The NFIP: GAO Report to Congress
By Anthony Cappelletti
Historically, the private insurance industry was unable to provide flood insurance as the risk was considered to be uninsurable. In 1968, the National Flood Insurance Program (NFIP) was established by the U.S. government. The program is currently managed by the Federal Emergency Management Agency (FEMA). Its goals are to provide flood insurance to homeowners, renters, and businesses, to assist communities with floodplain management, and to produce flood hazard maps.
The NFIP has a sunset clause and must be reauthorized by Congress to continue operating. Up until 2017, NFIP reauthorizations would last for several years. However, since 2017, there has been over 20 temporary extensions of the program, each lasting between three weeks and 12 months. A longer-term reauthorization, including reforms to address the NFIP’s issues, is required for stability of the program. This past July, the U.S. Government Accountability Office (GAO) released the report Flood Insurance, FEMA's New Rate-Setting Methodology Improves Actuarial Soundness but Highlights Need for Broader Program Reform. This report provides a number of recommendations for the program. In this article, I’ll highlight the major points made in the GAO report.
Background
The NFIP has generally succeeded in meeting its goals:
- It provides a risk-based alternative (i.e., insurance) to federal disaster assistance.
- It sets standards for flood plain management.
- It creates flood hazard maps.
But the program is not without issues. The program has been accumulating significant debt since Hurricane Katrina in 2005.
Top Five Catastrophic Flooding Events by NFIP Total Claims[1] from 1978 to 2022
|
Event Year |
Event |
NFIP Total Amount Paid ($ Billions) |
|
2005 |
Hurricane Katrina |
16.3 |
|
2017 |
Hurricane Harvey |
9.0 |
|
2012 |
Superstorm Sandy |
8.9 |
|
2022 |
Hurricane Ian |
3.9 |
|
2008 |
Hurricane Ike |
2.7 |
In 2017, Congress forgave $16 billion in NFIP debt. Despite this action of Congress, the program currently owes the U.S. Treasury $20.5 billion. This all comes down to the fact that premiums collected have been insufficient to cover claim payments from catastrophic flooding events. Annual interest payments made by the NFIP to service this debt are significant. According to the GAO report, these payments ranged from $300 million to $438 million over the period from 2017 to 2022. Additionally, while the NFIP makes flood coverage available, there is the issue of affordability of policy premiums for many homeowners in higher risk areas.
|
NFIP’s debt raises concerns about the actuarial soundness of the program, the program’s affordability for policyholders, and consumer participation. GAO Report |
NFIP Policy Pricing
NFIP policy pricing was significantly changed in 2021 under what is referred to as Risk Rating 2.0. Prior to Risk Rating 2.0, the rating methodology used by the NFIP was essentially the same methodology that was implemented when the program was created in 1968 (referred to as legacy rating). Under the legacy rating methodology, rates were mainly determined by broadly defined flood zones and height relative to the base flood plain. Furthermore, the legacy rating methodology did not consider some flood sources and did not consider flood risk from catastrophic events. The legacy rating system also had features that kept some properties at subsidized rates.
|
(S)ome properties … paid discounted “subsidized” rates if they were built before floodplain maps for their area were published … Other policies paid discounted “grandfathered” premiums when a new flood map placed them into a flood zone that would have increased their premiums … GAO Report |
The NFIP began implementing Risk Rating 2.0 in October of 2021. As of April 2023, all NFIP policies were subject to Risk Rating 2.0. Risk Rating 2.0 revised the rating methodology such that NFIP policies have a full-risk premium based on policy-level flood risk that includes specific features of the insured property.
However, there is a statute that caps annual NFIP premium increases to 18% for most policies. This cap was implemented to address affordability concerns. The effect of this is that policies with capped rate increases will have subsidized rates.
The GAO analysis estimates that, as of December 2022, premium increases would be required for 66% of policies.
Risk Rating 2.0 Implementation—Estimated Policy Premium Increases[2]
|
Estimated Increase as of December 2022 |
Percent of Policies |
|
No increase required[3] |
34% |
|
1% to 49% |
21% |
|
50% to 99% |
14% |
|
100% to 199% |
15% |
|
200% or higher |
16% |
The statutory cap on annual rate increases means that it may take many years for all policies to reach the Risk Rating 2.0 full-risk premium. For example, a policy requiring a 300% increase to go from the legacy premium to the full-risk premium would take nine years to arrive at the full-risk premium. This assumes that no additional increases are required over that period. The GAO estimates that it will take until 2037 for 95% of policies to reach the full-risk premium.
GAO Recommendations
In the GAO report, a number of recommendations were made. Some were for Congress. Some were for FEMA.
The following six recommendations were made regarding matters for Congress to consider:
- The reserve fund assessment should be based on actuarial principles and included within the full risk premium.
- Eliminate the statutory surcharge on policies[4] and replace lost revenue from this with actuarially determined adjustments to premiums.
