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Report to the Ranking Member, Committee on Banking, Housing, and Urban
Affairs, U.S. Senate:
United States Government Accountability Office:
GAO:
August 2009:
Flood Insurance:
Opportunities Exist to Improve Oversight of the WYO Program:
GAO-09-455:
GAO Highlights:
Highlights of GAO-09-455, a report to the Ranking Member, Committee on
Banking, Housing, and Urban Affairs, U.S. Senate.
Why GAO Did This Study:
Since 2004, private insurance companies participating in the Federal
Emergency Management Agency’s (FEMA) Write-Your-Own (WYO) program have
collected an average of $2.3 billion in premiums annually and, of this
amount, have been paid or allowed to retain an average of $1 billion
per year. Questions have been raised about FEMA’s oversight of the
program in light of the debts FEMA has incurred since the 2005
hurricanes. GAO placed NFIP on its high-risk list and issued several
reports addressing the challenges the program faces. This report
addresses the methods FEMA uses for determining the rates at which WYOs
are paid, its marketing bonus system for WYOs, its adherence to
financial control requirements for the WYO program, and alternatives to
the current system. To do this work, we reviewed and analyzed FEMA’s
data and policies and procedures and obtained the views of select WYOs
and flood insurance experts.
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.
What GAO Recommends:
GAO makes recommendations to improve oversight of the WYO program. They
include reviewing data on WYO companies’ expenses, targeting incentive
bonuses in line with NFIP goals, and providing more comprehensive
oversight of program requirements and procedures. FEMA agreed with our
recommendations regarding NAIC data, the incentive structure, and
program oversight, but not the transparency of WYO payments. We
continue to believe that FEMA could better leverage actual expense
data.
View [hyperlink, http://www.gao.gov/products/GAO-09-455] or key
components. For more information, contact Orice Williams Brown at (202)
512-8678 or williamso@gao.gov, or Jeanette M. Franzel at (202) 512-2600
or franzelj@gao.gov.
[End of section]
Contents:
Letter:
Background:
FEMA Does Not Systematically Consider WYOs' Actual Expenses When
Setting Payment Rates:
FEMA Has Not Aligned Its Bonus Structure with Its Long-Term Goals for
NFIP:
FEMA Followed Some but Not All of Its Internal Control Requirements and
Procedures:
Alternative WYO Program Administrative Structures Could Be Used to
Incorporate Competition into the Payment Process:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Briefing Slides:
Appendix II: Scope and Methodology:
Appendix III: Comments from the Department of Homeland Security:
Appendix IV: GAO Contacts and Staff Acknowledgments:
Abbreviations:
Control Plan: FEMA's Financial Control Plan and Procedures:
FEMA: Federal Emergency Management Agency:
NAIC: National Association of Insurance Commissioners:
NFIP: National Flood Insurance Program:
SFHA: special high-risk flood hazard area:
ULAE: Unallocated Loss Adjustment Expenses:
WYO: Write-Your-Own:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
August 21, 2009:
The Honorable Richard C. Shelby:
Ranking Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
Dear Senator Shelby:
Private insurers sell and service policies and adjust claims for the
National Flood Insurance Program (NFIP) under an arrangement with the
Federal Emergency Management Agency (FEMA) of the Department of
Homeland Security. Under this program, known as the Write-Your-Own
(WYO) program, these companies have collected an average of $2.3
billion in premiums annually since 2004 and have been paid or allowed
to retain an average of $1 billion for each of these years. These WYO
companies--around 90 in 2008--are not only compensated for their
services, but are also paid a bonus for expanding NFIP's policy base by
increasing the number of flood insurance policies they sell.
As we have previously reported, the amounts WYOs receive for their
services represent from one-third to two-thirds of the total NFIP
premiums collected annually, depending on the number of flood claims
filed.[Footnote 1] In fiscal year 2006, these payments peaked at more
than $1.5 billion, or about 67 percent of WYO premiums collected,
largely because of expenses related to the 2005 hurricanes. The amount
of payments and bonuses that WYOs have received has led to increased
scrutiny of FEMA's oversight of these insurance companies and its
methods for determining the rates at which they are paid.
At your request, we reviewed FEMA's oversight of the WYO insurance
companies that sell and service NFIP policies. Our objectives were to
(1) assess FEMA's practice of determining the amounts it pays WYOs for
selling and servicing flood insurance and adjusting claims; (2) examine
how FEMA evaluates the effectiveness of its WYO bonus incentive
structure and determine whether the bonuses it pays reflect actual
efforts to market flood insurance policies; (3) evaluate the extent to
which FEMA oversees the WYO companies, including reviewing external
audits, reinspecting flood claims, and conducting operational reviews;
and (4) evaluate the advantages and disadvantages of three alternative
arrangements for selling and servicing flood insurance policies and
adjusting claims using a competitively awarded contract.
On June 19, 2009, we briefed your staff on the results of our work.
This letter summarizes the briefing; the briefing slides are included
in appendix I of this report.
To assess FEMA's method for determining the amounts it pays WYOs for
their services, we selected a sample of six WYOs that represented 53
percent of total WYO program net premiums written, 71 percent of total
WYO program claim losses paid, and 59 percent of total expense payments
FEMA made to the approximately 90 companies for fiscal years 2005 to
2007. We compared the payments FEMA made to these companies in calendar
years 2005 to 2007 with the actual flood insurance expenses the
companies reported to the National Association of Insurance
Commissioners (NAIC) for those years. We also interviewed officials
from FEMA, WYO companies, and NAIC. To address the remaining
objectives, we selected a sample of 10 WYOs that represented more than
50 percent of the flood insurance premiums written in fiscal year 2007,
including companies of various sizes that incurred different levels of
flood losses and had different operating models. To assess the extent
to which FEMA evaluates the effectiveness of its WYO bonus incentive
structure, we discussed the bonus payment methodology with FEMA and WYO
officials and reviewed documents relating to the methodology and
history of the bonus payment system. To assess the extent to which FEMA
was implementing its oversight requirements for WYOs, we evaluated
FEMA's Financial Control Plan Requirements and Procedures (Control
Plan) and requested and reviewed all documents that were required under
the plan, and discussed the plan and procedures with appropriate FEMA
officials, WYO insurers, and other stakeholders. To evaluate the
advantages and disadvantages of alternatives to the WYO program, we
identified three possible arrangements, all of which would incorporate
a competitive feature. We then discussed these alternatives with WYO
insurers in our sample; FEMA staff; and other stakeholders, such as
flood insurance vendors and consultants. Appendix II contains a more
detailed description of our scope and methodology.
We conducted this audit from December 2007 to July 2009 in accordance
with generally accepted government auditing standards. Those standards
require that we plan and perform the audit to obtain sufficient,
appropriate evidence to provide a reasonable basis for our findings and
conclusions based on our audit objectives. We believe the evidence we
obtained provides a reasonable basis for our findings and conclusions
based on our audit objectives.
Background:
Because of the catastrophic nature of flooding and the difficulty of
adequately predicting flood risks, private insurance companies have
largely been unwilling to underwrite and bear the risk of flood
insurance. Under NFIP, the federal government assumes liability for
flood insurance losses and sets rates and coverage limitations, among
other responsibilities. Since its inception, NFIP, to a large extent,
has relied on the private insurance industry to sell and service
policies, as Congress envisioned when it authorized the program in
1968. The authorizing legislation provides broad authority for FEMA to
work with the private insurance industry, and over time, FEMA has
utilized several arrangements with private insurers, including with
companies themselves and with a single vendor.[Footnote 2] Because of
customer complaints and stagnant policy growth, in 1983, FEMA
established the WYO program. According to FEMA, the goals of the WYO
program are to increase the NFIP policy base and the geographic
distribution of policies, improve service to NFIP policyholders through
the infusion of insurance industry knowledge, and provide the insurance
industry with direct operating experience with flood insurance.
In 1986--the first year of the WYO program--48 WYO insurance companies
were responsible for about 50 percent of the more than 2 million
policies in force. As of September 2008, about 90 WYO insurance
companies accounted for 97 percent of the nearly 5.6 million policies
in force at that time.[Footnote 3] Because WYOs are not risk-sharing
insurers, they are not paid an explicit profit percentage or amount.
[Footnote 4]
Private insurers become WYOs by entering into an arrangement with FEMA
(the Financial Assistance/Subsidy Arrangement) to issue flood policies
in their own name. The insurers must have experience in property and
casualty insurance lines, be in good standing with state insurance
departments, and be capable of adequately selling and servicing flood
insurance policies. They must also comply with the provisions of FEMA's
Control Plan, which outlines the companies' responsibilities for
program operations, including underwriting, claims adjustments, cash
management, and financial reporting, as well as FEMA's responsibilities
for management and oversight.
WYOs adjust flood claims and settle, pay, and defend all claims arising
from the flood policies. Insurance agents from these companies are the
main point of contact for most policyholders. Based on information the
insurance agents submit, WYOs issue policies, collect premiums, deduct
an allowance for commission and operating expenses from the premiums,
and remit the balance to NFIP. In most cases, insurance companies hire
subcontractors--flood insurance vendors--to conduct some or all of the
day-to-day processing and management of flood insurance policies.
When flood losses occur, policyholders report them to their insurance
agents, who notify the WYO insurance companies. The WYO companies
review the claims and process approved claims for payment. FEMA
reimburses the WYO insurance companies from the National Flood
Insurance Fund for the amount of the claims plus expenses for adjusting
and processing the claims, using rates that FEMA establishes. Claims
amounts may be adjusted after the initial settlement is paid if
claimants submit documentation showing that some costs were higher than
estimated.
FEMA Does Not Systematically Consider WYOs' Actual Expenses When
Setting Payment Rates:
FEMA does not systematically consider actual flood insurance expense
information when it determines the amount it pays WYOs for selling and
servicing flood insurance policies and adjusting claims. Since the
inception of the WYO program, FEMA has used proxies to determine the
rates at which it pays WYOs. For example, payments for operating
expenses are determined annually based on the average industry
operating expenses for five lines of property insurance. WYOs' actual
flood insurance expense information has been available since 1997, when
the companies began reporting the data to NAIC. However, FEMA has not
systematically considered these data when setting its payment rates,
and thus does not determine in advance the amounts built into payment
rates for estimated expenses and profit. Further, FEMA has not, after
the end of each year, compared the WYOs' actual expenses to payments it
makes to the WYOs. Because FEMA does not routinely take WYOs' actual
flood expenses into account when calculating payments and does not
analyze actual payments and WYO flood insurance expenses, it does not
have the information it needs to determine whether its payments are
appropriate and how much profit is included in its payments to WYOs.
FEMA has occasionally modified its methods for determining the amount
of expense payments, but only the last of these modifications, made in
2008, has taken into account the amount of actual WYO insurance
expenses. In 2001, FEMA increased its payments to WYOs for servicing
flood policies by an additional 1 percent of written premiums after
some WYOs told FEMA that the payment amounts, based on the proxy used,
were not sufficient to cover their operating expenses. FEMA did not
take into consideration WYOs' actual expenses in making these
additional payments, which continued each year since 2001 and totaled
about $25 million in fiscal year 2007. However, we found that the
payments to the six WYOs we reviewed exceeded their actual operating
expenses even before these payments were increased by an additional 1
percent of written premiums. FEMA did consider actual flood insurance
expenses in 2008 when it changed its method of paying claims processing
expenses. Beginning in fiscal year 2008--in response to the significant
increase in total payments made to WYO companies in fiscal year 2005
and 2006 following the 2004 and 2005 hurricanes--FEMA changed its
method for paying claims processing expenses to take into account
actual flood expense data obtained from a selected number of WYO
companies. These examples illustrate the benefit of considering actual
flood expense data in administering the WYO program.
We recognize that the consistency of WYOs' reporting to NAIC needs to
be improved in order for data on the companies' expenses to be fully
utilized. For example, we found that, among other things, some
companies reported their flood insurance expenses to NAIC after
offsetting them with the payments they received from FEMA. We also
found that the actual expenses of one of the six companies we reviewed
included payments made under service agreements with an affiliated
company that may include profit distributions that should not be
included in the expense amounts considered when setting payment rates.
Nevertheless, we were able to use NAIC flood insurance data,
supplemented with information obtained from WYO company officials, to
compare the actual flood insurance expenses our six selected companies
incurred and the payments they received for calendar years 2005 through
2007. We found that FEMA's payments exceeded the companies' actual
expenses by $327.1 million, or 16.5 percent of total payments made.
Our results highlight the importance of FEMA's considering actual flood
expense data in administering the WYO program. In accordance with our
Standards of Internal Control in the Federal Government, FEMA should
ensure that its payment rates to WYOs are appropriate by, for example,
comparing payments with actual flood insurance expenses.[Footnote 5]
Further, federal managerial cost accounting standards state that
reliable cost information is critical to the proper allocation and
stewardship of federal resources and that actual cost information is an
important element agency management should consider when setting
payment rates.[Footnote 6]
FEMA Has Not Aligned Its Bonus Structure with Its Long-Term Goals for
NFIP:
FEMA has not aligned its bonus structure for WYOs with its goals for
NFIP, such as increasing penetration in low-risk flood zones, among
homeowners without federally-related mortgages in all zones, and in
geographic areas with repetitive losses and low penetration rates.
