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entitled 'Natural Catastrophe Insurance: Analysis of a Proposed 
Combined Federal Flood and Wind Insurance Program' which was released 
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Report to Congressional Requesters: 

United States Government Accountability Office: 
GAO: 

April 2008: 

Natural Catastrophe Insurance: 

Analysis of a Proposed Combined Federal Flood and Wind Insurance 
Program: 

GAO-08-504: 

GAO Highlights: 

Highlights of GAO-08-504, a report to congressional requesters. 

Why GAO Did This Study: 

Disputes between policyholders and insurers after the 2005 hurricanes 
highlight the challenges of determining the cause and extent of damages 
when properties are subject to both high winds and flooding. 
Additionally, insurers want to reduce their exposure in high-risk 
areas, and state wind insurance programs have grown significantly. H.R. 
3121, the Flood Insurance Reform and Modernization Act of 2007, would 
create a combined federal insurance program with coverage for both wind 
and flood damage. GAO was asked to evaluate this potential program in 
terms of (1) what would be required to implement it; (2) the steps the 
Federal Emergency Management Agency (FEMA) would need to take to 
determine premium rates that reflect all future costs; and (3) how it 
could affect policyholders, insurance market participants, and the 
federal government. To address these questions, GAO analyzed state and 
federal programs, examined studies of coastal wind insurance issues, 
and interviewed federal and state regulatory officials as well as 
industry participants and analysts. 

FEMA and the National Association of Insurance Commissioners generally 
agreed with GAO’s report findings. FEMA emphasized the challenges it 
would face in addressing several key issues. FEMA also provided 
technical comments, which were incorporated as appropriate. 

What GAO Found: 

To implement a combined federal flood and wind insurance program, FEMA 
would need to complete certain challenging steps. First, FEMA would 
need to determine wind hazard prevention standards that communities 
would have to adopt in order to receive coverage. Second, FEMA would 
need to adapt existing programs to accommodate wind coverage—for 
example, the Write Your Own program. Third, FEMA would need to create a 
new rate-setting process, as the process for setting flood insurance 
rates is different from what is needed for wind coverage. Fourth, 
promoting the new program in communities would require that FEMA staff 
raise awareness of the combined program’s availability and coordinate 
enforcement of the new building codes. Finally, FEMA would need to put 
staff and procedures in place to administer and oversee the new program 
while it faces current management and oversight challenges with the 
National Flood Insurance Program (NFIP). 

Setting premium rates adequate to cover all the expected costs of flood 
and wind damage would require FEMA to make sophisticated 
determinations. For example, FEMA would need to determine how the 
program would pay claims in years with catastrophic losses without 
borrowing from the Department of the Treasury. H.R. 3121 would require 
the program to stop renewing or selling new policies if it needed to 
borrow funds, effectively terminating the program. It is also unclear 
whether the program could obtain reinsurance to cover such losses, and 
attempting to fund losses by building up a surplus would potentially 
require high premium rates and an unknown number of years without large 
losses, something over which FEMA has no control. Further, FEMA would 
need to account for the likelihood that participation would be limited 
and only the highest-risk properties would be insured. These factors 
would further increase premium rates and make it difficult to set rates 
adequate to cover future costs. 

A federal flood and wind insurance program could benefit some 
policyholders and market participants but would also involve trade-
offs. For example, not requiring adjusters to distinguish between flood 
and wind damage could reduce both delays in reimbursing participants 
and the potential for litigation. However, borrowing restrictions could 
also leave property owners without coverage after a catastrophic event. 
In addition, the proposed coverage limits are relatively low compared 
with the coverage that is currently available, potentially leaving some 
properties underinsured. The program could also reduce the exposure of 
some insurers by insuring high-risk properties that currently have 
private sector coverage. However, an unknown portion of the exposure 
currently held by state wind programs—nearly $600 billion in 2007—could 
be transferred to the federal government. While H.R. 3121 would require 
premium rates to be adequate to cover any exposure and restrict 
borrowing by the program, the potential exists for losses to greatly 
exceed expectations, as happened with Hurricane Katrina in 2005. This 
could increase FEMA’s total debt, which as of December 2007 was about 
$17.3 billion. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-504]. For more 
information, contact Orice Williams at (202) 512-8678 or 
williamso@gao.gov. 

[End of section] 

Contents: 

Letter: 

Result in Brief: 

Background: 

Implementing a Combined Federal Flood and Wind Insurance Program Would 
Require FEMA to Address Several Management Challenges: 

FEMA Would Need to Set Premium Rates for the Flood and Wind Program 
Adequate to Cover All Future and Catastrophic Losses without Borrowing: 

A Federal Flood and Wind Insurance Program Could Benefit Some but Would 
Involve Trade-offs: 

Agency Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Comments from the Federal Emergency Management Agency: 

Appendix III: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1. Comparison of Combination of State Wind Program and H.R. 3121 
Flood Insurance Policy and State Wind Policy Limits with H.R. 3121 
Flood and Wind Policy Limits: 

Table 2. Comparison of Selected State Wind Insurance Program Policies 
in Force and Exposure from 2004 to Most Recent Available: 

Figure: 

Figure 1: Geographic Areas That Experience Floods and Hurricanes, 1980- 
2005: 

Abbreviations: 

AAA: American Academy of Actuaries: 

AIA: American Insurance Association: 

ASFPM: Association of State Flood Plain Managers: 

CBO: Congressional Budget Office: 

CRSNFIP: Community Rating System: 

FEMA: Federal Emergency Management Agency: 

NAIC: National Association of Insurance Commissioners: 

NFDA: National Flood Determination Association: 

NFIP: National Flood Insurance Program: 

WYO: Write Your Own: 

[End of section] 

United States Government Accountability Office:
Washington, DC 20548: 

April 25, 2008: 

The Honorable Barney Frank: 
Chairman, Committee on Financial Services: 
House of Representatives: 

The Honorable Ginny Browne-Waite: 
House of Representatives: 

Hurricanes can cause extensive wind and flood damage that can be 
devastating to property owners. Determining the extent of the damage 
caused by each peril can be difficult, leading to disputes between 
policyholders and private insurers and delays in payments that property 
owners need for living and rebuilding expenses. For example, in the 
aftermath of the unprecedented damage as a result of the 2005 
hurricanes, disputes emerged between policyholders and insurers over 
the extent to which damages would be covered under a homeowner's policy 
when both high winds and flooding occurred. As of November 2007, some 
of these disputes had yet to be resolved. 

Such disputes arise because events such as hurricanes are multi-peril 
events, making determinations of the cause of damage difficult. Private 
property-casualty insurance policies may cover wind damage but exclude 
flood damage, and in some cases, the presence of flood damage in 
addition to wind damage may raise questions about the extent to which 
wind damage is covered. Adjusters face several challenges in their 
efforts to determine the cause of damages after multi-peril events. For 
example, the scope of damage following Hurricane Katrina meant that not 
enough adjusters were available, that the available adjusters had 
difficulty reaching the properties, and that evidence at the damage 
scenes was often limited or compromised. 

The potential for extensive damages following hurricanes can also mean 
that insurance in hurricane prone areas (primarily on the eastern and 
Gulf coasts of the United States) may not be widely available and, when 
it is, may be unaffordable. In some high-risk areas, insurers have 
sought to increase their premium rates and reduce their exposure. To 
address these issues, a number of coastal states have created programs 
to sell wind insurance in the highest-risk areas within their states. 
In some states, such as Florida, Mississippi, and North and South 
Carolina, participation in these programs has grown tremendously since 
2004, exposing the programs to potentially large losses. 

In response to these and other concerns, the House of Representatives 
passed H.R. 3121, the Flood Insurance Reform and Modernization Act of 
2007, in September 2007. H.R. 3121 would, among other things, create a 
federal program to provide coverage for both wind and flood damage. 
[Footnote 1] You asked us to evaluate this program in light of current 
deliberations about the future of the National Flood Insurance Program 
(NFIP). This report discusses (1) the resources and processes that the 
Federal Emergency Management Agency (FEMA) would need to implement the 
program; (2) the steps that FEMA would need to take to determine 
premium rates that adequately reflected all expected costs; and (3) the 
possible effects of the program on policyholders, insurance market 
participants, and the federal government. 

To complete our work, we analyzed the provisions of H.R. 3121 that were 
related to the establishment of a federal flood and wind insurance 
program. We discussed the potential implications and effects of these 
provisions with officials from FEMA, the NFIP, the National Association 
of Insurance Commissioners (NAIC), state insurance regulators, state 
wind insurance program operators, insurers, reinsurers, insurance and 
reinsurance associations, insurance agent associations, risk-modeling 
organizations, actuarial consultants, the American Academy of 
Actuaries, and others. We also obtained information on state-sponsored 
wind insurance programs in three coastal states and one inland state 
and talked with program officials as well as the insurance regulators 
within those states. In addition, we reviewed academic and other 
studies of coastal wind insurance issues, Congressional Budget Office 
(CBO) reviews, and hurricane loss data. Appendix I contains additional 
information concerning the scope and methodology of our work. We 
conducted this performance audit from September 2007 to April 2008 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 that 
the evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. 

Result in Brief: 

To implement a combined federal flood and wind insurance program, FEMA 
would need to complete a number of steps, similar to those undertaken 
to establish the NFIP, which would require the agency to address 
several challenges. First, FEMA would need to determine appropriate 
building codes that communities would be required to adopt in order to 
participate in the combined program. Second, FEMA would need to adapt 
existing processes under the NFIP flood program to accommodate the 
addition of wind coverage. For example, revisions to the Write Your Own 
(WYO) program, which uses private insurers to sell and underwrite NFIP 
policies, would need to address the conflict of interest inherent in 
having these companies sell a federal wind product and their own wind 
coverage. Third, FEMA would need to create a rate-setting mechanism and 
process for wind insurance that, according to FEMA officials, would 
require contractor support. Fourth, promoting the combined program in 
communities would require that FEMA staff raise awareness of the 
combined program's availability and coordinate enforcement of the new 
building codes. Finally, FEMA is facing a $17.3 billion deficit and 
attempting to address several management and oversight challenges 
associated with the NFIP, and balancing those demands with expanding 
current staffing capacity and contractor services to administer, 
operate, and monitor and oversee a new program could further strain 
FEMA's ability to effectively manage the NFIP. 

