiana (10), Texas (9), Alabama (9), Illinois (9), Ohio (9), New Hampshire (8), Oklahoma (7), South Dakota (7), Kansas (7), Washington (7), Indiana (7), North Carolina (6), Minnesota (6), Arkansas (6), Pennsylvania (6), Connecticut (6) and North Dakota (5).

As a result of the study, GAO recommended that “FEMA: (1) ensure that its rate-setting methods result in rates that accurately reflect flood risks and (2) collect data to analyze the impact of newly created grandfathered properties on the NFIP.”

The GAO warned that unless the “NFIP addresses issues with its rate-setting processes, premiums collected will remain insufficient in the face of future flood losses – leaving both the program and taxpayers at increased financial risk.”

FEMA generally agreed with the report’s findings and recommendations, the GAO said, with some exceptions. FEMA felt the depiction of the current rate-setting process is overly negative “given the complexity and difficulty of setting flood insurance rates.”

In addition, FEMA said, among other things, the characterization of its map modernization efforts and their impact on premium rates was misleading and the impact on rate setting of older maps was overstated.

See related article: Fixing The NFIP – The Most Inefficient Insurer In The World