Instead, FEMA uses a broad-based distribution formula that awards a
bonus of 0.5 percent to 2 percent of the premiums collected if WYOs
achieve a 2 percent to 5 percent net growth in policies on an annual
basis. This formula primarily rewards companies that are new to NFIP,
when it is easiest to increase the percentage of net policies from a
small base. Further, we found that most WYOs generally offered flood
insurance when requested but did not strategically market the product
as a primary insurance line. As a result, any sales increases may in
fact result from external factors that are outside the companies'
control, rather than from marketing efforts--factors such as flood
events, changes in the housing market, and economic developments. For
example, sales of flood insurance tend to rise after flooding events,
and FEMA's Floodsmart media marketing campaign, which also has a goal
of increasing flood policies by 5 percent annually, may also impact
flood insurance sales. Moreover, FEMA does not review the WYOs'
marketing plans and therefore lacks the information needed to assess
the effectiveness of either the WYOs' efforts to increase participation
or the bonus program itself.
The Government Performance and Results Act of 1993 requires agencies to
conduct systematic studies to assess how well programs are working.
When program results could be influenced by external factors, agencies
can use intermediate goals to identify the program's discrete
contribution to a specific result. Although a study funded by FEMA
suggested that the agency should focus on increasing market penetration
in low-risk flood zones, in targeted geographical areas, and in small,
special high-risk flood hazard areas, FEMA has not set targeted market
penetration goals beyond its 5 percent goal of increasing policy
growth. Having intermediate targeted goals could help expand program
participation, and linking such goals directly to the bonus structure
could help ensure that NFIP and WYO goals were in line with each other.
FEMA Followed Some but Not All of Its Internal Control Requirements and
Procedures:
FEMA has explicit financial control requirements and procedures for
overseeing the WYO program. FEMA's Control Plan provides guidance for
WYOs that is intended to ensure compliance with the statutory
requirements for NFIP and that contains several checks and balances to
help ensure that taxpayers' funds are spent appropriately.[Footnote 7]
The plan has four major components that include requirements for: (1)
monthly data and financial reporting, (2) claims reinspections by
FEMA's contractor, (3) various audits by independent CPAs, including
required biennial audits, audits for cause, and state insurance
department audits, and (4) triennial operation reviews by FEMA staff.
FEMA's Standards Committee is responsible for ensuring that
participating companies are complying with the requirements.
For the 10 WYOs in our sample, FEMA followed some but not all of the
requirements and procedures of the Control Plan and did not
systematically track the outcomes of the various audits, inspections,
and reviews. Our review of FEMA's records for these WYOs showed the
following:
* FEMA collected nearly all of the required monthly data submissions.
* WYOs from our sample whose claims were selected for reinspections
were reinspected according to the Control Plan's methodology, and
evidence of these activities was provided.
* Biennial audits and underwriting and claims triennial reviews were
also mostly implemented. FEMA officials said that they focused on
claims and underwriting reviews because these areas were the most
important to determining whether claims reimbursements to WYOs were
appropriate.
* Other audits, including audits for cause, state insurance department
audits, and marketing, litigation, and customer service triennial
operation reviews, were rarely or never implemented. FEMA officials
said that they no longer performed marketing, litigation, and customer
service operations reviews because each of these functions were being
reviewed by other means. However, FEMA could not provide us with
evidence that these reviews met the Control Plan's requirements.
In addition, we found that WYO compliance with each component of the
Control Plan was the responsibility of multiple units, and FEMA did not
maintain a single, comprehensive monitoring system that would allow it
to ensure compliance with all components of the plan. That is, FEMA did
not centrally store WYO-specific evaluations, inspections, audits, or
reviews that were to be performed in accordance with the Control Plan.
FEMA officials told us that various staff within FEMA or its contractor
was responsible for ensuring that appropriate documentation of
oversight efforts were maintained. These officials told us that there
was no centralized access, either physical or electronic, to all of the
documentation produced in overseeing WYOs under the Control Plan.
Systematically tracking compliance with the Control Plan could ensure
that participating WYOs are collecting appropriate premiums and making
appropriate claims payments. Since most payments made to WYOs are based
on premiums collected and claims paid, adequate enforcement of the
Control Plan is important to ensuring that WYOs are being compensated
appropriately. Because FEMA does not implement all aspects of the
Control Plan, it cannot ensure that the WYOs are fully complying with
program requirements.
Alternative WYO Program Administrative Structures Could Be Used to
Incorporate Competition into the Payment Process:
FEMA's current relationship with WYOs facilitates insurance companies'
participation in NFIP. But, as previously discussed in this report,
this relationship is based on a payment structure that may not reflect
the actual expenses these companies incur. We examined three
alternative administrative structures that could replace NFIP's payment
arrangement with a competitively awarded contract that could lower
costs for selling and servicing flood insurance policies and
administering claims:
* contracting with one or more insurance companies,
* contracting with a single vendor (similar to the NFIP Direct
program), or:
* contracting with multiple vendors and maintaining the WYO network.
Each of these alternatives has advantages and disadvantages in terms of
the potential impact on the basic operations of administering flood
insurance policies and adjusting claims, as well as on FEMA's oversight
of the program and its contractors. For example, contracting with one
or more insurance companies might lower FEMA's costs for the program
through competitive bidding. But most insurance company officials we
spoke to said that they did not want to be federal contractors because
of the regulations that would apply and emphasized that they had agreed
to participate in the WYO program only because it was not based on an
explicit federal contract. Further, contracting with a single vendor,
as FEMA does under the current NFIP Direct program, might be less
expensive but would almost completely eliminate insurance companies'
participation and their network of insurance agents. Experts we spoke
with also pointed out that using a contractor to administer the flood
program failed in the early 1980s due to the contractor's lack of
experience in administering insurance policies. Finally, contracting
with multiple vendors to service flood policies would allow FEMA to
keep the WYO network and might make oversight more effective because
FEMA would have a contractual relationship with significantly fewer
companies. But experts we spoke to said that this structure would
encroach on WYOs' ability to use a subcontractor to administer their
flood line. Flood consultants, vendors, and trade groups we spoke to
were more receptive to exploring an alternative structure using
multiple vendors.
Conclusions:
Given the significant risk exposure to the federal government, it is
imperative that FEMA carry out its stewardship responsibilities by
effectively and efficiently overseeing the WYO program and the more
than 90 participating insurance companies. FEMA has taken some steps to
address these issues, including taking into consideration the actual
expenses of a selected number of WYOs before changing its method for
paying claims expenses and preparing a revised draft of its Control
Plan, which had not been updated since 1999. Additional opportunities
exist for FEMA to improve its oversight of the WYO program and ensure
that payments to the participating insurance companies are based on
actual company expenses, thereby improving the program's cost-
effectiveness. However, our review demonstrates the following:
FEMA sets rates for paying WYOs for their services without knowing how
much of its payments actually cover expenses and how much goes toward
profit. Specifically, it does not 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; or consider the
results of the analysis of payments, actual expenses, and profit in
evaluating the methods for paying WYOs. Moreover, it does not have a
sound basis for its practice of paying WYOs an additional 1 percent of
written premiums for operating expenses. As a result, FEMA does not
have the information it needs to determine whether its payments to WYOs
are reasonable.
FEMA has not tied its bonus structure to the long-term strategic goals
for the program. As a result, it cannot be assured that the WYO program
is achieving its intended goals in the most cost-effective manner.
Moreover, FEMA does not collect the information on the WYOs' marketing
efforts, which is needed to determine whether the companies' marketing
efforts are aimed at helping to promote increased participation among
targeted groups and in targeted areas in line with NFIP goals.
FEMA has not consistently implemented all aspects of its current
Control Plan and does not systematically track WYOs' compliance with
the plan's requirements. As a result, FEMA cannot ensure that the WYOs
are fully complying with NFIP requirements, including oversight of the
various payments that depend on accurate premiums collected and
appropriate claims made.
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.
Agency Comments and Our Evaluation:
We received written comments on a draft of this report in a letter from
the Department of Homeland Security's Director, Departmental GAO/OIG
Liaison Office, which is reproduced in appendix III. FEMA concurred
with our recommendations regarding (1) the usefulness of the data that
WYOs report to NAIC, (2) the alignment of the bonus structure with long-
term NFIP goals, and (3) the oversight of the WYO program. First, the
letter noted that FEMA would work with NAIC to improve the quality of
the flood expense data that WYOs report and would include the data as
an additional item in determining the annual WYO expense allowance.
Second, the letter stated that FEMA planned to examine the incentive
bonus prior to making arrangements with WYOs for 2010 and 2011. FEMA
said that this examination is to include an assessment of the
incentive's effectiveness in increasing policies; the need for such an
incentive; and possible alternatives to it, including identifying
target markets where penetration is low and providing incentives for
increasing policies in those markets only. Third, FEMA concurred with
our recommendations regarding WYO program oversight, although it stated
that the litigation, marketing, and customer service reviews were no
longer included in the revised Control Plan because they were completed
in other ways. Given the newness of these changes, this review did not
include an assessment of FEMA's compliance with these alternative
methods or their robustness relative to the Control Plan. Finally, the
letter stated that FEMA had implemented new processes to improve the
monitoring of WYOs' compliance with the Control Plan and would continue
to look for ways to improve oversight in the future. While the letter
did not provide details about the new monitoring processes, we are
encouraged by these new steps and will be following up on these
activities in our ongoing work.
FEMA did not concur with our recommendations on improving the
transparency and accountability of payments made to WYOs, specifically
our recommendation that FEMA consider WYOs' actual expenses and profits
when setting its payment rates. In its response, FEMA provided its
views on issues that it believes impacted our analysis and the
conclusions we drew from our work. Also, FEMA discussed why it does not
consider actual flood insurance expense information. We disagree with
FEMA's assertion that the issues it raised resulted in our reaching
misleading conclusions, and we continue to recommend that when setting
payments rates, FEMA should consider actual flood insurance expenses
and the profits that result from its payments to WYO companies.
Specifically, FEMA stated that our review was limited to only six
companies, which FEMA believes are the low-cost operators for the five
other lines of insurance used to determine the WYO expense allowance.
FEMA stated that it seems reasonable that these companies would also
have some of the lowest flood operating expenses and, therefore,
conclude that the results of our analysis can be expected to
significantly understate the operating expenses of the WYO companies as
a whole. Our analysis of the expenses and profits of these companies,
which represented 53 percent of total net premiums written, 71 percent
of total claims losses paid, and 59 percent of total expense payments
made by the WYO program for fiscal years 2005 to 2007, demonstrates the
importance of information that FEMA does not have about actual expenses
and profits that it was paying--information that we consider critical
for making decisions regarding the proper administration of NFIP.
FEMA stated that we did not perform a review of the stability of the
federal flood expenses because the results for other years were not
available to us. FEMA also stated that a review of the stability of
federal flood expenses would show the inadvisability of reaching any
conclusions from just 1 year of data and that basing compensation on a
single year of data is always questionable, especially since our
analysis, and the adjustments and assumptions we made in conducting our
analysis, have not been vetted. However, our analysis showed that
variances in profit over the 3 years we reviewed were caused by, among
other things, variations in the expenses incurred to adjust and pay
claims losses that also fluctuated from year to year. Moreover, we
recognize that setting payments based on a single year of data may not
be appropriate. Our recommendation that FEMA consider actual flood
insurance expenses and profits in setting payment rates would not limit
FEMA's consideration of actual expenses and profits to a single year of
data. We anticipate that FEMA would annually perform an analysis of
actual expenses and profits for the current year, and then incorporate
that result into its analysis of these data covering the number of
years that may be appropriate in the view of FEMA management. The
results of the longitudinal analysis would be used to evaluate the
rates being used and to determine in advance if a change to the rates
is needed. Moreover, we agree that time should be allowed for others,
such as the WYO companies and NAIC, to weigh in on the methodology for
analyzing payments to the WYOs and their actual flood expenses.
Importantly, however, any adjustments we made to the flood expenses
reported by the WYOs for the purpose of our analysis were the result of
information we obtained from and numerous discussions with WYO company
officials.
FEMA stated that actual expenses will be as much of a lagging indicator
as the current methodology that uses A.M. Best numbers. FEMA also
stated that even if actual expense data is considered to be completely
reliable, by the time NFIP could use it to lower expense ratios, about
2 to 3 years would have lapsed. FEMA uses the average expenses for five
lines of property insurance other than the federal flood line for
setting the operating expense payment rate. We recognize that
considering WYOs' actual flood expenses will be a lagging indicator of
the costs to service flood insurance policies. However, it will be a
better indicator than FEMA's current methodology precisely because it
will not reflect the trend of expenses for other lines of property
business. Importantly, data now used to set payment rates based on
other lines of business are subject to events and market forces that
affect their expense ratios, but which are not relevant to the WYO
program. Our recommendation that FEMA use actual flood expenses to set
payment rates would differ from its current methodology in one
important aspect: actual expenses and not a proxy would be used to set
those rates.
FEMA stated that our analysis assumes that actual WYO company expenses
are stable, which FEMA concludes could yield misleading results. FEMA
also stated that during the last 5 years insurance companies have
managed to significantly reduce their operating expenses in other
lines, and suspects that many of those efficiency gains also made it
into companies' flood insurance operations. Our analysis was not based
on any assumptions about the trends in WYO company expenses, in
general, or flood expenses, in particular. Rather, we analyzed the
actual flood expenses of selected companies over a 3-year period and
compared the payments to the companies' actual flood expenses. As
previously indicated, we observed fluctuations from year to year in
actual flood expenses--in particular, expenses for adjusting and
processing claims. Our recommendation that FEMA consider actual flood
expenses and profit when setting payment rates will move FEMA from not
knowing ("suspecting") the trend in actual flood expenses to
considering those trends when setting rates, and not continuing to
utilize proxies of other lines of business and the trends in those
other lines that may not be relevant to the WYO program. Whether actual
expenses are stable or otherwise is not relevant.