Setting premium rates that would adequately reflect all expected costs 
without borrowing from the U.S. Department of the Treasury (Treasury) 
would require FEMA to make a number of sophisticated determinations. To 
begin with, FEMA would need to determine what those future costs are 
likely to be, including costs in years with catastrophic losses. Such 
determinations can be difficult, particularly in the early years of a 
program's operations, when little is known about the properties that 
might be insured, and can have a significant impact on premium rates. 
Once FEMA has determined the expected future costs of the program, it 
would need to determine premium rates adequate to cover those costs. 
Such determinations could be challenging for several reasons. First, 
the rate would need to be sufficient to pay claims in years with such 
catastrophic losses without borrowing funds from the Treasury. Under 
the proposed legislation, if FEMA ever needed to borrow to pay claims-
-something that could occur in any year given the variability of wind 
and flood losses regardless of the rate setting process--the program 
would have to stop renewing or selling new policies and thus would 
effectively terminate. Private sector insurers generally use 
reinsurance--insurance for insurers--to cover potential catastrophic 
losses, but it is not clear that reinsurers would be willing to sell 
such coverage to a federal program because of the potential for a large 
concentration of high-risk properties. The program could attempt to 
build a surplus large enough to pay catastrophic losses, but doing so 
would require high premium rates compared to the size of expected 
claims and an unknown number of years without larger than average 
losses, over which FEMA has no control. Second, rate setting would have 
to account for two factors: adverse selection, or the likelihood that 
the program would insure only the highest-risk properties, and 
potentially limited participation because of comparatively low coverage 
limits. Both of these factors would necessitate higher premium rates, 
which in turn could further limit participation and require even higher 
premium rates. This circular process, known as an adverse selection 
spiral, could make rate setting very difficult. Finally, although no 
distinction between flood and wind damage would be necessary for 
property owners to receive payment on claims, such a distinction would 
still be necessary for rate-setting purposes. 

A federal flood and wind insurance program could benefit some property 
owners, state wind insurance programs, and private insurers, but these 
potential benefits involve trade-offs. For property owners, the program 
could reduce potential delays in claim payments for wind damage by not 
requiring adjusters to distinguish between wind and flood damage, 
potentially avoiding the wind-related payment delays and disputes that 
followed the hurricanes of 2005. In addition, the program could help 
ensure that property owners had access to wind coverage in high-risk 
areas. However, these benefits could be limited if FEMA needed to 
borrow money to pay claims, potentially shutting down the program and 
leaving property owners without coverage following a catastrophic 
event. In addition, comparatively low policy limits could leave some 
property owners underinsured. The program could also allow private 
insurers to further reduce their exposure to loss in some high-risk 
coastal areas, something that several insurers have been attempting to 
do since the 2005 hurricanes. However, this benefit for insurers could 
further limit market participation in the provision of catastrophe 
insurance.[Footnote 2] These possible benefits also need to be balanced 
against the potential for a federal flood and wind program to create an 
increased exposure for the federal government. Because of the potential 
for the program to insure only the highest-risk properties, this 
exposure could be very large. While H.R. 3121 would require premium 
rates be determined on an actuarial basis--that is, adequate to cover 
expected costs--estimating future losses is challenging and the 
potential exists for losses to exceed expectations by a large amount 
even if the rates are actuarially based, as happened when losses from 
Hurricane Katrina in 2005 were well beyond what was expected by the 
NFIP and private sector insurers. If losses for a combined flood and 
wind program did exceed the premiums collected by the program, FEMA 
would be forced to borrow from the Treasury to pay those losses, 
potentially adding to FEMA's total debt, which as of December 2007 was 
about $17.3 billion. 

We requested comments on a draft of this report from FEMA and NAIC. 
FEMA provided written comments that are reprinted in appendix II. NAIC 
provided oral comments. FEMA and NAIC generally agreed with our report 
findings. Overall, FEMA commended the report and stressed the 
challenges it would face in addressing several key issues. Finally FEMA 
provided technical comments, which we incorporated as appropriate. 

Background: 

Coastal properties in the United States that lie on the Atlantic Ocean 
and the Gulf of Mexico are at risk of both flood and wind damage from 
hurricanes. One study put the estimated insured value of coastal 
property in states on these coasts at $7.2 trillion as of December 
2004, and populations in these areas are growing.[Footnote 3] Property 
owners can obtain insurance against losses from wind damage through 
private insurance markets or, in high-risk coastal areas in some 
states, through state wind insurance programs. Flood insurance is 
generally excluded from such coverage, but property owners can obtain 
insurance against losses from flood damage through NFIP, which was 
established by the National Flood Insurance Act of 1968.[Footnote 4] 

As we have reported, insurance coverage gaps and claims uncertainties 
can arise when coverage for hurricane damage is divided among multiple 
policies because the extent of coverage under each policy depends on 
the cause of the damages, as determined through the claims adjustment 
process and the policy terms that cover a particular type of 
damage.[Footnote 5] This adjustment process is complicated when a 
damaged property has been subjected to a combination of high winds and 
flooding and evidence at the damage scene is limited. Other claims 
concerns can arise on such properties when the same insurer serves as 
both the NFIP's WYO insurer and the property-casualty (wind) insurer. 
In such cases, the same company is responsible for determining damages 
and losses to itself and to the NFIP, creating an inherent conflict of 
interest. 

H.R. 3121 Would Create a Combined Federal Flood and Wind Insurance 
Program: 

H.R. 3121, the Flood Insurance Reform and Modernization Act of 2007, 
set an effective date for its proposed flood and wind insurance program 
of June 28, 2008. A version of this bill, S. 2284, was introduced in 
the Senate in November of 2007, but this version did not include 
provisions that would establish a federal flood and wind program. As of 
March 2008, no additional action had been taken on S. 2284. In a 
September 26, 2007, Statement of Administration Policy regarding H.R. 
3121, the Executive Office of the President stated that the 
Administration strongly opposes the expansion of NFIP to include 
coverage for windstorm damage. 

H.R. 3121's provisions include the following: 

* In order for individual property owners to be eligible to purchase 
federal flood and wind coverage, their communities must have adopted 
adequate mitigation measures that the Director of FEMA finds are 
consistent with the International Code Council's building codes for 
wind mitigation.[Footnote 6] 

* The Director of FEMA is expected to carry out studies and 
investigations to determine appropriate wind hazard prevention 
measures, including laws and regulations relating to land use and 
zoning; establish criteria based on this work to encourage adoption of 
adequate state and local measures to help reduce wind damage; and work 
closely with and provide any technical assistance to state and local 
governmental agencies to encourage the application of these criteria 
and the adoption and enforcement of these measures. 

* Property owners who purchase a combined federal flood and wind 
insurance policy cannot also purchase an NFIP flood insurance policy. 

* Federal flood and wind insurance will cover losses only from physical 
damage from flood and windstorm (including hurricanes, tornadoes, and 
other wind events), but no distinction between flood and wind damage 
need be made in order for claims to be paid. 

* Premium rates are to be based on risk levels and accepted actuarial 
principles and will include all operating costs and administrative 
expenses. 

* Residential property owners can obtain up to $500,000 in coverage for 
damages to any single-family structure and up to $150,000 in coverage 
for damage to contents and any necessary increases in living expenses 
incurred when losses from flooding or windstorm make the residence 
unfit to live in. 

* Nonresidential property owners can obtain up to $1,000,000 in 
coverage for damages to any single structure and up to $750,000 in 
coverage for damage to contents and for losses resulting from an 
interruption of business operations caused by damage to, or loss of, 
the property from flooding or windstorm; 

* If at any time FEMA borrows funds from the Treasury to pay claims 
under the federal flood and wind program, until those funds are repaid 
the program may not sell any new policies or renew any existing 
policies. 

NFIP Is Designed to Offer Federally Backed Flood Insurance but Not to 
Be Actuarially Sound: 

Over 20,000 communities across the United States and its territories 
participate in the NFIP by adopting and agreeing to enforce state and 
community floodplain management regulations to reduce future flood 
damage. In exchange, the NFIP makes federally backed flood insurance 
available to homeowners and other property owners in these communities. 
Homeowners with mortgages from federally regulated lenders on property 
in communities identified to be in special high-risk flood hazard areas 
are required to purchase flood insurance on their dwellings. Optional, 
lower-cost coverage is also available under the NFIP to protect homes 
in areas of low to moderate risk. Premium amounts vary according to the 
amount of coverage purchased and the location and characteristics of 
the property to be insured. 

When the NFIP was created, Congress mandated that it was to be 
implemented using "workable methods of pooling risks, minimizing costs, 
and distributing burdens equitably" among policyholders and taxpayers 
in general.[Footnote 7] The program aims to make reasonably priced 
coverage available to those who need it.[Footnote 8] The NFIP attempts 
to strike a balance between the scope of the coverage provided and the 
premium amounts required to provide that coverage and, to the extent 
possible, the program is designed to pay operating expenses and flood 
insurance claims with premiums collected on flood insurance policies 
rather than tax dollars. However, as we have reported before, the 
program, by design, is not actuarially sound because Congress 
authorized subsidized insurance rates for some policies to encourage 
communities to join the program. As a result, the program does not 
collect sufficient premium income to build reserves to meet the long- 
term future expected flood losses.[Footnote 9] FEMA has statutory 
authority to borrow funds from the Treasury to keep the NFIP 
solvent.[Footnote 10] In 2005, Hurricanes Katrina, Rita, and Wilma had 
a far-reaching impact on NFIP's financial solvency. Legislation 
incrementally increased FEMA's borrowing authority from a total of $1.5 
billion prior to Hurricane Katrina to $20.8 billion by March 2006, and 
as of December 2007, FEMA's outstanding debt to the Treasury was $17.3 
billion. As we have reported, it is unlikely that FEMA can repay a debt 
of this size and pay future claims in a program that generates premium 
income of about $2 billion per year.[Footnote 11] 

Implementing a Combined Federal Flood and Wind Insurance Program Would 
Require FEMA to Address Several Management Challenges: 

To implement a combined federal flood and wind insurance program, FEMA 
would need to complete a number of steps, similar to those undertaken 
to establish the NFIP, which would require the agency to address 
several challenges. First, FEMA would need to undertake studies in 
order to determine appropriate building codes that communities would be 
required to adopt in order to participate in the combined program. 
Second, FEMA would need to adapt existing processes under the NFIP 
flood program to accommodate the addition of wind coverage. For 
example, FEMA could leverage current processes under the WYO program 
and the Direct Service program to perform the administrative functions 
of selling and servicing the combined federal flood and wind insurance 
policy. Third, to set wind rates, FEMA would have to create a rate- 
setting structure, which would require contractor support. Fourth, 
promoting the combined federal flood and wind insurance program in 
communities would require that FEMA staff raise awareness of the 
combined program's availability and coordinate enforcement of the new 
building codes. Finally, FEMA is facing a $17.3 billion deficit and 
attempting to address several management and oversight challenges 
associated with the NFIP, and balancing those demands with expanding 
staffing capacity to adjust existing administrative, operational, 
monitoring, and oversight processes and establish new ones to 
accommodate wind coverage could further strain FEMA's ability to 
effectively manage the NFIP. 

