Congress is preparing to extend the National Flood Insurance Program for another year, despite warnings that the program lacks adequate controls and may be shifting too much money to the insurance industry.
The insurance program, deeply in debt since Hurricane Katrina, operates as a public-private partnership, collecting more than $2 billion in annual premiums. The Federal Emergency Management Agency runs the program, and the government bears all the risk.
But the insurance policies are sold by individual companies under their own names, and those companies handle claims, pocketing a portion of the premiums and forwarding the rest to the government.
A recent report by the Government Accountability Office cited many inefficiencies in the program and found that the government overseers had no way of knowing how much profit their insurance partners were making and whether it was appropriate.
The program’s critics in Congress acknowledge that it serves an important purpose — indeed, some want it to cover even more types of damage — but say it has run off the rails and needs more oversight, if not a broader re-examination of the role of insurance companies.
The troubles with the flood insurance program offer a parallel to Congress’s grappling with how to expand access to health care, possibly through a government partnership with insurance companies.
“There are certain things to be learned,” said Robert Hartwig, president of the Insurance Information Institute. “If the price charged for the service rendered does not cover the cost, you will ultimately run a taxpayer-financed deficit.”
Clark Stevens, a spokesman for FEMA, said that by working through the insurance industry, the program was able to reach many more communities in a timely and cost-effective manner. The nation’s biggest insurers participate, including Allstate, State Farm , Traveler’s Insurance Companies, Liberty Mutual, Farmers and the American International Group . Many smaller and regional insurance companies also take part.
In all, the program takes in about $2.3 billion in premiums a year, and lets the insurance companies retain roughly $1 billion of that amount.
The Congressional auditors found that FEMA did not look at the insurers’ actual expenses when deciding what share of the premiums they could keep — even though the data has been available since 1997 from the National Association of Insurance Commissioners. Instead, the auditors found, the federal agency looked at the average expenses of companies selling five other types of property insurance.
When the auditors looked at the actual costs of selling flood insurance, they found that a sample of insurers in the flood program were retaining about $327 million more than they were incurring in actual expenses, a difference of about 16.5 percent.
The accountability office did not draw conclusions as to whether this profit level was too high, given that the insurers do not bear risk in the flood program. It simply stated that the government agency should be keeping better track.
Without accurate expense data, it said, the government “does not have the information it needs to determine whether its payments are appropriate and how much profit is included.”
Mr. Stevens said that the Congressional report was based on a small sample during a time when losses were unusually heavy.
“We have concerns about the report’s central finding because it is not representative of the program as a whole,” he said.
The accountability office also said that the roughly 90 insurance companies in the flood insurance program did not seem to market the flood insurance at all — they simply offered it when someone asked for it.
This seemed at odds with the government’s goal of trying to persuade more people to buy flood coverage, particularly people outside the most hazardous zones. Broadening and diversifying the risk pool of customers could lower the government’s costs and protect taxpayers.
Again, the accountability office faulted FEMA, saying it did not give the insurance companies any incentive to market their policies strategically. Instead of paying bonuses to insurers that brought in a more diverse group of policyholders, the federal agency has been using a broad-based formula that simply pays bonuses to companies that increase sales by 2 to 5 percent a year.
“This formula primarily rewards companies that are new” to the program, the auditors wrote.
The accountability office said that flood program representatives had expressed agreement with this finding and were already working on changes in the way the insurance companies are paid, which they hoped to have in place by next year.
Origins of flood insurance
The audit report was requested by Senator Richard Shelby of Alabama, the senior Republican on the Banking Committee, which also has responsibility for insurance. An aide to the senator said he would probably support a continuation of the flood insurance program, although he was concerned that it was not actuarially sound. The program is expected to receive month-to-month extensions, starting on Wednesday, when the government’s fiscal year ends, until a broader reauthorization is approved.
Before the flood insurance program was begun in 1968, most people with property in flood zones simply went without insurance. When there was a flood, people ended up relying on federal disaster relief, which was costly and poorly tailored to their needs.
The flood insurance program was based on the idea that if the government was paying for rebuilding anyway, it would be cheaper and more efficient to do so through insurance.
To keep the risks manageable and protect taxpayers, the program was set up to offer coverage only to property owners in communities that had floodplain management laws and enforced them, according to Douglas J. Elliott, a fellow at the Brookings Institution who has written a brief history of the flood program.
And the insurance was optional.
But over time, too few people were buying flood insurance — and too few communities were enforcing their floodplain rules. In 1972 Congress made the insurance mandatory for anyone who took out a mortgage from a federally regulated lender to buy property in a flood zone. In 1994, Congress added penalties for lenders that did not comply.
Mr. Hartwig of the Insurance Information Institute said the efforts to make flood insurance compulsory were reminiscent of the debate today over whether Washington should force everyone to buy health insurance.
“Forty years of experience found that the more people who opt into the program, the better the community is served,” he said. But people resisted.
“One reason people cite is that they believe they’ll be bailed out anyway, or they say they can’t afford it, no matter how much it is subsidized. And a third reason cited is, ‘Well, it won’t happen to me,’ ” he said. “All of these are analogous to the arguments in health care.”
To entice more people into the program, Congress limited the amount premiums could rise in a single year. But when real estate prices soared, so did the program’s risks. Premium revenue did not keep up, setting the program up for the financial calamity that accompanied Hurricane Katrina.
After that, the program had to borrow from the United States Treasury to stay afloat. Now it is $20 billion in debt. Last year more than half of its outlays were for interest.