FEMA stated that while we acknowledge in the body of our report that
the years we reviewed--2005 to 2007--included the heaviest loss years
in the history of the program and that these years are not indicative
of typical years for loss adjustment expenses, we do not carry these
caveats forward to our conclusions. FEMA stated that this results in a
significant distortion of the expense reimbursement to WYO companies
for the loss adjustment expenses. We did consider the unusually high
losses in 2005 and 2006 when reaching our conclusion that FEMA sets
rates for paying WYOs for their services without knowing how much of
its payments cover expenses and how much is for profit. An analysis of
actual expenses over time would enable FEMA to identify and correlate
trends in actual WYOs' flood expenses to flood events and related
claims losses. In fact, such an analysis could have helped FEMA to
determine before the hurricanes of 2004 and 2005 that its method for
paying claims processing expenses would result in significant payments
in excess of actual expenses in heavy loss years.
FEMA also stated that it addressed the problem that led to outsized WYO
compensation by changing how WYOs are paid for claims processing
expenses--referred to as Unallocated Loss Adjustment Expenses (ULAE).
As support, FEMA cited the fact that WYOs' compensation for ULAE would
have been $29 million less and $267 million less in fiscal years 2005
and 2006, respectively, and would have been $9 million more in 2007.
This would have been a combined decrease of $287 million for the 3
years had this new payment schedule been in place then. Further, FEMA
said that had the new payment schedule been in place in those years, it
is likely that most, if not all, of the $155 million in profit from
claims adjusting and processing that we reported for the six companies
we reviewed would disappear. Prior to 2008, FEMA paid WYOs 3.3 percent
of claim losses incurred for claims processing expenses. Beginning in
2008, FEMA began paying the WYOs 1 percent of net premiums written and
1.5 percent of claim losses incurred for their claims processing
expenses. Our analysis showed that for the years 2005 to 2007 FEMA paid
the six WYOs in our analysis profits of $327.1 million, including
$155.2 million for claims adjusting and processing expenses, without
knowing the actual flood expenses of any of these companies. FEMA's
statements that it is not clear how much of its "savings" would have
been borne by the six WYOs we reviewed and that FEMA can only speculate
as to the effect the change would have on the companies' profit support
our finding that FEMA does not know how much of its payments are for
actual flood expenses and how much are for profit. Our point is that
FEMA should know how much it is paying for expenses and for profit.
In our judgment, considering actual expenses and profit in setting
payment rates would result in a fair and equitable treatment of
policyholders and the WYO companies over time, as well as serve to
better protect the interests of taxpayers who ultimately bear the risk
of losses from the WYO program. In discussing why it does not consider
actual flood insurance expenses in setting payment rates, FEMA said
that the WYO flood insurance program is based on companies' applying
their normal business practices to NFIP and that these practices are
bound to vary from company to company, and that it would be impossible
for NFIP to accurately calculate actual expenses for 90 companies. FEMA
also said that because of these two factors, and the fact that in the
early years of the program actual flood insurance expenses of the
companies' were not available, the decision was made to use information
on other lines of insurance business from A. M. Best as a proxy in
setting rates for payments to NFIP companies. FEMA also stated that
even now, when some WYOs' flood insurance expense information is
available, FEMA is not certain how accurate this information is, and
that its management is skeptical that using actual flood insurance
expenses, as GAO recommends, would yield lower payment rates than would
result from the proxies that the program uses to set payment rates.
FEMA further stated that it will work with NAIC to improve the quality
of the flood expense data.
We agree that business practices will vary among the participating
companies and we agree with FEMA's statement that actual flood
insurance expenses of WYOs were not readily available 25 years ago,
when the program started. However, the National Association of
Insurance Commissioners (NAIC) began requiring that companies report
financial information on their federal flood insurance business in
1997. Therefore, continuing to use other lines of business as proxies
for setting WYO program payment rates is no longer necessary. Moreover,
continuing with the same practice without assessing the reasonableness
of the payments made to WYOs by comparing those payments to the WYOs'
actual expenses does not provide sufficient justification or
accountability for hundreds of million of dollars in federal program
expenses.
We are encouraged by FEMA's statement that, in the future, it will
consider actual flood insurance expenses WYOs report to NAIC as an
additional item when determining the annual WYO expense allowance,
which is intended to cover the companies' operating, marketing, and
administrative expenses. While this is a positive step, given the
changes in the program and available information, we continue to
recommend that FEMA consider all categories of expenses when setting
payment rates, including payments for commissions, claims adjusting,
and other claims-related expenses. Consideration of all categories of
actual flood insurance expenses reported by WYOs in setting payment
rates for these expenses, as well as the profits that the program pays
to the companies for their participation in NFIP, is necessary for FEMA
to know whether its payments to the WYOs are reasonable.
As agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution of this report
until 30 days from the report date. At that time, we will provide
copies to the Chairman of the Senate Committee on Banking, Housing, and
Urban Affairs; the Chairman and Ranking Member of the Senate Committee
on Homeland Security and Governmental Affairs; the Chairman and Ranking
Member of the House Committee on Financial Services; the Chairman and
Ranking Member of the House Committee on Homeland Security; and other
interested committees. We are also sending a copy of this report to the
Secretary of Homeland Security and other interested parties. In
addition, the report will be available at no charge on our Web site at
[hyperlink, http://www.gao.gov]. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last
page of this report.
If you or your staff has any questions about this report, please
contact Orice Williams Brown at (202) 512-8678 or willamso@gao.gov, or
Jeanette M. Franzel at (202) 512-2600 or franzelj@gao.gov. GAO staff
who made major contributions to this report are listed in appendix IV.
Sincerely yours,
Signed by:
Orice Williams Brown:
Director, Financial Markets and Community Investment:
Signed by:
Jeanette M. Franzel:
Managing Director, Financial Management and Assurance:
[End of section]
Appendix I: Briefing Slides:
Opportunities Exist to Improve Oversight of the WYO Program:
Senate Committee on Banking, Housing,and Urban Affairs:
June 19, 2009:
Overview:
* Objectives;
* Summary of Findings;
* Background;
* Scope and Methodology;
* Discussion of Findings and Recommendations.
Objectives:
Our objectives were to:
* Assess the Federal Emergency Management Agency’s (FEMA) practice of
determining the amounts it pays write-your-own(WYO) companies for
selling and servicing flood insurance and adjusting claims.
* Examine how FEMA evaluates the effectiveness of its WYO bonus
incentive structure and whether bonuses paid reflect actual efforts to
market flood insurance policies.
* Evaluate the extent to which FEMA oversees the WYO companies,
including collecting external audits, reinspecting flood claims, and
conducting operational reviews.
* Evaluate the advantages and disadvantages of three alternative
arrangements for selling and servicing flood insurance policies and
adjusting claims using a competitively awarded contract.
Summary of Findings:
FEMA does not systematically consider the WYO companies’ actual flood
expenses when it determines the amount it pays the companies.
Consequently, FEMA does not have the information it needs to determine
(1) whether its payments are appropriate and (2) the amount of profit
to the WYO companies that are included in its payments.[Footnote 8]
FEMA’s bonus program lacks the necessary information to evaluate the
incentive’s effectiveness, and the bonus that FEMA pays WYO companies
does not reflect the agency’s marketing priorities.
FEMA followed some but not all of the WYO oversight requirements for
the 10 insurance companies in our sample and did not systematically
track the outcomes of the audits, inspections, and reviews.
Three alternative arrangements—each with advantages and disadvantages—
could replace FEMA’s current payment structure: a competitively awarded
contract with either an insurance company, a single vendor, or a group
of vendors. If it decides to make a change, Congress would have to
balance the advantages and disadvantages of each option, particularly
in regard to cost, oversight, and program coverage.
Background:
Congress established the National Flood Insurance Program (NFIP)in 1968
to provide homeowners and businesses with insurance coverage against
flood damage as an alternative to costly disaster assistance. As of
September 2008, NFIP had 5.7 million policies in force.
The WYO program, which was established in 1983, is administered by FEMA
and as of September 2008, had about 90 participating insurance
companies, 10 of which collect approximately 80 percent of NFIP’s
premium revenue.
* In FY 2008, the WYO program administered 97 percent of FEMA flood
insurance policies. The remaining 3 percent were administered under the
NFIP Direct program, which is run by a federal contractor.
* The federal government assumes the liability for the insurance
coverage and sets rates and coverage limitations, among other
responsibilities.
* WYOs sell and service flood insurance policies and adjust and pay
claims on FEMA’s behalf; in turn, FEMA pays the companies for their
services.
FEMA annually enters into arrangements with WYO companies that set
forth the roles and responsibilities of the federal government and the
participating insurance companies, including the services the WYO
companies will provide and the basis for the amounts the government
will pay the companies for providing those services.
Effective oversight of the WYO program depends on having accurate
premiums and claims information to ensure that participating insurance
companies are complying with program requirements.
Figure 1: WYO Program Requirements:
[Refer to PDF for image: illustration]
Subsidy arrangement:
FEMA: expense payments to WYO.
Accurate expense payments calculations depend on accurate premium and
claim information.
Financial control plan:
FEMA: claims $ to WYO;
WYO: claims $ to policy holder.
Policy holder: premiums $ to WYO;
WYO: premiums $ to FEMA.
Source: GAO analysis.
[End of figure]
As noted in our 2007 report,WYO payments ranged from $695 million in FY
2004 to almost $1.6 billion in FY 2006, the year most of the Hurricane
Katrina payments were made.[Footnote 9]
In most years, WYOs receive between 30 and 40 percent of the total
flood insurance premiums they collect, but the companies received more
as a result of the 2004 and 2005 hurricanes.
Figure 2: Amounts Paid to WYOs in Dollars and as a Percentage of
Premiums, FY 2004 through 2008:
[Refer to PDF for image: vertical bar graph]
Fiscal year: 2004;
Dollars paid to participating insurance companies: $0.69 billion;
Dollars paid to participating insurance companies as a percentage of
premiums collected: 39.2%;
Total claims payments for the fiscal year: $0.76 billion.
Fiscal year: 2005;
Dollars paid to participating insurance companies: $0.98 billion;
Dollars paid to participating insurance companies as a percentage of
premiums collected: 50.7%;
Total claims payments for the fiscal year (Note: FEMA did not provide
September 2005 claims payment data): $2.86 billion.
Fiscal year: 2006;
Dollars paid to participating insurance companies: $1.59 billion;
Dollars paid to participating insurance companies as a percentage of
premiums collected: 69.4%;
Total claims payments for the fiscal year: $5.74 billion.
Fiscal year: 2007;
Dollars paid to participating insurance companies: $0.89 billion;
Dollars paid to participating insurance companies as a percentage of
premiums collected: 35.1%;
Total claims payments for the fiscal year: $1.03 billion.
Fiscal year: 2008;
Dollars paid to participating insurance companies: $0.94 billion;
Dollars paid to participating insurance companies as a percentage of
premiums collected: 33.9%;
Total claims payments for the fiscal year: $0.81 billion.
Source: GAO analysis.
[End of figure]
Table 1: Types of Payments Made to WYO Companies:
Types of payments: Commission expenses;
Proxy to determine payment: Established in 1983 after consultations
with industry representatives and have not changed since;
Basis for calculating the payment, per the FY 2007 subsidy agreement:
15 percent of net written premium.
Types of payments: Operating expenses;
Proxy to determine payment: Determined annually based on the average
industry operating expenses for five lines of property insurance, as
reported by A.M. Best;
Basis for calculating the payment, per the FY 2007 subsidy agreement:
16.2 percent, 15.8 percent, and 15.2 percent of net written premium in
fiscal years 2005, 2006, and 2007, respectively.
Types of payments: Claims adjustment expenses;
Proxy to determine payment: Determined periodically based on
information FEMA collects from independent adjusting firms on their
cost of adjusting losses in other lines of insurance business;
Basis for calculating the payment, per the FY 2007 subsidy agreement:
From $60 to $1,250 in flat fees for claims up to $50,000; fees for
claims over $50,000 are based on a percentage of the claim
loss,beginning at 3 percent and declining to 2.1 percent for claim
losses of more than $250,000.
Types of payments: Claims processing expenses;
Proxy to determine payment: Established in 1983 based on loss
adjustment expense data for other lines of insurance and remained
unchanged through 2007. Beginning in 2008, FEMA changed its payment
rate for these expenses;
Basis for calculating the payment, per the FY 2007 subsidy agreement:
3.3 percent per claim losses incurred.
Types of payments: Additional adjusting and other expenses;
Proxy to determine payment: None;
Basis for calculating the payment, per the FY 2007 subsidy agreement:
Actual expenses incurred (e.g., litigation, engineering, and
appraisal).
Types of payments: Incentive bonuses;
Proxy to determine payment: None;
Basis for calculating the payment, per the FY 2007 subsidy agreement:
0.5–2 percent of net written premium.
Source: FEMA.
Homeowners who have mortgages from federally-regulated lenders and
whose properties are located in participating communities that are
identified as being in special high-risk flood hazard areas (SFHAs) are
required to purchase flood insurance.
Most home and business owners with properties in participating
communities are eligible to purchase flood insurance, even if their
properties do not lie in SFHAs or do not carry a mortgage.
According to a February 2006 Rand Corporation study, about 50 percent
of homeowners inside SFHAs and less than 1 percent of homeowners
outside SFHAs have flood insurance policies.