FEMA Would Need to Determine Appropriate Building Codes: 

H.R. 3121 would require FEMA to determine appropriate wind mitigation 
measures that communities would be required to adopt in order to 
participate in the combined flood and wind program. For several 
reasons, this could be a challenging process. First, FEMA would have to 
determine how to most effectively integrate a new federal wind 
mitigation standard with existing building codes for wind resistance. 
As we discussed in a previous report, as of January 2007, the majority 
of states had adopted some version of a model building code for 
commercial and residential structures.[Footnote 12] However, some local 
jurisdictions within states had not adopted a statewide model code and 
had modified the codes to reflect local hazards. Standards determined 
by FEMA to be appropriate for participation in the combined federal 
flood and wind program could conflict with those currently used by some 
states and local jurisdictions, and resolving any such differences 
could be challenging. 

Second, as it did with the NFIP, FEMA would have to address 
constitutional issues related to federal regulation of state and local 
code enforcement. Further, FEMA would need to establish regulations 
similar to those governing the flood program to allow for appeals by 
local jurisdictions, a process that could be time intensive. Third, as 
we have noted in a previous report, reaching agreement with communities 
on appropriate mitigation measures can be challenging, as communities 
often resist changes to building standards and zoning regulations 
because of the potential impact on economic development.[Footnote 13] 

For example, community goals such as housing and promoting economic 
development may be higher priorities for the community than formulating 
mitigation regulations that may include more rigorous developmental 
regulations and building codes. Fourth, according to FEMA officials, 
the agency would have to resolve potentially conflicting wind and flood 
standards. For example, they told us that flood building standards 
require some homes to be raised off the ground, but doing so can 
increase a building's susceptibility to wind damage because the 
buildings are then at a higher elevation. 

FEMA Would Need to Adapt Existing NFIP Processes for Wind Coverage: 

While some of the NFIP's current processes could be leveraged to 
implement a combined federal flood and wind program, they would need to 
be revised, an action that could pose further challenges for FEMA. 
According to FEMA officials, both the NFIP's WYO and Direct Service 
programs could be used, with some revisions, to sell and underwrite the 
combined federal flood and wind insurance policy. The provision within 
H.R. 3121 that prevents FEMA from selling new policies or renewing 
existing policies if it borrows funds to pay claims would necessitate 
that the agency segregate funds collected from premiums under the new 
combined program and the flood program to ensure that it has sufficient 
funds to cover all future costs without borrowing, especially in 
catastrophic loss years. While the NFIP Community Rating System (CRS), 
a program that uses insurance premium discounts to incentivize flood 
damage mitigation activities by participating communities, could be 
adapted for combined federal flood and wind insurance coverage, it 
would not be required for the new program to begin operations because 
community participation in CRS is voluntary.[Footnote 14] 

The WYO Program Could Be Used, but Would Need to Be Expanded: 

As part of the WYO program, private property-casualty insurers are 
responsible for selling and servicing NFIP policies, including 
performing the claims adjustment activities to assess the cause and 
extent of damages.[Footnote 15] FEMA is responsible for managing the 
program, including establishing and updating NFIP regulations, 
analyzing data to determine flood insurance rates, and offering 
training to insurance agents and adjusters. In addition, FEMA and its 
program contractor are responsible for monitoring and overseeing the 
quality of the performance of the WYO insurance companies to ensure 
that NFIP is administered properly. These duties under the WYO program 
would be amplified with the addition of wind coverage and, according to 
FEMA officials, would require FEMA to expand the staffing capacity to 
include those with wind peril insurance experience. In addition, FEMA 
would need to determine whether existing data systems would be adequate 
to manage an increased number of policies and track losses for the new 
program. 

FEMA could face several challenges in expanding the WYO program. First, 
program staff would need to determine how to manage and mitigate the 
potential conflict of interest for those companies in the WYO program 
that could be selling both their own wind coverage and the combined 
federal flood and wind coverage. Current WYO arrangements with the NFIP 
prevent WYO insurers from offering flood-only coverage of their own 
unless it supplements NFIP coverage limits or is part of a larger 
policy in which flooding is one of the several perils covered. H.R. 
3121, however, does not appear to prevent companies that might sell a 
combined federal flood and wind policy from also selling wind coverage, 
which may be part of a homeowners policy. Without this restriction, a 
conflict of interest could develop because insurers would have an 
incentive to sell the combined federal policy to its highest-risk 
customers and their own policies to lower-risk customers. FEMA 
officials agreed that this would be an inherent conflict and noted that 
it would be difficult to prevent this from occurring without precluding 
the WYO insurers from selling their wind policies. Moreover, according 
to a WYO insurer with whom we spoke, attempting to eliminate the 
conflict by either restricting a WYO insurer from selling its own wind 
coverage or requiring it to sell both flood-only and the combined 
policy could discourage participation in the WYO program. As noted in a 
previous report, private sector WYO program managers have said that 
while NFIP has many positive aspects, working with it is complex for 
policyholders, agents, and adjusters.[Footnote 16] According to another 
WYO insurer we spoke with, adding wind coverage could increase these 
complexities. 

NFIP's Direct Service Program Could Also Be Used, but Would Need to Be 
Expanded: 

FEMA officials told us that the agency could also sell and service the 
combined flood and wind insurance policies through its Direct Service 
program, which is designed for agents who do not have agreements or 
contracts with insurance companies that are part of the WYO program. 
According to FEMA officials, the Direct Service program of NFIP 
currently writes about 3 percent of the more than 5.5 million NFIP 
policies sold. Further, as with the WYO program, FEMA may have to 
contend with an inherent conflict of interest, and expand staffing 
capacity including adding staff with wind peril insurance expertise in 
the Direct Service program to administer, monitor, and oversee the sale 
of the new product. 

The CRS Program, while Not Necessary to Initiate the Program, Would 
Also Need to Be Expanded: 

H.R. 3121 calls for FEMA to establish comprehensive criteria designed 
to encourage communities to participate in wind mitigation activities. 
As previously noted, the CRS program would be an important means of 
incentivizing wind mitigation activities in communities, but would not 
be necessary for the combined federal flood and wind insurance program 
to operate. According to FEMA, while the CRS process could be adapted 
for wind coverage, the agency would have to assess current practices, 
evaluate standards, and devise an appropriate rating system; a 
developmental process similar to what occurred for the NFIP. FEMA 
officials told us that it took approximately 5 years to develop the 
program, during which time extensive evaluation, research, and concept 
testing occurred. They estimate that replicating a similar approach for 
wind hazard would require at least the same number of years if not 
more, recognizing the complexities of current insurance industry 
experience associated with the wind peril and the complexities involved 
with evaluating current building code practices related to wind and 
other wind mitigation techniques. 

NFIP Would Need to Establish a New Rate-Setting Structure for Combined 
Flood and Wind Premiums: 

Establishing a new rate-setting structure for a combined federal flood 
and wind insurance program could pose another challenge for FEMA. 
According to several insurers and modeling consultants, wind modeling 
is the accepted method of determining wind-related premium rates, and 
FEMA does not have the necessary in-house wind modeling and actuarial 
expertise needed to develop and interpret wind models and translate the 
model's output into premium rates.[Footnote 17] They told us that 
modeling has several advantages in rate setting over methods that place 
greater emphasis on loss data from past catastrophic events, such as 
the method used by NFIP to determine flood insurance premium rates. For 
example, modeling uses wind speed maps and other data to account for 
the probability that properties in a certain geographic area might 
experience losses in the future, regardless of whether those properties 
have experienced losses in the past. In addition, according to a 
modeling expert, wind modeling incorporates mitigation efforts at the 
property level because it can estimate the potential reductions in 
damage without waiting to see how the efforts actually affect losses 
during a storm or other event. While several modeling companies that 
are already providing wind modeling to private sector insurers and 
state wind insurance programs exist, it is not clear how much such 
services would cost FEMA. And while FEMA officials told us that the 
agency would have to contract out for wind-modeling services because it 
lacks the necessary wind and actuarial expertise, the agency could 
benefit from at least some in-house expertise in these areas in order 
to oversee the contractors that will provide these services. 

FEMA would also need to determine to what extent it might need to use 
wind speed maps in its rate determination process. Flood maps are 
currently used in the NFIP to identify areas that are at risk of 
flooding and thus the areas where property owners would benefit from 
purchasing flood insurance. If FEMA determined that wind maps were 
necessary, it would then need to determine whether the agency could 
develop such maps on its own or whether contracting with wind-modeling 
experts would be required, and what the cost of these efforts might be. 

FEMA Would Need to Promote Participation in a Combined Federal Flood 
and Wind Insurance Program and Coordinate Enforcement: 

Implementing the combined program would require FEMA to promote 
participation among communities and coordinate enforcement, a task that 
could be challenging for FEMA for two reasons. First, FEMA would need 
to manage community and state eligibility to participate in the 
program. The proposal calls for FEMA to work closely with and provide 
any necessary technical assistance to state, interstate, and local 
governmental agencies, to encourage the adoption of windstorm damage 
mitigation measures by local communities and ensure proper enforcement. 
While communities themselves are responsible for enforcing windstorm 
mitigation measures, FEMA officials told us they would have to 
coordinate with existing code groups to provide technical assistance 
training and guidance to local officials, and establish a wind 
mitigation code enforcement compliance program that would monitor, 
track, and verify community compliance with wind mitigation codes. 
According to an official at an organization representing flood hazard 
specialists, some communities are very good at ensuring compliance, 
while others are not. For example, in some larger communities, a city 
or county may have experts with vast experience in enforcing building 
codes and land use standards, but in other communities, a local clerk 
or city manager with little or no experience may be responsible for 
compliance. According to FEMA, the effectiveness of mitigation measures 
is entirely dependent on enforcement at the local level. Proper 
enforcement would require that resources were in place to pay for and 
train qualified inspectors and building department staff. 