- Premiums should be actuarially determined. Affordability issues should not be through statutory premium reductions but by providing means-based assistance financed through the federal budget.
- Current and future NFIP debt must be addressed. Current debt could be cancelled or repaid by a transparent surcharge on policy premiums. Potential future debt may be dealt with through use of full actuarially indicated rates, increasing use of reinsurance, and considering alternatives for funding catastrophes.
- The NFIP's continuous coverage requirement should be changed so that private market flood insurance coverage can be used to meet the requirement.
- Risk-based partial premium refunds should be made for midterm NFIP policy cancellations when the policy is replaced by a private market flood insurance policy.
Of these six recommendations to Congress, the first four affect the way the program is funded. The last two are intended to encourage growth of the private market for flood insurance.
The following five recommendations were made regarding matters for FEMA to consider:
- Community Rating System discounts should be based solely on community activities that lower flood risk and are based on an actuarial evaluation.
- Community activities that are desirable but cannot be actuarially justified to lower flood risk should be encouraged through means other than premium discounts.
- An annual actuarial report should be published that includes the following: Loss level that full-risk premiums are intended to cover, loss level that current discounted premiums can cover, and projections for premiums, claims, expenses and debt.
- Directly inform policyholders about Risk Rating 2.0.
- Make property-specific flood risk information available to policyholders and agents so that there is a better understanding of the policy premium on a property and the potential for reducing costs through mitigation options.
Of these five recommendations to FEMA, the first two involve adjusting rating methodology, whereas the last three involve greater transparency of the program through communications.
The recommendations in the GAO Report bear similarities to some of the options presented in the Congressional Research Services (CRS) report Options for Making the National Flood Insurance Program More Affordable (updated Jan. 6, 2023).[5]
Private-Market Flood Insurance
Flood mapping and risk modeling has evolved considerably since the NFIP was created by Congress in 1968. This, along with the increased capacity of capital markets, has created an environment in which private-market insurers can offer flood insurance to properties that they would not have considered in the past. But several aspects of the NFIP constrain private-market growth: Actual premiums that are below the full-risk premiums, NFIP policy cancellation provisions and the continuous coverage requirement. The GAO report recommends the removal of impediments to the growth of private-market flood insurance. It is generally thought that encouraging private-market flood insurance is beneficial to insureds and the NFIP. Private-market insurers could increase the total amount of coverage purchased in the market, tailor policies to the needs of the insured, and integrate policies with homeowners insurance. Growth in the private market could also reduce NFIP’s overall risk exposures and potentially reduce future NFIP debt.
But growth in private-market flood insurance does have some downside. Currently, the NFIP is limited in its ability to reject potential insureds. Private-market insurers are not similarly constrained in underwriting. It is possible that adverse selection against the program will occur in which private-market insurers will write the most profitable risks leaving the least profitable risks to the program.
According to the GAO report, the NFIP wrote $3.2 billion in premium for fiscal year 2022. As a point of comparison, private-market insurers in the United States wrote $1.31 billion in premium 2022. This represents a significant growth of 24.4% from 2021 premium level,[[6]] and now represents nearly 30% of the total flood insurance premiums written in the United States. This is over double the market share of 12.5% in 2016.[7]
What Happens Next?
The GAO report is revealing. A lot of information is provided in the 85-page report to explain the basis for the recommendations made by the GAO. Both Congress and FEMA have actionable items that can address the issues faced by the NFIP.
GAO’s recommendations to FEMA are much easier to implement than the recommendations to Congress. This is illustrated by the fact that Congress has been unable to agree to a long-term reauthorization of the NFIP since 2017. It doesn’t seem that Congress is ready to agree to a long-term reauthorization of the NFIP, or significant program changes, any time soon.
As mentioned previously, flood mapping and risk modeling has evolved considerably since 1968. But there is now the issue of climate risk that should be considered when modeling flood risk. Climate risk needs to be considered as it will likely increase the exposure to flood losses to many communities. A 2019 GAO report on climate risk, Climate Change: Opportunities to Reduce Federal Fiscal Exposure, included the NFIP on its High-Risk List—in part due to increasing exposure levels from climate risk.
Those involved in the risk transfer of flood risks, such as actuaries and catastrophe modelers, must take into account climate risk. The SOA now offers a Climate Risk Certificate Program with an option for general insurance. The course is open to both actuaries and non-actuaries. It provides content on climate risk management and the measurement of the effects from climate risk. The education provided could prove useful for those involved in general insurance with exposure to climate risk (e.g., property insurance exposed to floods, windstorms, drought). An overview of the program is in the article SOA Climate Risk Certificate Program, General Insurance Course.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.
Anthony Cappelletti, FSA, FCIA, FCAS, is a staff fellow for the SOA. He can be contacted at acappelletti@soa.org.