Figure 3: Market Penetration in Special Flood Hazard Areas:
[Refer to PDF for image: illustrated table]
Inside special flood hazard areas:
Single-family homes with NFIP policies as a percentage of total homes,
percentage: 49%;
Single-family homes with NFIP policies as a percentage of total homes,
number: 1.76 million out of 3.57 million.
Outside special flood hazard areas:
Single-family homes with NFIP policies as a percentage of total homes,
percentage: 1%;
Single-family homes with NFIP policies as a percentage of total homes,
number: 0.81 million out of 75.6 million.
Source: Rand Corporation, February 2006 (data).
[End of figure]
FEMA’s Financial Control Plan Requirements and Procedures (Control
Plan) is designed to oversee participating insurance companies and
ensure that they are implementing the WYO program in accordance with
NFIP regulations.
Figure 4: Four Major Components of the Control Plan:
[Refer to PDF for image: illustration]
Four Major Components of the Control Plan:
* Audits;
* Monthly data and financial reporting;
* Triennial operation reviews;
* Claims reinspections.
FEMA: Ensures that audits, reinspections, and reviews are performed.
Standard committee: Reviews WYO performance under the Control Plan.
Source: GAO.
[End of figure]
Scope and Methodology:
To assess FEMA’s practice for determining the amount that it pays WYO
companies, we compared the payments FEMA made to six WYO companies to
the actual expenses that the companies reported to the National
Association of Insurance Commissioners (NAIC) for calendar years 2005–
2007.[Footnote 10] These six companies represent 53 percent of total
WYO program net premiums written, 71 percent of total WYO program claim
losses paid, and 59 percent of total expense payments FEMA made to the
approximately 90 companies for fiscal years 2005-2007. We also
interviewed FEMA officials, WYO company officials,and NAIC officials.
We did not audit the financial information the companies submitted to
FEMA, NAIC, or us. We reviewed this information and performed other
procedures, including converting FEMA’s fiscal year WYO data to
calendar year amounts, to ensure that the data were sufficiently
reliable for our purposes.
To evaluate the effectiveness of its WYO bonus incentive structure and
determine whether bonuses paid reflect actual efforts to market flood
insurance policies, we discussed the bonus payment methodology with
FEMA staff, WYO companies, and other stakeholders and reviewed
documents relating to the methodology used to make the bonus payments.
To evaluate the extent to which FEMA oversees the WYO companies,we
tested FEMA’s compliance with aspects of the Control Plan. In so doing,
we discussed procedures with appropriate FEMA staff, requested and
reviewed all the documents that are required under the plan, and
discussed these requirements with the WYO companies and other
stakeholders. We also selected a sample of 10 WYO companies that
represented approximately 50 percent of the flood insurance premiums
written in fiscal year 2007, including companies of various sizes that
incurred different levels of losses and had different operating models
(e.g., vendor usage). We used a data collection instrument to
facilitate our review of the required documents for the 10 WYOs
selected.
As requested, we identified three possible alternatives that would
incorporate a competitive feature. To evaluate the advantages and
disadvantages of these alternatives to the WYO program, we discussed
the alternatives with FEMA staff; the WYO companies in our sample; and
other stakeholders, such as flood insurance vendors and consultants.
Objective 1: FEMA Does Not Consider Actual Expenses When Paying WYO
Companies:
Since the inception of the WYO program, FEMA has used various proxies
to determine the amounts it pays WYO companies. FEMA officials stated
that proxies were initially used in part because actual flood insurance
expense data were not readily available.
Without considering actual expense data, FEMA does not have the
information it needs to determine whether its payments are appropriate.
Further, FEMA does not have the information it needs to determine the
amount of profit to the insurance companies that is included in its
payments.
For the purposes of this review, we considered profits to be the
difference between the amounts paid to the WYO companies and the
companies’actual flood insurance expenses on a pretax basis. The
companies report their flood insurance expenses to NAIC, along with the
expenses for their other property and casualty lines of business.
[Footnote 11] Our calculation of the companies’ pretax profit will not
equal the pretax profit for the flood line of business the companies
reported to NAIC because, among other things, the NAIC amounts include
allocations of miscellaneous other companywide income and expenses.
In accordance with on our Standards of Internal Control in the Federal
Government,FEMA should ensure that its payment rates to WYO companies
are appropriate by, for example, comparing payments to actual flood
insurance expenses.[Footnote 12]
Further, federal managerial cost accounting standards state that
reliable cost information is critical to the proper allocation and
stewardship of federal resources and that actual cost information is an
important element for agency management to consider when setting
payment rates.[Footnote 13]
Objective 1: NAIC Provides Information on WYO Companies’ Actual Flood
Insurance Expenses:
In response to a request by FEMA, in 1997 NAIC began requiring that
companies report financial information on their federal flood insurance
business as part of their annual filings.
However,FEMA continued its practice of not systematically considering
the actual historical flood insurance expense data that WYO companies
submitted to NAIC when setting its expense payment rates. FEMA also did
not consider this data after the fact, to compare payments it had made
to companies’ actual annual expenses for the year or to evaluate its
payment methodologies.
We recognize that the consistency of WYOs’ reporting to NAIC needs to
be improved in order for the benefits of the data to be fully realized.
For example, we noted that, among other things, some companies reported
their flood insurance expenses to NAIC after offsetting them with the
payments they received from FEMA. However, we were able to use NAIC
flood insurance data, supplemented with information obtained from WYO
company officials, to compare actual flood insurance expenses that our
selected companies incurred and the payments they received.
Objective 1: FEMA Has Made Some Changes to Its Methods for Paying WYO
Companies:
Since 1983, FEMA has occasionally modified its methods for determining
the amount of expense payments for certain WYO expenses. But in making
these changes, FEMA has not considered the amount of actual flood
insurance expenses incurred by the WYO companies, with one exception-—a
2008 change in the method for paying claims processing expenses.
FEMA also did not systematically consider actual flood insurance
expenses in deciding to continue to increase the amount of operating
expense payments by 1 percent of written premiums in each year since
2001.
FEMA instituted this increase after some WYO companies told FEMA that
their actual expenses to service flood insurance policies exceeded the
industry average for the five lines of property insurance other than
flood that are used as a proxy to set this payment rate. These five
lines of property insurance are fire, allied lines, farmowners multiple
peril, homeowners multiple peril, and commercial multiple peril
(nonliability portion).
FEMA's decision increased operating expense payments to the WYO
companies in 2001 and each year since; in fiscal year 2007, the
additional 1 percent of written premiums was about $25 million.
However, we found that the payments to the WYO companies we reviewed
exceeded their actual operating expenses before these additional
payments.
FEMA did consider actual flood insurance expenses in making a 2008
change in its method of paying claims processing expenses.
In response to the significant increase in total payments made to WYO
companies in fiscal years 2005 and 2006 after Hurricane Katrina,
beginning in fiscal year 2008, FEMA began paying claims processing
expenses that took into account actual flood expense data obtained from
a selected number of WYO companies.
FEMA estimated that its claims processing payments for all WYO
companies would have been reduced by approximately $300 million for the
period 2005 and 2006 had this new methodology been in effect.
These examples of operating and claims payments that exceeded WYO
expenses illustrate the need to consider annual actual flood expense
data in administering the WYO program.
Objective 1: FEMA’s Expense Payments to WYOs:
FEMA pays WYO companies to sell and service flood insurance policies
and to adjust claims. FEMA also pays WYO companies bonuses for
achieving certain marketing goals.
FEMA expense payments to WYO companies are determined by applying
various proxies to either premiums written or claim losses (see table
2).
Table 2: WYO Program Net Written Premium, Claim Losses Paid, and
Expense Payments to WYO Companies, Fiscal Years 2005 to 2007
(unaudited) (Dollars in millions):
Category: Net written premium;
FY05: $1,940.5;
FY06: $2,288.2;
FY07: $2,535.4.
Category: Claims losses paid;
FY05: $2,691.5;
FY06: $16,091.7;
FY07: $897.7.
Category: Expense payments to WYO companies;
FY05:
Based on net written premiums: $652.6;
Based on claim losses: $329.6;
Total: $982.2;
FY06:
Based on net written premiums: $738.2;
Based on claim losses: $805.8;
Total: $1,544.0;
FY07:
Based on net written premiums: $793.8;
Based on claim losses: $74.7;
Total: $868.5.
Source: NFIP financial statements.
[End of table]
The increase in claim losses paid in fiscal year 2006 caused a
significant increase in payments to WYO companies for adjusting and
paying those claims (see table 3).
Table 3: Types of Expense Payments Made to WYO Companies, Basis for
Payments, and Amounts Paid, Fiscal Years 2005 to 2007 (unaudited)
(Dollars in millions):
Types of payments: Commission expenses;
Basis for payments: 15 percent of net written premium;
Amount paid, FY 05: $291.1;
Amount paid, FY 06: $343.2;
Amount paid, FY 07: $380.3.
Types of payments: Operating expenses;
Basis for payments: 16.2 percent, 15.8 percent, and 15.2 percent of net
written premium in fiscal years 2005, 2006, and 2007, respectively[A];
Amount paid, FY 05: $322.5;
Amount paid, FY 06: $350.72;
Amount paid, FY 07: $393.5.
Types of payments: Incentive bonuses;
Basis for payments: 0.5-2 percent of net written premium[B];
Amount paid, FY 05: $39.0;
Amount paid, FY 06: $44.3;
Amount paid, FY 07: $20.0.
Types of payments: Claims adjustment expenses;
Basis for payments: From $60 to $1,250 in flat fees for claims up to
$50,000; fees for claims over $50,000 are based on a percentage of the
claim loss, beginning at 3 percent and declining to 2.1 percent for
claims losses of more than $250,000.
Amount paid, FY 05: $86.5;
Amount paid, FY 06: $422.5;
Amount paid, FY 07: $35.7.
Types of payments: Claims processing expenses;
Basis for payments: 3.3 percent per claim losses incurred;
Amount paid, FY 05: $236.7;
Amount paid, FY 06: $376.5;
Amount paid, FY 07: $26.2.
Types of payments: Additional adjusting expenses[C];
Basis for payments: Actual expenses incurred;
Amount paid, FY 05: $6.4;
Amount paid, FY 06: $6.9;
Amount paid, FY 07: $12.8.
Types of payments: Total;
Amount paid, FY 05: $982.2;
Amount paid, FY 06: $1,544.0;
Amount paid, FY 07: $868.5.
Source: NFIP financial statements.
Notes: GAO calculations of commissions and operating expenses are
derived from written premiums net of refunds and expense allowance
amounts reported in the NFIP financial statements.
[A] Operating expense amounts include miscellaneous expenses incurred
of $8.2 million, ($10.8) million, and $8.1 million for fiscal years
2005, 2006, and 2007, respectively.
[B] Incentive bonus amounts represent bonus expenses accrued during the
year in which WYO companies earned them. Bonuses are paid in the fiscal
year following the year in which they are earned. Bonuses paid in
fiscal years 2005, 2006, and 2007 were $31.6 million, $21.4 million,
and $44.6 million, respectively.
[C] Additional adjusting expenses include engineering, adjuster,
litigation, and appraisal expenses.
[End of table]
Objective 1: FEMA’s Payments to Six WYO Companies Exceeded Their Actual
Flood Expenses:
We compared FEMA’s payments to six WYO companies to the companies’
actual flood expenses for the 3 calendar years 2005, 2006 and 2007.
The total payments FEMA made to the six companies we tested exceeded
the companies’ actual expenses reported to NAIC (as adjusted) by $327.1
million. This profit, or excess of payments over expenses, represented
16.5 percent of the payments made to those companies for the 3-year
period ending December 31, 2007.
The significant profit in 2006 (see table 4) was primarily attributable
to payments the companies received to process claim losses incurred as
a result of the 2005 hurricanes. In 2007, total payments declined
primarily because of reduced claim losses. These factors, combined with
the companies’ adjustments to their loss adjustment expenses reported
to NAIC, contributed to payments in excess of expenses for 2007.
Amounts representing profit distributions should be excluded from WYO
company expenses for FEMA’s purpose of considering actual expenses when
setting payment rates. For example, we found that the actual expenses
of one of our six WYO companies included payments of over $30 million
made in 2007 under service agreements with an affiliated company. It is
not known what portion of these payments represent expense and profit
distributions between the affiliated companies. Excluding affiliated
company profits would increase the profit-excess of payments over
expenses shown in table 4.
Table 4: Total Expense Payments, Total Reported Expenses (as Adjusted),
and Total Profit-–Excess of Payments over Expenses, for Six Selected
Companies, Calendar Years 2005 to 2007 (Dollars in millions):
Types of payments: Commission and operating expenses;
Expense payments: $1,130.4;
Reported expenses per NAIC, adjusted: $1,008.7;
Profit: excess of payments over expenses: $121.7;
Profit: excess of payments over expenses: 10.8%[A].
Types of payments: Incentive bonuses;
Expense payments: $50.2;
Reported expenses per NAIC, adjusted: N/A[B];
Profit: excess of payments over expenses: $50.2;
Profit: excess of payments over expenses: [Empty].
Types of payments: Claims adjusting and processing expenses;
Expense payments: $802.2;
Reported expenses per NAIC, adjusted: $647.0;
Profit: excess of payments over expenses: $155.2;
Profit: excess of payments over expenses: 19.4%[C].