Second, FEMA would need to generate public awareness on the 
availability of wind insurance through the NFIP. Efforts to adopt new 
mitigation activities and strategies have been constrained by the 
general public's lack of awareness and understanding about the risk 
from natural hazards. To address this issue in NFIP, FEMA launched an 
integrated mass marketing campaign called FloodSmart to educate the 
public about the risks of flooding and to encourage the purchase of 
flood insurance. As we have noted in a previous report, according to 
FEMA officials, in a little more than 2 years since the contract began, 
in October 2003, net policy growth was a little more than 7 percent and 
policy retention improved from 88 percent to 91 percent.[Footnote 18] 
Educating the public on a new combined federal flood and wind insurance 
program and promoting community participation could demand a similar 
level of effort by FEMA to encourage participation. 

Expanding FEMA to Implement a Combined Federal Flood and Wind Insurance 
Program Could Add to Existing NFIP Management Challenges: 

Implementing a combined flood and wind insurance program and overseeing 
the requisite contractor-supported services could place additional 
strain on FEMA, which is already faced with NFIP management and 
oversight challenges and a $17.3 billion deficit that it is unlikely to 
be able to repay. In March 2006, we placed the NFIP on our high-risk 
list because of its fiscal and management challenges.[Footnote 19] In 
addition to the agency's current debt owed to the Treasury, FEMA is 
challenged with providing effective oversight of contractors. For 
example, as previously reported, FEMA faces challenges in providing 
effective oversight of the insurance companies and thousands of 
insurance agents and claims adjusters that are primarily responsible 
for the day-to-day process of selling and servicing flood insurance 
policies through the WYO program.[Footnote 20] In FEMA's claims 
adjustment oversight, the agency cannot be certain of the quality of 
NFIP claims adjustments that allocate damage to flooding in cases 
involving damage caused by a combination of wind and flooding. 
[Footnote 21] Expanding the WYO program to include combined flood and 
wind policies could increase the NFIP's oversight responsibilities as 
well as make resolving existing management challenges more difficult. 
In addition, FEMA faces ongoing challenges in working with contractors 
and state and local partners--all with varying technical capabilities 
and resources--in its map modernization efforts, which are designed to 
produce accurate digital flood maps.[Footnote 22] Ensuring that map 
standards are consistently applied across communities once the maps are 
created will also be a challenge. To the extent that FEMA uses wind 
speed maps under the combined program, the agency could face challenges 
similar to those currently faced by the NFIP's flood-mapping program. 

New management challenges created by implementing a combined federal 
flood and wind program could make addressing these existing challenges 
even more difficult. According to FEMA officials, implementing a new 
flood and wind program is a process that would likely take several 
years and would require a doubling of current staff levels. Determining 
appropriate wind mitigation measures, adapting existing WYO and Direct 
Service processes for wind coverage, establishing a new rate-setting 
process, promoting community participation, and overseeing the combined 
program would all require additional staff and contractor services with 
the appropriate wind expertise. While the total cost of adding staff 
and hiring contractors with wind expertise is not clear, FEMA's 2007 
budget for NFIP salaries and expenses was about $38.2 million. 

FEMA Would Need to Set Premium Rates for the Flood and Wind Program 
Adequate to Cover All Future and Catastrophic Losses without Borrowing: 

Setting premium rates that would adequately reflect all expected costs 
without borrowing from the Treasury would require FEMA to make a number 
of sophisticated determinations. To begin with, FEMA would need to 
determine what those future costs are likely to be, a process that can 
be particularly difficult with respect to catastrophic losses. Once 
FEMA has determined the expected future costs of the program, it would 
need to determine premium rates adequate to cover those costs, a 
challenging process in itself for several reasons. First, the rate 
would need to be sufficient to pay claims in years with catastrophic 
losses without borrowing funds from the Treasury. This determination 
could be particularly difficult because it is unclear whether the 
program might be able to purchase reinsurance, and because attempting 
to build up a sufficient surplus to pay for catastrophic losses would 
require high premium rates compared to the size of expected claims and 
an unknown number of years without larger than average losses, over 
which FEMA has no control. Second, rate setting would have to account 
for two factors: adverse selection, or the likelihood that the program 
would insure only the highest-risk properties, and potentially limited 
participation because of comparatively low coverage limits. Both of 
these factors would necessitate higher premium rates, which could make 
rate setting very difficult. Finally, although no distinction between 
flood and wind damage would be necessary for property owners to receive 
payment on claims, such a distinction would still be necessary for rate-
setting purposes. 

FEMA Would Need to Determine the Losses the Program Would Be Required 
to Pay, Including Losses from Catastrophic Events: 

The proposed flood and wind program would be required, by statute, to 
charge premium rates that were actuarially sound--that is, that were 
adequate to pay all future costs. As a result, in setting rates FEMA 
would need to determine how much the program would be required to pay, 
including in years with catastrophic losses, and use this amount in 
setting rates, as is done by private sector insurers. H.R. 3121 does 
not specify how a federal flood and wind program would pay for 
catastrophic losses beyond charging an adequate premium rate. According 
to insurers and industry consultants we spoke with, making such 
determinations can be difficult and involve balancing the ability to 
pay extreme losses with the ability to sell policies at prices people 
will pay. For example, insurers could charge rates that would allow 
them to pay claims on the type of event they would expect to occur only 
very rarely, but the resulting rates could be prohibitively expensive. 
On the other hand, charging premium rates that would enable an insurer 
to pay losses on events of limited severity could allow them to sell 
policies at a lower price, but could also result in insufficient funds 
to pay losses if a larger loss were to occur. Insurers can come to 
different conclusions over the appropriate level of catastrophic losses 
on which to base their premium rates. For example, one state regulator 
said that some private sector insurers in his state used an event he 
believes has about a 0.4 percent chance of occurring in a given year, 
but that the state wind insurance program based its rates on events he 
believes have about a 1 percent chance of occurring. For comparison, 
one consultant we spoke with believed that an event of the severity of 
Hurricane Katrina had about a 7 percent chance of occurring in a given 
year. 

Determining the losses the program might be required to pay, especially 
in the event of a catastrophic event, could be especially important for 
FEMA. This is because if an event occurs that generates losses beyond 
an amount the program is prepared to pay, the program would be forced 
to borrow funds to pay those losses, triggering a borrowing restriction 
that would force it to stop renewing or selling new policies, 
effectively ending the program. On the other hand, premium rates high 
enough to pay losses resulting from the most severe catastrophic events 
might make the program prohibitively expensive for property owners. 

Determining expected losses for the first year of the program would be 
complicated by the fact that FEMA would not know what type of 
properties would be insured. Private sector insurers set their premium 
rates using models that take into account several variables, including 
the number of properties to be insured, the risks associated with the 
properties' location, and the characteristics of the properties 
themselves. This information is used in the wind-modeling process to 
create a variety of scenarios that result in losses of differing 
severity that can then be used to create possible premium rates. 
Existing insurers have established portfolios of polices and can use 
data from these portfolios in the modeling process. A new combined 
federal flood and wind insurance program, according to wind-modeling 
companies we spoke with, would need to develop a hypothetical 
portfolio, making assumptions about how many policies it might sell and 
where, as well as the characteristics of the properties that might be 
insured. Such assumptions can be challenging because the number and 
type of properties insured will, in turn, be affected by the price of 
coverage. 

FEMA Would Need to Determine a Premium Rate That Is Adequate to Pay for 
Expected Losses without Borrowing: 

Once FEMA determines the severity of catastrophic losses a federal 
program would be required to pay, the agency would need to determine a 
premium rate that is adequate to pay such losses. This determination 
could be particularly difficult with regard to paying catastrophic 
losses--something that could occur in any year given the volatility of 
wind and flood losses--because of the borrowing restriction in H.R. 
3121. Because it would be difficult, if not impossible, to repay any 
borrowed funds without the premium income from new or existing 
policies, this restriction, if invoked, could end the program. This 
would effectively require the program to charge premium rates 
sufficient to pay catastrophic losses without borrowing. 

Private sector insurers generally ensure their ability to pay 
catastrophic losses by purchasing reinsurance, and include the cost of 
this coverage in the premium rate they charge. However, reinsurance may 
not be an option for FEMA. Some reinsurance industry officials we spoke 
with said that the potential for the program to insure a large number 
of only high-risk properties could create a risk of high losses that 
could make reinsurers reluctant to offer coverage. Another option would 
be to charge a premium rate high enough to build up a surplus adequate 
to pay for catastrophic losses. However, such a rate would likely be 
high, and it would require an unknown number of years of operations 
with lower than average losses to build up a sufficient surplus, over 
which FEMA has no control. For example, a loss that exceeds the 
program's surplus could occur in the early years, or even the first 
year, of the program's operations, potentially forcing the program to 
borrow funds to pay losses and effectively ending the program. 

FEMA Would Need to Account for Likely Adverse Selection and Limited 
Participation: 

In determining a premium rate for a federal flood and wind program that 
was adequate to pay all future costs, FEMA would also need to take into 
account the adverse selection--the tendency to insure primarily the 
highest risks--and limited participation the program would likely 
experience. These factors can make rate setting difficult because they 
can both lead to increased premium rates, which can, in turn, lead to 
further adverse selection, limited participation, and the need for 
additional rate increases. 

A Federal Flood and Wind Program Is Likely to Insure Primarily High- 
Risk Properties: 

For several reasons, a federal flood and wind program would probably 
insure mostly high-risk properties. First, a policy that combines flood 
and wind insurance would likely be of interest only to property owners 
who perceived themselves to be at significant risk of both flood and 
wind damage. Because consumers tend to underestimate their risk of 
catastrophic loss, those property owners who saw the need for a 
combined flood and wind policy would likely be those who knew they 
faced a high risk of loss. In addition, because the policy would 
include coverage for damage from flooding, those buying it would 
probably already have flood insurance, which is currently purchased 
almost exclusively in high-risk areas where lenders require it. 
[Footnote 23] As shown in figure 1, areas where there have been 
multiple floods as well as hurricanes and where consumers are most 
likely to see a need for both flood and wind coverage are primarily 
limited to the eastern and Gulf coasts. 

Figure 1: Geographic Areas That Experience Floods and Hurricanes, 1980- 
2005: 

[See PDF for image] 

This figure is a map of the United States depicting geographic areas 
that experienced floods and hurricanes, 1980-2005. The areas noted fall 
into one of the following categories: 

6 to 10 floods and 2 to 4 hurricanes; 
6 to 10 floods and 5 or more hurricanes; 
More than 10 flood and 2 to 4 hurricanes; 
More than 10 flood and 5 or more hurricanes. 

The vast majority of areas so indicated are along the Gulf Coast and 
the Atlantic Coastline. 

Source: GAO analysis of FEMA data. 

[End of figure] 

Second, a combined federal flood and wind insurance policy is likely to 
be of interest only in areas where state insurance regulators have 
allowed insurers to exclude coverage for wind damage from homeowners 
policies that they sell. According to several insurance industry 
officials we spoke with, in order to help protect consumers, state 
insurance regulators generally prohibit insurers from excluding wind 
damage from homeowners policies. According to insurers we spoke with, 
insurers can profitably write homeowners policies that include wind 
coverage in most areas. Only in the coastal areas that are at the 
highest risk of hurricane damage have insurers asked for and received 
permission from state regulators to sell homeowners policies that 
exclude wind coverage. Property owners who already have wind coverage 
through their homeowners policies--generally those living in areas 
outside the highest-risk coastal areas--would generally not be 
interested in a combined federal flood and wind insurance policy 
because they would already have wind coverage. Once again then, only 
property owners in high-risk coastal areas would be the most interested 
in purchasing a federal policy. A federal flood and wind insurance 
program would find itself in the same situation as state wind insurance 
programs that generally sell wind coverage only in areas where insurers 
are allowed to exclude it from homeowners policies. According to 
officials from the state wind programs we spoke with, their programs 
generally insure only the highest-risk properties. 

Participation in a Combined Federal Flood and Wind Program Is Likely to 
Be Limited: 

For several reasons, participation in a federal flood and wind program 
would probably be limited. First, a federal flood and wind insurance 
policy would likely cost more than purchasing a combination of flood 
insurance through the NFIP and wind insurance through a state wind 
insurance program, potentially limiting participation in the program. 
With respect to coverage for damages from flooding, while an estimated 
24 percent of NFIP policyholders receive subsidized premium rates--with 
average subsidies of up to 60 percent--H.R. 3121 would require the new 
program to charge rates adequate to cover all future costs, potentially 
precluding any subsidies. As a result, the flood-related portion of a 
federal flood and wind policy would cost more than an NFIP flood policy 
for any property owners currently receiving subsidized NFIP flood 
rates. With respect to the wind portion of the coverage, a number of 
state wind insurance programs typically do not charge rates that are 
adequate to cover all costs, so a policy from a federal program that 
did charge adequate rates would likely cost more than a state wind 
program policy.[Footnote 24] Property owners who are receiving 
subsidized NFIP rates and relatively low state wind insurance rates are 
unlikely to be willing to move to a new program that would be more 
expensive. 

Second, a federal flood and wind policy would have lower coverage 
limits than the flood and wind coverage currently available in high- 
risk coastal areas, further limiting participation. Currently, property 
owners in coastal areas subject to both flood and wind damage can 
purchase flood insurance through the NFIP and, in some areas, wind 
insurance through a state wind insurance program. Table 1 compares the 
policy limits for a federal flood and wind policy, as proposed in H.R. 
3121, with a combination of policy limits from state wind insurance 
program and NFIP policies. While the federal flood and wind policy 
would cover a maximum of $650,000 in damage for a residential property, 
a combination of NFIP and state wind program policies would provide on 
average, around $1.7 million in coverage, or about 166 percent more 
coverage, depending on the state. For commercial properties, the 
federal flood and wind policy would offer up to $1.75 million in 
coverage, but combined NFIP and state wind program policies would 
offer, on average, almost $4 million or 126 percent more coverage. 

Table 1: Comparison of Combination of State Wind Program and H.R. 3121 
Flood Insurance Policy and State Wind Policy Limits with H.R. 3121 
Flood and Wind Policy Limits: 

State: Alabama; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $970,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $320,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $2,340,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $590,000. 

State: Florida; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $1,470,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $820,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $2,340,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $590,000. 

State: Georgia; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $2,470,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $1,820,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $3,340,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $1,590,000. 

State: Louisiana; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $1,220,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $570,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $8,340,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $6,590,000. 

State: Mississippi; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $1,720,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $1,070,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $2,340,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $590,000. 

State: North Carolina; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $1,970,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $1,320,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $4,640,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $2,890,000. 

State: South Carolina; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $1,770,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $1,120,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $3,840,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $2,090,000. 

State: Texas; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $2,240,000; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $1,590,000; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $4,456,000; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $2,706,000. 

State: Average; 
Residential: (A) Combined NFIP flood and state wind program policy 
limits: $1,728,750; 
Residential: (B): Federal flood and wind program coverage limit: 
$650,000; 
Residential: (A-B): Difference: $1,078,750; 
Commercial: (C): Combined NFIP flood and state wind program policy 
limits: $3,954,500; 
Commercial: (D): Federal flood and wind program coverage limit: 
$1,750,000; 
Commercial: (C-D): Difference: $2,204,500. 

Source: GAO analysis of state wind program data and H.R. 3121. 

Note: H.R. 3121 proposes increased coverage amounts for NFIP flood 
policies, which we use in this analysis. Residential coverage is for a 
single dwelling and includes coverage for property damage, damaged 
contents, and living expenses. Commercial coverage is for a single 
building and includes coverage for property damage and business 
interruption expenses. 

[End of table] 

Adverse Selection and Limited Participation Could Lead to Escalating 
Premium Rates, Making Rate Setting Difficult: 

Adverse selection and limited participation could, in turn, force FEMA 
to raise rates still higher for the projected program, leading to 
escalating premiums. This possibility further complicates the rate- 
setting process. In general, having only a small pool of very high-risk 
insureds requires insurers to charge premium rates at levels above what 
could be charged if the risk were spread among a larger pool of 
insureds of varying risk levels. As we have discussed, high premium 
rates can, in turn, further reduce the number of property owners who 
are able and willing to pay for coverage and force insurers to raise 
rates yet higher. This cycle, referred to as an adverse selection 
spiral, can make it very difficult for insurers to find a premium rate 
that is adequate to cover losses. 

A Distinction between Flood and Wind Damage Would Still Be Necessary 
for Determining Premium Rates: 

Finally, although H.R. 3121 stipulates that a distinction between flood 
and wind damage would not be required for a policyholder's claim to be 
paid by a federal flood and wind program, a determination of the cause 
of damage would likely still be necessary for rate-setting purposes. 
According to several insurance industry officials we spoke with, 
separate determinations would be required because data on the losses 
associated with each type of damage are used to help determine future 
rates. For example, data on wind losses would be used to validate the 
losses predicted by wind models. While the officials said that such 
determinations would not need to be as accurate as when the distinction 
between flood and wind damage would determine under which policy a 
claim was covered, they would still need to be made. As a result, FEMA 
would need to determine whether and how such a determination might be 
made by FEMA staff, or if it would need to establish another process 
for doing so. 

A Federal Flood and Wind Insurance Program Could Benefit Some but Would 
Involve Trade-offs: 

While a combined federal flood and wind program would entail costs, it 
could benefit some property owners and market participants. First, 
property owners could benefit from reduced delays in payments and 
assured coverage in high-risk areas. In addition, taxpayers in some 
states could benefit to the extent that the exposure to loss of state 
wind insurance programs is reduced. At the same time, these benefits 
could be limited by a borrowing restriction that could terminate the 
program after a catastrophic event, and comparatively low coverage 
limits could leave some property owners underinsured. Third, private 
sector insurers could also benefit if high-risk properties moved to a 
federal program, reducing the companies' risk of loss. But this shift 
would further limit private sector participation. Finally, while H.R. 
3121 would require premium rates that were adequate to cover all future 
costs, actual losses can significantly exceed even the most carefully 
calculated loss estimates, as we learned from the 2005 hurricanes, 
potentially leaving the federal government with exposure to new and 
significant losses. 

A Combined Federal Flood and Wind Program Could Reduce Costs to 
Property Owners and Some State Taxpayers but Could Leave Some Owners 
Uninsured or Underinsured: 

The proposed federal wind and flood insurance program could help 
resolve claims more quickly and ensure continued coverage for property 
owners and could reduce costs to taxpayers in states with wind 
insurance programs. Specifically, a federal program that covered both 
wind and flood damage could limit the need to determine the extent of 
the damage caused by each peril when paying claims, effectively 
reducing potential delays in payment of wind claims to policyholders 
for rebuilding and other expenses. As we have seen, currently wind and 
flood coverage are generally available only under separate policies, 
with flood damage covered by the NFIP and wind damage generally covered 
under either a private market homeowners policy or a state wind 
insurance program policy. Because determining whether damages were 
caused by flood or wind also determines which entity is responsible for 
paying the claims, disputes can arise over the cause of the damage. As 
we saw after the hurricanes of 2005, such determinations can be a 
challenge because, for example, more adjusters were needed than were 
available, adjusters had difficulty reaching properties, and evidence 
at the damage scenes was often limited or compromised.[Footnote 25] 
Some disputes over the cause of damages following the hurricanes of 
2005 have taken several years to resolve, with consumers waiting months 
to receive payment on wind claims made shortly following those events. 

A combined federal flood and wind insurance program could also help 
ensure the availability of wind coverage for property owners in high- 
risk coastal areas where some insurers have sought to reduce their 
exposure. According to several state insurance regulators and wind 
insurance program officials we spoke with, insurers in their states 
have been seeking to reduce their exposure in high-risk coastal areas 
by writing fewer policies there, and their state wind programs have 
generally picked up the policies no longer written by the private 
market. We obtained data about eight state wind insurance programs and 
found that these programs have grown substantially since 2004 (table 
2). For example, between 2004 and 2007 the number of policies written 
by the Florida Citizens Property Insurance Corporation (Florida 
Citizens) grew about 47 percent to around 1.3 million, and the 
program's total exposure increased approximately 110 percent to around 
$434 billion. Over approximately the same period, the number of 
policies written by the Texas Windstorm Insurance Association increased 
by about 92 percent to almost 200,000 and the program's total exposure 
grew around 158 percent to around $54 billion. While state insurance 
programs appear to be providing wind coverage for those who cannot or 
do not obtain such coverage in the private market, a combined federal 
flood and wind insurance program could help further ensure the 
continued availability of wind coverage in areas that private sector 
insurers are leaving. 