Types of payments: Total;
Expense payments: $1,982.8;
Reported expenses per NAIC, adjusted: $1,655.7;
Profit: excess of payments over expenses: $327.1;
Profit: excess of payments over expenses: 16.5%[D].
Source: GAO analysis of WYO companies’data.
[A] Profit (excess of payments over commissions and operating expenses)
for calendar years 2005, 2006, and 2007 was 11.6 percent, 9.9 percent,
and 10.9 percent, respectively.
[B] Reported WYO company expenses attributable to marketing activities
are not separately identifiable.
[C] Profit for calendar years 2005, 2006, and 2007 was 9.1 percent,
74.5 percent, and (24.0) percent, respectively. Variances in the profit
ratio per year are caused by differences in the nature and amount of
claim losses, the amount of expenses to adjust and pay these losses,
and differences between when companies recognize actual expenses and
when they are paid for those expenses.
[D] Total profit for calendar years 2005, 2006, and 2007 was 11.6
percent, 28.2 percent, and 13.4 percent, respectively.
[End of table]
Objective 1: Recommendations:
To provide transparency and accountability over the payments FEMA makes
to WYO insurance companies for expenses and profit, 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 WYO companies 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 WYO companies report to NAIC.
Objective 2: FEMA Has Made Bonus Payments to WYO Companies:
First begun in 1989, WYO marketing bonuses were discontinued in 1991
after FEMA could not evaluate whether policy growth was due to WYOs’
efforts, flood events, the economy, or the mandatory purchase
requirement.
In 1995, FEMA restarted a new bonus program to allow WYOs to make up
for a 2 percent reduction in the subsidy arrangement expenses (from
32.6 percent to 30.6 percent of premiums collected).
FEMA regulations stated that the bonus was to be determined based on
whether WYOs met marketing goals set each year.
FEMA has maintained an overall goal for the WYO bonus and for its
current Floodsmart media marketing campaign of increasing flood
policies by 5 percent annually.
FEMA has administratively set a distribution formula that awards a
bonus of 0.5 percent to 2 percent of the premiums retained if WYOs
achieve a 2 percent to 5 percent net growth in policies.
Figure 5: Timeline of FEMA’s Bonus:
[Refer to PDF for image: illustration]
1989-1991: Active years for FEMA bonus payment program to WYOs;
1992-1994: No bonus payment program;
1995: Bonus program restarted to make up for 2 percent subsidy
agreement reduction;
1996: Federal regulation tying WYO marketing goals to bonus;
1995-1998: Cover America;
1999-2003: Cover America II;
2004-2007: Cover America III.
Source: GAO.
[End of figure]
Objective 2: Bonuses Have Fluctuated Over Time:
In 2005, following a record storm season, 60 percent of the WYOs
received over $21 million in bonus payments.
In 2006, the year after Hurricane Katrina, payments more than doubled,
with 67 of 88 WYOs receiving almost $45 million in bonuses, and 59
receiving the largest possible bonus.
In 2007, bonuses paid were closer to the 2005 figure, with about60
percent of WYOs receiving bonuses.
In 2008, bonuses dropped to $9.2 million, with about 40 percent of WYOs
receiving bonuses, reflecting a worsening economy and lower policy
retention.
Figure 6: Bonus Payments Made to WYOs, Fiscal Years 2005 through2008:
[Refer to PDF for image: illustrated table]
Policy growth level: less than 2.0%;
Bonus level (percentage of premiums): 0%.
WYO companies 2005 (percentage, number, dollars in millions): 40%; 37;
$0.
WYO companies 2006 (percentage, number, dollars in millions): 24%; 21;
$0;
WYO companies 2007 (percentage, number, dollars in millions): 38%; 36;
$0.
WYO companies 2008 (percentage, number, dollars in millions): 58%; 51;
$0.
Policy growth level: 2.0%;
Bonus level (percentage of premiums): 0.5%;
WYO companies 2005 (percentage, number, dollars in millions): 4%; 4;
$1.6.
WYO companies 2006 (percentage, number, dollars in millions): 1%; 1;
$0.01.
WYO companies 2007 (percentage, number, dollars in millions): 9%; 8;
$3.3.
WYO companies 2008 (percentage, number, dollars in millions): 6%; 5;
$3.0.
Policy growth level: 3.0%;
Bonus level (percentage of premiums): 1.0%;
WYO companies 2005 (percentage, number, dollars in millions): 8%; 7;
$3.0.
WYO companies 2006 (percentage, number, dollars in millions): 2%; 2;
$0.1.
WYO companies 2007 (percentage, number, dollars in millions): 11%; 10;
$6.0.
WYO companies 2008 (percentage, number, dollars in millions): 5%; 4;
$0.1.
Policy growth level: 4.0%;
Bonus level (percentage of premiums): 1.5%;
WYO companies 2005 (percentage, number, dollars in millions): 7%; 6;
$6.0.
WYO companies 2006 (percentage, number, dollars in millions): 6%; 5;
$2.4.
WYO companies 2007 (percentage, number, dollars in millions): 7%; 7;
$0.9.
WYO companies 2008 (percentage, number, dollars in millions): 7%; 6;
$4.6.
Policy growth level: 5.0%;
Bonus level (percentage of premiums): 2.0%;
WYO companies 2005 (percentage, number, dollars in millions): 40%; 39;
$10.7.
WYO companies 2006 (percentage, number, dollars in millions): 67%; 59;
$42.1.
WYO companies 2007 (percentage, number, dollars in millions): 35%; 33;
$11.7.
WYO companies 2008 (percentage, number, dollars in millions): 25%; 22;
$1.5.
Total:
WYO companies 2005 (percentage, number, dollars in millions): 100%; 93;
$21.3.
WYO companies 2006 (percentage, number, dollars in millions): 100%; 88;
$44.7.
WYO companies 2007 (percentage, number, dollars in millions): 100%; 94;
$21.9.
WYO companies 2008 (percentage, number, dollars in millions): 100%; 88;
$9.2.
Source: GAO.
Note: Percentages may not total 100% due to rounding.
[End of figure]
Objective 2: External Factors Affect Sales of Flood Insurance Policies:
FEMA and WYO officials agreed that other factors outside of the control
of the WYOs may have accounted for changes in the number of flood
policies, including:
* consumer awareness after a flood event,
* FEMA’s Floodsmart marketing program,
* housing market expansion/contraction, and,
* economic growth/recession.
WYO bonuses have generally tracked flood losses.
Figure 7: WYO Bonuses Earned and Flood Losses:
[Refer to PDF for image: line and vertical bar graph]
Year: 1996;
Losses paid: $828 billion;
Bonuses paid by FEMA to WYOs: $12,481,806.
Year: 1997;
Losses paid: $519.5 billion;
Bonuses paid by FEMA to WYOs: $6,813,433.
Year: 1998;
Losses paid: $886.3 billion;
Bonuses paid by FEMA to WYOs: $9,420,000.
Year: 1999;
Losses paid: $755 billion;
Bonuses paid by FEMA to WYOs: $4,200,000.
Year: 2000;
Losses paid: $251.7 billion;
Bonuses paid by FEMA to WYOs: $14,313,306.
Year: 2001;
Losses paid: $1,276.9 billion;
Bonuses paid by FEMA to WYOs: $15,737,006.
Year: 2002;
Losses paid: $433.6 billion;
Bonuses paid by FEMA to WYOs: $19,379,312.
Year: 2003;
Losses paid: $778.8 billion;
Bonuses paid by FEMA to WYOs: $25,188,512.
Year: 2004;
Losses paid: $2,214.3 billion;
Bonuses paid by FEMA to WYOs: $31,485,922.
Year: 2005;
Losses paid: $3,600 billion;
Bonuses paid by FEMA to WYOs: $21,394,212.
Year: 2006;
Losses paid: $632.7 billion;
Bonuses paid by FEMA to WYOs: $44,300,024.
Year: 2007;
Losses paid: $523.2 billion;
Bonuses paid by FEMA to WYOs: $21,900,010.
Year: 2008;
Losses paid: $626 billion;
Bonuses paid by FEMA to WYOs: $9,200,000.
Source: GAO analysis of FEMA data.
Objective 2: Bonuses Benefit Mostly Newer and Smaller WYOs:
FEMA and WYO officials also agreed that the bonus formula favored newer
WYOs with fewer flood insurance policies.
For example, in FY 2008:
* Of the nine WYOs collecting premiums of $100 million or more
(74percent of premiums written), four qualified for a bonus, and none
qualified for the top (2 percent) bonus. These nine WYOs average 19
years selling flood insurance.
* The 22 WYOs that received the top (2%) bonus accounted for less than
3 percent of all premiums. Nine had premiums of less than $1million,
and 10 had premiums of between $1 million and $10 million. The largest
WYO receiving the top bonus had $14.2 million in premiums. These 22
WYOs averaged 6years selling flood insurance.
Figure 8: FY 2008 Premiums Written and Bonuses Received by WYO Size:
[Refer to PDF for image: two pie-charts]
Premiums written:
Small (less than $1 million): 0.4%; 9.8 premiums; 29 WYOs;
Medium ($1 to $10 million): 4.7%; 129.2 premiums; 32 WYOs;
Large: ($10 to $100 million): 18.1%; 498.5 premiums; 17 WYOs;
Very Large (more than $100 million): 76.9% 2,117.3 premiums; 9 WYOs.
Top (2%) bonus received:
Small (less than $1 million): 40.9%; 9 WYOs;
Medium ($1 to $10 million): 45.5%; 10 WYOs;
Large: ($10 to $100 million): 13.64%; 3 WYOs;
Very Large (more than $100 million): none.
Source: GAO analysis.
[End of figure]
Objective 2: FEMA Has Not Evaluated WYOs’ Marketing Efforts:
FEMA’s bonus distribution formula is based on the number of net new
policies the WYOs sell. Moreover, FEMA has not tied the bonuses to
WYOs’ actual marketing efforts.
FEMA’s regulations state that the purpose of the premium withheld by
WYOs (including an adjustment for the bonus) is in part to pay them for
marketing expenses.
However, external factors such as recent flood events can help drive
sales of flood insurance. FEMA does not take such factors into account.
Further, FEMA has not evaluated the bonus since it was reinstated in
1996 or evaluated the feasibility of using a more targeted strategy.
Under the Government Performance and Results Act of 1993, systematic
studies should be conducted periodically or on an ad hoc basis to
assess how well a program is working. The studies are often conducted
by experts external to the program, either inside or outside the
agency, as well as by program managers. When program results could be
influenced by external factors, agencies can use intermediate goals to
measure the discrete contribution to a specific result.
Of the 10 WYOs that we reviewed:
* Only one WYO had submitted a marketing plan, and for only one year.
* FEMA officials had conducted only one marketing operational review,
as required by their policies and procedures.
* Most WYOs did not consider the flood insurance bonus as critical to
their company marketing strategy.
* Some WYOs generally offered flood insurance when requested but did
not strategically market the product as a primary insurance line.
- One of the WYOs we spoke with said that they received FEMA’s
performance bonus even though they did no marketing at all. They
explained that they get all of their new business from those mortgage
lenders that require flood insurance.
- Also, FEMA’s NFIP Direct program, which responds only to policy
inquiries and does not market its services, would have qualified for
the top bonus in 2006 if it were eligible for FEMA’s bonus program.
Objective 2: A FEMA-Funded Study Has Suggested Marketing Goals for
NFIP:
FEMA does not have an explicit goal beyond the 5 percent annual
increase in policies.
The February 2006 Rand Corporation study, part of a multi-volume study
of NFIP funded by FEMA, suggested that FEMA:
* assess strategies to increase market penetration among homes that are
not subject to the mandatory purchase requirement;
* develop a marketing strategy to increase penetration in certain
geographical areas, particularly noncoastal communities in SFHAs;
* limit the effects of policy growth on loss variability by focusing
efforts to increase market penetration outside the southeastern part of
the country and the Gulf States; and;
* address the low market penetration rates in communities with fewer
than 500 homes in SFHAs.
Objective 2: Recommendation:
As currently established, the WYO program primarily rewards companies
that are small or new to NFIP for sales increases that may result from
external factors.
The bonus would be more effective if FEMA established more targeted WYO
goals in line with its NFIP goals, such as increasing penetration in
low-risk flood zones, among homeowners without federally backed
mortgages in all zones, and in geographic areas with repetitive losses
and low penetration rates.
Recommendation:
To improve the WYO marketing bonus program should FEMA decide to
continue it, we recommend that the Secretary of Homeland Security
direct the Under Secretary of Homeland Security, FEMA, to consider
using more targeted marketing goals that are in line with FEMA’s NFIP
goals.
Objective 3: FEMA Uses Four Major Oversight Tools:
FEMA’s Control Plan includes a variety of tools for overseeing WYO
companies, but FEMA has not used these controls consistently.
The Control Plan is designed to ensure that WYOs are complying with the
requirements of the flood program—including assessing whether premiums
received and claims payments disbursed are accurate—through:
* monthly data reporting, with participating WYO companies submitting
signed certifications that are evaluated by FEMA’s contractor;
* claims reinspections performed by FEMA’s contractor;
* various audits by independent CPAs, including required biennial
audits, audits for cause, and state insurance department audits; and;
* triennial operation reviews performed by FEMA staff.
FEMA has also established a Standards Committee, composed of insurance
company representatives and FEMA officials, to oversee the performance
of WYO companies under the Control Plan.
Objective 3: FEMA Did Not Implement All Oversight Requirements:
FEMA implemented some but not all of the requirements and procedures of
the Control Plan.