Table 2: Table 2. Comparison of Selected State Wind Insurance Program 
Policies in Force and Exposure from 2004 to Most Recent Available
(Dollars in billions): 

State plan: Alabama Insurance Underwriting Association; 
2004: Policies in force: 2,909; 
2004: Exposure: $0.3; 
Most Recent Publicly Available: Policies in force: 8,649; 
Most Recent Publicly Available: Exposure: $1.5; 
Change (percentage increase): Policies in force: 5,740; (197%); 
Change (percentage increase): Exposure: $1.2; (347%). 

State plan: Florida Citizens Property Insurance Corporation; 
2004: Policies in force: 873,996; 
2004: Exposure: 206.7; 
Most Recent Publicly Available: Policies in force: 1,288,522; 
Most Recent Publicly Available: Exposure: 434.3; 
Change (percentage increase): Policies in force: 414,526; (47%); 
Change (percentage increase): Exposure: 227.6; (110%). 

State plan: Georgia Underwriting Association; 
2004: Policies in force: 28,501; 
2004: Exposure: 2.8; 
Most Recent Publicly Available: Policies in force: 26,445; 
Most Recent Publicly Available: Exposure: 4.4; 
Change (percentage increase): Policies in force: -2,056; (-7.2%); 
Change (percentage increase): Exposure: 1.6; (59%). 

State plan: Louisiana Citizens Property Insurance Corporation; 
2004: Policies in force: 135,457; 
2004: Exposure: 14.3; 
Most Recent Publicly Available: Policies in force: 129,203; 
Most Recent Publicly Available: Exposure: 21.1; 
Change (percentage increase): Policies in force: -6,254; (-4.6%); 
Change (percentage increase): Exposure: 6.9; (48%). 

State plan: Mississippi Windstorm Underwriting Association; 
2004: Policies in force: 14,796; 
2004: Exposure: 1.6; 
Most Recent Publicly Available: Policies in force: 30,962; 
Most Recent Publicly Available: Exposure: 5.4; 
Change (percentage increase): Policies in force: 16,166; (109%); 
Change (percentage increase): Exposure: 3.7; (229%). 

State plan: North Carolina Insurance Underwriting Association; 
2004: Policies in force: 94,612; 
2004: Exposure: 31.6; 
Most Recent Publicly Available: Policies in force: 148,411; 
Most Recent Publicly Available: Exposure: 60.8; 
Change (percentage increase): Policies in force: 53,799; (57%); 
Change (percentage increase): Exposure: 29.2; (92%). 

State plan: South Carolina Wind and Hail Underwriting Association; 
2004: Policies in force: 20,519; 
2004: Exposure: 6.0; 
Most Recent Publicly Available: Policies in force: 35,403; 
Most Recent Publicly Available: Exposure: 14.5; 
Change (percentage increase): Policies in force: 14,884; (73%); 
Change (percentage increase): Exposure: 8.5; (141%). 

State plan: Texas Windstorm Insurance Association; 
2004: Policies in force: 103,503; 
2004: Exposure: 20.8; 
Most Recent Publicly Available: Policies in force: 199,085; 
Most Recent Publicly Available: Exposure: 53.7; 
Change (percentage increase): Policies in force: 95,582; (92%); 
Change (percentage increase): Exposure: 32.9; (158%). 

State plan: Total; 
2004: Policies in force: 1,274,293; 
2004: Exposure: $284.1; 
Most Recent Publicly Available: Policies in force: 1,866,680; 
Most Recent Publicly Available: Exposure: $595.7; 
Change (percentage increase): Policies in force: 592,387 (46%); 
Change (percentage increase): Exposure: $311.6 (109%). 

Source: GAO analysis of state wind insurance program public financial 
statements. 

Note: Some states offer coverage for perils other than wind, including 
hail, fire, and broader homeowners coverage. However, policy limits are 
not based on the type of damage, so the exposure from wind damage is 
equal to the policy limit, regardless of whether the policy includes 
other types of coverage. Date of latest information publicly available 
as of February 2008: Alabama--September 2007, Florida--April 2007, 
Georgia--September 2007, Louisiana--March 2007, Mississippi--December 
2006, North Carolina--June 2007, South Carolina--July 2007, Texas-- 
August 2007. 

[End of table] 

Further, to the extent that the federal program insures properties that 
were previously insured through state wind programs, it could also 
reduce costs that some state residents pay to support the state wind 
programs. Some state wind insurance programs provide that if premiums 
are inadequate to cover the programs losses, the program can assess 
insurers operating within the state to make up the difference. For 
example, in 2005 the state of Florida assessed insurers a total of $163 
million to fund the deficit in its state wind insurance program 
(Florida Citizens), while the state of Mississippi assessed insurers 
$525 million to cover losses incurred by its wind program. Some states 
also use other methods to pay wind insurance program deficits, but 
ultimately taxpayers also cover those costs. For example, Florida 
Citizens also issued bonds totaling almost $5 billion and arranged for 
a $1 billion line of credit to cover losses following the 2005 
hurricane season, and the state of Louisiana issued bonds for 
approximately $978 billion. States generally allow insurers to pass 
along the costs of these assessments to their policyholders, so the 
costs of such assessments and financing arrangements are primarily born 
by insurers and insureds within those states. To the extent that a 
federal program could reduce losses to state wind insurance programs, 
it could reduce the costs to insurers and policyholders. 

These benefits could, however, be limited by the provision within H.R. 
3121 that prevents FEMA from selling new or renewing existing policies 
if it borrows funds to pay claims. As noted earlier in this report, 
FEMA could find it difficult to determine premium rates adequate to 
cover expected losses, especially catastrophic losses. If the program 
is unable to pay losses in any year, it could trigger the program's 
borrowing restriction and effectively end the program. Ending the 
program, especially following a catastrophic event, could leave 
property owners without insurance coverage, which in many cases is 
required by mortgage lenders, and with no means of buying such coverage 
quickly. Several insurance industry and state regulatory officials said 
that if a federal flood and wind insurance program were implemented, it 
could displace state wind insurance programs and private sector 
coverage in high-risk coastal areas. If it did, and then was 
effectively terminated because of the borrowing restriction, property 
owners might find themselves unable to quickly purchase new coverage 
because state wind programs and private markets would not be prepared 
to quickly offer such coverage, if at all. The situation would be 
particularly difficult for property owners whose homes or buildings had 
been destroyed. In this scenario, property owners could find themselves 
without the appropriate insurance coverage, in violation of their 
agreements with lenders. 

Further, the relatively low coverage limits under a federal flood and 
wind policy could leave some property owners without adequate 
insurance. As we have seen, property owners in coastal areas subject to 
both flood and wind damage can purchase flood insurance through the 
NFIP and, in some areas, wind insurance through a state wind insurance 
program. In table 1, we compared the policy limits for a federal flood 
and wind policy, as proposed in H.R. 3121, with a combination of policy 
limits from state wind insurance programs and the increased NFIP policy 
limits proposed in H.R. 3121. As shown, the federal flood and wind 
policy would provide less coverage than that provided by a combination 
of NFIP and state wind program policies for both residential and 
commercial properties. As a result, the comparatively lower policy 
limits proposed for the federal flood and wind policy could leave some 
property owners with significant exposure to losses. 

In addition, the proposed federal flood and wind policy would cover 
fewer perils than the combination of an NFIP flood policy and a state 
wind insurance program policy, possibly creating gaps in coverage for 
some property owners. For example, while flood and wind damages would 
be covered under the proposed federal policy, all of the state wind 
insurance programs we reviewed also covered hail damage, and several 
insured against additional perils, such as fire. As a result, property 
owners who purchased a combined federal policy as a replacement for 
NFIP and state wind program coverage might no longer be insured for 
certain perils or might have to purchase additional coverage in the 
private market to eliminate any coverage gaps. The prospect of reduced 
coverage or purchasing additional policies could make a federal flood 
and wind policy less appealing to property owners. 

Finally, the comparatively lower coverage limits and limited number of 
perils covered could result in some property owners purchasing a 
federal flood and wind policy as well as other coverage. In instances 
where a property owner purchased additional wind coverage through a 
private sector or state wind program policy, allocating damages between 
a federal flood and wind policy and the additional policy would require 
a determination of total wind damage. This determination would, in 
turn, require a distinction between flood and wind damage, potentially 
undercutting one of the primary goals of a federal flood and wind 
program. And to avoid confusion or disputes over how losses would be 
allocated among several policies, FEMA would need to reach agreement 
with other insurers, in advance, as to how losses would be apportioned 
across the separate insurance policies. For example, they would need to 
agree on whether one policy would pay before another, or whether losses 
would be divided up among policies and in what proportion. 

Some Insurers Could Benefit from Reduced Exposure in High-Risk Areas: 

Some insurers could benefit from a federal flood and wind program if 
the program insured properties in high-risk areas that were previously 
covered by private sector insurers. Several state insurance officials 
told us that insurers in their states had been seeking to reduce their 
exposure in high-risk coastal areas by writing fewer policies there. To 
the extent that a federal program insured properties currently insured 
by private sector insurers, those insurers would be less exposed to 
losses from those high-risk properties. However, the extent to which 
the federal program might insure properties currently insured by 
private sector insurers would in large part be determined by the 
premium rate for a federal program. If the federal policy were less 
expensive than private coverage, property owners would be more likely 
to move to the new program. 

While a federal flood and wind program would not need to include 
several costs that private insurers must generally include when 
determining a premium rate adequate to cover all future costs--such as 
the cost of capital or taxes--it is not clear that premium rates for a 
federal program would be lower than those charged by insurers.[Footnote 
26] We have noted that federal flood and wind insurance is most likely 
to be appealing to property owners in only the high-risk coastal areas 
where private sector insurers are trying to reduce their exposure. 
According to several insurance industry officials we spoke with, 
insurers are willing to write wind coverage in these areas if they can 
charge premiums that cover their expected costs. While NAIC takes issue 
with the claim, some insurance industry officials said that state 
insurance regulators had denied premium rate increases necessary to 
cover expected losses. To the extent that private sector insurers are 
not charging premium rates for wind insurance that are adequate to 
cover future costs in high-risk coastal areas, the rates for a federal 
program that is charging such rates could be higher. 