Figure 9: FEMA’s Compliance with the Control Plan for the 10 WYOs in
GAO’s Sample:
[Refer to PDF for image: illustrated table]
Oversight component (from the Control Plan): Monthly policy and claims
data review;
FEMA's level of compliance: Consistently implemented.
Oversight component (from the Control Plan): Claims reinspections;
FEMA's level of compliance: Consistently implemented.
Oversight component (from the Control Plan): Audits: Biennial;
FEMA's level of compliance: Partially implemented.
Oversight component (from the Control Plan): Audits: For cause;
FEMA's level of compliance: Rarely or never implemented.
Oversight component (from the Control Plan): Audits: State insurance
department;
FEMA's level of compliance: Rarely or never implemented.
Oversight component (from the Control Plan): Triennial operation
reviews[A]: Underwriting;
FEMA's level of compliance: Consistently implemented.
Oversight component (from the Control Plan): Triennial operation
reviews[A]: Claims;
FEMA's level of compliance: Consistently implemented.
Oversight component (from the Control Plan): Triennial operation
reviews[A]: Marketing;
FEMA's level of compliance: Rarely or never implemented.
Oversight component (from the Control Plan): Triennial operation
reviews[A]: Litigation;
FEMA's level of compliance: Rarely or never implemented.
Oversight component (from the Control Plan): Triennial operation
reviews[A]: Customer service;
FEMA's level of compliance: Rarely or never implemented.
Source: GAO.
[A] FEMA officials told us that they were revising the Control Plan and
no longer performed marketing, litigation, and customer service
operation reviews.
[End of figure]
Objective 3: FEMA Consistently Collected, Evaluated, and Reported WYO
Policy and Claims Data Submissions:
Our review of FEMA’s records for the 10 WYOs in our sample showed that
FEMA had collected nearly all of the required monthly data submissions.
* The Control Plan requires that FEMA collect policies, claims data,
and financial statements from participating WYO companies each month.
[Footnote 14]
* FEMA documents that we reviewed showed that the agency had collected
over 90 percent of the required monthly data submissions, financial
statements, and signed certifications for the 10 companies in our
sample.
Our analysis also showed that FEMA had evaluated most of the monthly
submissions for data errors and financial inconsistencies for the 10
companies in our sample.
* FEMA documents we reviewed showed that the agency had evaluated
nearly 90 percent of the required monthly data submissions and
financial statements, for the 10 companies in our sample.
- FEMA regularly found errors in the companies’ submissions, but none
of these errors were above FEMA’s tolerance threshold, which FEMA
officials identified as errors that are 6 months old.
- FEMA also consistently found financial inconsistencies in each
submission but did not assess these variances to determine whether they
were above the tolerance threshold.
FEMA documents we reviewed also showed that the agency had consistently
reported and summarized WYO performance under the monthly submissions
component of the Control Plan, including tracking errors, describing
the causes of these errors, and logging follow-up done on WYO
companies.
Objective 3: The Claims Reinspection Program Is Consistent With the
Control Plan:
The Control Plan requires that FEMA inspect claims payments on a sample
of policies for large flood events. FEMA’s contractor uses flood
insurance adjusters to visit recently damaged properties and assess
whether insurance company adjusters have accurately determined claims.
According to the Control Plan, FEMA is to select files from those
companies that have filed more than 400 claims for a single large flood
event.
Of the 10 WYO companies in our sample, FEMA officials said that 3 of
them were subject to claims reinspection based on the selection
methodology in the Control Plan. Using FEMA's flood insurance database,
we verified that FEMA accurately applied the selection methodology, and
FEMA provided evidence that claims reinspections were performed on
these three WYO companies.
Objective 3: FEMA Reinspected a Limited Number of Claims Files for Our
Sample:
Of the 11,998 flood claims filed in FY 2007 by the 10 WYOs in our
sample, FEMA identified 1,539 claims, or about 13 percent of the total,
that were eligible for reinspection according to the methodology in the
Control Plan.
* These eligible claims represent about 15 percent, or $31.2 million of
the $210.2 million in claims paid in FY 2007.
* FEMA reported that it actually reinspected 243 (about 16 percent)of
the eligible claims. We found that this number represented about 2
percent of the total claims (11,998) filed for these 10 companies in FY
2007.
We also confirmed that FEMA implemented a previous GAO recommendation
to select claims files at random as part of their claims operation
reviews. With the claims operation reviews, FEMA can potentially
evaluate the accuracy of those claims files that were not selected for
reinspection.
Figure 10: Claims Reinspections for FY 2007 for the 10 WYOs in GAO’s
Sample:
[Refer to PDF for image: illustration]
11,998 total claims filed: 100%;
1,539 claims eligible for reinspection: 13%
243 claims reinspected: 2%.
Source: GAO analysis of FEMA data.
[End of figure]
Objective 3: FEMA Did Not Collect All the Audits Required in the
Control Plan:
FEMA collected some but not all of the required biennial audits for the
10 companies in our sample.
FEMA did not perform any audits for cause or collect any state
insurance department audits on these 10 companies.
Table 5: Biennial Audits Collected from GAO’s WYO Sample between Fiscal
Years 2000 and 2007:
Complete set of biennial audits collected:
Number of companies in our sample for which FEMA had a full set of
biennial audits covering the period of review: 0.
Most biennial audits collected:
Number of companies in our sample for which FEMA collected biennial
audits covering two-thirds or more of the years we reviewed: 2.
Some biennial audits collected:
Number of companies in our sample for which FEMA collected biennial
audits for one-third to two-thirds of the years we reviewed: 6.
Few biennial audits collected:
Number of companies in our sample for which FEMA collected biennial
audits for less than one third of the years we reviewed: 2.
[End of table]
Objective 3: Starting in 2006, FEMA Began Consistently Collecting
Biennial Audits:
In response to findings that FEMA had failed to consistently enforce
the biennial audit requirement, FEMA officials told us that they had
exempted some companies from this requirement after the 2005 hurricane
season.
The officials said that they had exempted those companies that said
that they were overwhelmed with administering flood claims after the
2005 hurricane season.
Starting in fiscal year 2006, however, we found that FEMA consistently
collected the biennial audits from the 10 insurance companies in our
sample.
Objective 3: FEMA Focused on Underwriting and Claims Operation Reviews:
While FEMA conducted nearly all of the required underwriting and claims
reviews between FY 2000 and FY 2007, it conducted almost none of the
marketing, customer service, and litigation reviews.
Table 6: Operation Reviews for GAO’s Sample of 10 WYOs between FY 2000
and FY 2007:
Number of companies in our sample that did not undergo any operation
reviews for the period:
Underwriting: 9;
Claims: 8;
Marketing: 0;
Customer Service: 0;
Litigation: 0.
Number of companies in our sample that had 1 or more operation reviews
missing for the period:
Underwriting: 1;
Claims: 2;
Marketing: 1;
Customer Service: 1;
Litigation: 0.
Number of companies in our sample that had a complete set of operation
reviews for the period:
Underwriting: 0;
Claims: 0;
Marketing: 9;
Customer Service: 9;
Litigation: 10.
[End of table]
Objective 3: FEMA Focused on Underwriting and Claims Operation Reviews:
Nearly all of the operation reviews FEMA conducted involved
underwriting and claims.
* FEMA officials said that they focused on claims and underwriting
reviews because these areas were the most important to determining
whether participating insurance companies were collecting appropriate
premiums and making appropriate claims payments.
FEMA officials said that they no longer performed marketing,
litigation, and customer service operation reviews because each of
these functions were being reviewed by other methods.
* Litigation: FEMA officials said that they collected the data to
ensure correct litigation payments to insurance companies but did not
do operation reviews for these cases.
* Customer Service: FEMA officials said that they relied on state
insurance departments to report to them any deficiencies in customer
service from participating companies.
* Marketing: FEMA officials said that companies were already
incentivized to market flood insurance under the bonus program and that
as a result, FEMA no longer needed to perform operation reviews to
ensure that the companies were actually marketing flood polices.
Objective 3: FEMA’s Draft Control Plan Removes Three Operation Review
Requirements:
FEMA officials provided a draft Control Plan showing that the agency
would no longer require the marketing, litigation, and customer service
operation reviews.
We reviewed the draft Control Plan and found that FEMA had not replaced
the litigation and customer service operation reviews with the
information that they said that they had collected in lieu of these
reviews.
* FEMA officials said that they collected information on all payments
made for litigation expenses and approved those that were for more than
$5,000. However, their draft Control Plan did not include this
oversight requirement.
* In addition, FEMA staff said that they relied on the various state
insurance departments to report deficient customer service, but their
draft Control Plan did not include this review as a component of WYO
oversight.
* Furthermore, because FEMA did not obtain any state insurance
department audits on the 10 WYOs in our sample, we could not determine
whether this information was being collected from the states for any of
the WYO companies.
If FEMA views the Control Plan as its primary oversight tool, key
components should be included in the plan to help ensure that WYOs are
fully complying with program requirements.
However, if FEMA establishes a bonus program that is more in line with
its own marketing goals, FEMA will be able to measure WYO marketing
efforts annually and may not need a separate marketing operation
review.
Objective 3: The Standards Committee Focused on Data Submissions and
Operation Reviews:
The Standards Committee met at least twice a year to discuss WYO
performance under the Control Plan.
Our review of committee minutes found that the discussions centered
largely on monthly data reporting and claims and underwriting operation
reviews.
The committee did not discuss results from claims reinspections,
biennial audits, audits for cause, or state insurance department
audits.
Figure 11: Topics of Discussion at Standards Committee Meetings,
October 2003 to March 2008:
[Refer to PDF for image: stacked vertical bar graph]
Date: October 2003;
Number of WYOs discussed: Operation reviews: 0;
Number of WYOs discussed: Monthly data reporting: 11.
Date: June 2004;
Number of WYOs discussed: Operation reviews: 0;
Number of WYOs discussed: Monthly data reporting: 25.
Date: October 2004;
Number of WYOs discussed: Operation reviews: 3;
Number of WYOs discussed: Monthly data reporting: 14.
Date: February 2005;
Number of WYOs discussed: Operation reviews: 0;
Number of WYOs discussed: Monthly data reporting: 5.
Date: June 2005;
Number of WYOs discussed: Operation reviews: 1;
Number of WYOs discussed: Monthly data reporting: 8.
Date: October 2005;
Number of WYOs discussed: Operation reviews: 1;
Number of WYOs discussed: Monthly data reporting: 13.
Date: March 2006;
Number of WYOs discussed: Operation reviews: 3;
Number of WYOs discussed: Monthly data reporting: 8.
Date: July 2006;
Number of WYOs discussed: Operation reviews: 2;
Number of WYOs discussed: Monthly data reporting: 11.
Date: October 2006;
Number of WYOs discussed: Operation reviews: 1;
Number of WYOs discussed: Monthly data reporting: 11.
Date: January 2007;
Number of WYOs discussed: Operation reviews: 0;
Number of WYOs discussed: Monthly data reporting: 4.
Date: February 2007;
Number of WYOs discussed: Operation reviews: 1;
Number of WYOs discussed: Monthly data reporting: 7.
Date: March 2007;
Number of WYOs discussed: Operation reviews: 1;
Number of WYOs discussed: Monthly data reporting: 9.
Date: July 2007;
Number of WYOs discussed: Operation reviews: 1;
Number of WYOs discussed: Monthly data reporting: 11.
Date: January 2008;
Number of WYOs discussed: Operation reviews: 4;
Number of WYOs discussed: Monthly data reporting: 15.
Date: March 2008;
Number of WYOs discussed: Operation reviews: 1;
Number of WYOs discussed: Monthly data reporting: 15.
Source: GAO analysis.
[End of figure]
Objective 3: FEMA Implemented Three Previous GAO Recommendations on
Oversight:
Table 7: Assessment of FEMA’s Implementation of Previous GAO
Recommendations Relating to the Control Plan:
Oversight component of the Control Plan: Claims reinspections;
Previous GAO recommendation: FEMA should draw a statistically
representative sample of files for claim reinspections[A];
Status of recommendation: Partially implemented: FEMA’s March 2009
draft Control Plan changes the file selection methodology to a random
selection, but selects only from a population that fits a certain
criteria of over 400 claims per a single event. For our sample of 10
WYOs, we found that this eligible population represented a small
portion (13 percent) of all claims filed in FY2007.
Oversight component of the Control Plan: Biennial audits;
Previous GAO recommendation: FEMA should conduct and review biennial
audits[B];
Status of recommendation: Implemented: As of FY 2006, FEMA had
consistently collected the biennial audits from the 10 WYOs in our
sample. Furthermore, as of FY 2008 FEMA is using a tracking schedule to
document audits received and those reviewed by FEMA staff.
Oversight component of the Control Plan: Underwriting operation
reviews;
Previous GAO recommendation: FEMA should draw statistically
representative samples of files for underwriting reviews[A];
Status of recommendation: Implemented: FEMA’s March 2009 draft Control
Plan changes the methodology to reflect this recommendation and FEMA
documentation showed that the agency is currently selecting
statistically representative sample of files to review.
Oversight component of the Control Plan: Claims operation reviews;
Previous GAO recommendation: FEMA should draw statistically
representative samples of files for claims reviews[A];
Status of recommendation: Implemented: FEMA’s March 2009 draft Control
Plan changes the methodology to reflect this recommendation, and FEMA
documentation showed that the agency is currently selecting
statistically representative sample of files to review.
[A] See GAO, Federal Emergency Management Agency: Improvements Needed
to Enhance Oversight and Management of the National Flood Insurance
Program, [hyperlink, http://www.gao.gov/products/GAO-06-119]
(Washington, D.C.: Oct. 18, 2005).
[B] See GAO, National Flood Insurance Program: FEMA’s Management and
Oversight of Payments for Insurance Company Services Should Be
Improved, [hyperlink, http://www.gao.gov/products/GAO-07-1078]
(Washington, D.C.: Sept. 5, 2007).
Objective 3: FEMA Does Not Systematically Track or Centrally Maintain
Reports, Inspections, Audits, and Reviews:
FEMA tracks WYOs’ compliance with each component of the Control Plan
but does not have a single, comprehensive monitoring system.
* As of FY 2008, FEMA was tracking biennial audits and the results of
its internal reviews of these audits.
* As of FY 2009, FEMA tracked underwriting and claims operation reviews
and the results of these reviews.
FEMA does not centrally store WYO-specific evaluations, inspections,
audits or reviews performed under the Control Plan.
* FEMA officials said that various staff within FEMA or their
contractor manage the documentation of oversight performed on
participating WYO companies. For example, FEMA’s underwriting staff
manage the underwriting operation reviews and store the resulting
documentation.
* The officials told us that there was no centralized access, either
physical or electronic, to all the documentation produced in overseeing
the WYOs under the Control Plan.
Objective 3: Recommendations:
Because FEMA does not implement all aspects of the Control Plan,it
cannot ensure that the WYOs are fully complying with program
requirements.
Compliance with the Control Plan also ensures that participating WYO
companies are being compensated appropriately according to the
regulations.
In addition, because FEMA does not systematically track and centrally
store all required evaluations, inspections, audits, or reviews, FEMA
management cannot have timely access to all documentation in order to
help ensure that it is effectively overseeing the 90-plus participating
insurance companies.
Recommendations:
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 includes oversight of all
functions of participating WYOs, including customer service and
litigation; 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, inspections, and data
analyses performed for each participating insurance company under the
Control Plan.
Objective 4: Alternatives to the Current WYO Program Would Involve
Competitive Bidding:
We identified three alternatives to FEMA’s current payment arrangement.
Competition among firms could ensure that FEMA is incorporating the
private sector into the flood program in a more cost-effective manner.
Alternative 1: FEMA contracts with one or more insurance companies.
* FEMA would solicit bids or proposals for a contract—not an
arrangement—with one or more insurance companies to sell and service
flood polices and adjust claims.
Alternative 2: FEMA contracts with one vendor.
* FEMA would solicit bids or proposals for a contract with a flood
insurance vendor, as opposed to an insurance company, to service flood
polices. This alternative is similar to the NFIP Direct program.
* FEMA’s contractor would sell flood insurance policies only through
independent insurance agents, excluding those agents that have
contractual relationships to sell policies for only one insurance
company.
Alternative 3: FEMA contracts with multiple vendors and maintains the
WYO network.
* FEMA would solicit bids or proposals for contracts from multiple
flood insurance vendors to service flood polices.
* Insurance companies that want to sell flood insurance would contract
with one or more of these vendors to service flood policies sold by
insurance company agents.
* Since FEMA would pay vendors to administer the flood policies,
participating insurance companies would not incur any operational
expenses for their flood line. However, FEMA would pay the insurance
companies a sales bonus for performance.
Objective 4: Alternatives to the Current WYO Program Would Involve
Competitive Bidding:
Figure 12: Alternatives to FEMA’s Current Payment Structure:
[Refer to PDF for image: illustration]
Current WYO Program:
FEMA: arrangement based:
Insurance companies (90+);
Flood vendors (about 10);
Independent and dependent agents and claims adjusters;
Policyholders (5.5 million).
Alternative 1: One or more insurers:
FEMA: Contract based:
Insurance companies (1 or more on contract);
Flood vendor(s) (optional);
Insurance company's agents and adjusters;
Policyholders.
Alternative 2: Contract with single vendor:
FEMA: Contract based:
Flood vendor (1 on contract);
Independent agents only; Claims adjusters;
Policyholders.
Alternative 3: Contract with multiple vendors:
FEMA: Contract based (plus oversight):
[Bonus relationship with: insurance companies (90+)];
Flood vendors (about 10);
Independent and dependent agents and claims adjusters;
Policyholders.
Source: GAO.
[End of figure]
Objective 4: Each Alternative Has Advantages and Disadvantages:
Table 8: Advantages and Disadvantages of Alternative WYO Structures:
Alternative structures: Current program: WYO program;
Advantages:
* Incorporates insurance industry; maximizes the number of companies
and agents selling flood insurance and the number of claims adjusters.
* Offers presence in all states and territories.
* Has increased participation in the program since 1983 by 3.7 million
polices.
Disadvantages:
* Insurers are compensated per a schedule of fees rather than under a
competitively awarded contract.
* FEMA has not consistently been able to oversee the large number of
WYO companies.
* WYOs typically resort to using vendors to conform to the terms of the
program, and FEMA does not have direct oversight of these vendors.
Alternative structures: Alternative 1: FEMA contracts with one or more
insurance companies;
Advantages:
* Incorporates competition, potentially leading to lower costs.
* Incorporates insurance industry.
* Makes oversight easier because fewer companies are involved.
Disadvantages:
* A competitive process may or may not reduce the price per policy.
* Insurance companies may not want to be federal contractors.
* It minimizes the number of insurance companies by reducing the number
of agents, limiting choice for consumers.
* Insurers may not offer presence in all states and territories.
Alternative structures: Alternative 2: FEMA contracts with one vendor;
Advantages:
* Incorporates competition, potentially leading to lower costs.
* Makes oversight easier, with one company to oversee.
* Improves administrative efficiency because flood vendors service most
flood policies for the WYOs.
Disadvantages:
* The insurance industry is not directly involved.
* The sales network is restricted to independent agents.
* A Direct program failed in the early 1980s because the vendor did not
have the industry expertise—-including long-standing relationships with
agents and adjusters—to provide competent service to policyholders.
* Independent agents may prefer to sell through insurance companies
that they have a relationship with rather than through a vendor.
Alternative structures: Alternative 3: FEMA contracts with multiple
vendors and maintains the WYO network;
Advantages:
* Incorporates competition, potentially leading to lower costs.
* Incorporates insurance industry; maintains the current network of
insurance companies and their sales force.
* Removes the need to pay WYOs for servicing and claims-related
expenses.
* Makes oversight easier because FEMA has a contractual relationship
with significantly fewer companies.
Disadvantages:
* A competitive process may or may not reduce the price per policy.
* The direct relationship between the insurance industry and FEMA is
severed, so FEMA might be less likely to incorporate insurance industry
input.
* Participating insurance companies would be required to use a vendor,
even if they did not currently use one.
[End of table]
Objective 4: Experts Had Similar Views on the Three Alternatives:
Most WYOs said that they did not want to be federal contractors because
they did not want to conform to requirements such as labor laws.
* As a potential cost savings, WYO officials said that the federal
government should pass legislation to explicitly prohibit local
governments from charging premium taxes on flood insurance premiums.
FEMA officials that administer the WYO program were generally not
receptive to the alternative payments structures and proposed another
alternative for compensating WYOs.
* FEMA officials said that insurance companies did not want to become
federal contractors (alternative 1), that using a single vendor would
likely result in fewer agents selling flood insurance, and that the
hybrid approach would sever the long-standing relationship between FEMA
and the insurance industry.
* FEMA officials stated that in the past, they had considered various
alternative approaches, including a pure premium approach to
reimbursing the insurance companies that would authorize the WYOs to
charge any price per policy to cover their expenses. This price would
be above a minimum amount that FEMA identified as necessary to cover
expected flood claims (the pure premium) and would allow the insurance
companies to compete on price.
Objective 4: Experts Had Similar Views on the Three Alternatives:
Flood consultants, vendors, and trade groups were more receptive to
exploring the third alternative (FEMA contracts with multiple vendors).
* For example, one vendor we spoke to emphasized the need for multiple
vendors in FEMA’s contract so that participating insurance companies
could have a choice in determining which vendor to use, depending on
their needs.
FEMA Comments:
We provided a draft of this presentation to FEMA for its review and
they agreed with the content.
[End of section]
Appendix II: Scope and Methodology:
WYO Expenses:
To assess FEMA's practice of determining the amounts it pays to WYO
insurance companies for their services without considering the
companies' actual expenses, we compared the payments FEMA made to six
WYO companies to the companies' actual flood insurance expenses.
Insurance companies report flood insurance expense data in annual
statements that are submitted to NAIC, which also include expenses for
the companies' other property and casualty lines of business. The six
WYOs we selected wrote flood insurance policies whose premiums totaled
approximately 53 percent of the total WYO program premiums in fiscal
year 2007. Our sample is not a representative sample of all WYOs, so
the results of our analysis cannot be generalized to the universe of
WYOs.
We reviewed NAIC and FEMA flood financial information to assess the
reliability of the information for our purposes. Because FEMA's
payments to WYOs are determined by applying various proxies to premiums
written or claim losses, we identified differences between the written
premiums and claim losses that the companies reported to FEMA and NAIC.
We obtained from WYO company officials explanations of these
differences and determined that they would not significantly impact the
companies' flood expenses. Further, to review the payments and expenses
for the six companies selected, we:
* converted FEMA's fiscal year WYO payment data to calendar year
amounts for comparison to calendar year actual expenses reported to
NAIC;
* recalculated the expense payments reported by the six WYOs to FEMA on
a test basis, using the written premium and claim losses incurred
amounts the WYOs reported to FEMA and FEMA's payment rates, all without
exception; and:
* interviewed officials of the WYOs regarding their flood operations,
accounting for and assignment of expenses to the flood line, and
reporting of flood line data to NAIC.
To assist in comparing actual expenses to the expense payments, we
adjusted the WYOs' reported flood expenses in cases where, for example,
companies offset their expenses incurred with the payments they
received from FEMA. We found that the data the six companies submitted
to NAIC and FEMA were, as adjusted by us, sufficiently reliable for our
purposes.
For the purposes of this audit, we considered profits to be to the
difference between the amounts paid to the WYO companies and the
companies' actual flood expenses on a pretax basis. In determining
profits, we excluded miscellaneous other companywide income and
expenses.
We did not audit the financial data the six WYOs submitted to FEMA,
NAIC, or to us. However, the federal flood financial information the
companies submitted to NAIC was included in financial statements
prepared in accordance with statutory accounting principles that were
audited by independent certified public accounting firms, which
expressed unqualified opinions for those years covered by our review.
We compared amounts in the audited financial statements for calendar
year 2005 to 2007 to amounts the companies reported in their annual
statements for earned premiums, losses incurred, and underwriting and
loss adjustment expenses incurred for all lines of property and
casualty insurance. The differences we identified did not significantly
impact our analysis. Further, the federal flood financial information
the companies submitted to FEMA was included in biennial financial
statements prepared in accordance with generally accepted accounting
principles that were also audited by independent certified public
accounting firms who expressed unqualified opinions. We reviewed the
audited biennial financial statements for four of the six companies
that had submitted separately audited statements to FEMA. The
differences we identified did not significantly impact our analysis.
Marketing and Bonuses:
To evaluate the extent to which bonus payments to WYOs for increasing
the number of flood policies they sell were based on WYOs' actual
marketing efforts, we discussed the bonus payment methodology with FEMA
staff, WYOs, and other stakeholders and reviewed documents relating to
the methodology used to make the bonus payments. We analyzed the bonus
payments and evaluated the extent to which they could be attributed to
the marketing efforts of WYOs or to other external factors, such as
flood events and economic conditions. To determine whether the existing
bonus formula benefited WYOs with fewer policies and years in NFIP, we
compared those WYOs by size and year in the program to those receiving
top bonuses.
For the 10 WYOs that we selected to interview, we identified those that
had submitted marketing plans or undergone a marketing operations
review. We also asked whether the bonus was a major factor in their
marketing efforts and whether they considered flood insurance to be a
primary insurance line.
Program Oversight:
To evaluate FEMA's compliance with the Control Plan, we discussed
procedures with appropriate FEMA staff, requested and reviewed all the
documents that were required under the plan, and discussed these
requirements with the WYOs and other stakeholders. To address FEMA's
oversight of the WYOs, we selected a sample of 10 WYOs that
administered over 50 percent of the flood insurance policies written
for the year 2007. Our sample included companies that covered the
spectrum of WYOs--for instance, they differed in size based on premiums
written, losses incurred, and overall rank in market share and included
companies that did and did not use a vendor.
We used a data collection instrument to review the required documents
for the 10 WYOs selected for our review. Our data collection instrument
included the four major components of FEMA's Control Plan: (1) monthly
data and financial reporting; (2) claims reinspections performed by
FEMA's contractor; (3) various audits by independent CPAs, including
required biennial audits, audits for cause, and state insurance
department audits; and (4) triennial operation reviews performed by
FEMA staff. We used the 1999 Control Plan that was being used at the
time of our review NFIP has a draft plan that it began developing in
2007.
Alternative Administrative Structures:
In consultation with congressional staffers, we identified three
possible alternatives that would incorporate a competitive feature. To
evaluate the advantages and disadvantages of the three alternatives to
the WYO program, we discussed the alternatives with staff within GAO;
the WYOs in our sample; FEMA staff; and other stakeholders, such as
flood insurance vendors and consultants.