Further, while a federal flood and wind program would likely insure 
primarily high-risk properties, private sector insurers currently sell 
policies that include wind coverage in all geographic areas, including 
medium-and low-risk areas. Such diversification allows insurers to 
spread out the risks associated with catastrophic losses on high-risk 
properties over a larger group of policyholders, possibly allowing 
private sector insurers to charge lower premium rates on the highest- 
risk properties as compared to rates for a federal flood and wind 
program that does not experience such diversification. Further, private 
sector insurers can generally supplement premium income with investment 
income on funds that they hold, but a federal flood and wind program 
would probably not have such an opportunity. Finally, competition among 
private sector insurers can encourage insurers to operate more 
efficiently and hence more profitably. A combined federal flood and 
wind program would not be subject to such competition, and thus might 
not operate as efficiently as private sector insurers. 

While reducing private insurers' exposure to loss in high-risk areas 
would benefit these insurers, it is not clear that the public in 
general would benefit. In a previous report, we identified several 
public policy goals that could be used to examine the advantages and 
disadvantages of a federal role in the provision of catastrophe 
insurance.[Footnote 27] One of these goals was to encourage private 
markets to provide natural catastrophe reinsurance, thus reducing the 
potential costs to taxpayers. A federal wind and flood program that 
insured property owners who had previously had private insurance would 
not further that goal. To the extent that the federal program displaced 
coverage currently provided by the private market, it could actually 
shift more of the risk of loss to taxpayers. 

Program Could Expose the Federal Government to an Increased Risk of 
Loss: 

Although a combined flood and wind program could provide benefits to 
some property owners, states, and insurers, it could expose the federal 
government to an increased exposure to loss. While the actual exposure 
that a federal flood and wind program might create is unclear, the 
likelihood for the program to insure primarily high-risk properties 
could create a large exposure to loss. As of 2007, wind programs in 
eight coastal states--programs that insure primarily high-risk coastal 
properties--had a total loss exposure of nearly $600 billion . While it 
is unclear how much of this exposure would be assumed by the federal 
program, a risk management consulting firm developed another estimate 
of potential wind-related losses that took into account the federal 
program's likely adverse selection. [Footnote 28] Assuming that the 
program experienced just a moderate amount of adverse selection, and 
that the program would write coverage for around 20 percent of the 
current market for wind coverage, the firm used wind modeling 
technology to estimate the potential wind-related losses. The estimates 
ranged from around $6.5 billion in losses for the type of catastrophe 
that has a 10 percent chance of occurring each year, $11.4 billion for 
one that has a 5 percent chance of occurring each year, to around $32.7 
billion for the type that has a 1 percent chance of occurring each 
year. The same firm that did the modeling for this estimate considered 
Hurricane Katrina to be the type of event that has a 6.6 percent chance 
of occurring in any year. For purposes of comparison, NFIP flood losses 
from Hurricane Katrina alone totaled around $16 billion, and according 
to the Insurance Services Office, losses paid by private sector 
insurers--most of which were wind-related--totaled around $41 billion. 
[Footnote 29] 

The potential exposure to the federal government, however, could be 
reduced by several factors. First, the program could encourage 
mitigation efforts that would reduce damage from wind. As noted earlier 
in this report, H.R. 3121 would require communities to adopt mitigation 
standards approved by the Director of FEMA and consistent with 
International Code Council building codes related to wind mitigation. 
In addition, H.R. 3121 would require the Director of FEMA to carry out 
studies and investigations to determine appropriate wind hazard 
prevention measures. Further, according to FEMA, the CRS structure 
could be applied to a federal flood and wind program, reducing premium 
rates for communities and property owners that implemented wind 
mitigation measures. Such measures could reduce losses due to wind 
damage and thus the federal government's exposure to loss. Second, the 
federal government's exposure is potentially limited to the amount FEMA 
is authorized to borrow from the Treasury, which was raised to $20.8 
billion in March of 2006. However, if losses were to exceed this limit, 
Congress would be faced with raising the amount FEMA could borrow, 
thereby increasing the government's exposure or failing to pay 
policyholders up to the full amounts specified in their policies. 

While H.R. 3121 would require a federal flood and wind program to 
charge premium rates that were adequate to pay all future losses in 
order not to create additional liability for the federal government, as 
we have seen, estimating future losses is difficult, and losses can 
exceed expectations. For example, losses from Hurricane Katrina and 
other hurricanes were beyond what NFIP could pay with the premiums it 
had collected. NFIP reported unexpended cash of approximately $1 
billion following fiscal year 2004, but as of May 2007 the program had 
suffered almost $16 billion in losses from Hurricane Katrina. In 
addition, officials from several wind-modeling companies told us that 
the severity of Hurricane Katrina was well beyond their previous 
expectations, and rates that they had believed were actuarially sound 
turned out to be inadequate. As a result, they have had to revise their 
models accordingly. If losses for a combined flood and wind program did 
exceed the premiums collected by the program, FEMA could be forced to 
borrow from the Treasury to pay those losses. As of December 2007, FEMA 
still owed approximately $17.3 billion to the Treasury, an amount it is 
unlikely able to repay. In addition, the requirement in H.R. 3121 to 
stop renewing or selling new polices until such losses are repaid could 
actually increase the cost to the federal government. This is because 
the program's source of revenue, which it could use to pay back the 
borrowed funds, would be limited to premiums paid by those whose 
policies had not yet come up for renewal. And once those policies 
expired, the program would receive no premium income. It is not clear 
how any debt remaining outstanding at that time would be paid, and the 
costs could fall to the federal government and, ultimately, taxpayers. 

Agency Comments and Our Evaluation: 

We requested comments on a draft from FEMA and NAIC. FEMA provided 
written comments that are reprinted in appendix II. NAIC orally 
commented that they generally agreed with our report findings. FEMA 
also generally agreed with our findings and emphasized the challenges 
it would face in addressing several key issues. Finally, FEMA provided 
technical comments, which we incorporated as appropriate. 

In their comments, FEMA officials stressed their concerns over the 
effect that the program's proposed borrowing restriction would have on 
their ability to set adequate premium rates. Specifically, they said 
that: 

* It would be nearly impossible to set premium rates high enough to 
eliminate the possibility of borrowing to pay catastrophic losses. 

* Purchasing enough reinsurance to pay all catastrophic losses without 
borrowing, even if it were possible, would require premium rates so 
high as to be unaffordable. 

* The high variability of combined flood and wind coverage means that 
there is always the possibility of catastrophic losses in any given 
year regardless of how premiums are designed. 

In addition, FEMA officials said that the termination of the program 
due to the borrowing restriction would create other difficulties. They 
said that not only could it leave property owners without coverage, but 
it could also prevent the program from repaying any borrowed funds. 

As stated in our report, the proposed borrowing restrictions would make 
rate setting a difficult and challenging process, and could result in 
high premium rates. In addition, we stated that termination of the 
program due to the borrowing restriction could potentially leave some 
property owners uninsured following a catastrophic event and limit 
FEMA's ability to repay any borrowed funds. Finally, we acknowledged 
that the high variability of flood and wind losses would make setting 
rates adequate to pay losses without borrowing even more challenging, 
and we clarified language in the report that the risk of catastrophic 
losses could occur in any year regardless of how premiums are designed. 

As agreed with your offices, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the report date. At that time, we will send copies to the Ranking 
Member of the Committee on Financial Services, House of 
Representatives; the Chairman and Ranking Member of the Committee on 
Banking, Housing, and Urban Affairs, U.S. Senate; the Chairman and 
Ranking Member of the Committee on Homeland Security and Governmental 
Affairs, U.S. Senate; the Chairman and Ranking Member of the Committee 
on Homeland Security, House of Representatives; the Secretary of 
Homeland Security; the Executive Vice-President of NAIC; and other 
interested committees and parties. We will also make copies available 
to others on request. In addition, the report will be available at no 
charge on the GAO Web site at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-8678 or williamso@gao.gov. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. GAO staff who made major contributions 
to this report are listed in appendix III. 

Signed by: 

Orice M. Williams: 
Director: 
Financial Markets and Community Investment: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

Our objective was to examine the proposed federal flood and wind 
insurance program put forth in H.R. 3121, the Flood Insurance Reform 
and Modernization Act of 2007, in terms of (1) the program's potential 
effects on policyholders, insurance market participants, and the 
federal government; (2) what would be required for Federal Emergency 
Management Agency (FEMA) to determine and charge actuarially sound 
premium rates; and (3) the steps FEMA would have to take to implement 
the program. 

To evaluate the program's potential effects on policyholders, insurance 
market participants, and the federal government, we interviewed 
officials from the FEMA, the National Flood Insurance Program (NFIP), 
state insurance regulators, the National Association of Insurance 
Commissioners (NAIC), state wind insurance program operators, primary 
insurers, reinsurers, insurance and reinsurance associations, insurance 
agent associations, risk-modeling organizations, actuarial consultants, 
the American Academy of Actuaries (AAA), the Association of State Flood 
Plain Managers (ASFPM), the National Flood Determination Association 
(NFDA), and others. We also obtained information on state-sponsored 
wind insurance programs in three coastal states and one inland state, 
and discussed them with program officials as well as the insurance 
regulators within those states. We compared selected wind insurance 
program policies in force and exposure data from 2004 to the most 
recent available in eight states: Alabama, Florida, Georgia, Louisiana, 
Mississippi, North Carolina, South Carolina, and Texas. We also 
collected and analyzed state wind program data from these eight states 
and provisions of H.R. 3121 to compare the combination of state wind 
program and H.R. 3121's flood insurance policy limits with H.R. 3121's 
flood and wind policy limits. To develop our natural hazard risk maps, 
we used data from FEMA and the National Oceanic and Atmospheric 
Administration (NOAA). We used historical hazard data from 1980 to 2005 
as a representation of current hazard risk for flood, hurricanes, and 
tornadoes. Finally, to evaluate the federal government's exposure, we 
reviewed an estimate of potential wind-related losses for a federal 
program from an actuarial consulting firm. 

To examine the challenges FEMA would likely face in determining and 
charging a premium rate that would cover all expected costs, we spoke 
with FEMA/NFIP officials, state insurance regulators, NAIC, state wind 
insurance program operators, primary insurers, reinsurers, insurance 
and reinsurance associations, insurance agent associations, risk- 
modeling organizations, actuarial consultants, AAA, ASFPM, NFDA, and 
others. We also reviewed our previous reports and testimonies, 
Congressional Budget Office (CBO) reviews, and academic and other 
studies of coastal wind insurance issues. In addition, we reviewed 
information provided by professional associations, such as the American 
Insurance Association, and congressional testimony by knowledgeable 
individuals from the insurance industry, ASFPM, and NFDA. 