We conducted this audit from December 2007 to July 2009 in accordance
with generally accepted government auditing standards. Those standards
require that we plan and perform the audit to obtain sufficient,
appropriate evidence to provide a reasonable basis for our findings and
conclusions based on our audit objectives. We believe the evidence we
obtained provides a reasonable basis for our findings and conclusions
based on our audit objectives.
[End of section]
Appendix III: Comments from the Department of Homeland Security:
U.S. Department of Homeland Security:
Washington, DC 20528:
July 24, 2009:
Orice Williams Brown:
Director, Financial Markets and Community Investment:
U.S. Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Thank you for providing Draft Report GAO-09-455, "Flood Insurance:
Opportunities Exist to Improve Oversight of the WYO Program" to the
Department of Homeland Security, Federal Emergency Management Agency
(FEMA) for review and comment. FEMA completed its review and is
providing the following comments on the report and its recommendations.
FEMA concurs with recommendations 2, 3, and 4, however, does not concur
with recommendation 1.
FEMA Does Not Systematically Consider Actual WYO Company Expenses When
Setting Payment Rates:
The industry's willingness to participate in the Write Your Own (WYO)
Program was conditioned upon a number of factors that have been
explained before, including the nature of Federal oversight, an
understanding of the primary role of the States in regulating the
business of insurance, and a feasible method of determining equitable
compensation for expenses. Because the WYO Program is based on
companies applying their normal business practices to the sale and
servicing of National Flood Insurance Program (NFIP) policies, these
practices are bound to vary from company to company, and it would be
impossible for the NFIP to accurately calculate actual expenses for 90
companies. For that reason, and the fact that in the early years of the
program flood expenses were not available, the decision was made to use
as a proxy the expenses collected by A.M. Best for five similar lines
of property coverage. Since these lines, unlike flood, are competitive
lines of coverage, there is an inherent incentive to keep expenses
ratios as low as possible, an incentive that accrues to the benefit of
the NFIP. Even now, when some WYO company flood expense reports have
become available, it is not certain how accurate they are, and there is
serious skepticism on the part of FEMA management that they would yield
a lower expense ratio for flood insurance than the A.M. Best figures.
FEMA appreciates the analysis that GAO performed in determining the WYO
companies' actual expenses and we plan to use a similar type of
analysis when we initiate our own ongoing annual review of company
expenses. Our concerns that the conclusions drawn from the data are
misleading are discussed below:
* The review was limited to only six companies, which we believe are
the low cost operators for the five other lines of insurance used to
determine the WYO expense allowance. It seems reasonable to expect that
these companies would have some of the lowest flood operating expenses
as well. Hence, the results of the analysis can be expected to
significantly understate the operating expenses of the WYO companies as
a whole.
* There was no review of the stability of the Federal flood expenses
because the results for other years were not available to GAO. However,
such a review would show the inadvisability of reaching any conclusions
from just one year of data. Basing expense compensation on a single
year of data is always questionable, especially since this analysis has
not been vetted. There were many adjustments and assumptions made by
GAO. While we believe that those assumptions were reasonable, time
should be allowed for others to weigh in on the appropriateness of
those responses.
* Using "actual company expenses" will be as much of a lagging
indicator as the current methodology using A.M. Best's numbers. If
actual expense data is considered to be completely reliable, by the
time the NFIP could use it to lower expense ratios about two to three
years would have lapsed.
* The analysis assumes that actual WYO company expenses are stable,
varying little from year-to-year, which FEMA thinks could yield
misleading results. During the last five years, insurance companies
have managed to significantly reduce their operating expenses in other
lines and we suspect that many of those efficiency gains also made it
into their flood insurance operations.
* The time period analyzed includes the heaviest loss years in the
NFIP's history, which is not indicative of typical years for loss
adjustment expenses. This is acknowledged in the body of the report
but, these caveats are not carried forward to the conclusions. This
results in a significant distortion of the expected reimbursement to
WYO companies for their Loss Adjustment Expenses (LAE) expenses.
* The NFIP has addressed the Unallocated Loss Adjustment Expenses
(ULAE) problem that led to outsized WYO compensation and has determined
how much less the companies would have received if the current ULAE
schedule had been in place then. Based on the paid losses shown under
Marketing and Bonuses of the report, the WYO companies' compensation
for ULAE under the schedule in place today would have been $29M and
$267M less in fiscal years 2005 and 2006, and would have been $9M more
in fiscal year 2007, for a combined decrease of $287M for the entire
three years. It is unclear just how much of that reduction would have
been home by the six companies reviewed in Table 4, but it is likely
that most, if not all, of their $155M "profit" from claims adjusting
and processing would have disappeared.
FEMA Has Not Aligned Its Bonus Structure with Its Long-Term Goals for
the NFIP:
We will be examining the marketing incentive in anticipation of the
2010-2011 WO Arrangement Year. The examination will include the extent
to which the incentive has been effective in increasing policies,
whether an incentive is needed, and possible alternatives to the
current incentive. Of most interest is the possibility of identifying
target markets where penetration is low and incentivizing policy growth
in these areas.
FEMA Followed Some but Not All of Its Internal Control Requirements and
Procedures:
We are providing the following clarifications in response to GAO's
comments on FEMA's implementation of the Financial Control Plan.
* With regard to audits for cause, the Financial Control Plan requires
them only when the Federal Insurance Administrator, the Standards
Committee, or the OIG require them. During the review period, FEMA was
not required to perform an audit for cause. State Departments of
Insurance (DOI) audits also require a trigger. In the case of a State
DOI audit, a financial officer of the insurer alerts FEMA of an audit
involving NFIP activities. During the review period, no notice was
given to FEMA. In recent years State DOI's understand that the
responsibility for NFIP matters rests with the Federal government and
are most happy to routinely send those issues directly to FEMA.
* In the most recent version of the revised but unpublished Financial
Control Plan, the Litigation Operation Review is accomplished by a
review of litigation expenses. Under the new process, when litigation
expenses reach $5,000 or more for an individual law suit, they must be
approved by FEMA before the insurer can be reimbursed.
* FEMA's claims and underwriting branches receive copies of the
Biennial Audits and based on the nature of the findings, follow-up on
the next Claims or Underwriting Operational Review for that insurer. In
addition, copies of all Claims Operation Review Reports are provided to
the FEMA Claims Monitor of the contractor performing reinspections as
these findings can enrich the reinspection process. In return, when
reinspections are performed, the FEMA Claims Monitor will make findings
available to the Claims and Appeals Branch for use during Claims
Operation Reviews.
* The litigation, marketing, and customer service reviews are no longer
included in the revised, but unpublished Financial Control Plan.
Alternative WYO Program Administrative Structures Could be Used to
Incorporate Competitive Bidding into the Payment Process:
Considering possible alternatives to the current NFIP structure of
working through private insurance companies under the WYO Program
involves a degree of complexity that may not be immediately apparent.
The rationale underlying the WYO Program is that it is important to the
effective implementation of the NFIP that the private insurance
industry, with all its resources and expertise, be the primary vehicle
for selling and servicing NFIP policies. The soundness of this
rationale has been demonstrated time and again, especially in
catastrophic flooding events that require the mobilization of vast
company resources to respond quickly and efficiently. It has been
generally acknowledged that the NFIP performed admirably in the
response to Hurricane Katrina, which resulted in approximately 200,000
claims.
That said FEMA will give consideration to engaging a qualified firm to
analyze possible alternatives to the WYO structure, including those
proposed by the GAO, to determine the relative merits of such
alternatives. In addition to examining the costs and benefits of each
alternative, it will be important in this analysis to assess the
willingness of the private insurance industry to participate in such
alternatives and the extent to which various alternatives may reduce
the number of companies participating in a Federal program, which would
not be in the best interests of the NFIP.
Recommendation 1: "To provide transparency and accountability over the
payments FEMA makes to WYOs, we recommend that the Secretary of
Homeland Security direct the Under Secretary, 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 profits 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."
Response: Non-concur. FEMA does not concur with the set of
recommendations regarding providing transparency and accountability
over payments made to WYOs. The large number of insurers that
participate in the WYO Program benefits NFIP policyholders and supports
the goal of making flood insurance widely available. Since expenses
vary by company, considering profit in setting the WYO expense
allowance would potentially compromise achieving the NFIP's goals. We
do not believe that currently available North American Industrial
Classification (NAIC) data is adequate enough to allow us to consider
profit in determining company compensation.
Recommendation 2: "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."
Response: Concur. FEMA concurs with the set of recommendations
regarding increasing the usefulness of the data being reported by WYOs
to the NAIC. FEMA will continue to work with the NAIC to improve the
quality of the flood expense data and will include this data as an
additional item in determining the annual WYO expense allowance.
Recommendation 3: "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."
Response: Concur. FEMA concurs with the recommendation to use more
targeted marketing goals and will examine the marketing incentive
program in anticipation of the 2010-2011 WYO arrangement year.
Recommendation 4: "To improve oversight of the WYO Program and
compliance with program requirements, we also 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."
Response: Concur. FEMA concurs with the set of recommendations
regarding oversight of the WYO Program. It should be noted that the
litigation reviews are being addressed through a review of litigation
expenses. Companies are required to submit information about their
marketing activities as a condition of participation in the WYO Program
and FEMA will review them annually. FEMA will continue to monitor
customer service complaints filed with State insurance departments or
submitted to the NFIP. FEMA has implemented new processes to improve
the monitoring of WYO compliance with the Financial Control Plan and
will continue to look for ways to improve oversight in the future.
Thank you again for the opportunity to comment on this Draft Report and
we look forward to working with you on future homeland security issues.
Sincerely,
Signed by:
Jacqueline L. Lacasse, for:
Jerald E. Levine:
Director:
Departmental GAO/OIG Liaison Office:
[End of section]
Appendix IV: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Orice Williams Brown, (202) 512-8678 or willamso@gao.gov:
Jeanette M. Franzel, (202) 512-2600 or franzelj@gao.gov:
Staff Acknowledgments:
In addition to the contacts named above, the following individuals made
key contributions to this report: Andrew E. Finkel (Assistant
Director), Robert Owens (Assistant Director), Grace Haskins (Analyst-
in-Charge), H. Donald Campbell, Emily Chalmers, Tony Eason, Fredrick
Evans, Jeffrey Isaacs, Scott McNulty, Marc Molino, Roberto Pinero, Paul
Revesz, and Carrie Watkins.
[End of section]
Footnotes:
[1] See GAO, National Flood Insurance Program: FEMA's Management and
Oversight of Payments for Insurance Company Services Should Be
Improved, [hyperlink, http://www.gao.gov/products/GAO-07-1078]
(Washington, D.C.: Sept. 5, 2007).
[2] From 1969 through 1977, the Department of Housing and Urban
Development (HUD), which administered the NFIP at the time, had an
agreement with a consortium of private insurers known as the National
Flood Insurers Association. Under this agreement, HUD reimbursed the
association for operating costs and provided an annual operating
allowance equal to 5 percent of policyholders' premiums. From 1978 to
1983, a federal contractor--not an insurance company--sold and serviced
policies.
[3] Although WYOs handle most flood policies, FEMA still contracts with
a company that serves as the insurer of last resort when an eligible
customer cannot purchase insurance from a WYO. The Direct Program
services both standard policies and other types, including repetitive
loss and group policies.
[4] For the purpose of this review, we considered profits to be the
difference between the amounts paid to the WYO companies and the
companies' actual flood insurance expenses on a pretax basis. In
determining profits, we excluded miscellaneous other companywide income
and expenses.
[5] GAO, Standards for Internal Control in the Federal Government,
[hyperlink, http://www.gao.gov/products/GAO/AIMD-00-21.3.1]
(Washington, D.C.: November 1999).
[6] Statement of Federal Financial Accounting Standards (SFFAS) No. 4,
Managerial Cost Accounting Concepts and Standards for the Federal
Government.
[7] The WYO program is operating under a Control Plan from 1999, but
NFIP has a draft plan it began in 2007. The draft revises the Control
Plan to no longer require marketing, litigation, and customer service
operation reviews. The plan had not been finalized as of July 2009.
[8] For the purpose of this review, we considered profits to be the
difference between the amounts paid to the WYO companies and the
companies’ actual flood insurance expenses on a pretax basis.
[9] GAO, National Flood Insurance Program: FEMA’s Management and
Oversight of Payments for Insurance Company Services Should Be
Improved, [hyperlink, http://www.gao.gov/products/GAO-07-1078]
(Washington, D.C.: Sept. 5, 2007).
[10] NAIC is an organization of state insurance regulators that, among
other things, issues financial reporting requirements and guidance for
insurance companies. Property and casualty insurance companies must
submit an annual statement, including separate amounts for federal
flood insurance, to NAIC. Companies must also prepare audited financial
statements and reconcile amounts in those statements with the annual
statement.
[11] For the purposes of our analysis, we adjusted the flood insurance
expenses that our selected WYO companies reported to NAIC to assist in
comparing expense payments made by FEMA to the WYO companies’ actual
expenses.
[12] GAO,Standards for Internal Control in the Federal Government,
[hyperlink, http://www.gao.gov/products/GAO/AIMD-00-21.3.1]
(Washington, D.C.: November 1999).
[13] Statement of Federal Financial Accounting Standards (SFFAS) No. 4,
Managerial Cost Accounting Concepts and Standards for the Federal
Government.
[14] FEMA uses a contractor to manage the data collection, evaluate the
data for errors and inconsistencies, and follow up with companies as
needed. FEMA hired a new contractor for FY 2009 to perform these tasks,
and FEMA officials said that processing would change from monthly to
daily by fall 2009.
[End of section]
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