To examine the challenges FEMA would face in developing and 
implementing a federal flood and wind insurance program, we discussed 
the issue with FEMA/NFIP officials, state insurance regulators, NAIC, 
state wind insurance program operators, primary insurers, reinsurers, 
insurance and reinsurance associations, insurance agent associations, 
risk-modeling organizations, actuarial consultants, AAA, ASFPM, NFDA, 
and others. We also reviewed our previous reports on FEMA's management 
and oversight of NFIP. In addition, we reviewed congressional testimony 
by knowledgeable individuals from the insurance industry, ASFPM, and 
NFDA. 

We conducted our work in Washington, D.C., and via telephone from 
October 2006 to April 2007 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 that the evidence obtained provides a reasonable 
basis for our findings and conclusions based on our audit objectives. 

[End of section] 

Appendix II: Comments from the Federal Emergency Management Agency: 

U.S. Department of Homeland Security: 
FEMA: 
[hyperlink, http://www.fema.gov]: 
500 C Street, SW: 
Washington, DC 20472: 

April 15, 2008 

Orice M. Williams: 
Director: 
Financial Markets and Community Investments: 
United States Government Accountability Office: 
441 G Street, NW: 
Washington, DC 20548: 

RE: GAO Draft Report, Natural Catastrophe Insurance: Analysis of a 
Proposed Combined Flood and Wind Insurance Program (GAO-08-504): 

Dear Ms. Williams: 

Thank you for providing the Department of Homeland Security, Federal 
Emergency Management Agency (FEMA), the opportunity to review and 
comment on the GAO draft report, Natural Catastrophe Insurance: 
Analysis of a Proposed Combined Flood and Wind Insurance Program. 

FEMA has completed its review and commends the GAO for writing an 
excellent and well researched report that clearly lays out the issues 
and challenges in designing and implementing the combined federal flood 
and wind insurance program contemplated in H.R.3121. However, we would 
like to make the following comments which primarily concern the 
emphasis placed on several key issues: 

* The draft report states in numerous places the conundrum regarding 
the H.R.3121 requirement that the Federal Multi-peril Program would 
essentially have to terminate if it ever had to borrow from the 
Department of Treasury. As noted in the report there are serious 
problems with that requirement, as follows: 

(1) setting rates would be next to impossible if the premiums had to be 
set high enough to eliminate the possibility of borrowing;
(2) terminating the program abruptly would leave policyholders in the 
lurch without coverage; and; 
(3) when the program was forced to terminate, the loan could never be 
paid back because the premium revenues would stop. 

FEMA recommends that these points be stated comprehensively in the 
beginning of the report and be given more emphasis. For example, item 
#3 listed above, is a key point but it is not referenced until at the 
end of the report. 

* The draft report states in numerous places that setting the premium 
rates would be "difficult." It also states numerous reasons why setting 
the rates is difficult. However, the statements do not adequately 
convey the magnitude of the problem. As noted above, the H.R.3121 
requirement to terminate the program, if and when borrowing would be 
required, makes the setting of adequate premium rates nearly 
impossible. There are only three ways that to preclude the possibility 
of borrowing, none of which would be practical: 

(1) Purchase comprehensive reinsurance so that the catastrophic risks 
are assumed by the reinsurers. The draft report documents the problems 
with a reinsurance approach. Even if the Program could purchase such 
comprehensive reinsurance, the size of the premiums required to support 
it would make the Program unaffordable to homeowners;
(2) Establish such high premium rates that all conceivable catastrophic 
risks would be covered even if large loss events occurred early in the 
Program. Again, the magnitude of those rates would mean that few could 
afford to purchase the insurance; or; 
(3) Incorporate sufficient restrictions and exclusions in the coverage 
to protect the Program against catastrophic losses. However, that 
approach would negate one of the goals of the Program which is to 
provide security to homeowners located in high risk areas. 

* The report contains a statement that could easily be misinterpreted. 
On Page 4/42, it states: 

"Under the proposed legislation, if FEMA set premium rates too low and 
needed to borrow to pay claims, the program would have to stop renewing 
or selling new policies, and thus would effectively terminate." 

Comment: As written, this statement implies there is some level of 
premium rates that would assure borrowing would never be needed. 
However, that implication is erroneous because there is almost no level 
of premiums that could give this type of assurance. For example, if in 
the first year of its existence the Program is impacted by a 
catastrophic event, borrowing would be unavoidable. Therefore, the 
report should clearly indicate that the combination of wind and flood 
coverage is a highly volatile and risky line of insurance and that 
there is always the probability of catastrophic losses occurring in any 
given year regardless of how the premiums are designed. FEMA recommends 
that the following sentences replace the text above: 

"Under the proposed legislation, if FEMA needed to borrow to pay 
insurance claims, the Program would have to stop both renewing in force 
policies and selling new policies, and thus would effectively 
terminate. Realistically, because possible losses under the combination 
of wind & flood coverage are so highly variable from year to year, 
there is little chance of designing a program with premiums adequate 
enough to preclude the chance of borrowing." 

If you need additional information, please contact me by telephone at 
202-646-2780. 

Sincerely, 

Signed by: 

David I. Maurstad: 
Assistant Administrator: 
Mitigation Directorate: 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Orice M. Williams, (202) 512-8678 or williamso@gao.gov. 

Staff Acknowledgments: 

In addition to the person named above, Lawrence D. Cluff, Assistant 
Director; Farah B. Angersola; Joseph A. Applebaum; Tania L. Calhoun; 
Emily R. Chalmers; William R. Chatlos; Thomas J. McCool; Marc W. 
Molino; and Patrick A. Ward made key contributions to this report. 

[End of section] 

Footnotes: 

[1] H.R. 3121 uses the term "multi-peril coverage," which it defines as 
covering losses from physical damage resulting only from flooding or 
windstorm. For purposes of this report we will use the term "flood and 
wind coverage" to more specifically indicate the nature of the coverage 
provided. 

[2] GAO, Natural Disasters: Public Policy Options for Changing the 
Federal Role in Natural Catastrophe Insurance, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-08-7] (Washington, D.C.: 
Nov. 26, 2007). 

[3] Karen M. Clark, "The Coastline at Risk: Estimated Insured Value of 
Coastal Properties," AIR Worldwide Corporation (Boston, Massachusetts: 
Sept. 2005). 

[4] The National Flood Insurance Act of 1968, as amended, is codified 
at 42 U.S.C. §§ 4001 et seq. 

[5] GAO, National Flood Insurance Program: Greater Transparency and 
Oversight of Wind and Flood Damage Determinations are Needed, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-08-28] (Washington, D.C.: 
Dec. 28, 2007). 

[6] The International Code Council is a membership association 
dedicated to building safety and fire prevention. It develops the codes 
used to construct residential and commercial buildings, including homes 
and schools. 

[7] National Flood Insurance Act of 1968, Pub.L No. 90-448, § 1302 (d), 
82 Stat. 476, 572 (1968), codified at 42 U.S.C. § 4001(d). 

[8] Id, at Section 1302(a)(4), codified at 42 U.S.C. § 4001(a)(4). 

[9] GAO, Flood Insurance: Information on the Financial Condition of the 
National Flood Insurance Program, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-01-992T] (Washington, D.C.: July 
19, 2001). 

[10] See 42 U.S.C. § 4016. 

[11] See GAO, Federal Emergency Management Agency: Challenges for the 
National Flood Insurance Program, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-06-335T] (Washington, D.C.: Jan. 
25, 2006). 

[12] GAO, Natural Hazard Mitigation: Various Mitigation Efforts Exist, 
but Federal Efforts Do Not Provide a Comprehensive Strategic Framework, 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-403] 
(Washington, D.C.: Aug. 22, 2007). 

[13] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-403]. 

[14] The CRS is a voluntary incentive program that recognizes and 
encourages community floodplain management activities that exceed the 
minimum NFIP requirements, and as a result, flood insurance premium 
rates are discounted to reflect the reduced flood risk resulting from 
the community actions. 

[15] NFIP contracts with private insurers to sell and administer flood 
insurance policies through the WYO arrangement, allowing the insurers 
to write flood policies backed by the federal government. 

[16] GAO, NFIP: Oversight of Policy Issuance and Claims, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-05-532T] (Washington, D.C. 
Apr. 14, 2005) 

[17] According to insurance market participants, many, if not all, 
insurance companies and state authorities currently use computer 
programs offered by several modeling firms to estimate the financial 
consequences of various natural catastrophe scenarios and manage their 
financial exposures. To generate the loss estimates, the computer 
programs use large databases that catalog the past incidence and 
severity of natural catastrophes as well as proprietary insurance 
company data on policies written in particular states or areas. Using 
the estimates provided by these computer programs, insurers can attempt 
to manage their exposures in particular high-risk areas. GAO, 
Catastrophe Risk: U.S. and European Approaches to Insure Natural 
Catastrophe and Insurance Risks, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-05-199] (Washington, D.C.: Feb. 28, 
2005). 

[18] GAO, Federal Emergency Management Agency: Challenges for the 
National Flood Insurance Program, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-06-335T] (Washington, D.C.: Jan. 
25, 2006). 

[19] GAO, GAO's High-Risk Program, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-06-497T] (Washington, D.C.: Mar. 
15, 2006). 

[20] GAO, Federal Emergency Management Agency: Ongoing Challenges 
Facing the National Flood Insurance Program, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-08-118T] (Washington, 
D.C.: Oct. 2, 2007). 

[21] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-28]. 

[22] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-118T]. 

[23] In areas known as Special Flood Hazard Areas, federally insured or 
regulated lenders require borrowers to purchase flood insurance because 
of the risk of flood damage. 

[24] Officials from several state wind insurance programs said that 
they have not been allowed by state insurance regulators to charge 
rates sufficient to pay expected future losses, as evidenced by denials 
of rate increases and assessments on private market insurers to help 
pay state wind program losses. 

[25] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-28]. 

[26] The cost of capital is the return required by investors to 
compensate them for putting their money at risk by investing in a 
company. 

[27] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-7]. 

[28] Tillinghast, Towers, Perrin, "Analysis of H.R. 920, 'Multiple 
Peril Insurance Act of 2007'" (Washington, D.C.: July 2007). H.R. 920 
proposed a federal multi-peril insurance program and was essentially 
incorporated into H.R. 3121. We did not verify the methodology or 
results of this analysis. 

[29] The Insurance Services Office is a provider of data and analytics 
for the risk management industry. 

[End of section] 

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